Bad Debt? Get a Tax Break

It happens to nearly every business sooner or later: A customer makes a purchase on credit, then never pays up; or a vendor loans a customer money to help keep the customer's business afloat, but the company goes under anyway. The only good thing about bad debts is that you can turn them into a tax break.

First off, the bad debt must be directly related to operating your business, says Frederick W. Daily, author of Tax Savvy for Small Business; nonbusiness bad debts generally aren't tax-deductible. Note that you only take a bad-debt deduction if you previously recorded the amount owed as income received. If you have not previously included the uncollected amount in income, you don't get to deduct the bad debt.

However, you still get to deduct your cost for the goods at issue. Be sure to include the cost of goods sold for unpaid merchandise in your total for "cost of goods sold" on your tax form to help reduce your gross income.

Not every bad debt can be turned around, though: If you are in a service business and don't have much in the way of cost of goods, you're out of luck here. Also, unfortunately, only the cost of goods is deductible, not the full retail price you charged the deadbeat customer.

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