Sometimes customers don’t pay their bills. It’s called uncollected debt. And if you’re an accrual-based taxpayer and you’ve tried everything to get an uncollected debt, you may be able to deduct that uncollected debt in the year it goes bad.
Under the tax code, you can claim a full deduction for a business-related loan that goes bad. You can also write off the full amount against ordinary income (rather than as a short-term capital loss that may be limited to $3,000 per year). And you can deduct a partial loss for an uncollected debt.
Statute of Limitations
The statute of limitations for uncollected debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
Proving a Debt Is Bad
The IRS often challenges the timing of bad debt deductions. To get the write-off, you generally have to provide proof that the debt will not be paid.
Often, there is a significant event that demonstrates a debt’s worthlessness, such as a declaration of bankruptcy. If not, here are a few tips for proving the worthlessness of a debt:
Document all the efforts you make to collect amounts owed by a debtor, including records of telephone calls, dunning letters and email communications.
Make multiple efforts to collect. Don’t just send one letter and let it go at that.
Pursue bad debts quickly to ascertain whether recovery is possible. A bad debt deduction must generally be claimed on the tax return for the year it was sustained. You may not be able to take a loss in a later year.