What Is the Constructive Receipt Doctrine?
Understand the tax principle that treats income as received when it's made available, impacting the timing of your tax liability regardless of actual possession.
The constructive receipt doctrine is a principle within U.S. tax law that affects when taxpayers using the cash method of accounting must report income. The doctrine clarifies that income is considered received when it is credited to a person’s account or made available to them without restriction, not just when they have physical possession of the funds.
The Internal Revenue Service (IRS) established this rule to prevent taxpayers from artificially deferring their tax obligations by choosing not to collect a payment at year-end to postpone the tax liability. This principle ensures that income is taxed in the year the taxpayer gains control over it and applies to many forms of income, including wages, interest, and rent.
Conditions for Constructive Receipt
For income to be constructively received, it must be made available for the taxpayer to draw upon at any time. This can occur when funds are credited to an account or when a check is ready to be picked up.
The second condition is that the taxpayer’s control over the funds cannot be subject to substantial limitations or restrictions. If a significant barrier prevents access to the money, the doctrine does not apply. What constitutes a “substantial limitation” is based on the specific facts of the situation.
A taxpayer’s own choice not to take possession of available funds is not considered a substantial limitation. For instance, refusing to cash a check or delaying a trip to the bank does not prevent constructive receipt. A substantial limitation must be a genuine obstacle, such as a contractual agreement that specifies a payment will only be made in a future year.
Common Scenarios and Examples
A frequent example involves year-end payments. If an employer makes a paycheck available to an employee in late December, the income is considered received in December for tax purposes. This applies even if the employee chooses not to pick up the check until January because the funds were available without a substantial restriction.
Interest earned on a bank account provides another illustration. When a financial institution credits interest to a savings account in December, that interest is taxable income for that year. This is true even if the account holder does not withdraw the funds until the following year, as crediting the account makes the funds available.
The doctrine also extends to payments made to a taxpayer’s agent. If an individual authorizes an agent, such as an attorney or a broker, to receive income on their behalf, the income is constructively received by the taxpayer when the agent receives it. For example, if a lawyer receives a client’s settlement in December, the client has constructively received that income, even if the funds are not transferred until January.
A different outcome occurs if a payment is mailed at the end of the year. If a bonus check is mailed on the last day of December but does not arrive until January, there is no constructive receipt in December. The employee did not have access to or control over the funds until the check was delivered, as the mailing time acts as a barrier.
Situations Not Constituting Constructive Receipt
The doctrine does not apply when access to income is subject to significant restrictions, such as a valid deferred compensation agreement. If an employee and employer enter a binding contract to delay earnings to a future year, and this agreement is made before the income is earned, constructive receipt does not occur. The contractual obligation serves as a substantial limitation.
Installment sales also avoid constructive receipt. When property is sold under a contract specifying payments will be made over several years, the seller does not have a right to the full sale price at the time of the sale. The contract restricts access to future payments, so income is reported as it is received according to the schedule.
The financial standing of the payer can also create a substantial restriction. If a client provides a check in December, but the client’s bank account has insufficient funds, the freelancer has not constructively received the income. The inability of the payer to make the payment is a substantial limitation, and the income is recognized only once the payment is honored by the bank.