Reporting Income: When Is Income Actually Received?

Many times a client will ask me a question like, “I did some consulting work in 2006, but I did not receive the check for payment of the services until January 2007. What year do I report this income, 2006 or 2007?

Virtually all individual taxpayers use the cash-basis method of reporting income. this means that income is reported in the year that it is received and that expenses are deducted in the year paid.

So, the question becomes, “When is income actually considered received?” Well, the answer depends on what the IRS calls the “constructive receipt rule.” What this means is that you report income in the year that it is constructively received. Constructive receipt of income means income that has been credited to your account, subject to your control, or put aside for you.

For example, in the example in the opening paragraph of this blog, a check that is not received until January 2007 is considered not constructively received by the taxpayer until January 2007 as the taxpayer did not have any means of controlling the funds until he received the check. So, the income is reported in 2007. On the other hand, suppose the taxpayer had received the check on December 31, 2006, but did not deposit the check until January 5, 2007. In that case, the income is deemed to have been received in December of 2006.

In this case, the taxpayer has control of the funds even though he didn’t cash the check. The income is reportable in 2006. This is true even though December 31, 2006 was a nonbusiness day and the taxpayer could not cash the check or deposit it until the first business day of 2007.

Now there is an exception here if the taxpayer was handed a check in 2006, but was asked to hold the check for deposit until January 2007 due to the writer of the check not being able to cover the check until January 2007. In this case, the taxpayer would not be considered to have received taxable income until the check is cashed in 2007.

To help make your tax filing easier, every day I’m posting tax filing tips on my website, www.mynetprofittools.com/taxtips