Constructive receipt of income is an important concept for business owners and other individuals to be familiar with. In essence, constructive receipt means that income is taxed when you could have received it—even if you do not actually receive it until sometime in the future.
The concept can be confusing to people who are used to traditional payment practices, but it’s an important concept to understand if you want to stay compliant with tax laws. To make the concept a bit easier to understand, here are a few examples of constructive receipt in action.
Example 1: Stock Dividend Payments
If you invest in stocks or other types of investments, chances are that you will receive dividend payments at some point. These payments are usually sent out a few weeks after the announcement of the dividend is made. Since you had the option to receive these payments as soon as they were announced, the IRS considers you to have constructively received the income, and thus it is taxable in the same year.
Example 2: A Bonus Earned in One Year But Paid in the Next
Many companies pay out bonuses at the end of the year. If you work for a company that pays bonuses in January, but the bonus is earned in December, the IRS still considers that income as taxable for the year you received it. This means that even if the money isn’t physically in your bank account until the following year, it is still taxable for the prior year in which it was earned.
Example 3: Digital Payments
Thanks to the rise of digital payment options like PayPal, many people are now making and receiving payments electronically. This is considered to be the same as a cash payment for tax purposes, and thus it is taxable even if you haven’t cleared the payment. This means that if you send a payment via PayPal or another service, the other person is constructively receiving it—even if they haven’t accepted the payment.
Understanding constructive receipt of income is an important aspect of tax compliance. If you’re unsure if a specific payment is taxable, it’s always a good idea to consult with a tax professional so that you can ensure that you’re in full compliance with the law.