United States

Tennessee court disallows retailers bad debt deduction


On May 11, 2016, the Tennessee Court of Appeals issued a decision holding that a retailer could not receive bad debt deductions for a third-party credit card provider’s bad debt write-offs.

In 2003, the taxpayer outsourced its private label credit cards to a third-party bank operating under an agreement where the bank would compensate the taxpayer for customer card purchases, including the applicable sales tax. If a customer subsequently defaulted on their credit card debts, the bank became responsible for the losses, writing them off as bad debts on the bank’s federal income tax returns.

In 2005, the taxpayer began deducting the bank’s write-offs on its own sales tax returns. On appeal, the taxpayer argued that it was entitled to the deduction because the statute did not specifically require the party taking the deduction to be the party that wrote off the debt. The court disagreed with that interpretation, emphasizing that the taxpayer was fully compensated for the tax by the bank and had no obligation to reimburse the bank for bad debts.

The court additionally found the taxpayer ineligible for the deduction under a revised version of the statute permitting the deduction for debt written off by a ‘claimant,’ or a group or combination acting as a unit.

Taxpayers in arrangements with third-party credit card providers should review their eligibility for the bad debt deduction and determine whether the deduction is appropriate.

Mo Bell-Jacobs

Senior Manager

Mo examines state and local tax issues and the impact of legislation on middle market companies. Contact him at mo.bell-jacobs@rsmus.com.

Areas of focus: State and Local TaxWashington National Tax

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