Can Therapists Write Off Unpaid Invoices?
For therapists, the ability to deduct unpaid client invoices depends on your financial reporting. Learn the tax considerations for uncollected payments.
When clients do not pay for sessions, it can create financial strain and raises the question of whether these outstanding amounts can be written off on your taxes. The ability to deduct unpaid client bills depends entirely on the accounting method your practice uses.
Determining Your Accounting Method
Most small businesses, including therapy practices, use one of two methods: cash-basis or accrual-basis. The cash-basis method is the most common for its simplicity; you record income only when you physically receive a payment. Expenses are similarly recorded only when you pay them.
Under the cash-basis method, you cannot deduct an unpaid invoice. Since the income from that session was never recorded because you never received the cash, there is no income to subtract a loss from. The unpaid bill simply results in lower total income for the year. You have not paid taxes on that amount, so the Internal Revenue Service (IRS) does not allow a deduction for it.
With the accrual-basis method, you record income at the moment you earn it, not when the client pays. Likewise, you record expenses when you incur them, not when you pay them. If you use the accrual method, you have already reported the invoiced amount as income and paid income tax on it. Because this income was already taxed, you may be able to deduct the unpaid amount as a “bad debt.”
Requirements for Deducting Bad Debt
For therapists using the accrual method, an unpaid invoice can be deducted as a business bad debt, but only if it meets specific IRS criteria for being “worthless.” A debt is considered worthless when there is no longer any reasonable expectation of being paid. You must be able to demonstrate that you have taken meaningful steps to try and collect the payment from the client.
Examples of reasonable steps include consistently sending the client monthly invoices and follow-up statements, making phone calls to inquire about payment, and sending formal collection letters. It is important to document every attempt you make to collect the debt, noting the dates and types of communication.
You should maintain a dedicated file for each uncollectible account. This file should contain copies of all original invoices, a log of all communications with the client regarding the unpaid balance, and any correspondence, such as returned mail, that indicates the client cannot be located. The debt must be entirely worthless; a partial write-off is not permitted unless a client has made a partial payment and you are writing off the remaining balance.
How to Claim the Deduction
Once you determine a debt is worthless, the process for claiming the deduction is straightforward. The specific tax form you use depends on your business structure. For the majority of therapists who operate as sole proprietors, the deduction is reported on Schedule C (Form 1040), Profit or Loss from Business.
On Schedule C, you will find a specific line item for “Bad debts from sales or services.” This is where you will enter the total amount of all the worthless debts you are writing off for that tax year. You should claim the deduction in the same year that you determine the debt has become uncollectible.
If your practice is structured as a partnership or an S corporation, the bad debt would be reported on the respective business tax return, such as Form 1065 for partnerships or Form 1120-S for S corporations. The key is to ensure the amount is entered on the correct line designated for bad debts.
Reporting Recovered Bad Debt
A client may pay an invoice that you had previously written off as a bad debt in a prior tax year. You are required to report that recovered amount as income. You must include the payment in your gross income in the year you receive it.
The recovered amount should not be used to amend the tax return from the year you took the deduction. Instead, you report it on your current year’s tax return. For a sole proprietor filing a Schedule C, this recovered amount is included on the line for “Other income.” You should keep clear records that distinguish this payment from your regular sales revenue for the year.
The amount you must include in income is limited to the amount of the deduction that actually reduced your taxes in the prior year. This is known as the “tax benefit rule.” It is important to report these recoveries accurately to maintain compliance.