Bad Debt Write Off

A business that is unable to collect a debt with every effort having been made may opt to write the bad debt off. This is considered an expense by the business, considering it has lost the money due on the bad debt account. The business owed the debt will be allowed to deduct a given amount from taxes due to the expense occurred. Any given bad debt write-off can be a full contractual amount, or a partial amount. Rules are in force for businesses that try to claim write-offs.

 Criteria for Business Bad Debt Write Off

In order for a bad debt to be written off, the business which lost the money must be able to prove two things. The first is that it was a legal, bona fide debt and the second, that the debt became worthless in the taxable year. Additionally, the business must state whether the debt was totally worthless, or only partially worthless, as well as the amount left owed on the account before write-off. Certain facts concerning the debtor are also taken into consideration, such as health conditions.

The Difference between a Personal and Business Bad Debt Write-Off

A business bad debt includes monies owed in the normal course of business. An invoice unpaid by a client is one example of a business bad debt, and is deductible in full. Whereas, a personal loan to a friend or relative carries a maximum of $3000, and is considered a short term capitol loss. Both types of write-offs require documentation, with the IRS evaluating personal loans to relatives very closely. Invoices, promissory notes, and ledgers are types of collaboration needed with bad debt write-off.

Debtors May be Responsible for Taxes on a Bad Debt Write-Off

If the transaction and write-off were for more than $600, the IRS requires the business to report the debt. As a result, the debtor must claim the write-off amount as income on their taxes to avoid possible action by the IRS. The exception to this rule is if bankruptcy has been declared and insolvency occurred before the creditor wrote off the debt. In rare instances, the business writes off the debt as a gift, for which the debtor will owe no taxes.

Criteria for Personal Bad Debt Write Off

A personal loan or debt that is being written off as unrecoverable must have been previously claimed as income. Income expected by an individual, such as child support that had not been received is not eligible for a bad debt write-off. Furthermore, loans to friends and family must be well documented through promissory notes, notarized IOU’s or other proof deemed acceptable by the IRS. Non-business bad debt write-offs to a relative are highly scrutinized and must be handled carefully.

Creditors and debtors alike should take precautions before any type of bad debt write-off is attempted. The IRS requires different forms to be completed depending on if a write-off is business or non-business, as well as if it is deemed completely or partially worthless. Consider professional tax preparation if any questions remain on how best to handle a bad debt write-off.