Write-Off Debt

Let's break it down into bite-sized pieces. First, we'll look at what a write-off means. Then we'll discuss the benefits of writing off debt. Finally, we'll spend a moment on practice.


Although a business writes off bad debt as a loss, that does not relieve the debtor's obligation to pay the bill. Writing off debt is not a waiver by the business of its right to the money owed.

Definition of Bad debt

Bad debt is when someone owes you money, but the debt becomes worthless because you can’t collect it. Bad debt most commonly happens when goods or services are rendered on credit, and the customer fails to pay.


The term Write-off

If someone owes you money that you can't collect, you may have a bad debt.


As a business decides that it has little or no chance of collecting a debt, it will write it off as a loss. What it means is that the business doesn’t count the money owed to them as an asset of the company anymore, and it will reflect on the profit-and-loss statement of a business as a loss.


Bad Debt Deduction

When companies write off debts, then many times get to deduct the unpaid balance as a loss on its financial statements and tax returns. This will lower taxable income and result in a reduced tax liability.


Your accounting method will much affect whether or not you can deduct bad debt.

If your business uses the cash method of accounting, you generally cannot deduct a bad debt, because income is not reported until it is received.

However, the other method of accounting is the accrual method (used by most midsize businesses). With this method, all Accounts Receivables are treated as income, regardless of whether you have collected the money or not. Because the debt has been recorded as income you should be able to write it off.


Before you write-off.

Nonbusiness bad debts must be totally worthless to be deductible.


A debt becomes worthless when the surrounding facts and circumstances indicate there's no reasonable expectation that the debt will be repaid. To show that a debt is worthless, you must establish that you've taken reasonable steps to collect the debt. It's not necessary to go to court if you can show that a judgment from the court would be uncollectible. Generally, some warning signs that a debt may be uncollectible would include if a company refusing to answer communication, a company stating that they will not pay, or a company simply disappearing.

Once you have turned a debt over to a collection agency, you are also justified in writing it off on your taxes.


Are debtors still liable for a debt after It Is written off?

Although a business writes off bad debt as a loss, that does not relieve the debtor's obligation to pay the bill. Writing off debt is not a waiver by the business of its right to the money owed.

Since a creditor retains its right to pursue Its debt, it can still take certain steps to collect the debt. A creditor, or collection agency, may even sue a debtor for the amount due, and with a judgment, the creditor or collection agency may be able to seize personal or business assets to satisfy the debt. However, if a creditor or collection agency successfully collects the money, you will owe taxes on the amount collected.


The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.

Disclaimer: Any and all information is not intended to be, nor is it, legal advice. Please consult your attorney for information concerning allowable rates of interest.

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