When to Write Off a Bad Debt

There is an invoice you have not thought about in a while, except when you do.

Fourteen months old. Two emails, one phone call, then nothing. You are not chasing it any more but you have not decided to stop either, so it sits in your head as an unresolved thing, occasionally surfacing to make an otherwise fine Tuesday slightly worse.

That is the actual cost of an old debt, and it is worth ending deliberately rather than by drift.

What the money is really worth

Recovery rates fall hard with age. The precise figures vary by industry, but the shape is not controversial: an invoice a month past due is very likely collectable. At six months it is markedly less so. Past a year, without a payment plan or a legal process, it is unlikely.

So value it honestly. A $2,000 invoice at eighteen months is not a $2,000 asset. It is a small probability of $2,000, and you should decide what to do with the expected value rather than the face value.

Then subtract what pursuing it costs — your hours, court fees or a collections cut, and the fact that hours spent chasing are hours not earning.

For a lot of small debts the arithmetic is brutal and clarifying: three hours of your time to recover $400 at maybe a 30% chance is a bad trade against three hours of billable work.

Do these things before you decide

One clear final attempt. Not a threat. A short written note stating the amount, the original date, and that if it is not resolved by a specific date you will close the account. A surprising number of long-dead invoices resolve here, because your message arrives in a month where the money exists.

Offer a payment plan. Some people are not refusing; they are unable, and the size of the number is why they stopped answering. Four payments of $250 collects more than one demand for $1,000, and it collects it from somebody who then stops avoiding you.

Offer a settlement. Sixty cents on the dollar today beats a hundred cents never. This is not weakness; it is what the debt is actually worth.

Check the paperwork. Do you have proof of the work and the agreement? If the record is thin, that matters both for any formal route and for your own confidence in pursuing it.

The formal routes, briefly

Small claims court handles amounts up to a limit that varies by state — commonly a few thousand dollars. Filing is cheap, you do not need a lawyer, and the process is designed to be usable. The catch is that a judgment is not money: if the defendant has nothing collectable, you have an expensive piece of paper.

Collections agencies take a percentage, often substantial, and are worth considering on larger commercial debts. Understand that handing it over generally ends the relationship permanently.

Both are worth it in a narrow band: large enough to matter, documented well, against somebody who has assets. Outside that band, the write-off is the better business decision.

The tax part, which surprises people

Here is the thing most small operators have backwards.

If you are on the cash basis — which most sole proprietors are — you record income when you receive it. You never recorded that $2,000 as income, because it never arrived. So there is generally no bad-debt deduction to take. You cannot deduct income you never reported.

That feels wrong and it is arithmetically neutral: you were never taxed on it, so there is nothing to reverse.

If you are on the accrual basis — you recorded the income when you invoiced it — then the treatment is different, because you did pay tax on money you never received, and a bad debt deduction is how that gets corrected.

Which basis you are on, and how to treat a specific write-off, is a question for whoever prepares your return. But do not chase an unpaid invoice on the belief that writing it off will produce a tax benefit. For most small service businesses it will not, and that changes the calculation.

Write it off properly

Make it a decision with a date. Not a fade. Mark the invoice as written off, note the date and the reason. Something you decided is finished; something you drifted away from is not.

Keep the record. Do not delete the invoice. You want the history — for the tax question if it turns out to matter, and so this client's name is still attached to what happened.

Flag the client. This is the part that pays. A written-off debt is information about a customer, and the only way it protects you is if it is attached to their name when they call again in two years, cheerful, wanting a quote.

Then let it go. Genuinely. The debt is not an asset any more and neither is your resentment.

What it should change about how you work

One bad debt is bad luck. Two is a pattern, and the pattern is almost never about the customers.

Look at what the written-off jobs had in common. Were they large jobs with no deposit? New clients with no history? Work you continued while an earlier invoice was unpaid? Jobs with no written scope, where the dispute was about what was agreed?

The single most common cause is continuing to work for somebody who has not paid for the last thing. That turns a $400 problem into a $3,000 one, and it is entirely preventable with one rule: no new work until the balance clears.

A write-off that changes one rule is tuition. A write-off that changes nothing is just a loss.