Question 1

A taxpayer uses an allowance method (i.e.,aging method)of calculating bad debt expense for purposes of the business' financial statements.For income tax purposes,she will also use the allowance method to calculate the bad debt deduction.

Accepted Answer

The IRS requires the use of the direct write-off method for tax purposes, not the allowance method, which is used for financial reporting.

Question 2

Lisa loans her friend,Grace,$10,000 to finance a new business.If Grace defaults on the loan,Lisa may take a deduction for a business bad debt in the year of total worthlessness.

Accepted Answer

Lisa's loan to Grace is considered a nonbusiness bad debt, not a business bad debt, because it is a personal loan and not directly related to Lisa's trade or business. Nonbusiness bad debts are treated as short-term capital losses.

Question 3

A taxpayer's home in California is destroyed by wildfires which have been declared a federal disaster.The home's destruction results in a large casualty loss deduction exceeding the taxpayer's income.The taxpayer will be allowed to carry forward a net operating loss due to this personal loss.

Accepted Answer

This is true. The taxpayer can claim a casualty loss deduction and if it exceeds their income, they can carry forward the loss as a net operating loss.

Question 4

Daniel's cabin was destroyed in a massive tornado in 2019.After consideration of insurance,he has a loss of $15,000.Due to the tornado,the area has been declared a federal disaster area.Daniel can deduct this loss in

Accepted Answer

When a loss occurs in a federally declared disaster area, taxpayers have the option to deduct the loss in the year the disaster occurred or the previous year.

Question 5

A bona fide debtor-creditor relationship can never exist in the case of related parties.

Accepted Answer

A debtor-creditor relationship can exist between related parties, but it may be subject to a higher level of scrutiny to ensure that the transaction is conducted at arm's length and on commercial terms.

Question 6

Vera has a key supplier for her business who was facing cash flow problems which would impair Vera's ability to get shipments of key components for her production.Vera made a $10,000 loan to the supplier.Unfortunately the supplier filed for bankruptcy and has gone out of business without repaying Vera.Vera will be able to recognize a loss of

Accepted Answer

Vera can recognize a loss of the full $10,000 as she is not expected to receive any repayment from the bankrupt supplier.

Question 7

A net operating loss can be carried back three years or carried forward five years.

Accepted Answer

Under the current U.S. tax law, net operating losses (NOLs) can be carried forward indefinitely, but they cannot be carried back. Prior to the Tax Cuts and Jobs Act of 2017, NOLs could be carried back two years and forward 20 years.

Question 8

Ella is a cash method sole proprietor providing senior care services to clients.One of her clients passes away owing her $1,500 for services performed.Ella has been notified that there are no assets in the estate to pay her bill.Ella will be able to recognize a business bad debt.

Accepted Answer

Under the cash method of accounting, income is only recognized when it is actually received. Since Ella never received the $1,500, it was never included in her income, and therefore, she cannot claim it as a business bad debt.

Question 9

A net operating loss (NOL)occurs when taxable income for any year is negative because itemized deductions exceed business income.

Accepted Answer

A net operating loss (NOL) occurs when business expenses and deductions exceed revenues and taxable income. It is possible for itemized deductions to exceed business income without resulting in a NOL.

Question 10

Last year,Abby loaned her friend,Pat,$10,000.Although Pat had signed a note payable that contained interest payments and a maturity date,the loan had not been repaid this year when Pat died insolvent.For this year,assuming that the loan was bona fide,Abby should account for nonpayment of the loan as a(n)

Accepted Answer

The answer of Last year,Abby loaned her friend,Pat,$10,000.Although Pat had...

Question 11

In 2019,Grace loaned her friend Paula $12,000 to invest in various stocks.Paula signed a note to repay the principal with interest.Unfortunately the market for that industry sector plunged,and Paula incurred large losses.In 2019,Paula declared personal bankruptcy and Grace was unable to collect any of her loan.Grace had no other gains or losses last year or this year.The result is

Accepted Answer

The answer of In 2019,Grace loaned her friend Paula $12,000...

Question 12

Which of the following expenses or losses could create a net operating loss for an individual taxpayer?

Accepted Answer

An operating loss from a sole proprietorship can create a net operating loss for an individual taxpayer, as it directly affects the taxpayer's income from business operations.

Question 13

For a bad debt to be deductible,the taxpayer must have a basis in the debt.

Accepted Answer

According to the IRS, for a bad debt to be deductible, the taxpayer must have a basis in the debt. This means that the taxpayer must have previously loaned money to someone and must have included that loan in their income in a prior tax year.

Question 14

No deduction is allowed for a partially worthless nonbusiness debt.

Accepted Answer

According to the IRS, a taxpayer cannot take a deduction for a partially worthless nonbusiness debt. The debt must be completely worthless in order for a deduction to be allowed.

Question 15

A taxpayer guarantees another person's obligation and is forced to pay the debt under the terms of the guarantee.The original debtor does not repay the taxpayer.The taxpayer/guarantor may deduct the loss.

Accepted Answer

According to the IRS, a taxpayer who guarantees another person's obligation and is forced to pay the debt under the terms of the guarantee may take a bad debt deduction.

Question 16

An individual taxpayer has negative taxable income for the year.In calculating the net operating loss created,which of the following expenses or losses will be added back to the negative taxable income?

Accepted Answer

Both capital losses and nonbusiness deductions in excess of nonbusiness income are added back to the negative taxable income when calculating the net operating loss. This is because net operating loss is based on the taxpayer's ability to generate income, and these deductions and losses decrease the taxpayer's ability to do so.

Question 17

A business bad debt gives rise to an ordinary deduction while a nonbusiness bad debt is treated as a short-term capital loss.

Accepted Answer

A business bad debt is deductible as an ordinary loss in the year it becomes totally worthless or partly worthless. On the other hand, a nonbusiness bad debt is treated as a short-term capital loss and can only be deducted as a capital loss up to a maximum of $3,000 per year.

Question 18

Martha,an accrual method taxpayer,has an accounting practice.In 2018,she performs tax analyses for Arnold and sends him an invoice for $10,000.In 2019,Martha sells her practice and all accounts to David.Arnold's debt becomes worthless that year after David has purchased the practice.The result is

Accepted Answer

Since David purchased Martha's accounting practice, he takes over the accounts receivable and any bad debts that may arise. The debt owed by Arnold becomes a business bad debt for David, and he can deduct it on his 2019 tax return. Martha cannot deduct the bad debt since she has transferred ownership of the accounts to David.

Question 19

In October 2019,Jonathon Remodeling Co.,an accrual method taxpayer,remodels and renovates an office building for Dale and bills him $30,000.Dale signs a note for the debt.Dale keeps delaying payment and files bankruptcy in 2020.Creditors are informed that no assets are available for payment.Jonathon Remodeling Co.will report

Accepted Answer

Under the accrual method of accounting, income is recognized when earned and it is immaterial if payment is received. Therefore, Jonathon Remodeling Co. will report $30,000 of income in 2019. Since Dale is now bankrupt and there are no assets to satisfy the debt, Jonathon Remodeling Co. can take a bad debt deduction in the year the debt becomes partially or totally worthless, which is 2020. The deduction would be for the full amount of $30,000.

Question 20

Taj operates a sole proprietorship,maintaining the business records under the cash method of accounting.Taj performs services for a client and sends the client a bill for $12,000.Six months later,before payment is received by Taj,the client files bankruptcy,with no assets available for unsecured creditors such as Taj.Taj will deduct

Accepted Answer

Since Taj operates a sole proprietorship using the cash method of accounting, Taj would not have recognized any income until payment was received. Therefore, Taj cannot deduct any loss as no income was recognized.

Quiz 25: Losses and Bad Debts