Revenue Administrative Bulletin 1989-61

SALES AND USE TAXES - REVISED BAD DEBT GUIDELINES

(Replaces Sales and Use Tax Bulletin 1983-4)

RAB-89-61. Effective January 1, 1984, 1982 PA 23 amended the Sales Tax Act, MCL 205.51 et seq., to allow a deduction for bad debts. This Bulletin explains the bad debt deduction a retailer may claim relating to previously reported taxable retail sales. [MCL 205.54i(l)]

Effective May 24, 1985, a taxpayer may deduct the amount of bad debts relating to prepaid sales tax on gasoline. [MCL 205.56a(3)]

Bad Debt Defined

"Bad debt" means that portion of a debt or account receivable relating to a sale at retail, or to prepaid sales tax on gasoline, not otherwise deductible or excludable, that has become worthless or uncollectible between the last sales tax reporting period and the current sales tax reporting period. This bad debt must be eligible to be claimed, in accordance with the taxpayer's accounting method, as a deduction under Section 166 of the Internal Revenue Code.

Amounts Not Included as Bad Debt

The bad debt deduction for sales tax purposes shall not include any amount represented by the following:

1. Interest or finance charge.
2. Sales tax charged on the original sale.
3. Uncollectible amounts on property where the property remains in the possession of the vendor until the full purchase price is paid, i.e., property placed on layaway.
4. Expenses incurred in attempting to collect any account receivable or any portion of an account that is subsequently recovered.
5. Any debt or account receivable that has been sold, assigned or transferred to a third party for collection.
6. Sales tax charged on property that is subsequently repossessed.
7. A sale where tax was paid more than 4 years prior to the date of the bad debt claim. [MCL 205.59(3)]

Substantiating a Bad Debt Deduction

The taxpayer claiming a bad debt deduction must substantiate the validity of such a deduction by maintaining a record of all of the following:

1. The name of the purchaser/debtor.
2. The date of the sale or sales giving rise to the bad debt.
3. The price of the property and the amount of the sales tax charged.
4. The amount of interest, finance or service charges incorporated in the debt or an account.
5. The dates and amounts of any payments made on a debt or an account.
6. The portion of the debt or account representing a charge that was not subjected to tax in the original transaction.

If the above documentation is not available, then the maximum deduction allowed shall equal the amount of the bad debt times the percentage obtained by dividing the retailer's taxable sales in the preceding calendar year by total sales in the preceding calendar year.

Bad Debt Reserve Account

If the retailer maintains a reserve for bad debts, only actual charges against the reserve representing uncollectible debts or accounts may be deducted for bad debt purposes. Contributions to the reserve account are not deductible as a sales tax bad debt.

Recouping a Bad Debt After Deduction

If a retailer takes a bad debt deduction and later collects all or part of the account, then the amount collected must be reported as a taxable sale in the reporting period it was collected.