How Do I Write of a Bad Debt?
I recently received an email from a client about a bad debt. It’s the second time I’ve gotten that same question in one week, so it seemed like a good idea for a blog post.
Here’s the question: “I’ve had trouble collecting on a $500 invoice and I’m not sure it’s worth any more time and effort dealing with it. Is there a way to write it off and get some kind of tax advantage?”
Now most of my clients, including the person asking the question, are on what’s called a “cash basis accounting” system. If you’re on a cash basis accounting system, it means that you don’t record income unless you actually receive it. Same with expenses, you don’t count an expense that you’re going to pay, only ones that you’ve already paid. In a case like this–you don’t have to make a special line item adjustment for a bad debt–it’s just not counted in your income in the first place. So for this particular client, she doesn’t have to do anything (except fume over the dude who didn’t pay him for his work.)
But some businesses are on what’s called an “accrual” accounting basis–that’s where you count income as soon as it’s billed, not when it’s actually paid. Usually, businesses that have inventories, like stores for example, use an accrual basis method of accounting. With an accrual method of accounting, you’d report income as you billed it. Using the example from above, if the business owner billed the $500, he would have already counted it as income, even though it didn’t actually reach his pocket yet. For a business like that, you’d write the bad debt off as an expense. There’s actually a line right on the corporation forms for “bad debt expense”. While there’s no special line on the Schedule C for bad debts, you would just make your own line item for “bad debts” in part V–other expenses.
And that’s all there is to writing off a bad debt for a business. Now if you’re dealing with a personal bad debt–like a loan to a relative that’s never going to get paid, that’s a whole other story. I’ll write about those in my next post.