During the past tax year, Jane identified $50,000 as a nonbusiness bad debt. In

Question

During the past tax year, Jane identified $50,000 as a nonbusiness bad debt. In that tax year, Jane had $100,000 of taxable income, of which $5,000 con- sisted of short-term capital gains. During the current tax year, Jane collected $10,000 of the amount she had previously identified as a bad debt. Determine Jane’s tax treatment of the $10,000 received in the current tax year.

assuming that the $50,000 no business bad debt became wholly worthless. How much will Jane (single) include in her gross income during the current year?

Explanation / Answer

The Internal Revenue Service allows creditors to take a tax deduction for bad debts when a debtor refuses or is unable to make payments. A mere liability of the taxpayer is insufficient to take the deduction. The tax law requires an actual monetary loss before you are eligible to receive a benefit. If you eventually recover the amounts due after filing a tax return, you must reverse the prior bad-debt deduction.

Nonbusiness bad debts are deducted as short-term capital losses that can offset capital gains; if the result is a net capital loss, then it can be used to offset up to $3000 ($1500, if married, filing separately) of other income; any remaining loss can be carried forward as a short-term capital loss.

If a bad debt is eventually recovered, then a business simply has to add it to income in the year that is recovered.

So, $ 10000 is added to the Income of Jane as recovery of Bad debts.

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