Tax Information With A Mother's Touch
Published by Eva Rosenberg, MBA, EA
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Tax Information With A Mother's Touch Published by Eva Rosenberg, MBA, EA |
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Press/Media - Click Here Double Dipping . . . or Why You Can't Deduct Bad Debt Folks, this is a rather touchy subject. Say you've done work for a client or sold merchandise to a customer who has stiffed you. It's as though you've been burned twice once for doing the work, twice for not getting paid. Well, you may reason, when you go to your tax pro, he or she will be able to help you take a deduction for this miserable occurrence and you'll recoup some of the loss. WRONG! This is one of the hardest concepts to explain because people get angry at tax pros when they hear the bad news. To understand why it's not so unjust, you need to know the four terms defined below: Cash basis accounting - This is the method most self-employed folks use. When you report your income and expenses on your tax return, you do it by including only the money you've actually received from customers or clients (not amounts that have been billed but not yet collected). Also, you only report expenses that you have actually paid (not purchases for which you have unpaid invoices sitting in your desk drawer). Accrual basis accounting - This method is used by businesses that sell merchandise, maintain an inventory, and have unpaid purchases that exceed their Accounts Receivables. Working on an accrual basis means that your income, for tax purposes, includes all your sales even if you haven't collected the money for them yet (if you have Accounts Receivable). You report your expenses the same way by deducting all the invoices for everything that you have received, even if you haven't paid yet. Accounts receivable - Invoices you have sent clients or customers that have not yet been paid. Accounts payable - Invoices you have received but not yet paid. (Credit card debts are not included. They're loans. Items purchased with credit cards are immediately treated as expenses or equipment purchases.) Bad debt problems arise with businesses that operate on a cash basis, which is the kind most self-employed folks run. Many generate income by selling services, time, or advice. Since small businesses tend not to have a great deal of credit with merchants, you must pay all your bills when they are presented (or within 30 days) if you want maintain your credit. As a result, you rarely have many outstanding accounts payable. Usually, self-employed people have more accounts receivable, often outstanding for 90 days. or even more. The good news is, if you report income on a cash basis, you don't have to report all your billings until your customers pay you. Taxes are only paid on that money once it comes in. Now, come the end of the year you realize that the client for whom you gave up your evenings and weekends for a month is never going to pay. They owe you about $4,000 and you want to take a bad debt deduction on your tax return. Think about this carefully. How do you take the deduction if you've never reported the $4,000 in income? If you reread the definition of cash basis, it may help. Say your friend Roberto takes the deduction. How does he do it? Since his business is run on an Accrual Basis, he reported all his invoices. Roberto reported the $4,000 in income and now he can take the deduction for bad debts. For you to be able to take a deduction for bad debts, you would have had to report the billing in your income first. Do the math ($4,000 - $4,000 = $0). Since the net effect is 0, why bother reporting the bad debt at all? In fact, including bad debt on a tax return is an audit flag. Since most people who report bad debts do it erroneously, the IRS is almost assured of free money if it audits the return. Even if the final result of the audit is a "no change," the cost for the audit representation can exceed $2,000. After all, the IRS won't look solely at the bad debt. They'll look at the whole business return and investigate any questionable items under travel, entertainment, auto, and other categories. Where does this leave you? Don't push for things you don't really want. Sometimes, getting nothing is better than taking a deduction. Bio: Eva Rosenberg, EA, writes the Internet's popular weekly Ask TaxMama column on TaxMama.com. With a tax practice spanning the globe, she's faced just about any tax question you can imagine. A popular columnist, writer and speaker, Eva does a great 'Stand-Up Tax' routine for seminars and workshops that's both funny and informative. Copyright ©Eva Rosenberg 2003 |
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| Library of Congress - ISSN 1532-0790 Copyright © 2000-2007 - Eva Rosenberg |
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