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Free tax help Publication 939 - Introductory Material Table of Contents What's New Future developments. Free tax help IntroductionSimplified Method. Free tax help Ordering forms and publications. Free tax help Tax questions. Free tax help Useful Items - You may want to see: What's New Beginning in 2013, distributions from an annuity under a nonqualified plan are considered net investment income for the purpose of figuring the net investment income tax (NIIT). Free tax help For more information, see the instructions for Form 8960, Net Investment Income Tax – Individuals, Estates and Trusts. Free tax help Future developments. Free tax help For the latest information about developments related to Publication 939, such as legislation enacted after it was published, go to www. Free tax help IRS. Free tax help gov/pub939. Free tax help Introduction This publication gives you the information you need to determine the tax treatment of your pension and annuity income under the General Rule. Free tax help Generally, each of your monthly annuity payments is made up of two parts: the tax-free part that is a return of your net cost, and the taxable balance. Free tax help What is the General Rule. Free tax help   The General Rule is one of the two methods used to figure the tax-free part of each annuity payment based on the ratio of your investment in the contract to the total expected return. Free tax help The other method is the Simplified Method, which is discussed in Publication 575, Pension and Annuity Income. Free tax help Who must use the General Rule. Free tax help   Use this publication if you receive pension or annuity payments from: A nonqualified plan (for example, a private annuity, a purchased commercial annuity, or a nonqualified employee plan), A qualified plan if: Your annuity starting date is before November 19, 1996 (and after July 1, 1986), and you do not qualify to use, or did not choose to use, the Simplified Method, or Your annuity starting date is after November 18, 1996, and as of that date you are age 75 or over and the annuity payments are guaranteed for at least 5 years. Free tax help If your annuity starting date was between July 1, 1986 and November 19, 1996, you were able to elect to use the Simplified Method or the General Rule. Free tax help This choice is irrevocable and applied to all later annuity payments. Free tax help The following are qualified plans. Free tax help A qualified employee plan. Free tax help A qualified employee annuity. Free tax help A tax-sheltered annuity (TSA) plan or contract. Free tax help Simplified Method. Free tax help   If you receive pension or annuity payments from a qualified plan and you are not required to use the General Rule, you must use the Simplified Method to determine the tax-free part of each annuity payment. Free tax help This method is described in Publication 575, Pension and Annuity Income. Free tax help   Also, if, at the time the annuity payments began, you were at least age 75 and were entitled to annuity payments from a qualified plan with fewer than 5 years of guaranteed payments, you must use the Simplified Method. Free tax help Beginning in 2013, distributions from an annuity under a nonqualified plan are considered net investment income for the purpose of figuring the net investment income tax (NIIT). Free tax help For more information, see the instructions for Form 8960, Net Investment Income Tax – Individuals, Estates and Trusts. Free tax help Topics not covered in this publication. Free tax help   Certain topics related to pensions and annuities are not covered in this publication. Free tax help They include: Simplified Method. Free tax help This method is covered in Publication 575. Free tax help That publication also covers nonperiodic payments (amounts not received as an annuity) from a qualified pension or annuity plan, rollovers, special averaging and capital gain treatment of lump-sum distributions, and special additional taxes on early distributions, excess distributions, and excess accumulations (not making required minimum distributions). Free tax help Individual retirement arrangements (IRAs). Free tax help Information on the tax treatment of amounts you receive from an IRA is included in Publication 590, Individual Retirement Arrangements (IRAs). Free tax help Life insurance payments. Free tax help If you receive life insurance payments because of the death of the insured person, get Publication 525, Taxable and Nontaxable Income, for information on the tax treatment of the proceeds. Free tax help Help from IRS. Free tax help   If, after reading this publication, you need help to figure the taxable part of your pension or annuity, the IRS can do it for you for a fee. Free tax help For information on this service, see Requesting a Ruling on Taxation of Annuity , later. Free tax help Comments and suggestions. Free tax help   We welcome your comments about this publication and your suggestions for future editions. Free tax help   You can write to us at the following address: Internal Revenue Service Tax Forms and Publications Division 1111 Constitution Ave. Free tax help NW, IR-6526 Washington, DC 20224   We respond to many letters by telephone. Free tax help Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. Free tax help   You can send your comments from www. Free tax help irs. Free tax help gov/formspubs/. Free tax help Click on “More Information” and then on “Comment on Tax Forms and Publications”. Free tax help   Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products. Free tax help Ordering forms and publications. Free tax help   Visit www. Free tax help irs. Free tax help gov/formspubs/ to download forms and publications, call 1-800-TAX-FORM (1-800-829-3676), or write to the address below and receive a response within 10 days after your request is received. Free tax help Internal Revenue Service 1201 N. Free tax help Mitsubishi Motorway Bloomington, IL 61705-6613 Tax questions. Free tax help   If you have a tax question, check the information available on IRS. Free tax help gov or call 1-800-829-1040. Free tax help We cannot answer tax questions sent to either of the above addresses. Free tax help Useful Items - You may want to see: Publication 524 Credit for the Elderly or the Disabled 525 Taxable and Nontaxable Income 571 Tax-Sheltered Annuity Plans (403(b) Plans) 575 Pension and Annuity Income 590 Individual Retirement Arrangements (IRAs) 721 Tax Guide to U. Free tax help S. Free tax help Civil Service Retirement Benefits 910 Guide To Free Tax Services Form (and Instructions) 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Free tax help See How To Get Tax Help near the end of this publication for information about getting these publications and forms. Free tax help Prev  Up  Next   Home   More Online Publications
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Page Last Reviewed or Updated: 06-Mar-2014

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Free tax help 10. Free tax help   Business Bad Debts Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Definition of Business Bad DebtAccrual method. Free tax help Cash method. Free tax help Debt acquired from a decedent. Free tax help Liquidation. Free tax help Types of Business Bad Debts When a Debt Becomes Worthless How To Claim a Business Bad DebtSpecific Charge-Off Method Nonaccrual-Experience Method Recovery of a Bad DebtNet operating loss (NOL) carryover. Free tax help Introduction You have a bad debt if you cannot collect money owed to you. Free tax help A bad debt is either a business bad debt or a nonbusiness bad debt. Free tax help This chapter discusses only business bad debts. Free tax help Generally, a business bad debt is one that comes from operating your trade or business. Free tax help You can deduct business bad debts on Schedule C (Form 1040) or your applicable business income tax return. Free tax help All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. Free tax help For more information on nonbusiness bad debts, see Publication 550. Free tax help Topics - This chapter discusses: Definition of business bad debt When a debt becomes worthless How to claim a business bad debt Recovery of a bad debt Useful Items - You may want to see: Publication 525 Taxable and Nontaxable Income 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 556 Examination of Returns, Appeal Rights, and Claims for Refund Form (and Instructions) Schedule C (Form 1040) Profit or Loss From Business 1040X Amended U. Free tax help S. Free tax help Individual Income Tax Return 1045 Application for Tentative Refund 1139 Corporation Application for Tentative Refund 3115 Application for Change in Accounting Method See chapter 12 for information about getting publications and forms. Free tax help Definition of Business Bad Debt A business bad debt is a loss from the worthlessness of a debt that was either: Created or acquired in your trade or business, or Closely related to your trade or business when it became partly or totally worthless. Free tax help A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Free tax help Bad debts of a corporation (other than an S corporation) are always business bad debts. Free tax help Credit sales. Free tax help   Business bad debts are mainly the result of credit sales to customers. Free tax help Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. Free tax help After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt. Free tax help   Accounts or notes receivable valued at fair market value (FMV) when received are deductible only at that value, even though the FMV may be less than the face value. Free tax help If you purchased an account receivable for less than its face value, and the receivable subsequently becomes worthless, the most you are allowed to deduct is the amount you paid to acquire it. Free tax help    You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. Free tax help This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest. Free tax help Accrual method. Free tax help   If you use the accrual method of accounting, you generally report income as you earn it. Free tax help You can only claim a bad debt deduction for an uncollectible receivable if you have previously included the uncollectible amount in income. Free tax help   If you qualify, you can use the nonaccrual-experience method of accounting discussed later. Free tax help Under this method, you do not have to accrue income that, based on your experience, you do not expect to collect. Free tax help Cash method. Free tax help   If you use the cash method of accounting, you generally report income when you receive payment. Free tax help You cannot claim a bad debt deduction for amounts owed to you because you never included those amounts in income. Free tax help For example, a cash basis architect cannot claim a bad debt deduction if a client fails to pay the bill because the architect's fee was never included in income. Free tax help Debts from a former business. Free tax help   If you sell your business but retain its receivables, these debts are business debts because they arose out of your trade or business. Free tax help If any of these receivables subsequently become worthless, the loss is still a business bad debt. Free tax help Debt acquired from a decedent. Free tax help   The character of a loss from debts of a business acquired from a decedent is determined in the same way as debts acquired on the purchase of a business. Free tax help The executor of the decedent's estate treats any loss from the debts as a business bad debt if the debts were closely related to the decedent's trade or business when they became worthless. Free tax help Otherwise, a loss from these debts becomes a nonbusiness bad debt for the decedent's estate. Free tax help Liquidation. Free tax help   If you liquidate your business and some of the accounts receivable that you retain become worthless, they become business bad debts. Free tax help Types of Business Bad Debts Business bad debts may result from the following. Free tax help Loans to clients and suppliers. Free tax help   If you loan money to a client, supplier, employee, or distributor for a business reason and you are unable to collect the loan after attempting to do so, you have a business bad debt. Free tax help Debts owed by political parties. Free tax help   If a political party (or other organization that accepts contributions or spends money to influence elections) owes you money and the debt becomes worthless, you can claim a bad debt deduction only if all of the following requirements are met. Free tax help You use the accrual method of accounting. Free tax help The debt arose from the sale of goods or services in the ordinary course of your trade or business. Free tax help More than 30% of your receivables accrued in the year of the sale were from sales to political parties. Free tax help You made substantial and continuing efforts to collect on the debt. Free tax help Loan or capital contribution. Free tax help   You cannot claim a bad debt deduction for a loan you made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital. Free tax help Debts of an insolvent partner. Free tax help   If your business partnership breaks up and one of your former partners becomes insolvent, you may have to pay more than your pro rata share of the partnership's debts. Free tax help If you pay any part of the insolvent partner's share of the debts, you can claim a bad debt deduction for the amount you paid that is attributable to the insolvent partner's share. Free tax help Business loan guarantee. Free tax help   If you guarantee a debt that subsequently becomes worthless, the debt can qualify as a business bad debt if all the following requirements are met. Free tax help You made the guarantee in the course of your trade or business. Free tax help You have a legal duty to pay the debt. Free tax help You made the guarantee before the debt became worthless. Free tax help You meet this requirement if you reasonably expected you would not have to pay the debt without full reimbursement from the borrower. Free tax help You received reasonable consideration for making the guarantee. Free tax help You meet this requirement if you made the guarantee in accord with normal business practice or for a good faith business purpose. Free tax help Example. Free tax help Jane Zayne owns the Zayne Dress Company. Free tax help She guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet. Free tax help Elegant Fashions is one of Zayne's largest clients. Free tax help Elegant Fashions later defaulted on the loan. Free tax help As a result, Ms. Free tax help Zayne paid the remaining balance of the loan in full to the bank. Free tax help She can claim a business bad debt deduction only for the amount she paid, since her guarantee was made in the course of her trade or business for a good faith business purpose. Free tax help She was motivated by the desire to retain one of her better clients and keep a sales outlet. Free tax help Deductible in the year paid. Free tax help   If you make a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have rights against the borrower. Free tax help Rights against a borrower. Free tax help   When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. Free tax help The debt is then owed to you. Free tax help If you have this right, or some other right to demand payment from the borrower, you cannot claim a bad debt deduction until these rights become partly or totally worthless. Free tax help Joint debtor. Free tax help   If two or more debtors jointly owe you money, your inability to collect from one does not enable you to deduct a proportionate amount as a bad debt. Free tax help Sale of mortgaged property. Free tax help   If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt is a bad debt. Free tax help When a Debt Becomes Worthless A debt becomes worthless when there is no longer any chance the amount owed will be paid. Free tax help This may occur when the debt is due or prior to that date. Free tax help To demonstrate worthlessness, you must only show that you have taken reasonable steps to collect the debt but were unable to do so. Free tax help It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. Free tax help Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt. Free tax help Property received for debt. Free tax help   If you receive property in partial settlement of a debt, reduce the debt by the property's FMV, which becomes the property's basis. Free tax help You can deduct the remaining debt as a bad debt if and when it becomes worthless. Free tax help   If you later sell the property for more than its basis, any gain on the sale is due to the appreciation of the property. Free tax help It is not a recovery of a bad debt. Free tax help For information on the sale of an asset, see Publication 544. Free tax help How To Claim a Business Bad Debt There are two methods to claim a business bad debt. Free tax help The specific charge-off method. Free tax help The nonaccrual-experience method. Free tax help Generally, you must use the specific charge-off method. Free tax help However, you may use the nonaccrual-experience method if you meet the requirements discussed later under Nonaccrual-Experience Method . Free tax help Specific Charge-Off Method If you use the specific charge-off method, you can deduct specific business bad debts that become either partly or totally worthless during the tax year. Free tax help However, with respect to partly worthless bad debts, your deduction is limited to the amount you charged off on your books during the year. Free tax help Partly worthless debts. Free tax help   You can deduct specific bad debts that become partly uncollectible during the tax year. Free tax help Your tax deduction is limited to the amount you charge off on your books during the year. Free tax help You do not have to charge off and deduct your partly worthless debts annually. Free tax help You can delay the charge off until a later year. Free tax help However, you cannot deduct any part of a debt after the year it becomes totally worthless. Free tax help Significantly modified debt. Free tax help   An exception to the charge-off rule exists for debt which has been significantly modified and on which the holder recognized gain. Free tax help For more information, see Regulations section 1. Free tax help 166-3(a)(3). Free tax help Deduction disallowed. Free tax help   Generally, you can claim a partial bad debt deduction only in the year you make the charge-off on your books. Free tax help If, under audit, the IRS does not allow your deduction and the debt becomes partly worthless in a later tax year, you can deduct the amount you charged off in that year plus the disallowed amount charged off in the earlier year. Free tax help The charge-off in the earlier year, unless reversed on your books, fulfills the charge-off requirement for the later year. Free tax help Totally worthless debts. Free tax help   If a debt becomes totally worthless in the current tax year, you can deduct the entire amount, less any amount deducted in an earlier tax year when the debt was only partly worthless. Free tax help   You do not have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. Free tax help However, you may want to do so. Free tax help If you do not and the IRS later rules the debt is only partly worthless, you will not be allowed a deduction for the debt in that tax year because a deduction of a partly worthless bad debt is limited to the amount actually charged off. Free tax help See Partly worthless debts, earlier. Free tax help Filing a claim for refund. Free tax help   If you did not deduct a bad debt on your original return for the year it became worthless, you can file a claim for a credit or refund. Free tax help If the bad debt was totally worthless, you must file the claim by the later of the following dates. Free tax help 7 years from the date your original return was due (not including extensions). Free tax help 2 years from the date you paid the tax. Free tax help   If the claim is for a partly worthless bad debt, you must file the claim by the later of the following dates. Free tax help 3 years from the date you filed your original return. Free tax help 2 years from the date you paid the tax. Free tax help You may have longer to file the claim if you were unable to manage your financial affairs due to a physical or mental impairment. Free tax help Such an impairment requires proof of existence. Free tax help   For details and more information about filing a claim, see Publication 556. Free tax help Use one of the following forms to file a claim. Free tax help For more information, see the instructions for the applicable form. Free tax help Table 10-1. Free tax help Forms Used To File a Claim IF you filed as a. Free tax help . Free tax help . Free tax help THEN file. Free tax help . Free tax help . Free tax help Sole proprietor or farmer Form 1040X Corporation Form 1120X S corporation Form 1120S and check box H(4) Partnership Form 1065X if filing on paper or  Form 1065 and check box G(5) if filing electronically Nonaccrual-Experience Method If you use an accrual method of accounting and qualify under the rules explained in this section, you can use the nonaccrual-experience method for bad debts. Free tax help Under this method, you do not accrue service related income you expect to be uncollectible. Free tax help Because the expected uncollectible amounts are not included in income, these amounts are not later deducted from income. Free tax help Generally, you can use the nonaccrual-experience method for accounts receivable for services you performed only if: The services are provided in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, or the performing arts, or You meet the $5 million gross receipts test for all prior years. Free tax help Service related income. Free tax help   You can use the nonaccrual-experience method only for amounts earned by performing services. Free tax help You cannot use this method for amounts owed to you from activities such as lending money, selling goods, or acquiring receivables or other rights to receive payment. Free tax help Gross receipts test. Free tax help   To find out if you meet the $5 million gross receipts test for all prior years, you must figure the average annual gross receipts for each prior year. Free tax help If your average annual gross receipts for any year exceeds $5 million, you cannot use the non-accural experience method. Free tax help   The average annual gross receipts for any year is the average of gross receipts from the year in question and the 2 previous years. Free tax help For example, if you were figuring the average annual gross receipts for 2013, you would average your gross receipts for 2011, 2012, and 2013. Free tax help Interest or penalty charged. Free tax help   Generally, you cannot use the nonaccrual-experience method for amounts due on which you charge interest or a late payment penalty. Free tax help However, do not treat a discount offered for early payment as the charging of interest or a penalty if both the following apply. Free tax help You otherwise accrue the full amount due as gross income at the time you provide the services. Free tax help You treat the discount allowed for early payment as an adjustment to gross income in the year of payment. Free tax help Change in accounting method. Free tax help   Generally, you must obtain consent to change to a nonaccrual-experience method (other than one of the safe harbor methods) or to change from one method to another. Free tax help See Form 3115 and the Instructions for Form 3115 for more information. Free tax help Recovery of a Bad Debt If you claim a deduction for a bad debt on your income tax return and later recover (collect) all or part of it, you may have to include all or part of the recovery in gross income. Free tax help The amount you include is limited to the amount you actually deducted. Free tax help However, you can exclude the amount deducted that did not reduce your tax. Free tax help Report the recovery as “Other income” on the appropriate business form or schedule. Free tax help See Recoveries in Publication 525 for more information. Free tax help Net operating loss (NOL) carryover. Free tax help   If a bad debt deduction increases an NOL carryover that has not expired before the beginning of the tax year in which the recovery takes place, you treat the deduction as having reduced your tax. Free tax help A bad debt deduction that contributes to a NOL helps lower taxes in the year to which you carry the NOL. Free tax help For more information about NOLs, see Publication 536. Free tax help Also, see the Instructions for Form 1045, and the Instructions for Form 1139. Free tax help Prev  Up  Next   Home   More Online Publications