With the release of final regulation T.D. 9870, the IRS has officially revoked the multiyear deferral rule of Reg. section 1.451-5. Taxpayers relying on this rule must change their methods of accounting for advance payments currently recognized under this regulatory provision and look elsewhere in the code for ways to defer income recognition.
Prior to the enactment of tax legislation in 2017 (commonly referred to as the Tax Cuts and Jobs Act, or TCJA), Reg. section 1.451-5 allowed accrual method taxpayers to defer recognition of advance payments for goods and long-term contracts. Taxpayers could generally defer income from these advance payments until the taxable year the payments were recognized in the taxpayer’s books.
TCJA added a provision at section 451(b), generally requiring accrual basis taxpayers to recognize revenues no later for tax than when recognized in their applicable financial statement. New section 451(c) generally requires accrual taxpayers receiving advance payments to include the payments in the taxable years of receipt, or elect a partial deferral method that is similar to the method offered in Rev. Proc. 2004-34. Under section 451(c) a taxpayer may elect to include any portion of an advance payment in income in the taxable year of receipt to the extent required under section 451(b), and recognize the remainder into income in the following taxable year. The Conference Committee Report accompanying TCJA states the intent of section 451(c) is to render Reg. section 1.451-5 obsolete and the publication of these final regulations in the federal register formally removes the ineffective regulation.
In October 2018, the IRS served its notice to revoke Reg. section 1.451-5 when it released proposed regulations removing the provision.
The adoption of the proposed regulations is effective as of July 15, 2019 and impacted taxpayers should consult with their tax advisors on changing any current deferral under Reg. section 1.451-5 to a permissible method of accounting under the new tax law. The IRS has released limited guidance concerning the treatment of advance payments under section 451 and, as of this alert’s publication date, taxpayers continue to await proposed regulations under section 451(c), which remain under review at the Office of Management and Budget’s Office of Information and Regulatory Affairs.
What it means for restaurants and retailers
Restaurant and retail taxpayers have frequently relied on Reg. section 1.451-5 to defer income from a variety of sources – most notably gift cards and gift certificates. When a business sells a gift card, it typically receives an advance payment in exchange for the obligation to provide goods at a later date when the gift card is redeemed. Under Reg. section 1.451-5, revenues from gift card sales could often be deferred until the year they were recognized under the taxpayer’s financial accounting methods (or generally into the second taxable year following the year of payment in the case of inventoriable goods).
The enactment of section 451(c) could have unfavorable consequences for several taxpayers in the restaurant and retail industry by requiring them to recognize revenue earlier under the new law. Impacted taxpayers may elect to defer the recognition of revenue until the end of the tax year following the year of receipt, but the official loss of the multiyear deferral provision is certainly not welcome news.
Taxpayers relying on Reg. section 1.451-5 to defer income will likely be forced to start recognizing revenues sooner. Taxpayers should consult a tax professional to prepare an accounting method change and avoid noncompliance with the change in tax law. Automatic consent procedures are available to make a majority of revenue recognition changes, but certain circumstances may warrant a non-automatic accounting method change. For other taxpayers, this may be a reminder to explore options for deferring income as allowed under section 451(c), particularly for taxpayers issuing gift cards or certificates.