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Tax Deductions for Bad Debt (Unrecoverable Income)

If you are a business owner you may have encountered a situation where promised dues were not paid because a customer wasn’t able to pay. This is known as unrecoverable income, more commonly known as ‘bad debt’.

Fortunately, the Australian Taxation Office (ATO) lets you deduct bad debts from your bill, which can help relieve some stress at the end of the financial year (EOFY). Find out below how you assess a bad debt and how to deduct it when filing your taxes. 

How to assess your income

Not everyone can claim a bad debt deduction; it depends on which accounting method you use. There are two methods: accruals basis and cash basis.

Accrual basis

Accrual basis means you include all income for work done during the income year, even if you have not yet received payment. With this method, you can claim a tax deduction for unrecoverable income if you determine there is little-to-no likelihood of receiving the payment. However, you must write off the unpaid amount as a bad debt beforehand.

Notably, if you later recover the amount, then you must include it in your assessable income the next year around.

Cash basis

Cash basis means you only include payments you have received during the income year, even if the work was done in a different year. With this method, there is no point in writing off a bad debt because you only account for the cash you have received. The income is not included in your tax return, so writing it off has no income tax consequences.


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Writing off a bad debt

It’s important to know how to write off a bad debt because the ATO will need evidence. Before claiming the deduction, you must:

  • Include the income in your tax return
  • Prove that the debt is unrecoverable
  • Write off the debt in the same financial year it was invoiced

When accounting using an accrual basis, you must still include the income when you file your taxes. Otherwise, you cannot write it off.

Next, you must be able to prove that the debt is bad. You cannot simply doubt that you get paid. Instead, you have to prove that you cannot recover the money through any reasonable attempts. 

Here are some ways to prove the debt is unrecoverable:

  • Notices to the debtor to remind them about the payment
  • Communications with the debtor in an attempt to chase up the payment, including emails
  • Legal proceedings in an attempt to recover the debt

Armed with this information, you can write off the debt. You must record the decision to write off the debt as ‘bad’ before the EOFY, removing it from the customer’s account. When you write it off, the debt must still exist and not be dealt with. In other words, you cannot waive, forgive, or sell the debt.

What happens when you write off a bad debt?

When the debt is written off, you can deduct it from your income tax bill at the end of the year. This has implications for your business’s taxable income because it means you pay less tax. 

It allows you to move on and focus your resources on other areas of the business. While it can have a negative impact on your financial statements, it also provides a tax benefit to offset some of the losses incurred.

Bad debts and GST

If you use the accrual method to account for goods and services tax (GST), you can claim a decreasing adjustment on a bad debt. However, you must satisfy the following conditions:

  • You made a taxable sale and paid GST for that sale
  • You have not received the consideration (or part thereof) for the taxable sale
  • You write the debt off as bad, or the debt is overdue for 12 months or more

Similar to writing off bad debts normally, you must show that a debt is considered bad before deducting it for GST purposes. Again, you cannot write off unrecoverable income if you have forgiven the debt or offset it against other liabilities.

You can claim a decreasing adjustment during the tax period when you write off the debt, or when you become aware that the debt was overdue for 12 months or more. If you subsequently recover any of the amounts, you will have an increasing adjustment in the tax period when you recover the debt.

Grow Your Business with QuickBooks

How QuickBooks can help

Keeping track of your finances is vital if you want to run your business smoothly. Unrecoverable income might feel like a setback, but if you are on top of your finances you can reduce the impact. QuickBooks Online can help you with invoice tracking. You can see how much has been paid and how much is still owed.

When you know what you are owed and what to expect, it can help you save time running other parts of your business and get through tax season.

Sign up today for a 30-day free trial to see what a difference QuickBooks can make.

While every care has been taken to ensure the accuracy of the information presented as at 12 April 2024, Intuit is not providing you with professional advice and we recommend you obtain your own professional advice. Intuit is not liable for your use of the information presented.


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