Constructive receipt of income and tax reporting

Chad Silver

Chad Silver

Managing Partner of Silver Tax Group, author of the book "Stop the IRS". Practicing a variety of tax issues, regulations, laws and rights. Specializing exclusively on tax matters involving IRS audits, negotiation, settlements & compromises.

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On behalf of Silver Tax Group posted in IRS Tax Audits on Friday, March 10, 2017.

While reporting income on our tax forms is relatively straightforward under certain situations, it’s often complex in other instances. We use W-2 forms for reporting income from our employer, and a variety of 1099 forms for reporting other forms of income such as royalties, interest and dividends. This is easy to understand. However, we also sometimes are obligated to report income that does not involve cash such as the constructive receipt of income.

Under the theory of constructive receipt, a taxpayer must report income when he or she has the right to receive it. This includes an employee requesting to put off receipt of a year-end bonus in 2016 until 2017. Since the employee had the right to receive this income in 2016, that employee will need to report it as taxable income for 2016 (rather than 2017). However, if it is the employer who delays payment on this bonus until 2017, it may then be taxable income for 2017 – though even in those circumstances, the IRS may claim otherwise and have its own interpretation.

There are instances where employees can negotiate to have payments deferred while still avoiding the constructive receipt rules. Under such a scenario, this allows individuals to perform services in one year and receive payment during the next. It’s still a good idea to receive tax guidance regarding such negotiations to avoid mistakes in reporting.

The rules become even more complicated if you are a part of a partnership, limited liability company or S corporation. These businesses are pass-through entities. The owners pay the tax rather than the business. The owner will receive a Form K-1 stating his or her share of income – even if there is no distribution of this income. The IRS will examine the Form K1 while reviewing the owner’s tax returns.

It is important not to take chances when reporting income to the IRS. Mistakes will raise red flags and increase the possible chances of a tax audit. It could also lead to severe penalties and consequences.

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