IRS issues guidance on advance payments treatment

Tax Hot Topics: Section 451 question addressed

Tax Hot Topics newsletterThe IRS on April 12 issued Notice 2018-35, which allows taxpayers to continue to follow Rev. Proc. 2004-34 for recognition of advance payments until further regulations are issued under new Section 451(c). The new tax reform law, commonly referred to as the Tax Cuts and Jobs Act (TCJA), amended Section 451 to include a new subsection (b) which expanded the all-events test for taxpayers with applicable financial statements and a new subsection (c) that generally codified the one-year deferral of advance payments allowed in Rev. Proc. 2004-34. The rules provided in Section 451(c) are similar but not identical to the rules in Rev. Proc. 2004-34.

Prior to the enactment of the TCJA, a taxpayer could generally treat advance payments received for goods, services, use of intellectual property, occupancy of property ancillary to providing services, sale, lease or license of computer software, ancillary warranty contracts, certain subscriptions, certain organizational memberships and gift cards as income either in the year of receipt or deferred, in whole or in part, to the year following the year of receipt. An advance payment under Rev. Proc. 2004-34 is one for which the full inclusion in the gross income of the taxpayer in the year of receipt is a permissible method of accounting and that is recognized, in whole or in part, in the taxpayer’s applicable financial statements in a subsequent year or, if the taxpayer does not have applicable financial statements, earned in a subsequent taxable year.

The newly enacted Section 451(c) allows advance payments to be recognized under either the full inclusion method or deferral method, if elected, for goods, services or other items designated by the Treasury secretary. The deferral method as codified is limited to taxpayers with applicable financial statements – generally a 10-K or audited financial statement. The language in the statute is narrower than that of the revenue procedure, however the IRS has requested comments on advance payments, including what “other items” should be designated in future guidance and whether taxpayers without applicable financial statements should be able to continue to use the deferral method.

Until further guidance is issued, taxpayers may continue to rely on Rev. Proc. 2004-34 for the treatment of advance payments. Additionally, the government indicates its intention to modify the automatic method change provided in Section 16.07 of Rev. Proc. 2017-30 or its successor to waive the five-year eligibility rule for taxpayers to able to change to a permissible method of accounting for advance payments.

Sharon Kay
Washington National Tax Office
T +1 202 861 4140

John Suttora
Managing Director
Washington National Tax Office
T +1 202 521 1523

David Auclair
National Managing Principal,
Washington National Tax Office
T +1 202 521 1515

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