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How to Write Off Bad Debt

In: Business and Management

Submitted By tom99
Words 699
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Sometimes the answer is yes, and sometimes the answer is no.

Let’s start with the basics:

1. In order to write off a bad debt, you must have proof that the transaction was indeed a debt and not a gift. The IRS considers “loans” to your minor children as gifts making the ensuing bad debt not deductible. So the answer to the first question is no.

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2. There are two types of bad debts: business (from operating your business) and non business.

3. The debt must arise from cash out of your pocket, or in the case of business, bad debts must have been included in income.

4. You must have a basis in the debt. In other words, the debt must arise from funds you parted with, not from something you expected to receive. For example, you cannot claim a bad debt deduction for court-ordered child support not paid to you by your former spouse. If you are a cash basis taxpayer (most individuals are), you pretty much cannot take a bad debt deduction for unpaid salaries, wages, rents and similar items.

5. The debt must be deemed completely worthless and reasonable steps must have been taken to collect on the debt.

To determine if a debt can be written off, consumers should pretend they are sitting across from an auditor defending a deduction on the tax return. Proper defense involves having proper documentation. The first thing to do when engaging in any business transaction is to create a paper trail. If you are lending a friend $5,000 to open a business, have your friend sign a promissory note and pay your friend with a check, inscribing “business loan” on the memo line-- this is the first step to defending a future bad debt on your tax return.

If you have already made the bad…...

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