When is a debt bad
There is no universal date. Signs include a customer who has closed, filed for bankruptcy, disappeared, or refused after a long dispute. Time itself is a factor: the older an invoice, the lower the chance of collection. Many businesses review anything past a set number of days.
Before writing it off, make a documented effort to collect. See the guide on collecting late payments for steps. Keep records of the contact attempts.
The direct write-off method
This is the simplest approach. When you decide an invoice is uncollectible, you record the loss: debit bad debt expense, credit accounts receivable for the amount. The customer's balance goes to zero, and the loss lands in the month you made the decision.
Cash-basis businesses usually never recorded the income, so there is nothing to write off for tax purposes in the same way. Ask your tax preparer how your method applies.
The allowance method
Larger businesses estimate bad debts in advance. At the end of each period they record an expense and a contra asset account called allowance for doubtful accounts, based on history or an aging analysis. When a specific invoice is written off, it is charged against the allowance instead of the expense.
This matches the cost of bad debt to the period of the related sales. It needs a reasonable estimate, such as a percentage of older receivables. Small firms often do fine with the direct method.
If the customer later pays
Sometimes a written-off customer sends money. Reverse the write-off for the amount received, then record the payment against the receivable. Do not simply book it as new income, because the sale was already counted. Keep a note linking both entries.
Also review whether a partial payment arrangement was in place before you wrote it off.
Tax and controls
The tax treatment depends on your accounting method and the circumstances. Do not assume you can deduct every unpaid invoice. Share your write-off list and documentation with your tax preparer.
Set approval rules so the person who writes off invoices is not the one who handles incoming payments, to prevent cover-ups of missing cash. Review the list of write-offs each quarter and look for patterns that suggest tighter credit terms.
A worked example
A contractor invoices a customer for a job, and the customer stops answering after two partial payments. After several reminders, a demand letter and no response, the contractor decides the remaining balance will not be collected. The entry debits bad debt expense for the unpaid portion and credits receivables, with a note listing the dates of contact. The profit for that month drops, but the aging report now shows only invoices with a real chance of payment, and the owner tightens deposit rules for similar jobs.
Common questions
Can I write off a customer I still want to work with?
You can, but consider whether to continue extending credit. Keep clear records.
Is a write-off the same as forgiving the debt?
No. Writing it off is an accounting step. You may still pursue collection.
Where does bad debt appear on reports?
As an expense on the profit and loss, often listed under operating expenses.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.