In addition to receivables from customers or clients that arise in the normal course of your trade or business, there are other situations that could result in a business bad debt deduction.
Loans that you make for business reasons, that become worthless, can be deducted as business bad debts. These include loans to suppliers and employees. Loans to customers or clients, other than trade receivables, also qualify if they become worthless.
If your business is a partnership, you may be able to claim a bad debt deduction if the partnership breaks up and you have to pay more than your share of the total debts because one of the other partners is insolvent.
Guarantees
You may also be able to claim a bad debt deduction if you guarantee a business debt that becomes worthless. In this case, the following tests must be met:
You made the guarantee in the course of your trade or business.
You have a legal obligation to pay as the guarantor of the debt.
You reasonably expected that you would not have to pay the debt when you made the guarantee.
You made the guarantee in accordance with normal business practice, or you had a good faith business purpose for making the guarantee. This could be the case, for example, if you guarantee a loan for a valued client, customer, supplier, or contractor, in the interest of your business.
Normally, if you guarantee a loan that you eventually have to repay, you can deduct the amount you have to pay as a bad debt in the year you pay it. But if you have rights against the borrower, this may not be the case. If as the guarantor of the debt, you have the right to demand payment from the borrower after you have paid the debt, you cannot claim a bad debt expense deduction until your rights against the borrower become worthless.