Bad Debt Deduction for Small Business: How to Write Off Uncollectible Invoices
A business bad debt deduction under IRC 166 allows a business to deduct the amount of a debt that becomes wholly or partially worthless during the tax year. For businesses, bad debts are deducted as ordinary losses (not capital losses), meaning they directly offset business income with no limitation. The critical distinction is between cash-basis and accrual-basis taxpayers: a cash-basis business that invoices a client $10,000 and never receives payment has no bad debt deduction because the $10,000 was never included in income. An accrual-basis business that invoiced the same $10,000 already included it in income when the invoice was issued, so the uncollectible amount qualifies as a bad debt deduction. Business loans that become uncollectible are deductible regardless of accounting method, because the loan principal was an actual outlay of funds.
Bad debt deduction rules:
| Factor | Business Bad Debt | Non-Business Bad Debt |
|---|---|---|
| IRC section | 166(a) | 166(d) |
| Character of loss | Ordinary loss (fully deductible) | Short-term capital loss |
| Partial worthlessness | Deductible | NOT deductible (must be totally worthless) |
| Capital loss limits | None | $3,000/year against ordinary income |
Cash vs. accrual basis:
| Scenario | Cash Basis | Accrual Basis |
|---|---|---|
| Invoice $10,000, client never pays | No deduction (income never recognized) | $10,000 bad debt deduction |
| Loan $5,000 to client, client defaults | $5,000 deduction | $5,000 deduction |
| Sell inventory on credit, buyer defaults | COGS already claimed | Bad debt for full sale price |
Requirements to claim:
| Requirement | Details |
|---|---|
| Bona fide debt | Genuine obligation to repay (not a gift) |
| Previously included in income (A/R) | Accrual-basis only |
| Worthless in the year claimed | Not a future expectation |
| Reasonable collection efforts | Calls, letters, collection agency |
| Business purpose | Created in connection with the business |
Statute of limitations: 7 years for bad debt deductions (IRC 6511(d)(1)), longer than the standard 3-year statute.
How does a business owner write off a bad debt?
What is the difference between a tax deduction and a tax credit?
A tax deduction reduces your taxable income, which lowers your tax by the amount of the deduction multiplied by your marginal tax rate. A $1,000 deduction in the 24% bracket saves $240 in tax. A tax credit directly reduces your tax liability dollar for dollar. A $1,000 credit saves $1,000 regardless of your tax bracket. Some credits are refundable (you receive the excess even if your tax is zero), while others are non-refundable (they can only reduce your tax to zero). Credits are almost always more valuable than deductions of the same dollar amount.
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Yarik Yarosh, CPA. "Bad Debt Deduction for Small Business: How to Write Off Uncollectible Invoices." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-writing-off-uncollectible-invoices-irc-166
This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.