When one of your company’s customers can’t pay, you may be able to claim a tax deduction under Internal Revenue Code Section 166. To successfully claim the deduction, you’ll need to know how the tax code defines a partially or wholly worthless “bad debt.”
An accrual basis taxpayer records income at time of sale; not at collection. A deductible bad debt can generally be defined as a loss arising from the worthlessness of a debt created or acquired in your trade or business, or was closely related to your trade or business when it became partly or totally worthless. The most common bad debts involve credit sales to customers for goods or services.
Other examples of potential losses include loans to customers or suppliers made for business reasons and business-related guarantees of debts. Debts attributable to an insolvent partner may also qualify.
The IRS will scrutinize loans to be sure they’re legitimate. For example, it might deny a bad debt deduction if it determines a loan to a corporation was actually a contribution to capital.
There’s no standard test or formula for determining whether a debt is a bad debt; it depends on the facts and circumstances of each case. To qualify for the deduction, you must document you’ve taken reasonable steps to collect the debt and there’s little likelihood it will be paid. Our firm can look at your potentially bad debts and tell you for sure whether they’re deductible.
The HoganTaylor Tax Practice
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