How To Write Off Bad Debts
What Is A Bad Debt?
A bad debt is basically a sum owed by an individual or a company to another individual or company and is considered to be a debt that is not collectible. These receivables, or the sum in question, are deemed as a debt that can no longer be collected because the cost of pursuing the debtor to pay off the debt would be more than the actual cost of the debt itself. Once this happens, the bad debt becomes an expense for the company.
There are actually two types of bad debts, namely, the business bad debt and the non-business bad debt.
Business Bad Debt
As the name implies, a business bad debt is a debt that is a direct result of operating a business or a trade, and can only be considered as a tax deductible only if it has been included in the income of your business. You can even include the cost of earning your income along as part of the deductibles, depending on the situation.
Non-Business Bad Debt
The other bad debts that are not included in the business bad debts are considered to be non-business bad debts. These debts must be completely worthless in order for them to become tax deductible. In order for you to be able to show that it is indeed a totally worthless debt, you need to show that you have taken all the necessary steps in attempting to collect the debt from your debtor.
Are Bad Debts Deductible?
Some types of bad debts can actually be considered deductible from your total tax liability, regardless if they are business debs or non-business debts. For business bad debts, they are considered to be a deduction against your ordinary income, while a non-business bad debt can be considered to be a deduction from your gross income, but only as a short-term capital loss. However, in order for these bad debts to be considered as deductibles, they must meet certain requirements.
Requirements For Deduction
Before these bad debts can qualify as tax deductibles, they must first meet these simple requirements. One of the requirements is that the bad debt must in fact be a bona fide debt. This means that the debt, which is a determinable amount of money, should arise from a valid and enforceable obligation between the debtor and the creditor. Since a bad debt is a debt that cannot be collected, it is worthless. The second requirement is that it should become worthless within the year that it is taxable.
Another factor that could be viewed as a requirement for the bad debt to be considered as a tax deductible has something to do with how the debt was classified, as the classification can have a significant effect on its deductibility. A business bad debt can be deducted even if it is just partially worthless. However, a non-business debt needs to be completely worthless for it to be considered as a tax deductible.
Steps In Writing Off A Bad Debt
In order to understand how you can write off a bad debt, you need to learn the steps that you need to take in order to be able to do it. The first thing that you need to do is that you must take note of all the debts that people or companies will make. Keep track of all of these things, and make sure that you remember that receivables are taxable, and a debt owed is actually a receivable. If left uncollected, it will continue to be taxed, causing you some undue taxable hardships in the future. Make sure that you make an attempt to make a collection on all of the overdue receivables that are still not collected.
The Next step that you need to take is to make a decision as to whether you would “write off” the bad debt yourself, which means that you treat the bad debt as though it was not a transaction, giving you the chance to eschew taxes against the debt, or whether you would write off the bad debt by selling it to a collection agency at any price you choose. Just keep in mind that for a large corporation, writing off a bad debt can lead to more complicated problems later on.
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