Shutting down small business with income/expense tax year mismatch

[forummm]

My dad has a self-employed construction business. He has terminal cancer and won't be able to work anymore. In November 2024 he took sizeable payments in advance for a job. He did some of the work in 2024 and hired subcontractors to do other parts of it (but did not pay them yet). In early January he became severely ill and eventually was hospitalized and received the diagnosis. Since he cannot complete the job he either needs to refund money for the uncompleted work or hire subcontractors to complete it.

He has historically filed his taxes with Schedule C using "Cash" accounting. My understanding is that since he received the payments in 2024, they are taxable in 2024. And since he has not yet paid his subcontractors, including ones he may need to complete additional work, I'm concerned that these expenses may need to be deducted from 2025 income. However, he will not have 2025 income at all (or in any future year, if he lives that long).  Similarly, if he were to issue a refund, I'm concerned it might be a 2025 expense.

I don't want to switch him to "Accrual" accounting because the process looks as though it will invite scrutiny into his business. Having looked through his records, and found really poor record keeping, I am certain that I would not be able to find sufficient documentation to understand all the deductions he took, let alone successfully defend them during an audit. And he won't be around to clarify things himself.

Q1: Is it OK to deduct from 2024 income, payments made in 2025, to subcontractors for work completed in 2024?

Q2: Is it OK to deduct from 2024 income, payments made in 2025, to subcontractors for work completed in 2025?

Q3: Is it OK to deduct from 2024 income, refunds to the customer made in 2025 for uncompleted work?

Q4: My mom has a self-employed Schedule C administrative support job (completely unrelated to his construction business). Is there any way to deduct 2025 payments to his subcontractors from her 2025 income?

Q5: Is it OK to shift some of the payments received in 2024 to be 2025 income to match up with the expenses/refunds?

Any other ideas about how to handle this? Thanks!

[seattlecyclone]

First off, my condolences on your dad's condition.

I'll start by saying I think there are others on this forum who are much more knowledgeable about business accounting/taxation than I. This seems like a situation where retaining a tax accountant could be a wise expenditure.

Cash accounting is certainly convenient in a lot of cases because the revenue and expenses are recognized at the same time as the money flows into or out of your bank account, but if it's not too late to change to an accrual system for his 2024 taxes you might want to look into the process for doing that. That way the payment and subsequent refund for services not rendered could probably just stay off your father's tax returns entirely. Understandable that this might seem somewhat daunting due to his poor recordkeeping, but if you talk to an experienced accountant they might be able to advise you on what your biggest audit risks are and how to mitigate them.

If you do stick with cash accounting my understanding is it's perfectly possible for a legitimate business sole proprietorship to report a net loss for a year, and this loss would then count against any other income that your father (and mother if filing jointly) would claim for this year. Business losses can invite IRS scrutiny because they're often a result of people trying to claim a money-losing hobby as a tax deduction, but in this case it seems like your dad has a history of operating this business at a profit and any losses this year would come for a very understandable reason.

[terran]

I think your concerns are valid, and as a cash basis taxpayer I don't think there's any way to legally deduct these payments from 2024 income or shift the income to 2025, however a business loss in 2025 should be deductible against other income, including your mom's business income and any income they might manufacture from, for example Roth conversions or capital gains harvesting if either of those are options. Something else I'd suggest looking into is whether your mom could continue to carry the business loss forward once she's a single filer or if it needs to be used while the business operator is still on the return. Something else you could look into based on very little google searching so I might be misunderstanding is a Net Operating Loss carryback which might let you write off a business loss in excess of total 2025 income against 2024 income, presumably by filing an amended return. Hopefully someone will come by to give you more definitive answers.

[forummm]

Net Operating Loss carryback

Thanks, but it sounds like the US doesn't have that law anymore.

[secondcor521]

I think your concerns are valid, and as a cash basis taxpayer I don't think there's any way to legally deduct these payments from 2024 income or shift the income to 2025, however a business loss in 2025 should be deductible against other income, including your mom's business income and any income they might manufacture from, for example Roth conversions or capital gains harvesting if either of those are options.

There is no longer the opportunity to generate income from Roth conversions or capital gains harvesting for 2024.  Both of those tax planning opportunities expired on 12/31/2024.

[secondcor521]

My dad has a self-employed construction business. He has terminal cancer and won't be able to work anymore. In November 2024 he took sizeable payments in advance for a job. He did some of the work in 2024 and hired subcontractors to do other parts of it (but did not pay them yet). In early January he became severely ill and eventually was hospitalized and received the diagnosis. Since he cannot complete the job he either needs to refund money for the uncompleted work or hire subcontractors to complete it.

He has historically filed his taxes with Schedule C using "Cash" accounting. My understanding is that since he received the payments in 2024, they are taxable in 2024. And since he has not yet paid his subcontractors, including ones he may need to complete additional work, I'm concerned that these expenses may need to be deducted from 2025 income. However, he will not have 2025 income at all (or in any future year, if he lives that long).  Similarly, if he were to issue a refund, I'm concerned it might be a 2025 expense.

I don't want to switch him to "Accrual" accounting because the process looks as though it will invite scrutiny into his business. Having looked through his records, and found really poor record keeping, I am certain that I would not be able to find sufficient documentation to understand all the deductions he took, let alone successfully defend them during an audit. And he won't be around to clarify things himself.

Q1: Is it OK to deduct from 2024 income, payments made in 2025, to subcontractors for work completed in 2024?

Q2: Is it OK to deduct from 2024 income, payments made in 2025, to subcontractors for work completed in 2025?

Q3: Is it OK to deduct from 2024 income, refunds to the customer made in 2025 for uncompleted work?

Q4: My mom has a self-employed Schedule C administrative support job (completely unrelated to his construction business). Is there any way to deduct 2025 payments to his subcontractors from her 2025 income?

Q5: Is it OK to shift some of the payments received in 2024 to be 2025 income to match up with the expenses/refunds?

Any other ideas about how to handle this? Thanks!

Sorry to hear about your father's health.

A1:  Not if he operates his 2024 business on a cash basis; see below.

A2:  Not if he operates his 2024 business on a cash basis; see below.

A3:  Not if he operates his 2024 business on a cash basis; see below.

A4:  Assuming your parents file MFJ, then probably.  Check the rules for Schedule C line 32 et seq.  He would file a 2025 Schedule C reflecting his business income and expenses, showing a net loss.  She would file a 2025 Schedule C reflecting her business income and expenses, showing (presumably) a profit.  The two Schedule C profits and losses would offset each other (and any other income, like capital gains or W-2 income or SS.

A5.  Not if he operates his 2024 business on a cash basis; see below.

You mentioned looking at changing to accrual.  I wouldn't bother, unless a CPA really advises it.  It increases audit risk, increases the complexity of you finishing his 2024 and 2025 returns, and provides zero tax benefit as far as I can tell.

[forummm]

A4:  Assuming your parents file MFJ, then probably.  Check the rules for Schedule C line 32 et seq.  He would file a 2025 Schedule C reflecting his business income and expenses, showing a net loss.  She would file a 2025 Schedule C reflecting her business income and expenses, showing (presumably) a profit.  The two Schedule C profits and losses would offset each other (and any other income, like capital gains or W-2 income or SS.

A5.  Not if he operates his 2024 business on a cash basis; see below.

You mentioned looking at changing to accrual.  I wouldn't bother, unless a CPA really advises it.  It increases audit risk, increases the complexity of you finishing his 2024 and 2025 returns, and provides zero tax benefit as far as I can tell.

The thing is her income is well below the standard deduction as it is (and they have no other income except a small SS). So they will have no tax burden in 2025 other than her SE tax. But his 2024 Schedule C profit will prompt both 2024 SE tax and 2024 income tax that can't be benefitted from in 2025 (taking income further below the standard deduction is useless).

If they can't deduct from his 2024 Schedule C the tens of thousands in subcontractor payments and refund, those deductions will just be lost, and they'll be paying tax on something that wasn't really income.

If they changed to accrual, there would be a tax benefit because the income would match up with the refund/subcontractor payments. But I couldn't recommend this to my mom. His poor practices will end up costing her, one way or another.

[secondcor521]

A4:  Assuming your parents file MFJ, then probably.  Check the rules for Schedule C line 32 et seq.  He would file a 2025 Schedule C reflecting his business income and expenses, showing a net loss.  She would file a 2025 Schedule C reflecting her business income and expenses, showing (presumably) a profit.  The two Schedule C profits and losses would offset each other (and any other income, like capital gains or W-2 income or SS.

A5.  Not if he operates his 2024 business on a cash basis; see below.

You mentioned looking at changing to accrual.  I wouldn't bother, unless a CPA really advises it.  It increases audit risk, increases the complexity of you finishing his 2024 and 2025 returns, and provides zero tax benefit as far as I can tell.

The thing is her income is well below the standard deduction as it is (and they have no other income except a small SS). So they will have no tax burden in 2025 other than her SE tax. But his 2024 Schedule C profit will prompt both 2024 SE tax and 2024 income tax that can't be benefitted from in 2025 (taking income further below the standard deduction is useless).

If they can't deduct from his 2024 Schedule C the tens of thousands in subcontractor payments and refund, those deductions will just be lost, and they'll be paying tax on something that wasn't really income.

If they changed to accrual, there would be a tax benefit because the income would match up with the refund/subcontractor payments. But I couldn't recommend this to my mom. His poor practices will end up costing her, one way or another.

Right.

You have a few issues to work through:

1.  Can you decide now to retroactively change to accrual for 2024?  Maybe, I don't know the rules.

2.  You'd have to do accrual for everything in 2024, not just this last incomplete job.  Do you really want to do that?

3.  There might be expenses in early 2024 that were actually accrued in 2023.  Do you really want to deal with that?

4.  Most significantly:  If you are able to switch, I'm not sure you could actually treat any refund or additional (sub)contractor labor on the last incomplete job as a 2024 expense as you wish.  Accrual means (I'm pretty sure) when he incurred the expense, not when he paid it.  The refund would only be incurred when he agreed to refund the client's money, and the subcontractor labor would only be incurred when he contracted with them or when they did the labor - I'm not exactly sure on that.  Both those accrual periods occurred in January/February 2025, even though they're associated with a job he started in 2024.

A small consolation is that I'm pretty sure his 2025 business loss will reduce her SE tax liability if they file MFJ.

Paging @MDM who may know this stuff.

[MDM]

Comments from someone like @SeattleCPA who works with business returns would be most beneficial.

Off the top of my head I don't see any errors in the collective wisdom to this point, but the above sentence remains.

[forummm]

4.  Most significantly:  If you are able to switch, I'm not sure you could actually treat any refund or additional (sub)contractor labor on the last incomplete job as a 2024 expense as you wish.  Accrual means (I'm pretty sure) when he incurred the expense, not when he paid it.  The refund would only be incurred when he agreed to refund the client's money, and the subcontractor labor would only be incurred when he contracted with them or when they did the labor - I'm not exactly sure on that.  Both those accrual periods occurred in January/February 2025, even though they're associated with a job he started in 2024.

A small consolation is that I'm pretty sure his 2025 business loss will reduce her SE tax liability if they file MFJ.

I believe the income would only be accrued upon earning it (i.e. completion of the project), so it would be a 2025 reporting for all the income (adjusted for refund) and all the expenses.

How can his loss decrease her SE tax? My understanding is there's a separate Schedule SE for each person on the return. And there's nowhere that I see you can import your spouse's loss onto your SE calculation. And at line 4, his loss would be zeroed out.

[secondcor521]

I believe the income would only be accrued upon earning it (i.e. completion of the project), so it would be a 2025 reporting for all the income (adjusted for refund) and all the expenses.

I don't know the rules for accrual very well, and that's really something for a CPA to opine on.  I would guess that at least the portion of the job completed in 2024 might need to be recognized as income in 2024.

How can his loss decrease her SE tax? My understanding is there's a separate Schedule SE for each person on the return. And there's nowhere that I see you can import your spouse's loss onto your SE calculation. And at line 4, his loss would be zeroed out.

You're right; my bad.  I was thinking of a scenario of one person with multiple Schedule Cs - those are all combined into one SE.  But MFJ could have 2 SEs as in your parents' situation.

[sonofsven]

OP, sorry to hear of your dad's health issues
My first thought when I read your list was that the answer was basically no to each of your questions. But not being a tax or accounting expert myself I was hoping that more knowledgeable posters would chime in.
I've operated similarly to your father for many years, a small time contractor on a cash accounting basis, so I do have a little insight there.
I've often "cheated" a little, like if I do a job in 2024 and all the expenses are in 2024, but I'm paid in 2025, I will move the payment back to '24 for tax reasons. But that's kind of the opposite of what you're dealing with.
I'm assuming your father is still in contact with the client, and it sounds like he wants to do right by them and finish the job by hiring subs to do so? Is the relationship still solid? Are they understanding?
If so , is there enough money left to pay subs to finish the job?
Can your father just write a check and return the balance to the clients?
When you are a schedule C filer, no one is checking dates or really looking that closely at your return, unless you are audited.
I would be sorely tempted to have your father write a check dated 2024 sending the balance of the money back to the clients. Then the clients could write a check to your father now in 2025 if they/your father wanted to try to finish the job. Essentially this is your question 3 & 5. Also, to question 1, the issue is if you have to send 1099's to any of the subs that would be a red flag to the IRS.
I think it's justifiable, given the situation, but it's likely the IRS would see it differently.
Really, though, it would probably be best for your father to give up on the idea of finishing the job and just focus on his health and family.
Perhaps a silver lining is that the recent purge of IRS workers makes the chance of an audit less likely.

[terran]

I think your concerns are valid, and as a cash basis taxpayer I don't think there's any way to legally deduct these payments from 2024 income or shift the income to 2025, however a business loss in 2025 should be deductible against other income, including your mom's business income and any income they might manufacture from, for example Roth conversions or capital gains harvesting if either of those are options.

There is no longer the opportunity to generate income from Roth conversions or capital gains harvesting for 2024.  Both of those tax planning opportunities expired on 12/31/2024.

My understanding is that they expect to have too much business income in 2024 and too many business expenses resulting in a loss in 2025. That's where extra income in 2025 (not 2024) could help: by having income to use that loss against.

Edit: actually, I just noticed forummm's other post about their parents selling there house with a possible gain. That seems like a good opportunity to use the business loss if they aren't able to get that gain down below the exclusion.

[SeattleCPA]

@forummm , first very sorry you're going through this.

Second, I think while your dad's business has used cash basis accounting, there's probably wiggle room to apply some accrual basis accounting to expenses related to winding down the business. I would think your "Q1" above, for example, can be answered "yes." (This comment for @secondcor521 and other tax folk here: This treatment wouldn't be the same thing as changing the accounting method to "accrual" but a sort of hybrid accounting where final expenses of running the business--so a particular sort of transaction--was recorded on an accrual basis. Boris Bittker, the venerable Yale Law School tax professor had a great discussion of in one of his masterpieces.)

A third thought: I would think you can get deduction or loss transactions onto the 2024 return: Possible pension deductions? Maybe losses on asset dispositions?

Again, condolences to you and your family.

[forummm]

I think your concerns are valid, and as a cash basis taxpayer I don't think there's any way to legally deduct these payments from 2024 income or shift the income to 2025, however a business loss in 2025 should be deductible against other income, including your mom's business income and any income they might manufacture from, for example Roth conversions or capital gains harvesting if either of those are options.

There is no longer the opportunity to generate income from Roth conversions or capital gains harvesting for 2024.  Both of those tax planning opportunities expired on 12/31/2024.

My understanding is that they expect to have too much business income in 2024 and too many business expenses resulting in a loss in 2025. That's where extra income in 2025 (not 2024) could help: by having income to use that loss against.

Edit: actually, I just noticed forummm's other post about their parents selling there house with a possible gain. That seems like a good opportunity to use the business loss if they aren't able to get that gain down below the exclusion.

His death will cause a step up in basis to the current market price for the house since they live in a community property state. So there won't be any tax from selling the house.

[forummm]

OP, sorry to hear of your dad's health issues
My first thought when I read your list was that the answer was basically no to each of your questions. But not being a tax or accounting expert myself I was hoping that more knowledgeable posters would chime in.
I've operated similarly to your father for many years, a small time contractor on a cash accounting basis, so I do have a little insight there.
I've often "cheated" a little, like if I do a job in 2024 and all the expenses are in 2024, but I'm paid in 2025, I will move the payment back to '24 for tax reasons. But that's kind of the opposite of what you're dealing with.
I'm assuming your father is still in contact with the client, and it sounds like he wants to do right by them and finish the job by hiring subs to do so? Is the relationship still solid? Are they understanding?
If so , is there enough money left to pay subs to finish the job?
Can your father just write a check and return the balance to the clients?
When you are a schedule C filer, no one is checking dates or really looking that closely at your return, unless you are audited.
I would be sorely tempted to have your father write a check dated 2024 sending the balance of the money back to the clients. Then the clients could write a check to your father now in 2025 if they/your father wanted to try to finish the job. Essentially this is your question 3 & 5. Also, to question 1, the issue is if you have to send 1099's to any of the subs that would be a red flag to the IRS.
I think it's justifiable, given the situation, but it's likely the IRS would see it differently.
Really, though, it would probably be best for your father to give up on the idea of finishing the job and just focus on his health and family.
Perhaps a silver lining is that the recent purge of IRS workers makes the chance of an audit less likely.

There is enough money in his business account to pay subs or refund the portion of uncompleted work. So that's good. And the customer is understanding. But I assume they want their house project finished and not an eyesore.

I tried to help him resolve the project and close it out but he's stubborn and also delusional. I had to talk him out of going to bid on another project after he got out of the hospital (in reality world he's been unable to leave the house except for medical appointments). He's on too much medication to make good decisions, even if he were dispositionally a reasonable person in the first place.

Less likelihood of an audit is good. But I want to do things correctly enough to not risk them looking back at prior years that I will not be able to defend.

He did really dumb things like being paid a large % in cash in 2023, declaring the cash as 2023 income, and then keeping it on hand, and then slowly depositing it in 2024 when he needed it to pay bills. So it will look at first glance like he was being paid in cash in 2024 and not declaring it. Let alone missing out on 5% interest, theft/fire risk, etc. And he didn't keep any analysis of why he was deducting what he did. There is a big pile of receipts, but they are incomplete (even expenses I know he had are missing). And he paid personal expenses out of the business account. Mixed business and personal on the business credit card. Any audit would probably be expensive and involve a lot of effort.

I don't know what the rule is for sending 1099s to subcontractors, but I'm certain he's never done that. And it's too late to timely file them for 2024. He only has one payment over $10,000.

[forummm]

@forummm , first very sorry you're going through this.

Second, I think while your dad's business has used cash basis accounting, there's probably wiggle room to apply some accrual basis accounting to expenses related to winding down the business. I would think your "Q1" above, for example, can be answered "yes." (This comment for @secondcor521 and other tax folk here: This treatment wouldn't be the same thing as changing the accounting method to "accrual" but a sort of hybrid accounting where final expenses of running the business--so a particular sort of transaction--was recorded on an accrual basis. Boris Bittker, the venerable Yale Law School tax professor had a great discussion of in one of his masterpieces.)

A third thought: I would think you can get deduction or loss transactions onto the 2024 return: Possible pension deductions? Maybe losses on asset dispositions?

Again, condolences to you and your family.

Thanks. Do you have anything you can point to by Bittker that I can read and use as a defense if I "shut down" the business in a hybrid way? No work was completed in 2025, so it'll really just be accounting at this point for whatever remaining payments are made.

They have no assets or pensions or anything else to have losses/deductions from.

[forummm]

Second, I think while your dad's business has used cash basis accounting, there's probably wiggle room to apply some accrual basis accounting to expenses related to winding down the business. I would think your "Q1" above, for example, can be answered "yes." (This comment for @secondcor521 and other tax folk here: This treatment wouldn't be the same thing as changing the accounting method to "accrual" but a sort of hybrid accounting where final expenses of running the business--so a particular sort of transaction--was recorded on an accrual basis. Boris Bittker, the venerable Yale Law School tax professor had a great discussion of in one of his masterpieces.)

If I wound down the business in this way, would it be helpful (or harmful) to attach a statement to the Schedule C explaining that the checks have 2025 on them but are just a resolution of the 2024 project to terminate the business? I just want whatever is done to be legal and not cause bigger problems. I don't know if transparent disclosure is helpful or harmful.

[forummm]

Update: I had a realization that even if he paid extra/unnecessary SE tax, it would increase the amount of the SS survivors benefit my mom would get for the rest of her life. He has a bunch of $0 SS earnings years in his top 35 that could be replaced. So it would be more of an investment in her retirement than wasted expense. Even without the deductions for a refund/payments to subcontractors in 2025, I can keep the regular income tax to the 10% bracket. So between that and the amount of the SE tax going to Medicare, it's not that much money she won't get back (if she lives to actuarial median age). And I think it's small enough that it's justifiable as insurance for avoiding problems in any audit. I feel good/responsible about recommending that to her.

Thanks to everyone for the feedback.