Key Takeaways

• If you use cash basis accounting (as many solo therapists do), you generally can’t deduct unpaid session fees, because you never counted that money as income.
• If you use accrual accounting and already reported the fee as income, an uncollectible balance may be deductible as a business bad debt in the year it becomes worthless.
• Insurance contractual adjustments, sliding scale discounts, and pro bono work are not bad debt, and are generally not deductible.
• The same cash vs. accrual split applies to unpaid invoices if you work as a 1099 contractor.

The phrase “writing off bad debt” gets tossed around a lot, and often newly self-employed therapists wonder whether they can deduct unpaid client bills from their taxes.

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While the idea you can save on your tax bill every time a client goes AWOL is certainly appealing, the reality of writing off bad debt is more complicated than that. 

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Here’s everything you need to know about writing off bad debt when you run your own therapy practice. The short version: whether an unpaid fee is deductible depends on whether you use cash basis or accrual accounting.

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Are unpaid therapy sessions bad debt?

First, a definition of “bad debt.” Bad debt is any debt that has become worthless because you’re unable to collect it. Bad debt only shows up on your books if you use the accrual accounting method. More on that in a moment.

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With accrual accounting, debt owed to your business is classified as “accounts receivable,” and listed on your balance sheet as current assets.

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If you charge a client $1,000 for services you performed, you enter that transaction in the books under accounts receivable. It counts as $1,000 added to your total assets—along with cash, goods, and other items of value you hold. That applies even if the debt hasn’t been paid yet.

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Suppose the client owing you $1,000 goes bankrupt, and can’t pay their bill. That $1,000 is now uncollectible, and becomes bad debt. You now have to take special steps in order to remove that $1,000 from your assets and balance your books. 

Cash vs. accrual accounting

Whether you do your own bookkeeping or have it handled by a professional, your books are handled one of two ways: with the accrual method or with the cash basis method.

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How accrual accounting works

Using the accrual method, any time you charge a client a fee, you record it as income on the books. That applies even if they haven’t paid yet. 

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The same goes for expenses. If a contractor sends you a bill, it’s recorded as accounts payable, and added to the liabilities on your balance sheet.

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Once you receive cash in hand from the client—or pay your own bill—you complete an extra step, converting your accounts payable or accounts receivable to cash. 

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Naturally, the entire process is much more complicated than that, but those are the fundamentals of how accrual accounting works.

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How cash basis accounting works

Using cash basis accounting, you only record transactions on the books once you have cash in hand.

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Meaning, you can send out one hundred bills to one hundred clients, but you don’t make a record of the money you’re owed—only the money you’re paid.

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The same goes for expenses. A contractor may send you a bill, but the expense isn’t recorded on the books until the cash leaves your bank account.

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Because of this, cash basis accounting does not use accounts receivable or accounts payable ledgers. 

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And here’s the most important thing: if you use the cash basis method, you can’t accumulate bad debt. Since there’s no debt recorded on the books, there’s no debt that can go bad.

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That also has a tax consequence, which we cover below: because you never counted an unpaid fee as income, there’s generally nothing to deduct.

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How to write off unpaid sessions with accrual accounting

Many small businesses prefer the cash basis method because of its simplicity, and many solo therapists use it for the same reason. If you work with certain bookkeepers, they might use the accrual method. Because accrual accounting is more complex and often isn’t necessary for a small practice, many bookkeepers stick with cash basis.

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However, if you do use the accrual method, and you do your own bookkeeping as well, it’s necessary to write any bad debt off the books.

Why write bad debt off the books?

When you have bad debt on the books, your financial records fail to match up with reality.

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Remember, money clients owe you is recorded in accounts receivable, and appears as an asset on your balance sheet. But if that money can’t be collected, it’s worth nothing; it’s no longer an asset, and you need to correct your books in order to reflect that.

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If bad debt accumulates on your books, your balance sheet will tell you your business has assets it doesn’t really have. And that can lead to cash flow troubles down the line.

How to write bad debt off the books

For a therapy practice billing its clients, bad debt in the form of unpaid bills will typically appear on the books as receivables that cannot be collected.

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In that case, the amount of bad debt your business is dealing with is relatively small, so you may wish to use the “direct write-off method.”

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In order to remove the bad debt from receivables, you credit your accounts receivable the amount owing, and debit a bad debt expenses account the same amount. The bad debt expense reduces your net income for the period.

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On your tax return, the IRS generally requires the specific charge-off method for business bad debts, which means you deduct a specific debt in the year it becomes worthless (see IRS Publication 334). In practice, that is similar to the direct write-off method described here.

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The biggest benefit of using this method is that it’s straightforward and, for most small businesses dealing with small amounts of bad debt (ie. hundreds, not thousands of dollars’ worth), it won’t seriously disrupt cash flow.

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The biggest drawback is that you may end up reporting bad debt in a different accounting period (ie. year) from the one in which you charged it—meaning your receivables and payables aren’t matching for that period. For that reason, direct write-offs go against Generally Accepted Accounting Principles (GAAP).

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Larger companies dealing with a significant amount of bad debt each accounting period use the allowance method to write it off. You can see a comparison of the two methods in this article from the Corporate Finance Institute.

If a client doesn’t pay for a therapy session, can I write it off my taxes?

It depends on your accounting method. If you use cash basis accounting, as many solo therapists do, the answer is generally no. If you use accrual accounting and already counted the fee as income, you may be able to deduct it as a business bad debt.

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Here’s how each method works, based on the IRS guidance on the bad debt deduction.

Cash basis: generally no (income never recognized)

With cash basis accounting, you only report income when you actually receive payment. A session fee a client never pays was never income, so there’s nothing to subtract. The IRS says that if you use the cash method, you generally can’t take a bad debt deduction for unpaid fees.

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Put another way, unpaid sessions don’t cost you extra tax, since you’re only taxed on the payments you actually collect. But they don’t earn you a deduction, either.

Accrual basis: may deduct as a business bad debt, only if previously included in income

With accrual accounting, you report income when you earn it, even if the client hasn’t paid yet. If you included a fee in your income and the client never pays, the uncollectible balance may be deductible as a business bad debt. The IRS describes a business bad debt as a loss from a debt created or acquired in your trade or business, and says you can deduct it only if the amount you were owed was included in your gross income in the current or a prior year.

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Business bad debts aren’t limited to debt you buy from another company. For a therapy practice, the most common example is your own unpaid receivables for services you already provided and counted as income.

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The deduction generally applies only in the year the debt becomes worthless, meaning there’s no reasonable expectation it will be repaid. You don’t necessarily have to go to court, but it’s worth keeping records of your collection attempts, such as reminders and follow-up messages.

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For more detail, see IRS Topic 453 and IRS Publication 334, which now includes the bad debt guidance that used to appear in Publication 535.

Example: the same unpaid $1,000, two different outcomes

• Accrual: You bill a client $1,000 in Year 1 and report it as income that year. In Year 2, it becomes clear you’ll never collect it, so you write it off as uncollectible. You may be able to claim a $1,000 bad debt deduction in Year 2.
• Cash: You bill a client $1,000 and never receive a dime. Because you never received the money, it was never income, so there’s nothing to deduct.

Cash vs. accrual: what happens when a client doesn’t pay

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Not sure which method your practice uses? Check how your bookkeeping or tax software records income, or ask your bookkeeper or tax advisor.

If a client pays with insurance, can I write it off?

If a client pays for a $200 session using insurance, and insurance only reimburses you $150, you may be inclined to believe you can write off the remaining $50 as bad debt.

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This is not the case. The rate at which you’re reimbursed by the insurance company was agreed upon when you were paneled with them, and any difference between that amount and your advertised rate generally does not qualify as either bad debt or a tax deduction.

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Patient responsibility is a different situation. If a client never pays a copay, coinsurance, or deductible they owe you, that unpaid balance follows the same rules as any other unpaid fee. If you use cash basis accounting, you generally can’t deduct it, because you never counted it as income. If you use accrual accounting and already reported the patient-owed balance as income, a balance you genuinely can’t collect may qualify as a bad debt. Check with a tax professional before claiming it.

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Denied claims need a closer look, too. A denial isn’t automatically bad debt. Whether you’re allowed to bill the client for a denied claim often depends on your contract with the insurance company, so it’s worth appealing or correcting and resubmitting first. For more on denials, patient balances, and contractual adjustments, see our complete guide to insurance billing for therapists.

If I offer a sliding scale, can I write off the difference when a client pays less?

Suppose you typically charge $200 per session, but offer low income clients a sliding scale rate of $40 to $60 per session. If a client pays you $50, can you write off the $150 as bad debt?

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In this case, you’ll have to accept generosity as its own reward. The difference between what the client pays and what you’d charge without the sliding scale generally does not qualify as either bad debt or a tax deduction. 

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The same applies if you offer some clients special discounted rates or pro bono services. Pro bono sessions were never billed, so there’s no income recorded and no receivable to write off as bad debt.

Are unpaid invoices tax deductible?

If you work as a contractor for another business (eg. a private therapy practice, a health clinic, or a community organization), you’re in a contractor-client relationship. If you receive a 1099, our guide to the difference between a W-9 and a 1099 explains how that works. You send your client invoices listing work performed and the amount they should pay you.

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If a contracting client fails to pay you, whether the unpaid invoice is tax deductible depends on the same cash vs. accrual split:

• Cash basis: You report income when you’re paid, so an unpaid invoice never shows up as income. There’s nothing to report and nothing to deduct, and there’s nothing to write off your books.
• Accrual basis: If you already counted the invoice as income, an uncollectible invoice may be deductible as a business bad debt, and you’ll also need to write it off your books.

For example, say you invoice a clinic $2,400 for three months of contracted sessions, and the clinic closes without paying. If you use cash basis accounting, that $2,400 was never income, so you simply don’t report it, and there’s no deduction to claim. If you use accrual accounting and recorded the $2,400 as income when you invoiced, you may be able to deduct it as a bad debt in the year it becomes clear you won’t be paid.

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Either way, follow up in writing and keep a record of your attempts to collect.

How to write off an unpaid invoice

1. Confirm whether you use cash basis or accrual accounting.
2. If you use cash basis, there’s nothing to write off. Make sure you didn’t record the unpaid invoice as income.
3. If you use accrual accounting, once you’ve determined the invoice is uncollectible, remove it from accounts receivable by crediting accounts receivable and debiting bad debt expense.
4. If the amount was already included in your income, ask your tax advisor whether you can deduct it as a business bad debt for the year it became worthless.

Frequently asked questions

Can therapists write off unpaid sessions on their taxes?

It depends on your accounting method. With cash basis accounting, which many solo therapists use, you generally can't deduct unpaid fees because you never counted them as income. With accrual accounting, an uncollectible fee you already reported as income may be deductible as a business bad debt in the year it becomes worthless.

What's the difference between cash and accrual accounting for unpaid client fees?

With accrual accounting, you record a fee as income when you charge it, even before the client pays. With cash basis accounting, you only record income once you have the money in hand, so an unpaid fee never shows up as income or as debt on your books.

Can I write off the difference between my rate and what insurance pays?

No. The reimbursement rate was agreed on when you were paneled, so the gap between that rate and your usual fee generally isn't bad debt or a tax deduction. An unpaid copay, coinsurance, or deductible follows the same cash vs. accrual rules as any other unpaid fee.

Can I deduct sliding scale discounts or pro bono sessions?

No. The difference between a sliding scale rate and your full fee generally isn't bad debt or a tax deduction. Pro bono sessions were never billed, so there's no income or receivable to write off.

Are unpaid invoices tax deductible for 1099 contractors?

The same cash vs. accrual split applies. On cash basis, an unpaid invoice was never income, so there's nothing to deduct. On accrual basis, an uncollectible invoice you already counted as income may be deductible as a business bad debt. Either way, follow up in writing and keep records of your collection attempts.

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Because many solo therapists use cash basis accounting, an unpaid session generally isn’t deductible. There are plenty of other, more straightforward ways to lower your tax bill. Check out our complete guide to tax deductions for therapists.

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Summary

• If you use cash basis accounting, as many solo therapists do, unpaid fees generally can’t be deducted, because you never reported that money as income
• If you use accrual accounting and already included the fee in income, an uncollectible balance may be deductible as a business bad debt in the year it becomes worthless
• Confusion arises because accrual bookkeeping requires you to “write off” unpaid sessions from your books. For accrual filers, that write-off may also be the tax deduction. For cash basis filers, there’s nothing to write off
• Unpaid invoices follow the same split: a cash basis contractor never reports the unpaid amount, while an accrual basis contractor may be able to deduct an uncollectible invoice already counted as income
• When you earn a lower session fee than usual due to accepting insurance or offering sliding scale fees, you generally can’t claim the difference as a bad debt or business expense

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.

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Bryce Warnes is a West Coast writer specializing in small business finances.

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