This post deals with business bad debt. Here’s a post on CPA explanation of personal bad debt.
Every business CPA sees bad debt, especially in a recession. Sometimes business bad debt is tax-deductible. But, of course, bad debt prevention is better. Primary defenses against bad debt include good credit policies and a trained accounts receivable clerk .
How do Business CPAs Know the rules?
- Tax code.
- For pay professional interpretations of the tax code.
- Experience.
- Tax court cases.
- IRS instructions, in this case IRS Publication 535.
What is a Business Bad Debt?
- A partial or totally worthless debt generated or acquired through your business.
- Your company must have already included the expected revenue on its tax return. So the bad debt deduction is available only if you’re using the accrual method of tax accounting.
- Collection attempts have proven useless.
Examples of Business Bad Debt include:
- Loans to clients and suppliers. If you loan money to a client, supplier, employee, or distributor for a business reason, and the loan receivable becomes worthless, you have a business bad debt.
- Credit sales to customers.
- Business loan guarantees. Of course, you had to make the guarantee before the loan became worthless. The guarantee was made as normal business practice of your trade or business. And you must have paid it.
- Debts secondary to an insolvent partner. If you have to pay Partnership debt, over your basis, the overpayment is bad debt.
- Loan or capital contribution. You cannot claim 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.
When Does a Debt Become Worthless?
Every case is different. A customer going bankrupt is just one example. But sometimes, legitimate leeway in the time frame exists, perhaps allowing the company to choose when it needs the deduction. Ask your business CPA when there is a gray area.
Bad Debt Recovery?
You have to report a later bad debt recovery on the company’s tax return.
The Two Methods to Claim a Business Bad Debt
- The specific charge-off method.
- The nonaccrual-experience method.
Ask your business CPA which technique works for your business.
Miss a Bad Debt Deduction?
You can amend the company’s prior tax return to claim the refund.
We’re a business CPA firm that provides tax preparation. Our Virtual Office allows us to serve long distance and international clients. We stay sharp on taxation. For a free phone consult, call (910) 399-2705.
