Taxpayers May Continue to Rely on Rev. Proc. 2004-34 for Advance Payments

(Parker Tax Publishing April 2018)

As a result of the enactment by the Tax Cuts and Jobs Act of 2017 (TCJA) of a new provision dealing with the tax treatment of advance payments, the IRS is providing transitional guidance until more formal guidance can be issued. Noting that the TCJA provision largely tracks the approach in Rev. Proc. 2004-34, the IRS stated that a taxpayer receiving advance payments (regardless of whether the taxpayer has an applicable financial statement), may continue to rely on the 2004 revenue procedure until further guidance is issued. Notice 2018-35.

Background

Code Sec. 451(a) provides that 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 method of accounting used in computing taxable income, the amount is to be properly accounted for as of a different period.

Reg. Sec. 1.451-1(a) provides that, under an accrual method of accounting, 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. Proc. 2004-34 provides a full inclusion method and a 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.

The Tax Cuts and Jobs Act of 2017 (TCJA) redesignated certain provisions of Code Sec. 451 and created new Code Sec. 451(b) and new Code Sec. 451(c). Code Sec. 451(b)(1)(A)(i) provides that for an accrual method taxpayer, the all events test for any item of gross income is not treated as met any later than when the item is taken into account as revenue in an applicable financial statement of the taxpayer. Code Sec. 451(c)(1)(A) generally provides that an accrual method taxpayer must include an advance payment in gross income in the tax year of receipt. Alternatively, under Code Sec. 451(c)(1)(B), 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 method of accounting;

(2) any portion of which is included in revenue by the taxpayer in an applicable financial statement, or such other financial statement as the IRS may specify, for a subsequent tax year; and

(3) which is for goods, services, or such other items as may be identified by the IRS.

Code Sec. 451(c) generally contains rules similar to the ones in Rev. Proc. 2004-34.

Notice 2018-35 Provides Interim Guidance for Rev. Proc. 2004-34

According to the IRS, it expects to issue guidance for the treatment of advance payments to implement the changes made to Code Sec. 451 by TCJA. In Notice 2018-35, the IRS states that, until further guidance for the treatment of advance payments is applicable, taxpayers, with or without applicable financial statements, may continue to rely on Rev. Proc. 2004-34 for the treatment of advance payments. During this time, the IRS will not challenge a taxpayer's use of Rev. Proc. 2004-34 to satisfy the requirements of Code Sec. 451, although the IRS will continue to verify on examination that taxpayers are properly applying Rev. Proc. 2004-34.

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

IRS Requests Practitioner Suggestions for Future Guidance

The IRS is inviting practitioners to make suggestions for future guidance under Code Sec. 451(b) and (c). In particular, it is requesting comments concerning the following issues under Code Sec. 451(c):

(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 (c) should be the same as the definition in Section 4.06 of Rev. Proc. 2004-34;

(4) whether other items in addition to those listed in Section 4.01(3) of Rev. Proc. 2004-34 should be included in the definition of an "advance payment";

(5) whether certain payments other than those listed in Section 4.02 of Rev. Proc. 2004-34 should be excluded from the definition of an "advance payment";

(6) whether any new procedural rules for changing a method of accounting 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.

Comments must be submitted by May 14, 2018. Comments, identified by Notice 2018-35, may be sent by mail to: Internal Revenue Service; Attn: CC:PA:LPD:PR (Notice 2018-35); Room 5203; P.O. Box 7604; Ben Franklin Station; Washington, D.C. 20044. Comments may also be delivered by hand or by courier Monday through Friday between the hours of 8 a.m. and 4 p.m. to: Courier's Desk; Internal Revenue Service; Attn: CC:PA:LPD:PR; (Notice 2018-35); 1111 Constitution Avenue, NW; Washington, DC 20224. Finally, persons may submit comments electronically to Notice.Comments@irscounsel.treas.gov. The subject line should say "Notice 2018-35."

For a discussion of the tax treatment of advance payments, see Parker Tax ¶241,720.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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