Writing Off Bad Debts Before Year-End
Every business that sends invoices eventually meets a customer who never pays. Carrying those dead invoices into a new year makes your books look healthier than they are and can mean you pay tax or VAT on money you will never see. Here is how to decide when a debt is truly bad, write it off properly and keep the paperwork that backs you up.
Key takeaways
- A bad debt is money a customer owes you that you have good reason to believe will never be paid.
- Writing it off removes it from your receivables so your books and reports show reality.
- In the US, accrual-method businesses can generally deduct business bad debts that become worthless; cash-method businesses cannot deduct income they never reported.
- In the UK, VAT bad debt relief is available once a debt is over 6 months overdue and written off in your accounts.
- Document every collection attempt, because the write-off decision needs evidence.
Late October is a good moment to look hard at your unpaid invoices. There are still two months left in the calendar year, which is enough time to chase what can be saved, make a clear decision on what cannot and get the paperwork in order before your accountant asks for it in January.
Writing off a debt can feel like admitting defeat. It is not. It is a bookkeeping decision that reflects what has already happened. The customer stopped paying months ago; the write-off just makes your records catch up. And in some cases, it can lower your tax or VAT bill. This guide covers the decision, the process, the tax angle in the US and UK and the habits that mean fewer write-offs next year.
What counts as a bad debt
A bad debt is an amount owed to your business that you no longer expect to collect. The invoice was real, the work was delivered or the goods were shipped, but the customer cannot or will not pay.
Common reasons include:
- The customer has gone out of business or entered insolvency.
- The customer has disappeared and stopped responding to every channel.
- The amount is so small that chasing it further would cost more than it is worth.
- A dispute has been settled for less than the full amount, leaving a balance you have agreed not to pursue.
- A court or collection agency has confirmed there is nothing to recover.
Slow payers are not automatically bad debts. A customer who is 90 days late but still talking to you and paying in small amounts is a collection problem, not a write-off. The test is whether you have a reasonable basis to believe the money is gone.
Bad debt vs doubtful debt
Accountants often draw a line between the two:
| Doubtful debt | Bad debt | |
|---|---|---|
| Status | Collection is uncertain | Collection is not expected |
| Action | Keep chasing; may set aside an allowance or provision | Write off and remove from receivables |
| Tax effect | Usually none on its own | May allow a deduction or VAT relief, depending on the rules |
Common mistake
Writing off a debt and then forgetting to stop chasing it, or worse, writing it off while the customer is still paying. Pick one status for each invoice, record it, and tell anyone who handles collections.
Why write off before year-end
There are three practical reasons to deal with bad debts now rather than letting them drift into the new year.
Your reports become trustworthy
If your receivables include invoices you will never collect, every report built on them is off. Your balance sheet shows assets that do not exist, your average collection time looks better or worse than it should, and any lender looking at your accounts gets a distorted picture.
You may be paying tax on money you never got
If you use accrual accounting, you counted that invoice as income when you issued it. If it is never paid, a write-off may let you reverse that effect for tax purposes. If you are VAT-registered in the UK, you may have already paid VAT on the invoice, and bad debt relief may let you claim it back once the conditions are met.
It forces a decision
Old invoices sitting in limbo take up mental space. Reviewing them once a year, with a clear rule for what gets written off, frees you to focus collection efforts on the invoices that can still be saved.
Pro tip
Book a 90-minute session in early November to review every invoice over 60 days old. It leaves time for one last round of reminders before December, when many customers are distracted and slow to reply.
The tax side: US and UK basics
This section is general information, not tax advice. The rules have conditions and exceptions, so check the official guidance and talk to an accountant before claiming anything.
United States
In the US, the key question is your accounting method.
- Accrual method: you report income when you earn it, not when you are paid. If a business debt you already reported as income becomes worthless, you can generally deduct it as a business bad debt. You need to show the debt was genuine and that it became worthless, which is where your collection records matter.
- Cash method: you report income only when you receive it. Because an unpaid invoice was never counted as income, there is nothing to deduct. Writing it off still cleans up your records, but it does not create a tax deduction.
The IRS has detailed guidance on business bad debts, including partial worthlessness and what to do if a written-off customer later pays. Check the current publications or ask your tax preparer.
United Kingdom
For income tax or corporation tax, a debt that is genuinely irrecoverable and written off in your accounts generally reduces your taxable profit, because you had already counted it as income.
VAT has its own rules. If you have already accounted for VAT on a sale and the customer does not pay, VAT bad debt relief may let you reclaim it. The main conditions are that the debt is over 6 months overdue and that you have written it off in your accounts. There are record-keeping requirements and time limits, so read HMRC's current guidance before you claim.
Europe and elsewhere
Most countries offer some form of relief for VAT or sales tax on unpaid invoices, but the conditions differ. Some require proof of legal action or insolvency. Check with your local tax authority or adviser.
How to write off a bad debt, step by step
Here is a process you can follow for each invoice you are considering. It works whether you use bookkeeping software or a spreadsheet.
- Pull your aged receivables report. Sort by age and focus on invoices well past their due date.
- Check the history. For each one, list every reminder, call and reply. Note any partial payments or promises.
- Make a final attempt. Send a clear, polite final notice with a deadline, a payment link and an offer to set up a plan.
- Decide using a written rule. For example: no response after a final notice and 120 days overdue, or confirmed insolvency, equals write-off. Apply the same rule to every customer.
- Record the write-off. In most bookkeeping software you create a credit note or use a bad debt feature that moves the amount to a bad debt expense account. Avoid deleting the original invoice.
- Keep the evidence. Save emails, letters, insolvency notices and your decision note in one folder per customer.
- Claim any relief. Pass the list to your accountant for the tax return, and for UK VAT, include eligible amounts in the right return.
- Update your customer record. Flag the account so nobody extends credit again without a conversation.
Example
Dev runs a two-person design studio in Manchester and uses accrual accounting. A retail client owes £1,800 including VAT for work invoiced in March. After four reminders and a final notice, the client's phone line is disconnected and their website is offline. By October the invoice is seven months overdue. Dev writes it off in the books with a bad debt entry, saves the email trail and notes the date. His accountant then reviews whether VAT bad debt relief applies and reduces his taxable profit by the net amount. (These figures are made up for illustration.)
A bad debt review template
Use this table for your year-end review. One row per invoice. All amounts are made-up examples.
| Customer | Invoice no. | Amount | Days overdue | Last contact | Evidence saved | Decision |
|---|---|---|---|---|---|---|
| Northside Retail | 1042 | $1,800 | 210 | Final notice, no reply | Yes | Write off |
| Lakeview Studio | 1077 | $650 | 95 | Promised payment next month | Yes | Keep chasing |
| Hart & Co | 1013 | $4,200 | 160 | Insolvency notice received | Yes | Write off, file claim |
Common mistake
Deleting the original invoice to "tidy up." That wipes the audit trail and can break your VAT or sales tax records. Always write off with a separate entry so the history stays intact.
What if the customer pays later?
It happens more often than you would expect. A customer gets back on their feet, or a debt collector recovers part of the amount. If money comes in after a write-off, record it as a bad debt recovery. In practice, that usually means reversing part of the write-off and recording the payment against it.
The tax effect generally reverses too. A recovered amount you deducted may need to be reported as income, and UK VAT relief you claimed may need to be repaid. Your accountant can tell you exactly how to handle it.
Preventing bad debts next year
Every write-off is a lesson. Use your year-end review to spot patterns and tighten up for the coming year.
- Check new customers. For larger jobs, do a quick check on the business: how long it has been trading, whether it has public reviews, whether a credit check makes sense.
- Take deposits. For project work, a deposit before you start reduces how much is at risk.
- Shorten payment terms. The longer the terms, the more can go wrong. Consider shorter terms for new clients.
- Invoice promptly. An invoice sent the day work finishes gets paid faster than one sent three weeks later.
- Automate reminders. Most invoicing tools can send polite reminders before and after the due date.
- Pause work on overdue accounts. Agree in your contract that you can stop work if invoices go unpaid.
- Write a credit policy. One page listing your terms, deposit rules, reminder schedule and write-off rule keeps everyone consistent.
Pro tip
Track your bad debt total as a share of revenue each year. If it creeps up, look at which customer types or services are behind it and adjust your terms for those first.
Your year-end bad debt checklist
- Run an aged receivables report and list every invoice over 60 days
- Gather the collection history for each overdue invoice
- Send a final notice with a clear deadline and payment options
- Write down your write-off rule and apply it consistently
- Record write-offs with a credit note or bad debt entry, never by deleting invoices
- Save evidence in a folder per customer
- Confirm your accounting method and any tax or VAT relief with your accountant
- Flag written-off customers in your records
- Update your credit policy for next year
Frequently asked questions
How long should I wait before writing off a debt?
There is no single legal deadline for the write-off itself. Many small businesses use a rule based on age and response, such as no contact after a final notice and 120 days overdue. Specific reliefs, like UK VAT bad debt relief, have their own timing conditions.
Can I still chase a debt after writing it off?
Yes. A write-off is an accounting entry, not a legal release. The customer still owes the money unless you have agreed otherwise. If you recover it later, record the recovery and adjust any tax relief.
Should I use a debt collection agency first?
For larger amounts it can be worth it, but agencies usually take a share of what they recover. Compare that cost with the amount owed and the time you would spend chasing yourself.
I use cash accounting. Is there any point writing off?
Yes, for clean records. You will not get a tax deduction for unreported income, but your receivables and reports will be accurate, and you will stop wasting time on dead invoices.
Related reading
The bottom line
Bad debts are part of running a business that extends credit. Review overdue invoices before year-end, make a final attempt, apply a clear write-off rule and record each write-off with a proper entry and saved evidence. Then check with your accountant whether tax or VAT relief applies.
The aim is not to give up on customers; it is to make your books tell the truth and to learn from each loss. A tidy receivables list going into January is one of the best gifts you can give your future self.
