How to save taxes with a bad debt


October 16, 2017

6 minutes to read

Be sure to document all failed collection efforts.


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Which optometric professional has not suffered from non-payment of patients? Accounts receivable are not always fully collected and claims are rarely resolved for a variety of reasons. Sometimes patients simply escape payment, and the cost of their lawsuit exceeds the recoverable amount; sometimes they go bankrupt, sometimes the debt becomes time-barred.

The bottom line is that no matter how hard the practice tries, it just can’t bring a particular account to zero. Even after friendly collection attempts, a firm may not receive the full amount owed and begin to suspect that it will never receive it. At this point, you have your options: write off the account as bad debt or write off the debt entirely. Each approach has tradeoffs for small optometric practices.

Mark E. Battersby

Good vs. Bad Debt irrecoverable debts

Commercial and non-commercial bad debts are treated very differently under our tax rules. A non-commercial bad debt is only deductible when it has no value, and then only as a short-term capital loss. Business bad debts, on the other hand, can be deducted even if they are only partially worthless and used to offset ordinary income.

Unfortunately, just labeling something as bad debt doesn’t necessarily make it tax deductible. A bad debt deduction can only be claimed if the amount owed has been included in gross income for the year in which the deduction is claimed. This is almost never the case for taxpayers using the cash payment method (i.e. most of us who report income when we receive it). However, taxpayers on the accrual basis of accounting report their income as it is earned; if receivables have already been reported as revenue, a bad debt deduction is appropriate.

Forgiveness or radiation

Some optometrists and optometric practices forgive the unpaid debts of those who may have gone through difficult times. Debt cancellation simply means that the open accounts receivable will be reduced to zero, with some kind of offset note explanation.

Although there is no tax deduction associated with this adjustment, a Form 1099-C, Debt Cancellation, must be filed with the IRS to record the cancellation of debt over $ 600.

Good bad debts

A bad debt is defined as an account or a note receivable which turns out to be totally or partially uncollectible despite the efforts of collection. In order for an optometric practice to deduct bad debts from a business as an expense on its income tax return, the receivable must have been created or acquired by the practice or closely related to the practice when it became partially or totally unreliable. value.

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Unfortunately, the IRS often denies deductions for bad debt, even partial, simply because the rules were not followed. In one case, a practice was denied a partial deduction for bad debts because the amounts had not been charged strictly in accordance with the rules. An increased reserve account did not meet the legal requirement for write-off.

According to the IRS, the purpose of requiring a write-off is to perpetuate evidence of a taxpayer’s choice to drop a portion of the debt. Therefore, an optometrist or his office must eliminate debt as an asset on his books in order to comply with the write-off requirement.

In addition, before an optometric practice can deduct and deduct a debt in part, it must be able to demonstrate that in the year in which the partial nullity was claimed, the amount of the nullity could be predicted with reasonable certainty. Bad debts are written off as soon as they are determined because optometric practice does not expect future economic benefits and it no longer remains an asset. No way around this, the ultimate proof of worthlessness depends on the facts and circumstances as they existed at the time the debt was said to have become worthless.

A bad personal debt is generally not deductible. However, in the rare cases where it is allowed as a deduction by the IRS, it would be treated as a short-term capital loss, limited to $ 3,000 per year.

Bad debts of the business

As mentioned, bad debts are written off as soon as it can be determined that the optometric practice does not expect future economic benefits and that it no longer remains an asset. A bad debt of a business is a loss resulting from the uselessness of a debt that was either:

  • created or acquired in a trade or business or

  • closely related to trade or business when it has become partially or totally worthless.

A debt is closely related to a trade or business if the primary reason for incurring the debt is practice. Bad debts from an incorporated optometry practice (other than an S corporation) are always bad debts.

Bad debts of businesses are usually the result of granting credit to patients, third-party payers or insurers. Services that have been performed, even goods that have been sold but not yet paid for, are recorded in the firm’s books as accounts or receivables. After a reasonable period of time, if attempts have been made to collect the amount owed but unsuccessfully, the bad part becomes a bad trade debt.

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Under our tax rules, accounts or notes receivable measured at fair market value (FMV) when received are only deductible at that value, although the FMV may be less than face value.

When money is loaned to a patient, client, client, supplier or employee for a business reason and the practice is unable to collect the amount after a reasonable attempt, it becomes a bad trade debt. On the other hand, a deduction for bad debt for a loan granted to a corporation cannot be claimed if, according to the facts and circumstances, the loan is in fact a capital contribution.

The value of worthless debts

Generally, a debt becomes worthless when the surrounding facts and circumstances indicate that there is no reasonable expectation of payment. To demonstrate that a debt is worthless, an optometric professional must establish that reasonable steps have been taken to collect it. There is no need to go to court if it can be shown that a court judgment would be irrecoverable.

In addition, the deduction can only be claimed in the year in which the debt becomes worthless. Of course, you don’t have to wait until a debt is due to determine if it is worthless. Debtor’s bankruptcy is usually good evidence of the uselessness of at least part of an unsecured and unsecured debt.

Again, it should be noted that deductions for bad debt are generally not available to optometrists or practices that use the cash method of accounting. To deduct a bad debt, the optometrist or his office must have previously included the amount in his income.

Bad debt collection

If a deduction for a bad debt is claimed and all or part is subsequently recovered (collected), some or all of the amounts recovered may need to be included in the gross income of the optometry practice in the year of recovery. The amount included is limited to the amount actually deducted. Of course, any amount deducted that did not reduce the previous tax bill can usually be excluded. The recovery is usually reported as “other income” on the appropriate form or schedule.

In the event that an asset is received in partial settlement of a debt, the debt is reduced by the FMV of the asset, which becomes the basis or book value of the asset. The remaining debt can be deducted as bad debt if and when it becomes worthless. If the property is sold later for more than its base, any gain on the sale is due to the appreciation of the property. It is not about the collection of a bad debt.

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Method of unearned experience

If the accrual method of accounting is used, income which is expected to be uncollectible need not be recognized using the “unaccounted experience method”. Since expected uncollectible amounts are not included in income, these amounts are not subsequently deducted from income. Typically, the practice needs to have $ 5 million in gross revenue for all previous years to use this simplified strategy.

In addition to costing the optometric practice money, bad debts make accounting difficult. When using accrual accounting (as many practices do), revenue is realized at the time of billing, not when it is received. Due to this lag when unpaid fees become overdue accounts, many optometrists go through various collection procedures, with the overdue account eventually becoming a deductible bad debt on the optometry practice’s tax return.

Of course, the optometrist or practice must be able to demonstrate that any “bad debt” is partially or totally worthless. To ensure that the optometric practice does not miss a bad debt deduction during the current tax year, records should be reviewed carefully to identify potentially worthless debts still on the books. It is also a good idea to ensure that all failed collection efforts are carefully documented in the event that the IRS disputes the bad debt deduction.

Obviously, bad debt rules are delicate and require justification, special procedures and records. Any optometric professional with questions should make sure to check with their tax specialist.

Disclosure: Battersby has no relevant financial information.



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