When can a businessperson take a tax deduction for an unpaid
account receivable? What amount can a businessperson deduct? The
answer to these two questions can be confusing.
When can a businessperson take a tax deduction for an unpaid account receivable? What amount can a businessperson deduct? The answer to these two questions can be confusing.
The IRS guidelines contain the term “worthless” in dictating when a business’ bad debt is deductible. The deduction can be taken in the tax year that the debt becomes “totally worthless.” Taxpayers must satisfy three criteria under the “worthless” definition. First, the debt had some previous value. Second, the taxpayer had a reasonable expectation of collecting the debt. Third, the taxpayer has no reasonable hope that the debt has any value in the future.
The accounts receivable a business incurs in its daily routine of providing goods or services to its clients usually meet the first two criteria. The third criterion, future value, may be determined by a single event. A bankruptcy filing by your client may fully satisfy the question of future value. The future value is nothing. Another common event, the assignment of the account receivable to a collection agency, may answer some taxpayers’ questions of future value. The future value is reduced by the amount of the commission the agency charges upon collection.
In order to deduct the amount of an unpaid account receivable, the taxpayer must first have included that receivable as income. Therefore, cash-basis taxpayers may not deduct unpaid accounts receivable because no amount was ever included in income. However, they may deduct the costs associated with the sale when the receivable becomes worthless. Accrual-basis taxpayers can deduct unpaid accounts receivable as they meet the guidelines. For a bankrupt client, the amount may be the total receivable. In the case of an assignment to a collection agency, the agency’s commission may be deductible.
For more information regarding deductibility of unpaid accounts receivable, contact our office.
Mary Hubbell is a partner at Bianchi, Lorincz & Company in downtown Hollister.
