Bad Debt Expenses

[geekgirldany]

Not directly related to taking a bad debt expense. But deducting expenses from a customer that did not pay.

I have a customer that does electrical. Does work in the residential building industry. He said that a air contractor told him he could not deduct the expenses (he called them bad debt) unless there is a lien taken on the house that was foreclosed upon from the builder. Anyone ever heard of this?

I told him I had never heard of that unless the company is on a accrual basis. That is the only time you can deduct a bad debt. Since my customer is cash basis I told him that his loss is what he paid out for labor and material doing the job. That he can't say "oh the job was $10,000 I am going to deduct that". He said he understood that but this other guy told him different.

Just making sure.

[sea-tax]

Not directly related to taking a bad debt expense. But deducting expenses from a customer that did not pay.

I have a customer that does electrical. Does work in the residential building industry. He said that a air contractor told him he could not deduct the expenses (he called them bad debt) unless there is a lien taken on the house that was foreclosed upon from the builder. Anyone ever heard of this?

I told him I had never heard of that unless the company is on a accrual basis. That is the only time you can deduct a bad debt. Since my customer is cash basis I told him that his loss is what he paid out for labor and material doing the job. That he can't say "oh the job was $10,000 I am going to deduct that". He said he understood that but this other guy told him different.

Just making sure.

If I understand you correct then you are right in your thinking. I also get calls from time to time from Restaurant clients who want to know if there is some kind of deduction for food waste when the powers goes out for a couple of days during a wind storm. As if deducting the cost of the food once was not enough. they will also try to convince you that they should be able to deduct the lost revenue.

[geekgirldany]

Thanks so much for posting. I wasn't sure if there was something new come out with all this mortgage stuff going on and the builders industry going down the tubes.

[JohnH]

I think this is one of the most difficult things we can try to explain to a cash basis taxpayer. You can go through it repeatedly, ask him if he gets it, he will say "yes" and leave.

Then a few days later he comes back and says "But my mechanic says he gives his tax person a list of bad debts and he gets to write them off, so why can't I?". It does almost no good to explain that if the mechanic is on the cash basis, his tax person isn't doing anything with his bad debt list either, except maybe tossing it in the shredder. After all, he's a mechanic and everybody knows that mechanics understand all this tax stuff. Right?

[geekgirldany]

I know. I had one customer I explained it every year at tax time. I finally just took their list and did nothing with it. Explained again when they picked it up.

I don't know if the mechanic, heating and air man, and restaurant man says to do it but tax pro says no... maybe it is right. 3 out of 4 just kidding.

[JohnH]

It's always a good idea to tell them to double-check with their hairstylist on matters like this, just to get a second opinion. After all, hairstylists understand cash-basis accounting on a totally different level than we do, and I mean they REALLY understand cash-basis accounting.

[JG EA]

Tell them "Lost revenue can certainly be counted, but I'll have to put it into income first."

[Nashville]

Taking Out a Lien

This whole thread reeks of tax mythology propogated by mechanics and hairdressers. Bad debt actually CAN be deducted on a cash value return if it had previously or currently been counted in revenue. [Example: cash receipt is counted as revenue in 2007, but then a customer's check bounces in 2008.]

Where this electrician probably got his idea of a "taking out lien" requirement: Under audit, there often needs to be evidence that the taxpayer has actually pursued collection. Auditors know that sometimes bad debts are simply unpaid bills from friends, relatives, or customers who have a cozy relationship with the taxpayer and who work out their arrangements with alternate elliptical connections other than downright cash payments.

Whereas the above is certainly not the majority of reportable "bad debt" it occurs much more often than one would think. One red flag to an auditor is if the taxpayer is still continuing to do business with the customer in question. Collection effort is an indicator that the bad debt is bona fide and adds credibility to the deduction.

Other debtors are "judgement-proof" i.e. parties who cannot raise the money for payment even though ordered to do so by a court. No one wastes time in legal pursuit of such an offender, and this should also be taken into account by an auditor.

[geekgirldany]

Good point. Might be considered a trail for them.