What is cash basis accounting and how does it affect bad debt deductions?

Under cash basis accounting, a service business records income only when the customer actually pays, not when the invoice goes out. So an unpaid invoice is not yet income in your records. That has a specific implication for bad debt: if revenue was never recognized in the first place, there's no bad debt deduction to take when the invoice goes uncollected. Cash-basis businesses generally can't deduct uncollected invoices as bad debts for tax purposes because they never included that income to begin with. Not tax advice; consult your accountant.

Most small businesses use cash basis because it's simpler. Your bank statements and your income roughly line up with when money hits the account. The IRS permits cash basis for most small businesses, with some restrictions based on revenue thresholds and business type. Larger businesses, or those with inventory, are generally required to use accrual accounting.

The cash-vs-accrual distinction matters most for collections and tax strategy. Under accrual, an invoice is income the moment it is issued, which means it can also be written off as a bad debt expense when it proves uncollectable. Under cash basis, the uncollected invoice was never income, so the write-off is typically not available. If your business is cash-basis and has significant uncollected invoices, talk to your accountant about the tax treatment in your specific situation.