Tax Planning: Deducting a Bad Debt

When a debt -- whether business or personal -- becomes uncollectible, it can be claimed as a deduction on your tax return. You do not have to wait until a debt is due to determine that it is worthless. A debt becomes worthless when there is no longer any chance the amount owed will be paid.

To deduct a bad debt, you must show that you have taken reasonable steps to collect the debt. This includes sending statements, collection letters, and making collection phone calls. Keep copies of all correspondence and make notes of all telephone calls (date, time, who you spoke with, what was said). You don't have to go to court as part of your debt collection effort if you can show the IRS that a judgment from the court would be uncollectible. The IRS considers bankruptcy of the debtor as good evidence of the worthlessness of at least part of an unsecured and unpreferred debt.

If you have debt on your books that you might want to deduct on your 2010 tax return, now is the time to make sure you meet the IRS requirements for collection efforts and that the particular type of debt qualifies under the IRS rules. Check with your accountant or tax advisor if you have any questions.