Typically, small business owners can write off unpaid invoices if they meet three key criteria:
- They recorded the unpaid invoices in their accounting system or invoicing software.
- They’re an accrual-basis taxpayer.
- They can prove to the IRS that they’ve taken reasonable steps to collect the unpaid invoice amount.
To find out whether these apply to you and your unpaid invoices, start by answering these questions:
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1. Did you record the invoice in your books?
If you use an accounting program, like QuickBooks Online or Xero, to send invoices, then the answer is yes.
That’s because when you save the invoice, the software automatically adds the amount to your books. Then the invoice appears on reports until a customer pays it or you write it off.
Let's say you use Word or Google Docs to send invoices instead. If you don't add the invoice amounts to your books at some point, you can't write them off.
2. Did you report income from the invoice on your tax return?
This largely depends on whether you use cash or accrual accounting. Accrual accounting recognizes payment when services are rendered. Cash accounting doesn't recognize payment until money actually changes hands.
Let's say you created a website for a client in December 2025 and charged them for it that same month. However, you never received payment. Regardless, if you use accrual accounting, you would include the invoice amount on your 2025 tax return. After all, that's the year your services were rendered. Then you'd deduct the amount from your 2025 taxable income as bad debt.
If you use cash accounting, however, you'd need to wait until you receive payment to report it. That means you wouldn't be able to claim the bad debt deduction until money changes hands.
3. What is the likelihood that the invoice will be paid in the future?
To write off an unpaid invoice, you must be able to prove that you've taken reasonable steps to collect payment. Did you send a late payment reminder? Did you try to call the client or hire a collections agency?
In other cases, the invoice doesn't actually need to be past due to write it off. You just need to be able to prove that it's worthless. This may apply if a client goes out of business or tells you flat-out that they have no intention of paying you.
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How to deal with unpaid invoices
Here are a few suggestions to help keep your cash flowing:
Progress billing
This involves incrementally invoicing clients for a project. Each invoice amount is based on the percentage of work you've completed. You may use this type of billing on larger, long-term projects that span multiple months.
You might also use it with clients you don't necessarily trust to pay you back in full. This could help ensure you receive at least a portion of the price you quoted them. What's more, you can still write off the unpaid portion.
Start by negotiating a contract that clearly defines how often you'll bill based on project milestones (25% completion, 50% completion, etc.). You'll then need to provide the client with a project timeline, along with how much you'll need at each step. When you reach each project milestone, send your client an invoice for a portion of the agreed-upon total cost.
Invoice financing
If unpaid invoices are hindering cash flow, you might consider invoice financing. This type of financing can provide cash advances on up to 90% of your unpaid invoice amount. Just know that you'll eventually need to pay back the loan amount on top of interest fees. Lenders may also charge processing fees, along with other costs. Make sure to ask them about additional fees before applying.
This article originally appeared on Fundera, a subsidiary of NerdWallet.
