Posted by Rosovich & Associates, Inc.

What Is The Constructive Receipt?

What Is The Constructive Receipt?

The constructive receipt is a tax concept based on which it is assumed that a taxpayer has received income, even though the income has not yet been physically received, which must then be declared to calculate income tax. The concept serves to ensure that taxpayers are not unreasonably late in paying taxes. For example, a cash payer receives a check from a customer at the end of the fiscal year but chooses not to cash the check until the following year. In the concept of a constructive receipt, it is assumed that the taxpayer received the income upon receipt of the check and not upon payment of the check.


What is the constructive receipt?

The constructive receipt is determined when the person who receives income takes control of that income. A person or business is considered to have control over the income when the person or entity is credited. At that time, the entity could spend, redirect or exercise control over that income. Even if the entity decides to do nothing with the income, the constructive receipt still appears because the entity has the ability to do something with that income.

The constructive receipt applies to any form of income, not just wages or other exchanges of money. For example, suppose goods, services, or securities are received as a method of payment. In that case, they should be accounted for at fair market value, provided there are no restrictions on payment, and they qualify as a constructive receipt.

The constructive receipt is a concept that describes when the income must be taken, both for accounting and tax purposes. Constructive receipt is particularly important for transactions that fall at the end of the year, affecting the year in which the income is taxed.


How does the constructive receipt of income work?

The constructive receipt of income only applies to cash accounting reports. Most people and various businesses use cash accounting, so constructive receipts are important concepts that most people should understand. However, some companies use accrual accounting, and constructive receipt does not apply in these cases.

For a payment to be considered a constructive receipt, the Internal Revenue Service (IRS) declares that the recipient must not have any restrictions on the payment received. For example, If you receive a check and don't deposit it, it will still be in your control (you can decide to deposit it at any time), so it counts as income. On the other hand, if you deposit a check and the bank holds it, it will not be under your control (there are restrictions on the funds), so you have no control over it, and it is not considered income.

If you receive shares from the employer indicating that you cannot sell the shares for six months, the shares do not belong to you, as far as the constructive receipt is concerned, until you can sell the shares at will. Stocks can be purchased immediately but are not considered income until you can use them as desired.


Dividends

Dividends are a good example of where an ordinary person may encounter complex constructive receipt situations. This is because there are three important dates in the process of distributing dividends to shareholders:

  • The first significant day is the day the board of directors of the company declares or announces the dividend.

  • Second, the dividend record date will decide who will receive the dividend payment (anyone who purchases shares after that date will not receive that round of dividends).

  • Finally, the dividend payment date is the date the dividend is deposited into your brokerage account.

Of these three dates, the dividend payout date is what matters when it comes to constructive receipt. This is the day you actually hold the dividend in your brokerage account. You cannot spend the dividend before this date.

The constructive receipt still applies to this dividend scenario, even if you are enrolled in an automatic dividend reinvestment program. The IRS considers this as "assignment of income." If you ceded the income to a third party (an agent or reinvestment program), it would be subject to income tax when you deposit it into that third party's account.

Suppose the dividend distribution process begins in December, but the dividend payment date is January. In that case, the dividend will be recognized in income tax on the most recent date, with the new year starting in January. This is an unusual scenario, dividends are usually announced and paid in the same fiscal year, but it can happen and is an example of where it is important to understand a constructive receipt.


Constructive receipt at the end of the year

The constructive receipt is an important concept for calculating business income and expenses at the end of the calendar year. Here are a few more examples of how the year-end tax constructive receipt works:

  • Employee Paycheck: If the check is in an employee's bank account before the end of the year, it will be considered a payment for that year, even if the employee has not spent it.

  • Interest payment: If you receive interest on an investment or a bank balance, the date that interest is entered into your account is the date that matters. The funds were in your control that day, so a constructive receipt will be applied.

  • Other income: If you earned an interest payment or other income before the end of the year, it will be available to you and should be counted as income in that year. This is the case even if you do not enter the amount in your accounting system.

  • Prepayments: Most insurance payments are made in advance. For example, your auto insurance is usually paid six months in advance. These payments are considered payments for the year in which the check is dated.


Summary

  • Constructive receipt is an accounting theory that defines which fiscal year income or expenditure will be included.

  • The constructive receipt applies to all forms of payment, including merchandise and inventory.

  • The IRS states that constructive receipt occurs when the recipient of the payment has full control over the funds, with no restrictions on how those funds are used.


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