IRS Definition of Bad Debt
A bad debt is an uncollectible amount of money. There are two types as defined by the Internal Revenue Service -- business bad debt and nonbusiness bad debt. The most commonly claimed bad debt deduction is for business.
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Definition
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Bad business debt as defined by the IRS is money that cannot be collected against a good sold or service provided during the course of your business. A bad debt can also be money that cannot be collected against a good or service, which may not have been a direct result of your business, but the primary intent of the sale was to benefit your business.
Credit Sales
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Bad debts are generally the result of the sale of goods or services on credit. When a consumer defaults in paying a bill on a good or service he has received, the debt is considered bad.
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Accrual Accounting
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When a business uses an accrual method of accounting, a bad debt can be deducted only if the total amount of the sale was included in the income section. Since the accrual method records payment at the time of the sale, not when the money is actually collected, a sale is recorded as income before the money is received.
Cash Accounting
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When a business uses the cash method of accounting, a sale is recorded when the money is received and therefore it cannot claim a deduction for bad debt as the sale is not recorded into the business' income statement.
Special Circumstances
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If a business liquidates and some debts are not paid, these can be claimed as bad debts on a tax return.
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