The IRS released final revenue recognition regulations (TD 9941) that significantly modify the proposed regulations issued in 2019. The regulations provide rules for accrual method taxpayers regarding both the acceleration of income under Section 451(b) and the deferral of advance payments for goods, services and certain other items under Section 451(c).
Section 451(b) was amended by the Tax Cuts and Jobs Act (TCJA) to generally require that taxpayers recognize income no later than when it is recognized in their applicable financial statements (AFS). For many taxpayers, this creates an acceleration of income to a year earlier than it would have been recognized under the all-events test. The proposed regulations under Section 451(b) provided that the amount of revenue required to be accelerated under the income inclusion rule was generally the gross receipts recognized in a taxpayer’s AFS, and did not allow taxpayers to offset those accelerated revenues with any kind of cost offset.
The final regulations in Treas. Reg. Sec. 1.451-3 deviate substantially from the proposed regulations by providing that certain eligible taxpayers with inventory may use a new “AFS cost offset method,” which provides a specified way of reducing the accelerated gross receipts by a portion of the related cost of goods. The AFS cost offset method is not available to taxpayers that do not produce or sell inventory. Alternatively, any amount that is taken into account in a taxpayer’s AFS is reduced by the amount that the taxpayer does not have an enforceable right to recover (based on the terms of the contract and applicable law) as of the end of the taxable year.
The final regulations require other adjustments to AFS revenues by having taxpayers:
- Reduce the transaction price for any increase recorded as a result of a significant financing component in AFS
- Add back any reductions made in AFS that may be due to amounts that represent cost of goods sold or liabilities accounted for under other provisions of the Code (e.g., Section 461)
- Reduce for actual disputed income amounts, but add back any amount of reduction in AFS related to anticipated disputes or uncollectible amounts
The final regulations also modify and clarify provisions for allocating the transaction price among multiple performance obligations under a contract or between items of income subject to Section 451(b) and income subject to a special method of accounting. The final regulations provide additional rules related to credit card fees.
Section 451(c) was amended by the TCJA to allow accrual method taxpayers with an AFS to elect to defer the inclusion of income associated with advance payments for goods and services to the taxable year following the taxable year of receipt if such income is deferred for AFS purposes. This rule largely codified the deferral method in Rev. Proc. 2004-34, but left out taxpayers without an AFS and did not include the longer list of eligible advance payments beyond goods and services. The proposed regulations expanded the list of eligible advance payments and provided a non-AFS deferral method for taxpayers.
The final regulations in Treas. Reg. Sec. 1.451-8 largely adopt the proposed regulations, with a few modifications:
- An AFS cost offset rule was added for the deferral method for sales of goods, with a consistency rule that requires using the AFS cost offset method if used under Treas. Reg. Sec. 1.451-3, and vice versa.
- Taxpayers must make certain adjustments to the AFS revenue amount, similar to the rules described under the acceleration of income rules in Treas. Reg. Sec. 1.451-3 above.
- A new special rule allows taxpayers with specified goods to use a Section 451(c) method.
- New allocation rules were added for taxpayers that have contracts with advance payments and items subject to a special method of accounting, or multiple performance obligations under one contract.
The final regulations are generally applicable to tax years beginning on or after Jan. 1, 2021 (or the date filed for public inspection), but taxpayers may choose to apply the final regulations to a tax year beginning after Dec. 31, 2017, as long as they are applied in their entirety and in a consistent manner to such tax year and all subsequent taxable years. The regulations also render obsolete certain credit card fee procedures, Rev. Proc. 2004-34 for deferral of advance payments and other related guidance, effective the same date. The guidance could significantly affect how many businesses recognized revenue for tax purposes, and the IRS is expected to publish additional procedural guidance to provide rules for taxpayers to apply with the final regulations.
A Tax Insights article that goes into greater detail regarding the new regulations and the method change procedures for implementing the regulations is forthcoming.
Partner, Washington National Tax Office
Sharon Kay is the National Managing Partner of Grant Thornton LLP's Washington National Tax Office. Sharon has over 25 years of tax experience and primarily advises clients on federal income tax issues such as accounting method changes, income and expense recognition, inventories, tangible and intangible asset capitalization and recovery, and certain business credits.
Washington DC, Washington DC
- Strategic federal tax
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