payments received in one year paid out the next year (US IRS tax question)

Question

If you have an agreement that 70% of the profits from an activity will go to a contractor, and you receive the 100% of profits in year 1, but to protect against credit card fraud, you hold those payments for 120 days, and then you pay out to the contractor the 70% in year 2 (because the 120 crosses over to the next year), how do you handle the taxes for it?

• Do I file a 1099 for the payment for the contractor in year 1 or year 2?
• Do I pay for the taxes on the full profits in year 1 even though the the majority of the profits will go to the contractor?
• How do I avoid having to pay taxes on money that is to be disbursed.

Answer 1

If the business uses cash accounting the income counts (as income) in the year it was received (year 1) and the payment counts (as an expense) in the year it was made (year 2). If the business uses accrual accounting the income counts in the year it became due (presumably year 1) and the payment counts in the year it became due (year 1). If you're not familiar with those terms, you're almost certainly cash based.

In any event, talk to an accountant.