Do you still have to pay a charge off account?

Charge Off is an accounting entry by the lender to acknowlege he lost money. It is not a Forgiveness of Debt.

DON'T BE CONFUSED - THE ONE YOU OWE MONEY TO "Charging it off" IS ONLY THEM RECORDING THAT THE DEBT THEY ARE OWED IS NOT EXPECTED TO BE PAID. It does NOT relieve your obligation to pay it, nor his right, even obligation (to investors, partners, etc) to continue to try and collect as much of it as they can. They would record whatever they do get as income, just like they recorded whatever the original deal was that you were so supposed to pay and they had to reverse by "charging it off".

The below is a full discussion, which was originally written in response to a tax question -

Explanation Charge Offs & Forgiven Debt

If what your asking is really when a company charges off an account does it get a tax benefit, below is more than everything you ever wanted to know, but feel free to ask more or challenge any of my answer.

Lets limit this to business charging off a debt that is owed to them through some type of transaction, as non Business Taxes are an entirely different area. And of course, like anything to do with taxes, everything is prefaced with a �generally or normally� as there are always special circumstances and exceptions.

A charge off (or write off) is the accounting process where a business acknowledges a receivable (an asset) it believes is uncollectable effectively does not exist. It is taking the cost of not collecting that receivable as a charge against current earnings. Hence the companies net current earnings is lower than they would have been and subsequently, the amount of income taxes they pay is also lower. IMPORTANT: It does not mean the debt is forgiven, just that they can�t collect it, or some portion of it. (See below).

They had an increased expense, made less money, they pay less taxes. It�s fair to say given a choice they would have preferred to have made the less net income by increasing say, salaries, medical benefits, advertising, new machinery, etc. than essentially giving away their assets/earnings to someone else for free.

Taking a $100 sale on credit, the company shows the $100 as income on its income statement when the sale is made and, as no cash was received, reflects it by establishing a $100 asset (due from customer) on its balance sheet. If the transaction is completed, as the customer pays, the balance sheet cash account is increased by the $100, and the due from customer account is decreased � no income effect (as that was recognized with the original posting).

So, say a company sold $100 in year 1, reported the income (through the income statement) and paid taxes on it and establishes an asset for the receivable. Then in year 2 finds that customer isn�t going to pay, it will have a charge of -$100 in year 2 (reducing the balance sheet asset account, with offset to the income statement), effectively lowering income and recovering the taxes it paid in year 1.

While this seems fair there are, not suprisingly, a number of accounting, especially IRS tax accounting rules, that complicate it and it is not unusual at all for a company to not receive a complete or timely benefit for all of it�s charge offs. (The tax rules for when an asset can be charged off are stricter than accounting). And for there to really be any benefit, the company must actually be making enough money on a tax basis in all those years. It must have taxable income and a tax it would have had to pay. If it was already losing money, paying little or no tax, losing more doesn�t get it more! But also at the State level where, the taxable income need is even greater, but another tax is frequently encountered. If that $100 also had say $6 sales tax collected and paid over to the State, the state makes recovering that $6 that was in reality never collected, very difficult, near impossible. (Note that the $6 is normally NOT part of the company�s income or sales but a collection in trust for the State and paid over on behalf of the customer). I think you would be hard pressed to call the above a benefit! The one not paying (who still owes and will forever owe the money), actually receives all the benefit, by basically enriching themselves through a theft. (Walking out and agreeing to pay, then not doing so is really very similar to simply walking out with out paying...it's theft by deception).

However, there is another consideration: What happens if the debt (or some portion) is forgiven?

Lets start with a basic tax concept: If you receive something of value (remember we�re talking in business, so from someone other than family), you have received a taxable income. (The one giving it rightfully has an expense). For example, remember the Oprah Winfrey thing where the audience got cars�and then found out they owed taxes on the value of the cars. In fact, when Oprah stepped up to pay the tax for them, she had to actually pay more than the tax on the car, as the money she gave them to pay the tax is also taxable - that's called a gross up.

Hand in hand with that, and the example above, if you get a loan, it is NOT taxable income. The money was exchanged for the equally valued promise to repay.

So taking the example above, if a buyer receives the $100 merchandise and gives $100 value for it, obviously nothing income taxable to the buyer. But in this case the buyer receives the $100 of value and say makes a deal in year 2 that if the $100 promise it gave is forgiven for a payment of $75 sent today (frequently offered with Words like ��because it�s all I have and otherwise you ain�t getting nothing�.�), then the $25 is considered a cancellation of indebtedness. COD income is taxable to the recipient. It isn�t a loan/exchange of value anymore, it�s a gift of value, and value, as in Oprah is taxable. While no one likes to pay tax, it is the correct outcome. The advantage is the debtor doesn�t owe anything anymore�other than tax on the gift.

This COD is a very big issue in major corporation financial reorganizations. When these companies financially restructure (Chapter 11 Bankruptcy), and creditors, generally Bondholders, agree to take less than the bond was issued for�and we are talking billions of dollars here frequently, the company has COD income of the amount forgiven.