The IRS, on Sept. 9, 2019, released long-awaited proposed regulations regarding the timing of income inclusion under section 451 of the Internal Revenue Code of advance payments for goods, services, and certain other items (the advance payment proposed regulations). The proposed regulations:
- Expand on items eligible for, or excluded from the definition of an advance payment;
- Provide a regulatory deferral method for advance payments received by taxpayers without an applicable financial statement (AFS);
- Clarify rules to ensure taxpayers recognize the full amount of advance payment when there has been a financial statement adjustment and the timing for recognizing such adjustments;
- Replicate the existing 92-day rule contained within Revenue Procedure 2004-34; and
- Define performance obligations and allocation of the transaction price for AFS and non-AFS taxpayers.
The proposed regulations under Reg. section 1.451-8 closely emulate the existing deferral method of accounting under Revenue Procedure 2004-34 and this is intentional. The Conference Report to Accompany the Tax Cuts and Jobs Act and an earlier released IRS Notice (Notice 2018-35) indicate the intent and approach of the statute was to codify rules similar to the Revenue Procedure. While similar, the proposed regulations address new topics, such as financial statement adjustment effects on the recognition of advance payments, the allocation of a transaction price to items such as discount vouchers and rewards, and the treatment of contingent consideration or chargebacks when recognized in a taxpayer’s AFS. The proposed regulations also add an exclusion item for certain payments from the definition of advance payments – payments received in a taxable year earlier than the taxable year immediately preceding the taxable year of the contractual delivery date for a specified good.
The proposed regulations decline to provide a widely requested offset for anticipated (or even incurred but not transferred) cost of goods sold. Adversely impacted taxpayers may still yet have hope as the IRS has requested comments on the topic and continues to study the issue.
Finally, the proposed regulations clarify that the use of the AFS or non-AFS deferral method is the adoption of, or a change in, method of accounting, requiring consent of the Commissioner. In anticipation of the need for a change in method of accounting under the proposed regulations, the IRS published Revenue Procedure 2019-37 for taxpayers to obtain automatic consent to change methods of accounting to comply with section 451 and the proposed regulations under Reg. sections 1.451-3 and 1.451-8.
The regulations are effective for taxable years beginning on or after the date the final regulations are published in the Federal Register. Until such date, a taxpayer may rely on the proposed regulations for taxable years beginning after Dec. 31, 2017, provided that the taxpayer applies the proposed rules in total to all advance payments.
RSM will be issuing a series of in-depth guidance on these proposed regulations, proposed regulations under Reg. section 1.451-3, the release of automatic change procedures to comply with the regulations, and the overall impact and tie-ins to entities that are still in the process of adopting the financial accounting revenue recognition standard. Stay tuned for those release items.
Many taxpayers, in a variety of industries, currently defer the recognition of advance payments following Revenue Procedure 2004-34, or other avenues of deferral. The examples in the proposed regulations illustrate the potential breadth of these advance payment rules and include industries, such as:
- Computer software sales and licensing,
- Service providers,
- Manufacturing of industrial and commercial products,
- Restaurants, retailers, and other entities that sell and redeem gift cards,
- Travel industries,
- Broadcasting, and
Taxpayers in these industries that receive payment in advance of providing goods, services, intellectual property or other items for which advance payments are received should consult with their tax advisors to discuss how these proposed regulations may impact them.