Home Business Taxes: Deducting Business Bad Debts

Charge off on the books? You might be able to deduct it on your home business taxes.

One of the most frustrating issues you face in your home business is someone who doesn't pay you as agreed. You can send the account to collections, take the other business owner to small claims court, or try other methods to collect. Unfortunately, you might not get paid.

If you end up charging off a business debt, you might be able to deduct it on your home business taxes.

Balancing The Account

What Debts are Deductible on Your Home Business Taxes?

You have to pass a few tests if you want to deduct a charge off. Here are some items to consider before you decide to claim a bad debt on your home business taxes:

  1. Bone fide debt: This is a debt that the customer/client is contracted to pay to you. It must be an enforceable debt.
  2. Basis: You need to have included the debt in your income, and then had to charge it off. If you ?use a cash method of accounting, you count the income when you are to be paid. With the accrual method of accounting, you count the income when the order is made, or when you deliver the goods
  3. Debt is acquired as part of your business: In order to deduct the charge off on your home business taxes, the bad debt must be related to your business or trade.
  4. Worthless debt: Before you can deduct the charge off, you need to show that the debt is not going to be repaid. If the debt is partially repaid, but you can't get the full amount, then you can deduct the portion you didn't get. You do have to prove to the IRS that you have made efforts to collect, and that they just didn't work.

Unfortunately for those of us who provide services, the IRS doesn't allow you to deduct bad debts. If someone hasn't paid you for the time you spent on a project, that's not something you can deduct. For the most part, you can only deduct your charge off if you are owed for goods. However, you should consult a knowledgeable tax professional for more information on your options.

Deducting Your Bad Debt

Once you have determined that your charge off is eligible for a deduction, it's time to claim it. For the most part, you report bad debt on your home business taxes as “ordinary losses.” Depending on your business setup, you will report these losses on Schedule A, C, or F (choose only one schedule; don't deduct your business losses on multiple schedules).

You should try to deduct your bad debt in the year it became worthless. If the debt is partially worthless, you can deduct that amount now, or wait another year until the entire debt is bad, and eligible for the deduction. You will need to decide what is best for you on your own, or with the help of a professional.

The IRS has helpful information on business bad debts, and you should consider reading it if you want more information about how to at least offset some of the pain associated with being stiffed on what you're owed.

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