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Tax Cuts and Jobs Act

Transitional guidance issued on the treatment of advance payments under TCJA

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

In a Notice, IRS has issued transitional guidance which, pending future guidance that IRS expects to issue on the treatment of advance payments under the Tax Cuts and Jobs Act (TCJA, P.L. 115-97), provides that taxpayers, with or without applicable financial statements, receiving advance payments may continue to rely on Rev Proc 2004-34, 2004-1 CB 991. Under Code Sec. 451(c), as amended by TCJA, accrual method taxpayers can elect a limited deferral of the inclusion of income associated with certain advance payments.

Background. Under Code Sec. 451(a) the amount of any item of gross income is included in gross income for the tax year in which received by the taxpayer, unless, under the accounting method used in computing taxable income, the amount is to be properly accounted for as of a different period.

Reg 1.451-1(a) provides that, under an accrual accounting method, income is includible in gross income when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. All the events that fix the right to receive income generally occur when: (1) the payment is earned through performance, (2) payment is due to the taxpayer, or (3) payment is received by the taxpayer, whichever happens earliest. (Rev Rul 2003-10, 2003-1 C.B. 288)

Rev Proc 2004-34 provides a full inclusion method (the Full Inclusion Method) and a deferral method (the Deferral Method) of accounting for the treatment of advance payments for goods, services, and other items. Under the Full Inclusion Method, advance payments are included in income in the year of receipt. Under the Deferral Method, an advance payment is included in gross income for the tax year of receipt to the extent recognized in revenue in a taxpayer’s applicable financial statement for that tax year or earned (for taxpayers without an applicable financial statement) in that tax year, and the remaining amount of the advance payment is included in the next succeeding tax year after the tax year in which the payment is received.

Generally effective for tax years beginning after Dec. 31, 2017, Code Sec. 451(b)(1)(A)(i), as amended by TCJA, provides that for an accrual method taxpayer, the all events test for any item of gross income will not be treated as met any later than when the item is taken into account as revenue in the taxpayer’s applicable financial statement. Code Sec. 451(c)(1)(A) generally provides that an accrual method taxpayer will include an advance payment in gross income in the tax year of receipt.

Alternatively, under Code Sec. 451(c)(1)(B), as amended by TCJA, an accrual method taxpayer may elect to defer the recognition of all or a portion of an advance payment to the tax year following the tax year in which the payment is received, except any portion of such advance payment that is required under Code Sec. 451(b) to be included in gross income in the tax year in which the payment is received. Code Sec. 451(c)(4)(A) defines an advance payment as any payment: (1) the full inclusion of which in the gross income of the taxpayer for the tax year of receipt is a permissible accounting method, (2) any portion of which is included in revenue by the taxpayer in an applicable financial statement (or such other financial statement as IRS may specify) for a subsequent tax year, and (3) which is for goods, services, or such other items as may be identified by IRS. Code Sec. 451(c) generally contains rules similar to Rev Proc 2004-34.

New guidance. Notice 2018-35 provides that pending expected guidance on the treatment of advance payments to implement the changes made to Code Sec. 451 by TCJA, taxpayers may continue to rely on Rev Proc 2004-34 for the treatment of advance payments until that future guidance is effective.

During this time, IRS will not challenge a taxpayer’s use of Rev Proc 2004-34 to satisfy the requirements of Code Sec. 451, although it will continue to verify on examination that taxpayers are properly applying Rev Proc 2004-34.

In addition, IRS announced that it intends to modify Rev Proc 2017-30, 2017-18 IRB 1131, Section 16.07, to provide a waiver of the eligibility rule in Rev Proc 2015-13, 2015-5 IRB 419, Section 5.01(1)(f), to enable taxpayers to make a change to an accounting method that is allowed under Rev Proc 2004-34.

Comments requested. IRS requests comments containing suggestions for future guidance under Code Sec. 451(b) and Code Sec. 451(c). In particular, comments are requested concerning: (1) whether taxpayers without an applicable financial statement may continue to use the Deferral Method, as provided in Rev Proc 2004-34; (2) whether clarity is needed for the definition of an applicable financial statement under Code Sec. 451(b)(3); (3) whether the definition of applicable financial statement under Code Sec. 451(b) and Code Sec. 451(c) should be the same as the definition in Rev Proc. 2004-34, Section 4.06; (4) whether other items in addition to those listed in Rev Proc 2004-34, Section 4.01(3), should be included in the definition of an advance payment; (5) whether certain payments other than those listed in Rev Proc 2004-34, Section 4.02,  should be excluded from the definition of an advance payment; (6) whether any new procedural rules for changing an accounting method for advance payments would be appropriate and helpful; and (7) the extent, if any, to which the IRS may provide procedures expanding the rules of Code Sec. 451(c) to apply to additional taxpayers and types of income.

References: For deferral of certain advance payments in income, see FTC 2d/FIN ¶ G-2548 et seq.; United States Tax Reporter ¶4514.011.

Notice 2018-35, 2018-18 IRB

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