Write Off Unpaid Invoices: Bad Debt on Cash or Accrual Books

Can I write off an invoice a customer never paid?

A business can deduct an unpaid customer invoice as a bad debt only if the invoice amount was already counted in its income (IRS Topic 453; Publication 334). An accrual-basis business counted the invoice when it earned it, so it may deduct the unpaid part once the debt is worthless (uncollectible). A cash-basis business never counted it, so it generally has nothing to deduct.

Three things make a case less simple. First, the method on the filed tax return decides the deduction, not the cash or accrual setting on a software report. Check the accounting-method box on the last return: Schedule C line F, Form 1120 Schedule K line 1, Form 1120-S Schedule B line 1, or Form 1065 item H. If your books and your return use different methods, the unpaid invoice may never have reached the return. Second, an invoice that is large, old or tied to a bankruptcy needs proof and the right year. Third, when the books are behind or several returns are unfiled, an invoice may sit in the wrong year or be missing, and a debt that went bad in an earlier year may now be a time-limited refund claim.

An accrual-basis service business may also be allowed to skip accruing fees it expects not to collect, which changes the answer: see the allowance section below.

Gather the invoices, an aging report (your unpaid invoices listed by age), every collection attempt, any bankruptcy or closure notice, and the method shown on the last return.

Why can't a cash-basis business deduct an unpaid invoice?

A cash-basis business reports income only when it receives payment, so an unpaid invoice never reached its return, and a bad debt deduction exists only for income already reported. Under the cash method in Publication 538, income counts when received, and Publication 334 says no deduction is allowed for unpaid amounts never included in income. The regulation lists unpaid wages, salaries, fees and rents as examples (26 CFR 1.166-1(e)).

The lost payment is not deducted a second time: it never raised taxable income, and a cash-basis business generally deducts what it paid to do the work, such as materials, subcontractors and wages, in the year it pays them (Publication 538).

A business that carries inventory may have counted some invoices as income and not others. One that must account for inventory, and is not a small business taxpayer, uses accrual for purchases and sales of goods and can generally use cash for other items (Publication 538, hybrid method). Check each invoice against the return. Which method applies is covered in cash or accrual for a small business.

When does an unpaid invoice become a bad debt on the accrual basis?

An accrual-basis invoice becomes a deductible bad debt in the year it becomes worthless, meaning the facts show no reasonable expectation of being repaid (Topic 453). The sources set no number of days past due. It is a judgment on the facts.

• Deduct in one year. The deduction belongs in the year the debt becomes worthless. The business does not have to wait until the invoice is due (Topic 453).
• One invoice at a time. The business deducts specific debts that go bad, not an estimate across all receivables (Publication 334).

A totally worthless debt must be deducted in the year it becomes worthless, not a later one. If that year has passed, a refund claim may still be open for a limited time: see the section on a debt that became worthless in an earlier year. A debt from a credit sale to a customer is a business debt; a loan is a different kind of debt: see the section on loans and money lent to a friend or relative.

How do I prove an invoice is really unpaid and worthless?

Show that you took reasonable steps to collect and that, on all the facts, nothing more will come in (Topic 453). The regulation looks at all pertinent evidence, including the value of any collateral and the debtor's financial condition (26 CFR 1.166-2(a)). A lawsuit is not required if the facts show that suing would probably not lead to collecting on a judgment (26 CFR 1.166-2(b)).

Bankruptcy is generally an indication that an unsecured and unpreferred debt is worthless at least in part. A debt may become worthless before the case settles, or only at settlement. If the facts already showed it worthless earlier, the case ending in a later year does not move the deduction to that later year (26 CFR 1.166-2(c)).

A write-off in the books is not itself proof of worthlessness. The regulation also calls for a statement of the facts supporting a bad debt deduction to accompany the return (26 CFR 1.166-1(b)). Whether a customer who has simply stopped answering has become worthless in a given year is a judgment the IRS can question.

Can I write off part of an invoice?

Yes, for a business debt already counted in income that is only partly collectible, but the deduction is limited to the amount charged off on the books in that year (Publication 334; 26 CFR 1.166-3). The business must be able to show how much is worthless and how much was charged off.

If the customer paid part and the rest will never come in, the unpaid balance is a totally worthless debt, not a partly worthless one. For a totally worthless debt the deduction does not depend on a book entry, but make one anyway: if the IRS later treats the debt as only partly worthless, an amount not charged off that year is not deductible (Publication 334).

A partly worthless debt can be charged off in a later year, but no part can be deducted after the year the debt becomes totally worthless (Publication 334). A nonbusiness debt cannot be deducted in part at all (Topic 453).

What if the customer pays later?

If an accrual-basis business deducted the debt and later collects some or all of it, the recovery is income up to the amount deducted, less any part of the deduction that did not reduce its tax (Publication 334; 26 CFR 1.166-1(f)). It is reported as other income. A deduction that added to a net operating loss carryover not yet expired counts as having reduced tax (Publication 334).

A cash-basis business deducted nothing, so a late payment is ordinary income in the year it arrives (Publication 538).

How do I record the write-off and bad debt expense in my books?

The journal entry on accrual books is a debit to bad debt expense and a credit to accounts receivable, dated in the year the debt became worthless. Charging off means removing the invoice from accounts receivable (money customers owe you) and recording it as bad debt expense. Bookkeeping calls this the direct write-off method. On cash-basis books there is no expense to record.

Use a separate bad debt expense account so the total can be traced to the return. Keep the customer name, invoice number, date and evidence with each entry. If the invoice includes sales tax, split the price and the tax before posting, and make the entry balance. Sales tax imposed on the buyer, which you collect and pass to the state, is not your income, so it is outside the bad debt deduction (26 CFR 1.166-1(e); Publication 334). Tax imposed on you as the seller is part of gross receipts, so it follows the invoice. How the tax part is cleared, and whether the state lets you recover it, follows state rules: see sales tax payable and the return and filing sales tax returns. A customer refund or credit memo is not a bad debt: see recording refunds in the books. If books and return use different methods, see accrual books and a cash-basis tax return. Writing off an invoice does not require a Form 1099-C: that form is filed by lenders and similar creditors, not by an ordinary business that sold on credit (Instructions for Forms 1099-A and 1099-C).

Can I deduct an allowance for doubtful accounts?

Generally no. A business generally must use the specific charge-off method, deducting each debt as it goes bad (Publication 334). Congress repealed the general bad debt reserve in section 166 (26 U.S.C. 166); banks have their own rules.

An allowance in the books is an estimate. The expense recorded to build it is not a tax deduction, so keep a note of the difference for whoever prepares the return. The deduction comes later, invoice by invoice.

A different rule exists for service providers. An accrual-basis business need not accrue service fees its own experience says it will not collect if it works in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, or if it meets the small-business gross receipts test of section 448(c) for all prior years. That covers many small service businesses. The rule does not apply to an amount that carries interest or a late-payment penalty (26 U.S.C. 448(d)(5); Publication 334). Fees left unaccrued this way were never income, so they are not deducted later as bad debts. It is an accounting-method question with conditions, not a deduction for an allowance: ask whoever prepares your return which method your books follow.

Where does a bad debt go on my return, and how long do I keep the records?

A business bad debt goes on the business's own return, and a recovery goes on its other income line. Line numbers below are from the latest published forms; confirm them on the form you file.

Sources: instructions for Schedule C, Form 1065, Form 1120-S and Form 1120. A cash-basis corporation or partnership cannot claim a bad debt unless the amount was previously included in income, and the partnership and S corporation lines cover business debts only.

Keep records that support a bad debt deduction for 7 years, the period Publication 583 gives for a bad debt claim, counted from the due date of the return for the year the debt became worthless (26 U.S.C. 6511(d)(1)). That is longer than most records need. For the other record periods, see how long to keep business records.

What if the debt became worthless in an earlier year and I never deducted it?

A business, or its owners, can file a claim for refund instead of deducting in the original year. The deadline is the later of the two dates in the row (Publication 334; 26 U.S.C. 6511(d)(1)).

A pass-through's correction changes its owners' income, so the owners usually also amend their own returns, on Form 1040-X for an individual, to claim the refund. An AAR is due within 3 years after the later of the partnership return's filing date or its due date without extensions, and never after a notice of an administrative proceeding is mailed (26 U.S.C. 6227; Instructions for Form 1065-X). The longer windows above do not extend it; ask a preparer before relying on them for a partnership or S corporation.

The claim needs the same proof of worthlessness and the year it happened, and for a partly worthless debt it covers only the part charged off on the books that year (Publication 334, Table 8-1; 26 CFR 1.166-3). Each year has its own window, so older years close first.

What if the unpaid amount was a loan, or a friend or relative, not a sale?

A loan is a separate kind of debt. It is a business bad debt only if it was made for a business reason, such as a loan to a client, supplier, employee or distributor (Publication 334).

A debt must also be bona fide: a valid, enforceable obligation to pay a fixed or determinable sum (26 CFR 1.166-1(c)). Cash that was lent counts, so a cash-basis business does not need to have reported it as income (Topic 453). A C corporation is outside the nonbusiness rules, so a loan that has gone bad is tested under the ordinary bad debt rules, including the bona fide debt and gift conditions (26 U.S.C. 166(d)(1)).

An unpaid balance owed by an owner, or by another company the owner controls, may be a shareholder or member loan rather than a customer invoice: see loans to shareholders on the balance sheet. If a relative lent money to the business instead, see a family loan to your business.

How do I clean up old invoices and accounts receivable at year end?

Tie every open invoice to proof, then write off only the ones that are worthless. The order below keeps the books and the return in step.

1. Confirm the method on the filed return (the accounting-method box on Schedule C, Form 1120, Form 1120-S or Form 1065).
2. Run an aging report and tie its total to the accounts receivable balance on the balance sheet.
3. Sort each old invoice: still collectible, disputed (a credit or refund), partly paid, or worthless.
4. For each worthless invoice, gather the invoice, the collection record and any bankruptcy or closure notice, and note the date it became worthless.
5. On accrual books, charge off each worthless invoice, or its uncollectible part, in the year it became worthless. On cash-basis books, void the invoices that will never be paid.
6. Apply payments to the right invoices, and check for money received in January that belongs to December (an invoice paid in the next tax year).
7. Give the preparer a list of each charge-off: customer, amount, date billed, date it became worthless and the evidence.

The rest of the close is in the year-end close checklist.

Example

All figures are illustrative, in US dollars.

A cash-basis consultant is never paid

A sole proprietor consultant on the cash method bills $5,000 in March, and the client never pays. The invoice was never reported as income, so there is no bad debt deduction. Schedule C profit never included the $5,000. The books void the open invoice. If the client pays in a later year, the $5,000 is income when received.

An accrual-basis firm and a bankruptcy

In Year 1, a design firm on the accrual method bills and reports $12,000 of revenue. In Year 2, the client files for bankruptcy and the firm sees no assets to pay creditors. The firm concludes the debt became worthless that year, keeps the court notice and its collection record, and charges off $12,000 in the books and on its return for Year 2. In Year 3, the trustee finds an asset and pays $2,000. If the Year 2 deduction reduced the firm's tax, the $2,000 is income in Year 3, reported as other income.

A $3,000 favor to a friend

An owner hands a friend $3,000 and later calls it an unpaid invoice. If it was a genuine loan with no business reason behind it, it is a nonbusiness debt: a short-term capital loss, allowed only in the year it is wholly worthless, with a statement attached. If both sides understood the friend might not repay, it was a gift and nothing is deductible. A loan made for a business reason, such as to a client or supplier, and a real sale of services on credit follow the business rules above.

Different for you?

• Receivables are large or old, or you cannot tell which method your returns used: the method, the invoices that were ever counted as income, and the year each write-off belongs in all need to be settled before anything is charged off. Get bookkeeping help to reconcile the receivables to the returns.
• Your books are on accrual but your return is on cash: the unpaid invoices may never have reached the return. See accrual books and a cash-basis tax return and bookkeeping help.
• A customer filed for bankruptcy: the year of worthlessness can differ from the year the case closes. Bring the notice and the invoices to bookkeeping help before the books for that year close.
• Several years are unfiled or the books are behind: receivables from those years may be in the wrong year or missing. See catching up on overdue books and bookkeeping help.
• You must switch, or want to switch, from cash to accrual: the switch changes which invoices count as income, and receivables already worthless at the end of the prior year are left out of the adjustment (Rev. Proc. 2025-23, sec. 15.01(3)(a)). See switching from cash to accrual.
• You sold or closed the business and kept the receivables: they stay business debts if they go bad later (Publication 334), so keep the proof after the books close. Bring the invoices to bookkeeping help.
• Sales tax was already paid on the unpaid sale: state law decides what you can recover. See filing sales tax returns.
• You lent the money yourself, outside the business: whose return carries the loss depends on who made the loan. See individual tax help.
• You are in Canada: see writing off unpaid customer invoices in Canada.