Constructive Receipt of Income

Under the cash method of accounting, not only is income recorded in the year in which it was received, but income is also reported in the year in which it is constructively received.

The constructive receipt refers to income that you do not have physically but made available to you without restrictions. In other words, you receive constructive income when you control that income.

What is the constructive receipt?

A constructive receipt is an accounting term that requires a person or business to pay income tax, even if the money was not received in actuality. Instead, what matters is that the income recipient can control or use that money even if it is not on hand, for example, being able to spend the funds deposited on a check before it is cleared.

A constructive receipt is important for reporting taxable income, especially with the cash-basis method of accounting.

• Constructive receipt refers to situations in which income can be used even though that money has not yet been physically received.

• Constructive receipt takes place in the cash accounting statements but does not apply or occurs with accrual accounting statements.

• Taxpayers should include the income in their taxes based on the year in which the income was constructively received, even if they did not possess the funds.

How does the Constructive Receipt Work?

A person is considered to be constructively earning income when they can control or use the funds, even if they do not directly own them or are guaranteed to use them in the future.

A business is said to have a constructive receipt if it can use the money without restrictions or if it has been deposited into the business account. When there is constructive income, it means that the taxpayer cannot pay their income tax or compensation that has not yet been spent. The constructive income doctrine applies to employees using the cash method of accounting. It does not affect the accrual method of accounting. The constructive receipt doctrine also states that an agent's receipt of funds is considered to have been received by the administrator at that time.

The IRS in Pub. 538 describes the constructive receipt as: "an amount [which] is credited to your account or made available without restriction." This document is published by the Internal Revenue Service (IRS) and details commonly accepted accounting methods and how to report taxable income under each. 

Constructive receipt of income prevents taxpayers from deferring income tax or compensation that they have not yet used or spent.

Example of constructive receipt 

There are several cases in which constructive receipt can affect your taxable income. For example, if your business pays an annual bonus as a fringe benefit and is paid on December 29, the income is taxable for the year received.

It is impossible to transfer funds in the next fiscal year to stay in the lower tax bracket. There are other cases where the constructive receipt applies.

Another example is if you own stocks, the company declares a dividend on December 24, but regular dividends aren't paid until January 10, so you don't have a constructive receipt of the funds. Therefore, you will not pay taxes on them until the following year.

It is important to keep track of income, such as rent, business bonuses, dividends, and capital gains, to properly report taxes. If you have control over the funds before the last day of the fiscal year, you have taken constructive receipt of income, and those funds will affect your taxes.

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