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 in most situations, it gets 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
However, we also sometimes are obligated to report income that does not involve cash such as the constructive receipt of income.
What Is Constructive Receipt Anyway?
Under the theory of constructive receipt, a taxpayer must report income when he or she has the right to receive it. Even if that person hasn’t actually received the income yet, he or she still needs to report it.
So how do you define what’s constructive receipt and what’s just promised income? Constructive receipt of income happens if you are able to use or control the funds without physically having them in your possession. It can also happen if an income amount is guaranteed at a future date.
One of the most common types of constructive receipt of income 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. Even in those circumstances, the IRS may claim otherwise and have its own interpretation.
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.
Another situation that can lead to constructive receipt of income is backdated paychecks. In some cases, especially when a pay period falls near the New Year, employees may receive paychecks that are backdated. Even though the employee is receiving the paycheck in the New Year, he or she will still need to report that income for last year.
Backdated payments can also occur in the service industry. Say you perform a service and receive a payment for it on December 30th, but you wait until January 1st to deposit the payment. Even though you deposited the payment in January, you received the payment in the previous year. This means that you will need to report that payment in last year’s income.
Cancellation of Debt
Cancellation of debt also causes constructive receipt of income. How? By making funds available to you that you didn’t realize you had.
For example, if a creditor cancels a debt of $1,000 in December, you now have an extra $1,000 in your pocket. That $1,000 needs to be included in your income reporting.
Avoiding Constructive Receipts
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
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.
Don’t risk getting into a sticky situation because of constructive receipt. Reach out today and we’ll get started making sure your income is reported correctly.