Bad Debt Write-Off: How to Write Off an Unpaid Invoice

Quick answer: A bad debt write-off removes an unpaid invoice you no longer expect to collect from accounts receivable and records it as bad debt expense. Small businesses using the direct write-off method debit bad debt expense and credit accounts receivable. The write-off is an accounting entry; it does not cancel the customer's debt, and tax relief has separate rules.

Sooner or later most businesses send an invoice that never gets paid. Leaving it in your receivables overstates your assets and distorts your cash forecast, while writing it off too early can throw away a recoverable debt or a tax claim. This guide covers when to write off an unpaid invoice, the journal entries for both main methods with worked numbers, how the tax side works in the US, UK and Australia, and what to do if the money turns up later.

Important: This is general information, not tax, legal or accounting advice. Tax treatment of bad debts depends on your accounting method and jurisdiction. Check the official guidance, such as the IRS Topic 453 on bad debt deductions or HMRC VAT Notice 700/18, or ask an accountant.

What is a bad debt?

A bad debt is an amount a customer owes you that you have concluded will not be paid. In invoicing terms, it is an overdue invoice that has moved past "late" into "uncollectible". Common causes are customer insolvency, a business that has closed or disappeared, a disputed amount you decide not to pursue, or a balance too small to justify legal action.

Bad debt expense is the cost of those uncollectible invoices in your profit and loss account. It is a normal cost of selling on credit, which is why businesses track it as a share of credit sales.

When should you write off an unpaid invoice?

Write off an invoice when you have good evidence it will not be paid, not just because it is old. Typical triggers:

• The customer has entered bankruptcy, liquidation or administration.
• You have followed your full collection process, including reminders, calls and a final demand, with no result.
• A collection agency has returned the account as uncollectible.
• The cost of further recovery, such as a small claims court filing, exceeds the likely recovery.
• The customer cannot be traced.

Before writing off, make sure you have tried the steps in our guide to sending an invoice to collections. Keep copies of every reminder, email and response; they support both the accounting decision and any tax claim.

Direct write-off method: journal entry and example

The direct write-off method records bad debt expense only when a specific invoice is written off. It is simple and common for small businesses, though it can put the expense in a different period from the original sale.

Example: You invoiced a client $2,400 in March. By October the client's company has closed. You write it off:

Account	Debit	Credit
Bad debt expense	$2,400
Accounts receivable (client)		$2,400

Your receivables fall by $2,400 and your profit for the period falls by $2,400. If you charged sales tax or VAT on the invoice, the tax portion is handled separately; see the tax sections below.

Allowance method: allowance for doubtful accounts

The allowance method estimates bad debts in advance and matches the expense to the period of the sale. It is required under generally accepted accounting standards when bad debts are material, and lenders and investors expect it in larger businesses.

Step 1: estimate the allowance from your aging report

Apply a loss percentage to each bucket of your accounts receivable aging report. The percentages below are illustrative; base yours on your own history.

Aging bucket	Balance	Estimated loss %	Allowance
Current	$40,000	1%	$400
1-30 days overdue	$12,000	5%	$600
31-60 days overdue	$6,000	15%	$900
Over 60 days overdue	$4,000	40%	$1,600
Total	$62,000		$3,500

Step 2: record the allowance

If the allowance account currently has a zero balance, record:

Account	Debit	Credit
Bad debt expense	$3,500
Allowance for doubtful accounts		$3,500

Net receivables on the balance sheet are now $62,000 − $3,500 = $58,500. If the allowance already had a $1,000 credit balance, you would record only the $2,500 difference.

Step 3: write off a specific invoice against the allowance

When the $2,400 invoice is confirmed uncollectible, the entry hits the allowance, not expense:

Account	Debit	Credit
Allowance for doubtful accounts	$2,400
Accounts receivable (client)		$2,400

Net receivables do not change ($59,600 − $1,100 = $58,500), because the expense was already recognized when you set up the allowance.

Direct write-off vs allowance method

Feature	Direct write-off	Allowance method
When expense is recorded	When an invoice is written off	When estimated, usually each period
Matches expense to sale period	No	Yes
Complexity	Low	Moderate
Accepted under GAAP / IFRS for material amounts	No	Yes (IFRS uses an expected credit loss model)
US tax deduction	Follows specific write-offs	Allowance additions generally not deductible; specific write-offs are

How to record a bad debt recovery

If a written-off customer later pays, reverse the write-off and then record the payment. Using the direct method example, when the $2,400 arrives:

1. Debit accounts receivable $2,400, credit bad debt expense (or a bad debt recovery income account) $2,400.
2. Debit cash $2,400, credit accounts receivable $2,400.

Under the allowance method, the first entry credits the allowance instead. If you claimed tax relief, the recovery is usually taxable again or requires repaying the VAT or GST relief.

Bad debt write-off and taxes

United States: income tax

Under IRS rules, you can deduct a business bad debt only if the amount was previously included in your gross income. That means:

• Accrual-method businesses that recorded the invoice as income can deduct it, in whole or in part, in the year it becomes worthless, on Schedule C or the relevant business return.
• Cash-method taxpayers, including most freelancers, generally cannot deduct unpaid fees, because the income was never reported. The unpaid invoice simply never becomes taxable income.

For US sales tax, many states let sellers recover tax already remitted on invoices later written off as bad debts, under state-specific conditions. See our guide to sales tax on invoices for background and check your state's rules.

United Kingdom: VAT bad debt relief

If you accounted for VAT on an invoice that was never paid, you may reclaim it through bad debt relief under VAT Notice 700/18. Key conditions, which you should confirm in the notice:

• You have already accounted for and paid the output VAT.
• The debt has been unpaid for at least six months from the later of the payment due date and the date of supply.
• You have written the debt off in your VAT accounts.
• You claim within four years and six months of the later of the due date and the date of supply.

Worked example: A £1,200 invoice including £200 VAT at 20% was due on 31 January and remains unpaid on 31 July. Once you have written it off in your VAT records, you can claim the £200 back on your VAT return as extra input tax. If the customer later pays, you repay the relief. Businesses on the VAT cash accounting scheme do not need bad debt relief, because they never paid VAT on the unpaid invoice.

Australia: GST

Businesses accounting for GST on a non-cash (accruals) basis can generally make a decreasing adjustment to recover GST on a debt written off as bad, or overdue for 12 months or more. Cash-basis businesses do not account for GST until paid. Check the details with the ATO.

Bad debt write-off checklist

• Full collection process documented (reminders, calls, final demand, agency if used).
• Decision approved and dated, with a short note of why the debt is uncollectible.
• Journal entry posted under your chosen method.
• No credit note issued unless you are genuinely cancelling the charge.
• Sales tax, VAT or GST relief assessed and claimed on time.
• Customer flagged in your system so you do not extend credit again without a deposit.
• Invoice, correspondence and write-off records kept for the retention period. See how long to keep invoices.

Common bad debt mistakes

• Issuing a credit note instead of a write-off. The credit note guide explains when a credit note is right.
• Deducting unpaid fees on a cash-method return. You cannot deduct income you never reported.
• Missing the VAT relief window. Diarize the six-month point for every large overdue invoice.
• Keeping dead invoices in receivables. It inflates assets and DSO and misleads your forecast.
• Not learning from it. Ask for deposits, tighten terms or run credit checks for similar customers.

How to reduce future bad debts

Most bad debts start as unclear invoices or loose terms. Agree payment terms in writing, take a deposit on large or new-customer jobs, invoice promptly, and follow up the day an invoice becomes overdue. Clear invoices with a due date, PO number and itemized lines are harder to dispute and easier to enforce.

Next step

Run your aging report today and list every invoice over 90 days overdue. For each, decide: chase, send to collections, or write off. For new work, issue invoices with clear terms and a deposit line using the free invoice generator, so fewer invoices reach that list.