Can You Write Off Unpaid Invoices? Rules by Accounting Method

Writing off unpaid invoices is possible only if your business uses the accrual method of accounting and already reported the invoice as income. Cash-basis businesses, which is most sole proprietors and small shops, generally cannot deduct the unpaid amount because that money was never counted as taxable income in the first place. Federal tax law under 26 U.S.C. § 166 permits a deduction for debts that become worthless, but only for amounts previously included in gross income.¹

Your Accounting Method Decides Everything

Before you plan any write-off, confirm how your business reports income. Cash-basis taxpayers record revenue when payment arrives. If a client never paid, that invoice never became income, so there is nothing for the IRS to let you deduct. You cannot claim a loss on money the tax system never saw.¹

Accrual-basis taxpayers work under different rules. Under accrual accounting, you book income when you earn it, not when the check clears. A consulting firm that bills $15,000 in October reports that amount as income for the year whether or not the client pays. Because the $15,000 was already in gross income, the firm can deduct it later as a bad debt if collection fails.¹

What Cash-Basis Businesses Can Still Deduct

Cash-basis operators aren’t entirely empty-handed when a client stiffs them. Any out-of-pocket costs you actually paid on the job (materials, supplies, subcontractor labor) remain deductible as ordinary business expenses in the year you paid them. That deduction stands on its own; the client’s nonpayment doesn’t change it.²

What you cannot recover is the value of your own time or your expected profit margin. A cash-basis accountant who spent 40 unpaid hours on a client’s books cannot deduct those hours, because the fee was never reported as income. Software or printed materials purchased for that engagement, though, were real expenditures already deductible.

What Qualifies as a Business Bad Debt

For accrual-basis taxpayers, Section 166 sets three conditions.

The debt must arise from a genuine business transaction. The IRS requires a real debtor-creditor relationship based on an obligation to pay a fixed amount, created in the ordinary course of your trade or business. A favor between friends doesn’t count.³

The debt must be worthless. This is where most claims stand or fall. You need to show no reasonable expectation of collecting. Bankruptcy, a shuttered business, or a debtor who has vanished without traceable assets are the kinds of indicators the IRS looks for. A client who is 60 days late is not a worthless debt; a worthless debt is one where collection is genuinely hopeless.

The amount must have been included in gross income for the current or a prior tax year. This is the requirement that closes the door on cash-basis claims for the invoice itself.¹

Total Worthlessness vs. Partial Worthlessness

If the debt is completely uncollectible, you deduct the entire unpaid amount in the year it becomes worthless.⁴

Partial worthlessness is different. You can deduct only the uncollectible portion, and only up to the amount you formally charge off on your books during that tax year. If a client owes $10,000 and $6,000 is unrecoverable, you must record that $6,000 write-down in your accounting records before claiming the deduction. The books come first, then the return. The IRS will not allow a partial deduction for an amount you never actually charged off.⁵

Which Tax Year to Claim It

The deduction belongs in the year the debt becomes worthless, not the year you sent the invoice and not the year you gave up in frustration.⁴

Pinpointing that year is often the hardest part. A bankruptcy filing gives you a clean date. A debtor who slowly stops answering calls is murkier, and reasonable people can disagree on when hope was objectively lost. Document your collection timeline so you can defend the year you picked.

Miss the right year and you still have room to correct it. The tax code allows a seven-year window to file a refund claim for overpayments tied to bad debt deductions, longer than the usual three-year window for amended returns. You would file an amended return for the year the debt actually became worthless.⁶

Where to Report It on Your Return

The form depends on your entity.

Sole proprietors and single-member LLCs report the bad debt on Schedule C (Form 1040) under Part V, Other Expenses (Line 48). The total flows to Line 27b. Include only debts from sales or services previously counted in income and now definitively worthless.⁷
C corporations report bad debts on Form 1120, Line 15. A cash-method corporation still cannot claim the deduction unless the amount was previously included in income.⁸
S corporations and partnerships report bad debts on Form 1120-S or Form 1065, with the deduction passing through to owners’ or partners’ individual returns.

Records to Keep

Bad debt deductions attract IRS scrutiny, so build a file for each one. You want the debtor’s name and address, the original contract or invoice showing the amount and date, evidence that the amount was reported in your gross income (the relevant return or ledger entries), copies of demand letters and collection efforts, and proof of worthlessness such as a bankruptcy notice, returned mail, or a collection agency’s written determination that the debt is uncollectible.

Retention matters. The general IRS recommendation is three years, but keep bad debt records for seven to match the extended refund-claim window.⁹

Getting the numbers wrong carries real cost. The accuracy-related penalty is 20% of any underpayment caused by negligence or a substantial understatement.¹⁰ A fraudulent claim runs to 75% of the underpayment.¹¹

If the Client Eventually Pays

Sometimes a written-off debtor resurfaces with a check. When that happens, you generally must report the recovered amount as income in the year you receive it. The Schedule C instructions state this directly: if you later collect a debt you deducted as bad, include it in income for the year of collection.⁷

The tax benefit rule provides a narrow exception. You only report the recovery as income to the extent the original deduction actually reduced your tax. If the deduction produced no real tax benefit (for example, other losses had already zeroed out your taxable income that year), the recovery can be partially or fully excluded.¹² Applying that exception requires the original year’s computation, another reason to hold the file for seven years.

Personal Loans Are a Different Rulebook

The rules above cover business debts. If you loaned money personally to a friend or made a bad personal investment, that is a nonbusiness bad debt, deductible only when totally worthless and treated as a short-term capital loss subject to the $3,000 annual capital loss limit ($1,500 if married filing separately), with the excess carried forward.⁴¹ Personal loans do not follow the business-invoice path described above.

1
Internal Revenue Service. Topic No. 453, Bad Debt Deduction
2
Internal Revenue Service. Publication 334 (2025), Tax Guide for Small Business
3
eCFR. 26 CFR 1.166-1 Bad Debts
4
Office of the Law Revision Counsel. 26 USC 166 Bad Debts
5
eCFR. 26 CFR 1.166-3 Partial or Total Worthlessness
6
Office of the Law Revision Counsel. 26 USC 6511 Limitations on Credit or Refund
7
IRS. 2025 Instructions for Schedule C (Form 1040) – Profit or Loss From Business
8
Internal Revenue Service. Instructions for Form 1120 (2025)
9
Internal Revenue Service. How Long Should I Keep Records?
10
Internal Revenue Service. Accuracy-Related Penalty
11
Internal Revenue Service. 20.1.5 Return Related Penalties
12
eCFR. 26 CFR 1.111-1 Recovery of Certain Items Previously Deducted or Credited