Does anyone have experience with how this affects state returns? I'm in California and dealing with a similar situation. Would reclassifying from ordinary income to rental income on the federal flow through correctly to CA Form 565?

This is a great discussion on rental income classification. I want to add a practical tip that might help with documentation when you amend these returns. When I've dealt with similar partnership rental misclassifications, I always prepare a detailed memo explaining the correction that gets attached to the amended return. I include citations to IRC Section 1402(a)(1) which specifically excludes rental income from self-employment tax, and Reg. 1.1402(a)-4 which clarifies that real estate rentals are not considered carrying on a trade or business for SE tax purposes. For the self-rental aspect, I also cite Reg. 1.469-2(f)(6) to show that while the income may be recharacterized as non-passive under the self-rental rules, it's still rental real estate income exempt from SE tax. This documentation has been helpful when dealing with IRS inquiries on amended returns. One more thing to consider - if your clients have been overpaying SE tax for multiple years, make sure you calculate the interest the IRS will owe them on the refunds. For substantial amounts, that interest can add up to a meaningful sum that clients appreciate knowing about upfront.

4 Has anyone used TurboSelf-Employed for this situation? Is it good at handling both W-2 and Schedule C income?

One thing that helped me tremendously when I started my side business was using Form 1040ES worksheets to calculate my quarterly payments more precisely. The IRS provides these worksheets specifically to help people in situations like yours estimate what they owe. The key insight is that you don't need to worry about being pushed into higher tax brackets - tax brackets are marginal, meaning only the income above each threshold gets taxed at the higher rate. Your 40% set-aside is likely more than sufficient for most income levels. Also consider the safe harbor rule: if you pay either 100% of last year's tax liability (110% if your prior year AGI exceeded $150,000) OR 90% of this year's liability through withholding and estimated payments, you won't face penalties even if you owe a bit more at filing time. This gives you some breathing room while you figure out the right withholding amount.

One additional strategy worth considering is implementing an Employee Stock Ownership Plan (ESOP) if your retail business has sufficient value and cash flow. While more complex than the other options discussed, ESOPs can provide massive tax deferrals and even permanent tax avoidance on the sale proceeds if structured properly. For a less complex approach, consider maximizing your HSA contributions if you're on a high-deductible health plan. For 2025, you can contribute $4,300 for individual coverage or $8,550 for family coverage (plus $1,000 catch-up if over 55). While the amounts aren't huge compared to retirement plans, every bit helps when you're in the phase-out range. Also, if you're doing any business travel or have a home office, make sure you're maximizing those deductions. The home office deduction can be particularly valuable for S-corp owners - you can either take the simplified method ($5 per square foot up to 300 sq ft) or actual expense method if you have significant home office costs. Finally, consider income shifting through family partnerships or gifting business interests to adult family members in lower tax brackets, though this requires careful structuring and ongoing compliance. The key is finding the right combination of strategies that work for your specific situation while staying well within IRS guidelines.

Another approach that might help with your QBI situation is exploring captive insurance company strategies if your retail business has sufficient income and risk exposure. While more sophisticated than traditional retirement plans, captives can allow you to deduct up to $1.2 million annually in premiums while building tax-deferred wealth. For a simpler immediate strategy, consider accelerating any business loan payments or prepaying business expenses like insurance, rent, or supplier agreements if you have the cash flow. These prepayments can create legitimate business deductions in the current year while providing operational benefits. Also, don't overlook equipment leasing versus purchasing decisions. If you need new fixtures, POS systems, or delivery vehicles, structured leases might provide better current-year deductions compared to depreciation schedules, especially with the reduced bonus depreciation percentages for 2025. One often-missed opportunity: if your retail business involves any intellectual property (proprietary processes, customer lists, brand development), consider whether those assets should be held in separate entities and licensed back to your operating company. The licensing fees create deductions for the S-corp while potentially qualifying for different QBI treatment. The key is layering multiple strategies rather than relying on just one approach. Given that you're already maxing retirement contributions, combining several smaller strategies (HSA, home office optimization, expense timing, equipment decisions) can collectively move you back into the favorable QBI range.

Has anyone used QuickBooks Online for handling the accrual method with unshipped inventory? I'm struggling with the same issue as OP.

I'm a newcomer here but dealing with a very similar situation! I've been researching the accrual method switch for weeks and this thread has been incredibly helpful. One thing I'm still confused about - when you're tracking inventory only at the beginning and end of the year (not quarterly), how do you handle COGS throughout the year? Do you estimate it based on purchases, or do you wait until year-end to make adjustments? Also, for those who mentioned Form 3115, is there a specific deadline for filing it when switching methods? I want to make sure I don't miss any important timing requirements. The deferred revenue approach makes total sense for unshipped orders. I'm definitely going to implement that in my QuickBooks setup. Thanks everyone for sharing your experiences!

Great thread with lots of helpful info! I wanted to add one important point about record-keeping that might help others in similar situations. Even if you've lost original receipts, the IRS accepts "reconstructed records" as long as they're reasonable and based on available evidence. I learned this when preparing for my home sale last year. You can use: - Bank statements showing payments to contractors or home improvement stores - Credit card statements with clear descriptions - Canceled checks made out to contractors - Permits pulled for work (these are public records) - Before/after photos with written explanations - Contractor invoices or estimates (even old ones) The key is being able to demonstrate that the improvements actually happened and provide a reasonable estimate of costs. I was able to reconstruct about $35,000 in improvements this way, which made a huge difference in my capital gains calculation. Also, don't forget about smaller improvements like new appliances, fixtures, or even landscaping that adds value - these all count toward your adjusted basis if you have documentation.

One thing I haven't seen mentioned yet is the importance of documenting the selling expenses when you calculate your capital gains. These can significantly reduce your taxable gain and include: - Real estate agent commissions (usually 5-6% of sale price) - Title insurance and escrow fees - Attorney fees - Transfer taxes - Home inspection fees paid by seller - Staging costs - Marketing expenses - Any repairs required by the buyer as part of the sale These selling expenses are subtracted from your sale price along with your adjusted basis to determine your actual capital gain. For a $400,000 home sale, you might have $25,000+ in selling expenses, which is a substantial reduction in your taxable gain. Also, @AstroAlpha, regarding your mother's inheritance situation - make sure she gets a proper appraisal of the property's fair market value as of the date of death. This becomes her new basis, and having professional documentation will be crucial if the IRS ever questions the stepped-up basis amount. Don't rely on online estimates like Zillow - get a real appraisal from a licensed appraiser.