

Every business owner faces collection challenges at some point in their businesses. Whether the amounts are large or small, when you’re trying to grow your business, every dollar counts. Likewise, every dollar you don’t get paid means either hours of hunting down the payment, writing it off as bad debt, or both.
To qualify as a bad debt in the eyes of the IRS, the debt must either have been created or acquired in your business, or closely related to your trade or business when it became partly or totally worthless.
Remember, you can claim a business bad debt deduction only if the amount owed to you was included in your business’s gross income or lent out of your cash. If you use an accrual method of accounting, you generally report income as you earn it. If you use the cash method of accounting, you generally report income when you receive payment. With the cash method, you generally cannot claim a bad debt deduction for unpaid wages, rents, fees, and similar items because you never included those amounts in income.
You must be able to prove the debt is worthless by showing you have taken reasonable steps to collect the debt. Keep records of every correspondence and collection attempt, and make sure the debt is recorded in your business’s accounting system. If the debtor has entered into bankruptcy, make sure you keep documentation from the bankruptcy court.
Generally, you must claim a business bad debt in the same year the debt became worthless. If you have some partially worthless debts, you can use the Specific Charge-Off Method, which allows you to claim parts of the debt over several tax years if the debt’s worthlessness is drawn out. There is also the Nonaccrual-Experience Method, for accounts receivable for services you performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, performing arts; or if your business meets the $5 million gross receipts test. For more on these methods, see the IRS website.
If the bad debt was worthless, you must file the claim by the latter of the following dates:
If the claim is for a partially worthless bad debt, you must file the claim by the latter of the following dates:
You have longer to file the claim if you were unable to file your taxes and submit the claim due to a physical or mental impairment.
Copyright © 2023 SCORE Association, SCORE.org
Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.