You may not always be able to collect the debt that's owed to your business. Fortunately, there is a strong probability of writing off these business bad debts.
Let's dive into the business bad debt deduction.
What's a business bad debt?
A business bad debt is an unpaid amount owed to you that you cannot collect on. Further, you previously reported these on your gross income. In most cases, the uncollectible portion is deductible.
What are some examples of business bad debt?
Business bad debts can come from many things. A business bad debt can include:
- Loans to clients or suppliers
- The debt of an insolvent partner
- Business loan guarantees
- Credit to customers for goods and services
When are bad debts deductible?
You can deduct business bad debts and non-business bad debts under certain circumstances.
In fact, business bad debts are deductible when:
- You incurred a loss on a business debt
- The business incurred the debt or was closely related to your business
- The primary motive for the debt relates to the business
Therefore, you can deduct non-business bad debts if the liability is entirely worthless.
How do you claim the business bad debt deduction?
You can deduct qualifying business bad debt either in part or full from your gross income when figuring taxable income. Claim the business bad debt deduction in one of two ways: the specific charge-off method or the nonaccrual-experience method.
- Specific Charge-Off Method: You deduct bad debts that have become partially or totally worthless during the tax year.
- Nonaccrual-Experience Method: You don't recognize the service-related income you expect to be uncollectible. The rule applies to specific service-related income with a gross receipts threshold.
