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Merlo
Merlo, Accountant
Category: Tax
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Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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I have a question regarding income recognition with a paypal

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I have a question regarding income recognition with a paypal account which withholds 5% of revenue received as "rolling reserve" for a cash basis taxpayer. We don't have access to these reserves but the customer has bought and paid for the product. When does the income that paypal holds as a rolling reserve have to be recognized as income? I've looked briefly into the constructive receipt rules of section 446 and IRS Pub 538 but am not sure as to the timing of the recognition of these reserves.

Hello JA Customer,

 

Cash basis taxpayers must include gains, profits, and income in gross income for the taxable year in which they are actually or constructively received. Under the constructive receipt doctrine, which is codified in § 451(a), income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given.

 

However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. See § 1.451-2(a) of the regulations.

 

http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&sid=1b3a6b89a4a97e34eac1804eb7395dfb&rgn=div8&view=text&node=26:6.0.1.1.1.0.5.23&idno=26

 

It is my understanding that the 5% rolling reserve implemented by Paypal applies only for 30 days. So every 30 days, the amount previously held back as a rolling reserve is released. The amount that Paypal withholds as a rolling reserve is not available for your constructive use, and therefore does not need to be included in your income for the year in which the funds are held back. But since this rolling reserve is released every 30 days, it appears that this would only be an issue on the rolling reserve held back during the month of December, as those funds would not be available to you until January of the next tax year. Reserves withheld for months prior to December should all be released within 30 days, and so they should be constructively received during the current tax year and must be reported as income.

 

 

Thank you

 

 

Customer: replied 6 years ago.
So your understanding is the amount in the reserve (may be 30 days not 60) should not be considered taxable income until received. What about the product costs (cost of goods sold) associated with the sales that have been reserved? Do you think a calculation should be made to back out some of these costs? Or not.

Hello again JA Customer,

 

Yes, it is correct that I would not consider the amount held as a rollover reserve as income you have constructively received. You have absolutely no access to this money and this is not by your choosing. So at the end of the year, any funds which continue to be held as a rollover reserve would not need to be included as part of your taxable income for the current year.

 

No adjustment is necessary on your cost of goods sold. You still sold the goods in the current year and incurred those costs in the current year. It is no different than if the customer was paying you directly for goods you sold to him directly. The cost of goods sold expense is incurred and reported in the year the sale is made and the cost is incurred, and is not reduced by the fact that the income has not yet been received.

 

 

Thank you

 

 

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