Business Bad Debt Write-offs: What You Can & Can’t Do

Nearly every small business has faced it: Work completed, invoice sent, and…silence on the other end. When a customer vanishes without paying, that loss is more than frustrating—it could be a tax deduction. This guide breaks down what counts as a bad debt write-off, when it’s deductible, and how to protect your business going forward.

What Are Bad Debt Write-Offs?

In business terms, a bad debt write-off is money you expected to collect but later realized you weren’t able to. It's often the result of unpaid invoices for goods delivered or services completed.

Example:

You’re a contractor who finishes a $12,000 kitchen remodel. The client goes dark, ignores calls, and never pays despite several follow-ups. If you report income on an accrual basis, you have already counted that $12,000 as earned revenue. When it becomes clear the money isn’t coming, you may be eligible for a business bad debt deduction.

To qualify, the debt must be:

• A bona fide debt, meaning it stems from a real obligation to repay

• Previously recorded as income (on an accrual basis)

• Backed by some form of agreement—formal invoice, contract, or consistent past behavior showing a credit arrangement

When Can You Claim a Bad Business Debt Deduction?

The IRS only allows bad business debt deductions for accrual-based businesses. Why? Because these businesses count income when it's earned, not when it’s received. If you operate on a cash basis, unpaid invoices were never recorded as income, and so there’s no tax benefit to writing them off.

That said, cash-basis businesses still suffer the loss. It affects your bottom line and cash flow, but not your taxes. You can (and should) still:

• Pursue collection

• Report the debt to a collection agency

• Take legal steps, if appropriate

Also worth noting: a debt can be partially worthless. If you recover only a portion of what you’re owed, you may still write off the rest.

What Counts as a Reasonable Collection Effort?

To deduct a bad business debt, you must show you made real efforts to collect it. The IRS expects you to try and then document those attempts.

Examples of reasonable efforts include:

• Multiple follow-up emails

• Collection letters with due dates and consequences

• Phone calls or texts with the client

• Using a collection agency

• Small claims court action

It’s important to keep a paper trail. If the IRS questions your business’s bad debt tax deduction, they’ll want proof. Save copies of contracts, invoices, emails, and notes from any attempts to resolve the issue.

How to Write Off Business Bad Debt

Once you’ve determined a debt is truly uncollectible, record the bad debt write-off in your accounting software.

Here’s how:

• In QuickBooks or similar platforms, create a journal entry that reduces accounts receivable and adds the amount to “Bad Debt Expense” or “Other Expenses.”

• Sole proprietors report this on IRS Form 1040 Schedule C under “Other Expenses.”

• Partnerships and corporations also report bad debt under “Other Deductions” on their respective tax forms—Form 1065 for partnerships, Form 1120 for corporations, and Form 1120-S for S corporations. In each case, the deduction must be supported by proper documentation and clearly identified as a business-related debt. Unlike individuals deducting non-business bad debts, these business entities can deduct partially worthless debts as long as the portion being written off is clearly identified and charged off during the tax year.

What Can’t Be Deducted as a Business Bad Debt?

Some common traps disqualify deductions. You cannot claim:

• Unpaid invoices that were never recorded as income (cash-basis issue)

• Anticipated losses or future unpaid work—not actual, proven losses

• Deposits or down payments that weren’t recognized as revenue

• Personal loans to friends or family—unless they were tied directly to a legitimate business activity with clear terms and a repayment plan

A note on informal loans: Even if you call it a “business loan,” it doesn’t count unless it was made in the course of your trade or business and was expected to be repaid under formal terms.

Impact on Financial Statements

A bad debt write-off directly lowers your business income and affects profitability.

For accrual-basis businesses, the write-off reduces accounts receivable and taxable income.

For cash-basis businesses, you don’t get a deduction, but you still suffer a hit to expected cash flow.

Understanding this impact helps you plan ahead. A pattern of unpaid debts can indicate a need for better credit screening or revised payment policies.

Writing off a debt doesn't mean you stop trying to collect it. Businesses can and often do continue pursuing payment. If a previously written-off debt is later repaid, the amount recovered must be reported as income in the year it's received. This “recapture” is required because the original deduction reduced taxable income; therefore, repayment effectively reverses part of that tax benefit.

How to Minimize Bad Business Debt in the Future

A few simple steps go a long way in reducing your risk:

• Use written contracts or signed work orders to confirm terms before starting work

• Require deposits or progress payments, especially for large jobs

• Run credit checks for new clients, particularly if you’re extending terms

• Offer auto ACH payments, so you can automatically withdraw funds owed to you from their bank on the due date

These steps won't eliminate bad debt entirely, but they do make it less likely and easier to prove if it happens.

For a review of other potential tax mistakes or opportunities, see this prior blog post.

When to Talk to an Accountant

Not every uncollected payment qualifies for a business bad debt deduction. That’s where a tax professional adds value. An accountant can:

• Review your bookkeeping and spot deductible write-offs

• Help you classify debts correctly (business vs. non-business)

• Guide you on proper documentation to support your claim

• Advise if a partial deduction makes sense

If you’ve ever guaranteed someone else’s debt for business reasons and ended up paying it yourself, you may even qualify for a deduction as a guarantor—another good reason to consult a pro.

These and other occurrences are good reasons many small business owners choose to partner with an outside accounting firm.

Final Thoughts

Unpaid invoices sting, but they don’t have to be a total loss. By understanding the rules around how to write off bad debt, keeping good records, and improving your client screening, you can lessen the financial blow.

If in doubt, bring in experienced support like JLS Accounting. We can help you claim what you’re entitled to and protect your business from future loss. Contact us here for a no-obligation review.