Recognizing lump sum income over time

[obstinate]

This situation does not pertain to me, but I'm curious. Under US law, suppose I'm an author, and I am to receive an advance of $400,000 on a book that will take four years to write. In all likelihood, royalties will never cover the advance, and so, that will be all my income for those four years.

The naive tax treatment is to recognize the income all in the first year. This gives you a federal tax liability of around $115,000 in that year, then none for the following three. If I were able to recognize the income at $100,000 per year, my tax liability would be a good deal less: around $80,000 for the four years. The difference is more and more stark as the amount of money in question decreases.

My question, then, is whether there is any legal way to set it up so that you can recognize the income this way. Would it work to have the payor pay an irrevocable trust which disburses the money at fixed intervals? Does it work if the payor sets up an annuity rather than giving you the money directly? In both cases, you're really receiving all the value immediately, you're just choosing to make some of it off-limits to yourself.

Please satisfy my curiosity, dear tax experts!

[El Marinero]

I suspect there are folks here with more specific knowledge than I have, but the key is picking the right accounting method for your small business.

You might  be able use an accrual basis for revenue.  If $400K is the payment for four years of future work, then you can recognize $100K annually.

Most small businesses use the cash method, recognizing income when the check is received.  It is simpler, and easier to document if you ever get audited.  But it's not the only choice.

Another alternative is to simply negotiate with the publisher to take the money in 4 annual installments.  I suspect that is easiest.

[dandarc]

Not sure there is a way to do exactly what you're talking about - as far as the IRS is concerned, when you receive the money, it is yours in general.

Suggest reading publication 538, particularly the section on Advance Payments for services.  Appears at best, you can only defer up to 1 tax year in general, but the services must be rendered by the end of that year.  Your 4 years of work with an up-front payment example = must recognize in year of receipt, due to the contract being longer than the end of the next tax year.

The concept you want to apply here is that of "Unearned Revenue".  Which in GAAP Accounting is a very important thing - think of all of those deposits for Tesla Model 3s - not revenue until the cars are delivered and the money is earned, so it is accounted for as Unearned Revenue which is a liability on the balance sheet.  But accounting for SEC filings and financial statements and such is not the same thing as accounting for tax purposes, which usually skews more towards cash-flows, even when using the accrual method allowed by the IRS.