Hopefully it rarely happens to your business, but there may be times where you cannot collect. In this event, your accounting method determines how it applies to your taxes.
If you use cash accounting, you can’t write off an unpaid invoice since you only record revenue when you get paid. By contrast, if you use accrual accounting, you’ll have accounted for the revenue when you delivered the product. In this case, you classify the unpaid invoice as a bad debt expense.
Unpaid invoices can be written off on your tax return if you can prove to the IRS that they’re bad debts. Three conditions must be met:
1. The unpaid invoice has no value
All your efforts and systems to document and track your invoicing and collections process will help to prove the invoice is worthless. Unless the customer went bankrupt or passed away you need to be able to show that they simply won’t pay you.
2. It is connected to your small business
Again, invoices can prove that your non-paying customer was obligated to pay your business.
3. It has created an economic loss for your business
You simply have to show that you accrued the income related to the invoice for products delivered and services rendered and now have to record it as a bad debt expense (loss).
Once these conditions are met, you can most likely write off the debt. However, we strongly advise you to consult with an account or your tax advisor regarding writing off unpaid invoices.