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They Didn’t Pay My Bill: Can I Deduct the Bad Debt?

“Billables” do not always equal “collectibles”.  Can an unpaid bill (or portion of a bill) be deductible?  The short answer is: Possibly, but you must have previously included the amount in your income or loaned out your cash (Treasury Regulation § 1.166-1(e)see IRS Topic 453).

 

Analysis

1) General Rule§ 166(a) of the Internal Revenue Code allows a deduction for any debt which becomes worthless within the taxable year.  It provides that if only part of a debt is recoverable, a deduction may be allowed not in excess of the part charged off within the taxable year.

2) Determination of WorthlessnessTreasury Regulation § 1.166-2(a) provides that the IRS will consider all pertinent evidence in determining whether a debt is wholly or partially worthlessness.  § 1.166-2-(b) provides that legal action is not required to prove worthlessness if the taxpayer can show that surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in satisfaction of execution on a judgment.  § 1.166-2(c)(1) provides that bankruptcy is generally an indication of worthlessness of at least part of an unsecured and unpreferred debt.

3) Limitation of General Rule to Debts of a Corporation and Business Debts:   § 166(d) provides, however, that if a taxpayer is not a corporation, these rules do not apply to nonbusiness debts.  A nonbusiness debt is a debt that (i) is not created/acquired in connection with the taxpayer’s trade or business, OR (ii) the worthlessness of which is incurred in the taxpayer’s trade or business.

4) Rule for Nonbusiness Debts of Non-Corporate Taxpayer:  § 166(d) and Treasury Regulation § 1.166-5(a)(2) provide that a loss that arises from a non-corporate taxpayer’s nonbusiness debt becoming worthless during the taxable year is treated as a short-term capital loss.  In addition, § 1.166-5(a)(2) provides that a nonbusiness bad debt must be totally worthless to be deductible.

 

Please contact me at 954-944-3929 or nrumbak@rumbaklaw.com if you want to further discuss these issues.

 

*This document contains legal information, but does not contain legal advice.

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