To be sure you're on solid ground with the IRS regarding a bad-debt deduction, you must be able to demonstrate that the debt existed and establish that it became worthless in a particular year. Ordinarily, some definable event, such as the debtor's bankruptcy, needs to occur during the year to show that you don't expect to ever collect the debt.
When declaring a bad-debt deduction, be sure to attach a written statement to your tax return, says Jacksack. The statement should describe the nature of the debt, the amount of the debt, the name of the debtor, whether you're related to the debtor, the date it became a bad debt, the efforts you made to collect the debt, and the reasons why you determined the debt was worthless.
One last point to keep in mind: If you've written off a bad debt as totally worthless and your customer eventually pays all or part of it, you have to count the amount paid as income in the year you receive it, says Jacksack.
Nobody likes to get stuck with outstanding debts, but turning them into tax deductions takes some of the sting away.
CCH Inc., 2700 Lake Cook Rd., Riverwoods, IL 60015, http://www.toolkit.cch.com
Jan Zobel, E.A., (510) 482-1015, JanZtax@aol.com