A bad debt is an amount a creditor is owed and has concluded it will not collect. Federal tax law recognizes two kinds, business bad debts and nonbusiness bad debts (IRS, Publication 334 (2025), chapter 8). The term names the debt itself, the unpaid receivable or loan still sitting in the ledger, and not the estimate carried against it, which is the allowance for doubtful accounts, or the charge that estimate produces, which is bad debt expense. A balance still in doubt rather than given up on is not yet a bad debt but a doubtful debt.
The Two Tax Categories
Which category a bad debt falls into decides where the loss goes. One section sits behind both categories, 26 U.S.C. 166. Its general rule allows a deduction for any debt which becomes worthless within the taxable year (26 U.S.C. 166(a)(1)), and the subsections that follow decide which taxpayers may use it.
A business bad debt is a loss from the worthlessness of a debt that was either created or acquired in your business, or closely related to your business when it became partly or totally worthless, and a debt is closely related if your primary motive for incurring it was a business reason (IRS, Publication 334 (2025), chapter 8).
The statute defines the other category by exclusion, and only for noncorporate taxpayers. For a taxpayer other than a corporation the general deduction rule does not apply to a nonbusiness debt, which means a debt other than one created or acquired in connection with a trade or business of the taxpayer, or one the loss from the worthlessness of which is incurred in the taxpayer’s trade or business (26 U.S.C. 166(d)). Where such a debt becomes worthless within the taxable year, the loss is considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year (26 U.S.C. 166(d)(1)(B)), so it enters as a short-term capital loss rather than a deduction against business income.
The Consumer Sense Is a Different Term
Personal finance uses the same two words for a borrower’s own costly or unproductive borrowing. That sense describes the borrower’s liabilities, not a creditor’s uncollectible receivable.
Where a Bad Debt Shows Up in a Firm’s Work
Nothing in the ledger declares a balance bad. The judgment is made on a specific account during the close, against a threshold the IRS states plainly: a debt becomes worthless when there is no longer any chance the amount owed will be paid (IRS, Publication 334 (2025), chapter 8). What evidence carries that judgment in a receivables file is worked through in how to read an accounts receivable aging report.
Schedule C carries no bad debts line. A sole proprietor’s business bad debts land in Part V, Other Expenses, and reach the front of the form through lines 48 and 27b, and what belongs there is narrow: debts and partial debts from sales or services that were included in income and are definitely known to be worthless (IRS, Instructions for Schedule C (2025)).
That “included in income” clause closes the door on a cash-basis client’s unpaid invoices, because an unpaid invoice was never income. A business cannot take the deduction for amounts owed to it that it has not received and cannot collect if it never included those amounts in income (IRS, Publication 334 (2025), chapter 8).
A loan is a different case. If a firm lends money to a client, supplier, employee, or distributor for a business reason and is unable to collect the loan after attempting to do so, it has a business bad debt (IRS, Publication 334 (2025), chapter 8), and the amount of the deduction is set by adjusted basis rather than by the face of an invoice (26 U.S.C. 166(b)).
Common Questions
Money a creditor is owed and cannot collect. In a business, goods and services customers have not paid for sit in the books as accounts receivable or notes receivable, and the uncollectible part of those is a business bad debt (IRS, Publication 334 (2025), chapter 8).
A business debt that has become worthless, in whole or in part. Business bad debts are mainly the result of credit sales to customers, and can also result from loans to suppliers, clients, employees, or distributors (IRS, Publication 334 (2025), chapter 8). A nonbusiness debt has to be totally worthless, because no deduction is allowed for a nonbusiness debt which is recoverable in part during the taxable year (26 CFR 1.166-5(a)(2)).
An invoice a firm billed for services, included in income, chased through its normal collection steps, then judged uncollectible once the client’s business closed. Where only part of it is uncollectible, that partial debt is what qualifies (IRS, Instructions for Schedule C (2025)).
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