Constructive receipts determine a taxpayer’s gross income, including income earned but not received during the taxable period. US law distinguishes between constructive and actual receipt, with the IRS regulating taxpayer assessment and returns. Laws vary by country, so it’s important to consult tax professionals before assuming deferred payments are not taxable.
Constructive receipts are a mechanism used to determine a taxpayer’s gross income. While the concept of constructive receipt is common in many countries, US law draws clear lines regarding the differences between constructive receipt and actual receipt of income. The Internal Revenue Service or IRS uses these laws to regulate taxpayer assessment and returns.
Essentially, a constructive receipt refers not only to income actually received during the taxable period, but also to income earned but not actually received during the same period. Essentially, the question of whether the taxpayer intentionally chose not to receive income during the period is the key to understanding constructive receipt. This determination is necessary to verify whether the taxpayer has deliberately chosen to defer income in order to avoid a tax liability that is not considered legal and proper by the laws of the land. At the same time, the constructive receipt assessment process will determine whether income cannot be collected due to factors beyond the taxpayer’s control.
An example of income that would not be subject to constructive receipt is earnings from projects carried out by a freelance professional. Often, remuneration for freelance projects is paid according to the terms and conditions described in the contract between the freelancer and the client. Since payments may not begin until all terms and conditions are met, this could mean that income is earned during one tax period but not actually received until the following tax period. As receipt of payment is controlled by the payer and not the freelancer, the income is considered to be monetary in nature, and no type of compensation plan would have allowed the freelancer to have been paid at the time the income was earned. Therefore, there would be no evidence that the freelancer intentionally chose to delay receiving income.
Dividend payments are another example of income that may be subject to laws governing constructive receipt. If dividend payments are deferred due to an investor-initiated request, the dividends will likely be considered under constructive receipt terms and treated as if the income were received in the fiscal period under consideration. However, if the issuing company chooses to initiate a deferral of dividend payments for some reason, there is a good chance that the dividend payments will not be subject to tax until after the dividend payments are actually received.
Laws regarding the actual application of the principles of constructive receipt vary from country to country. This makes it imperative that anyone with deferred income, for whatever reason, check with the jurisdiction’s tax professionals before assuming that any deferred payments are not subject to taxation until the income is actually received.
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