Bad Debt- How It Affects Tax Return

Bad debt has been defined as that money that is owed to a creditor but which, he is not able to collect from the debtor due to some given reasons. This, in many cases, is the kind of money that makes many creditors go bankrupt as they are not able to keep the business running. While some clients will just be going through a rough time and therefore be rendered incapacitated, some will just decide never to pay up.

Bad debt means, bad business to the creditor. This is because even record keeping and accounting become a big challenge for them. Do not forget that, it adds to the expenses of the business because the creditor has got to arrange for the collection of the money. Paying of tax also becomes a problem.

To be on the safe side and to make your accounts work, it is advisable that you deduct bad debt from your records. However, this is only applicable if you had included that amount in your records of income. To have a better understanding of what the process should look like, you are advised to consult the Publication 550, Investment Income and Expenses, Publication 535 and the Business Expense publication. These will act as a guide through the process.

Note that, there are two types of bad liabilities which fall into the categories of business and non-business. Those that fall under the business category emanate from the operations of the business. The non business ones are those that are accrued from loss of capital. It is described more in detail in the Part 1 on Form 1040, Schedule D. These ones are captured on a separate detailed statement attached to your return records.

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