Customers often come to Larry looking for special pieces. In order to meet customer needs, Larry often accepts orders and then travels looking for the desired item, which he purchases and delivers to the customer. The pieces are expensive, and Larry requires customers to demonstrate their sincerity by providing deposits. If it turns out that the item costs more than expected, Larry contacts the buyer and asks for additional funds. If the item costs less than expected, Larry refunds the excess amount. Also, Larry sometimes returns amounts he received in advance because he is unable to find what the customer wants. What tax issues should Larry's Art Gallery consider?
My assumption in preparing the response to this problem presumes that customer orders are not sales, but rather requests for specific items where the availability and the price is unknown.
1. Are the deposits taxable income on receipt?
Yes, deposits are taxable for a cash basis taxpayer as well as an accrual basis taxpayer in the year in which received presuming Larry has full use of the cash received. It is still true even when the deposit amount may be returned.
2. Are the amounts Larry collects actually ...
The 366 word solution presents six scenarios that could occur dealing with advances or deposits. Each is answered in a sentence or two explaining the tax treatment.