Debt Collection Agent or Debt Write-off?

Debt collection agent or write off a bad debt, which is the way to go? Read on for help in preparing for the decision.

The end of the year is approaching with tax season just around the corner. Your tax professional will soon ask for a list of your accounts receivable. The question will be what you want to do about bad debts. Should you write off a bad debt and take a bad debt reduction? Or, do you send it to a debt collection agent? This will give you an understanding of two common options. 

Bad Debt Reduction

  • Cash Basis

If your business is on a cash basis, you pay taxes on income when you receive the money. So that if a customer or client does not pay your invoice, you have not realized income. Therefore, as far as the IRS is concerned, there is no tax to pay. And that means, because you will not pay tax,  you may not take a bad debt reduction. As you know, a bad debt reduction lowers your taxes.

  • Accrual Basis

However, if your business is on an accrual basis, the business earns income when you send out an invoice. The income trigger is not receipt of payment. The income trigger is the invoice. Consequently, billing a client in 2018 equals income earned in  2018. It doesn’t matter whether the invoice is paid in 2018, 2019, or later.

When Is a Debt Uncollectable?

It is only when you realize that the account will prove to be uncollectable that you can take a bad debt reduction. Then you merit a tax credit for unpaid accounts.

“You should review your accounts receivable aging every year to see what accounts might not be collectable. At that time you can set up an allowance and when it’s determined that the receivable will not be collectable, you can take the bad debt expense,” says Mark J. Lenski, CPA, partner at Tarlow & Company, CPAs and Advisors

Many companies set up an allowance for doubtful accounts receivable. Although the accounts are identified, they cannot be a bad debt reduction until it is determined that the bad debt will not be collected.

“There is potential for there to be a tax write-off, but you should follow up with a tax advisor to ensure that you can take a deduction,” adds Lenski.

The tax deduction you’re getting is pennies on the dollar. The current tax rate for corporations is 21 %. So that if you write off a debt, you get only 21% of what you’re writing off. A debt collection agent may be the answer.

Here’s an example: If you write off $100K, you are getting $21K in tax savings. But if you collected $100K rather than take the loss and deduction, you would see $100K tax-free. That’s because you already paid tax when it was invoiced.

A Debt Collection Agent Can Help

No one wants to take a bad debt expense — pennies on the dollar.

Try to collect instead of taking the write-off.

Check out the IRS website for information on bad debt deduction, particularly the types of bad debt and examples.

We’re here to help tax season and all year long. Call us with questions on this and any other debt collection issue. To discuss your concerns, call (212) 686-0100 or email.