How to Apply 'Constructive Receipt' in Reporting Year-End Income

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When Form 1040 time rolls around, individuals usually list their income and deductions on a "cash basis." In most cases, that means you’re supposed to report all income items and deduct all allowable expenses in the year that you actually receive or pay them.

As a cash-basis taxpayer, you’re also subject to the "constructive receipt" rule. This long-standing rule requires you to report income not actually received, but which has been credited to your account (interest on savings, to cite the most common example), made subject to your control or set aside for you.    

The IRS routinely invokes this rule to exact additional taxes. For instance, the Tax Court held that the IRS properly refused to permit an executive to defer reporting part of a severance payment beyond the year in which he received the disputed funds in a lump sum.

In one such case, Joseph Ewers' job as a bank president came to an end on Oct. 1 of the year in issue. The bank's board of directors intended to send severance of $47,000 to him in equal amounts over a seven-month period, starting Oct. 1. Instead, for reasons unknown, Joseph received all of his severance within a month after he lost his job.

Joseph reported three-sevenths of this amount on his return for the year in which he received the severance pay and the remaining four-sevenths on his return for the subsequent year. But the court held he had to declare the entire amount as income in the year of receipt, regardless of what the bank actually intended to do; there were no restrictions on his use of the money in that year.

IRS Doesn’t Always Get Its Way

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About Julian Block

Julian Block

Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com

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