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What is a Constructive Receipt of Income?

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

In this lesson, we will discuss what constitutes constructive receipt of income and address issues related to the timing and distribution of business income.

Constructive Receipt of Income

Fred owns a local landscaping business. He has grown to the point where customers pay him on a variety of different schedules. Some pay cash as services are performed and others pay him a monthly fee. This December his customers on a monthly fee plan are scheduled to autopay on the 31st because of the holiday. The question has come up of whether or not this counts as income for the current year or the following year. Let's walk Fred through how the IRS considers when income is received for tax purposes as well as some of the common pitfalls surrounding income timing.

Definition

The IRS is concerned about how businesses report when they receive income because that has an impact on when taxes or paid. Constructive receipt is a term that refers to income that has been credited to a taxpayer's bank account or otherwise becomes available. In other words, constructive receipt is when a business has taken control of money even if it hasn't been physically received yet. This concept applies to businesses and individuals operating on a cash accounting basis but not an accrual basis. If Fred receives a check on December 31st, he legally has constructive receipt of the money even though he may not be able to deposit it until the first week of January. The money can come from any source, including bank account interest or dividends. Once control of the money has been given up by the other party, Fred has constructive receipt as of that date.

Examples

Why is this important? Timing of income affects taxable income that is reported for the year. Constructive receipt of income on or before December 31st means that Fred will have to pay taxes on the money for that year. If receipt were delayed until on or after January 1st, the taxes would not be due until the following year. The concept of constructive receipt creates a clear line between accounting periods for the year that income is subject to tax.

There are plenty of other instances where constructive receipt comes up in business income and expense timing. Any bank interest that is deposited into Fred's account by the end of the year counts for that year. If he pays his employees on December 31st, that expense is considered to have occurred in that year even if the checks won't clear the bank until later in the week.

Bills are another item which can be timed. Let's say Fred's insurance bill is due on January 15th. If he pays the bill in December he counts that expense for the current tax year. The fact that the bill is due in the next year doesn't mean he gets to claim that expense in the following year. Prepaying expenses can result in a lower tax burden for the current year, but the expenses cannot be claimed again on the following year's tax return.

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