Generally you must use the specific charge-off method for bad debts. Under this method, you write off specific bad debts in the year they become worthless. Accounting practice provides a method for accruing bad debt expense, by setting up an allowance for doubtful accounts. This may be determined as a percentage of sales that, based on experience, will not be possible to collect. But this method is not allowed for income tax purposes. For tax purposes, each debt must be considered separately, and a bad debt expense deduction can be taken when only the debt becomes partially or totally worthless.
Partial Bad Debts
You can deduct part of a debt that becomes worthless and that you write off on your books. You do not necessarily have to charge off partially worthless debts on your books every year. You could delay the charge-off until a subsequent year, but you cannot take a deduction in a year after the debt becomes totally worthless.
If you claim a tax deduction for a part of a debt that you write off on your books, and the IRS disallows the deduction, you may still be able to claim the bad debt deduction in a subsequent year, when part of the debt actually becomes worthless. If you reversed the expense when the IRS disallowed the deduction, you would have to record the write-off again the year you claim the deduction. If you did not reverse the entry, you would take the tax deduction in the subsequent year and would have a timing difference between your bad debt expense for book and tax purposes for both years.
In order to claim a tax deduction for a partial bad debt, you have to write off that amount on your books. You do not necessarily have to write off a totally worthless debt on your books in order to be able to take the tax deduction. But if you do not, the IRS may determine that the debt is only partially worthless, and if you did not write off the debt on your books, you would not be able to claim a deduction for the partially worthless debt.