A retainer fee or retainer balance is money that your client pays upfront for services that you will perform later on. Retainer balances but be reported as income in certain scenarios.
When Do I Need to Declare Retainer Balances As Income?
What needs to be determined is whether the income you received fits into what the IRS considers advance payments of income that cannot be deferred to the next year for cash-basis taxpayers. There are some descriptions of court cases here that help explain what income is taxed in the year received.
Below are probably the two most relevant cases.
To clarify, if the payments you received are clearly defined as being refundable to the client and are not able to be kept by you once you provide the promised goods and services, then you are not required to report them as income. But if the payments received are merely payments in advance for goods and services to be provided later, they are included in income.
If you have any questions about these examples, please talk to your CPA. The most important thing is that you feel comfortable that what you have chosen can be defended if the IRS were to question it.
- Comm. vs. Indianapolis Power & Light Co. 110 S. Ct. 589 (1990)
The U.S. Supreme Court made a distinction between the taxation of refundable deposits. The Court confirmed advance payments are generally taxable and defined “advance payments” as a nonrefundable payment. With a non-refundable payment, the payee is “guaranteed” it can keep the money as long as the payee performs its own obligation under the contract. - Michaelis Nursery Inc. 69 TCM (1995) (CCH) 2300, T.C. Memo 1995-143
The sole issue is whether amounts received by Nursery from its customers in connection with the sale of trees should have been recognized as income in the year the payments were received or in subsequent years when the trees were delivered. Court held that the deposits received by the Corporation were advance payments of income constituting taxable income to the petitioner when received. The corporation enjoyed “complete dominion” over these payments because it had no obligation to repay any amount to the buyers unless the corporation defaulted on its commitment to deliver the trees.
Accrual basis taxpayers have more flexibility in deferring revenue received in advance. It is possible to switch from cash to accrual if you feel that would be worth it. It would take extra work to make the switch, and we would need to determine if it can be done for the year we are discussing. You will need to reach out to your CPA for further details.
– Jeremy Niswonger, CPA
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