Discussion:Income Deferral Allowed Under Cash Basis?

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Discussion Forum Index --> Tax Questions --> Income Deferral Allowed Under Cash Basis?


Tfisher (talk|edits) said:

16 January 2006
I have an S Corp client who does small construction projects and is cash basis. At the end of 2005, he received a $200,000 advance from a customer for the purchase of construction materials which he had not done as of 12/31/05. Is he required to report the $200,000 as 2005 income since he is cash-basis, or can it be treated as an unearned customer deposit for tax purposes?

DZCPA (talk|edits) said:

16 January 2006
If refundable, legal rights to materials never passed to buyer....show as deposit.

Riley2 (talk|edits) said:

16 January 2006
In order to escape taxaton in 2005, the taxpayer must not have an unrestricted right to access or spend the deposit until 2006. This rule is substantially different from the advance deposit rule for accrual basis taxpayers.

Tfisher (talk|edits) said:

16 January 2006
It seems to me it would be impossible to show that money in my client's bank account could not be accessed or spent. Riley2, can you suggest a way he could demonstrate this?

MEJungman (talk|edits) said:

17 January 2006
The point is that you can't show the client doesn't have access—he has to include the money in his 2005 income. You can't defer income until it is earned under the cash method—because that would be using the accrual method. Under the cash basis, income is recorded when cash is received. The corollary to this it that, under the cash method, you can defer income until cash is received. If the client had performed services in 2005, but was not paid until 2006, he could delay recognition until 2006.

MEJungman (talk|edits) said:

17 January 2006
Remember also, that if the client refunds the deposit in 2006, he can deduct the repayment or (since the amount is over $3,000) take a tax credit in 2006. (See Publication 525).

DZCPA (talk|edits) said:

17 January 2006
Were there services performed or was it a deposit on construction materials? Did you have an agreement to what it was for?

Jaybird9640 (talk|edits) said:

17 January 2006
Due respect to Mr. Jungman, no taxpayer is required to recognize income untill the "All Events Test" is met. In this case, this means even though your client has the money in his bank account, if an agreement exists that he must refund the monies if certain events occur, he must record this as deposits. The current law concentrates on whether your client takes ownership of the materials purchased and whether in a written contract your client can spend this money on whatever he likes without having a liability to the client.

In other words, is the deposit not spent, refundable or not?

Riley2 (talk|edits) said:

17 January 2006
The all-events test is applicable to accrual basis taxpayers, but not to cash basis taxpayers.

Advance payments for future services are taxable when received by a cash basis taxpayer unless there are substantial restrictions on the taxpayer’s access and use of the funds (e.g. escrow or trust accounts). The fact that a cash basis taxpayer may be required to refund the money in future years if certain contingencies develop does not change this basic principle of cash basis accounting. See E. George Schaefer v. Commissioner, TC Memo 1959-229.

The claim of right issue on advance payments is unsettled. There are at least 3 different appellate courts that have ruled that a refund necessitated by post year-end developments would fall within the scope of Sec. 1341. However, the Internal Revenue Service does not share this viewpoint, reasoning that an “actual unrestricted right” as opposed to an “apparent unrestricted right” in the year of receipt would disqualify the repayment from 1341 treatment.

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