Self-Employed Service Providers, about deduction of bad debt

PAYSTUBMAKR.COM invite you to Read about: Self-Employed Service Providers that are unable to deduct unpaid services           

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According to the Bureau of Labor Statistics, 15,000,0000 About 10% of the American workers are self-employed, it means that we have a few millions of independent people. Being your boss is a nice way to make a living, you do not have a boss on top, you can take your time to work as you like, however not all is easy or simple, any problem needs your personals attention. One of the issues is bad debts, unpaid services you gave to bad clients and became lost money. Some people or companies can pay late or not pay at all. As this unpaid jobs are lost money how can you deduct this amounts for your taxes? Expenses are money that you spent on the activities of your business bad-debt are money that you never received how you deduct what you did not spend? There are three conditions that you must prove their existence to the IRS to get accepted this bad credit as a deductible amount.

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  • Bona fide business debt

  • A worthless debt, and

  • An economic loss.

Bona Fide

The first condition is easy to prove; you can show the order for the job or service, the invoice you made for it and the requests for payment from the client.

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A Worthless Debt

For the second condition, it is to show that your client does not pay you even though you sent him letters and got no reply or a negative one. It may happen that the client went into bankruptcy. You need to show the IRS that you did all the possible and reasonable measures to collect the debt. You can show that it would be futile to collect this debt. It is not an obligation to go to Courts.


For example:

  • You have made many collection actions that failed to collect.

  • The person that owes you filed for bankruptcy and was discharged by the court.

  • The debtor is already out of business, died or disappeared.

An Economic Loss

You need to prove that bad credit is a loss by showing that you lost the money and not lost the income only. If you are a consultant and you are not paid by a client, you lost the income only. You filed the expenses and the income and have the balance for tax payment, the money you never got is not a loss though you lost having it. In the case that you sold a product and never was paid you lost the cost of the product which is declared as expenses, and the lost profit is lost with no tax to pay on it.

Recovery of Bad Debt Accounting

A loss is when:

  • The debt is already reported to the IRS as business income

  • You paid out cash and got no payback.

  • Credit sales of inventory that were not paid for.

Self-Employed people mostly work on a cash basis and pay taxes on what they already collected, any amount that was not paid to you is not an economic loss for the IRS. You can not claim a bad debt deduction because the client did not pay you.

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Example: John a self-employed accountant, worked 44 hours for a garage owner that never paid John the $1760 he should pay. John reported his tax without the unpaid amount. The IRS can not accept the $1760 as an economic loss though John lost the money and could not pay his bills with this money.

The IRS concept is that the unpaid money is not an economic loss and afraid that people will be inflating this kind of loss if he will accept it as a loss to take advantage of it as a loophole.

Accrual basis taxpayers have a different situation; they report their sales before being or not. Once the make invoice the amount is reported as income and tax is calculated on this amount. In this case, the taxpayer can get a deduction for unpaid service or bad debts. 

Example: Smith and Sons Co. Issued a $20.000 invoice to a client for the bookkeeping of the year.

As Smith and Sons Co. is an Accrual basis, the $20,000 are registration in the book as income and Tax is paid on them as a taxable income. As Smith and Sons did not receive this income, they going to lose the tax paid on this bad debt money.  Smith and Sons have proven that they never received this money. And they will never receive it because client filed for bankruptcy, so the bad credit became worthless. The only way to repair this situation it to deduct those $ 20,000 for the coming tax-year filing.

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As a cash basis business, you do not need the bad debt deduction, there is nothing to deduct from tax report; you never got this income, so you never paid tax on it, it is not an expense, it is just unpaid work, you lost only your time. When goods are sold and never paid, you have an economic loss and the right to deduct it for your tax.

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