Here are 2 common scenarios that can be a source of bookkeeping confusion for mental health professionals in private practice.
For illustrative purposes, these examples assume a hypothetical fee of $200 per hour:
1. Dr. A saw John in therapy for one session. John did not pay the $200 fee at the time, but promised to pay it next time. However, he canceled his appointment and didn't reschedule. Dr. A's attempts to collect payment from John were not successful. Dr. A says that because she provided $200 worth of service and was not paid, this represents a loss of $200 from her income.
2. Dr. B participates in one insurance network. For patients who are not covered by this insurance, he charges $200/hr. His agreement with the insurance company is to accept a discounted fee of $120 for patients who use this insurance. Dr. B says, "Each time I see a patient with insurance, I lose $80."
Given that Dr. A and Dr. B did not collect full payment for services they provided, can the "losses" described above be written off (i.e., deducted) on their income tax returns?
First, this 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.
The simple answer is to both the above questions 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 $200 but collect zero, your income is zero. If you charge $200 but collect $120, your income is $120. At tax time you will deduct various expenses - rent, supplies, etc. that you paid for during the year. However, in the cash method of accounting, you cannot deduct or "write off" bad debts or other uncollected fees, because they incurred no out-of-pocket payment 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.
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 $200, 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., $200-$120=$80 per session).
Accrual accounting is used by large companies, and often by smaller businesses that maintain physical inventories or have other special circumstances. 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:
How to decide which method of accounting to use
Although cash accounting is more common among small businesses that provide professional services, it may not be optimal for your particular situation. There are multiple factors to consider, not just in terms of taxes, but also for business planning. Therefore, it is recommended that you consult with your accountant or professional tax advisor.