Can anybody explain this IRS sentence to me? (It is about bad debts)

  • Thread starter Friendly person
  • Start date

F

Friendly person

IRS: "You cannot take a bad debt deduction for amounts owed to you that
you have received and connot collect if you never included those
amounts in your income."

Here is why I ask: I provided services to others as self employed
little business woman. Many of my customers paid, a few did not. I
hired collection company to get the money but they told me that the
customers will not pay but that the amount is not big enough to sue
them.

I spend a lot of time in providing the service to these non-paying
customers. Can I deduct the amount they owe me or not?

I don't understand the sentence as to include the amount in your
income. If these customers did not pay me, how can it be my income?

Ette
 
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R

Richard Macdonald

Friendly person said:
IRS: "You cannot take a bad debt deduction for amounts owed to you that
you have received and connot collect if you never included those
amounts in your income."

Here is why I ask: I provided services to others as self employed
little business woman. Many of my customers paid, a few did not. I
hired collection company to get the money but they told me that the
customers will not pay but that the amount is not big enough to sue
them.

I spend a lot of time in providing the service to these non-paying
customers. Can I deduct the amount they owe me or not?

I don't understand the sentence as to include the amount in your
income. If these customers did not pay me, how can it be my income?
Bad debts can only be claimed against income that has already been
recognized and reported for tax. This is usually only for accrual basis
taxpayers that recognize and report income when earned, but before
collected. So if you never recognized and reported the income billed,
then there is nothing to deduct against. However all of your other
ordinary expenses paid in attempting to earn and collect are deductible.
 
P

Phil Marti

Friendly person said:
I spend a lot of time in providing the service to these non-paying
customers. Can I deduct the amount they owe me or not?
Not if you're a cash basis taxpayer. (If you don't understand what that
means, you are.) Presumably you deducted your expenses for supplies,
travel, etc. as you incurred them. There has never been any income recorded
from this client, so there's no bad debt deduction.

An accrual basis taxpayer records the income (and pays taxes on it) when the
service is provided. If that debt turns out to be uncollectible, there is a
bad debt deduction since income that was taxed was never actually received.
 
F

Friendly person

Richard said:
Bad debts can only be claimed against income that has already been
recognized and reported for tax.
Can you give me an example? I made graphic design for two customers in
Europe. I invested a week of my time to give them what they asked me to
do. And then they don't pay. They took the product, said thank you very
much and ran. It happened this tax year. I have a copy for the product
and the correspondence with those non-paying customers.

And I can't deduct that? I don't understand what recognized income is.
I made a loss here. I should get the money from the customers but they
don't pay.

This is usually only for accrual basis
taxpayers that recognize and report income when earned, but before
collected.
I file my taxes returns once a year like other people too.
So if you never recognized and reported the income billed,
then there is nothing to deduct against.
I don't understand it. How can I report income that these customers did
not pay me? What about my week hard work?
However all of your other
ordinary expenses paid in attempting to earn and collect are deductible.
Right, this is what I think too. But I still have not fully understood
if I can deduct these non paid bills of my customers or not.

Please advice.

Kindly

Ette
 
F

Friendly person

Phil said:
Not if you're a cash basis taxpayer. (If you don't understand what that
means, you are.)
That sounds very mysterious to me. Yes, I report my cash to the IRS,
that is my income, that is how I make my living. I provide the
graphics, good people pay me bad people cheat me. But I heard from
another graphic designer that he writes his non-payed bills off.
Presumably you deducted your expenses for supplies,
travel, etc. as you incurred them. There has never been any income recorded
from this client, so there's no bad debt deduction.
One of the customers paid me for another job earlier that year but not
for all. But what about my time?
An accrual basis taxpayer records the income (and pays taxes on it) when the
service is provided.
You mean not just once a year? But what is the different between paying
it right away and once a year? And who has time write the IRS a check
with each bit of income?
If that debt turns out to be uncollectible, there is a
bad debt deduction since income that was taxed was never actually received.
I don't understand why people who do not have income report income to
the IRS. What kind of service providers are these accrucal tax payers?

Kindly

Ette
 
J

Jim Kingdon

Can you give me an example? I made graphic design for two customers in
Europe. I invested a week of my time to give them what they asked me to
do. And then they don't pay. They took the product, said thank you very
much and ran. It happened this tax year.
The IRS isn't in the business of compensating you for wasted time.

If you spent money (salaries to your employees, paper, whatever), then
that could be a business expense, so there might be a loss here. But
"loss" in the tax code is about money, not about your time.
 
A

Arthur Kamlet

That sounds very mysterious to me. Yes, I report my cash to the IRS,


The term "cash" in that sentence is a very technical term, which
describes the method of accounting chosen by the taxpayer.



In many cases the taxpayer has an option as to which methid of
accounting to use.



Most individual taxpayers choose to use the cash basis method,
which means recognizing income when it is received and recognizing
expenses when they are paid.



Another method, "Accrual" means recognizing income when it is
booked and billed, and recognizing expenses under a ratable
system.


I doubt you would have elected to use the Accrual method of
accounting.



that is my income, that is how I make my living. I provide the
graphics, good people pay me bad people cheat me. But I heard from
another graphic designer that he writes his non-payed bills off.

If he uses the Accrual method, then he recognizes income when he
bills for it, and if it turns out the receivable is no good, he
writes off that already-declared income item. And if he keeps a
balance sheet with receivables listed, he writers off that
receivable. And writing off a receivable on a balance sheet can
be done for cash basis taxpayers too.



One of the customers paid me for another job earlier that year but not
for all. But what about my time?
Unfortunately, for income tax purposes, there is no dollar value
that can be assigned against the value of your time or services
performed. The cost of the items sold, including the cost of
their manufacture or assembly, becomes part of the Cost of Goods
Sold, and somewhere on your tax return, probably Schedule C, you
can account for cost of goods sold.



If you have no inventory, but you produce an service byproduct,
such as a consulting report, the cost of items like paper and ink
cartridges, goes into some other expense category and is deducted
from income.




You mean not just once a year? But what is the different between paying
it right away and once a year? And who has time write the IRS a check
with each bit of income?

No, this discussion is about when the taxpayer records taxable
events in his records, which could be daily or weekly, etc.
 
P

Phil Marti

Friendly person said:
That sounds very mysterious to me. Yes, I report my cash to the IRS,
that is my income, that is how I make my living. I provide the
graphics, good people pay me bad people cheat me.
Cash basis and accrual basis are accounting terms indicating which way you
keep your books to prepare your annual return. A cash basis taxpayer cannot
deduct unpaid billings. Period.

I know it doesn't seem fair to you, but it's the law. When you don't like
the law, Congress is the place to direct your complaints.

Please don't take the following as a slam. You don't know enough about
accounting to be in business without an accountant. It's not rocket
science, and you could spend the time to learn it. I think your time would
be better spent attending to your better mousetrap and hiring assistance
where you need it. You'd be $$ ahead in the end.
But I heard from
another graphic designer that he writes his non-payed bills off.
You'll hear all sorts of things about taxes from all sorts of people. My
favorites are sourced to Sally's mother's hairdresser's cousin's roommate's
boyfriend. Your colleague is one of the following:

1. An accrual basis taxpayer
2. A liar
3. A tax cheat
 
R

Richard Macdonald

Friendly person said:
Can you give me an example? I made graphic design for two customers in
Europe. I invested a week of my time to give them what they asked me to
do. And then they don't pay. They took the product, said thank you very
much and ran. It happened this tax year. I have a copy for the product
and the correspondence with those non-paying customers.
If they still you, you are out your direct expenses.
And I can't deduct that? I don't understand what recognized income is.
I made a loss here. I should get the money from the customers but they
don't pay.
Recognized income is income that has been reported and taxed,
if you have not reportedthe income, it has no tax basis.
I file my taxes returns once a year like other people too.
If you only report the income you actually recieved, then any billings
that are unpaid, have not been reported and are thus not deductable.
I don't understand it. How can I report income that these customers did
not pay me?
There are many businesses that reposr income at the point of
service or goods delivered and later deduct for the failure to collect.
What about my week hard work?
That is a job for lawyers and collection agancies,
if you didn't claim the income, there is no deduction.
Right, this is what I think too. But I still have not fully understood
if I can deduct these non paid bills of my customers or not.
The uncollected billings are deductible ONLY if the income was reported.
 
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A

Arthur Kamlet

If they still you, you are out your direct expenses.



Your direct expenses, what you paid for the product, but not your
time and value of any services performed, are deductible. Either
they become a part of cost of goods sold or a direct expense of
the business.


Example: You spent $500 to purchase 20 pounds of widgets and
spent 100 hours converting those widgets into 5 widget boards
which the customer picked up from you, but when you sent him the
bill he lost it and continues to lose it, then you will be
deducting the $500 in one form or another, but the 100 hours of
your valuable service and the value inherent in manufacturing
widgets into boards are not deductible.
 
F

Friendly person

Jim said:
The IRS isn't in the business of compensating you for wasted time.

If you spent money (salaries to your employees, paper, whatever), then
that could be a business expense, so there might be a loss here. But
"loss" in the tax code is about money, not about your time.
I am getting it, Jim.


Also lots of time gets lost figuring the taxes out. Wasn't it Einstein
who said that nothing is more complicated that the American tax code?

Perhaps we could get a tax break if the IRS would be dismantled and a
flat tax rate would be implemented instead of this large apparatus.
Just a thought.

Kindly,

Ette
 
F

Friendly person

Arthur said:
The term "cash" in that sentence is a very technical term, which
describes the method of accounting chosen by the taxpayer.



In many cases the taxpayer has an option as to which methid of
accounting to use.



Most individual taxpayers choose to use the cash basis method,
which means recognizing income when it is received and recognizing
expenses when they are paid.



Another method, "Accrual" means recognizing income when it is
booked and billed, and recognizing expenses under a ratable
system.


I doubt you would have elected to use the Accrual method of
accounting.






If he uses the Accrual method, then he recognizes income when he
bills for it, and if it turns out the receivable is no good, he
writes off that already-declared income item. And if he keeps a
balance sheet with receivables listed, he writers off that
receivable. And writing off a receivable on a balance sheet can
be done for cash basis taxpayers too.





Unfortunately, for income tax purposes, there is no dollar value
that can be assigned against the value of your time or services
performed. The cost of the items sold, including the cost of
their manufacture or assembly, becomes part of the Cost of Goods
Sold, and somewhere on your tax return, probably Schedule C, you
can account for cost of goods sold.



If you have no inventory, but you produce an service byproduct,
such as a consulting report, the cost of items like paper and ink
cartridges, goes into some other expense category and is deducted
from income.







No, this discussion is about when the taxpayer records taxable
events in his records, which could be daily or weekly, etc.

Thanks, Arthur, I understand it now. If a customer doesn't pay me, it
is tough luck and IRS will not allow deduction of service/time lost.

I pay my taxes on a cash received basis.

Kindly,

Ette
 
F

Friendly person

Phil said:
Cash basis and accrual basis are accounting terms indicating which way you
keep your books to prepare your annual return. A cash basis taxpayer cannot
deduct unpaid billings. Period.
I understand. I am not trying to deduct them. I posted this thread to
know for sure.
I know it doesn't seem fair to you, but it's the law. When you don't like
the law, Congress is the place to direct your complaints.

Please don't take the following as a slam. You don't know enough about
accounting to be in business without an accountant. It's not rocket
science, and you could spend the time to learn it. I think your time would
be better spent attending to your better mousetrap and hiring assistance
where you need it. You'd be $$ ahead in the end.
I have a tiny business. I just started. I always think I should let my
business grow better before I go to an accounting.
You'll hear all sorts of things about taxes from all sorts of people. My
favorites are sourced to Sally's mother's hairdresser's cousin's roommate's
boyfriend. Your colleague is one of the following:

1. An accrual basis taxpayer
2. A liar
3. A tax cheat
I don't think he is a liar and a cheat. I think number one applies and
I will check once more with him.

Anyway, thanks for your answer. I appreciate your time.

Kindly,
Ette
 
F

Friendly person

Richard said:
If they still you, you are out your direct expenses.


Recognized income is income that has been reported and taxed,
if you have not reportedthe income, it has no tax basis.


If you only report the income you actually recieved, then any billings
that are unpaid, have not been reported and are thus not deductable.


There are many businesses that reposr income at the point of
service or goods delivered and later deduct for the failure to collect.


That is a job for lawyers and collection agancies,
if you didn't claim the income, there is no deduction.


The uncollected billings are deductible ONLY if the income was reported.
Richard, thanks, I got it now. I never was a business woman before. I
just started out. I don't want to file anything wrong, this is why I
posted my question in this newsgroup and asked to explain it to me.

I report my cash/income to the IRS and just deduct my business expenses
as paper and ink and stuff like that.

Thanks for you advice and the time that you invested explaining me this
thing about the nad debts.

Kindly,

Ette
 
F

Friendly person

Arthur said:
Your direct expenses, what you paid for the product, but not your
time and value of any services performed, are deductible. Either
they become a part of cost of goods sold or a direct expense of
the business.


Example: You spent $500 to purchase 20 pounds of widgets and
spent 100 hours converting those widgets into 5 widget boards
which the customer picked up from you, but when you sent him the
bill he lost it and continues to lose it, then you will be
deducting the $500 in one form or another, but the 100 hours of
your valuable service and the value inherent in manufacturing
widgets into boards are not deductible.

Thanks, Arthur, also for that example. It is clear to me now.

Kindly,

Ette
 
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J

jmlieder

A bad debt deduction is meant to reverse the recognition of the billing to
the customer and recognition as income. This is generally done by accrual
basis taxpayers. Cash basis taxpayers don't have to include the amount
billed to somebody in income until they pay you. Consequently, if they
don't pay you and you don't have to include the amount in income in the
first place, you have the same standing as the person who has included the
amount in income but doesn't get paid and then has to take a bad debt
expense.

Allowing you to take a deduction for something you haven't included in
income would be allowing you to "double dip" and have the advantage of not
claiming the income but yet getting a deduction. That is hardly fair, and
doesn't fly with the tax law.

John M Lieder, CPA
Pueblo, Colorado
 

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