Sales Tax Slice: Every Cloud Has a Silver Lining — Sales Tax Deductions for Bad Debt


Sears filed for Chapter 11 bankruptcy protection on Monday, Oct. 15, unable to meet its mounting debt payments. Over the company’s 132-year history, Sears had established other brands like Kenmore, Craftsman, Allstate Insurance, and the Discover card. Large retailers like Sears commonly issue private-label credit cards, which allow customers to make larger purchases by paying over time and participate in rewards programs.

In 2003, Sears sold its consumer credit division to Citigroup, eliminating a large portion of its operating income. If instead it had retained this credit division, the company could have written off the bad debt on its private label credit card. In turn, it also may have been able to receive a deduction or credit for sales tax paid on the written-off debt.

Illinois, where Sears is headquartered, allows retailers to deduct bad debt, with some limitations. The state decrees that bad debt deductions only apply to purchases from the retailer claiming the deduction, not including purchases of titled property, like motor vehicles. A deduction may be taken for all qualifying outstanding credit sale amounts, regardless of when each transaction occurred. However, the only parties entitled to these deductions are the retailer and its successors, who must maintain adequate records to support their deductions.

Other states vary in their treatment of bad debt. Michigan, for example, allows more flexibility. There, retailers and third-party lenders can form an agreement that designates which party may take the deduction or claim the tax refund on written-off transactions. However, Michigan defines “private label credit card” narrowly, requiring that it be branded with the logo of a retailer, and only be used for purchases from that retailer.

New York takes a different approach to private label credit cards. As of July 1, 2010, only retailers that manage their own private label credit card can claim a credit or tax refund for sales tax paid on bad debt accounts. Third-party lenders that hold accounts of a private-label credit card are ineligible for tax credits or deductions for bad debt write-offs.

While the fate of Sears hangs in the balance of Chapter 11 bankruptcy reorganization, retailers grappling with bad debt on their private label credit cards may be able to take advantage of available sales tax relief for bad debt.

Continue the discussion on Bloomberg Tax’s State Tax Group on LinkedIn. How does your state treat bad debt from private-label credit cards?

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