It is an unfortunate fact of life that businesses often have difficulties collecting debts. It is important that businesses take proactive steps to address their bad debt so that they can either collect the debt or obtain the benefit of a tax deduction.
The Internal Revenue Code (as of the date this article was published) allows businesses to take an ordinary deduction for a debt that is “worthless” and if the business has suffered an actual loss or claimed the debt as income. This would include businesses using accrual accounting or debts relating to defaulted loans. The Internal Revenue Code does not define “worthlessness,” but courts have determined a debt to be worthless if the creditor is justified in abandoning hope of recovery. This must be determined on a case-by-case basis, but generally the business must establish that it has exhausted all of the usual reasonable means of collection without a full recovery.
The burden is on the business to establish that the debt is “worthless.” An attorney experienced in creditor’s rights can assist with collecting debts and proving that the business has used all reasonable methods to pursue the debt. This may include reducing the debt to a judgment and then pursuing collection activities based on the judgment, including levies and garnishments. In Virginia, and depending upon the nature of the debt, there may be other remedies available, including landlord’s and mechanic’s liens. In many cases, it is possible to collect a portion of the debt and at the same time establish that the remainder of the debt is “worthless.”
Businesses should be proactive in managing their debt. Often, the more aggressive creditor is more likely to be paid. If the debt cannot be collected, the Internal Revenue Code only allows a deduction for the tax year that the debt became “worthless.”