Bad Debts Expense for Tax Purposes Explained

This post provides some basic information on bad debt expenses in regards to reporting income tax.

Deductions for bad debt are allowed only if income derived from the original debt, or loan, was previously included in the calculation for a past years income. Bad debt deductions are not allowed for bad debts arising from sales when the taxpayer uses a cash basis reporting method because the income is not reported until actual cash is collected.

Specific charge-off methods will allow taxpayers to claim a bad debt expense when a debt becomes worthless or if a portion of a debt becomes worthless.

By the way, a non business debt is a debt unrelated to a taxpayer’s business when the loan was made or the debt was created.

A non business bad debt expense is always treated as a short term capital loss.

Business debt that goes bad is deductible as an ordinary loss for the tax year the loss was incurred.

Wow was that not an exciting tutorial on bad debt expenses and taxes or what!

I hope this information is able to help somebody because it is not the most exciting finance related topic. I was originally planing to write more on tax and accounting related topics but I may rethink this idea. Ha.

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  1. Since this exclusion of income is only applied for Federal income taxes, I am not sure what impact this law has on State income taxes.

    1. Just as I have no idea why we would want to discuss such a habit. I confess I write this stuff down in a organized manner in hopes that I learn and master the subject. but wow.... this one is particularly boring... anyone else agree lol?

      Thanks for checking out my finance blog!

  2. The personal assets of directors or shareholders cannot be seized to pay off company debts (with the exception of extreme cases where directors are considered to have been trading recklessly).