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A friend uses the cash method of accounting for her business. She billed a client for work done during december, mailed out the bill Jan 2nd. She received payment today, with a check dated DECEMBER 31st. This was a LARGE payment, nearly 30% of her annual income.

She had been expecting this to count as 2004 income, but the client has told her the 1099 she receives would be for 2003, not 2004.


I'm having trouble understanding how the client knew what to pay in 2003 when an invoice wasn't issued until 2004. Shall we assume that he consulted Miss Clio or that your friend delayed the billing because she didn't want the income in 2003?

Clearly the client wants a 2003 expense, and your friend wants 2004 income. It doesn't smell right to me that a check just now received was issued and mailed in 2003. That, however, is between the client and the IRS.

Let's assume that it's your friend's practice, demonstrable throughout the year, to bill once a month for the prior month's charges. The payment in question is 2004 income to your cash basis friend regardless of how the client treats it.

My question is, does she have to follow the 1099 the client gives her when reporting her income?

No. She reports based on her meticulous records. She can show the erroneous 1099 as gross receipts and then back it out with an explanation if she wishes. (I don't like these entries, but many professionals do. Such an entry reduces the likelihood that IRS will inquire about the discrepancy, but when your only correspondence is bills from the mental health center, you welcome the change, so I don't fret about IRS correspondence.)

The primary problem is that this income if attributed to 2003 will disallow her Jan 2003 Roth Contribution AND the $70,000 Roth COVERSION she made.

This is why I'm extremely hopeful that there was no deviation from standard practice with respect to this particular payment.

The client is resisting the request to issue a new check.

I'm so stunned I may take to my bed.

Another question is, using the cash method, what determines the legal receipt of income? The receipt of the check? The depositing of the check?

"Constructive" receipt. Let's say, for example, that the work was concluded on December 2, 2003. Client stops by friend's office December 3, checkbook in hand, wanting to settle accounts. Friend, who usually bills within a week of completion, stalls until after the first of the year. for the reason stated, before issuing an invoice. Friend had sufficient control over the payment to have constructive receipt in December.

OTOH, we'll go back to our assumption that friend bills once a month. The payment is income when received. (It's a deductible expense to the payor when mailed, so it's entirely possible for a payment to be legitimately a 2003 expense for the client and 2004 income for friend.)

Only friend and client know what really happened, and were I you I'd pass along the information and then butt out of it.

Phil
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