April 24, 2018 IRS issues transitional guidance on treatment of advance payments On April 12, 2018, the IRS issued transitional guidance (Notice 2018-35) on the treatment of advance payments in light of the modifications made to Section 451 by the Tax Cuts and Jobs Act (the Act). Background Revenue Procedure 2004-34 contains a full inclusion method and a deferral method of accounting for the treatment of advance payments for goods, services and other items. The full inclusion method requires taxpayers to include an advance payment in income in the year of receipt. The deferral method requires taxpayers to include an advance payment in gross income for the tax year of receipt to the extent recognized in a taxpayer's applicable financial statement in that tax year. The taxpayer includes the remaining amount of the advance payment in the next succeeding tax year after the tax year in which the payment is received. The Act added new subsections (b) and (c) to Section 451, effective December 31, 2017. For an accrual-method taxpayer, under Section 451(b)(1)(A)(i), the all events test for an item of gross income will not be treated as met any later than when the taxpayer takes the item into account as revenue in an applicable financial statement. Section 451(c)(1)(A) requires an accrual-method taxpayer to include an advance payment in gross income in the tax year of receipt. Section 451(c)(1)(B), however, allows an accrual-method taxpayer to 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. The taxpayer cannot make the election for any portion of the payment that is required under Section 451(b) to be included in gross income in the tax year in which the payment is received. The provisions of Section 451(c) are generally similar to the rules of Revenue Procedure 2004-34. Interim guidance In Notice 2018-35, the IRS states that taxpayers may continue to rely on Revenue Procedure 2004-34 for the treatment of advance payments until further guidance is issued. During the interim period, the IRS will not challenge a taxpayer's use of Revenue Procedure 2004-34, but will continue to verify on examination that taxpayers are properly applying the provisions of Revenue Procedure 2004-34. Notice 2018-35 also indicates that the IRS plans to modify Section 16.07 of Revenue Procedure 2017-30 to provide a waiver of the eligibility rule in Section 5.01(1)(f) of Revenue Procedure 2015-13, which will allow taxpayers to make a change to a permissible accounting method under Revenue Procedure 2004-34. The IRS requests comments on: — Whether taxpayers without an applicable financial statement should be allowed to continue to use the deferral method — Whether the applicable financial statement definition under Section 451(b)(3) should be clarified — Whether the applicable financial statement definition under Section 451(b) and (c) should be the same as the definition in Section 4.06 of Revenue Procedure 2004-34 — Whether other items, in addition to the items listed in Revenue Procedure 2004-34, should be included in the advance payment definition — Whether certain payments other than those listed in Revenue Procedure 2004-34 should be excluded from the advance payment definition — Whether new procedural rules for changing an accounting method for advance payments would be helpful — The extent, if any, to which the IRS should expand the rules of Section 451(c) to apply to additional types of income and taxpayers Comments are due by May 14, 2018. Implications The Department of the Treasury and the Internal Revenue Service expect to issue future guidance regarding the treatment of advance payments under Section 451(c). As such, Notice 2018-35 provides only stop gap relief until that guidance is released. Section 451(c) only applies to advance payments "for goods, services or other items to be identified." Accordingly, it provides a narrower scope than Revenue Procedure 2004-34, which permits deferral for advance payments received for not only goods and services, but also numerous other items including, but not limited to, computer software, intellectual property, gift cards and subscriptions. It is critical that taxpayers affected by Section 451(c) provide comments to the Government if they wish to preserve or expand their ability to defer certain types of revenue in the future. Taxpayers must still apply by the provisions contained in Section 451(b), however, which may, based on changes in book treatment of items, effectively limit or prevent deferral of items that were previously deferrable under Revenue Procedure 2004-34. For more information on advance payments, please watch our recent webcast, Advance payments: highlights and implications of tax reform and ASC 606 implementation. ———————————————
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