My first year self-employed, but employer didn't pay my invoices until the end of the year

[ThisIsSoTaxing]

This is my first year as an independent contractor.  I knew I had to pay self-employment taxes but decided I would wait until I got my first pay check before I worried about paying taxes.  Unfortunately, even though I started working in April of 2022 and put some hours in each month after that, I didn't receive my first pay check until January of this year (dated Dec 23, 2022).  Should I have been paying the taxes each quarter even though I had not received the income yet?  I assume now I need to make tax payments for all of April thru December, but will I owe penalties also?

[xmasbaby0]

If you were self-employed---you did not have an employer.  You had a client for whom you worked as an independent contractor.  Did they issue a 1099NEC to you--or will they do that by end of January?  

You say you worked for a few hours a month.  Doing what?  Were you doing some sort of ongoing project that you would not be paid for until the project was complete?  Why the delay in being paid?

And what do you mean by "first pay check" in December?  Have you been paid in full for the work done in 2022 or do they still owe you more?

We need more details.

[ThisIsSoTaxing]

Hi xmasbaby0,

I have not received a 1099NEC but I assume I will.

I worked as a manager for the company for six years before retiring.  I am now writing user manuals for the company's product since I know the product so well.  I submitted invoices monthly.  My work from April through September totaled about 75 hours.  I did not worry when it was taking so long because it was just extra income that I knew I would eventually get.  But it did get to the point of being ridiculous and I eventually hunted down the person that pays the bills and discovered the disconnect.  At that point, in early December, I decided not to submit more invoices until they paid the ones I already submitted so as not to confuse matters and introduce more delay.  When I received the check last week I submitted my remaining 65 hours for October and November.  I expect it will take a couple of weeks to be paid for those hours.

[xmasbaby0]

@ThisIsSoTaxing Good grief.   We may need some input from a couple of other volunteers here.

@Mike9241    @Critter-3 

[Mike9241]

last week would be 2023. unless you are an accrual basis taxpayer (you elected to be taxed on income when you invoiced the customer and not later when you get paid), you don't report the income until you file your 2023 return in 2024

[ThisIsSoTaxing]

Hi Mike9241,

The check arrived at my house some time between Jan 5th and Jan 16th while I was out of town.  The check is dated 12/23/22.  So which date determines the tax year it belongs in, the date the check was cut or the date I received it?  Also, I don't recall anyone asking me to elect whether I wanted to be on a cash or accrual basis when I was hired on as a contractor.  I only became aware of the terminology just recently.  Does it default to one or the other if you don't make an election?

[VolvoGirl]

You select Cash or Accrual when you file your tax return.  Turbo Tax will ask you.   The most common method is CASH. It means you report your income in the year you actually receive it and report your expenses in the year you actually pay them. See,
https://ttlc.intuit.com/community/business/help/what-is-the-cash-method-of-accounting/00/25658

So you report the income next year on your 2023 return.  If you get a 1099Nec from them for 2022 you will have to report it as income on 2022 schedule C but then back it out as a Misc Expense.  Then add it to next year again.  

[ThisIsSoTaxing]

Hi VolvoGirl,

I like your response but I'm having trouble verifying that I can do what you are recommending.  I looked at the link you provided for the description of the cash method of accounting but the example provided doesn't really address my case where the check was sent by mail in 2022 but not received in 2023.  However, IRS publication 538 says "Under the cash method, you include in your gross income all items of income you actually or constructively received during the tax year" which seems to imply that if I didn't actually have the check in hand until 2023 then it is 2023 income.  But the problem is that I cannot prove that I didn't receive the check in 2023.  Additionally, even if I can prove that I didn't get the check until 2023, I can't find anything that tells me that it is OK to back income out as a Misc Expense.

[Mike9241]

@ThisIsSoTaxing 

Constructive receipt is an accounting term that requires an individual or business to pay taxes on income despite the fact that the money has not yet been received in actuality. What matters instead is that the recipient of the income is able to control or utilize that money even when it is not in hand, for instance being able to spend funds deposited from a check before it has cleared. Constructive receipt refers to situations where income can be used despite the fact that this money has not yet been physically received.

sources

https://www.investopedia.com/terms/c/constructive-receipt.asp 

https://www.lawyers.com/legal-info/taxation/income-tax/constructive-receipt-of-income-under-cash-bas... 

you can't control or spend the money because the check is not in your possession until after 12/31/2022.

proofing it to the IRS's satisfaction can at times be difficult. if you had asked beforehand I would have suggested keeping the envelope the check came in and writing on it the date you actually received it. the postmark on the envelope could help you establish 2023 receipt.   The problem you face by recognizing this income in 2022 is that you're using the accrual method. see IRS PUB 538 for what this requires you to do in reporting income and expenses. you would have to continue this method until you applied for a change in accounting methods. 

[ThisIsSoTaxing]

The envelope is postmarked 12/23/31, so I'm not sure why it took over a week to get to us.  

I don't understand why recognizing the income in 2022 would require that I use the accrual method.  By using the cash method, income is recorded when I actually receive it.  Although I didn't actually receive it until 2023 I don't think I would have any problem convincing the IRS that I received it in 2022 considering I'm having so much trouble proving that I received it in 2023.  And if/when I get a 1099 for the money then it would also show that the money was earned in 2022.

[GeorgeM777]

To follow-up on the prior responses, if you choose the cash method of accounting, then receipt of the check is the important date for purposes of reporting the income on your tax return.   IRS Publication 538, which you reference in a prior post, does indicate that you cannot hold checks or postpone taking of similar property from one tax year to another to postpone paying tax on the income.  You must report the income in the year the property is received or made available to you without restriction.

Based on what you have stated, it does not appear that you held the check in order to avoid reporting it on your 2022 tax return.  And, you are correct in that your 1099 will likely reflect that the funds were paid to you in 2022.   In terms of proving that you received the check in 2023, you might consider reviewing when you received checks in the past and when you deposited those checks in order to show that it was not your practice to hold checks before cashing/depositing them.  Ultimately though, you will have to make the decision in what year to report the income and if questioned by the IRS, what proof you have to establish actual receipt of the check at issue. 

@ThisIsSoTaxing

[ThisIsSoTaxing]

I received an e-mail from TurboTax asking me to mark one of the replies as the accepted solution.  I can't say that any of the replies fully answered my questions but all of them together pointed me in the direction of choosing what I am ultimately doing.

Since I started this post I have verified with my employer that the check that they cut on 12/23/22 will be on my 2022 1099 as you might expect.  I learned through this post the difference between the cash and accrual method.  Armed with this knowledge I decided it is in my best interest to go with the cash method, otherwise I would be way behind on my quarterly payments since my first invoice was back in April of last year.  Even though I didn't actually get the check until some time after Jan. 5th, I have decided it is easier to allow the income to be reported for 2022 since I can't prove when the check was received and also since the penalty for late payment on my Social Security and Medicare is so small (0.5% per month late which is less than $5).  I also discovered while looking at the instructions for the 1040-ES that I don't have to make the estimated payment that was due on Jan 17th if I file my 2022 taxes by Jan 31st.  So I can avoid any penalties that I might have incurred otherwise for not making my estimated income tax payment before Jan 17th.  I don't know if I'll have all the tax documents by the 31st but I suppose I can make my best guess and then submit a revised return later.

[ThomasM125]

The income should be reported in the year it was available to you. That would seem to be 2022 in this case, as you could have called the company and asked about it before year-end and I assume you could have picked it up or had it delivered to you by end of year. It merely has to be available to you, not necessarily delivered to you.

[ThisIsSoTaxing]

In December I asked my point of contact multiple times before Christmas to send my check and then again after Christmas with no response.  I assumed that she must already be on an extended Christmas break and that I would have to start harassing her again in the new year.  The main office is in Kansas and I am in California so the only way for it to be available to me is it's delivered to me because I am not setup for direct deposit.