Be sure to write off any bad business debts you can’t recover. To qualify for any deduction, the business bad debt must be totally or partially worthless. Be sure you can prove that the debt is genuine and uncollectable. This requires the following:
- A copy of the invoice and proof that the product or service was delivered.
- Proof that you made a reasonable attempt to collect the debt. That doesn’t mean you have to file a lawsuit or use a collection agency, but you should detail your collection efforts. Document any phone calls to the customer and keep copies of any collection letters you send.
You can claim the deduction in the year in which the debt became worthless or partially worthless (meaning you agreed to accept less than the full amount in order to get paid some portion).
This includes a possible write-off in a previous year for some debts where worthlessness was not immediately apparent. If you failed to write off the debt in past years, you can amend your tax return and take the bad debt deduction in the correct year. But it is customary to write these off in the current year if the amounts are minor in nature, as long as you treat all write-offs consistently. Be sure to write out your policy and follow it.
Warning: Cash-basis taxpayers can’t deduct bad business debts unless they’ve included the value of the note in their gross income.