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Deducting Business Bad Debts
If debt collection is a problem in your business, deducting
uncollectible (bad) debts from your tax bill may somewhat lessen the sting
of simply writing them off. Here is some basic information on deducting
business bad debts.
First, the debt must be legitimate. A bona fide debt arises from a debtor-creditor relationship and is based on a valid and enforceable obligation to pay a fixed or determinable amount of money. For debt creation, the business must be able to show that it was the intent of the parties at the time of the transfer to create a debtor-creditor relationship. In other words, the business must he able to show that at the time of the transaction, there was a real expectation of repayment, and there was intent to enforce the indebtedness.
For most businesses, it is common to incur uncollectible
or worthless debts. Two types of bad debt deductions are allowed by the
IRS: business bad debts and nonbusiness bad debts. Business bad debts
give rise to ordinary losses that can generally offset taxable income
on a dollar-for-dollar basis. Nonbusiness (personal) bad debts are considered
to be short-term capital losses. Because there is a limitation on deducting
capital losses, distinguishing business and nonbusiness bad debts is critical.
Business bad debts generally originate as credit sales
to customers for goods delivered or services provided. If a business sells
goods or services on credit and the account receivable subsequently becomes
worthless, a business bad debt deduction is permitted, but only if the
revenue arising from the receivable was previously included in income.
Business bad debts can also take the form of loans
to suppliers, clients, employees, and distributors. Additionally, a business
bad debt deduction is allowed for any payments made in the capacity as
guarantor if the reason for guaranteeing the debt was business related.
Here, the guarantor's payment results in a loan to the debtor, and the
taxpayer is generally allowed a bad debt deduction once the loan becomes
partially or totally worthless.
Worthlessness can be established when the business
sues the debtor, and then shows the judgment is uncollectible. However,
when the surrounding circumstances indicate a debt is worthless and uncollectible,
and that legal action to collect the debt would in all probability not
result in collection, proof of these facts is generally sufficient to
justify the deduction.
Please contact us to discuss this tax-saving opportunity
in more detail
Tax Calendar
July 15 - If the monthly deposit rule applies, employers must
deposit the tax for payments in June for social security, Medicare, withheld
income tax, and nonpayroll withholding.
August 2 - If you have employees, a federal unemployment tax
(FUTA) deposit is due if the FUTA liability through June exceeds $500.
-The second quarter Form 941 (Employer's Quarterly
Federal Tax Return) is also due today. (If your tax liability is less
than $2,500, you can pay it in full with a timely filed return.) If you
deposited the tax for the quarter in full and on time, you have until
August 10 to file the return.
August 1 - If the monthly deposit rule applies, employers must
deposit the tax for payments in July for social security, Medicare, withheld
income tax, and nonpayroll withholding.
September 15 - Third quarter estimated tax payments are due for
individuals, trusts, and calendar-year corporations.
-If a five-month extension was obtained, partnerships
should file their 2009 Form 1065 by this date.
-If a six-month extension was obtained, calendar-year
corporations should file their 2009 income tax returns by this date.
-If the monthly deposit rule applies, employers must
deposit the tax for payments in August for social security, Medicare,
withheld income tax, and nonpayroll withholding.
Loans from IRAs Not Permitted
During this difficult economic period, taxpayers struggling
financially should be wary of using IRA funds to supplement their income.
In a recent real-life example, a taxpayer struggled to pay his business
expenses, home mortgage, and family living expenses. To meet those needs,
he withdrew funds from his Individual Retirement Account (IRA), which
he intended to be a loan and not a distribution. He had previously borrowed
money from his 401(k) plan to purchase a home.
However, in this particular case, the Tax Court determined
that unlike a loan from a qualified employer plan, i.e., 401(k) plan (which
is permitted), a loan from an IRA to its owner is always a prohibited
transaction. (There is no exception for loans from an IRA to its beneficiary.)
The court's opinion added that, regrettably, there is no exception to
the 10% early distribution tax for amounts used for business and living
expenses. (This 10% penalty is in addition to the regular income tax due
on the distribution.) Although the taxpayer's financial circumstances
were not unusual during this tumultuous period, the tax code is sometimes
unforgiving in its attempts at standardization.
Note: It is permissible to withdraw funds from an IRA
and redeposit the same amount back in to an IRA within 60 days to avoid
taxation and the 10% penalty.
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Retiree's State of Residency Tax Issues
When a person retires, he or she may decide to move
to another state for a variety of reasons, such as living in a warmer
climate, being closer to children or other relatives, avoiding state income
tax, health reasons, or a combination thereof.
If the retiree's move is intended to be permanent,
it is important that legal domicile be established in the new state. If
domicile is not established, the retiree may be subject to income tax
as a resident of both the old and new states. In addition, since each
state has its own rules relating to residence and domicile, both states
may try to impose taxes on the retiree even if he or she has established
domicile in the new state, but has not adequately re1inquished domicile
in the previous state.
Furthermore, if the retiree dies without establishing
domicile, both the old and the new states may claim jurisdiction over
the retiree's estate.
The more time that elapses after the move and the more
steps the retiree takes to establish domicile in the new state, the more
difficult it will be for the old state to assert that the retiree resides
or has domicile there.
The following steps tend to establish domicile in a
new state:
- Register to vote in the new location.
- File a change of address form with the post office at the old location
and change the address on documents, such as tax returns, wills, contracts,
insurance policies, passports, and living trust agreements.
- Obtain a driver's license and register automobiles in the new location.
- Open and use bank accounts in the new location.
- Move items from safe deposit boxes in the old location to the new
location.
- Purchase or lease a residence in the new state and sell the residence in the old state.
- If an income tax return is required, file a resident return in the
new state and a nonresident return (or no return, if appropriate) in
the old state.
- File for property tax relief under a homestead exemption (if any)
in the new state.
- Move all items that make a house a home, such as mementos, heirlooms,
sentimental items, trophies, collections, furniture, etc., to the new
state.
For many purposes, the location of property is determined
by reference to state law, and may be somewhere other than where the property
is physically located. The state in which the property is deemed to be
located may assess income taxes (if any) on income or gains relating to
the property. The state may also assess death and succession taxes, and
that state will be where probate proceedings will occur when the individual
dies. Furthermore, rules of that state will be used to determine whether
testamentary instruments are valid and whether the terms of the instruments
(such as the powers of a trustee) are legally enforceable.
The retiree's state of domicile generally determines
the rules relating to the ownership and tax treatment of intangible personal
property. Thus, if the retiree established domicile in a new state, that
state's laws generally will apply to his or her intangible assets, such
as bank accounts, stocks, bonds, notes, partnership interests, trust income
rights, and insurance contracts. Interest income from a savings account,
for example, will normally be taxed by the state of domicile, rather than
the state in which the account is located.
Please contact us if you have questions on the tax
ramifications of moving to another state or any other tax planning or
compliance issue.
Distributions from Inherited IRAs
It is becoming increasingly common for individuals
to inherit IRAs. By inheriting an IRA, we mean when you become entitled
to some or all of the balance in a deceased account owner's traditional
IRA or Roth IRA by virtue of being designated as an account beneficiary.
In this scenario, you may think your share of the inherited
IRA can be rolled over tax-free into your own IRA before the familiar
60-day deadline for rollovers has passed. While this seems like a very
reasonable assumption, it is often incorrect. In fact, only the deceased
IRA owner's surviving spouse is allowed to roll over distributions from
an inherited IRA into his or her IRA. Nobody else can.
Thankfully, there is a way for nonspousal IRA beneficiaries
to accomplish the same result as a tax-free rollover. A direct (trustee-to-trustee)
transfer of an inherited traditional or Roth IRA into a (brand new) receiving
IRA in the deceased account owner's name does not count as a rollover.
The receiving IRA is a new IRA set up solely for the specific purpose
of receiving the inherited balance from the deceased account owner's IRA.
When the deceased account owner's IRA is a traditional IRA, the receiving
IRA must be a traditional IRA. When the deceased account owner's IRA is
a Roth IRA, the receiving IRA must be a Roth IRA.
By taking advantage of this procedure, the balance
in an inherited IRA with a sole beneficiary who is a nonspouse can be
transferred tax-free into a receiving IRA controlled by the beneficiary.
Similarly, an IRA with several nonspousal beneficiaries can be divided
up and transferred tax-free into several receiving IRAs, one for each
beneficiary. That way, each beneficiary can pursue his or her own investment
strategy with the inherited money.
Even though the beneficiary is effectively in control
of the receiving IRA, the account must be kept in the name of the deceased
IRA owner to indicate that it is an inherited IRA rather than an IRA that
was originally set up to be owned by the beneficiary. For example, a receiving
IRA might be titled "Coastal Bank, Custodian, for IRA of Joe T. Samson,
Deceased, Fred Samson, Beneficiary."
To avoid adverse tax outcomes, please contact us before
taking any distributions from an inherited IRA. That way, we can work
with you to achieve the most favorable tax consequences for your inherited
IRA money.
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The
Tax and Business Alert is designed to provide accurate information regarding
the subject matter covered. However, before completing any significant
transactions based on the information contained herein, please contact
us for advice on how the information applies in your specific situation.
Tax and Business Alert is a trademark used herein under license.
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