07 Jan Does my income count this year or last year?
Q. I do some side work as an independent contractor and my boss wants to pay me for work I haven’t done yet — he plans to use me in January 2015 but he says taxwise it’s better for him to pay me in 2014. This sounds fishy. What should I tell him? Of course I could use the cash, but…
A. Great question, especially in times like these when many people are working as independent contractors.
Almost all individual and small businesses report their taxable income and expenses on the cash receipts and disbursements method, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
“This means it is income when you receive the money and it is an expense when you pay it,” he said. “It doesn’t matter when you actually earned the money or when you incurred the expense.”
Kiely said this is known as the “Cash Basis of Accounting.”
One exception to this rule is when you pay a bill with a credit card, Kiely said.
“You deduct the expense when you charge it, not when you pay the credit card bill,” he said. “This is so because when you use a credit card you are actually paying the bill. You are doing so with borrowed money.”
For an example of how the cash method works, we turned to Joe Matheson, a certified public accountant with Matheson & Assoc. in Whippany.
He posted this example: On Dec. 30, 2012, Mrs. Sycamore sent you a check for interior decorating services you provided to her. You received the check on Jan. 2, 2013. You must include the amount of the check in income for 2013.
“Under the cash method, include in your gross income all items of income you actually or constructively receive during your tax year,” Matheson said. “If you receive property or services, you must include their fair market value in income.”
He then turned to the phrase “constructive receipt.”
“You have constructive receipt of income when an amount is credited to your account or made available to you without restriction. You do not need to have possession of it,” he said. “If you authorize someone to be your agent and receive income for you, you are treated as having received it when your agent received it.”
Matheson said you cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income.
“You must report the income in the year the property is received or made available to you without restriction,” he said. “So your income does not have to match the 1099s and often will not.”
One favorable scenario, Matheson said, is if your employer writes the check on Dec. 31 and mails it to you, and you receive it in January the following year, you would treat it as 2015 income.
There’s another method used by large corporations. It’s knows as the “Accrual Basis of Accounting,” Kiely said.
“Large corporations are required to report income when they earned it, regardless of when they get paid,” Kiely said. “They also deduct expenses when they are incurred regardless of when they pay the bill.”
What your boss is attempting to do, Kiely said, was to get a 2014 tax deduction for work you will do in 2015.
“If he pays you in 2014 for work you do the next year, he gets a tax deduction this year,” Kiely said. “Cash basis of accounting works both ways. If you collect the money this year, you have to pay both income and self-employment — Social Security and Medicare taxes — on it this year.”
Kiely said there’s nothing wrong or illegal about what your boss is trying to do.
“You say you could use the cash, so I say go for it,” he said. “Just be sure to report the money on your tax return.”
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This story was first posted in January 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.