If a taxpayer has paid somebody or a business and that payment turned out to be a bad debt, then he/she can claim a deduction from the taxes. Bad debt is an amount that has been incurred by a taxpayer in carrying on his or her profession or trade but which becomes worthless. In other words, it’s an expense that won’t yield any future benefit for the individual or business. As far as claiming deductions from income tax returns are concerned, there are 2 ways of claiming bad debts – they are: Claiming as a deduction from ‘Income from Business and Profession’ under section-10A Deduction u/s-80P If one follows methods.
2 Ways of Claiming Bad Debts:
1, then only the loss up to Rs-1 lakh is allowed as taxable deduction. So if the loss is much higher than Rs-1 lakh, then it can be claimed in future years too. If one follows method
2, then the entire amount of bad debt (up to various limits) is allowed as a deduction under section-80P irrespective of whether or not you are carrying on any business activity for that year.
This implies that even if a taxpayer has closed his/her business in earlier years because of losses and has stopped filing ITRs since then but still has unclaimed balance bad debts which could have been carried forward to later income tax returns, he/she can claim them now in current financial year (provided other conditions mentioned below are satisfied). Further, these bad debts must arise out of non-business transactions to be claimable under section 80P. Deepak Maheshwari, CEO of ITRADARNG.com says that “Bad debts are deductible for the purpose of computing taxable income from business or profession.
When you pay someone some money and receive no benefit in return, it is called bad debt if circumstances indicate that the money will not be received back.” Bad debts can also arise on account of non-payment by customers on sale/purchase of capital assets like land, buildings etc. These bad debts arising out of non-trading transactions are allowable as deductions u/s 10A. According to him further added that “Any deduction which is claimed against such payments must also be incurred directly and all payments.
Bad debts are amounts of money that are owed to you but have not been paid. The IRS classifies bad debts as either business or no business. A business bad debt is an amount of money that is owed to you by a customer or client who does not pay. A non-business bad debt is an amount of money that is owed to you by someone other than a customer or client, such as a family member or friend.
According to Aron Govil you can claim a bad debt as a tax write-off on your tax return if it becomes worthless during the year. To claim a bad debt as a tax write-off, you must first determine if the debt is deductible. You can deduct a bad debt only it is entirely worthless. You cannot deduct a bad debt if you are able to collect any part of the amount owed.
You must also have included the bad debt in your income in the previous year. This means that you must have included the amount in your income when you first became owed the money. For example, if you lent your friend $1,000 and he never paid you back, you would not be able to claim the bad debt as a tax write-off because you never included the $1,000 in your income. However, if you lent your friend $1,000 and he paid you back part of the loan, but then stopped paying and the loan became worthless, you could claim the bad debt as a tax write-off.
To claim a bad debt as a tax write-off, you must have previously included the amount in your income.
You can complete and file IRS Schedule D (Form 1040), Capital Gains, and Losses with your Form 1040 or Form 1041. You report a bad debt as a short-term capital loss on line 1 of Schedules, D (Form 1040) if the bad debt occurs in a month after December 31st of the current year.
If you claim a bad debt as a tax deduction, it affects your taxes as follows:
If you use the cash method of accounting:
A business’s bad debt is deducted on Schedule C or C – EZ if it arose from sales to customers. It reduces the basis of the invoice and cost of goods sold.
If you end up receiving some or all the money owed to you, then report it as “other income” on line 21 of your Form 1040.
Conclusion by Aron Govil:
According to the latest amendment in Income Tax Act, 1961 bad debts can be claimed as deductions even if they are not incurred while doing business. This provision can be used by taxpayers who have closed their business in earlier years and have not been filing ITRs since then. The bad debts must arise out of non-business transactions to be claimable.
