Bob Parrish CPA, P.C. Send email to pro1040@home.com (Hint: Any topic can be read in full screen by rt-click, then new window)
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Introduction
Objectives - Your Question
Analyses
Plain English Analysis - Your Answers
Increase Wealth
How To Do This
Tools
A few closely related topics & pages From Bob Parrish CPA PC:
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Client Letter - What this idea is about
To deduct a bad debt, you must have a basis in it - that is, you must have already included the amount in your income or you loaned out your cash. If you are a cash basis taxpayer, as most individuals are, you may not take a bad debt deduction for expected income you have not received, because it was never included in your income. A business bad debt, generally, is one that comes from operating your trade or business. A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full. All other bad debts are nonbusiness. Nonbusiness bad debts must be totally
worthless to be deductible. You cannot deduct a partially worthless nonbusiness
bad debt. You must establish that you have taken reasonable steps to collect A nonbusiness bad debt is reported as a short-term capital loss in Part I on Schedule D, Form 1040. It is subject to the capital loss limit of $3,000 per year. This limit is $1,500 if you are married filing a separate return. TOP
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Learning Objectives (What You Asked)YOUR QUESTION(S) May Bad Debts Be Written Off?
What You Will Need
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Plain English Analysis What it does, Why it works - The Answer, Alternatives
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YOUR ANSWERS What it does, Explanation of this topic and how it may affect you: A business bad debt is a loss from the worthlessness of a debt that was either of the following.
A debt is closely related to your trade or business if your primary motive for incurring the debt is a business reason. Example. John Smith, an advertising agent, made loans to certain clients to keep their business. His main reason for making these loans was to help his business. One of these clients later went bankrupt and could not repay him. Since John's business was the main reason for making the loan, the debt was a business debt and he can take a business bad debt deduction. When debt is worthless. You do not have to wait until a debt is due to determine whether it is worthless. A debt becomes worthless when there is no longer any chance that the amount owed will be paid. It is not necessary to go to court if you can show that a judgement from the court would be uncollectible. You must only show that you have taken reasonable steps to collect the debt. Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt. Debts from sales or services. Business bad debts are mainly the result of credit sales to customers. They can also be the result of loans to suppliers, clients, employees, or distributors. Goods and services customers have not paid for are shown in your books as either accounts receivable or notes receivable. If you are unable to collect any part of these accounts or notes receivable, the uncollectible part is a business bad debt. Accounts or notes receivable valued at fair market value at the time of the transaction are deductible only at that fair market value, even though the value may be less than face value. You can take a bad debt deduction for these accounts and notes receivable only if the amount owed you was included in your gross income for the year the deduction is claimed or for a prior year. This applies to amounts owed you from all sources of taxable income, such as sales, services, rents, and interest. If you qualify under certain rules, you can use the nonaccrual-experience method of accounting, discussed later. Under this method, you do not have to accrue income that, based on your experience, you expect to be uncollectible. Accrual method taxpayers. Accrual method taxpayers normally report income as they earn it. They can take a bad debt deduction for an uncollectible receivable if they have included the uncollectible amount in income. Cash method taxpayers. Cash method taxpayers normally report income when they receive payment. They cannot take a bad debt deduction for amounts owed to them that they have not received and cannot collect because they never included those amounts in income. Debts from a former business. If you sell your business but keep its accounts receivable, these debts are business debts since they arose in your trade or business. If an account becomes worthless, the loss is a business bad debt. These accounts would also be business debts if sold to the new owner of the business. If you sell your business to one person and sell your accounts receivable to someone else, the character of the debts as business or nonbusiness is based on the activities of the new holder of these debts. A loss from the debts is a business bad debt to the new holder if that person acquired the debts in his or her trade or business or if the debts were closely related to the new holder's trade or business when they became worthless. Otherwise, a loss from these debts is a nonbusiness bad debt. Debt acquired from a decedent. The character of a loss from debt of a business acquired from a decedent is determined in the same way as a debt sold by a business. If you are in a trade or business, a loss from the debts is a business bad debt if the debts were closely related to your trade or business when they became worthless. Otherwise, a loss from these debts is a nonbusiness bad debt. Liquidation. If you liquidate your business and some of your accounts receivable become worthless, they are business bad debts. Debts of political parties. If a political party (or other organization that accepts contributions or spends money to influence elections) owes you money and the debt becomes worthless, you cannot take a bad debt deduction unless you use an accrual method of accounting and meet all the following tests.
Loan or capital contribution. You cannot take a bad debt deduction for a loan you made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital. Debts of an insolvent partner. If your business partnership breaks up and one of your former partners is insolvent and cannot pay any of the partnership's debts, you may have to pay more than your share of the partnership's debts. If you pay any part of the insolvent partner's share of the debts, you can take a bad debt deduction. Business loan guarantee. If you guarantee a debt that becomes worthless, the debt can qualify as a business bad debt if all the following requirements are met.
Consider any guarantee you make to protect or improve your job as closely related to your trade or business as an employee. Example. Bob Zayne owns the Zayne Dress Company. He guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet. Elegant Fashions is one of Zayne's largest clients. Elegant Fashions later filed for bankruptcy and defaulted on the loan. Mr. Zayne made full payment to the bank. He can take a business bad debt deduction, since his guarantee was made in the course of his trade or business for a good faith business purpose. He was motivated by the desire to retain one of his better clients and keep a sales outlet. Deductible in the year paid. You can deduct a payment you make on a loan you guaranteed in the year of payment unless you have rights against the borrower. Rights against a borrower. When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. The debt is then owed to you. If you have this right, or some other right to demand payment from the borrower, you cannot take a bad debt deduction until these rights become partly or totally worthless. Bankruptcy claim. You can deduct as a bad debt only the difference between the amount owed to you by a bankrupt entity and the amount you received from the distribution of its assets. Sale of mortgaged property. If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt after the sale is a bad debt. If the debt represents capital or an amount you previously included in income, you can deduct it as a bad debt in the year it becomes totally worthless or in the year you charged it off as partially worthless. Recovery of bad debt. If you deduct a bad debt and later recover (collect) all or part of it, you may have to include all or part of the recovery in gross income. The amount you include is limited to the amount you actually deducted. However, you can exclude the amount deducted that did not reduce your tax. Report the recovery as "Other income" on the appropriate business form or schedule.
Example. In 1998, the Willow Corporation had gross income of $158,000, a bad debt deduction of $3,500, and other allowable deductions of $49,437. The corporation reported on the accrual method of accounting and used the specific charge-off method for bad debts. The entire bad debt deduction reduced the tax on the 1998 corporate return. In 1999, the corporation recovers part of the $3,500 deducted in 1998. It must include the part recovered in income for 1999 as "Other income" on its corporate return. Net operating loss (NOL) carryover. If a bad debt deduction increases an NOL carryover that has not expired before the beginning of the tax year in which the recovery takes place, you treat the deduction as having reduced your tax. A bad debt deduction that contributes to a net operating loss helps lower taxes in the year to which you carry the net operating loss.
Start of Plain English Section Why or How it works - Both Sides of the Equation and Examples: Start of Plain English Section Start of Plain English Section Start of Plain English Section Other Start of Plain English Section Reserved
Start of Plain English Section
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Technical Analysis & Citations What It does, Why it works -
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CommentaryStart of Revenue Procedures Section Start of Private Letter Rulings
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Tax KillersThis is about Activity Based Taxplanning - maximizing deductions, minimizing cash outlay and maximizing the amount of cash retained and the net worth. Activity Based Taxplanning (ABT) is a methodology developed by Bob Parrish CPA, that assists people with the tax issues by focusing on the activity (or actions - events) that are being undertaken or contemplated (or have already taken place). The, research is compiled from the myriad of sources to help you complete the activity with the least tax cost, while maintaining compliance the tax laws, other laws and regulations and place yourself in a position to protect your objectives. Tax is a subject that many view in order to cut costs. Taxes are a cost just as any other cost. It happens this cost is somewhat intangible and is defined by legislation without a tangible item to view and control. The money is spent and the control of the expenditure is more appropriately administered by someone trained in the law.
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Cost Killers Management Info Sys, Cost Acctg, Activity Based Costing)This is about Activity Based Costing - methods to cut costs, management accounting, management information systems, decision support systems - in general about being a manager.
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Preparing for your CPA, attorney, or preparing to start your own What to gather -
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From Your Other Business, or Financial Records From Corporation Records or Organization Records (meetings, etc.) Start of Preparing For You CPA Section
Forms - checklists, time-line to do, etc. Assistance - What To Do -
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Financial Accounting: Bookkeeping & Financials
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Financial Statement Presentation Back to Start of Financial Accounting: Bookkeeping & Financials Back to Start of Financial Accounting: Bookkeeping & Financials Back to Start of Financial Accounting: Bookkeeping & Financials Back to Start of Financial Accounting: Bookkeeping & Financials Bookkeeping Methods - Cash, Accrual and Other Back to Start of Financial Accounting: Bookkeeping & Financials How the Business Entity Affects the Recording
Compliance - what is required for protection, defense, etc.Compliance Checklist Back to Start of What is required for protection, defense, etc.
Alerts & Dangers - Risks, Asset Protection, IRS DefenseClick on the title to expand or collapse the topics
Back to Start of Alerts & Dangers Back to Start of Alerts & Dangers Back to Start of Alerts & Dangers Back to Start of Alerts & Dangers
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Spreadsheets & Computations
Spreadsheet #1 Back to Start of Spreadsheets & Math
Contracts, Trusts, etc.Agreement #1 Back to Start of Contracts, Trusts, etc.
Reports RequiredReport #1 Back to Start of Reports Required
Checklists for DeploymentChecklist #1 Back to Start of Checklists - Deployment
Checklist for MonitoringChecklist #1 Back to Start of Checklist - Monitoring
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business_bad_debt.htm
