If someone owes you money you cannot collect, you may have a bad debt. There are two kinds of bad debts: business bad debts and nonbusiness bad debts. A business bad debt is generally one that comes from operating your trade or business. You may be able to deduct business bad debts as an expense on your business tax return; however, there are different locations to report it on the return depending on which type of return you file.
Where To Deduct a Business Bad Debt
- If you file as a Sole proprietor, then deduct your bad debt on Line 27a of Schedule C (Form 1040) Profit or Loss From Business.
- If you file as a Farmer, then deduct your bad debt on Line 32 of Schedule F (Form 1040) Profit or Loss From Farming.
- If you file as an S corporation, then deduct your bad debt on Line 10 of Form 1120-S U.S. Income Tax Return for an S Corporation.
- If you file as a Partnership, then deduct your bad debt on Line 12 of Form 1065 U.S. Return of Partnership Income.
- If you file as a C corporation, then deduct your business debt on Line 15 of Form 1120 U.S. Corporation Income Tax Return.
The data can be entered in the Federal Q&A interview screens for these forms.
A business bad debt is a loss from the worthlessness of a debt that was either of the following:
- Created or acquired in your trade or business, or
- Closely related to your trade or business when it became partly or totally worthless.
A debt is closely related to your trade or business if your primary motive for incurring the debt is business-related. Bad debts of a corporation (other than an S corporation) are always business bad debts.
Business bad debts are mainly the result of credit sales to customers. Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt.
Accounts or notes receivable valued at FMV when received are deductible only at that value, even though the FMV may be less than the face value. If you purchased an account receivable for less than its face value, and the receivable subsequently becomes worthless, the most you’re allowed to deduct is the amount you paid to acquire it.
CAUTION! You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest.
All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses on Schedule D of the taxpayer's return. The data would be entered in the Investment Income section of TaxAct®.
Related Links
- Publication 550 Investment Income and Expenses
- Publication 535 Business Expenses
- Publication 334 Tax Guide for Small Business
Note that any link in the information above is updated each year automatically and will take you to the most recent version of the webpage or document at the time it is accessed.
