I understand that any advice given is not binding and all standard disclaimers apply. I have a small law firm, sole proprietor, and use cash method of accrual.
I settled a case on November 18, 2016 and on that date, the judge approved my fee. The check was to be mailed forthwith. The holidays caused some delays and all of the checks except mine where mailed in the middle of December, 2016.
Apologies all around, we will reissue your check, and it was dated January 6 and received on January 11, 2017.
I am wondering if I should include this on 2016 taxes or next year.
I looked at the doctrine of constructive receipt:
It gives me pause because it the funds were likely both “set apart” for me in 2016 and I could have made a "notice of intent to withdraw"to the payor.
I know I should ask an accountant, but does anyone have any thoughts? Am I grossly misreading the constructive possession doctrine?
I am not an accountant, but I don’t believe there is a cash method of accrual. Did you mean cash basis of accounting (as opposed to accrual basis of accounting)?
I assume you mean the cash method of accounting or the cash receipts method.
You might want to look over the actual regulation 26 CFR §1.451-2. The punctuation that you quoted above does change its meaning.
Plus, the next sentence in the regulation is significant: However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.
Simply submitting a “notice of intent to withdraw” to the payor does not change the year of inclusion if that demand could not be met. For example, in PLR 200945005, the taxpayer submitted a demand to withdraw money from his retirement account in Year 1. The administrator notified the taxpayer that a check was available to be picked up at the office on December 31 of Year 1. Unfortunately, the office where the check was located was closed on Dec 31. The taxpayer did not pick up the check until Jan 2 of Year 2. The PLR held that since the “Taxpayer could not have received the
disbursement check in Year 1,” it was not constructively received in Year 1.
Also somewhat related, in Hornung v. Commissioner, 47 T.C. 428 (T.C. 1967), Paul Hornung was awarded a Corvette by Sports Illustrated Magazine on December 31, 1961. Hornung was in Green Bay that day, but the car was waiting for him in New York. The Tax Court held that there were substantial limitations on his control or posession of the car in 1961 and that he did not constructively receive it in 1961.
So the question is was the payment made in 2017 because you failed to give “notice of intent to withdraw to the payor” in 2016 or was it just because of a series of oversights by the payor? If there is no way you would have been paid in 2016, whether or not you gave this notice, there is no constructive receipt.
Thanks for the long reply. Yes, I meant the cash (as opposed to accrual) basis of accounting.
The payment should have been made prior to Thanksgiving, 2016. I had a right to receive the payment after November 18, 2016. The payor was an insurance company, and of course it is unknown if it was an intentional delay by the insurance company to defer to the 2017 tax year or negligence, or oversights. If I had to guess it was due to a clerical error.
There was a batch of checks (four total checks) to my clients which should have also included a fifth check for my fee that was sent in mid-December. The other attorney apologized that my check was not included and promised to “re-order” the check to me.
So, on one hand, I had every right to demand payment in 2016, and I indeed “demanded” (asked where in the hell is my money) payment in 2016. Any judge would rule that way (of course, the court case would not have been heard until 2017).
I have no problem reporting it in either year, but want to do it in the correct way. It just seems that if I am permitted to report this in 2017 it would be trivially easy to defer income by telling people who owed me money in December just to hold on on to their checks for a month.
As a followup, I am thinking of switching to the accrual method to: 1) prevent this type of stuff from happening, and 2) to get a more complete financial picture.
Under the accrual method, when would I have realized this income?
As I completed each hour of work?
When I got off the phone with the other attorney in September and we verbally agreed on the deal?
When the judge informally approved the deal in October?
When the ink was dry on November 18?
The work was done on a contingency basis, so I was unsure when (or even if) I would get paid for doing the work until a settlement is reached. It is possible to do contingency work and get a zero verdict.
If it was within your control to obtain the check by the end of the year, then you constructively received it. If you actively tell people to not send you a check until next year, you could very well be held to have constructively received the money so long as it is your own request that is causing the delay of payment to be completed. I would think, however, if you send an invoice with a due date in late January and highlight the date that the payment is due but in no way imply not to send it before the end of the year, you would be in the clear if it’s not received.