Salvage Your Sunken Uncollectable Debt


Victims of reneged payment agreements might have a tax deduction

Let’s face it – it’s always frustrating not being paid what is owed to you. The IRS has created a system for you that may help with debts and help you salvage some of what’s owed. If it’s clear that the debt is not going to be paid, then you may be able to recoup some of the lost money as a tax deduction. The IRS has two classifications for bad debt: business and non-business. Each has its’ own deductibility rules.

Business Bad Debt

If the debt owed is business-related, this deduction is a little easier to obtain approval for. In order to be considered a deductible business bad debt, the IRS states that the debt must be closely related to your trade or business. Business bad debt is typically unpaid customer invoices, but it can also include business-related loans. To qualify as a deduction, these two statements must be true:

  • The amount is already included as income or as an asset
  • The debt is considered either partially or completely worthless

There are ways to determine the worthlessness of a debt, but at a minimum, you should be able to produce a recap of collection efforts. Worthlessness is classified by an objective standard, and is usually shown by identifiable events that present reasonable grounds for abandoning the hope of recovery or collection. You need to show the IRS that you did everything you could to collect the debt. If you determine the bad debt is valid, you can deduct it as a business expense.

Non-Business Bad Debt

All bad debt not classified as business-related becomes a non-business-related debt. For a non-business bad debt deduction, the debt must be considered 100% worthless. Unfortunately, there is no partial deduction available for non-business bad debts. In addition, you need to prove that the debt is a loan intended to be repaid and not a gift – especially if loaned to by a friend or family member. The best way to prove this is a signed agreement.

If you determine the bad debt is valid, you can report the amount as a short-term capital loss. The loss is subject to capital loss limitations and you need to submit a statement with your tax return that includes the following:

  • Description of the debt
  • Amount of the debt and when it became due
  • Name of the debtor
  • Business or family relationship between you and debtor
  • Efforts you made to collect the debt
  • Why you decided the debt was worthless

Bottom Line

While no one wants to be in a position to write off debt, it’s nice to know that you can at least benefit from a tax deduction. If you find yourself in this situation, Jeffrey A. Schneider, EA, CTRS, NPTIF can help you resolve your issues. If you’re planning to loan funds in the future, he can help you set up the proper measures in case your debtor doesn’t comply.

Jeffrey Schneider, EA, CTRS, NTPI Fellow has the knowledge and expertise to help you reach a favorable outcome with the IRS. He is the head honcho at SFS Tax & Accounting as well as an Enrolled Agent and a Certified Tax Resolution Specialist.
Now What? I Got A Tax Notice From The IRS. Help! Defining and deconstructing the scary and confusing letters that land in your mailbox. Jeff defines and deconstructs the scary and confusing letters in a fashion that mixes attention to detail with humor and an intricate clarification of what is what in the world of the IRS.

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For more on SFS Tax & Accounting Services, visit
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Phone: 772-337-1040

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