How to Handle Bad Debt and Taxes
When can you use bad debt to reduce business income?
Even when you take the customer to court and you still don’t get your money, there’s a way to make lemonade from this lemon of a customer.
If your business has already shown this amount as income for tax purposes, you may be able to reduce your business income by the amount of the bad debt. Look at bad debt as an uncollectible account—a receivable owed by a customer, client or patient that you are not able to collect.
Bad debt may be written off at the end of the year if it is determined that the debt is in fact uncollectible.
According to the IRS, bad debt includes:
- Loans to clients and suppliers
- Credit sales to customers
- Business loan guarantees
How do you write off bad debt?
Your business uses the accrual accounting method, showing income when you have billed it, not when you collect it.
If your business operates on a cash accounting basis, you can’t deduct bad debt because you don’t record income until you’ve received the payment. If you don’t get the money, there’s no tax benefit to recording bad debt. You only record the sale when you receive the money from the customer.
Under accrual accounting, manually take the bad debt out of your sales records before you prepare your business tax return.
You must wait until the end of the year, just in case someone pays.
- Prepare an accounts receivable aging report, which shows all the money owed to you by all your customers, how much is owed and how long the amount has been outstanding.
- Total all bad debt for the year, listing all customers who have not paid during the year. Only make this determination at the end of the year and only if you’ve made every effort to collect the money owed to your business.
- Include the bad debt total on your business tax return. If you file business taxes on Schedule C, you can deduct the amount of all bad debt. Each type of business tax return has a place to enter bad debt expenses.
It makes sense in any kind of business—no income recorded, no bad debt.
Collection efforts are important
A business bad debt often originates as a result of credit sales to customers for goods sold or services provided. The best documentation is likely to be a detailed record of collection efforts, indicating you made every effort a reasonable person would in order to collect a debt.
Take some solace by claiming a bad business debt deduction on your tax return. Not exactly a guarantee because you need to show that the debt is worthless, but it’s good to know there may be some relief.
We’ve got your back
The tax experts at KRS can help you with important accounting issues such as bad debt. Contact us today at 201.655.7411. And did you know that KRSCPAS.com is accessible from your mobile device and is loaded with tax guides, blogs, and other resources? Check it out today!