Contrary to what many freelancer writers mistakenly believe, long-standing regulations usually prohibit most of them from claiming bad-debt deductions on their tax returns when they’re unable to recover amounts due from clients. Why should freelancers forget about any kind of relief when they fill out their tax forms? Because, says the IRS, there are no tax breaks for “cash-basis taxpayers,” agency argot for individuals who weren’t previously required to count those unpaid amounts as reportable income. The IRS 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 myexpenses. 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. 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: You can’t take any deduction for the $2,000. The snag: You’re what’s known as a “cash-basis taxpayer.” That’s the IRS’s designation of individuals (including most of us) who generally don’t have to report payments for articles and books until the year that they actually receive them and don’t get to deduct their expenses until the year that they pay them. As the tax code doesn’t require you to count the $2,000 as reportable income, it doesn’t 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 hasn’t actually arrived and is a lost cause.