Bad Debt Write-Offs Explained

Every business that sends invoices eventually meets a customer who never pays. Writing that money off feels like admitting defeat, but it is really just good housekeeping. Handled properly, a bad debt write-off makes your books honest, may reduce your tax or VAT bill, and frees your attention for customers who do pay.

The end of May is a natural moment to look at old invoices. A quarter is about to close, and invoices from last autumn are now old enough to show which ones are never coming in. This guide explains what a write-off is, when it makes sense, how to record it, and what to check on the tax side.

A quick note before we start: this is general information about bookkeeping and tax, not accounting, tax or legal advice. Rules differ by country and change over time, so check the details with your accountant or the official tax authority before you claim any relief.

What a bad debt actually is

When you deliver work or goods and send an invoice, you usually record the amount as income and as an asset called accounts receivable (sometimes called trade debtors in the UK). That asset represents money you expect to receive. A bad debt is a receivable you no longer expect to collect, whether because the customer has gone out of business, disappeared, disputed the bill beyond recovery, or simply refuses to pay and chasing further would cost more than the debt is worth.

Writing off a bad debt means taking it out of receivables and recording a matching expense, usually called bad debt expense. Your income from the original sale stays on the books, but the expense cancels out the money you never received.

Doubtful vs bad

Accountants often separate two stages. A doubtful debt is one you are worried about: it is late, the customer has gone quiet, but there is still a realistic chance of payment. A bad debt is one you have given up on. Many businesses flag doubtful debts first, keep chasing, and only write them off when a clear trigger is met. This two-step approach keeps you from writing off money too early while still giving you an honest picture of risk.

Why it matters even if you never get the cash

Dead invoices make your receivables look healthier than they are and fill your cash forecast with money that will not arrive. If you account on an accrual basis, you may also have paid tax on income you never collected. Writing off the debt fixes all three.

When to write off a debt

There is no single legal date when an invoice becomes "bad" for bookkeeping purposes. It is a judgment call, which is exactly why a written policy helps. The goal is to write off debts when collection is genuinely unlikely, not when you are simply annoyed.

Common trigger points

• The customer is insolvent: they have entered bankruptcy, liquidation or administration, or closed and dissolved their company.
• You cannot find them: emails bounce, phones are disconnected and post comes back.
• Collection costs more than the debt: a small balance where further chasing, a collection agency or a small claims filing would cost more time or money than you would recover.
• Your collection steps are exhausted: you have sent reminders, a final demand and, where appropriate, a formal letter, with no response.
• Age: the invoice has passed an internal age limit you set in advance, such as a certain number of days overdue.

How to record a bad debt write-off

The exact buttons differ between accounting packages, but the logic is the same everywhere. You are reducing an asset (receivables) and recording an expense (bad debt expense).

The direct write-off method

Most very small businesses use the direct method. When a specific invoice is judged uncollectable, you write off that exact amount. The journal is simple: debit bad debt expense, credit accounts receivable. Many accounting tools handle this with a "write off" option or a credit note posted to a bad debt account.

The allowance method

Larger businesses, and those that follow formal accounting standards, often estimate future bad debts in advance. They create an allowance (sometimes called a provision for doubtful debts) based on past experience and the age of current invoices. When a specific debt finally goes bad, they charge it against the allowance. It gives a more realistic receivables figure but takes more judgment, and tax rules do not always follow the accounting estimate, so ask your accountant before switching.

1. Pull your aged receivables report. Sort invoices by days overdue and highlight anything past your review threshold.
2. Check the collection history. Confirm reminders, calls and final demands were actually sent and logged.
3. Apply your policy. Decide for each invoice: keep chasing, flag as doubtful, or write off.
4. Get sign-off. Even in a two-person business, have the owner approve write-offs above a set amount.
5. Post the write-off. Use your software's write-off or credit note function and the bad debt expense account.
6. Handle sales tax or VAT. Check whether you can reclaim tax already paid on the invoice and note the date you become eligible.
7. File the evidence. Save the invoice, your chasing emails and the approval in one folder for each written-off debt.

Tax and VAT: what may apply

This is where write-offs can actually put money back in your pocket, but only if you meet the conditions. The rules below are summaries, so confirm the details with an accountant or the official guidance for your country.

US: income tax deduction

US businesses that use accrual accounting have already counted the unpaid invoice as income. Because of that, they can generally deduct business bad debts when the debt becomes worthless. Businesses on the cash method usually never recorded the income in the first place, so there is typically nothing to deduct for unpaid fees. The IRS distinguishes between debts that are wholly and partly worthless, and it expects evidence that you took reasonable steps to collect. If you charged state or local sales tax on the sale, some states let you recover tax remitted on a bad debt, but the rules vary widely, so check with your state tax agency.

UK: VAT bad debt relief and corporation tax

If you are VAT registered and charged VAT on an invoice that was never paid, you may have already handed that VAT to HMRC. VAT bad debt relief lets you reclaim it once the debt is more than six months overdue and has been written off in your accounts. There are further conditions, including keeping proper records, so read HMRC's current guidance before you claim. For corporation tax or self-assessment, a specific bad debt written off is generally treated as a business expense, though general provisions may be treated differently. Your accountant can confirm how it fits your accounts.

Elsewhere in Europe, many countries offer some form of VAT relief on bad debts, but the conditions differ, so ask a local adviser.

A simple bad debt write-off log

A log keeps every decision in one place, which is useful for your accountant, a lender, or a future you trying to remember why that invoice vanished. Copy these columns into a spreadsheet:

All amounts above are made-up examples. Add a final column for "Recovered later" so you can record any money that comes in after the write-off.

What if the customer pays after all?

It happens more often than you might think. If you recover money on a debt you already wrote off, you reverse the write-off for the amount received, or record it as bad debt recovered, depending on your software and method.

The tax side reverses too. If you claimed a deduction or VAT relief, the recovered amount generally becomes taxable again, or the VAT has to be repaid. Note it in your log and tell your accountant so it is handled in the right period.

Writing off does not mean forgiving

Writing off a debt in your books is an accounting step, not a legal one. Unless you formally agree to release the customer, the debt may still be legally owed, and you may still be able to pursue it, subject to local time limits. Be careful with wording in any final letters: if you tell a customer the debt is "cancelled," you may have given up rights you meant to keep.

Preventing the next bad debt

Write-offs are part of business, but they should be rare. A few habits make a big difference.

• Agree terms before work starts: due dates, late payment terms and what happens if a project stops.
• Take deposits on larger jobs and for new customers with no track record.
• Invoice promptly and send reminders on a schedule, not when you remember.
• Watch for early warning signs: slower payments, partial payments, unanswered emails or sudden requests for longer terms.
• Pause work on accounts that fall behind instead of letting the balance grow.
• Use small claims or a collection agency early enough that the customer still exists to pay.

Frequently asked questions

The bottom line

A bad debt write-off is not a failure. It is an honest update to your books that shows what you will really collect. Set clear triggers, record write-offs properly, keep evidence, and ask your accountant whether income tax, sales tax or VAT relief applies.

Block an hour before the end of this quarter to clear out your oldest invoices. You will finish with cleaner records, a more realistic cash forecast, and fewer ghosts in your receivables report.