Cash basis cannot deduct
A cash-basis sole proprietor cannot deduct an unpaid invoice as a bad debt because the income was never recognized. The economic loss is real, but no deduction is needed because no income was reported. Accrual-basis filers, who recognized the receivable as income, may deduct the bad debt when uncollectible.
Specific charge-off method
Most non-bank taxpayers use the specific charge-off method: identify each specific debt that has become wholly or partially worthless during the year and deduct the worthless amount. The reserve method (general allowance for doubtful accounts) is not allowed except for certain financial institutions.
Worthlessness
A debt is worthless when there is no reasonable expectation of recovery. Indicia include the debtor's bankruptcy, the running of the statute of limitations, and uncollectible after reasonable collection efforts. Document the worthlessness analysis contemporaneously.
Recovery in a later year
If you later collect a previously deducted bad debt, the recovery is taxable income in the year received under the tax benefit rule. Report it on Schedule C as "Other income" or as a reduction of bad debts in the recovery year.
Loans to others
Business loans to vendors, suppliers, or related parties that go unpaid may be deductible as business bad debts. Personal loans to friends or family are non-business bad debts deductible only as short-term capital losses on Schedule D.
Where this fits in the larger Schedule C picture
Schedule C has more than two dozen named expense lines plus an "Other expenses" catch-all. For most small businesses, four or five lines drive the bulk of the deduction total — vehicle, home office, depreciation, contract labor or wages, and supplies — and the remaining lines individually contribute small amounts that nevertheless add up. Treating each named line as a recurring decision rather than an afterthought, and revisiting the categories each January, often surfaces $2,000–$5,000 in additional legitimate deductions that a less disciplined process would have missed entirely.
Documentation that survives an exam
An IRS examination of this deduction will request three things: proof of payment (bank or card statement), proof of the underlying transaction (invoice or receipt), and proof of business purpose (a contemporaneous note or calendar entry). The first two are usually trivial to produce; the third is where most filers fall short. Capturing business purpose at the moment of the expense — a one-line note in your bookkeeping software or a category and memo on the receipt-capture app — converts a generic charge into a documented deduction that will withstand scrutiny three to six years later when memory has faded.