As a business owner, however, it’s naturally not your intention to get bad debt paid off for you. Ideally, you’d prefer to keep it as minimal as possible by effective collection and billing practices. If your company takes out bad debt, however, it needs to demonstrate that efforts have been made to recover the debt owed. So how does one do that? The answer is to contact the collection agency and ask them for written proof that the account was paid in full. In order to do that, here are some things to look for:
* An accurate accounting method. It’s important to find out which method the company is using to determine how much money is owed to whom. Many companies calculate their debts based on an average balance per account instead of an accurate date-due statement. To ensure that you’re getting an accurate number, request a written statement from the collection agency.
* Details about all of the receivables and collectibles. These will include the date that the account was opened and the date that it was last paid. You’ll also want to know who is paying for what, the amount of the debt and any other pertinent information. Keep in mind, though, that most businesses are legally required to turn this information over to you within a month of the last sale or transaction.
* Details about the customers. This refers to the accounts receivables that the business has collected and that it plans to repay. Sometimes, accounts receivables aren’t even real; they’re just an itemization of all of the money owed to the business. If you find a line of credit or a small business loan on an account that isn’t valid, it’s a bad debt write off and you can expect that your tax bills will be significantly higher than they would be if you didn’t write off the bad debt.
* Details about the collectible items. This includes things like damaged goods, collections, discontinued programs, discontinued leases and expired lines of credit. These too can be written off as uncollectible assets. Often, the tax law will require the business to make an effort to make good on the bad debts before writing them off, so it’s very important to be aware of this requirement. The IRS may also have special rules regarding these types of assets, so make sure you discuss them with a certified public accountant before making a final decision.
Bad debt is only one factor that determines your taxable income. Other factors, such as business assets, depreciated payroll and many other financial considerations play an important role. If you can’t disburse funds quickly enough, the cash flow problems can lead to significant problems in the business. Depending on the nature of your business, this could mean that you will be required to take out loans. The bottom line is that any expense that is not clearly linked to a direct benefit to the company must be itemized, documented and properly claimed as a deduction.
As a general rule, if you are deducting bad debt expense, you must always itemize. Just because your balance sheet shows a profit doesn’t mean that you shouldn’t always maintain accurate inventory and statements. Just because you took care of an item, doesn’t mean that it should necessarily be re-listed as a revenue item on your income statement. Items that are deductible under the appropriate tax code, but aren’t listed as revenues on your balance sheet, may still need to be itemized as part of your overall expense accounting for your business.
So how do you claim your bad debts? The best way to make a reasonable claim for bad debts is to itemize every penny of your expenses. All expenses must be properly documented and itemized so that your taxable income statement and your income tax return can contain the proper figures. Even if your accountant has provided you with a custom allowance for your specific situation, make sure you verify the amount and use it in your final budget.