Advance Payment for Sales

There are special rules that apply as to when you should report income for advance payments you receive on agreements for future sales; that is, for the future delivery of the goods held for sale in the normal course of your trade or business.  Normally, you would include the payment in your income when you receive it, but there is an alternative method.

Under the alternative method, you include the advance payment in the earlier tax year in which you would include the payment in gross receipts according to the accounting method you use for tax purposes, or the tax year in which you include any part of the advance payment in income for financial reporting purposes.

Examples

1. You use the accrual method for both tax and financial reporting purposes.  You record sales for book purposes when you deliver the goods.  You can recognize the income for tax purposes either when you deliver the goods, or when you receive payment.
2. You are a manufacturer and you record sales when you ship the finished products for book purposes.  For tax purposes you accrue income when the products are delivered and accepted.  You receive an advance payment of $5,000 in one year on a total order of $15,000 of products to be manufactured.    You ship the products in December of that year, and the products are delivered and accepted by the customer in January of the following year.  For tax purposes, you include the $5,000 advance payment in income for the tax year in which you received it, and the balance of $10,000 in the following year.

Expenses

Under the accrual method, you report expenses when:

• all events have occurred that fix your liability,
• the amount of your liability can be determined reasonably accurately, and
• economic performance has occurred.

The timing as to when economic performance occurs depends on the type of expense.  If the expense is for services, economic performances occurs as the services are provided.  If the expense is for property, economic performance occurs when the property is delivered.  When the expense is rent (the use of property), economic performance occurs as the property is used.  For interest expense, economic performance occurs with the passage of time.  In the case of compensation for services, economic performance occurs as employees or contractors are rendering services.