Writing Off Bad Debts: An ATO-Compliant Guide for 2026

It's late June. You're looking at an aged receivables report, one customer hasn't paid in months, another has gone silent, and your bookkeeper has marked both as “probably bad”. That label feels useful. For tax, it means almost nothing.

I've seen the same mistake too many times. Business owners think writing off bad debts is an accounting tidy-up. It isn't. It's a tax position that has to survive ATO scrutiny, and the difference between “overdue”, “doubtful”, and “bad” decides whether the deduction stands up or gets knocked back.

The ATO Litmus Test When Is a Debt Truly Bad

An invoice can be old, disputed, awkward, and still not be deductible. Under section 25-35 of the Income Tax Assessment Act 1997, you can deduct a debt, or part of a debt, only if it is bad rather than merely doubtful, you write it off in the accounts in the income year you claim it, and the amount was previously included in your assessable income (or, if you're a money lender, it was money lent in the ordinary course of that business). The write-off has to happen before the end of the income year.

Overdue is not enough

People often get sloppy. They assume age proves worthlessness. It doesn't.

A debt is doubtful when payment looks shaky but recovery is still possible. A debt is bad when the facts support a commercial decision that you won't recover it. That distinction matters because the deduction turns on the point where recovery is no longer reasonably expected, not the point where you get annoyed enough to stop chasing.

Practical rule: If your records still show a real path to recovery, the debt probably isn't ready to be written off for tax.

The harder cases are the ones in the middle. The customer is still replying, maybe asking for time, maybe promising instalments, maybe contesting part of the invoice. In that situation, calling it bad too early is risky. The ATO won't care that you were pessimistic. It will care whether your records show the debt was worthless at the time you claimed the deduction.

The three conditions that matter

When I review a proposed write-off, I boil it down to three questions.

1. Did the debt exist in a form the tax law recognises? You need a real debt. For trade debt, that usually means an invoice tied back to the sale, contract, or engagement terms. If the amount was never properly raised, never finalised, or was still contingent, the foundation is weak.
2. Was the amount already brought to account properly? The amount needs to have been included in your assessable income or, if you're in the business of lending money, be money you lent in the ordinary course of that business. If the ledger trail is a mess, you're already on the back foot.
3. Did the facts support a decision that the debt was bad in that year? This is the judgement call, but it can't be a guess. You need a recovery history, failed contact attempts, and something concrete showing that further pursuit was unlikely to produce a result.

Here's the practical test I use with clients:

QuestionWeak positionDefensible position

Payment status

Old and unpaid

Old, unpaid, and supported by failed recovery efforts

Ledger support

Balance sitting in debtors

Clear invoice and account trail

Timing

“We meant to write it off”

Written off in the accounts in the correct income year

The businesses that get this right treat the write-off as a decision backed by evidence, not a year-end shortcut.

Why this matters: The first call you make, doubtful or genuinely bad, determines whether the deduction is valid at all.

Building Your ATO-Proof Evidence File

If the ATO asks why you wrote off a debt, your opinion won't carry the day. Your file will. The strongest files read like a clean chronology: debt raised, reminders sent, recovery attempted, decision approved, write-off posted.

Build the file like you expect questions

The most defensible workflow is simple. Evidence the debt as irrecoverable, document a reasonable recovery trail, and write it off in the period the debt becomes worthless.

That doesn't mean every debt needs a solicitor's letter. It does mean the file needs to show that someone acted like they wanted the money back.

A proper file usually starts with the source documents, then moves into the chase history. Don't rely on memory. Save the emails. Keep the call notes. Export the aged receivables report that shows the debt ageing over time. If the debtor stopped trading, went insolvent, disappeared, or flatly refused to pay, preserve that evidence too.

Common Pitfall

A single overdue invoice isn't an evidence file. It proves there was a debt. It doesn't prove you had sound grounds to write it off.

That mistake shows up all the time in small businesses using Xero, MYOB, or QuickBooks. Someone flags the invoice, posts a journal, and assumes the software entry creates the tax deduction. It doesn't. Software records the decision. It doesn't justify it.

If your bookkeeping process is loose, tighten the record-keeping side before year-end. AWTS has a practical guide to ATO record-keeping requirements that's worth using as a housekeeping benchmark.

What belongs in the file

Use this as a minimum checklist:

• Original debt support such as signed terms, invoices, statements, work orders, lease records, or loan documents.
• Aged receivables evidence showing the debt has remained outstanding and how long it has been unpaid.
• Contact history including reminder emails, letters, file notes of phone calls, and any payment plan discussion.
• Escalation records such as final notices, letters of demand, collection agency correspondence, or legal communications.
• Debtor status material including insolvency notices, bankruptcy material, returned mail, bounced email records, or evidence the business ceased trading.
• Internal approval with a dated management note, board note, or authorised write-off memo explaining why recovery was no longer expected.
• Ledger posting support showing the debt was written off in the accounts in the relevant income year.

Some businesses overcomplicate this by building huge folders full of duplicates. Don't. Build a file that answers the obvious audit questions in order.

A short internal memo often helps. State the debt amount, identify the debtor, summarise recovery steps, note why further action isn't commercially sensible, and record the date the write-off was approved. That memo can do a lot of heavy lifting when memories fade.

Why this matters: A strong evidence file turns a vulnerable deduction into one you can defend calmly if the ATO asks.

Tax and GST Mechanics of the Write-Off

Bookkeeping shortcuts create expensive mistakes. The tax deduction and the GST treatment are related, but they aren't the same entry and they don't solve the same problem.

Income tax and GST are separate decisions

For income tax, the issue is whether the bad debt deduction is available in the year you wrote the debt off. That affects taxable income. If you leave the decision too late and don't post the write-off before year-end, the deduction can slip into the next income year. That timing error is common and avoidable.

For GST, the question is different. If you account for GST on an accrual basis and paid GST on the invoice, you can make a decreasing adjustment on your BAS once the debt is written off as bad, or once it has been overdue for 12 months or more, whichever happens first. If you account for GST on a cash basis, there's nothing to adjust, because you never paid GST on money you didn't receive. Business owners often remember the deduction and forget the GST adjustment, which leaves money sitting with the ATO.

A short comparison helps:

AreaWhat matters most

Income tax

Whether the debt was deductible when written off in the accounts

GST

Whether a BAS adjustment should be made after the debt is treated as bad

Accounting records

Whether the journal entry and supporting records line up with the decision

If your BAS work is handled separately from year-end accounts, force those teams to talk to each other. I've seen plenty of files where the debt was written off in the ledger, but the BAS adjustment was missed, or the reverse. That kind of mismatch attracts questions because the records tell two different stories. AWTS also has a plain guide on GST return requirements if you need to check your BAS process.

Writing off part of a debt

Sometimes only part of a debt is lost, for example where a liquidator pays 20 cents in the dollar, or you settle with a customer for less than the full balance. Australian tax law lets you deduct part of a debt that you write off as bad, so you don't have to wait until every cent is gone. The same rules apply to that part: it must be genuinely bad, previously included in your income, and written off in the accounts in the year you claim it.

If you're still actively negotiating recovery of a meaningful part of the balance, don't assume the whole debt is ready to be written off.

That doesn't mean you must chase forever. It means your records should show why the amount you wrote off had no realistic recovery path at the time, and why any part still under genuine negotiation stayed on the books.

Why this matters: Clean treatment of tax and GST protects cash flow and avoids contradictory records that are hard to defend later.

Worked Examples Trade Debt vs Rental Debt

Bad debt rules look neat on paper. Real files never are. A design studio handles one kind of debt. A property investor deals with another. The records differ, the commercial decisions differ, and the tax treatment has to follow the facts.

Example one trade debt

A graphic design studio issues a $5,000 invoice to a client. The work was completed, the invoice was raised properly, and the amount was included in income. Then the client goes quiet. Emails bounce. Calls stop getting answered. A final demand goes out. The business later learns the client has ceased trading.

At that point, the studio has the ingredients for a defensible write-off if the decision is documented and posted in the accounts in the correct year.

The journal effect is straightforward in concept:

Entry effectTreatment

Expense side

Recognise bad debt expense

Asset side

Remove the receivable from debtors

Say the $5,000 invoice included GST and the studio accounts for GST on an accrual basis. It can claim a GST decreasing adjustment of $454.55 (one-eleventh of the invoice) on its BAS, and an income tax deduction for the remaining $4,545.45 it included in income. For a company taxed at the 25% base rate entity rate, that deduction is worth about $1,136 in tax.

Those numbers only help if the file supports them. If the studio can't show the debt was uncollectible when written off, the tax effect becomes vulnerable no matter how neat the journal looks.

The write-off doesn't become valid because the debtor closed the business. It becomes defensible because the records show that fact, plus the failed recovery trail, plus the timing of the write-off.

Example two rental debt

A property investor is owed $3,000 in rent arrears. The tenant has absconded, and the investor keeps the $2,000 bond to cover part of it. The instinct is to claim the remaining $1,000 as a bad debt. In most cases, that isn't available.

The reason is timing. Most individual landlords include rent in their income when they receive it, not when it falls due. The $2,000 bond kept to cover the rent is rental income in the year you keep it. The $1,000 you never receive was never counted as income, so there's nothing to deduct: a bad debt deduction only works for amounts that were already included in your assessable income.

The records in a rental debt file usually look different from trade debt. You'd expect to see the lease, rent ledger, arrears notices, bond application records, property manager correspondence, and any evidence showing the tenant has left or can't be traced. If you handle rental schedules yourself, it also helps to review AWTS's ATO rental property guide so the debt treatment lines up with the rest of the property records.

Pro-Tip

For rental debts, the bond and any landlord insurance payout for lost rent are part of the core calculation.

Bond money and insurance payouts for lost rent are assessable income when you receive them. If you claim the gross arrears as a bad debt instead of declaring what you actually received, you're overstating the loss. That's the sort of basic mismatch that causes avoidable trouble in a review.

Why this matters: Worked examples force the legal rules back into real records, which is where most bad debt claims either stand up or fall apart.

The Comeback Handling Bad Debt Recoupment

Every now and then, a debt you wrote off comes back from the dead. A former customer wants to clear old accounts. A liquidator makes a distribution. A tenant reappears and pays part of the arrears. Nice surprise. It still needs proper tax treatment.

What to do when money comes in later

If you claimed a deduction when the debt was written off, a later recovery doesn't just vanish into the bank account. The recovered amount needs to be brought back into your income in the year you receive it.

The GST side also needs attention if you previously made a bad debt GST adjustment. In that case, you'll need to reverse that position through the BAS for the period of recovery. Keep the paper trail tight. Match the incoming payment to the original written-off debt, note the date received, and post the recovery clearly so no one mistakes it for ordinary current-period sales.

Use this sequence:

1. Identify the original debt and confirm it was previously written off.
2. Match the payment to that historical balance, not to a fresh invoice.
3. Record the receipt as bad debt recovery income in the correct period.
4. Review BAS treatment if a prior GST adjustment was claimed.
5. Retain support for the original write-off and the later recovery in the same file.

Tracing before writing off versus after recovery

Sometimes the issue isn't whether to account for a recovery. It's whether more tracing should have happened before the debt was written off in the first place. When a debtor has moved or gone silent, reasonable tracing steps, such as searching the ASIC and personal insolvency registers or using a collection agency, help establish whether recovery was still realistic.

If a recovered amount lands after you've already claimed the deduction, don't treat it casually. It changes your taxable income for that year. If you're unsure how that feeds into your numbers, revisit the basics of calculating taxable income in Australia before lodging.

Why this matters: Recoupments are easy to overlook, and mishandling them can turn an earlier valid claim into a later reporting problem.

Your Bad Debt Write-Off Checklist

Most bad debt problems don't start with the ATO. They start with businesses leaving decisions too late, keeping thin records, and assuming the accountant can fix the story after year-end. Sometimes we can clean it up. Sometimes the evidence was never created, and then the deduction is exposed.

The practical next steps

Run each overdue debtor through this checklist before year-end:

• Confirm the debt is real by matching the balance to the invoice, contract, lease, or ledger source.
• Check it was previously recognised properly in income or as a qualifying amount.
• Review the recovery trail and make sure your file contains dated emails, letters, call notes, and any escalation record.
• Decide whether it is doubtful or bad based on facts, not frustration.
• Document the decision with an internal approval note that explains why further recovery isn't reasonably expected.
• Post the write-off in the accounts in the correct income year if the debt is bad.
• Check the BAS position so the GST treatment lines up with the accounting treatment.
• Create one complete file for each written-off debtor, not scattered notes across inboxes and software.
• Review recoupment risk so any later payment is recorded correctly if it turns up.
• Use a year-end process rather than ad hoc clean-ups. A structured BAS preparation checklist helps keep the tax and GST steps aligned.

A final point. Don't use bad debt write-offs as a substitute for credit control. Chasing debts properly, escalating at the right time, and documenting every step will always put you in a better tax position than trying to reconstruct events later.

Why this matters: A repeatable checklist turns writing off bad debts from a rushed year-end scramble into a controlled, defensible process.

If you need help reviewing old debtors, documenting an ATO-defensible write-off, or cleaning up the tax and BAS treatment before lodgement, Australia Wide Tax Solutions can assist with the accounting records, compliance steps, and supporting documentation needed to get it right.