If I use the cash method, how can I deduct invoices in my business income that I know I can't collect?

[hdmacias]

I provide manual labor services that are due immediately on completion.  A company 1) underpaid some work and 2) won't pay the other (though there's dispatch records).  The only reason I kept working for that company out of my own money was because they promised in good faith the money would come along soon.  My attorney says I likely won't get paid and to just write it off as bad debt, and if I happen to win the case, to report it as income on the date it's actually paid.  However, I thought only the accrual method can write off bad debt.  Is there any way I can write it off under the cash accounting method?  I don't want to change accounting methods.  Accrual looks intimidating.

[Bsch4477]

Generally, to deduct a bad debt, you must have previously included the amount in your income or loaned out your cash. If you're a cash method taxpayer (most individuals are), you generally can't take a bad debt deduction for unpaid salaries, wages, rents, fees, interests, dividends, and similar items.

[DavidD66]

You cannot "write off" for tax purposes the invoices that are not collectible.  Because you use the cash method of accounting, you have not recognized the income; therefore, you cannot take a deduction.  If you were on an accrual basis, you would have recognized those unpaid invoices as income, and would be able to write them off.  In your case, writing off the invoices simply means remove them from you uncollected invoices that you expect to be paid.   

[hdmacias]

Thank you so much for your reply. 

I don't think I understand.  In my line of work, site preparation, whatever labor I can't finish myself I have to sub it out further.  I paid out of pocket for the materials and that additional labor.

Does that make it a type of loan?

Also, Publication 538, Accounting Periods and Methods says:

Methods you can use.

Generally, you can figure your taxable income under any of the following accounting methods.

• Cash method.

• Accrual method.

• Special methods of accounting for certain items of income and expenses.

• A hybrid method which combines elements of two or more of the above accounting methods.

...

Hybrid method.

Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. However, the following restrictions apply.

• If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. However, see Exception for Small Business Taxpayers, later. Generally, you can use the cash method for all other items of income and expenses. See Inventories, later.

• If you use the cash method for reporting your income, you must use the cash method for reporting your expenses.

• If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income.

• Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code.

When I read that, I just got more confused.

[GeorgeM777 · Accepted solution]

No, it does not appear to be a type of loan.  When you have to pay sub-contractors, laborers, and purchase supplies/materials, such expenses are business expenses and you can deduct those expenses because you, and/or your business, paid for them.  However, the fact that you did not get paid for the work that you personally did, is not a deductible expense as discussed in the previous posts.  

Businesses are free to select whatever accounting method they feel is best suited for their business. In your last post, you found the IRS guidance on the various accounting methods, and that is a good place to start to understand what each accounting method entails. However, once a business selects a particular accounting method, i.e., cash, accrual, hybrid, the business must continue to use that accounting method.  If a business wishes to change its accounting method, it must inform the IRS and seek the IRS' approval.  The business needs to complete Form 3115, Application for Change in Method of Accounting.

@hdmacias 

[hdmacias]

I think this made it easier to understand.  Thanks.