Constructive receipt is an accounting term that describes when someone receiving funds effectively gains control over that income. Once constructive receipt has occurred, the recipient can control the income, and they must also report the income on their taxes for that period.
Learn examples of how constructive receipt could apply to both businesses and individuals.
What Is Constructive Receipt?
Constructive receipt is determined by when the person who receives the income first gains control over that income. An individual or company is considered to have control over income when it is credited to that entity. At that point, the entity could spend, redirect, or otherwise exercise control over that income. Even if the entity decides not to do anything with the income, constructive receipt has still occurred because the entity has the option of doing something with that income.
Constructive receipt applies to any form of income, not just paychecks or other exchanges of money. For example, if you receive property, services, or securities as a form of payment, those must be accounted for at fair market value—so long as there are no restrictions on the payment and it qualifies as constructive receipt.
Constructive receipt is a concept that describes the moment at which income must be taken, for both tax and accounting purposes. Constructive receipt is especially important to consider for transactions that fall toward the end of a year because it could affect which tax year the income is taxed in.
How Does Constructive Receipt Work?
Constructive receipt applies only to cash accounting situations. Most people and many businesses use cash accounting, so constructive receipt is an important concept for most people to understand. However, some businesses use accrual accounting, and constructive receipt doesn't apply in these cases.
For a payment to qualify as constructive receipt, the Internal Revenue Service (IRS) says that the recipient must have no restrictions on the payment received. For example, if you receive stock from your employer with the stipulation that you can't sell the stock for six months, the stocks aren't yours—as far as constructive receipt is concerned—until you can sell the stock at will. The stock may be your property immediately, but it doesn't count as income until you can use it as you see fit.
If you receive a check and you don't deposit it, it's still under your control (you can choose to deposit it any time), so it counts as income. Conversely, if you deposit a check, and the bank puts a hold on it, it's not under your control (there are restrictions on the funds), so you don't have control over it and it doesn't count as income.
Dividends are a good example of when an average person may encounter more complicated constructive receipt situations. That's because three important dates occur in the process of giving dividends to shareholders:
- The first important day is the day that the dividend is declared or announced by the company's board of directors.
- Second, the dividend record date will determine who will receive a dividend payment (anyone who buys stock after this date won't get this round of dividends).
- Finally, there's the dividend payment date, which is the date the dividend is deposited into your brokerage account.
Of these three dates, the dividend payment date is the one that counts, when it comes to constructive receipt. That's the day you actually have the dividend in your brokerage account. You can't spend the dividend before that date.
Constructive receipt still applies to this dividend scenario, even if you are enrolled in an automated dividend reinvestment program. The IRS considers this "assignment of income." If you've assigned your income to go to a third party (an agent or a reinvestment program), then it's taxable on your income taxes the moment it landed it that third party's account.
If the dividend process begins in December, but the dividend payment date is in January, then the dividend will be accounted for on the income taxes that you file for the latter date, the new tax year that starts in January. This is an unusual scenario—dividends are usually announced and paid within the same tax year—but it could happen, and it's an example of when it's important to understand constructive receipt.
Constructive Receipt at the End of a Year
Constructive receipt is an important concept when timing business income and expenses at the end of the calendar year. Here are some more examples of how constructive receipt works in end-of-year tax timing:
- Employee paychecks: If a check is in an employee's bank account before the end of the year, it's considered pay for that year, even if the employee hasn't spent it.
- Other income: If you receive an interest payment or other income before the end of a year, it's available to you, and you must count it as income in that year. That's the case even if you don't put the amount in your own bookkeeping system.
- Pre-payments: Most insurance payments are pre-paid. Your auto insurance, for example, is usually paid for six months in advance. These payments are considered payments in the year the check is dated.
- Interest payments: If you receive interest on an investment or bank account balance, the date the interest is added to your account is the date that counts. The funds were under your control on that day, so constructive receipt applies.
Constructive Receipt in Accrual Accounting
Constructive receipt doesn't apply in accrual accounting. In accrual accounting, income is counted when the work is done and the bill is sent to the customer, and expenses are counted when they are incurred (when the bill is received).
- Constructive receipt is an accounting concept that determines which tax period income or expenses will fall into.
- The IRS says constructive receipt occurs once a payment recipient has full control of the funds without any restrictions on how those funds are used.
- Constructive receipt applies to all forms of payment, including property and stocks.