What are Advance Payments?

Anyone managing a business is familiar with advance payments. Suppose a company wants to purchase replacement chairs for all the offices. They may bargain to make initial payments of 70% and pay the rest when the chairs are delivered.  

The concept of special account advances may seem pretty straightforward. However, there are certain precepts that you may not understand. If that is the case, you have nothing to worry about! Join us as we discuss everything you need to know about making advance payment.

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Definition of an Advance Payment

A prepayment is a form of fee that an individual or business makes before the agreed period. For example, suppose you make an order for some goods. The seller may require a 50%-payment to consolidate the deal. In other words, sellers see this as protection against rejection on supplying goods. 

Certain situations make it crucial. Insurance companies usually require an unliquidated advance to provide coverage. A customer with a bad credit union score may need to pay upfront.

Many small businesses often require a down payment. These initial payments may be an essential component of the business funding. As a result, they may need it to buy items to process the order and deliver it. Payments of the balance can be on delivery or in installments, depending on the agreement between both parties.

Tax Types

All taxpayers whose aggregate tax liability reported on certain tax returns for the previous calendar year was $150,000 or more are required to make an advance payment. The following categories of taxes are subject to such payments: 

  •     Sales Tax on Telecommunications
  •     Sales and Use Tax
  •     Sales Tax on Meals
  •     Retail Taxes on Marijuana
  •     Room Occupancy Excise Tax
  •     Sales and Use Tax for Marketplace Facilitators

From 1 April 2021, vendors and operators must remit monthly tax payments in two installments for a special account:

  1. The seller must remit the tax collected on gross sales during the first 21 days of the month.
  2. The tax for the rest of the monthly period must be paid by the 30th of the month following the period in which the return is filed.

The threshold for Making an Advance Payment

The threshold for making a prepayment is usually determined every year. Taxpayers are qualified for an unliquidated advance when their cumulative tax liability exceeds a threshold value of $150,000 for the previous year.

Factors like the line items (Tax Type) are used to ascertain the prepayment and if the threshold is met. The threshold is applied individually to each special account sales tax. For example, a taxpayer reports sales tax on meals and goods. The threshold for each tax return is calculated separately and combined to give a final value.

The taxpayer meets the requirement for prepayment when the $150,000 threshold is exceeded on fees reported. However, Tax on Purchases is not a part of the calculation. As a result, does not influence the outcome of the threshold value or determine advances.

Advance Payments Requirements

The prepayment is the liability you must report on the line items listed above. It is influenced by two factors: 

  •     The tax liability from the first day to the twenty-first of the month
  •     80% of the total liability from the previous month

However, the special account payments must be remitted on or before the 25th day of the month. A retailer may remove the total value of prepaid tax remitted from the 1st to the 21st of the month in which the prepayment was filed.

The prepayment is an agreed 80% of the liability of the previous month. Therefore, the retailer may need to subtract the total prepaid tax claimed on the previous month to calculate the unliquidated advance. 

However, a material man is not qualified for this kind of payment. Instead, they must register with MassTaxConnect because they do not meet the prepayment requirement.

Penalties and Self-Assessment Worksheet

Two situations call for a 5% penalty: when the prepayment is paid on the 25th day of the month but less than the due. In addition, when the total tax liability reported for the filing period is less than 70%, a 5% penalty is incurred. However, the penalty can only be enforced on the amount due to underpayment. 

From the first day of the new year, you can self-assess the penalty when the prepayment made on the 25th is less than 80% of the liability from the previous month. Suppose you are still unclear on how to verify if you will pay the 5% penalty. The self-assessed advance penalty worksheet can help you calculate the penalty imposed on you.

How to Account for Advance Payment?

Maintaining a solid cash flow is crucial to running a business, and late payments invariably lead to difficulties with funds flow. When money is not paid on time, making investments, paying bills promptly, and staying on good terms with suppliers can pose a challenge.

 Such payments ensure a stabilized relationship between counterparties and safeguard the interests of the product owner in an unstable economic environment, inflation, slower turnover rates, and solvency crises. 

Benefits comprise the following:

  •     Funding of the operation will be done upfront, which reduces the risk of losing money
  •     Revenues and costs of the project are recorded in the same period
  •     Collection of debts is rarely necessary
  •     Maintaining a constant cash flow is facilitated
  •     The process of creating automated invoices is simplified

For Buyers

It is essential that buyers have a special account for advances made for any goods or services. The buyer can record the payments by crediting the cash account and debiting the seller’s account. 

Pending when the goods or services are received, the debit balance of the seller’s account is written as a current asset. However, the status changes when the buyer is given a receipt for the goods delivered.

For sellers

Sellers receiving an unliquidated advance need to document them properly. They can do this by crediting the buyer’s special account and debiting their account with the same price. Therefore, the credit union balance of the buyer’s special account increases current liabilities.

Immediately after the customer receives the goods or services, the seller has to issue an invoice. It contains the total amount due after deducting the unliquidated advance. Here are the transactions that the seller must record in the accounting books: 

  •     Revenue is credited
  •     The buyer’s special account is debited
  •     Receivable accounts are debited.

What to consider when making an Advance Payment

Unliquidated advance is nothing new in the business world. Most sellers require an initial deposit to provide assurance that the buyers will not back out, especially after making a large order. This validates the order in case the customer wants to withdraw before the agreed delivery date.

 Some sellers may not have enough capital to fulfill an order. This must be considered when determining the percentage of the total amount due to be paid in advance. Suppose a corporation makes a large order. They record it in the balance sheet as prepaid expenses according to the accrual accounting method. 

Although these payments are a good deal, some risks are involved. Suppose the company experiences some financial challenges. Hence, they are unable to make the required deliveries. Getting your money back may become a legal battle, especially if there is no formal contract to protect the unliquidated advance. 

In addition, some scam companies may utilize the unliquidated advance method to their benefit. This is a significant risk that must not be overlooked; companies and individuals are not spared from this sham. For this reason, it is important to do thorough research on a seller’s special account before making such payments. 

How can I avoid advance payment issues?

Prepayment may become necessary in some transactions between buyers and suppliers for various reasons- as a gesture of commitment from the buyer and also to provide capital to fund expensive projects. 

However, special account issues may arise from this unliquidated advance method in cases where the seller runs into financial challenges, such as bankruptcy, putting the buyer at risk of losing all prepaid funds. 

Possible steps to avoid potential issues from unliquidated advance include the following: 

Problem Solution
Paperwork manipulation Securing your interest with a well-crafted Article 9 in black and white.
Refusal to pay Ensuring the buyer’s security with a subordination agreement that explicitly guarantees payments of larger credit union debts should the seller become bankrupt.
Unreliable special account of the seller Confirm the seller’s records by running a lien search against their security interests.

A standby letter of credits may also be used to protect the buyer’s interest by ensuring an unliquidated advance is returned in the event that the supplier defaults on the contractual agreement.

What Is an Advance Payment Guarantee?

An advance payment guarantee is a form of insurance that assures the buyer of a complete refund if the seller does not hold up their end of the bargain. Suppose a seller does not deliver goods or services. 

This guarantee gives the buyer the authority to consider any contract void. The buyer is entitled to full money-back privileges if the seller cannot meet the agreed special account deadline. 

Why is an unliquidated advance fee guarantee for a special account important? 

  •     It protects the seller from a buyer with a bad credit union score
  •     It reduces the risk of non-payment
  •     Offers a form of financial assistance to the seller in making the goods
  •     Builds trust between the buyer and seller; many business owners find it difficult to trust others with money
  •     Serves as a complete refund guarantee for the buyer when the seller fails to perform as expected.

What Does an Advance Payment Guarantee Cost? 

The cost of an advanced payment guarantee cost depends on the financial review of the contract. While some guarantees may be issued for level rate without financial review, others may require a bit more detail to be granted. Generally, the cost is usually within the range of 10% to 20% of the contract price.

Conclusion

Prepayment is a percentage of the total fee paid by the buyer before goods or service is delivered. The balance is then paid in installments or in full on delivery. These payments may be described as a capital-raising strategy to help a company produce the order.  Sellers see these payments as a way for customers to show their commitment to the agreement. 

For example, an order of 200 chairs may take some weeks to complete. Therefore, when the buyer makes a down payment, the seller can be assured they are not wasting their time in manufacturing. Good contracts can protect buyers from the risk associated with advanced payments. Requesting advanced payments may be a marketing strategy for promoting sales.

FAQ

How to mention advance payment in the invoice?

An advance invoice should contain the following:      The name, address, phone number/ email of the seller's company     The name, address, phone number/ email of the buyer's company     Invoice date and number     VAT details     Clearly stated goods or services     Clearly stated terms and period.

How can I protect my advance payment? 

Firstly, request a prepayment return guarantee from the seller. The bank will take care of the unliquidated advance amount due if they fail to honor the contract. Secondly, you may consider hiring a local inspection agency to oversee the inspection and have a report sent to you about the order's condition. 

What is the difference between a performance bond and a payment bond?

A performance bond secures the contractor's promise to perform the work as agreed in the contract at the negotiated price. A performance bond protects some workers against non-payment by contractors for completed jobs or services. This is the distinction between them.

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