Cash Receipt & Disbursement Accounting Method
Under this accounting method, amounts received are included in gross income in the year of actual or constructive receipt, regardless of whether the income is earned in that year. Expenses are usually deducted in the year paid. All that is needed for income recognition is that the amounts have a FMV (i.e., a cash equivalent). So, if a cash method taxpayer receives a note in payment of services, there is income in the year of receipt of the note equal to its FMV.
Note: A creditor’s promise to pay (without a formal note) is not considered to have an FMV--thus, no income is received.
Receipt of a check is considered a cash equivalent. For this reason, a cash basis taxpayer recognizes income when a check is received--even if the check is received after banking hours.
Exception To “Normal” Cash Basis Rules - Constructive Receipt
Income that hasn’t actually been received by a taxpayer is taxed as though it had been, if the following are true:
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The amount is readily available to the taxpayer.
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The taxpayer’s actual receipt isn’t subject to substantial restrictions.
The rationale behind constructive receipt is that if income is available, the taxpayer shouldn’t be allowed to postpone income recognition. Many times, constructive receipt determination is simply a judgment call--based on the facts and circumstances.
Example 1 - Constructive Receipt: Randy was a member of a barter club. In 2022, he performed services for several club members and earned 1,500 points. Each point meant that he was entitled to $1 in goods and services sold by others in the club. The points could be used at any time. In 2023, Randy exchanged his points for a big screen TV. He must recognize $1,500 in income in 2022 when the points were credited to him.
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Example 2 - Constructive Receipt: On 12/31/21 Linda’s employer gave her a bonus check but asked her to hold it until 01/2022 so that the employer could deposit funds to cover the check. The check amount is income to Linda in 2022 when it became cashable.
Example 3 - Constructive Receipt: Ken is a key employee of ABC Company. The company gave stock valued at $12,000 to Ken. However, the stock couldn’t be sold for 5 years. Ken isn’t required to recognize income for the stock until the restrictions on the stock lapse. (IRC §83)
Example 4 – Constructive Receipt: Landlord Lionel received a security deposit from a new tenant to pay for apartment damage during the tenant’s period of occupancy. If no damage occurs, Lionel is required to return the deposit to the tenant. The deposit is not income to Lionel in this case. He will recognize income to the extent of the deposit amount he doesn’t return to the tenant in the year he returns the deposit to the tenant. If the deposit had been prepayment of rent, it would be income in the year received.
Actual Cases:
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Patch, TC Memo 1995-449: A bank robber was required to report stolen cash as income in spite of the fact that he paid it back the next year., The court stated, “a taxpayer who unlawfully acquires cash has possession and receives gross income in the taxable year that he unlawfully acquires the cash, even though he makes restitution in a later year.”
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TAM 9519002: Advances to a life insurance agent after life insurance policies were sold were considered taxable income in the year they were received., These advances were not loans, but compensation for past services.
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Childs, Richard A., 103 TC No. 36 (1994): Partners in a law firm had fees paid under a structured format; they only reported the cash received., The IRS sought to tax them on the FMV of an arrangement in the year a tentative settlement was made. The Tax Court held, however, that the attorneys never had the right to receive full payment, because they didn’t have ownership until actual settlement was received.