You Make the Call - Oct. 26, 2023

Question: Fred is preparing a final Form 1120-S, U.S. Income Tax Return for an S Corporation, for a client. The S corporation uses the accrual method of accounting and its accounts receivable account has a balance of $25,000, which has remained in the account for several years. It has been deemed impossible to collect the balance and is therefore worthless. Can the corporation deduct the accounts receivable as a bad debt expense and, if so, where is it reported on Form 1120-S?

Answer: Yes. The accounts receivable can be deducted as a bad debt expense if the balance is a bona fide debt and is completely or partially worthless. A bona fide debt is defined as a debt based on a debtor-creditor relationship that the debtor is legally obligated to pay back.

Because the debt is an accounts receivable generated in the ordinary course of the S corporation's business operations, meets the requirements of a bona fide debt and has been deemed uncollectible and worthless, it will be considered a business bad debt. As a pass-through entity, the S corporation deducts the bad debt at the corporate level and each shareholder deducts their pro rata share on their individual tax return.

To report the bad debt expense, Fred will enter the amount as a deduction on Form 1120-S, Line 10 under “Bad debts”. The amount is included as part of ordinary business income (loss) on Form 1120-S, Schedule K, Line 1, and in the ordinary business income (loss) reported to the shareholder on Schedule K-1 (Form 1120-S), Shareholder's Share of Income, Deductions, Credits, etc., Box 1.