Are business bad debts deductible?

What counts as a business bad debt

Publication 334 starts with a plain definition: if someone owes you money you cannot collect, you have a bad debt, and there are two types, business and nonbusiness. A business bad debt is a loss from the worthlessness of a debt that was either created or acquired in your business or closely related to your business when it became partly or totally worthless. A debt is closely related to your business if your primary motive for incurring it was a business reason.

In practice most business bad debts are customer invoices. The publication says they mainly result from credit sales to customers, and can also come from loans to suppliers, clients, employees or distributors. Goods and services customers have not paid for appear on your books as accounts or notes receivable, and the uncollectible part is the bad debt.

The income rule: no deduction for income you never reported

This is the rule that decides most cases. You can take a bad debt deduction for accounts and notes receivable only if the amount you were owed was included in your gross income for the year the deduction is claimed or for a prior year. The reason is that a deduction restores nothing if you never paid tax on the income to begin with.

The publication spells out what that means by accounting method. If you use an accrual method, you normally report income as you earn it, so you can deduct an uncollectible receivable that you included in income. If you use the cash method, you normally report income when you receive payment, so you cannot take a bad debt deduction for amounts owed to you that you never received and never included in income. A freelancer on the cash method who is never paid for a $2,000 job simply does not report the $2,000; there is no loss to deduct.

When a debt is worthless, and how to claim it

A debt becomes worthless when there is no longer any chance the amount owed will be paid. That can be on the date the debt is due or earlier. To demonstrate worthlessness you must show only that you have taken reasonable steps to collect the debt and were unable to.

Generally you must use the specific charge-off method: you deduct specific business bad debts that become partly or totally worthless in the year. For a partly worthless debt, the deduction is limited to the amount you charged off on your books during the year, and you can delay the charge-off to a later year. For a totally worthless debt you deduct the entire amount, minus any amount you deducted earlier when it was only partly worthless, and no actual book charge-off is required, though the publication suggests doing it anyway: if the IRS later decides the debt was only partly worthless and you did not charge off, you are not allowed the deduction for that year. A narrow alternative, the nonaccrual-experience method, is available only to those who meet its requirements.

Worked example

An accrual-method consultant bills a client $6,000 in 2025 and includes it in income. In 2025 the client goes quiet; the consultant writes off $2,000 on the books as partly worthless. The 2025 deduction is capped at $2,000. In 2026 the client is confirmed insolvent and the remaining $4,000 becomes totally worthless: the 2026 deduction is $6,000 minus the $2,000 already deducted, or $4,000. The calculator above reproduces both steps. Enter owed 6000, included 6000, before 0, partly worthless, chargeoff 2000, then enter owed 6000, included 6000, before 2000, totally worthless.

Now change the facts: a cash-method consultant never reported the $6,000. Enter 0 as the amount included in income and the deduction falls to zero.

Other situations the publication addresses

If a loan is really a contribution to the capital of a corporation, it is not a bad debt. If you guaranteed a debt in the course of your business, for a good faith business purpose, with a legal duty to pay, you may deduct the amount you pay, in the year paid, unless you have rights against the borrower. If two debtors jointly owe you money, being unable to collect from one does not let you deduct a share. If you sell your business but keep its receivables, the debts remain business debts. If you receive property in partial settlement of a debt, reduce the debt by the property’s fair market value, which becomes the property’s basis.

If you forgot to deduct a worthless debt, you may file a claim for refund. For a totally worthless debt it must be filed by the later of seven years from the date the original return was due (not counting extensions) or two years from the date you paid the tax. For a partly worthless debt it is three years from filing or two years from payment. Sole proprietors use Form 1040-X.

Limits of this page

Nonbusiness bad debts, such as a loan to a friend, are treated differently and are not covered here. Related rules on recovering amounts you deducted earlier are in is a refund of a business expense taxable, and the cash and accrual distinction is explained in cash or accrual accounting.

Sources

• IRS Publication 334, Tax Guide for Small Business (2025): Bad Debts, in chapter 8 (Business Expenses). Page last reviewed or updated by the IRS April 30, 2026. Read November 2, 2026.

Edition read: Publication 334 (2025), for use in preparing 2025 returns. Dollar limits and thresholds quoted on this page are for 2025 and can change; check the current publication and form instructions for your tax year. This page summarizes the publication and does not replace it. Marked for human review.