Question

Color Paint Shop, Inc. is an accrual basis taxpayer that paints automobiles. During 2018, the company painted Sam’s car and was to receive $1,000 payment from his insurance company. Sam was not satisfied with the work, however, and the insurance company refused to pay. In December 2018, Color and Sam agreed that Color would receive $800 for the work, subject to final approval by the insurance company. In the past, Color had come to terms with customers only to have the insurance company negotiate an even smaller amount. In May 2019, the insurance company reviewed the claim and paid the $800 to Color. An IRS agent thinks that Color should report $1,000 of income in 2018 and deduct a $200 loss in 2019.

Answer 1

This question is mainly related with the timing of recording the Income by Color Paint Shop & how much it will be record.

As Color Paint shop is an accrual basis taxpayer and an accrual basis taxpayer is required to recognize income when

1. All the events have occurred to establish the taxpayer's right to receive the income and

2.The amount of the income can be determined with reasonable accuracy.

In this case of Color Paint shop, Insurance company had not approved the work in 2018 and it could be the reason that Insurance company depends on Sam decision to approve the work & will negotiate with the color.

So it does not appear that all the conditions is satisfied to recognize the income in the books in the year 2018 that's why the amount of income should report in 2019 by the color with $800 which they received by the insurance company.