Disclaimer: The following is descriptive information only, and is not intended as professional financial advice. For your specific situation, do check with your accountant and/or tax attorney.
When you provide and bill for an hour of professional service, and fail to get paid for it, the income from that hour is lost. Colleagues often ask us:
"Can I write off that lost income on my tax return?"
A related question is, "My fee is $150 but insurance allows only $90. Can I "write off" the $60 that I don't collect?"
The simple answer is to both the above is, "Probably not." Here's why:
If you're like most mental health clinicians in private practice, you use the simple "cash" method of accounting, in which income is recorded only as you receive it, and expenses are recorded only as you pay them.
In cash accounting, if you charge $150 but collect zero, your income is zero. If you charge $150 but collect $90, your income is $90. At tax time you will deduct various expenses - rent, supplies, etc. that you paid for during the year. However, you cannot deduct or "write off" bad debts or other uncollected fees, because they incurred no out-of-pocket cost above your normal business expenses.
There is a way to deduct uncollected fees, but you will need to use the accrual system of accounting, which requires more complex bookkeeping. Also, as you'll see below, you may not be any further ahead money-wise by doing so.
In the accrual system of accounting, income is recorded at the time you render services, regardless of whether or how much you get paid at the time. Thus, if you see a client, say, on Tuesday at 1 pm, and charge him $150, that is earned income for Tuesday, whether or not you get paid on that day. Expenses are recorded at the time you incur them. When you receive your phone bill it is recorded as an expense on that day, not when you pay it two weeks later.
At tax time, under the accrual system, your reported income will reflect the total of what you charged, not what you collected. From that you would deduct expenses for the year, as well as debts to you that are noncollectable, including the difference between your standard fee and the discounted fees you contracted with insurance (e.g., $150-$90=$60 per session).
Accrual accounting is used by large companies, and often by smaller businesses that maintain physical inventories. There are some advantages, such as enabling you to view your overall business activities and profitability for a given time period. There may also be some tax advantages. However, as noted above, accrual accounting requires more complex bookkeeping.
More basic detail on cash and accrual accounting methods are on the U.S. Small Business Administration website. This video also explains the difference:
In terms of net income, you will probably end up with the same amount, whether you use cash-based or accrual-based accounting with regard to uncollected fees. Here's an illustrative example:
Suppose that over the course of a year, you charged $100,000 in fees, of which $10,000 was noncollectable. Furthermore, suppose you had $30,000 in expenses.
1. Using the ACCRUAL method of accounting: Your income is $100,000 (fees you charged). You subtract the $10k in noncollectable receivables and $30k in expenses. Your net income is 100,000 - 10,000 - 30,000 = $60,000
2. Using the CASH method of accounting: Your income is $90,000 (i.e., only what you actually collected). Subtract $30k in expenses. Your net income is 90,000 - 30,000 = $60,000
Thus, you end up with the same net income either way. But the cash method of accounting is simpler to use.
Not all practices fit this model. Consult your tax professional as to what's best for you.