Bad Debt Deductions

Q. We have some customers who aren't paying their bills. Can we at least get a tax break for business bad debts?

A. If you are an accrual-based business taxpayer and your customers don't pay their bills, Uncle Sam provides a last resort. You can deduct a bad business debt in the year it becomes worthless -- if you've tried everything to collect.

In order to get the write-off, you have to prove that the debt will not be paid. If you're lucky, there is a significant event that demonstrates a debt's worthlessness, such as the debtor's death or declaration of bankruptcy. Otherwise, your company has the responsibility for proving the worthlessness of the debt.The IRS often challenges the timing of bad debt deductions, so it's important to build a solid case. Here are a few tips:

Document all the efforts you make to collect amounts owed by a debtor, including records of telephone calls, dunning letters and e-mail communication.

Be persistent. Don't just send one letter and let it go at that.

Pursue bad debts quickly to ascertain whether recovery is possible. That's because 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.