Business Bad Debt Write-Off

When a business offers services or make sale on credit, it is unlikely to collect all the receivable on the account. If you make serious efforts to collect debt and still can't get payment, it is considered as bad debt. It can be written off on your income tax.

To have a bad debt tax deductible, bad debt should have been created in your business or it should be closely related to your business. If the debt has no connection to business operations or activities, it can not be considered as business bad debt.

A business bad debt is deducted from the gross income (taxable). Business bad debts may be deducted partially or wholly, depending how they occur.

The requirements to write off a business bad debt on your tax return are:

A legal relationship between the business and the debtor
There should be a legal relationship between the business and the debtor. You must have proper documents to prove that the debtor has legal obligations to your business. It can be a signed contract agreement between the creditor and the debtor or the invoices issued to the debtors. In the absence of written proof, you can not claim tax deduction.

The receivables should be proven worthless
Business is required to prove that the receivables are worthless. When there is no chance to get receivables collected, it becomes worthless. You must have sufficient documents to show that you have taken reasonable efforts to collect debt. For example, you can establish the debt worthless when the debtor files for bankruptcy.

The debt is written off in the year it becomes worthless. You need not wait till it actually becomes worthless because of the supporting documents proving that it can not be paid in the future either.

A business debt that is partially worthless is also deductible. 

If you were unable to make a claim for tax deduction because worthlessness of bad debt couldn't be determined in the particular year, you may file amended tax returns to get a refund.

Bad debt loss should be reported previously as an income
Business bad debt is deductible only when it is previously recorded as an income. If your business follows the accrual method of accounting and includes the receivable in your income, you can claim for tax deduction if customer fails to pay it.

If you run a business on a cash basis, you may not claim for a bad debt write off (for example rent) because the debt was never included in your income.