Constructive Receipt Defined

Anyone who earns money by any means must pay their taxes. Remittance of taxes is supposed to be done regularly. That set time schedule when income must be taken is called the constructive receipt. Constructive receipt is determined by when the recipient of the income had control over it.
For example, I get paid for a service I render (let’s assume it’s website designing) at the end of January. Cheque was issued to my name. However, I hold off encashing or depositing it until February. That will be accounted for on January because the company that paid me issued the cheque on January regardless of when I deposited or encashed it.
Another example is when I get a dividend from a business. Let us say the company sent it to me via snail mail and it was from overseas. Even if I get it the next month, it is credited to the company on the month it was sent.
In effect, the Doctrine of Constructive Receipt taxes income the minute it was sent, regardless of when you received it or used it.
The operative Treasury Regulation is § 1.451-2(a) states:

General rule. Income although not actually reduced to a taxpayer’s possession is constructively received by him/her in the taxable year during which it is credited to his/her account, set apart for him/her, or otherwise made available so that he or she may draw upon it at any time, or so that he/she could have drawn upon it during that taxable year if notice 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.

The Constructive Receipt doctrine only affects your ability to obtain a tax-exempt structured settlement annuity, as part of your settlement plan.
If you have multiple sources of income, either through work, structured settlement, trust, dividends and eve inheritance, you need to be concerned with constructive receipt. Remember that any income of any form needs to be filed. Even if it is not taxable, such as structured settlement, you need to be aware of how constructive receipt will affect it.

Taxable Damages Explained

One of the prevailing issues that the public has against the government is their continuous belligerence in collecting taxes from any sort of income. This includes the settlements that people get from lawsuits. The Internal Revenue Service field agents follow an audit guide that allows them to determine whether certain lawsuits and settlements are taxable. Structured settlements are also being examined even if the Structured Settlement Protection Act is already in place. As we have mentioned before, sometimes, the way structured settlement agreements are written allow the IRS the opportunity to tax a portion if not the full amount.
Section 61 of the Internal Revenue Code (26 U.S.C.) states that all income from whatever source derived is taxable, unless specifically excluded by another IRC section. This means that taxation is the default and non-taxable income is the exemption. Section 104(a)(2) is the only provision that specifically addresses income exclusions for any type of lawsuit proceeds.
Settlements that arise from personal injuries are long established to be tax-exempt. However, there are still prevailing discussion on physical versus non-physical (mental anguish) injuries and sickness, and whether punitive damages are received on account of personal injuries. Damages like depression are argued to be something that should be taxable.
Legally, this has long been settled by the Congress. In 1996, the Congress resolved the controversy by amending section 104(a)(2). Congress now restricted the tax exclusion to just physical injuries or physical sickness. Since the August 21, 1996, effective date of that amendment the IRS has a more definite guideline to work with than it had previously.
We published a case where a settlement from an emotional injury was exempted from tax. The case we discussed indicated that the victim treated his emotional health as a capital which he uses for his work. Thus, the settlement he received from it is but a return of capital and not an income. The 1996 amendment provided that personal injury recovery amounts excludable for emotional distress are limited to actual out of pocket medical costs in cases of non-physical injuries, such as discrimination, fraud, etc. However, all amounts received on account of a physical injury, with the exception of punitive damages, are excludable under section 104(a)(2), including amounts for emotional distress.