Cash or Accrual Basis Reporting With a Deduction for Bad Debts

Currently under LAMC Section 21.00, taxpayers are required to report their gross receipts using the accrual accounting method including any bad debts that are never collected. Effective January 1, 2005, gross receipts can now be calculated on either a cash or accrual basis (with a deduction for bad debts) in accordance with Internal Revenue Service guidelines. This means that a business owner can now report gross receipts to the City of Los Angeles, Office of Finance in the same manner gross receipts were calculated (cash or accrual) and reported to the IRS.

The definition of gross receipts as used in this article has been amended to exclude any uncollectible amount apportioned to the City of Los Angeles which is written off in the taxpayer’s IRS filing provided that the bad debt amount was previously reported as income (gross receipts). Please see apportionment rules under the PDF iconBusiness Tax Rulings. However, the collection of any bad debt amount that had been previously written off and is later collected, is to be reported as gross receipts in the year it is collected.

Generally, a business that uses an accrual method of accounting will normally report income as it is earned (billed). Under this method of accounting, a business reports income in the year earned and deducts bad debt expenses in the year the expenses are written off.

Accrual Method

A department store had gross receipts (billings) of $1,000,000 in 2016 and also had uncollectible bad debts that same year in the amount of $50,000 attributable to sales made in the prior calendar year (2015), which were reported in the 2016 business tax renewal. The business will be able to deduct the uncollectible bad debt expenses from gross receipts, provided that the bad debts have been reported to the IRS.

2016 gross receipts:  $1,000,000 $ 1,000,000
Less amounts written off in 2016:         50,000
2016 reportable gross receipts: $    950,000

Cash method

A business that uses a cash method of accounting, will normally report income when payment is received. For example:

A doctor had $500,000 in taxable cash receipts received during his 2016 fiscal year. In 2017, he will report $500,000 as his taxable gross receipts, provided he reports his income to the IRS on a cash basis.

A business cannot take a bad debt deduction for amounts owed to it, that it has not received, and cannot collect if these amounts have never been included in income. For example, a cash basis accountant cannot take a bad debt deduction if a client does not pay the bill because the accountant’s fee was not previously included in income. Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. However, if an inventory is necessary to account for a business' income, an accrual method of accounting for sales and purchases should be used.

Under IRS regulations, if a business wants to change its accounting method, it must generally get IRS approval. Therefore, the Office of Finance will not allow taxpayers to change their accounting method unless they have received IRS approval.

**Please note that this amendment became effective January 1, 2005.

FREQUENTLY ASKED QUESTIONS

I have a business and my accounting method is on a cash basis. Will I be able to report my gross receipts on a cash basis?

Yes, effective January 1, 2005, gross receipts can be reported on a cash basis, provided that this is the method you report to the IRS.

My business maintains records on an accrual basis. I have always included bad debts when I have reported my gross receipts. Will I be able to deduct bad debts from my gross receipts?

Yes, effective January 1, 2005, businesses filing on an accrual basis will be able to deduct the apportioned bad debts that are uncollectible, provided that they have previously been reported as gross receipts to the City.

Example:

A pharmacist generated a total of $250,000 in gross receipts in 2016. That same tax year, the pharmacist had written off bad debts in the amount of $25,000 (uncollectible from the prior year), which were reported as gross receipts for the 2015 business tax renewal. The pharmacist also reports these bad debts as uncollectible to the IRS in 2016.

What should the pharmacist report as taxable gross receipts for the 2017 business tax renewal?

The pharmacist will report $225,000 in gross receipts for the 2017 business tax renewal.

**Please note that this amendment becomes operative on January 1, 2005 and taxpayers must still report under the prior accrual method for any prior tax years.