Yesterday, the Roni Deutch Tax Center – Tax Help Blog posted a new entry in their deduction of the week series. This new article explains bad debts and the deduction they create for business owners. You can find the text of the blog entry below, or visit the Roni Deutch Tax Center – Tax Help Blog and subscribe to the RSS feed and stay updated on all future deduction of the week entries.
If you are a business owner then you should know that certain bad debts are eligible for a deduction on your tax return. So, if you are unable to collect on a client/customer debt this year, do not forget your consolation prize come next tax season. The ability to claim bad debt deductions depend on what your business sells.
In order for your business to claim a bad debt deduction, you need to sell products. If someone purchases goods from your store but never pays for them, you can usually deduct the total cost of the unpaid products.
Service Based Businesses
Unfortunately, if your business provides services you will not be allowed to take a bad debt deduction for the time devoted to attempting to collect from a nonpaying client.
According to IRS Topic 453, to show that a debt is worthless – and eligible for the deduction – you must have taken reasonable steps to collect the debt. You also must take the deduction in the year that the debt became worthless; meaning the same year you realized you would not be paid for the goods.