Bad Debts

From a tax point of view, there are two kinds of bad debts – business and non-business. A business bad debt is a loan that is not getting paid back, that in some way is connected to a business. It might be the equivalent of an accounts receivable or similar type advance to a customer; it might be a loan, if you are for instance, in the business of making loans; or perhaps, a loan/advance to an employee that doesn’t get paid back. These are business bad debts and can be deducted as an ordinary operating expense against the business income. 

On the other hand, there is the non-business bad debt – for instance, you loan money to a friend. Of course, if that money is not getting paid back, perhaps it’s loaning money to a former friend. While such a bad debt is deductible, it is not deductible as an ordinary loss or expense, but rather as a capital loss. In general, that is less valuable, less usable, than a business write-off. 

One of the problem areas involving a non-business or personal bad debt, is that it is often to a friend or relationship, and thus claiming a loss (a bad debt) is typically suspect (by the IRS) on its face. In order to qualify as a deductible bad debt, there has to have been an expectation of repayment, and (reasonable) efforts made to effectuate repayment. Particularly when dealing with relations, it’s a good idea to get (in writing) some form of a note obligation, acknowledging the loan, so as to give you a stronger foundation for writing it off if it’s never collected. 

Furthermore, you have to make reasonable efforts to collect the debt. That means you’ve got to, in some fashion, press for collection, show a series of correspondences, maybe even get an attorney involved. A suit of course is very helpful – but if there’s support for the futility of a suit, then you need not actually initiate a lawsuit. However, the burden is on you, the one looking to claim the loss, to prove that in fact it was intended as a loan that was going to be repaid.