Constructive Receipt: Meaning & Example
When is taxable income counted?
Is it the moment you theoretically receive the payment or the moment that you physically have it?
This is a question that constructive receipt aims to solve.
Read on as we take a closer look at everything to do with constructive receipt.
Table of Contents
- Constructive receipt is the situation where income can be used. This is despite the money not being physically received.
- Any taxpayers must include any income on their yearly taxes that was constructively received during that period.
- Publication 538 of the Internal Revenue Service (IRS) describes constructive receipt as “an amount credited to your account or made available to you without restriction.”
What Is a Constructive Receipt?
Constructive receipts is an accounting term. It refers to when somebody that is receiving funds effectively gains control over that income. So once constructive receipt has occurred, the recipient can control the income. This is also the point at which they must report the income on their taxes for that period.
This does not mean that the recipient has the cash in hand. Instead, it is when they have effective control over their income. For instance, being able to spend capital that has been deposited from a check before it has effectively cleared.
Constructive receipt is an important issue when it comes to reporting taxable income. This is especially true under the cash-basis method of accounting.
How Does Constructive Receipt Work?
An individual would be in constructive receipt of income when they gain the ability to utilize or simply control the funds. This is even if they don’t have direct possession of them. Or if the income is guaranteed, they will have the ability to draw upon the funds at some point in the future.
When it comes to business income and business expenses, they would be in constructive receipt if the business has the ability to use the money without restriction. Or if the money has been deposited into the business’s account.
It works slightly differently in terms of income. When there is constructive receipt of income, the taxpayer cannot pay their taxes on compensation or income that has yet to be spent. The rules of constructive receipt apply to employees that utilize the cash-basis method of accounting. The rules also state that the receipt of funds by an agent is considered to also be received by the principal at that time.
Dividends are a good example of when a person may encounter a more complicated situation involving constructive receipt. That’s because there are three important dates that occur in the process of handing out dividends to shareholders:
- The day that the dividend is announced or declared by the board of directors of the company.
- The dividend record date determines who receives a dividend payment. As anyone who purchases stock after this decided date will not receive dividends during this round.
- The dividend payment date. This is the date that the dividend is deposited into the shareholder’s brokerage accounts.
When it comes to dividend payments, it is the payment date that counts when it comes to constructive receipt. This is because the payment date is the actual date that you have the dividend in your control. A shareholder would be unable to spend their dividends before the payment date.
Constructive Receipt Example
Say that an employee receives their paycheck at the end of the year. This person must report the amount of the paycheck as earned income for that year for tax purposes. This is even if they didn’t actually deposit the check until the next year.
The important part here isn’t that the individual actually received the benefit of depositing or spending that money, but that they possessed the capacity to do so. Even if they took their time and didn’t deposit the paycheck straight away.
Constructive receipt is an important calendar tax term that affects how you pay your taxes. It is a clear way of determining which tax period expenses or income will fall into. This allows your tax return to be clear and consistent, with little room for error.
FAQS About Constructive Receipts
What Is Not Considered Constructive Receipt of Income?
Constructive receipt does not apply or occur when using the accrual method of accounting. It is mainly used in the cash-basis method of accounting.
What Is the Difference Between the Actual Receipt and the Constructive Receipt?
The constructive receipt doesn’t require you to have physical possession of the income in question, whereas the actual receipt does require this.
How Do You Avoid Constructive Receipt?
Constructive receipt is mainly used in the cash-basis method of accounting. So if you were looking to avoid it, you can use the accrual method of accounting.
What Is the Rule of Constructive Receipt?
The rule of constructive receipt is that the income is counted as soon as you are in control of it. This doesn’t mean that you physically have it, but that you can utilize it.
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