This past year was the first year that I was fortunate enough to work from my home. Working from my home has been a wonderful change for both personal and professional reasons. The only thing that caused a slight issue was the tax filing changes that I had to endure. The office in my home was now considered a tax deduction. I had to get some help learning how to deduct the things that are allowed on my federal taxes. If you are new to working from home and have a home office, this blog can help you learn what you need to know before tax time rolls around.
Every business must deal with noncollectable debts during the course of their operations. While you understand that debts which aren't being paid back affect your bottom line, you should also understand how, and when, they affect your taxes and financial reports. Here's a short guide to bad debts for the layperson.
When Is It a Bad Debt?
A bad debt is basically a noncollectable debt that has basically no real chance of ever being paid. It isn't a debt that's gone overdue and on which you're still in the process of chasing down the customer for payment. You must have already done all the work to try multiple ways to collect, including notices, demand letters, phone calls, and electronic means to get paid. Document these efforts as well as any evidence, like a bankruptcy notice, that you don't expect ever to be paid.
Is it a Business Bad Debt?
In order to claim a deduction on your business taxes, the bad debt must be a part of your regular and ongoing business purpose. This would generally include things like credit extended to customers or vendors that provide regular business for your company. However, a bad investment choice in which your company lost money would not be considered a bad debt. Nor would an unpaid loan to your brother to buy a boat.
Non-business bad debts are deducted by individuals and are subject to somewhat different rules. There is a limitation to how much can be deducted each year on a person's taxes as well as when worthless debts can be deducted.
How are Bad Debts Deducted?
So, you have a legitimate business bad debt. Now what do you do with it? Generally, you must be using the accrual method of accounting since the cash method means you didn't include any of that money as income. You would "write off" the debt as noncollectable on your accounts receivable books. This amount can then be grouped with any other write-offs during the fiscal year to be deducted as an expense on your business's tax form.
While you can only deduct the actual amount written off each year for tax purposes, many businesses also track what they expect to lose out on over the course of their year. This is often entered into the firm's books as a percentage based on past history. If you look at three prior years, for instance, you may find that your wrote off about 3% one year, 4% the next year, and 5% last year. Average this and it would be appropriate to include 4% expected bad debts for accounting purposes. This makes your books more realistic.
If you have questions about specific debt situations within your company or your personal life, consult with a qualified accounting services specialist as soon as possible. He or she will help you navigate this complicated subject so you don't lose out on any deductions or incur the IRS' scrutiny.
Share20 November 2018
