The Michigan Department of Treasury updated its guidance on the sales and use tax bad debt deduction for periods after September 30, 2009. The revised release (Revenue Administrative Bulletin 2019-3) incorporates the Michigan Supreme Court’s 2018 decision in Ally Financial Inc. et. al. v. Department of Treasury.
In Ally Financial, the Court clarified that third-party lenders and retailers are entitled to bad debt deductions if the parties agreed to a split of their interest in the debt. The parties may allocate the debt between themselves consistent with their agreement – it is not an an-all-or-nothing issue for either the retailer or the lender.
The bad debt deduction allows a taxpayer to claim a refund for sales and use tax that becomes worthless or uncollectible, or to deduct bad debts from its gross proceeds to compute sales or use tax liability.
A bad debt is any portion of a debt arising from a taxable retail sale that is eligible to be claimed (or would be eligible to be claimed) as a deduction under Section 166 of the Internal Revenue Code, if the taxpayer kept account on an accrual basis.
“Bad debt” is the part of a debt relating to a taxable sale at retail that is not otherwise deductible or excludable and which becomes worthless or uncollectible. The debt must be eligible to be claimed as a deduction as a bad debt for federal tax purposes.
Bad debt does not include:
Here are some scenarios that illustrate the definition:
The bad debt deduction allows an eligible taxpayer to deduct bad debts from gross proceeds used to compute its sales and use tax liability. All of the following requirements must be met to claim the deduction:
If, after claiming the deduction, the taxpayer receives the entire payment of a bad debt, the taxpayer must remit on its next remittance to the Michigan Department of Treasury the taxes for which it had previously claimed the deduction.
If a partial payment is received, the taxpayer must proportionally apply the payment to the taxable price of the property – and the tax on the property before applying it to any interest, service, or other charge – and remit the appropriate tax to the Michigan Department of Treasury with its next remittance.
To demonstrate the application of the requirements, assume the same facts as Example 2 above. Acme must apply $18,868 of the proceeds from the auctioned vehicle to the price of the property and $1,132 to sales tax which must be remitted to the Michigan Department of Treasury. There would be no remaining proceeds applied to any interest, service, or other charges.
For bad debts incurred before September 30, 2009, the person who remitted the sales or use tax directly to the Department (i.e., the retailer) may only take the deduction. Lenders may not claim the deduction for bad debts incurred before that date.
The retailer must independently meet all of the statutory requirements to claim a bad debt deduction. For example, if a retailer sells the account receivable associated with the bad debt to a third-party lender, it may not claim the deduction because it did not write the bad debt off its books and records.
After September 30, 2009, either a retailer or lender may claim the deduction if these conditions are met:
Two examples to demonstrate the conditions:
If you own or manage a retailer, lender, or other business and have questions about sales and use tax, bad debt deductions, or other tax liability, please contact us to discuss your situation.