account or note receivable that proves to be entirely or partially uncollectible despite collection efforts. If the allowance method of estimating bad debts is used, the entry at time of uncollectibility is to debit allowance for bad debts and credit accounts receivable. If the direct write-off method is employed, the entry is to debit bad debt expense and credit accounts receivable.
loans classified as a probable loss and having no economic values. These loans, past due as to payment of interest and principal, are removed from the loan portfolio and their book value loss is charged to a reserve account (the loan loss reserves). Usually, an offsetting charge to current income is made to adjust for the deduction from the reserve account
debt that is not collectible and is therefore worthless to the creditor. A debt may become uncollectible because the debtor is insolvent. A business bad debt may be written off under the specific charge-off method A personal bad debt is normally not deductible and, if allowed deductible by the IRS, would be treated as a short-term capital loss, which is limited to $3,000 per year.
Banks and Corporations: open account balance or loan receivable that has proven uncollectible and is written off. Traditionally, companies and financial institutions have maintained a reserve for uncollectible accounts, charging the reserve for actual bad debts and making annual, tax deductible charges to income to replenish or increase the reserve. Companies and large banks ($500 million or more in assets) must generally use the direct charge-off method for tax purposes, although bad debt reserves continue to appear on balance sheets for reporting purposes. Small banks and thrift institutions continue using the reserve method for tax purposes, although with strict limitations. The relationship of bad debt write-offs and recoveries to accounts receivable can reveal how liberal or conservative a firm's credit and charge-off policies are.
Individuals: Individuals lending money may deduct bad debts on their tax return when the debtor does not repay the loan. Bad business debts are fully deductible from gross income on Schedule C for selfemployed individuals. Nonbusiness bad debts can be deducted as short-term capital losses on Schedule D. These short-term losses can offset capital gains plus $3,000 of other income. Any excess bad debt losses can be carried forward into future tax years. In order to determine whether a bad debt deduction is legitimate:
- the debt must be legally valid
- A debtor-creditor relationship must be formalized at the time the debt arose
- the funds providing the loan must have previously been reported as income or part of the individual's capital and
- the individual must prove that the debt became worthless in that tax year.
customer failing to pay for the merchandise or service received; also called bad pay. In the case of magazines, two or three issues are usually sent before service is suspended because of nonpayment.
