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Statetaxes Publication 3402 - Introductory Material Table of Contents Reminder IntroductionOrdering forms and publications. Statetaxes Tax questions. Statetaxes Useful Items - You may want to see: Reminder Photographs of missing children. Statetaxes  The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Statetaxes Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. Statetaxes You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child. Statetaxes Introduction This publication provides federal income, employment, and excise tax information for limited liability companies. Statetaxes This publication does not address state law governing the formation, operation, or termination of limited liability companies. Statetaxes This publication does not address any state taxes. Statetaxes Comments and suggestions. Statetaxes   We welcome your comments about this publication and your suggestions for future editions. Statetaxes   You can write to us at the following address: Internal Revenue Service Business Forms and Publications Branch SE:W:CAR:MP:T:B 1111 Constitution Ave. Statetaxes NW, IR–6526 Washington, DC 20224   We respond to many letters by telephone. Statetaxes Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. Statetaxes   You can email us at *taxforms@irs. Statetaxes gov. Statetaxes (The asterisk must be included in the address. Statetaxes ) Please put “Publications Comment” on the subject line. Statetaxes Although we cannot respond individually to each email, we do appreciate your feedback and will consider your comments as we revise our tax products. Statetaxes Ordering forms and publications. Statetaxes   Visit www. Statetaxes irs. Statetaxes gov/formspubs to download forms and publications, call 1-800-829-3676, or write to the address below and receive a response within 10 days after your request is received. Statetaxes Internal Revenue Service1201 N. Statetaxes Mitsubishi MotorwayBloomington, IL 61705-6613 Tax questions. Statetaxes   If you have a tax question, check the information available on www. Statetaxes irs. Statetaxes gov or call 1-800-829-1040. Statetaxes We cannot answer tax questions sent to either of the above addresses. Statetaxes Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 334 Tax Guide for Small Business 505 Tax Withholding and Estimated Tax 535 Business Expenses 541 Partnerships 542 Corporations 544 Sales and Other Dispositions of Assets 583 Starting a Business and Keeping Records 925 Passive Activity and At-Risk Rules Form (and Instructions) 1065 U. Statetaxes S. Statetaxes Return of Partnership Income 1120 U. Statetaxes S. Statetaxes Corporation Income Tax Return 1120S U. Statetaxes S. Statetaxes Income Tax Return for an S Corporation 2553 Election by a Small Business Corporation 8832 Entity Classification Election See How To Get More Information near the end of this publication for information about getting publications and forms. Statetaxes Prev  Up  Next   Home   More Online Publications
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Understanding your CP71D Notice

You received this notice to remind you of the amount you owe in tax, penalty and interest.

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You can also authorize someone (such as an accountant) to contact the IRS on your behalf using this Power of Attorney and Declaration of Representative (Form 2848).

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Page Last Reviewed or Updated: 06-Mar-2014

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Statetaxes 10. Statetaxes   Business Bad Debts Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Definition of Business Bad DebtAccrual method. Statetaxes Cash method. Statetaxes Debt acquired from a decedent. Statetaxes Liquidation. Statetaxes 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. Statetaxes Introduction You have a bad debt if you cannot collect money owed to you. Statetaxes A bad debt is either a business bad debt or a nonbusiness bad debt. Statetaxes This chapter discusses only business bad debts. Statetaxes Generally, a business bad debt is one that comes from operating your trade or business. Statetaxes You can deduct business bad debts on Schedule C (Form 1040) or your applicable business income tax return. Statetaxes All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. Statetaxes For more information on nonbusiness bad debts, see Publication 550. Statetaxes 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. Statetaxes S. Statetaxes 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. Statetaxes 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. Statetaxes A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Statetaxes Bad debts of a corporation (other than an S corporation) are always business bad debts. Statetaxes Credit sales. Statetaxes   Business bad debts are mainly the result of credit sales to customers. Statetaxes 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. Statetaxes 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. Statetaxes   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. Statetaxes 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. Statetaxes    You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. Statetaxes This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest. Statetaxes Accrual method. Statetaxes   If you use the accrual method of accounting, you generally report income as you earn it. Statetaxes You can only claim a bad debt deduction for an uncollectible receivable if you have previously included the uncollectible amount in income. Statetaxes   If you qualify, you can use the nonaccrual-experience method of accounting discussed later. Statetaxes Under this method, you do not have to accrue income that, based on your experience, you do not expect to collect. Statetaxes Cash method. Statetaxes   If you use the cash method of accounting, you generally report income when you receive payment. Statetaxes You cannot claim a bad debt deduction for amounts owed to you because you never included those amounts in income. Statetaxes 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. Statetaxes Debts from a former business. Statetaxes   If you sell your business but retain its receivables, these debts are business debts because they arose out of your trade or business. Statetaxes If any of these receivables subsequently become worthless, the loss is still a business bad debt. Statetaxes Debt acquired from a decedent. Statetaxes   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. Statetaxes 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. Statetaxes Otherwise, a loss from these debts becomes a nonbusiness bad debt for the decedent's estate. Statetaxes Liquidation. Statetaxes   If you liquidate your business and some of the accounts receivable that you retain become worthless, they become business bad debts. Statetaxes Types of Business Bad Debts Business bad debts may result from the following. Statetaxes Loans to clients and suppliers. Statetaxes   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. Statetaxes Debts owed by political parties. Statetaxes   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. Statetaxes You use the accrual method of accounting. Statetaxes The debt arose from the sale of goods or services in the ordinary course of your trade or business. Statetaxes More than 30% of your receivables accrued in the year of the sale were from sales to political parties. Statetaxes You made substantial and continuing efforts to collect on the debt. Statetaxes Loan or capital contribution. Statetaxes   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. Statetaxes Debts of an insolvent partner. Statetaxes   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. Statetaxes 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. Statetaxes Business loan guarantee. Statetaxes   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. Statetaxes You made the guarantee in the course of your trade or business. Statetaxes You have a legal duty to pay the debt. Statetaxes You made the guarantee before the debt became worthless. Statetaxes You meet this requirement if you reasonably expected you would not have to pay the debt without full reimbursement from the borrower. Statetaxes You received reasonable consideration for making the guarantee. Statetaxes You meet this requirement if you made the guarantee in accord with normal business practice or for a good faith business purpose. Statetaxes Example. Statetaxes Jane Zayne owns the Zayne Dress Company. Statetaxes She guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet. Statetaxes Elegant Fashions is one of Zayne's largest clients. Statetaxes Elegant Fashions later defaulted on the loan. Statetaxes As a result, Ms. Statetaxes Zayne paid the remaining balance of the loan in full to the bank. Statetaxes 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. Statetaxes She was motivated by the desire to retain one of her better clients and keep a sales outlet. Statetaxes Deductible in the year paid. Statetaxes   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. Statetaxes Rights against a borrower. Statetaxes   When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. Statetaxes The debt is then owed to you. Statetaxes 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. Statetaxes Joint debtor. Statetaxes   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. Statetaxes Sale of mortgaged property. Statetaxes   If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt is a bad debt. Statetaxes When a Debt Becomes Worthless A debt becomes worthless when there is no longer any chance the amount owed will be paid. Statetaxes This may occur when the debt is due or prior to that date. Statetaxes To demonstrate worthlessness, you must only show that you have taken reasonable steps to collect the debt but were unable to do so. Statetaxes It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. Statetaxes Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt. Statetaxes Property received for debt. Statetaxes   If you receive property in partial settlement of a debt, reduce the debt by the property's FMV, which becomes the property's basis. Statetaxes You can deduct the remaining debt as a bad debt if and when it becomes worthless. Statetaxes   If you later sell the property for more than its basis, any gain on the sale is due to the appreciation of the property. Statetaxes It is not a recovery of a bad debt. Statetaxes For information on the sale of an asset, see Publication 544. Statetaxes How To Claim a Business Bad Debt There are two methods to claim a business bad debt. Statetaxes The specific charge-off method. Statetaxes The nonaccrual-experience method. Statetaxes Generally, you must use the specific charge-off method. Statetaxes However, you may use the nonaccrual-experience method if you meet the requirements discussed later under Nonaccrual-Experience Method . Statetaxes 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. Statetaxes However, with respect to partly worthless bad debts, your deduction is limited to the amount you charged off on your books during the year. Statetaxes Partly worthless debts. Statetaxes   You can deduct specific bad debts that become partly uncollectible during the tax year. Statetaxes Your tax deduction is limited to the amount you charge off on your books during the year. Statetaxes You do not have to charge off and deduct your partly worthless debts annually. Statetaxes You can delay the charge off until a later year. Statetaxes However, you cannot deduct any part of a debt after the year it becomes totally worthless. Statetaxes Significantly modified debt. Statetaxes   An exception to the charge-off rule exists for debt which has been significantly modified and on which the holder recognized gain. Statetaxes For more information, see Regulations section 1. Statetaxes 166-3(a)(3). Statetaxes Deduction disallowed. Statetaxes   Generally, you can claim a partial bad debt deduction only in the year you make the charge-off on your books. Statetaxes 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. Statetaxes The charge-off in the earlier year, unless reversed on your books, fulfills the charge-off requirement for the later year. Statetaxes Totally worthless debts. Statetaxes   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. Statetaxes   You do not have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. Statetaxes However, you may want to do so. Statetaxes 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. Statetaxes See Partly worthless debts, earlier. Statetaxes Filing a claim for refund. Statetaxes   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. Statetaxes If the bad debt was totally worthless, you must file the claim by the later of the following dates. Statetaxes 7 years from the date your original return was due (not including extensions). Statetaxes 2 years from the date you paid the tax. Statetaxes   If the claim is for a partly worthless bad debt, you must file the claim by the later of the following dates. Statetaxes 3 years from the date you filed your original return. Statetaxes 2 years from the date you paid the tax. Statetaxes You may have longer to file the claim if you were unable to manage your financial affairs due to a physical or mental impairment. Statetaxes Such an impairment requires proof of existence. Statetaxes   For details and more information about filing a claim, see Publication 556. Statetaxes Use one of the following forms to file a claim. Statetaxes For more information, see the instructions for the applicable form. Statetaxes Table 10-1. Statetaxes Forms Used To File a Claim IF you filed as a. Statetaxes . Statetaxes . Statetaxes THEN file. Statetaxes . Statetaxes . Statetaxes 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. Statetaxes Under this method, you do not accrue service related income you expect to be uncollectible. Statetaxes Because the expected uncollectible amounts are not included in income, these amounts are not later deducted from income. Statetaxes 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. Statetaxes Service related income. Statetaxes   You can use the nonaccrual-experience method only for amounts earned by performing services. Statetaxes 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. Statetaxes Gross receipts test. Statetaxes   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. Statetaxes If your average annual gross receipts for any year exceeds $5 million, you cannot use the non-accural experience method. Statetaxes   The average annual gross receipts for any year is the average of gross receipts from the year in question and the 2 previous years. Statetaxes For example, if you were figuring the average annual gross receipts for 2013, you would average your gross receipts for 2011, 2012, and 2013. Statetaxes Interest or penalty charged. Statetaxes   Generally, you cannot use the nonaccrual-experience method for amounts due on which you charge interest or a late payment penalty. Statetaxes However, do not treat a discount offered for early payment as the charging of interest or a penalty if both the following apply. Statetaxes You otherwise accrue the full amount due as gross income at the time you provide the services. Statetaxes You treat the discount allowed for early payment as an adjustment to gross income in the year of payment. Statetaxes Change in accounting method. Statetaxes   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. Statetaxes See Form 3115 and the Instructions for Form 3115 for more information. Statetaxes 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. Statetaxes The amount you include is limited to the amount you actually deducted. Statetaxes However, you can exclude the amount deducted that did not reduce your tax. Statetaxes Report the recovery as “Other income” on the appropriate business form or schedule. Statetaxes See Recoveries in Publication 525 for more information. Statetaxes Net operating loss (NOL) carryover. Statetaxes   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. Statetaxes A bad debt deduction that contributes to a NOL helps lower taxes in the year to which you carry the NOL. Statetaxes For more information about NOLs, see Publication 536. Statetaxes Also, see the Instructions for Form 1045, and the Instructions for Form 1139. Statetaxes Prev  Up  Next   Home   More Online Publications