A bad debt write-off is a way to remove uncollectable debt from a company’s accounts receivable and use it as a tax deduction. It can occur when a customer defaults on a balance or files for bankruptcy, but efforts to collect the debt may still continue through collection agencies or debt sales.
A bad debt write-off is an accounting method that allows you to remove or write off a debt that has been deemed uncollectable. Companies sometimes use this type of write-off to adjust checking account receivables after determining that a particular debt owed to a customer will not be paid. The cancellation of uncollectable debt does not necessarily mean that some type of debt collection activity will not continue or that the debtor is no longer responsible for the outstanding amount. Instead, it means that by classifying the debt as irrecoverable, the business may be able to use that amount as a deduction on its taxes.
There are several situations in which a bad debt write-off can occur. The most common is when a customer defaults to a pending account balance. In this scenario, the seller makes reasonable efforts to collect at least a portion of the debt. Should these efforts prove unsuccessful, the outstanding balance is declared uncollectible and this amount is no longer recorded in the accounts receivable of the company. Bad debt is still tracked through the remainder of the tax year and can be used as a deduction, depending on the applicable tax laws in the jurisdiction where the company is located.
A bad debt write-off can also occur when a customer chooses to seek bankruptcy protection. Depending on the type of bankruptcy you file, your chances of collecting your debt may be slightly reduced. Either way, debtor bankruptcy will mean that contacting the customer directly in an attempt to collect the overdue amount will no longer be an option. Going forward, any chance of realizing at least some of the debt will depend on the decision of the court overseeing the bankruptcy proceedings.
It is important to note that processing a bad credit write-off does not mean that further efforts will not be made to collect the debt. Many companies choose to write off the debt as a business expense, then turn the insolent customer account into a collection agency. Often, the agency is tasked with attempting collections, with the understanding that if successful, the agency will keep a specified percentage of the debt collected as compensation for their services. Other times, the business may choose to sell the bad debt directly to collection agencies, usually for a certain percentage of the total amount, then declare a non-performing debt relief on the remaining balance on the sold account. That agency will then attempt to collect the full amount plus any interest charged as a means of generating a profit on the transaction.
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