Carry forward bad debt loss

Hi rtmaguire,

Unfortunately the answer is usually no. There are three requirements that must be satisfied to deduct a bad business debt:

• the debt is a bona fide business debt
• it is a worthless debt, and
• you suffered an economic loss.

If you are self-employed and sell personal services, you will be able to satisfy the first two requirements with most business debts. The problem will be showing the third.

You are not automatically entitled to deduct a debt because the obligation has become worthless. To get a deduction, you must have suffered an economic loss. According to the IRS, you have a loss only when:

• you have already reported the money owed as business income
• you paid out cash, or
• you made credit sales of inventory that were not paid for.

If, like most self-employed people, you're a cash basis taxpayer who sells services to your clients, you don't report income until you actually receive it. As a result, you don't have an economic loss (in the eyes of the IRS) when a client fails to pay. Thus, you can't claim a bad debt deduction if a client fails to pay you.

Here is an IRS link that provides additional information:

https://www.irs.gov/taxtopics/tc453#:~:text=Generally%2C%20to%20deduct%20a%20bad,similar%20items%20of%20taxable%20income.

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