Question

In Year 2, Ms. Lamont, an accrual-basis, calendar-year taxpayer under contract, received a $14,000 advance payment for consulting services to be performed ratably from October 1, Year 1, to December 1, Year 2. As of December 31, Year 2, however, the services contracted were only 90% completed. What amounts should Ms. Lamont include in income for tax years ending in Year 1, Year 2, and Year 3, assuming the consulting services are completed early in Year 3 and she prefers to defer income?

Answer 1

Ms. Lamont should include $0 in income for Year 1, $12,600 for Year 2, and $1,400 for Year 3, deferring income by recognizing it as services are performed.

Step-by-step explanation:

In the provided scenario, Ms. Lamont is a calendar-year taxpayer who uses the accrual method of accounting and has received an advance payment for consulting services. In terms of recognizing income from this advance, the IRS allows taxpayers to defer the inclusion of income received for services to be performed by the end of the next tax year. As Ms. Lamont would prefer to defer income, the income will be recognized as the services are performed.

For Year 1, Ms. Lamont would not include any of the advance in her income because the services were not provided until Year 2. In Year 2, she would recognize a portion of the income based on the percentage of services that were completed. Since the services were 90% completed, Ms. Lamont should include 90% of the $14,000 in her Year 2 income, which is $12,600. The remaining 10%, or $1,400, should be included in her Year 3 income when the services are fully completed.

It's important to note that if the services had been completed by December 31 of Year 2, then Ms. Lamont would have been required to report the full $14,000 as income for Year 2.

Year 1: $0

Year 2: $12,600

Year 3: $1,400