Before you can appreciate the rule, you must understand the function of cash basis over accrual basis of taxation. I strongly encourage you to read: Tax-Basis-of-Accounting-Accrual-or-Cash before proceeding with this article. If you are already aware of the difference, then most likely, you are a cash basis business operation. Your goal by December 31 of each year is to reduce the tax implications based on income. How do you reduce your tax obligation?
Well, simply put, you pay all your bills as much as you have cash available. The difficulty with this is the desire of management to issue bonuses to staff related to the Christmas holidays. Bonuses are deductible for cash basis employers, but often the employer fails to pay the associated payroll taxes. Pay those taxes by December 31 too.
How does the mailbox come into play with paying your bills? It is simple; the payment must be in the mailbox and post marked by December 31 in order for you as the business owner to take the expense as a deduction. It isn’t good enough to just print the check and reduce the bank account ledger, you ‘MUST INSERT A STAMPED ENVELOPE INTO THE MAILBOX’. Of course, don’t forget to insert the check 🙂 . This is a rule under the Internal Revenue Service Code. Internal Revenue Code Section 7502(a)(1) sets forth the regulation as follows:
The rule was originally created to address the timely filing of tax forms such as the annual tax return. However, it is used to address the issue of proper deduction related to calculating the tax implication for cash basis taxpayers.
On the flip side of this, is of course the receipt of the check from a customer. If the customer’s check arrives prior to December 31, that dollar amount must be included in revenue for tax purposes. It doesn’t matter whether or not you deposit the funds into the business account. The receipt even on December 31 is considered ‘Constructive Receipt’, i.e. you have control over the money. Does it count if the customer post marks his check on December 31 and you receive it after January 1?
Answer: In most cases, NO. You didn’t have actual receipt by year end nor did you have constructive receipt. Therefore, you are not obligated to include in your cash basis income the amount of the payment from that customer. However, you may want to consider including this income if this particular customer issues a Form 1099 to you or your business and includes this dollar value in the Form 1099. You may be able to get by not including it by taking several precautionary steps. One example is to scan in the envelope to electronic files which identifies the mailing date of December 31. This way the IRS will accept your exclusion. But make sure it is definitely included in your following year tax return. You should use reconciliation schedules to demonstrate proper compliance with the law.
There are other situations whereby the income must be included. One example is when the check is held by a third party agent such as in legal cases or in real estate. By law, this is considered constructive receipt and therefore taxable. I know you don’t like it; but that’s the rule. Other examples include an attempt by the Postal Service to deliver a certified check to your business on the 31st and you were closed that day for New Year’s Eve. By prior court cases, it is considered constructive receipt and therefore inclusive in your calendar year income.
I had one client believe if he just didn’t go to his mailbox to get his mail then he didn’t have to include the income in his income for that year. Didn’t work!
As a business owner utilizing the cash basis of tax reporting, you need to understand the ‘Mailbox Rule’ promulgated by the Internal Revenue Service and the justice system via court cases. Act on Knowledge.