As a business owner, you need business partners and clients to pay their debts for you to generate revenue. If you advance goods and services and then wait for payment, you might find that clients often do not hold up their ends of the deal.
It becomes even worse when a debt becomes uncollectable. Do you write it off? If you do, how do you go about it? This is a question best reserved for one-on-one consultations with accountants and other professionals that can take a good look at your specific circumstances, but Entrepreneur.com does provide some general information.
Writing off bad debt
If you handle your own accounting, you might wonder how to add this to the books. The two options are the allowance method and the debt write-off method. The allowance method is proactive and accounts for the possibility that some accounts receivables might not come back to the business. The direct write-off method takes a more reactive approach as it occurs after the fact and begins with removing the debt from the accounts receivables.
Getting tax deductions
In some instances, businesses get to deduct bad debt when filing taxes for the business. This tends to occur if the business owners realize they might not get the debt repaid within a reasonable period of time. What counts as reasonable may depend on the type of business, the industry it operates in and general business norms. Reducing the business income with this debt amount may help to reduce the taxes due as well.
Filing for earlier debts
If you did not get to claim the debt in the year the business should have received it, you might still have time to do so. If the debt became totally worthless, you might have the opportunity to claim the debt up to seven years from the original return due date or three years from the date of paying taxes on the earnings. For only partially worthless debts, the time limits become three and two years for the same instances, respectively.
Bad debt remains an unfortunate risk of doing business. While many owners appreciate the opportunity to deduct these from earnings, successful commercial collections are even better.