If your business is having trouble collecting payments from customers, you might be eligible for an uncollected debt deduction on your 2025 income tax return. But this tax treatment isn’t automatic. You must show that the debt is worthless and meet other requirements.
What’s Required
First, a cash-basis taxpayer may claim a business bad debt deduction only if the amount that’s owed was previously included in gross income. If it wasn’t, the deduction isn’t available.
Second, a business must establish that the debt is legitimate and can’t be recovered from the debtor. To this end, you must make a “reasonable” effort to collect the amount that’s due. This doesn’t necessarily mean you have to file a lawsuit against the debtor. But you can’t just make a single phone call either.
So you may have to ramp up your collection efforts. The best outcome generally is to actually collect the debt, which would help your cash flow. If, however, it turns out that the debt is uncollectible, you may be able to claim the deduction.
Partially vs. Totally Worthless
Often, the specific charge-off method (also called the “direct write-off” method) is used for writing off bad debts. In this case, you can deduct business bad debts that become either partially or totally worthless during the year.
For tax purposes, partially and totally worthless are defined as follows:
Partially worthless. The deduction is limited to the amount charged off on your books. You don’t have to charge off and deduct your partially worthless debts annually, so you can postpone this to a later year. However, you can’t deduct any part of a debt after the year it becomes totally worthless.
Totally worthless. If a debt becomes totally worthless in the current tax year, you can deduct the entire amount (less any amount deducted in an earlier tax year when the debt was partially worthless).
Note that you don’t have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. But if you don’t record a charge-off and the IRS later rules the debt is only partially worthless, you won’t be allowed a deduction for the debt in that tax year. Reason: A deduction of a partially worthless bad debt is limited to the amount actually charged off.
Get Going on Collection Efforts
If you haven’t begun your collection efforts yet and are hoping to claim a bad debt deduction on your 2025 tax return, time is short. Start making calls and sending emails — and documenting your efforts. Contact us to discuss your prospects of claiming a business bad debt deduction on your 2025 income tax return.