What Is A Constructive Receipt? – Definition, Working, and Example

A constructive receipt mainly helps you find out how to count your taxable income. It also helps you find out how you shall receive your payments. The constructive receipt also gives you an idea of where to use your income, despite the fact that you did not receive your payments physically.

As a taxpayer, you will need to include your income on your yearly taxes that you constructively receive later.

In this article, you will have a general idea of what constructive receipt is and how it works as per the rules of the Internal Revenue Service (IRS). Next up, we will show you what is a constructive receipt with the help of a common example.

Finally, we will give you an idea of what are the major facets that make this receipt important for taxpayers. Hence, read on till the end of the article to find out.

What Is A Constructive Receipt?

According to FreshBooks.com,

“Constructive receipts is an accounting term. It refers to when somebody who is receiving funds effectively gains control over that income. So once constructive receipt has occurred, the recipient can control the income. This is also the point at which they must report the income on their taxes for that period.”

However, you will have to report your income even if you have not received the cash at hand. What matters with constructive receipt is that you will be able to control or utilize the money that you have not received physically. For example, you will be able to spend funds that were deposited to the bank by a check before it gets cleared by that bank.

If you want to report your taxable income, the constructive receipt can be of great help to you, especially if you are using the cash-basis accounting method.

How Does A Constructive Receipt Work?

According to Investopedia.com,

“An individual is considered to be in constructive receipt of income when they have the ability to control or utilize the funds, even if they do not have direct possession of them, or if it is guaranteed they will have the ability to draw upon the funds in the future.”

Suppose you are the owner of a business. Your business can be in a situation of constructive receipt only when the business possesses the ability to use the money without getting any restrictions. The business can use the money when the money is deposited into the business account, and despite that, the business does not possess the money.

You can see from here that the business, despite not possessing the money in its account, can still make payments from that money. This is because the money has already been deposited into the business’s account.

From the point of view of income, when a taxpayer has an income through constructive receipt, they cannot pay their taxes on income that they have not spent yet. This holds true also for compensations that the business received.

The doctrine of constructive receipt also applies to employees as well, that is, the ones that use the cash-basis accounting method and not the ones that use the accrual accounting method. The doctrine also says that if an agent receives funds, it should be considered that the principal also received those funds at the same time the agent received them.

An Example Of Constructive Receipt

Receiving checks in a “constructive receipt” manner is a good example:

According to The Balance Money,

“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.”

Another example of constructive receipt is when a person receives dividends. There are three stages of dividend – declaration, record, and payment. As per the constructive receipt doctrine, the third stage basically counts. It means this is the day when you will have your dividend in your brokerage account.

Why Constructive Receipt Is Important?

Basically, a constructive receipt is a calendar term when it comes to taxes. It heavily affects the way you pay taxes. It determines the way your tax period expenses or your income fall into. This ensures that your tax returns are clear and consistent, as there is little to no room for errors.

The importance of constructive receipt lies in the fact that your income is taxable, even when your income is not under your possession. This rule is made so that taxpayers cannot unreasonably delay their payments to reduce the income that they earn.

Let’s say that you are an employee and you have received your payments at the end of the year. In that case, you must report your paycheck amount as earned income for that year. You will need to do that for tax purposes. You will need to consider this even before you have deposited the check until the next year.

The importance of constructive receipt lies in the fact that the individual actually received the benefit of possessing the capacity to spend the money. It is not about depositing or spending the money solely. The tax on that money counts even if you have taken your time and did not deposit your paycheck right away.

Final Thoughts

Hope this article was helpful for you to get an idea of what constructive receipt is and how it can help you in tax payments. A constructive receipt is a term in accounting that shows a situation where you can use the money to spend on something, even when you have not physically received the money.

This holds true at the time of paying taxes. You will need to include your constructive receipt incomes, even when you are not in possession of the funds. Do you have anything more to add regarding how someone can benefit from constructive receipt? Share your views with us in the comments section below.

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