BY DAVID ENSZ
A question that often arises at tax time is which year we must report our income. Many people think that it does not need to be reported until it is deposited. Don’t believe it! Income tax regulations decree that you must report it the year that you have “constructive receipt” of the income. And the IRS says you have constructive receipt when it is available to you, regardless of whether you actually take possession of it. For instance, if you are a farmer and have the elevator make out a check for grain sales in December of 2024, but you don’t pick it up or deposit it until January 2025, you had constructive receipt of the amount in 2024. Constructive receipt is also defined as the first date the taxpayer has the right to claim the income, whether or not that claim was actually exercised. A little story is in order here to illustrate this point.
Some years ago, a farmer was wisely trying to do some tax planning, and realizing that his income in the current year was already high, he decided he would not sell any more of his livestock until after the 1st of the next year. But he had a pen of cattle that needed to go to the slaughterhouse before that because of their size, so he made arrangements to have the check made out the first week of January. The cattle were delivered sometime in December, and the last week of the year, a check arrived in his mailbox. The irate farmer called the buyer and was told that they were sorry about the mistake but that if he brought the check back, they would void it and make him a new one after the end of the year, which he promptly did. On the 2nd of January, the packing house took out bankruptcy, and the farmer never did get paid for his cattle. A couple of years later, he was picked for an audit, and somehow, the IRS discovered the issue of the voided check. Using the rule of constructive receipt, they included the cattle sale in that year’s income, and he was forced to pay income tax on the lost income!
Now, what about reporting expenses? For most people, expenses are deducted when they are paid, and that usually means the date the check is written. (Notice I did not say the date on the check. More on that later.) One exception to that is a business using the accrual method of reporting, which we may talk about in another issue. Another one is the use of a credit card. In addition to its other attendant evils, there is the problem of figuring out when to report the expenses charged to the card. When they are paid or when they are charged? Tax law allows the deduction when it is charged because a credit card is a line of credit, and when you sign that slip, it is just as though you had borrowed the money to make that purchase. If you are paying the card in full every month, there is usually little problem with just recording the expense when you write the check. But if you are not paying it in full and then carry a balance over the end of the year and you need the deduction for things charged to the card, it will take some diligent record keeping to keep it all straight. QuickBooks has a couple of ways this can be handled, but to use either one of them effectively and stay out of trouble will require a proper understanding of liability accounts and a consistent review of the balance sheet accounts involved. Get some help with this if you aren’t sure, and keep those liability accounts reconciled!
I am going to digress a bit now from the technicalities of accounting and talk about the ethics of some of these same issues. If my comments about deposits and check dates made you nervous, you may want to skip the rest of this. But I hope you won’t! The issue with deposits is really quite simple. If you have the money, just take it to the bank and record it in the old year. Anything less is trifling with honesty! It is income whether you take it to the bank or not and whether it is cash or a check. Another question that comes to mind is how we go about paying those last-minute expenses. Writing checks on the last day of the year for more than the balance in your account and then covering them with a deposit on the first or second day of the year is not deductible and will be disallowed by the IRS. If you have to have those expenses in the old year for tax reasons, do it safely and honestly and make a short-term loan to cover them. The date on the check will be an important issue to the conscientious businessman. Practices such as pre-dating checks to the old year or leaving a few blank checks after my last one in the old year so I can go back later and add one in, will, of course, not be viewed as a viable options.
** A taxpayer received a “second notice” that his tax payment was overdue. The next day, he went to City Hall, made out a check, and apologized for overlooking the first notice. “I’ll tell you a little secret,” said the tax collector with a smile. “We don’t send out first notices. We’ve found that second notices are much more effective.”
**I was at the drug store to pick up my prescription. The line wasn’t clearly formed, and there was an old man with a cane nearby me. It was unclear as to who was next. When we got to the front of the line, the man gestured to me and said, “After you.” I smiled at him and said, “No, please, after you. I have all day.” Then he said, “No. You go ahead. My doctor says I have at least six months.”