April 20, 2020

Bad Debts: An Overlooked Tax Incentive

By John Bonk, Director, Tax & Business Services & Matthew Brust, Staff Accountant, Tax & Business Services

Bad Debts: An Overlooked Tax Incentive State & Local Tax

During these unprecedented times, taxpayers are looking for ways to get cash in hand to keep their businesses running. One often-overlooked tax incentive is a bad debt credit or refund for the collection and remittance of sales tax. Many states offer a bad debt deduction, credit or refund to taxpayers who sell tangible personal property and collect and remit sales tax, if the purchaser fails to pay, in whole or part, any of the purchase price. Each state has its own requirements, ranging from the procedures required to claim such a deduction, credit, or refund, to the documentation required to substantiate such a claim. The majority of states define a bad debt by referring to the federal income tax definition. Each state requires the taxpayer to eliminate the debt from their books before claiming such tax incentive. This article will briefly discuss five key states.

California

California allows a bad debt deduction for debt that is “charged off” for income tax purposes. If the taxpayer is not required to file an income tax return, charged off will mean generally accepted accounting principles. The deduction must be made on the sales and use tax return for the reporting period in which the transaction was found worthless and charged off. The taxpayer will enter the amount under “Bad Debt Losses on Taxable Sale.”

New York

No credit or refund will be allowed until an account has been found to be uncollectible and has been charged off for federal income tax purposes. An application for a refund or credit for such a bad debt shall be filed with the Department of Taxation and Finance within three years from the date the tax was payable by the applicant. Taxpayers filing such application may, as part of the application, take such credit on the return which is due coincident or immediately subsequent to the time the debt is written off. Taxpayers must attach a schedule of the computation of the state and local taxes for which the refund or credit is sought.

Illinois

A taxpayer wishing to claim a bad debt deduction must satisfy three requirements:

  • The amounts must be found worthless or uncollectible.
  • The amounts that were found worthless or uncollectible must be charged off on the books.
  • The taxpayer must have taken a federal income tax deduction for a bad debt.

The amount that the taxpayer has previously paid may be taken as a deduction. A taxpayer claiming such a deduction shall maintain adequate books, records, and other documentation supporting the charge-off for which the deduction is taken.

Pennsylvania

There is no bad debt deduction in the state of Pennsylvania for sales and use tax purposes. However, taxpayers who have written off all or a portion of the purchase price of goods as uncollectible or bad debt on their federal return may receive a refund of sales tax paid. The taxpayer must have written off the purchase price, in whole or in part, on their books and records, and the amount must have been deducted as a bad debt on the taxpayer’s federal income tax return. An application for a refund must be made within three years of actual payment of such tax. Taxpayers should be advised: Pennsylvania has special requirements when the request is for a large refund. Pennsylvania defines a large refund as the excess of $100,000; this threshold can be met in a single request or the aggregate of requests in a one-year period.

Florida

Florida allows a credit or refund for the tax paid on any unpaid balance due on a worthless account within 12 months after the month in which the bad debt is actually charged off for federal income tax purposes. However, if a taxpayer does not file a federal tax return, then then the credit or refund must be claimed within 12 months following the month in which the bad debt has been charged off in accordance with generally accepted accounting principles.

Please contact your Marcum tax advisor to fully understand the tax incentives behind a bad debt deduction or refund or contact John Bonk at 954.320.8112 or email John.

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