On April 12, 2018, the IRS issued Notice 2018-35, allowing taxpayers to continue to rely upon Rev. Proc. 2004-34 until the IRS issues future guidance on section 451.
Rev. Proc. 2004-34 offers taxpayers an option to defer the inclusion of certain advance payments into income (the Deferral Method) instead of including the full amount of advance payments in the year of receipt (the Full Inclusion Method). Under the Deferral Method, a taxpayer includes an advance payment in gross income for the taxable year of receipt to the extent recognized in a taxpayer’s applicable financial statement (AFS) for that taxable year, or earned, for taxpayers without an AFS. A taxpayer may include the remaining amount of the advance payment in the following taxable year.
The new tax law changes, commonly referred to as the Tax Cuts and Jobs Act (TCJA) made significant changes to section 451, which governs revenue recognition. TCJA largely incorporated the rules of Rev. Proc. 2004-34 into new section 451(c) as they relate to taxpayers with an AFS. However, taxpayer’s questioned whether section 451(b) supplanted Rev. Proc. 2004-34 and whether taxpayers without an AFS could continue to rely upon the Rev. Proc.
Notice 2018-35 states that taxpayers may continue to rely on Rev. Proc. 2004-34, and the IRS will not challenge a taxpayer’s use of Rev. Proc. 2004-34 to satisfy the requirements of section 451. The IRS will, however, continue to verify that taxpayers are properly applying the rules of Rev. Proc. 2004-34. The Notice states that the IRS intends to modify section 16.07 of Rev. Proc. 2017‑30, to provide a waiver of the eligibility rule in section 5.01(1)(f) (prohibition of having filed the same item in the last five years) of Rev. Proc. 2015‑13, to enable taxpayers to change to a method of accounting that is permitted under Rev. Proc. 2004-34. Future guidance is expected to clarify the specific goods and services to which these rules will apply.
Section 4 of Notice 2018-35 solicits public comments on seven particular issues under section 451:
- Whether taxpayers without an AFS may continue to use the Deferral Method, as provided in Rev. Proc. 2004-34;
- Whether clarity is needed for the definition of an AFS under section 451(b)(3);
- Whether the definition of AFS under section 451(b) and (c) should be the same as the definition in section 4.06 of Rev. Proc. 2004-34;
- Whether other items in addition to those listed in section 4.01(3) of Rev. Proc. 2004‑34 should be included in the definition of an advance payment;
- Whether certain payments other than those listed in section 4.02 of Rev. Proc. 2004‑34 should be excluded from the definition of an advance payment;
- Whether any new procedural rules for changing a method of accounting for advance payments would be appropriate and helpful;
- The extent, if any, to which the Service may provide procedures expanding the rules of section 451(c) to apply to additional taxpayers and types of income.
The IRS and Treasury will accept comments submitted by May 14, 2018.
Deferring income from 2017 to 2018 has additional significance with lower Federal income tax rates provided by the TCJA. Businesses relying upon Rev. Proc. 2004-34 currently or who may benefit from the Deferral Method are encouraged to consult with their tax professionals.
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