Worthless debts shall be allowed as deductions from income after being ascertained as such. There are two types of bad debts an individual may incur, business and non-business. A business bad debt is created and deductible from the taxpayers ordinary net income computation. A non-business bad debt is listed on a Federal schedule “D” with documents and deducted as a short term capital loss. There shall accompany the return a statement showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and deduct a debt in part, he must ascertain and be able to demonstrate with a reasonable degree of certainty the amount thereof which is uncollectible. An amount subsequently received on account of a bad debt, or on account of a part of such debt previously charged off and allowed as a deduction for income tax purposes must be included in gross income in the tax year in which received.

Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and unpreferred debt. Actual determination of worthlessness in bankruptcy cases is sometimes possible before and, at other times, only when settlement in bankruptcy shall have been made. Where a taxpayer ascertained a debt to be worthless and charged it off in one tax year, the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later tax year, confirming the conclusion that the debt is worthless, will not authorize shifting the deduction to such later tax year. If a taxpayer computes his income upon the basis of valuing his notes or accounts receivable at their fair market value when received, which may be less than their face value, the amount deductible for bad debts in any case is limited to such original valuation.

Worthless debts arising from unpaid wages, salaries, rents and similar items of taxable income, will not be allowed as a deduction unless such items have been entered as income in the books of the taxpayer in a prior tax year or in the tax year in which the deduction was made. Only the difference between the amount received in distribution of the assets of a bankruptcy and the amount of the claim may be deducted as a bad debt. The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedent's estate and the amount of his claim may be considered a worthless debt. A purchaser of accounts receivable which cannot be collected and are subsequently charged off the books as bad debts is entitled to deduct them, the amount of the deductions to be based upon the price he paid for them and not upon their face value.

Where mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been reported by him) as a bad debt for the tax year in which it is ascertained to be wholly or partially worthless and charged off. In addition, where the creditor buys in the mortgaged or pledged property, loss or gain is realized, measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer, in the absence of clear and convincing proof to the contrary. If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquisition.

Accrued interest may be included as part of the deduction only when it has previously been reported as income.

Bonds, when ascertained to be worthless, may be treated as bad debts to the amount actually paid for them. Bonds of an insolvent corporation secured only by a mortgage from which, on foreclosure, nothing is realized for the bondholders, are regarded as ascertained to be worthless not later than the tax year of the foreclosure sale and no deduction for a bad debt is allowable in computing a bondholder's income for a subsequent tax year.

A taxpayer (other than a dealer in securities) possessing debts evidenced by bonds or other similar obligations, cannot deduct from gross income any amount merely on account of market fluctuations, when a taxpayer ascertains, however, that due to the financial condition of the debtor or conditions other than market fluctuations, he will recover upon maturity none or only a part of the debt evidenced by the bonds or other similar obligations and so demonstrates to the satisfaction of the Director, he may deduct, in computing net income, the uncollectible part of the debt evidenced by the bonds or other similar obligations.