Can you write off unpaid invoices? Tips and practices for business
Ever been caught in a loop of chasing payments that never come through? Well, it’s about time to learn when to let go. At some point, you have to ask yourself, “Is this worth my time anymore?” The same goes for unpaid invoices. Sure, you’ve sent reminders, called, maybe even begged for payment—but there comes a time when you need to face facts and decide it’s time to write off that debt. It’s a big decision, but one that can help your business regain financial control. We’ll walk you through the steps and give you the expert tips you need to write off your unpaid invoices the right way—and save some serious cash in the process.
Introduction to writing off unpaid invoices
Dealing with unpaid invoices makes accounts receivable management tough. These formal payment requests sit there past their due dates, creating a gap between money you've earned and what's actually in your bank account.
The numbers tell a concerning story: Research shows all but one of these invoices get paid on time - just 38%. This leaves much of your earned revenue hanging in the balance. Your business operations feel the ripple effects of this payment uncertainty.
Unpaid invoices affect your business way beyond the reach and influence of your balance sheet. Here's how these payment delays can hurt your operations:
Cash flow disruption: your daily expenses and supplier payments suffer without steady cash flow
Growth limitations: late payments stop 89% of small-to-medium businesses from expanding
Resource drain: the core team wastes precious time chasing payments instead of doing what matters
Additional costs: collection efforts and legal fees pile up as extra expenses
Damaged relationships: late payments strain your connections with customers and suppliers
Poor cash flow stands out as the biggest problem here. It causes 90% of small business failures, with unpaid invoices often at the root. Money tied up in accounts receivable can't help you pay bills, invest in growth, or grab new opportunities.
Invoice age makes the financial hit worse. Your collection chances drop substantially after 90 days - by about 60%. These numbers highlight why you need solid systems to manage and write off unpaid invoices when needed.
By using Enty’s all-in-one back-office automation services, businesses can simplify their invoicing process, track payments, and automate reminders—allowing them to focus on growth and not on chasing down overdue invoices. With tools for contract management, accounting, and invoicing, Enty helps businesses regain control of their finances and ensure smoother cash flow.
When is an unpaid invoice considered a bad debt?
The IRS has specific rules about writing off unpaid invoices as bad debt. You must know exactly at the time an invoice becomes truly uncollectible. A simple overdue payment does not qualify automatically, and businesses must meet precise criteria to claim these tax deductions.
Bad debt happens when you've counted an invoice in your income but can't expect payment anymore. Tax authorities need proof that your unpaid invoice is completely worthless, not just late. You must show that collection is impossible despite your efforts to get paid.
Proving the debt is worthless
Concrete evidence must show that the debt cannot be collected. Several types of proof demonstrate this effectively:
The debtor's bankruptcy declaration
The debtor's death when the estate lacks sufficient funds
A business that shuts down without any remaining assets
Collection attempts that failed with proper documentation
Mail returned as "deceased" or proof that the debtor cannot be found
Demonstrating economic loss
Your bad debt claim needs proof of actual economic loss to be valid. Accrual-basis accounting requires you to show that you reported the income on your previous tax return.
Important note: Cash-basis taxpayers usually can't deduct unpaid invoices because they haven't included these amounts in their income yet.
Establishing a business connection
Your business operations must relate to the debt. The main reason for extending credit should be business-related. A legal obligation for payment must exist, and proper documentation like contracts or service agreements helps prove this connection.
Note that voluntary cancelation of debt doesn't qualify as worthlessness. The deduction applies only in the tax year the debt becomes worthless, not before or after that period.
Steps to write off unpaid invoices
A systematic process to write off your unpaid invoices is significant for your business. You need to document these write-offs and keep your financial records accurate.
Documenting collection efforts
You must have detailed documentation of your collection attempts when you start the write-off process. Your records should include:
All payment reminder copies and notices you sent
Your call logs and written communications
Proof of any mail returns or unsuccessful contact attempt
Records of any payments received
A complete timeline showing collection agency's involvement (if applicable)
Creating a bad debt expense account
Your chart of accounts should include a dedicated bad debt expense account that tracks write-offs properly. This account ensures transparency in your financial reporting and makes tax preparation easier. Important: You need to get approval from your senior business officer for amounts under $5,000. The controller must approve amounts over $5,000.
Using credit memos to write off invoices
Here's how to process the write-off:
Check your accounts receivable aging report
Set up a credit memo that matches the bad debt amount
Link the credit memo with its matching invoice
Add a clear note like "Bad Debt Write-off"
Keep all transaction documents together
Adjusting financial statements
These accounting entries reflect the write-off process:
For standard write-offs: Debit Bad Debt Expense and credit Accounts Receivable
For businesses with allowance accounts: Debit Allowance for Doubtful Accounts and credit Accounts Receivable
Note that your accounting entries need proper authorization documentation. Keep detailed records of the write-off process to support future reference and potential audits.
Tax implications of writing off unpaid invoices
Writing off unpaid invoices can substantially affect your business's bottom line. Proper documentation of these write-offs helps reduce your taxable income and provides financial relief from uncollected debts.
Tax implications of writing off unpaid invoices are straightforward. Here's a simple example: Your business earns $100,000 annually and you write off a $5,000 uncollectible invoice. This reduces your taxable income to $95,000, which directly affects your tax liability and could save you money during tax season.
The IRS requires specific conditions to claim these deductions. Your unpaid invoice must qualify as a legitimate business bad debt, which means:
The amount was previously included in your income
You've made reasonable collection attempts
The debt is completely worthless
There's a clear business connection
You have proper documentation of all efforts
Important Tax Considerations: The timing of your write-off substantially matters. You must claim the deduction in the year the debt becomes worthless – not before or after. Missing this window gives you three years to amend your return, though bad debt claims can extend this to seven years.
Your accounting method is vital in handling these write-offs. Cash-basis accounting typically prevents you from writing off unpaid invoices because you never recorded the revenue. Accrual-based accounting allows you to write off these amounts since you've already reported and paid taxes on the expected income.
Specific tax forms are needed for claiming bad debt deductions. Your business structure determines which form to use - sole proprietors use Schedule C, while corporations use Form 1120. Keep detailed records of your collection attempts and documentation that proves the debt's worthlessness. These records may be needed during an audit.
Any amount recovered from a previously written-off invoice must be included in your gross income for that tax year. This helps maintain compliance with IRS regulations and ensures accurate reporting.
How to write off an unpaid invoice in accounting software
Modern accounting software platforms like Enty make writing off unpaid invoices quick and simple. These platforms come with features that handle transactions and keep your financial records accurate.
Your accounting software needs these steps to write off an unpaid invoice:
Create a Bad Debt Expense Account
Find the Chart of Accounts
Select "New Account"
Choose "Expenses" as account type
Label it "Bad Debt Expense"
Set Up a Bad Debt Item
Access the Products/Services list
Create new service item
Name it "Bad Debt"
Link to Bad Debt Expense account
Generate a Credit Memo
Pick the customer with unpaid invoice
Enter the write-off amount
Use the Bad Debt item
Add relevant notes and documentation
Apply Credit to Invoice
Open the original unpaid invoice
Apply the credit memo
Check if balance shows zero
Save all changes
Important Software Considerations:
Use today's date or when you determined the debt uncollectible
Add detailed notes in the software for audit purposes
Your accounting method (cash vs. accrual) should match your setup
Back up your data before major write-offs
Cloud-based accounting software updates your financial statements and tax reports automatically after these transactions. Your software adjusts the accounts receivable balance and records bad debt expense properly.
Accrual-basis accounting software creates journal entries automatically by debiting bad debt expense and crediting accounts receivable. Cash-basis users might need different entry handling, so check with your accountant about proper software setup. Bad debt reports in your software help track write-off patterns and adjust credit policies. Your accounting platform's customizable reports show these trends clearly.
With Enty, businesses can ensure their invoicing and payment processes are streamlined and automated, helping to maintain accurate records and stay compliant with legal requirements. Enty’s platform also allows for clear invoice documentation and easy tracking of write-offs, ensuring that you’re always prepared for tax season.
Legal considerations for unpaid invoices
Your business must follow IRS regulations and compliance requirements when writing off unpaid invoices. The process needs attention to detail. You should remember several legal aspects that will protect your business and help you manage bad debt write-offs effectively.
IRS requirements for bad debt deductions
The IRS enforces strict guidelines for qualifying bad debt deductions. Businesses can claim these deductions by proving several key requirements.
A legitimate business transaction must originate the debt
Your previous tax returns should already show the expected income
You must demonstrate reasonable debt collection attempts
The debt's worthlessness must occur in your claiming tax year
Note that: The burden of proof rests with you, the business owner. Your records must detail all collection attempts thoroughly. Keep emails, letters, and phone calls to show your due diligence.
Statute of limitations for amended returns
The timing of bad debt write-offs plays a significant role. The IRS provides a special seven-year window for bad debt deductions, though the general statute of limitations for amended returns spans three years. This extended timeframe offers you more flexibility to claim previously unclaimed bad debt deductions or fix earlier claims.
The IRS might inspect other parts of your tax filing if you decide to amend a return. A tax professional should review your case before you file an amended return for bad debt deductions.
Potential audit red flags
Your business's bad debt write-offs could raise IRS audit concerns when certain patterns show up. Key triggers include:
Write-offs that are too large compared to your business revenue
Bad debt claims that keep showing up every year
Missing documentation that proves your collection efforts
Write-offs for debts that still seem valuable
Gaps between your reported income and claimed losses
You can reduce your audit risks by maintaining proper documentation and keeping write-offs reasonable for your business size and industry norms. The IRS will inspect businesses closely when they report continuous losses or claim unusually high deductions against their income.
Best practices for preventing unpaid invoices
How to set up better invoicing procedures
A business needs consistent and clear invoicing procedures. Create professional, detailed invoices that include everything in this list:
Payment terms and due dates
Multiple payment options
Late payment penalties
Early payment incentives
Clear itemization of services/products
Leveraging invoice management software
Invoice management software will revolutionize your billing process. These platforms automate reminders and track payment status while giving you live updates about your accounts receivable. The best software solutions should include:
Automated payment reminders
Payment tracking capabilities
Integration with accounting systems
Custom invoice templates
Live reporting features
Enty’s invoicing solution takes this to the next level by offering features that help you match transactions with invoices seamlessly. It also integrates directly with your accounting systems, so you can easily manage your finances in one place. From automated reminders and payment tracking to generating customizable invoices and handling contracts, Enty’s all-in-one back-office services ensure that your operations run smoothly, and your cash flow stays on track.
Offering multiple payment options
Your business needs a variety of payment methods to make customer payments easier. Research shows that businesses offering multiple pay options receive payments up to 30% faster. Think over accepting credit cards, ACH transfers, and digital payment platforms that match your customers' priorities.
Using invoice financing or factoring
Businesses facing tight cash flow can quickly access working capital through invoice financing. This financial tool lets you receive 85-95% of your invoice value right away. A factoring company takes care of collecting the payments from your customers. You should call it a viable solution if your business deals with extended payment terms or experiences seasonal ups and downs.
Improving customer communication
Building strong customer relationships plays a significant role in preventing payment issues. Your clients need regular contact to address any potential risks with payments early. Be proactive in your communication:
Send friendly payment reminders before due dates
Follow up quickly on overdue payments
Address payment concerns right away
Keep professional records of all communications
Set up flexible pay arrangements when needed
Good prevention beats expensive collection efforts. These strategies help maintain healthy cash flow and reduce payment chase time. Automated systems can streamline these processes and let you focus on growing your business instead of managing overdue invoices.
Final thoughts
If unpaid invoices have been weighing you down, the good news is that you don’t have to carry them forever. By writing off bad debt, you’re taking control of your financial future and putting yourself in a position to thrive. Armed with the knowledge of how to document, track, and follow the rules for writing off unpaid invoices, you’ll be better prepared to navigate the complexities of bad debt. And with the right practices in place, your business can avoid running into these issues down the line. So, go ahead—clear those debts and make space for new opportunities. Your business deserves a fresh start.
