s-corp - huge tax liability shutting down the business based on end of fiscal year?

[rproemer]

Hi All -
I'm sure this is a relatively common question/concern, but I can't seem to locate it on the forums. It seems like you open yourself up to a huge amount of liability just based on the dates you do business and your fiscal year. I don't believe this can be correct, but I'm trying to find the mechanism that allows you to true-up after the conclusion of the transaction.
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Simple Scenario:
Single owner s-corp. Fiscal Year matches the Calendar Year

A customer hires the s-corp to build a widget for 100k. The s-corp sub-contracts the widget out to another company for 90k. The customer pays the s-corp 100k on December 31st. The s-corp pays the sub-contractor 90k on January 2nd. The s-corp never does any additional business and closes.
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Logically, it would seem your personal tax liability should only be against the 10k you actually made. But as I understand it, wouldn't the IRS regard the 100k that was in your bank account on January 1st as taxable personal income? The following year you could show a 90k loss, but if the business is gone, that wouldn't matter, so you'd end up losing a tremendous amount of money.

This is a simple scenario, but it applies to a much larger scenario. If an s-corp is going out of business (paying last paychecks, PTO, contractors, etc), I find it difficult to believe there would be such a tremendous tax benefit for doing it at the end of the fiscal year vs the beginning of the next, and they can potentially tax you on income you never actually made, but was in your account when the year rolled over.

Any pointers on how this gets reconciled would be greatly appreciated.

Thanks!

[rproemer]

I believe at a minimum you could take a long term capital loss to offset future personal gains... but since that maxes out at 3k a year, it would barely make a dent in the potential tax loss of many small business s-corps.

[Fulcrum]

Was it a prepayment from the customer and what is the billing date? This makes a difference.

[rproemer]

it's an oversimplified example to a more complicated question... but to get to the heart of what I'm trying to ask, lets say that the s-corp delivered the widget, billed the customer and was paid in FY 2016, and the s-corp was billed by the sub-contractor and paid the subcontractor in FY 2017.

[nealrm]

The solution to this is simple. Use accrual accounting system instead of a cash based accounting system. The IRS allows for both. In an accrual based system, income and expenses are dated as they occur versus a cash system in which they are dated when the money changes hands. In the above example, the expense occurred when the business contracted to have the software designed. So under the accrual system, both items happened in the same tax year.

An other option would be to change the financial tax year. File the proper tax form and file for a short tax year. (say ending in November). Both transaction now fall under the 2nd tax year. Pay your estimated taxes on scheduled and file a second tax return next December.

[nealrm]

It should also be noted that while the IRS does allow for both accounting methods, you cannot change from one to the other. Also, check with a tax accountant before taking any advise posted on a public forum.

[turboguy]

Using an accrual accounting method is the easiest way to solve the problem. I believe there are some businesses that are required to use an accrual system and for the type of business we are talking about it would be the preferred method.