What is Constructive Receipt?

We had a reader reach out to us concerning farmer’s constructive receipt of grain sales.  Here are his comments:

“Please address the proper way to execute deferred payment contracts. I have several farm clients that will sell grain to an elevator, processor or other entity. The client does not inform the buyer at the time of the sale if they want a check immediately or if they want to defer the payment into the next year. Then several weeks or months later (usually late December) they inform the buyer to issue a check for so much money and then defer the payment of the balance of the sale into the next year. I believe the taxpayer will have a constructive receipt issue if the IRS ever finds out how the sale was handled. Do you agree?”

The quick answer is “YES”, I agree with his comments.  Unless a farmer has a valid deferred payment contract with the local cooperative or purchaser of their grain, the farmer will be taxed at the time of sale.  Simply indicating to the buyer of the grain to cut a check for a certain amount in December and then remit the remaining amount in January is not a valid deferred payment contract.

We have been contacted several times on this issue and some of the numbers can be staggering (we have seen close to $50 million of contracts under audit with the IRS and the IRS will likely win in all cases).

The correct way to entering into a deferred payment contract is to set it up with your buyer before you sell any grain.  Then as you sell grain, you can indicate to the buyer if that particular sale should be part of the deferred payment contract.  If so, then it is taxable when you collect the money, not when you sell it.  Otherwise, it is taxable when you sell.

There are two exceptions to this.  First, if you call the elevator and tell them to sell grain and mail the check to you on December 31, under the mailbox rule, that will be income when you receive the check (at least in most normal cases).  However, be aware that if you sell to a cooperative you may have to reconcile the Form 1099-PATR since the cooperative will report the sale in 2021 and you will report it in 2022.

Second, you may want to bring some of the deferred payment contract sales into income in the current year.  The tax rules allow us to elect out of the installment method and report, ON A CONTRACT-BY-CONTRACT basis the income in the current year.  This allows us to more easily optimize your taxable income if you had more expenses than planned.

The bottom line is make sure to do your deferred payment contracts properly.  It appears that the IRS knows this is an issue and you may get an audit notice that may not make your day.