With tax season upon us, the IRS reminds us that companies are required to make efforts to collect past due accounts before they can be written off as bad debts.
But how involved should collection efforts be? Can you charge off expenses incurred to collect a bad debt? Is there a cap or formula for expenses contracted in pursuit of a bad debt that can be deducted?
Internal Revenue Service spokesperson Ruth Davidson said you do not have to wait until a debt is due to determine whether it is worthless.
“The debt becomes worthless when there is no longer any chance that the amount owed will be paid,” Davidson said. “It is not necessary to go to court. You must only show you have taken reasonable steps to collect the debt. A bankruptcy from a debtor is quick evidence, for example.”
Legal and professional fees, charged by accountants, attorneys, collection agencies, are deductible as business expenses.
“However, you usually cannot deduct the same expenses you pay to acquire business assets,” Davidson said.
There’s no formula by which the IRS makes allowances for writing off deductions related to collection efforts.
“But you have to exercise common sense,” she said. “It’s not worth $600 to hire a lawyer to collect a $500 debt, especially when a lawyer isn’t necessary to prove a debt is worthless and uncollectible.”
Outstanding consumer installment debt totals more than $1 trillion dollars. In July, 1998, the total was $1.2 trillion, a 4% increase over the previous year.
Bankruptcy filings in 1997 increased by 19% to a record high of 1.4 million filings with another double-digit increase predicted for 1998. Also in 1997, almost 500 million fraudulent checks were written for about $10 million.
Of this staggering amount, only 3% of consumer debt was charged off as a loss in 1997.
Keith West, sales manager for Advanced Recovery Systems of Jackson, said the bulk of their collection business consists of medical collections.
The federal government estimates healthcare is a $1 trillion industry. According to a U.S. Census Bureau report, almost 42 million Americans were without healthcare insurance in 1996. The American Hospital Association estimates nearly 46 million people will be without health insurance by the year 2000.
“Everyone wants to see a greater effort made at collecting bad debts,” West said. “Our business has remained steady.”
Michelle Phillips, vice president for Teleco of Mississippi, said businesses with less than 30 employees and less than $1 million in gross revenues are companies that fall into the small to medium category.
“Proving (collectibility of debts) won’t apply to a company the size of WorldCom, but it will apply to most businesses in Metro Jackson.”
Miller Reid, president of the Mississippi Society of Certified Public Accountants, and member of Haddox, Reid, Burkes & Calhoun in Jackson, said debts can be deemed uncollectible in a number of ways.
“One common way is by showing that someone who owes a business money has filed bankruptcy with no assets,” Reid said. “Others have attorneys research and recommend by letter that the debt is uncollectible. A taxpayer would have to exhaust all the usual and reasonable means of collection to establish worthlessness.”
Without a precise test for defining worthlessness, the burden is on the taxpayer, Reid said. “The best thing you can do is document all efforts, including requests for payment.”
Other than writing off debts, what can businesses do about trifling no-pays?
As the Internet is becoming more widely used, information is a mere search engine away. Directories can track down long-lost customers, for instance. But collection efforts take time.
Credit & Financial Associates Inc., a Cincinnati-based company, offers a service via its Web site for a fee of $8.75 per letter to send a series of notices to collect past due accounts.
In 1996, about $122 billion was placed for collection with professional third-party collection agencies who collected more than $20 billion, according to Ben Saukko of American Collectors Association. ACA is an international trade organization of credit and collection professionals in the U.S. and 55 foreign countries.
“We usually have accounts placed for collection that have gone unpaid for about eight months with no communication from debtors,” Saukko said.
For fees ranging from 30% to 60%, collection agencies handle all the pesky paperwork, tracking and collecting of debts. Some agencies send a monthly statement with a detailed status report.
Walt Dallas, tax attorney and partner with Barnes Broom Dallas & McLeod, PLLC, said the IRS has not recently changed its laws on requiring businesses to prove debts uncollectible before writing them off.
“There’s not a rule you can refer to,” Dallas said. “It’s vague. Just make sure you make every effort possible to collect the debt before you write it off.”