A bad debt is owed by a consumer who refuses to pay their payment and from whom you are unable to collect. However, you don’t have to completely lose out on bad debt. They may be eligible for a tax break. But there are exceptions.
A number of conditions must be met before a debt can be written off.
Priority one: make sure the debt is legitimately owed to you. For this, you’ll need evidence of the services provided, the agreed-upon payment, and the client’s failure to make payment. Oral agreements may be enforceable, but written verification of the debt is preferred.
You must also be able to explain why you owe the money. For a basis in debt to occur, you must have previously included the amount owed by the debtor in your company’s gross income for the year. In this case, you’ve paid yourself  since you’ve treated the money as taxable in that tax year.
Your business actions must have resulted in the debt in order for it to be written off. Debts incurred by individuals cannot be deducted from taxable income. Unless there is adequate documentation to the contrary, these gifts are not tax deductible according to the IRS.
At the very least, your loan should be regarded worthless. If there is no hope of repayment, a debt is termed worthless. This does not need sending your client’s account to collections or pursuing legal action against them. When it comes to paying off debt, you don’t even have to wait until the full amount is due.
A reasonable effort to recover a debt must be demonstrated, though. Additionally, it shows that any collection efforts would be fruitless. This could involve
countless attempts to acquire them have been fruitless.
Deceased, missing, or gone out of business
When it comes to bad debt, it’s important to document everything, just like any other financial issue. Anything that serves as evidence, such as unpaid invoices, collection letters, or credit reports, should be preserved.
When it comes to taxes, it’s crucial to keep track of deadlines. In the year that the debt is completely worthless, it must be written off. Deducting the unpaid component of a debt that isn’t completely worthless is an option if you’re dealing with a partially worthless obligation.
Bad debts are recorded on Schedule C, F, or A of Form 1040 as ordinary losses. A credit or refund may be requested if the bad debt was not deducted from your original return in the year it was rendered worthless. If you failed to deduct the debt from your taxable income in the year it became worthless, you still have time to file a claim. You can file a claim  if the bad debt is declared worthless.
Or, if you filed an extension, seven years from the original due date of your tax return. Your tax return is valid for two years up to: if your debts are just half worthless. Three years after the return was filed, or the day the return was filed, whichever comes first. Your tax return is valid for two years.
What happens if you get your hands on a bad loan and pay it back? Recovered funds are treated as gross income for tax purposes if you deducted them from your prior tax year’s gross income in accordance with the rule of tax advantage.