“Losses and Bad Debts”

Scenario:

Ashley is an attorney who specializes in family law. She uses the cash method of accounting and is a calendar-year taxpayer. Last year, she represented a client in a lawsuit and billed the client $5,000 for her services. Although she made repeated attempts, Ashley was unable to collect the outstanding receivable. Finally, in November of the current year, she finds out that the individual has moved without leaving any forwarding address. Ashley’s attempts to locate the individual are futile.

What is the amount, if any, of the deduction that she may claim in connection with this bad debt?

Can you make response each posted below # 1 to 3?

1. From: Stacy Brown posted Jun 16, 2018 8:14 PM

Using the accrual method of accounting, a taxpayer is generally able to report income in the year the service is performed. Since Ashley is using the cash method of accounting, the taxpayer reports income only in the year in which they receive payment for the service.

Unfortunately, in Ashley’s case, she will not be able to deduct a bad debt for the uncollectible amount. She has no basis in the debt.

Under other circumstances, Ashley could have had her client sign a note for the debt, and she would have been able to report the income in the amount of the note’s FMV during that year.

I can’t imagine how any of this is fair considering there’s likely more than enough documentation showing the uncollected debt and foul play. But it may be as easy a fix as switching to an accrual method of accounting. I’m sure Ashley has a reason for choosing the cash method but that is something to consider.

References

Weygandt, J. J., Kimmel, P. D., Kieso, D. E. (2015-01-05). Accounting Principles, 12th Edition. [Bookshelf Online]. Retrieved from https://bookshelf.vitalsource.com/#/books/97811190…

2 . From: Carolyn Holland posted Jun 15, 2018 10:23 AM

Hello everyone,

In the accrual basis of accounting debt is recorded when services are rendered. But in the cash basis of accounting the debt is not recorded until the debt is paid. Therefore, Ashley did not record the debt as income so she will not be able to claim it as a loss to income. Ashley should collect the retainer up front like my divorce attorney did. You don’t have the money then you don’t have an attorney. Since it was a large amount, it might be worth it to Ashley to hire an investigator to find the client and file a court case in hopes of getting a garnishment of wages.

References

Wilson, J. (2018). Writing off bad debt cash vs accrual. Retrieved from

http://joshuawilsoncpa.com/writing-off-bad-debt-cash-vs-accrual/

3. From: Christy Brown posted Jun 14, 2018 11:52 PM

Good evening everyone and Prof,

Ashley should of collected the money up front instead of billing the client for the $5000. How did she know the family would be able to pay the bill? Did she do a credit check? Unfortunately with the cash method of accounting, Ashley will not be able to claim the bad debt and make that deduction. Cash method of accounting does not have a bad debt deduction. She would of had needed to use the accrual method of accounting in order to claim the bad debt. She could of set herself up for the possibility of the bad debt if she had accrued the money. Ashley would not even be able to claim it as a loss on her taxes. It is a shame the family ran out on the bill.

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