Julian Block

freelance writer
Larchmont, New York

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No Tax Break If Client Stiffs You

You jump hoops for the client and then get stiffed. How much of a break do you get at tax time? Usually, zip.

Written Sep 02, 2008, read 2477 times since then.

Contrary to what many freelancers, consultants and other self-employed individuals mistakenly believe, long-standing regulations usually prohibit most of them from claiming bad-debt deductions on their federal and state returns when they are unable to recover amounts due from clients and customers. Why should freelancers forget about any kind of relief when they fill out their tax forms? Because, says the Internal Revenue Service, there are no tax breaks for “cash-basis taxpayers,” agency argot for individuals who were not previously required to count those unpaid amounts as reportable income.

The Internal Revenue Code helps ease the hurt only for freelancers who come within the definition of “accrual basis taxpayers,” meaning individuals who were previously required to declare such amounts as income.

Below is a representative question that I have frequently received from freelancers.

Question: Last year, a magazine agreed to pay $2,000 for an article, plus reimburse my expenses. Usually, I ask and receive more for this kind of article, but I wanted the exposure this publication could provide. This year, I made sure to deliver the article well in advance of its due date, along with my bill for $2,700, comprised of the $2,000 fee and $700 for travel, telephone and other expenses incurred in the course of research.

The assignment turned out to be a fiasco. I will collect zilch, because the magazine went kaput; last I heard of its publishers, they had gone into the witness protection program. When tax time rolls around, I know where the various out-of-pocket expenses aggregating $700 go on which lines of Form 1040’s Schedule C (Profit or Loss From Business). It seems only fair that I should be entitled to a further reduction in my income taxes with a bad-debt deduction on Schedule C for that unpaid $2,000 fee.

As I fall into a 30 percent federal and state bracket, the additional write-off works out to a savings of $600 — not monumental moola, but likely enough to cover several sumptuous spreads of my favorite paella at a Zagat-recommended restaurant. Some extra consolation is that a decrease in Schedule C’s net profit will lower what I owe for self-employment taxes. But where do I enter the $2,000 deduction in the expenses part of Schedule C? Or am I supposed to amend the previous year’s return in order to claim it?

Answer: Downsize your dining desires and be content to gorge with the other gringos at La Casa Internacional de Pancakes. You cannot take any deduction for the $2,000.

The snag: You are what is known as a “cash-basis taxpayer.” That is the Internal Revenue Service’s designation of individuals (including most of us) who generally do not have to report payments for articles, books and other income items until the year that they actually receive them and do not get to deduct their expenses until the year that they pay them. As the tax code does not require you to count the $2,000 as reportable income, it does not allow you to deduct an equivalent amount.

Only if you were an “accrual basis taxpayer,” and had previously counted the $2,000 as reportable income at the time it became due to you, could you deduct it now, as it has not actually arrived and is a lost cause.

Learn more about the author, Julian Block.

Posted by John Huddleston, Bellevue, Washington | Sep 07, 2008

Great article Julian. I get this question all the time. This is one the IRS got right. Since you never had to pay tax on the income, you shouldn't receive a deduction when they don't pay. Still, cash basis is often a better deal than accrual. Most my clients receivables are larger than their payables. Thus, less tax when you are cash basis.
John Huddleston
Huddleston Tax Accountants

CPA tax preparation in Seattle Bellevue Redmond
Posted by Terra Paley, Los Angeles, California | Sep 07, 2008

As freelancers we are often ripe for the picking from freeloaders. My biggest debtor is a new gold star supporting member on biznik. She owes many people on biznik and we all grit our teeth to see that she can afford the gold star but not her many debtors.

I feel your pain and will feel it again at tax time.

I have done many assignments without first collecting with good results. I have to keep the faith but one or two of those a year is very hard.
Posted by Terra Paley, Los Angeles, California | Sep 07, 2008

Hi Julian,

Logically I understand the concept of no billing, no tax. The few times I have been in this situation, I have gone out of my way to help someone. My big freeloader has elements of a sociopath-not worrying whether the money was really there and believing in her strong personal communication skills. We all did things for her last minute at great personal cost-either putting off other paying projects, interrupting holidays, lending her money, etc. to toil on her projects.

The effort was intense because there was no strategic plan or forethought. Her work is project based with firm due dates, etc. Lots of profuse thanks and promises and no cash seems to be her MO.

I always use my best and highest skills to assist others. Therefore, I really am out the time, effort, overhead, gas, meals, etc. Sure, I didn't pay taxes but neither did she on my time and efforts-same with many others. I see my freeloader as a thief. She took my time, efforts, gas and furthermore she used my work at one of her events.

This is not someone you can take to small claims court(in my case it exceeded the small claims limit). She cons legal counsel as well and is good at that. Then they call you later and ask if you know where she is....they did not get paid. Hello, that scenario played out twice.
Posted by Julian Block, Larchmont, New York | Sep 07, 2008

John, I appreciate your kind words. As it happens, I was recently in Seattle, Bellevue and Tacoma. Particularly like the main public library in Seattle, visited friends in Bellevue and they took us to the glass museum in Tacoma.
Posted by Julian Block, Larchmont, New York | Sep 07, 2008

Terra,

First time around, shame on the client. If there is a second and later times, shame on vous.

Possibly there is a misunderstanding on your part about small claims court. When your claim exceeds the cap in small claims court for your area, you still can sue for an amount up to the cap. An example: Cap in New York State is $3,000. If amount of claim is $5,000, you go to court for $3,000. Hope that helps.
Posted by Terra Paley, Los Angeles, California | Sep 07, 2008

Only once with this client. There are many of here on biznik who have burned by her.

I don't have time to take her to small claims court. This particular person has many judgements against her. Many of the larger hotels, smaller clubs, etc. have taken her and won. They just never get the money and never will. Even a private club here was stiffed and to my knowledge did not take her to court. Someone lost their position because they trusted her... and the stories go on.

As for having two sets of counsel call, all for the same incident. She goes through them with rapidity. It doesn't take long before they realize they have also been conned. So, I had two different solo practicioners call me for the same claim.
Posted by Martin Greenberg, Seattle, Washington | Sep 08, 2008

Can you send the person a 1099 (or whatever the proper IRS form is) for services rendered so at least they have to pay something for our services?

Marty
Posted by Julian Block, Larchmont, New York | Sep 08, 2008

Martin,

First, the stiffee would have to send a payment to the stiffer. And why, pray, would the stiffee want to do that? Also, the IRS might get miffed at misuse of the reporting requirements for 1099 forms.
Posted by John Huddleston, Bellevue, Washington | Sep 08, 2008

1099-c (cancellation of debt) may be a possibility. I wouldn't do it without research, however, and where does that get you? Besides, one of the exceptions to recognizing cancellation of debt income is insolvency.
John Huddleston
Huddleston Tax Consulting

CPA tax preparation in Seattle Bellevue Redmond
Posted by Julian Block, Larchmont, New York | Sep 08, 2008

John, It's a possibility. But I'd hesitate to invoke cancellation of debt. Among other snags, the stiffer might contend there was no debt to cancel, because the stiffee provided an unsatisfactory product or service.
Posted by Keith Gormezano, Seattle, Washington | Oct 06, 2008

Terra, I would recommend that you name this gold star member who can afford to pay for her membership and appear "legitimate" but has stiffed you and other members. It is already a matter of public record that she has judgements against her. What's one more complaint?

I trust members who are paying members more than someone who is not and that is why this issue is important to all of us.

The other alternative is to file a complaint with Dan and Laura that her behavior may be in violation of Section 4 "fraudulent activities" of the Biznik Code of Conduct because it is an ongoing behavior rather than an isolated occurrance.

It may also be a violation of Section 4 of the Biznik Terms of Service in that not regularly paying your bills to other Biznik members harms Biznik members.

A good practice for all of us is to ask for the money at the time of service or a portion, usually 1/3 to 1/2 down.

John, filing a 1099-c is a good idea as it creates reportable income to her and a major tax headache (karma?) Maybe that will wake her up rather than a few judgements by the corporate world.

It seems that she is avoiding paying her bills rather than simply being unable to which would be a different kettle of fish. Thus, in my opinion it would be difficult to claim insolvency as a "defense." And even if she claims that the product or service was unsatisfactory, so what?

Dr QuickBooks & Quicken: I make house calls to help you
Posted by Shaun Lawrence, Irvine, California | Oct 29, 2009

I can relate, I have been stiffed by one of my clients after I jumped through many hoops to complete tax return. I am looking at my option to pursue what is due and a little confused where to start. Shaun Lawrence, Accountant, Anaheim