Taxing Lessons From Court Decisions

Decisions — Timing is everything

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The time may never be just right, but there is a right time for everything, including reporting income.

In T.C. Memo 2018-27 (RJ Channels, Inc.), the taxpayer was an accounting firm doing business as a regular “C” corporation with a May 31 fiscal year end. The taxpayer maintained its books and records and filed its tax returns using the accrual method of accounting.

In February 2012, the taxpayer received a check for $150,000 as payment for tax services. The check was deposited in the taxpayer’s bank account and was to be returned if the taxpayer was unable to obtain a favorable result for the client (the fee was subject to a condition subsequent). No restrictions were placed on the use of the fee.

In April 2012 the taxpayer received a check for $65,000 for tax services. The check was deposited in the taxpayer’s bank account with no restrictions on its use. The taxpayer would return the fee if the taxpayer did not obtain a favorable result for the client.

In September 2012, the taxpayer received a check for $153,600 in additional payment for the February tax services. The check was deposited in the taxpayer’s bank account with no restrictions on its use. The taxpayer would return all the fees (both February and September) if the taxpayer did not obtain a favorable result for the client.

None of the fees were returned.

The taxpayer said the fees were prepaid income.

The IRS examined the taxpayer’s timely filed May 31, 2012, and 2013 tax returns, and included the income should be reported in the taxable year received.

The question before the court: are fees in question includible in gross income for some taxable year after the taxable year of receipt, or for the taxable year of receipt?

Here are the rules the court used:

From treasury regulation section 1.446-1(c)(1)(ii): a taxpayer on the accrual method of accounting is required to include income for the taxable year when (1) all the events have occurred that fix the right to the income and (2) the amount of income can be determined with reasonable certainty.

Under the all events test, it is the fixed right of a taxpayer on the accrual method of accounting to receive the income that is controlling, not whether there has been actual receipt thereof.

In applying the all events test, courts have distinguished between conditions precedent, which must occur before the right to income arises, and conditions subsequent, the occurrence of which will terminate an existing right to income, but the presence of which does not preclude accrual of income.

The right of a taxpayer on the accrual method of accounting to receive income is fixed upon the earliest of (1) the taxpayer’s receipt of payment, (2) the contractual due date of the payment, or (3) the taxpayer’s performance.

Where a taxpayer receives money under a claim of right and without restriction or limitation as to the disposition of the money, the taxpayer must include the money in gross income for the year in which the taxpayer receives it, even though the taxpayer may not be entitled to retain the money and even though the taxpayer may be liable to return its equivalent.

 

In which fiscal year do you think the taxpayer should report the $50,000 February 2012 receipt?

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or

 

In which fiscal year do you think the taxpayer should report the $65,000 April 2012 receipt?

For a full explanation, hover your mouse over the link

or

 

In which fiscal year do you think the taxpayer should report the $153,600 September 2012 receipt?

For a full explanation, hover your mouse over the link

or

 

THE DECISION

Make your selection, then hover your mouse
over the link beneath “The Decision”

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy court decisions. The full case may include facts and issues not presented here. Please use the link provided in the post to read the entire case.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Right answer!
Sorry, wrong answer :(
Right answer!
Sorry, wrong answer :(
Sorry, wrong answer :(
Right answer!

On the record before us, we find that the taxpayer is required to include in gross income

(1) for fiscal year end 5/31/12 the fees of $150,000 and $65,000, or a total of $215,000, received during that taxable year,

and

(2) for fiscal year end 5/31/13 the fees of $153,600 received during that taxable year.

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