A taxpayer is a cash-basis sole proprietor. In Year 1, the taxpayer performed services for a client and sent a bill for $5,000. In Year 2, the client disputed the bill and paid only $2,000. The taxpayer accepted this as full payment. What is the bad debt deduction for the taxpayer in Year 2?

Answer options:

$3,000

$5,000

$2,000

How to approach this question

Cash Basis Rule: No Income Recognized = No Bad Debt Deduction.

Full Answer

A.$0✓ Correct

A cash-basis taxpayer reports income only when cash is received. Since the $5,000 was never included in income, the taxpayer has no tax basis in the receivable and thus cannot claim a bad debt deduction for the uncollected amount.

Common mistakes

Applying accrual basis rules to a cash basis taxpayer.

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