Discussion:Reasonable steps to collect a bad debt

Quoting from IRS [Topic 453 - Bad Debt Deduction] (emphasis added): “A debt becomes worthless when the surrounding facts and circumstances indicate there is no longer any chance the amount owed will be paid. To show that a debt is worthless, you must establish that you have taken reasonable steps to collect the debt. It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless. You do not have to wait until a debt is due to determine whether it is worthless.”

A client loaned $3,500 cash to an unrelated person. The person is a former employee of a business associate of my client. Because of that connection, the client has personal knowledge that the person has become unemployed and is suffering economic hardship. The client has sent two certified letters over the past year, with return receipt signed and returned.

They believe they will never be repaid.

Is there anything more a “reasonable” person would be required to do to establish that they took “reasonable steps to collect the debt”?

The TP has sent two scorching letters of demand to the hapless, and almost dead, debtor. Such letters have been acknowledged in due form, and yet the debtor continues to shirk his responsibilities, and continues on the road downhill (another victim, no doubt, of the Depression ...err recession).

I don't think it proper to waste the court's time with such frivolity! To chase after this poor man now would be a mere sport; akin to the safaris of old, in the hunt for a useless trophy: an uncollectible judgment.

Yes, the client could pursue a judgement, but the IRS is stating clearly that it is not necessary to go to court to get a judgement. So obviously, there are other actions that can convince them that you have a basis for judging the debt uncollectible.

This question raises a second: "You may take the deduction only in the year the debt becomes worthless." Since the determination of worthlessness is subjective, is there anything to keep my taxpayer from making that determination in a future year, not 2009 when their taxable income will mostly likely be reduced to zero already?

If the lawyer wrote something like this: "Based upon the facts and circumstances presented to me on this date (meaning a date in 2009), I find that it would most likely be a waste of legal resources to pursue this debt"

Frankly, even without such a sentence, the letter would be dated this year, and the lawyer could just say it's not worth pursuing.