Question

Explain why it is difficult for a cash basis taxpayer that sells goods or services to claim a bad debt deduction when an account receivable resulting from such sale goes bad?

Answer 1

For a cash basis taxpayer to claim a bad debt deduction following 2 problems are noteworthy:-

Cash-basis taxpayers generally will not have reported income due them as an open account receivable. Since the basis of the receivable is zero, no deduction is allowed when the debt becomes uncollectible. However, income of a cash-basis taxpayer that is evidenced by a note is reportable when the note is received. Therefore, notes receivable of cash-basis taxpayers do have a basis and would be charged off upon becoming worthless.

Accrual-basis taxpayers generally report income as it is earned. Therefore, they may take a bad-debt deduction on accounts or notes that have become worthless during the year. However, the item must have been included in income either for the year of the deduction of the bad debt or in a previous year.