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IRC 451(b) and Revenue Recognition: Proposed Regulations, Changes in Accounting Method, Special Accounting MethodsTUESDAY, JUNE 30, 2020, 1:00-2:50 pm Eastern

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June 30, 2020

IRC 451(b) and Revenue Recognition

Ryan Corcoran

Senior Manager, Accounting Methods & Periods

RSM US

[email protected]

Karen Messner

Tax Managing Director

BDO USA

[email protected]

David Strong, CPA

Managing Director

Crowe

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

IRC 451(b) and Revenue Recognition:

Proposed Regulations, Changes in Accounting Method, Special Accounting Methods

Speakers

Ryan Corcoran, Senior Manager

Washington National Tax

RSM US LLP

David Strong, Managing Director

Washington National Tax

Crowe LLP

Karen Messner, Managing Director

National Tax

BDO USA, LLP

6

Agenda

7

Introduction 5 minutes

451(b): an overview 20 minutes

Topic 606, Revenue from Contracts with Customers

15 minutes

Proposed section 1.451-3 regulations 20 minutes

Advance payments under 451(c) 15 minutes

Changes in accounting method 25 minutes

Best practices 10 minutes

Total 110 minutes

Section 451(b): An overview

• Enacted as part of 2017 Tax Cuts and Jobs Act• Generally requires income recognition no later than when

recognized in taxpayer’s applicable financial statement (AFS)• Staggered effective date provisions (general rules and

specific rules for bonds and other debt instruments)• General rules effective for taxable years beginning after December 31, 2017• Specific rules for bonds and other debt instruments having OID effective for

taxable years beginning after December 31, 2018

8


• Applicability of section 451(b)• Accrual-basis taxpayer• Must have applicable or other defined financial statement• Not applicable to a special method of accounting

• For example, long-term contracts under section 460 or rental agreements under section 467

9


• Applicable financial statement (AFS)

• (A) Financial statement prepared in accordance with GAAP which is

• (i) A 10–K (or successor form), or annual statement to shareholders, required to be filed by the taxpayer with the United States Securities and Exchange Commission (‘‘SEC’’),

• (ii) an audited financial statement of the taxpayer which is used for (I) credit purposes, (II) reporting to shareholders, partners, or other proprietors, or to beneficiaries, or

• (iii) any other substantial nontax purpose, but only if there is no statement of the taxpayer described in clause (i), or (iii) filed by the taxpayer with any other Federal agency for purposes other than Federal tax purposes, but only if there is no statement of the taxpayer described in clause (i) or (ii);

OR

10


• Applicable financial statement (AFS)

• (B) A financial statement which is made on the basis of international financial reporting standards and is filed by the taxpayer with an agency of a foreign government which is equivalent to the SEC and which has reporting standards not less stringent than the standards required by such Commission, but only if there is no statement of the taxpayer described in subparagraph (A); or

• (C) a financial statement filed by the taxpayer with any other regulatory or governmental body specified by the Secretary, but only if there is no statement of the taxpayer described in subparagraph (A) or (B). If the financial results of a taxpayer are reported on the applicable financial statement for a group of entities, such statement is treated as the applicable financial statement of the taxpayer.

11


• Prior law• All-events test required accrual basis taxpayers to generally recognize income upon the

earlier of when it was due, earned, or received• Income generally must be realized prior to recognition

• TCJA and forward• Modification generally requires recognition of income upon the earlier of when it is due,

earned, received, or recognized as revenue in the AFS• Section 451(b)(1) is a one-way street – only accelerates income; is not a book conformity

provision• Income still must generally be realized prior to recognition

12


• Section 451(b)(2) – Special methods of accounting• If income is recognized under a special method of accounting then

the book acceleration provisions of section 451(b) do not apply• Examples

• Amounts received by accrual method taxpayers in the year of the taxpayer’s death• Employee tips• Crop insurance proceeds and disaster payments• Proceeds from livestock sold on account of drought, flood, or other weather-related conditions• Income from the sale or furnishing of utility services• Interest on frozen deposits in certain financial institutions• Qualified prizes including a cash option• Sales or dispositions to implement Federal energy regulatory commission or State electric restructuring

policy• Gross profit from installment sales• Prepaid subscription income• Prepaid membership dues• Adjustments for certain retained merchandise• Certain long-term contracts• Rental income under section 467 leases

13


• Section 451(b)(4) – Allocation of transaction price• In the case of a contract which contains multiple

performance obligations, the allocation of the transaction price to each performance obligation shall be equal to the amount allocated to each performance obligation for purposes of including such item in revenue in the applicable financial statement of the taxpayer.

• First, and only, tie in to ASC 606 in section 451(b)

14


• Section 451(b) / ASC 606 / IFRS 15 interaction• Financial accounting changes are behind vast majority of

tax related revenue recognition changes• Section 451(b)(4) tie in to definition of performance

obligations

15


• Examples (from JCT Blue Book)• A taxpayer enters into a one-year contract with a customer to provide

cleaning services twice a month for $100 per cleaning service. The taxpayer invoices the customer and receives payment of $200 after the end of each month. The taxpayer provides cleaning services to the customer 10 times during the last five months of year one and 14 times during the first seven months of year two. The taxpayer receives payments from the customer of $800 in year one and $1,600 in year two. The taxpayer includes in revenue in its financial statements $1,000 in year one and $1,400 in year two. Under prior law, the taxpayer would have included in gross income $1,000 in year one and $1,400 in year two.Under the provision, the taxpayer includes in gross income $1,000 in year one and $1,400 in year two.

16

Section 451(b): An overview • Examples (from JCT Blue Book)

• A taxpayer provides construction services to a customer to expand the customer’s warehouse facility for $100,000. The taxpayer begins providing the construction services in year one and construction is completed during year two. Under the contract, the taxpayer bills the customer $50,000 in year one when construction begins and $50,000 in year two when construction is complete. In addition, the performance of the construction services is non-severable (i.e., there are no milestones that have to be met before payment is due).While the construction services are being provided, the customer retains control of the original warehouse facility and the expansion. The taxpayer includes in revenue in its financial statements $60,000 in year one and $40,000 in year two.Under prior law, the taxpayer would have included in gross income $50,000 in year one and $50,000 in year two. Under the provision, the taxpayer includes in gross income $60,000 in year one and $40,000 in year two.

17


• Key takeaways:• Applies to accrual-basis taxpayers with an AFS• Accelerates timing of revenue recognition (will never

defer revenue recognition past due, received, or earned)• New financial accounting standards causing most of the

accounting method changes

18

Topic 606: Revenue from Contracts with Customers

• Released in May 2014• Public entities required to adopt in first reporting

period after December 31, 2017• Nonpublic entities required to adopt in first annual

reporting period after December 31, 2018*• FASB has issue a delay of one year for nonpublic entities

that have not yet issued their financial statements as of June 3, 2020

19


• Part of generally accepted accounting principles (GAAP)

• Impacts audited, reviewed, and compiled financial statements

• Remember section 451(b) is generally applicable to audited financial statements

• Companies are seeing significant changes in timing of revenue and expense recognition

20


• The five step principles-based framework• Identify the contract with a customer• Identify the performance obligations in the contract• Determine the contract price• Allocate the transaction price to the performance

obligations• Recognize revenue when (or as) each performance

obligation is satisfied• Due to ASC 606/section 451(b) interaction, tax

professionals must be able to understand the financial accounting conclusions in each of these steps

21


• Identification of performance obligations• A promise explicit in the contract or implied by business

practices, published policies, or specific statements made at the time of entering into the contract

• Each performance obligation must be capable of being distinct and the promise to deliver is separately identifiable from the other promises in the contract

22


• Determine the transaction price• ASC 606 requires an entity to take into account an

estimate of variable consideration • For example, performance bonuses, penalties, price

concessions, milestone payments• Variable consideration is recognized as revenue (or

contra-revenue) when it is probably that a significant reversal will not occur

• Prior financial accounting required revenue to be fixed or determinable

• What tax implications might this have?

23


• Allocate consideration to performance obligations• If an item is considered a performance obligation,

financial accounting will allocate some portion of the total determined transaction price to each performance obligation

• Remember section 451(b)(4)…

24


• Recognize revenue• ASC 606 requires revenue recognition upon transfer of

control• Legacy GAAP focused on the transfer of risks and

rewards of the goods or services by determining whether revenue is earned and realized or realizable (fixed or determinable)

25


• Legacy GAAP• Revenue recognized

when earned and realized or realizable

• ASC 606• Revenue recognized

upon transfer of control

• Reg. section 1.451-1(a)• All events test• Earlier of due, received,

or earned

• Section 451(b)• Modifies all events test

to include earlier of AFS prong

26


• Transfer of control model may require revenue recognition over time or at a point in time

• Over time revenue recognition• The customer simultaneously receives and consumes the

benefits provided by the entity’s performance as the entity performs

• The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced

• The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

28


• If revenue isn’t recognized over time, then it’s recognized at the point in time at which the customer obtains control

• Note: This could still be at a point prior to risk and rewards being transferred under legacy GAAP

• Factors:• The entity has a present right to payment for the asset.• The customer has legal title to the asset.• The entity has transferred physical possession of the asset. • The customer has the significant risks and rewards of

ownership of the asset. • The customer has accepted the asset.

29


• Matching of revenue and costs• Financial accounting will match revenues with costs in

many transactions

• What tax implications might this have?

30

Proposed section 1.451-3 regulations• Issued September 9, 2019• Describes and clarifies the statutory requirements of

section 451(b)• Section 451(b) = the ‘AFS income inclusion rule’

• Highlights transactions in which character of item may be different for Federal income tax and AFS purposes

• Expands upon list of an AFS• Adds multi-year contract rules• Defines revenue in an AFS• Final regulations not yet published

31

Proposed section 1.451-3 regulations• Scope of AFS income inclusion rule

• AFS income inclusion rule generally applies to accrual method taxpayers with an AFS when the timing of one or more items of income is determined using the all events test

• AFS income inclusion rule only applies to taxpayers that have one or more AFS covering the entire taxable year

• Proposed regulations provide that the AFS income inclusion rule applies on a year-by-year basis and, therefore, an accrual method taxpayer with an AFS in one taxable year that does not have an AFS in another taxable year must apply the AFS income inclusion rule in the taxable year that it has an AFS, and does not apply the rule in the taxable year in which it does not have an AFS

• What about taxpayers that alternate between a review and an audit?

32


• Statute (and regulations) do not change the character of a transaction for Federal income tax purposes to conform to the character in the AFS

• For example, a rental agreement that is treated as a lease for Federal income tax purposes may be treated as a sale or financing for AFS purposes, or vice versa.

• Similarly, a transaction that is deemed to occur (for example, under a mark-to-market method) for AFS purposes may not be deemed to occur for Federal income tax purposes.

• AFS income inclusion rule though is intended to include unbilled receivables for partially performed services

33


• Variable consideration in ASC 606 may be contingent future income under section 61 or liabilities subject to section 461

• Section 451(b) only intended to change the timing of income

34


• Proposed regulations provides that the transaction price that is used to determine whether an amount has been included in revenue does not include

• Items to which a taxpayer’s entitlement is contingent on the occurrence or nonoccurrence of a future event,

• Reductions for amounts subject to section 461 (including allowances, adjustments, rebates, chargebacks, refunds, rewards, and amounts included in the cost of goods sold), or

• Amounts collected for third parties• Proposed regulations contain presumption rule for

contingent future income

35


• Applies to transactions when (i) the taxpayer’s customer controls the asset that is created or enhanced, or (ii) the taxpayer has a right to partial payment, even when a contract requires delivery, acceptance, and title transfer before a taxpayer can bill its customer

36

Proposed section 1.451-3 regulations• Proposed regulations add a financial statement that is

certified as being in prepared in accordance with IFRS and is:

• An audited financial statement of the taxpayer that is used for:

• Credit purposes;• Reporting to shareholders, partners, or other proprietors, or

to beneficiaries; or• Any other substantial non-tax purpose

• Provide clarity on the priority of an AFS (e.g., restated AFS versus original AFS or annual financial statements versus periodic AFS filed with a government agency)

37

Proposed section 1.451-3 regulations• Applicability to multiple year contracts

• Proposed regulations require taxpayers to take into account the cumulative amounts previously included in prior taxable years in determining a given contract year’s income inclusions under section 451(b)(1)

• Cumulative approach prevents distortions and administrative burden in tracking contract revenues

38

Proposed section 1.451-3 regulations• Guidance on year-end mismatch

• For example AFS year ending September 30, 20XX; taxable year ending December 31, 20XX.

• Taxpayer must use one of three permissible methods to determine revenue for the taxable year to properly apply the AFS income inclusion rule

• Use of the same accounting principles• Use of a pro rata portion of revenue• The ending taxable year AFS income inclusion method

39

Proposed section 1.451-3 regulations• Proposed regulations incorporate a broad reading

of the term revenue• Do not allow a cost offset.

• For example, allowances to income for future cost of goods sold, future estimated costs, or other cost offsets are not allowed

• Also clarify that AFS income inclusion rule does not allow tax to follow a book deferral that is later than when the all events test is satisfied

40

Proposed section 1.451-3 regulations• Rules for certain debt instruments

• Certain credit card fees associated with pools of credit card receivables have been treated as creating or increasing original issue discount (OID)

• Intent of section 451(b) is to subject these fees to the all events test

• Legislative history describes credit card late fees, credit card cash advance fees, and interchange fees as subject to section 451(b)

• Section 451(b) is not intended to affect the application of many of the general OID timing rules

41

Proposed section 1.451-3 regulations• Examples – Provision of goods

• Taxpayer C is a calendar-year accrual method taxpayer with an AFS. In 2018, C enters into a contract with a customer to provide 50 customized computers for $80,000. Under the contract, C can bill $80,000 after the customer accepts delivery of the computers. However, because of the customization, the contract provides that C can be paid for work performed to date, even if the contract is not completed for reasons other than C’s failure to perform. C delivers all of the computers in 2018. Customer accepts delivery of the computers and C bills the customer in 2019. C includes all $80,000 in revenue in its 2018 AFS.

• Under the AFS income inclusion rule in paragraph (b) of this section, because $80,000 of revenue from the provision of goods is included in C’s 2018 AFS, the all events test for that $80,000 of income is met in C’s 2018 taxable year.

• Under the proposed regulations, the limitation on C’s ability to bill until after the customer accepts delivery of the computers is not a future event that restricts C’s enforceable right to payment for the goods.

42

Proposed section 1.451-3 regulations• Examples – Contingent consideration

• Taxpayer E, a manufacturer of automobile parts, is a calendar-year accrual method taxpayer with an AFS. E normally sells parts for $10 per part with a 2% bonus if the parts are delivered on time. Traditionally, 5% of parts sold are returned. In 2018, E enters a contract to sell 1,000 parts to a customer for $10 per part, for a total of $10,000 (1,000 x $10 = $10,000). The contract also provides that E will receive a 2% bonus if it delivers all the parts to the customer by February 1, 2019. E delivers 500 parts to the customer on December 31, 2018. On December 31, 2018, the additional 500 parts were scheduled for shipment to the customer on January 4, 2019. For AFS purposes, E expects to earn the 2% bonus and to have 5% of the parts returned. In its 2018 AFS, E reports $4,850 ($5,000 + $100—$250 = $4,850) of revenue from the contract, including a $100 (2% x $5,000 = $100) adjustment for the expected bonus and a $250 (5% x $5,000 = $250) adjustment for anticipated returns.

43

Proposed section 1.451-3 regulations• Examples – Contingent consideration (cont.)

• E’s transaction price does not include anticipated returns. See § 1.461–4(g)(3) for rules on when the return liability is incurred. While the performance bonus is presumed not to be contingent on the occurrence or nonoccurrence of a future event, at the end of the year, all parts have yet to be delivered within the February 1, 2019 deadline. Under the contract, E has no right to payment of the bonus at the end of the year. Therefore, the presumption is rebutted. Because $5,000 of revenue from the sale of parts is taken into account in E’s 2018 AFS, the all events test for $5,000 of income allocated to those parts is met in E’s 2018 taxable year.

44

Proposed section 1.451-3 regulations• Key takeaways

• Expand on statute’s intent and purposes• Deny cost offset for both contra-revenue as well as cost

of goods sold incurred• Expands financial statements considered an AFS• Expand on examples of special methods of accounting• Provide guidance on multiple year contracts and

taxpayers with alternative AFS years

45

Advance payments under 451(c)

• TCJA also codifies, in substantial part, the one-year deferral method of advance payments under Rev. Proc. 2004-34

• Impacts of codification• Treasury revoked Reg. section 1.451-5 multi-year deferral

method for the advance payments for goods and integral services (July 2019)

• Treasury released proposed 1.451-8 regulations (September 2019)

• Rev. Proc. 2004-34 is still a valid method of accounting for advance payments

• Effective for taxable years beginning after December 31, 2017

46


• Treatment of advance payments is similar to the already existing deferral method for AFS taxpayers under Rev. Proc. 2004-34

• Statutory deferral method for goods, services, and other specified items that the Secretary can identify

• Statute provides that allocation of revenue to multiple obligations is to follow AFS allocation

• 451(c) deferral method does not allow for a cost of goods sold offset

• 451(c) also does not provide for a deferral method for non-AFS taxpayers

47


• What is an advance payment?• Any payment for which the full inclusion into gross

income for the year of receipt is a proper method of accounting

• A portion of the payment must be included in revenue in the taxpayer’s AFS in a year subsequent to the year of receipt

• Payment must be for an eligible item

• An advance payment could be actual or constructive receipt OR if an amount due and payable to the taxpayer

48


• Eligible items• Goods• Services• Other that the Secretary may identify

• Excluded items• Rent• Insurance premiums governed by subchapter L• Payments with respect to financial instruments• Payments with respect to warranty or guarantee contracts

under which a third party is the primary obligor• Payments subject to section 871(a), 881, 1441, or 1442• Payment in property to which section 83 applies• Other that the Secretary may identify

49


• Example from JCT Blue Book• A taxpayer enters into a contract with a customer to manufacture 500

widgets at a price of $10 each. Taxpayer receives a prepayment of $5,000 from the customer in year one for which it elected to apply a two-year deferral under prior law. In addition, the taxpayer elects to defer advance payments under section 451(c). Taxpayer manufactures the widgets during year two and year three and the widgets are delivered to the customer during year three.

• The taxpayer does not include any portion of the advance payment in revenue in its financial statements in year one or year two and, instead, includes the $5,000 in revenue in its financial statements in year three.

• Under prior law, the taxpayer would have not have included any portion of the advance payment in gross income for year one or year two and, instead, would have included the entire amount in gross income in year three.Under the provision, the taxpayer defers including the $5,000 advance payment in gross income from year one to year two. Accordingly, under the provision, the taxpayer includes the $5,000 advance payment in gross income in year two.

50


• Proposed regulations released September 9, 2019 as Proposed Regulation section 1.451-8

• Proposed regulations –• Provide a non-AFS deferral method (1.451-8(d))• Expand upon listing of eligible items – mirrors Rev. Proc.

2004-34• Add new exclusion item – a specified good exclusion• Provide more detailed acceleration provisions as well as

how to account for AFS adjustments and short taxable years

• Provide no cost offset

51


• Proposed regulations eligible items• Services• The sale of goods• The use, including by license or lease, of intellectual property, including

copyrights, patents, trademarks, service marks, trade names, and similar intangible property rights, such as franchise rights and arena naming rights

• The occupancy or use of property if the occupancy or use is ancillary to the provision of services

• The sale, lease, or license of computer software• Guaranty or warranty contracts ancillary to an item or items listed

above• Subscriptions in tangible or intangible format• Memberships in an organization• An eligible gift care sale• Any other payment specified by the Secretary in other guidance

published in the IRB

52


• Proposed regulations excluded items• The same as the statute other than specified goods• Payments received in a taxpayer year earlier than the

taxable year of the contractual delivery date for a specified good

53


• Proposed regulations specified good exception• A specified good means a good for which

• During the taxable year a payment is received, the taxpayer does not have on hand (or available to it in such year through its normal source of supply) goods for a similar kind and in a sufficient quantity to satisfy the contract to transfer the good to the customer; and

• All of the revenue from the sale of the good is recognized in the taxpayer’s AFS in the year of delivery

• What might this exception apply to?

55


• Proposed regulations provide clarity on AFS adjustments

• These adjustment generally occur during purchase adjustment accounting

• If a taxpayer treats an advance payment as an item of deferred revenue in its AFS and writes-down or adjusts that item, or portion thereof, to an equity account (for example, retained earnings) or otherwise writes-down or adjusts that item of deferred revenue in a subsequent taxable year, revenue for that subsequent taxable year includes that item, or portion thereof, that is written down or adjusted.

• Effectively puts into regulation form the IRS viewpoint expressed in CCA 201619009

56

Advance payments under 451(c)• Example from proposed regulations

• On May 1, 2018, A, a corporation that files its federal income tax return on a calendar year basis, received $100 as an advance payment for a 2-year contract to provide services. For financial accounting purposes, A recorded $100 as a deferred revenue liability in its AFS, expec ng to report 1⁄4 of the advance payment in revenue in its AFS for 2018, 1⁄2 for 2019, and 1⁄4 for 2020. On August 31, 2018, C, an unrelated corporation that files its federal income tax return on a calendar year basis, acquired all of the stock of A, and A joined C’s consolidated group. A’s short taxable year ended on August 31, 2018, and, as of that date, A had included only 1/4 ($25) of the advance payment in revenue in its AFS.

• On September 1, 2018, after the stock acquisition, and in accordance with purchase accounting rules, C wrote down A’s deferred revenue liability to its fair value of $10 as of the date of the acquisition. The $10 will be included in revenue on A’s AFS in accordance with the method of accounting A uses for financial accounting purposes. For federal income tax purposes, A uses the deferral method. For federal income tax purposes, A must take ¼ ($25) of the advance payment into income for its short taxable year ending August 31, 2018, and the remainder of the advance payment ($75) ($65 write down + $10 future financial statement revenue) must be included in income for A’s next succeeding taxable year.

57


• Proposed regulations also incorporate 92-day rule from Rev. Proc. 2004-34

• If the taxpayer’s next succeeding taxable year is a short taxable year, other than a taxable year in which the taxpayer dies or ceases to exist in a transaction other than a transaction to which section 381(a) applies, and the short taxable year consists of 92 days or less, a taxpayer using the deferral method must include the portion of the advance payment not included in the taxable year of receipt in gross income for the short taxable year to the extent included in revenue in an AFS. Any amount of the advance payment not included in the taxable year of receipt and the short taxable year must be included in gross income for the taxable year immediately following the short taxable year.

58


• Proposed regulations non-AFS deferral method• Mirrors deferral method in Rev. Proc. 2004-34• Requires taxpayer to determine when payment is

earned• Either actual determination or• On a statistical basis• On a straight-line ratable basis over the term of the agreement• On a clear reflection of income basis

• If contract contains multiple obligations, non-AFS taxpayer must use an allocation method based on objective criteria

59


• Example from proposed regulations• B is in the business of providing internet services. On

September 1, 2018, B receives an advance payment from a customer for a 2-year term for access to its internet services, beginning on that date. B does not have an AFS. B is unable to determine the extent to which the payment is earned in the taxable year of receipt. For federal income tax purposes, B may determine the extent to which the payment is earned in the year of receipt on a straight line ratable basis over the term of the agreement if it is not unreasonable to anticipate at the end of the taxable year of receipt that the advance payment will be earned ratably over the term of the agreement.

60


• Key takeaways• Advance payment treatment is substantially similar to

Rev. Proc. 2004-34 method• Use of specified good exception may be limited as a

result of ASC 606 revenue recognition

61

Changes in accounting method

• Revenue recognition changes under TCJA and proposed regulations are all considered changes in method of accounting

• Vast majority are automatic accounting method changes (no user fee, extended filing dates)

• Rev. Proc. 2019-43 is the most recent listing of automatic changes

62


• Several automatic changes available for revenue recognition (this can get confusing!)

Rev. Proc. 2004-34 full inclusion method Rev. Proc. 2004-34 deferral method (AFS/non-AFS)

Section 451(b) – AFS income inclusion rule change (AFS taxpayers only)

Proposed regulation section 1.451-3 change (AFS taxpayers only)

Proposed regulation section 1.451-8 AFS deferral method change

Proposed regulation section 1.451-8 non-AFS deferral method change

Change in underlying AFS recognition for deferral method under Rev. Proc. 2004-34

Change in underlying AFS recognition for AFS deferral method under proposed section 1.451-8 regulations

Change in underlying AFS recognition for section451(b) AFS income inclusion rule / change in allocation of transaction price

Change in underlying AFS recognition forproposed section 1.451-3 AFS income inclusion method / change in allocation of transaction price

63


• List of automatic accounting method changes also includes a change in timing of recognition of income due to adoption of new financial accounting revenue recognition standards

64


• ASC 606 related changes – Rev. Proc. 2018-29; Rev. Proc. 2018-49 (section 16.11 of Rev. Proc. 2019-43)

• Issued May 2018 and September 2018, provides procedures for taxpayers to change Federal income tax methods of accounting as a result of changes to financial accounting revenue recognition

• Automatic accounting method change is available for• Identification of performance obligations, • Allocating transaction price to performance obligations, and/or• Considering performance obligations satisfied

• This method change is only automatic in the taxable year in which the taxpayer adopts the new financial accounting revenue recognition standards

• Change is automatic for AFS and non-AFS taxpayers and may only be made for a taxable year ending on or before May 10, 2021 (update from Rev. Proc. 2018-49)

65


• Section 451(b) changes – Rev. Proc. 2018-60 (section 16.12 of Rev. Proc. 2019-43)

• Issued November 2018, provides procedures for taxpayers to comply with TCJA section 451(b)

• Provides streamlined procedures for certain taxpayers under which qualifying taxpayer does not have to file an automatic change

• Provides procedures for both section 451(b) general revenue recognition changes and bonds and other debt instrument changes

• Automatic change is generally effective for taxable years beginning after December 31, 2017 (December 31, 2018 for bonds and other debt instrument changes under section 451(b))

66


• Section 451(b) changes – Rev. Proc. 2018-60 (continued)

• Applicable for a change to conform to revenue recognition under section 451(b)(1)(A) – AFS income inclusion rule

• Also includes a change under the all events test (earlier of due, received, or earned)

• Applicable for a change in allocation of the transaction price (section 451(b)(4)) if taxpayer is not adopting the financial accounting standards in the year of change

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• Not applicable for a change to allocate the transaction price if in the year of change the taxpayer is adopting the new financial accounting revenue recognition standards (but see ASC 606 change)

• Not applicable for a change to a special method of accounting

• Not applicable for a taxpayer that does not have an AFS

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• Taxpayer completes Short Form 3115• Change requires legal basis (line 16a and 16b of Form

3115)• Taxpayer must also list where the section 481(a)

adjustment is located on the federal income tax return (line number or schedule)

• Duplicate filing copy (Ogden, UT) is waived

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• Streamlined method change procedures• Available for the taxpayer’s first taxable year beginning after

December 31, 2017• Taxpayer must meet section 448 gross receipts test OR• Any required changes as a result of section 451(b)(1)(A)and/or

section 451(b)(4) have a zero section 481(a) adjustment• No Form 3115 filing required• No audit protection received for streamlined changes

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• Concurrent changes• Taxpayer may file a single Form 3115 that includes multiple

changes under section 451(b) and also changes under ASC 606 accounting method change

• Eligibility restriction waivers• Waives the five-year item restriction for the taxpayer’s first,

second, or third taxable year beginning after December 31, 2017

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• Proposed regulation changes – Rev. Proc. 2019-37 (section 16.12 of Rev. Proc. 2019-43)

• Issued September 2019 and provide procedures for taxpayers to conform to proposed regulations 1.451-3 and 1.451-8 changes

• Adds the following changes:• Change to a method of accounting that complies with the

proposed regulations under section 1.451-3• Change to a method that complies with the proposed

regulations under section 1.451-8(c)• Change for a non-AFS taxpayer to the non-AFS deferral method

that complies with the proposed regulations under section 1.451-8(d)

• What about a full inclusion change?

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• Proposed regulation changes – Rev. Proc. 2019-37 (continued)

• Allows for a cut-off basis or section 481(a) adjustment for section 451(b) changes or Prop. Reg. section 1.451-8 changes provided the change is filed concurrent with the ASC 606 change

• Allows for a cut-off basis or section 481(a) adjustment for advance payment changes

• Eligibility restriction waivers• Waives the five-year item restriction for the taxpayer’s first,

second, or third taxable year beginning after December 31, 2017• Provides favorable audit protection rule exceptions for

taxpayers under examination

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• Allows concurrent change (single From 3115) for section 451(b) changes, proposed regulation section 1.451-3 changes, proposed regulation section 1.451-8 changes and ASC 606 change

• Modifies underlying change in AFS automatic changes

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• Interaction between changes• Nonpublic entities – ASC 606 and section 451(b)• Section 451(b) changes versus proposed regulation 1.451-3

changes• Attribution of section 481(a) adjustment

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Best practices

• Matrix format of changes to revenue recognition appears to be ‘easiest’ way to track changes

• Matrix should include GAAP treatment, GAAP changes, present method for tax and proposed method for tax

• Separating revenue from costs is very helpful in performing analysis

• Concurrent filings of appropriate changes numbers is helpful, but sometimes can be too much of a good thing

• Point in time to over time changes must be analyzed carefully

• Limited automatic changes to cover• Section 460 long-term contract analysis and method change

issues

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