A taxpayer collects a debt that was previously written off as a bad debt. What t

Question

A taxpayer collects a debt that was previously written off as a bad debt. What tax consequences arise if the recovery is received in a subsequent tax year?

A. When a taxpayer collects a bad debt that was previously written off and deducted, the recovery must be reported as an increase in cash and a decrease in expense. This removes the bad debt deduction that was reported in the prior year.

B. When a taxpayer collects a bad debt that was previously written off and deducted, the recovery must be reported in income to the extent the taxpayer received a tax benefit from the deduction in the prior year.

C. When a taxpayer collects a bad debt that was previously written off and deducted, the recovery must be reported as a decrease in liabilities and a decrease in receivables. The debt recovery removes the bad debt liability sitting on the books as well as the receivable that is now collected.

D. When a taxpayer collects a bad debt that was previously written off and deducted, the recovery must be reported as a decrease in receivables and an increase in cash. The debt recovery amount will not affect income for the year because the amount was previously included when the sale occurred.

Explanation / Answer

Answer:

B. When a tax payer collects a debt that was previously written off and deducted, the recovery must be reported in income to the extent the taxpayer received a tax benefit from the deduction in the prior year.

This is because in the earlier taxation period the taxpayer has received a tax benefit by reducing it from the income, now when the debt is received the income should be increased to the extent of amount of tax benefit availed.

The deduction could have been earlier taken under paragraph 20(1).

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