How To Be Ready To Secure a Business Bad Debt Deduction on Your 2023 Tax Return
Is your business having trouble collecting payments from clients or vendors? You might be able to claim a bad debt deduction on your tax return. But if you hope to take the deduction on your 2023 return, you’ll have to get busy, because you must be able to show that you’ve made a “reasonable” effort to collect the debt.
Requirements
First, a cash-basis taxpayer may claim a business bad debt deduction only if the amount that’s owed was previously included in gross income. Second, a business must establish that the debt is legitimate and can’t be recovered from the debtor. To this end, as mentioned, you must make a reasonable effort to collect the amount that’s due.
This doesn’t necessarily mean you have to file a lawsuit against the debtor. But you can’t just make a single phone call either. Give it your best shot. You might actually be able to collect the debt! But if you can’t, you’ll have put yourself in a position to potentially claim a bad debt deduction.
Partially or Totally Worthless
Often, the specific charge-off method (also called the direct write-off method) is used for writing off bad debts. In this case, you can deduct business bad debts that became either partially or totally worthless during the year.
For tax purposes, partially and totally worthless are defined as follows:
Partially worthless. The deduction is limited to the amount charged off on your books. You don’t have to charge off and deduct your partially worthless debts annually, so you can postpone this to a later year. However, you can’t deduct any part of a debt after the year it becomes totally worthless.
Totally worthless. If a debt becomes totally worthless in the current tax year, you can deduct the entire amount (less any amount deducted in an earlier tax year when the debt was partially worthless).
Note that you don’t have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. But if you don’t record a charge-off and the IRS later rules the debt is only partially worthless, you won’t be allowed a deduction for the debt in that tax year. Reason: A deduction of a partially worthless bad debt is limited to the amount actually charged off.
Time Is Short
If you haven’t started your collection efforts yet but hope to claim a business bad debt deduction for 2023, time is short. So, spring into action now. For instance, you might start collection efforts through phone and email contacts. If that doesn’t work, you may want to follow up with a series of letters or even hire a collection agency. Finally, if all else fails, contact the office about the prospects of claiming a business bad debt deduction on your 2023 return.
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Is Disability Income Taxable?
If you may be eligible for disability income should you become disabled, it’s important to know whether that income will be taxable. As is often the case with tax questions, the answer is “it depends.”
Key Factor
The key factor is who paid it. If your employer will directly pay the disability income to you, it will be taxable to you as ordinary salary and wages would be. Taxable benefits are also subject to federal income tax withholding, though, depending on the disability plan, disability benefits sometimes aren’t subject to Social Security tax.
Frequently, the payments aren’t made by an employer but by an insurer under a policy providing disability coverage or under an arrangement having the effect of accident or health insurance. In such cases, the tax treatment depends on who paid for the coverage. If your employer paid for it, the disability income will be taxed to you, as if paid directly to you by the employer. But if you paid for the policy, the payments you receive under it won’t be taxable.
Even if your employer arranges for the coverage (in other words, it’s a policy made available to you at work), the benefits won’t be taxed to you as long as you paid the premiums. For these purposes, if the premiums were paid by your employer but the amount paid was included as part of your taxable income from work, the premiums will also be treated as paid by you and the benefits won’t be taxable.
2 Examples
For simplicity, let’s say your salary is $1,000 a week ($52,000 a year). Under a disability insurance arrangement made available to you by your employer, $10 a week ($520 for the year) is paid on your behalf by your employer to an insurance company. You include $52,520 in income as your wages for the year: the $52,000 paid to you plus the $520 in disability insurance premiums. In this case, the insurance is treated as paid for by you. If you become disabled and receive benefits, they won’t be taxable income to you.
Now, let’s look at an example with the same facts as above, except that the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, you include only $52,000 in income as your wages for the year because the insurance is treated as paid for by your employer. So, if you become disabled and receive benefits, they will be taxable income to you.
Note: There are special rules in the case of a permanent loss (or loss of the use) of a part or function of the body, or a permanent disfigurement.
How Much Coverage Is Needed
In deciding how much disability coverage you need to protect yourself and your family, take tax treatment into consideration. If you’re buying the policy, you need to replace only your after-tax, “take-home” income because your benefits won’t be taxed. On the other hand, if your employer pays for the benefit, you’ll lose a percentage to taxes.
If your current coverage is insufficient, you may wish to supplement an employer benefit with a policy you take out personally.
Any Questions?
This discussion doesn’t cover the tax treatment of Social Security disability benefits, which may be taxed under different rules. Contact the office to discuss this further or if you have questions about regular disability income.
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One-Time Thing: IRA to HSA transfer
Did you know that you can transfer funds directly from your IRA to a Health Savings Account (HSA) without taxes or penalties? Under current law, you’re permitted to make one such “qualified HSA funding distribution” during your lifetime.
Typically, if you have an IRA and an HSA, it’s a good idea to contribute as much as possible to both to maximize their tax benefits. But if you’re hit with high medical expenses and have an insufficient balance in your HSA, transferring funds from your IRA may be a solution.
Calling in the Cavalry
An HSA is a savings account that can be used to pay qualified medical expenses with pre-tax dollars. It’s generally available to individuals with eligible high-deductible health plans. For 2023, the annual limit on tax-deductible or pre-tax contributions to an HSA is $3,850 for individuals with self-only coverage and $7,750 for individuals with family coverage. If you’re 55 or older, the limits are $4,850 and $8,750, respectively. Those same limits apply to an IRA-to-HSA transfer, reduced by any contributions already made to the HSA during the year.
Here’s an example illustrating the potential benefits of a qualified HSA funding distribution from an IRA: Joe is 58 years old, with a self-only, high-deductible health plan. In 2023, he needs surgery for which he incurs $5,000 in out-of-pocket costs. Joe is strapped for cash, has made no contributions to his HSA in 2023 and has only $500 left in his HSA, but he does have a $50,000 balance in his traditional IRA. Joe may move up to $4,850 from his IRA to his HSA tax- and penalty-free.
Considering Other Factors
If you decide to transfer funds from your IRA to your HSA, keep in mind that the distribution must be made directly by the IRA trustee to the HSA trustee, and, again, the transfer counts toward your maximum annual HSA contribution for the year.
Also, funds transferred to the HSA in this case aren’t tax deductible. But, because the IRA distribution is excluded from your income, the effect is the same (at least for federal tax purposes).
Exploring the Opportunity
IRA-to-HSA transfers are literally a once-in-a-lifetime opportunity, but that doesn’t mean they’re the right move for everyone. If you’re interested, contact the office to explore whether taking this step makes sense in the context of your tax and financial circumstances.
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New Per Diem Rates for Business Travel
The IRS has announced the per diem rates for ordinary and necessary business travel expenses in fiscal year 2023-24:
- When using the high-low substantiation method, the rate for travel to high-cost localities is $309 per day and the rate for all other continental United States (CONUS) localities is $214 per day.
- For meals, the rate is $74 (high) and $64 (all other) per day.
- The rate for incidental expenses when traveling in or outside the CONUS is $5 per day.
These rates are effective beginning Oct. 1, 2023. Questions about per diem rates or other options for deducting business travel expenses? Contact the office.
Follow IRS Rules to Nail Down a Charitable Tax Deduction
Donating cash and property to your favorite charity is beneficial to the charity, but also to you in the form of a tax deduction if you itemize. However, to be deductible, your donation must meet certain IRS criteria.
First, the charity you’re donating to must be a qualified charitable organization, with tax-exempt status. The Exempt Organizations Search tool on the IRS website allows users to search for a specific organization and check its federal tax-exempt status.
Second, contributions must be actually paid, not simply pledged. So, if you pledge $5,000 in 2023 but have paid only $1,500 by Dec. 31, 2023, you can deduct only $1,500 on your 2023 tax return.
Third, substantiation rules apply, and they vary based on the type and amount of the donation. For example, some donated property may require you to obtain a professional appraisal of value.
Many additional rules and limits apply to the charitable donation deduction. Contact the office to learn more.
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Withdrawing ERC Claims
Recently, the IRS halted processing of claims for the Employee Retention Credit (ERC), due to a high volume of fraudulent claims. The moratorium is through at least the end of 2023. ERC claims that were already filed are now subject to longer processing, including heightened scrutiny to weed out fraud.
Now the IRS is creating a path for businesses that are concerned they may be victims of aggressive ERC marketing schemes. Eligible businesses can opt to withdraw unprocessed claims that they now believe may be invalid. Among other things, to be eligible, the business must have made the claim on an adjusted employment return that included no other adjustments and must want to withdraw the entire amount of the ERC claim.
Withdrawing a claim can allow the business to avoid receiving a refund for which it’s ineligible (and that would have to be repaid) as well as interest and penalties. Businesses that aren’t eligible to use the withdrawal process may be able to reduce or eliminate their ERC claim by filing an amended return.
Do You Sell Products? How QuickBooks Can Help You Track Them
If your business sells products, you know how important it is to be able to track their numbers precisely. Keep your stock at the right levels, and you shouldn’t run out of items. You also won’t have a lot of money tied up in products that aren’t selling.
You probably have a sense of what’s hot and what’s not just from fulfilling orders, but you need more than guesses. You need real numbers, so you know when it’s time to reorder and when it’s time to discount and discontinue items that aren’t selling.
QuickBooks can provide a solution to your inventory problems. It:
- Allows you to create records for the products you sell.
- Keeps a real-time running tally of your item levels and alerts you when they’re running low.
- Generates specialized reports so you can get a detailed snapshot of your inventory at any time.
Getting Started
Before you begin setting up an inventory system, make sure QuickBooks is ready. Open the Edit menu and select Preferences, then Items & Inventory. If you’re the software administrator, you can access the options that appear when you click the Company Preferences tab, as shown in the image below.
Be sure QuickBooks is set up to manage inventory tracking before you start.
Click the box in front of Inventory and purchase orders are active if it’s not already checked. If your version of QuickBooks supports sales order and purchase orders, select the options you want for the next two lines. For example, select When the quantity I want to sell exceeds Quantity Available in case you have items that are committed to assembles. When you’re done, click OK.
Building Your Product Records
Even if you don’t have a lot of inventory, consider creating a record for each item you sell so you always know where you stand. You don’t want to have to count or hunt for a unique product every time you fulfill an order. If you come up short and can’t complete a sale, you may lose that customer to a competitor who can.
Open the Lists menu and select Item List. Once you’ve created records, they’ll appear in this table. Click the down arrow next to the Item field in the lower left corner and select New. In the upper left corner of the window that opens, select Inventory Part for the Type so QuickBooks knows it will be tracking it.
Let’s say you’re buying bracelets in volume from a wholesaler and reselling them. If you’re assembling a product that requires multiple parts, that requires more complex records.
Partial view of a product record
Enter an Item Name/Number. The next two fields are optional. Now, enter the Purchase Information and Sales Information, starting with descriptions for transactions. Then, how much did you pay for them, and at what price will you sell them? The default COGS Account should be fine, and you can select a Preferred Vendor if you’d like. Be sure to select a Tax Code. If you need to collect sales tax and haven’t set it up, be sure to do that as well. The Income Account should be Retail Sales for this example.
The fields under Inventory Information are important. The default Asset Account should be correct. Enter the minimum Reorder Point and the number of this item you currently have On Hand. QuickBooks will calculate the Total Value of your stock. When you’re finished, click OK.
Built-In Safeguards
How does QuickBooks keep you from selling inventory items you don’t have? That’s easy. It’s unlikely, but let’s say someone really likes those multicolor beaded bracelets you’re selling and thinks he or she could sell them for more and make a bigger profit. They want to order 120 of them.
QuickBooks warns you if you try to sell items you don’t have.
There are two ways QuickBooks warns you about this. The first is pictured in the image above. If you try to invoice the customer for 120 of them, you’ll see that message. Second, if you get an unusually large order, you can consult QuickBooks’ Inventory Stock Status by Item report to get a real-time count (Reports | Inventory).
Need More Inventory Tracking Power?
QuickBooks does a good job of tracking inventory items. It’s up to you, though, to keep an eye on how everything is selling and determine your future purchasing habits. Other reports may be able to help you here, like Sales by Item Detail. If your business is doing really well and you need more inventory features than QuickBooks Pro or Premier offer, there are options. Please contact the office about your inventory tracking questions.
Upcoming Tax Due Dates
November 15
Employers – Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in October.
Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in October.
December 11
Individuals – Reporting October tip income of $20 or more to employers (Form 4070)
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