Definition§
The Specific Charge-Off Method for bad debts permits the deduction of bad debts on a tax return when an individual or business determines that a specific receivable is uncollectible. This typically occurs after all reasonable collection efforts have failed.
Examples§
- A company extends credit to a customer but, after several attempts at collection and legal action, determines the account is uncollectible. The company then writes off the receivable as a bad debt using the specific charge-off method.
- An individual loans money to a friend who agrees to repay, but the friend declares bankruptcy. After futile attempts to recover the amount, the individual uses the specific charge-off method to deduct the bad debt.
Frequently Asked Questions§
Q: What are bad debts according to tax purposes? A: Bad debts are accounts receivable or loans that have become uncollectible and are written off as deductions.
Q: Why must accrual basis taxpayers use the specific charge-off method? A: The IRS mandates accrual basis taxpayers to use this method as it matches deductions with the period in which the debt becomes uncollectible, ensuring accurate reflection of a business’s taxable income.
Q: Are cash basis taxpayers also required to use the specific charge-off method? A: Generally, cash basis taxpayers cannot use this method because they do not report income until cash is received, so there’s no receivable to write off.
Related Terms§
- Bad Debt: An account receivable that is no longer collectible.
- Accrual Basis: An accounting method that records revenues and expenses when they are earned or incurred, regardless of when cash is exchanged.
- Reserve Method (Bad Debts): An earlier method under which businesses could set aside a reserve for anticipated bad debts; now discontinued by the IRS for tax purposes.
Online References§
Suggested Books for Further Studies§
- Federal Taxation: Comprehensive Topics by Ephraim Smith and Philip Harmelink
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Practical Guide to Partnerships and LLCs by Robert Ricketts and Larry Tunnell
Fundamentals of Specific Charge-Off Method: Accounting Basics Quiz§
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