Are there conditions that you must meet before you can claim a bad debt?  Of course! 

Just because you believe you are unable to recover a debt, you must be absolutely certain there is no prospect of recovery. And even then, the loss may be disallowed. The courts will look at the level of collection effort that was made by the creditor, and if there is even a remote possibility that the debt can be collected on.

So how do you determine if a debt is worthless?  

According to Spidell’s, “For a debt to be deductible as worthless, it must be a bona fide debt which arises from a debtor–creditor relationship and is based upon a valid and enforceable obligation to pay a fixed or determinable sum of money.”

Unfortunately, this isn’t a formal checklist or standard test to determine if a debt is worthless — but there are specific elements that will factor into the case.  Such as:

• A decline in the debtor’s business;
• A decline in the value of the debtor’s assets;
• The overall business climate;
• The debtor’s serious financial reverses;
• The debtor’s earning capacity;
• Events of default;
• The debtor’s insolvency or bankruptcy;
• The debtor’s refusal to pay;
• Actions the creditor took to collect the debt; and
• Subsequent dealings between the creditor and debtor.

Keep in mind that just because a debtor’s business is in decline or has failed to turn a profit, or if a debt is merely difficult to collect, does not prove that the debt is worthless. The court will look to see if there is a possibility of future profits and if the debtor continues to be an ongoing concern.

Source: http://www.elderclientplanner.com