March 21, 2024

Tax Deductions for Non-Business Bad Debts

[[{“value”:”

Updated for tax year 2023.

Have you ever lost money to a loan you’ll never collect? If you answered yes, the good news is you’re not alone. Many of us have lent money to a friend or relative at some point. And while the intent might have been good, there are times when things don’t go according to plan. Sometimes, the payments stop coming, and eventually, you realize you’ll never get your money back.

While finding yourself in this situation is unfortunate, you may be able to take consolation in the form of a tax deduction — even if you don’t own a business. If the amount you lent was substantial, it’s possible to write off the money in the year the debt becomes uncollectible.

At a glance:

Even if you aren’t a business owner, you might be able to write off bad debts.
To take a non-business bad debt deduction, you must have documents showing you had a legal debt that is now uncollectible.
TaxAct® can help you deduct non-business bad debts.

Step 1: Identify if it’s non-business or business bad debt.

Bad business debt is precisely how it sounds — debt from operating a trade or business. A non-business bad debt is basically anything else. If you loan money from your personal bank account to a family member and they never repay you, that’s a non-business bad debt.

Step 2: Determine if you can claim the bad debt on your tax return.

The debt must have been declared completely uncollectible to claim non-business bad debt as a deduction on your tax return. A debt becomes uncollectible after you have tried every reasonable way to collect on it and have been unsuccessful. It’s also deemed uncollectible if the borrower files for bankruptcy and the debt is discharged.

Once a non-business bad debt becomes uncollectible, it is considered completely “worthless,” meaning you have no chance of being repaid, and you can provide proof you guaranteed the debt to protect your investment. At that point, you can then deduct the bad debt on your tax return.

However, if you guarantee a debt as a friend with no consideration in return and the debt goes bad, it is considered a gift instead of a loan. And as you may be able to guess, gifts can’t be used as a tax write-off on your income tax return as non-business bad debt.

Step 3: Document your bad debt.

To take a tax deduction for bad debt, you must show that you, the lender, had a legal debt and cannot collect on it. Be sure to keep track of the following information:

Note or loan agreement proving you had a legal, enforceable debt: You don’t need mountains of legal paperwork, but you will need to have at least one document showing there was an understanding with the borrower that you were to be repaid. Otherwise, the IRS will determine that you made a nondeductible gift. An oral agreement may be permissible, but a written one is always better.
Name of the debtor: Be sure to include their business information or relationship with you.
Records showing your basis in the debt: Keep a record of the amount of money you loaned. Note that you can’t take a bad debt deduction for certain money you never received, such as uncollected alimony.
Documentation showing you tried to collect on the debt: Any letters, emails and notes from phone calls are examples of documentation that will work here.
Additional documentation indicating why the debt is worthless: You can only deduct debts if they are totally worthless, so you’ll want any and all evidence showing the debt is worthless. If, for example, the borrower went bankrupt, you’ll want to keep that documentation to help prove that it’s a worthless debt.

Step 4: Enter the bad debt on your tax return.

While having bad debt is never a good situation, you have a few options to help offset the loss. There are just a couple of details to pay attention to.

To deduct a bad debt, you must have included the amount in your income or loaned out cash. For example, you cannot claim a bad debt for money you expected to receive for repairing your sister’s air conditioner, even if she promised to pay. You will need hard evidence, preferably in writing, to prove all parties understood the repayment obligations, and the debt must be declared totally worthless.

If you can claim the bad debt on your tax return, you must complete Form 8949, Sales and Other Dispositions of Capital Assets. The bad debt loss will then be treated as short-term capital loss on Schedule D by first reducing any capital gains on your return and then reducing up to $3,000 of other income, such as wages.

TaxAct can help walk you through taking a non-business bad debt deduction if you choose to file with us. We will ask you to attach a statement detailing a description of the debt, the debtor’s name and their relationship to you, the efforts you made to collect the debt and how you decided the debt was worthless.

If you cannot take the full deduction in the year of the loss, you can carry it forward to later years. You have seven years from the due date for your original tax return to file a deduction for uncollectible bad debts or two years from the date you paid the tax for that year, whichever is later.

What if I already filed my tax return for the year?

If you’ve already filed a tax return for the year in which the debt became worthless, you’ll need to amend your return by filing Form 1040-X, Amended U.S. Individual Income Tax Return, with Form 8949 attached to your amended return.

What happens if a bad debt comes back to life?

Say you’ve given up on getting paid back on a loan and decided to take a tax deduction for a non-business bad debt. If you later collect on that debt, part or all of the amount you received may be counted as taxable income. However, you’ll only have to pay income tax on the amount of bad debt that actually reduced your tax. This could be less than the amount you deducted when you filed your return with the bad debt deduction.

This article is for informational purposes only and not legal or financial advice.

All TaxAct offers, products and services are subject to applicable terms and conditions.

The post Tax Deductions for Non-Business Bad Debts appeared first on TaxAct Blog.

“}]] – ​Tax Tips and Tax Planning Resources | TaxAct Blog

​Read More

 

6 Things You Should Know About the Alternative Minimum Tax (AMT)

[[{“value”:”

Updated for tax year 2023.

Don’t let the alternative minimum tax catch you by surprise this tax season. The alternative minimum tax (AMT) was created in 1969 to keep a small number of wealthy taxpayers from using tax loopholes to avoid paying taxes. Instead of closing the loopholes, Congress devised a plan to calculate a person’s tax two different ways — once with the traditional tax system and once with a special “alternative” system. The taxpayer then pays the higher of the two results.

As you may imagine, this double system can be complex and confusing. Initially, the system didn’t bother many people as it only applied to especially well-off taxpayers. However, the AMT amounts did not keep up with inflation and, unfortunately, quickly began to affect more and more Americans.

Here’s how to know if the alternative minimum tax could affect you and what you can do about it.

1. If your income was less than $81,300 in 2023, you generally won’t have to pay AMT.

A certain amount of income per year is exempt from the AMT. This is called your exemption. If your income is less than the exemption, you generally don’t have to worry about the AMT.

For tax years 2023 and 2024, the AMT exemption amounts for each tax filing status are:

Your income for this purpose is calculated from your adjusted gross income (AGI), with certain changes required by the AMT. It’s best to use these amounts as a rule of thumb for determining whether the AMT may apply to you. Even if your income exceeds the exemption amounts listed above, it doesn’t automatically mean you’ll be taxed at AMT rates.

For reference, the AMT tax brackets for 2023 are:

The AMT exemptions phase out at 25 cents per dollar earned once your AMT income reaches the phaseouts listed above.

2. Some tax breaks are not allowed under AMT rules.

Some kinds of income and tax deductions are deductible for the regular income tax but not under AMT rules. A few examples include the standard deduction or personal exemptions, state and local taxes, and tax breaks that affect mostly high earners such as incentive stock options.

However, that doesn’t automatically mean these deductions and exemptions won’t do you any good. As we mentioned before, the AMT uses its own set of tax rates, 26% or 28%, and your total AMT may still be lower than the regular income tax amount.

Remember, you pay the highest amount between the regular income tax and the AMT. Unless you have significant deductions and other tax preference items not allowed by the AMT, you probably still only owe regular income tax.

3. You may need to file Form 6251 if you have specific AMT items.

If you need to report any of the following items on your tax return, the IRS requires you to attach Form 6251, Alternative Minimum Tax – Individuals, to your federal income tax return, even if you do not owe AMT:

The qualified electric vehicle credit.
The personal-use part of the alternative fuel vehicle refueling property credit.
The credit for prior year minimum tax.
Any general business credit (and either line 6 or 25 of Form 3800 is more than zero).

Other less common items include Section 1202 exclusions, intangible drilling, circulation, research, experimental or mining costs, tax-exempt interest from private activity bonds, etc.

Don’t worry if this sounds confusing. If Form 6251 is required, TaxAct® will populate the form for you based on the information you give us.

4. A little tax planning can help you avoid the AMT.

The best way to plan for the AMT is to read your annual tax return, including Form 6251, carefully.

Your tax strategy depends on your income and the type of tax benefits that trigger the AMT in your case. For example, if accelerated depreciation deductions cause you to pay AMT, you may want to choose a different depreciation method.

Simply knowing how the AMT works can help you make better tax decisions. If you have itemized deductions close to the amount of your standard deduction, you may be better off taking the itemized deductions to avoid the AMT because the standard deduction is not allowed under AMT. TaxAct can help you determine if itemizing or taking the standard deduction will result in a lower tax bill.

If you are subject to the AMT in some years but not others, you can try to time deductible expenses for the years in which you get the most tax benefit.

5. If you pay AMT, you may get a credit later.

Some of the tax items that affect the AMT are what the IRS calls deferrals. These items “defer” tax under the regular tax system rather than simply lowering it within a given year.

For example, accelerated depreciation lets you take depreciation deductions early on within an asset’s life and defers any tax liabilities to later years. Once the depreciation of an asset has been recognized, it is no longer available to shelter taxable income in the following years.

The IRS makes up for this in the following years by giving you an AMT credit when applicable. TaxAct can help calculate potential AMT amounts available to you on Form 8801, Credit for Prior Year Minimum Tax.

6. The AMT is complicated, but TaxAct does the hard work.

TaxAct can help determine if you’re required to pay the AMT when you file using our tax preparation software. Our guided Q&A interview will help us determine if you need Form 6251 to finish your tax return. If you do, TaxAct will complete the form using your provided information.

For tax planning purposes, if you used a tax professional or other tax software product in previous years, you can find Form 6251 in your return and see how the AMT affected you, allowing you to make more informed tax decisions.

This article is for informational purposes only and not legal or financial advice.

All TaxAct offers, products and services are subject to applicable terms and conditions.

The post 6 Things You Should Know About the Alternative Minimum Tax (AMT) appeared first on TaxAct Blog.

“}]] – ​Tax Tips and Tax Planning Resources | TaxAct Blog

​Read More