134 / May a creditor take a bad debt deduction for a worthless debt even though the creditor holds an insurance policy on the life of the debtor as collateral?

Yes, provided the cash surrender value of the policy is less than the debt. The creditor may deduct the difference between the cash surrender value and the debt or, if the policy has no cash surrender value, the creditor may deduct the full amount of the worthless debt. The creditor may take the deduction even though the creditor continues to hold the policy and the face of the policy exceeds the debt. Collateral need not be liquidated to establish the worthless portion of the debt.¹ If a deduction was not previously taken, a deduction for the uncollectible balance may be taken in the year the creditor surrenders the policy.² No bad debt deduction will be allowed at any time, however, for advances that were made when prior loans exceeded the face of the policy and the debtor was insolvent.³

---

1. Hatboro Nat’l Bank v. Commissioner, 24 TC 786 (1955).

2. Mattlage v. Commissioner, 3 BTA 242 (1925).

3. Blumenthal v. Commissioner, TC Memo 1963-269, aff’d, 14 AFTR 2d 5094 (4th Cir. 1964).