Business Bad Debts
Practically speaking every small business has receivables that it cannot obtain from clients. In case if your small business doesn't have any such receivables, consider yourself lucky. For those small business bad debts that suffer from uncollected receivables, solace can be taken from the simple point that you can claim a tax deduction.
Bad Debt Tax Deduction
Remember that small business bad debts losses if it meets nominal requirements. To claim such a tax deduction, the below mentioned must be shown:
A. First and foremost the existence of a legal relationship between the small business and debtor;
B. The receivables are worthless; and
C. Of course the small business suffered an actual loss.
Proving there is some sort of a legal relationship between the small business and debtor is fairly simple. You must generally show that the debtor has a legal obligation to make a payment. Large chunk of businesses issue invoices or sign contracts with debtors and these documents suffice to prove the legal relationship. In case if you are not putting your business relationships in writing, you should begin doing so immediately.
Proving receivables are worthless is slightly more complex in nature. A small business is needed to show that the debt has become both worthless and will remain so. In addition you must also show that you took reasonable steps to collect the receivables, but you are not necessarily required to go to court to meet this requirement. A clear instance where you would meet this requirement is if the debtor filed bankruptcy.
While proving that you suffered a loss may sound like the simple need to meet, the issue is a bit more complicated. Fact remained that the Tax
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Code defines the loss as an amount that is included in your books as income, but is never collected. A classic instance of such a scenario would be a manufacturer that provides products to retailers on credit. The manufacturer can depict a real loss if the retailer files bankruptcy. Its your bad luck that there is almost no way to claim a loss if you provide hourly services and use a cash accounting method. Furthermore the IRS does not consider the expenditure of time and effort to be a sustained economic loss.
Remember that small business bad debts suffer all to often from uncollected receivables. In case if you failed to claim such losses as a tax deduction during your last three tax filing years, you should file amended tax returns to get a refund.
There is two types of debt: good debt and there is bad debt, how do you tell the two apart As is evident with the name, good debt does good things for your financial standing, helps you build assets and there is potential for the value to appreciate like property, business, stocks and unit trusts. On the other side of the coin, bad debt is defined as consumption debt like hire purchase for cars and credit card debt.
In theory the nature of the debt doesn't only depend on what the loan is for but also on whether you can make your money work harder for you. For instance, if you can get a higher return compared to what you're paying for interest, it may pay to borrow to invest. Leveraging on a loan can play a pivotal part in helping improve your financial standing by reducing the interest charges you pay overall and help you reduce your debt faster. Another instance of a good debt is an educational loan or loan given to employees to take up share options, when the market price is significantly higher than the exercise price of the shares.
Remember that bad debt is not only borrowing to gamble, but also a loan with unfavorable terms and conditions like an overdraft facility of $95,000 against a fixed deposit of $100,000 as collateral or credit facilities with excessively high interest rates.
You required looking at the risk versus the return and the period required before a profit can be made. It may sound a good investment but the person may have no individual ability to sit it out and service the debt until the investment gains can be realized. According to experts when taking out a loan, consumers should factor in all the costs involved including legal fees, stamp duty and any commitment fees for unutilized portions of a line of credit. Not only that, its your responsibility to make sure you compare 'apples with apples'; a 4.6% interest rate per annum on a hire purchase, no-rest term loan is not cheaper than a daily-rest 6.2% per annum interest rate on a housing loan.
The ubiquitous credit card is often the most problem free way to obtain a line of credit, but it's also one of the most expensive in terms of interest rates. What's the solution then Is that can be termed as an overdraft
If you have a standby line of credit, you can draw on the overdraft instead of banking on a credit card, as the advantages is savings in interest expense. In case if you're planning to use an overdraft to help pay off another business bad debts, check out the terms and conditions applied. Overdrafts are generally need collaterals like fixed deposits, shares, unit trusts and property. In an ideal scenario drawing fully on an overdraft secured with cash to pay a credit card debt doesn't make sense.
In case if you have to pledge a fixed deposit to get an overdraft, you might as well take the cash to pay off the debts. After all, fact remained that a fixed deposit may earn you 3% per annum while the loan may cost you 8%.
There's an argument for getting a secured overdraft; you may not want to liquidate your assets, but you want to have a line of credit on standby. The fixed deposit may be maturing in say 6 months time and people may not want to uplift it and lose out on the interest, therefore they get an overdraft for that amount. Furthermore when the fixed deposit matures, they pay off the loan.
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