Business versus Nonbusiness Bad Debts
Business bad debts, as the term implies, arise in connection with a business. Nonbusiness bad debts are all other debts; they can arise in either a personal or investment context.
Business bad debts are deductible as ordinary losses. A C corporation's debts are always business bad debts. Nonbusiness bad debts are deductible by an individual only as short-term capital losses. As such, they are deductible only to offset your capital gains, and then up to $3,000 of ordinary income.
Business bad debts are deductible if partially or wholly worthless. Nonbusiness bad debts must be wholly worthless to be deductible.
Business Bad Debts
Business bad debts are treated as ordinary losses that offset ordinary business income. To be treated as a business bad debt, the debt must be closely related to the activity of the business. There must have been a business reason for entering into the debtor-creditor relationship.
Business bad debts typically arise from credit sales to customers. They can also be the result of loans to suppliers, customers, employees, or distributors. Credit sales are generally reported on the books of the business as accounts receivable. Loans to suppliers, customers, employees, or distributors generally are reported on the books of the business as notes receivable. When accounts receivable or notes receivable become uncollectible, this results in a business bad debt.
Valuing a Bad Debt
Accounts receivable and notes receivable generally ...
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