How to Write Off Debts for Your Small Business

Your small business may have to write off debts of two different kinds: (1) debts your business owes to suppliers and creditors and (2) bad debts that are owed to you from customers. Read further to find out how to write off both of these types of debt for your small business.

Bad Debts—Money Owed to You from Customers

Money due from your customers may be logged under accounts receivable. This is when you have extended credit to your customers, generally for 30 days but possibly longer. If they do not pay you for the goods and services they have received within 90 days, you can consider this amount as a bad debt and that it will not be collectable.

What Are the Criteria to Write Off Bad Debt?

There are three legal criteria involved in writing off bad debt. First, you must prove you had a legal business relationship with the debtor. This is easy to do. You make and record a sale to the customer and deliver the items they ordered, along with an invoice for payment, to prove the legal business relationship. The second criterion is to prove that this account receivable is worthless to your company. This can be done easily if you find out that the customer has gone bankrupt or has had similar financial issues with other suppliers. The third criterion is that your small business must have a verifiable history of good credit standing itself and show diligence in collecting payments. The Internal Revenue Service will want to see the records you have kept with other customers so they can determine how you track your accounts receivable and manage your credit. If you have a solid, written history of issuing credit and receiving payment from several customers, the IRS will probably allow you to write off this bad debt with no questions.

How to Write Off a Bad Accounts Receivable Debt

You will need to set up an allowance for bad debts account. The amounts you write off as bad debt should be in proportion to your small business's overall income and average billing to a customer for purchases. Enter the amount of the bad debt, for example, $800, into your allowance for bad debts accounting page as a debit. Then post an entry of $800 as a credit onto the accounts receivable page for that customer.

Your Business Debts to Other Suppliers

Unfortunately, if many of your customers on credit begin to default on their payments to you, you may find your business gets into trouble with its own suppliers sooner or later. You may find that your accounts get sent for collection after 90 days with no recourse. It may be necessary for you to declare bankruptcy of your small business. Your alternative is to make a proposal to your creditors to write off a portion of the debt in exchange for a schedule of payments, which will be rigorously enforced by the creditors and possibly monitored by the IRS. Any sudden influx of income into your business will be directed to your creditors first.

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