Continued from “The Frustration of Bad Debt Part 3”
Cited: ABA Journal
Consequences for Creditors
Bad-Debt Deduction
An ordinary bad debt deduction under IRC section 166 entitlements may be allowed a creditor cancels the debt either by reducing the principal or accepting property worth less than the debt amount in full satisfaction of the debt. The roles governing deductibility depend on whether the bad debt is business related or non-business related except for C corporations.
The creditor may deduct a non-business bad debt as a short-term capital loss, while a business bad debt is entitled to an ordinary deduction from income. The difference matters. Although an ordinary deduction may be taken in full, a short-term capital loss may only offset capital gains, plus, in the case of individual taxpayers, $3,000 of other income.
To claim the deduction for a business bad debt, the creditor must establish that the debt became worthless during the taxable year in which it is being claimed—in other words, there is, in the creditor’s sound business judgment, no reasonable hope for recovery. That shouldn’t be too difficult to establish in the case of many debts during the current economic woes.
If, however, a creditor claims a bad-debt deduction and later recovers all or a portion of the bad debt, part of the recovered amount may be includable in the creditor’s income for the year in which it was recovered.
For those who would like to think of a simpler time when they did not have to worry about debt . . . You can find vintage nostalgic replica products at competitive prices on the Internet. Those items include brass bells that were carried on ships that were on foggy days. You can also find unique vintage graphic lake house signs or even tin signs. Of course, if you are interested in an aviation gift this holiday season you might look for a wood propeller from a biplane to hang on your wall. You can find an octave group of nostalgic products online now.
Sale or Exchange
To the extent that the creditor receives something in exchange for the debt—such as the underlying collateral, a modified debt instrument or an equity interest—the creditor will recognize gain or loss under IRC section 1001 equal to the difference between the value of what was received and the creditor’s adjusted basis in the debt.
The character of the gain or loss is determined by the character of the debt instrument in the creditor’s hands. If the creditor repossesses the underlying property, it takes a basis in the property equal to the amount of the debt satisfied plus any gain recognized.
Special rules (described in IRC section 1038) govern repossession of seller-financed real property, which can occur directly or through purchase in a foreclosure sale. In such cases, the seller does not recognize loss, nor is it entitled to a bad-debt deduction. But any gain is limited to the amount of cash (or the fair market value of other property) received prior to the repossession with respect to the sale of the property, less the amount of gain on the sale of the property already included in income, and any repossession costs.
If, after applying the value of the property to the unpaid debt, there still remains unsatisfied debt, the creditor may deduct that amount as bad debt.
The creditor must be sure to file the appropriate tax forms when it cancels debt or acquires an interest in property in a foreclosure or repossession. The creditor must send copies of any required informational forms to the debtor.
For a couple facing foreclosure or the owner of a small business struggling to make ends meet, the need to take tax consequences into account when trying to restructure debt might seem like adding insult to injury. But the reality is that there are few, if any, financial transactions that do not have tax consequences.
Ignoring them is not an appropriate strategy.
Understanding the applicable tax rules is the best approach so that debt reconstruction minimizes the debtor’s tax liabilities. Ignoring debt only makes the problem worse.
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My Take: I definitely agree with the last part of this article. You cannot ignore debt! Besides ruining your credit, you will probably end up in the poor house for the rest of your life. And credit cards are usually the one thing in the financial world that causes a lot of debt.
The financial wizard, who came up with the idea of credit cards, definitely came up with a better mousetrap. When businesses started credit card processing, the debt in our country grew. Today, if you do not find a business that uses a merchant account, it is an unusual event.
Do not get me wrong, credit cards and cells are not the problem. It is the people who use them and how they use them. Businesses utilize various forms of advertising and promotional bags to entice customers to purchase products. People will sometimes take advantage of these things just to get the offered custom plastic bags instead of buying just a tote. This is the kind of activity that causes debt and credit cards.
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Other Resources
Natural Beauty Products for Christmas
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Educate for Christmas
One academy driving school trains on all types of vehicles such as cars, motorcycles, buses, trucks, tractor-trailers and forklifts. They have staff and representatives standing by seven days a week guide you through the training process. What better gift could you give a teenager about to get their first drivers license? Driver’s education! They are ready, willing and able to help your teenager from A to Z become a safe licensed driver. Even the New York DMV recognizes this school as a defensive driver training site. That means you could have points taken off your license and lower your insurance. And if you are interested, you can even take NY motorcycle lessons.
Enough Is Enough!
Debt is a burden as everybody knows and nobody wants to be harassed or threatened because of a debt. So when a collector or lawyer tells you something that just does not make sense, you should contact FCRA lawyers. It makes no difference if you owe the debt for some portion of the debt and have fallen behind, it does not give anybody the right to harass you. If you have had enough, contact collection harassment lawyers who can explain the “Fair Debt Collection Practices Act of 1977″ to you and the fact that you can sue the collector for harassment.
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