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indicating the compensation is unreasonable. The IRS and the courts have
scrutinized year-end salary payments in
the past to prevent companies from disguising nondeductible distributions of
profits as deductible compensation.
ADVANCE/PREPAID INCOME
Traditionally, the IRS has been on
the opposite side of the fence regarding advance payments, arguing for the
most part that income from advance
payments is income when received and
cannot generally be deferred, whether
the taxpayer is on the cash or the accrual
basis method. In either case, payments
received in advance are usually income
in the year received, provided no restriction has been placed upon their use.
Even advances that are returnable as
refunds upon the happening of some
specified condition generally cannot
escape immediate taxation.
Under Rev. Proc. 2004-34, however, the IRS permits accrual-basis taxpayers to defer the inclusion of advance
payments until the next tax year to the
extent that the recipient’s performance
takes place after the year of receipt.
An “advance payment” eligible for the
“deferral method” generally includes
payments for services; sale of goods; use
of intellectual property; limited occupancy and use of property ancillary to
providing services; sale, lease or license
of computer software; ancillary guaranty
and warranty contracts; subscriptions;
and certain memberships.
Under the deferral method, the
amount of the advance payment recognized in revenues in a taxpayer’s financial statement for the year of receipt
(or, absent a financial statement, the
amount earned in that year) must be
part of taxable income for that year.
The rest of the advance payment is
included in taxable income in the next
tax year. Despite qualification under
Rev. Proc. 2004-34, a taxpayer receiving advance payments can recognize
them as income in the year received,
under the full inclusion method.
TRADITIONAL IRAS VS. ROThS
Assets held in traditional IRAs will
eventually be taxed as ordinary income
when distributed. Now may be a good
time to reconsider when those distributions will occur. If a higher-bracket
individual has reached age 59½ or has
another circumstance that avoids the
10% early withdrawal penalty, a current distribution may provide a good
way to accelerate income into the current lower-rate structure.
Another way to accelerate IRA
income and enhance long-term retire-
ment and estate planning is to convert
to a Roth IRA. For a 2010 conversion,
the taxpayer has the additional option
of recognizing income evenly between
2011 and 2012, instead of all in 2010.
While full income recognition in 2010
may appear to be the better choice now,
this special election allows an individual
to wait until their 2010 return is timely
filed before making a final decision.
George G. Jones, LLM, is managing editor and Mark A. Luscombe, LLM, CPA,
is principal analyst at CCH Tax and
Accounting, a Wolters Kluwer business
in Washington.
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