Understanding Constructive Receipt in Taxation
The doctrine of constructive receipt in taxation dictates that income, even if not physically received, is taxable when made available to the taxpayer. This principle applies to various scenarios such as interest credited to accounts and compensation for services rendered. Failure to recognize constructive receipt could result in improper income reporting.
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Constructive Receipt Constructive Receipt County of Ventura Auditor-Controller s Office December, 2016 1
Constructive Receipt Doctrine Constructive Receipt Doctrine Under Treasury Regulations 1.451-2(a): income, although not actually reduced to a taxpayer s possession, is constructively received by him in the taxable year during which the income is: Credited to the taxpayer s account; Set apart for the taxpayer; Made available so that the taxpayer may draw upon the income at any time; or Made available so that the taxpayer could have drawn upon it during the tax year if notice of intention to withdraw had been given. However, income is notconstructively received if the taxpayer s control of the income s receipt is subject to substantial limitations or restrictions. 2
Constructive Receipt Doctrine Constructive Receipt Doctrine The Doctrine of Constructive Receipt is a taxation principle that taxes income before that income is actually received. You need not have possession of it. Gross income under a taxpayer s control before it is actually received must be included by the taxpayer in gross income, unless the actual receipt is subject to significant constraints. Example: Interest credited to the taxpayers savings account on 12/31/16 is reportable as income in 2016, even though it may not be used until 2017. Therefore, even if the income is not actually received, the fact that the person could have had it if he/she had simply requested it, means that, for all intents and purposes, that person did have it. 3
Constructive Receipt Explained Constructive Receipt Explained As a general rule, compensation is included in an employee s gross income in the year the amounts are received, whether actually received or constructively received. Actually received: On or about the Friday of each biweekly pay period, an employee receives a paper check or direct deposit for wages earned in the preceding work period. A paper check may be presented to a financial institution for an exchange in cash; or A direct deposit at a financial institution of amounts received is available for immediate withdrawal of funds in the form of cash. 4
Constructive Receipt Explained Constructive Receipt Explained As a general rule, compensation is included in an employee s gross income in the year the amounts are received, whether actually received or constructively received. Constructively received: Accrued hours are credited to an employee s account or otherwise made available so that the employee can draw upon it at any time during the taxable year in the form of compensation. An employee has the discretion to convert unused leave hours to cash, without substantial limitations or restrictions. The employee is constructively in receipt of income as soon as the right to receive cash in exchange for hours becomes fixed. 5
Tax Implications Tax Implications Memoranda of Agreement with employee unions (MOAs) and the Management, Confidential Clerical and Other Unrepresented Employees Resolution (Management Resolution) give some employees the option to redeem (i.e., cash-out) specified amounts of accrued leave subject to certain conditions. If these conditions are determined not to be substantial limitations and restrictions on employee control over the cash-out of leave hours, employees who had the option to cash out leave hours would be subject to taxation under the constructive receipt rule even when they had not, in actuality, cashed out leave. 6
Tax Implications Tax Implications Even though the employee has received no cash compensation, the County is required by law to include the cash value of what the employee could have received in the employee s taxable wage base as of December 31 of the tax year. If the amount is not reported as W-2 wages until used, the County and employee will be subject to penalties for failure to properly withhold: Federal and State income taxes; Federal Insurance and Contributions Act (FICA- Social Security/Medicare) taxes; and Federal and State Unemployment taxes. 7
Other Implications Other Implications Amounts reported as W2 wages may be treated as wages again when they are paid out. Further, a true up of withholding amounts may be necessary. Amounts reported as W2 wages may be compensation earnable for retirement reporting and may be reportable to VCERA when earned, as opposed to when paid. Statistics: 2015 Actuals Eligible in 2017 Employees Purchased Amount Employees Eligible Amount 2,303 $11,676,778 5,760 $30,232,284 8
Examples: Fines and Penalties for Violations Examples: Fines and Penalties for Violations Offense Fine/Penalty Late tax deposits 2% - 25% penalty Failure to file a return 5% - 25% penalty of what the return should have shown Failure to withhold required income or FICA taxes Up to 100% of taxes owed Willfully evading federal employment taxes Felony, fines, imprisonment up to 5 years Willfully failing to collect or pay federal employment taxes Felony, fines, imprisonment Willfully fail to file a return Misdemeanor; step financial penalty, imprisonment up to 1 year Willfully submitting a false claim Fines, imprisonment up to 1 year Person responsible for withholding, collecting, accounting for, and paying federal employment taxes, and willfully sign or submit a false document Felony; fines, imprisonment IRS Trust Fund Recovery Penalty is 100% of the unpaid tax, plus interest 9
Remedy: Cash In Lieu of Leave Program Remedy: Cash In Lieu of Leave Program To avoid this risk, the County has established a leave cash-out program modeled on plans approved by the Internal Revenue Service in private letter rulings. The County s program contains two key limitations on the option to cash-out leave: 1. The employee must make an irrevocable election to cash-out leave in the calendar year (2016) preceding the year in which the leave is cashed out (2017); and 2. Only leave accrued during calendar year 2017 may be cashed out, and only after earned. Accrued hours carried over from a prior calendar year are not eligible for cash in lieu of leave. Applicable only to unions that adopt program changes 10
Remedy: Cash in Lieu of Leave Program Remedy: Cash in Lieu of Leave Program Exceptions Under certain CBAs, an employee may cash out leave hours carried over from a prior calendar year if and only if the following conditions are met: At the time the employee makes an irrevocable election to receive cash in lieu of leave, the employee must submit a notice of intent to the County Executive Office- Human Resources (CEO-HR) to retire in the calendar year in which the leave will be cashed out. At the time the employee makes a request for cash out payments, the employee must submit an irrevocable notice of resignation/retirement to the CEO-HR on a specified date in the calendar year during which the payment is to be made. Sunset provisions: Tier I: January 1, 2018 Tier II: December 31, 2020 Refer to your CBA for additional provisions governing the Program. 11
Timeline Timeline December 2016 December 13-15 December 6 and 13 Open House Forums December 31 - Board letters and amendments approved by BOS December 13: Department of Airports Election forms due to ACO December 14: BOS Hearing Room - Unions ratify amendments - Election forms mailed December 15: VCMC Large Auditorium 12
Timeline Timeline Calendar Year 2017 December November 1 December 29 - Final payouts for 2017 elections by ACO January 1 - December 16 - Cash out period for leave accrued in calendar year 2017 or for Retiree elections - Open enrollment for 2018 Cash in Lieu of Leave Elections - Constructive Receipt included on W2; applicable taxes withheld 13
Election Process Election Process Covered Employees Covered Employees Employees covered by the Management Resolution or Collectively Bargained Agreements (CBA) that adopt this policy: Employee completes Auditor-Controller s Office (ACO) form: Payroll Services Election/ Deduction Authorization Cash in Lieu of Leave Hours 2017 making an irrevocable election to cash out leave in the calendar year preceding the year in which the leave is to be cashed out. Forms are available from the ACO internet website located at: http://www.ventura.org/auditor-controller/payroll-information Employees anticipating retirement within the exception period window submit forms to CEO-HR. Employee returns the ACO Election form to the ACO by close of business December 30, 2016. Signed electronic (e.g. PDF) copies may be sent to AC.Payroll@ventura.org followed by the original with a wet signature. 14
Election Process Election Process Covered Employees Covered Employees Employees who do not make an election will not be eligible for cash in lieu of leave hours for calendar year 2017. Exception: Financial hardship provision Employees expecting to become eligible during calendar year 2017 due to a CBA cumulative service hours requirement may elect to purchase accrued leave. Complete and submit the form and return to ACO by December 30, 2016. Complete the form by indicating the number of election hours you intend to purchase in calendar year 2017. Sign and date the form. Return the form to ACO by December 30, 2016. All forms will be date stamped when received by ACO Administration. Forms received after this date will not be honored. Incomplete forms will be returned to the employee for correction. The employee is responsible for obtaining, completing and submitting request forms by the statutory deadlines imposed. The ACO is not responsible for lost, destroyed, or misdirected forms. 15
Purchase Process Purchase Process Employee completes and submits ACO Payroll Services Request for Payment of Cash in Lieu of Leave Hours 2017 form. Forms are available from the ACO internet website located at: http://www.ventura.org/auditor-controller/payroll- information ACO will confirm qualifications and process request, if applicable. ACO will notify employee should disqualification occur. 16
Election Process Election Process Non Non- -Covered Employees Covered Employees Employees not covered by the Management Resolution or Collectively Bargained Agreements (CBA) that adopt this policy: Employee election forms received from non-covered union members will not be honored. Existing collectively bargained agreement provisions for purchasing leave will be honored. However, for employees eligible to receive cash in lieu of leave in calendar year 2017, who choose not to receive cash in lieu of leave and, instead, carry over accrued leave, the following will occur: ACO will calculate the amount the employee could have received, to include any CBA gross-up provisions, and will add that amount to the employee s 2017 IRS Form W-2. ACO will withhold and report all employee and employer applicable taxes and retirement contributions, potentially resulting in a Net Pay Distribution balance of -0- on the final pay check received for calendar year 2017. The IRS regulations contain a three-year claw back and additional employee tax consequences may apply. 17
Sample: Non Sample: Non- -Covered Employee Covered Employee Regular Check (SEIU Legacy) Buydown Only (SEIU Legacy) Imputed Buydown Included (SEIU Legacy) Earnings: Earnings: Earnings: Educational Incentive Flex Credit *Regular Earnings Total Earnings: $ 2,759.80 $ 60.07 $ 297.00 $ 2,402.73 *Buydown $ 2,402.73 Educational Incentive Flex Credit *Regular Earnings Total Earnings: $ 2,759.80 $ 60.07 $ 297.00 $ 2,402.73 excludes buydown earnings Total Earnings: $ 2,402.73 Deductions: FID457 *Ret EE COL Before Tax *Ret EE Reg Before Tax Total Deductions: $ (250.35) $ (12.00) $ (63.19) $ (175.16) Deductions: Medical Dental Vision Life1X 401K FID457 LOAN *Ret EE COL Before Tax *Ret EE Reg Before Tax SEIU Dues Total Deductions: $ (837.09) Deductions: $ (352.95) $ (19.40) $ (4.60) $ (3.09) $ (72.08) $ (12.00) $ (86.37) $ (72.58) $ (197.27) $ (16.75) Medical Dental Vision Life1X 401K FID457 LOAN *Ret EE COL Before Tax *Ret EE Reg Before Tax SEIU Dues Total Deductions: $ (1,075.44) $ (352.95) $ (19.40) $ (4.60) $ (3.09) $ (72.08) $ (12.00) $ (86.37) $ (135.77) includes buydown taxes $ (372.43) includes buydown taxes $ (16.75) Taxes: *MEDI *FICA *Federal Withholding *SDI *State Withholding Total Deductions: $ (371.18) $ (34.84) $ (148.98) $ (105.12) $ (21.62) $ (60.62) Net pay: $ 1,781.20 Taxes: Taxes: *MEDI *FICA *Federal Withholding *SDI *State Withholding $ (34.55) $ (147.73) $ (86.60) $ (21.45) $ (49.54) $ (339.87) *MEDI *FICA *Federal Withholding *SDI *State Withholding $ (69.39) includes buydown taxes $ (296.71) includes buydown taxes $ (552.51) includes buydown taxes $ (43.07) includes buydown taxes $ (269.41) includes buydown taxes $ (1,231.09) Net pay: $ 1,582.84 Net pay: $ 453.27 18
QUESTIONS 19
