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IRS requests comments on potential tax issues raised by new revenue recognition standards

Notice 2015-40, 2015-24 IRB

In a Notice, IRS is seeking comments regarding the effect on taxpayers’ methods of accounting of new financial accounting revenue recognition standards announced last year by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).

Background—accounting methods. Code Sec. 446(a) and Reg. § 1.446-1(a)(1) provide that taxable income is computed under the method of accounting the taxpayer regularly uses to compute income in keeping the taxpayer’s books. Reg. § 1.446-1(a)(4) requires a taxpayer to maintain accounting records that include the taxpayer’s regular books of account and other records and data necessary to support the entries on the taxpayer’s books of account and on the taxpayer’s return.A taxpayer using an accrual method of accounting accrues income when the right to receive income is fixed and the amount can be determined with reasonable accuracy (the all events test). (Reg. § 1.451-1(a))

In most cases, a taxpayer that wishes to change its method of accounting must apply for and secure the prior consent of IRS. (Code Sec. 446(e)) However, for some accounting method changes, IRS provides an automatic procedure for obtaining its consent to the change.

When a taxpayer changes its accounting method, Code Sec. 481(a) adjustments are generally required to be made to prevent items from being duplicated or omitted. (Reg. § 1.446-1(e)(3)(i)) However, in limited circumstances, a “cut-off” method can be used instead, where only the items arising on or after the beginning of the year of change are accounted for under the new accounting method.

New financial accounting standards. In a joint announcement on May 28, 2014, the FASB and the IASB announced new financial accounting standards for recognizing revenue titled “Revenue from Contracts with Customers” (new standards).

The new standards for the timing of income for financial accounting purposes may affect the timing of income for tax accounting purposes for many taxpayers, such as those that (1) presently use the percentage of completion method, (2) derive income from the provision of services, (3) engage in bill and hold transactions for the sale of goods, (4) account for sales and returns of goods, or (5) earn income from warranties. According to commenters, the new standards may affect some industries more than others—particularly the software, entertainment, manufacturing, and construction industries.

Issues. Accounting method changes for federal income tax purposes require IRS’s permission. The new standards raise a number of substantive and procedural issues for IRS, including whether the new standards are permissible methods of accounting for federal income tax purposes, the types of accounting method change requests that will result from adopting the new standards, and whether the current procedures for obtaining IRS consent to change a method of accounting are adequate to accommodate those requests.

Input sought. Adoption of the new standards may create or increase differences between financial accounting and tax accounting rules.As a result, the Treasury Department and IRS are considering whether to issue guidance on the new standards and have requested public comments on the scope, substance, and form of guidance needed.

Comments are requested on issues of conformity between the new standards and the Code, specifically on:

1. the extent to which the new standards deviate from the requirements of Code Sec. 451 and how they may affect deferral of income;
2. industry and/or transaction-specific issues that may arise as a result of the new standards and that might be addressed in future guidance;
3. types of changes in methods of accounting that taxpayers anticipate requesting;
4. whether taxpayers anticipate requesting changes in methods of accounting prior to the effective dates of the new standards;
5. whether taxpayers should be required to use the automatic consent accounting method change procedures or the advance consent procedures to request permission to change a method of accounting under the new standards, and why;
6. which accounting method changes under the new standards, if any, should be allowed using a cut-off method instead of a Code Sec. 481(a) adjustment, and why;
7. whether advance or automatic consent procedures or other procedural guidance will need to be modified and if so, how;
8. what transition procedures may be helpful; and
9. what related accounting method changes taxpayers anticipate requesting that may appropriately be made on a single Form 3115, Application for Change in Accounting Method.

IRS requested that comments be submitted by Sept. 16, 2015.

References: For accounting method changes, see FTC 2d/FIN ¶  G-2100  et seq.; United States Tax Reporter ¶  4464.21; TaxDesk ¶  442,400  et seq.; TG ¶  6300  et seq.