just in the nick of time

© 2017 Eversheds Sutherland (US) LLP

A Cliff Notes Edition of Rev. Proc. 2021-34 to Assist Taxpayers in Considering Income Recognition Method Changes

Just in the Nick of Time

September 23, 2021

Ellen McElroy

Mike Resnick

Mary Kate Nicholson

Eversheds Sutherland

• Income Recognition Rules• Pre-TCJA: All Events Test, Rev. Proc. 2004-34 and Other

Methods• Post-TCJA: Modified All Events Test, Sections 451(b) and (c)• Final Regulations under Section 451(b) and (c)

• Rev. Proc. 2021-34

• CMOA Considerations• 2020 Early Adoption• 2021 Compliance in accordance with Effective Date

Agenda

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• Income Recognition• The “All Events Test” under Section 451 and Treas. Reg. §1.451-1

• Under an accrual method of accounting, income is recognized when:• All events that fix the right to receive the income has occurred; and• Amount can be determined with reasonable accuracy.

• Always consider potential conditions precedent and/or subsequent• CP – conditions must be fulfilled before a right to income is fixed• CS – terminates the right income after the right fixes

• Treatment of Advance Payments• Rev. Proc. 2004-34 – Full Inclusion or Deferral Method• Treas. Reg. §1.451-5• Alternative deferral methods supported by caselaw

Pre-TCJA: Income Recognition Rules

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• May 2014 ASC 606 changes announced

• June 2015 Notice 2015-40

• March 2017 Notice 2017-17

• December 2017 TCJA (addition of Section 451 (b)/(c) to IRC)

• May 2018 Rev. Proc. 2018-29

• December 2018 JCT Bluebook & Rev. Proc. 2018-60

• September 2019 Proposed regulations (with Rev. Proc. 2019-37)

• December 2020 Final regulations

• August 2021 Rev. Proc. 2021-34

Pre-TCJA to Post-TCJA: How Did We Get Here?

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• Section 451(b)− Requires taxpayer to recognize gross income no later

than the tax year that income is taken into account for financial accounting purposes.

− New “prong” to All Events Test, i.e., requires recognition of income at the earlier of:

• When the all events test is met for an item of income, or• When the taxpayer takes the income into account on its applicable financial

statements

− Transaction price must be allocated between performance obligations in the same manner as AFS

− Applicable Financial Statement (“AFS”) includes: • Certain financial statements that are certified as prepared in accordance with

generally accepted accounting principles; • A financial statement based on international financial reporting standards that is

filed by the taxpayer with a foreign governmental agency similar to the SEC; and • A financial statement filed by the taxpayer with any other regulatory or

governmental body specified by the Secretary

Post-TCJA: Modified All Events Test and Section 451(b)

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• Essentially codified the Deferral Method provided under Rev. Proc. 2004-34

• Allows TPs to elect to defer the recognition of advance payments to the taxable year following the year of receipt to the extent such income is deferred for book purposes

• On July 15, 2019, Treas. Reg. §1.451-5 (and its lengthier income deferral period) was officially repealed

Post-TCJA: Section 451(c)

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• AFS Income Inclusion Rule• If a taxpayer uses an accrual method of accounting for Federal

income tax purposes and has an AFS, the all events test under Treas. Reg. § 1.451– 1(a) for any item of gross income, or portion thereof, is met no later than when that item, or portion thereof, is taken into account as AFS revenue

• Exceptions. The AFS income inclusion rule does not apply to:• (i) Any item of gross income, or portion thereof, if the timing of income

inclusion for that item, or portion thereof, is determined using a special method of accounting;

• (ii) Any item of gross income, or portion thereof, in connection with a mortgage servicing contract; or

• (iii) Any taxable year that is not covered for the entire year by one or more AFS

Final Regulations under Section 451(b):Treas. Reg. §1.451-3

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AdjustmentsTreas. Reg. §1.451-3 – AFS Income Inclusion Rule

─ Increased to…• For inventory, remove

reductions for costs of goods sold

• Liabilities that are required to be accounted for under other Code provisions, i.e., Section 461 (e.g., rebates, chargebacks, rewards)

• Amounts anticipated to be in dispute or anticipated to be uncollectable

─ Decreased for…• An amount the taxpayer does

not have an enforceable right to recover if the customer were to terminate the contract on the last day of the taxable year

• A significant financing component recorded for AFS purposes

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Treas. Reg. §1.451-3 – AFS Income Inclusion Rule

─ Enforceable right standard• Amounts the taxpayer would have a right to recover if the

customer were to terminate the contract on the last day of the taxable year

• Includes any right under contract terms or applicable law (e.g., liquidated damages, equitable relief)

─ Alternative AFS revenue method• Taxpayer takes into account revenue recognized in AFS, but does

not adjust for enforceable right (only increases to add back future liabilities and decreases for significant financing component)

• Optional at trade or business level• Taxpayer can also utilize AFS cost offset method if using the

alternative AFS revenue method

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Treas. Reg. §1.451-3 – Cost Offsets

─ An optional method of accounting that may be used to determine the AFS income inclusion amount for an item of gross income from the sale of inventory

─ Taxpayer must first determine the AFS inventory inclusion amount and then reduce such amount by the cost of goods in progress offset for the taxable year

─ During the year of sale, a taxpayer must determine the appropriate gross income to take into account

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• Optional methods for qualifying advance payments − Full inclusion method − One-year deferral method

• Include the amount taken into account as AFS revenue under Treas. Reg. §1.451-3

• Remainder is recognized in the year immediately following the year of receipt

• An advance payment is a payment received by a taxpayer if − Full inclusion in gross income for the taxable year of receipt is a

permissible method of accounting, − Any portion of the payment is taken into account as AFS

revenue (under the same rules as the AFS income inclusion rule) for a subsequent taxable year • Amount taken into account as AFS revenue determined under Reg. §

1.451-3, but is NOT adjusted for amounts for which the taxpayer does not have an enforceable right

− The payment is for one or more qualifying items

• Advance payment includes amounts received or due

Final Regulations under Section 451(c):Treas. Reg. §1.451-8

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Treas. Reg. §1.451-8 - Advance payment cost offset method

─ In general, mechanics and limitations are similar to the AFS cost offset method• Cost offset equals lesser of cumulative costs incurred or advance

payment • Consistency required: Must be used for both section 1.451-3 and

-8 • Method not permitted for gift card sales or payments received for

customer reward program points

─ Advance payment cost offset method available to taxpayers using AFS deferral method as well as taxpayers without an AFS that receive advance payment (non-AFS deferral method)

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Treas. Reg. §1.451-8 - Specified goods

─ Exclusion from the definition of an advance payment

─ No change in definition / applicability from the proposed regulations

─ A taxpayer can make an election to treat all prepayments that qualify for the specified goods exception as advance payments subject to section 451(c)

─ Unless election made, payments received for specified goods are not advance payments • Specified good is good generally not on hand or available through

normal supply and for which all revenue from the sale of the good is recognized in the taxpayer’s AFS in the year of delivery

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• Released August 12, 2021

• Published in IRB August 30, 2021• Practice Tip: Two notable differences between initial released

version and corrected version in IRB, so ensure you’re looking at the latest version (struck DCN 239, and clarified ability to early adopt Final Regs)

• Compliance with Final Regulations available:• In 2020, to early adopt guidance, or• In accordance with Effective Date, for tax years beginning on or

after January 1, 2021• Practice Tip: Automatic CMOA available only once, as waiver of

5-year limitation occurs only in first year of compliance with Final Regs

• Practice Tip: Compliance with Final Regs requires compliance with complete reg package (a consideration for those seeking to early adopt in 2020)

• Practice Tip: Currently available automatically only for 3 years

Rev. Proc. 2021-34: Overview

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• Eliminates CMOA to comply with statute (on a going forward basis)• Practice Tip: If TP has already filed Ogden copy of CMOA to

comply with statute in 2020, TP may file return copy for 2020

• Provides 6 designated change numbers (“DCNs”) to comply with Final Regulations• DCN 250 – Comply with AFS IIR other than cost offset• DCN 251 – Comply with AFS IIR implicating single cost offset• DCN 252 – Change to Deferral Method in Final Regs without cost

offset• DCN 253 – Change to Deferral Method implicating single cost

offset• DCN 254 – Change to Full Inclusion Method in Final Regs• DCN 255 – Change relating to cost offsets implicating

concurrent cost-offset related inventory changes• Practice Tip: Depending on year of change (2020 or 2021),

consider availability of other DCNs to create future methods flexibility

Rev. Proc. 2021-34: Impact on CMOAs

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• Reduced filing information required with Short Form 3115

• Confirm applicability of potentially flexible Section 481(a) adjustment options• Some changes may be made on cutoff basis• Some changes require a netting of Section 481(a) adjustments

among concurrent AFS IIR changes

• Significance of streamlined method change procedures

• Consider availability of audit protection

Rev. Proc. 2021-34: The Fine Points

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DCN Change Description 2020 Availability 2021 Availability

83/84 Change to RP 2004-34 AP method Yes No

231 Change to comply with New Standards Yes Yes (but unlikely)

239 Change to comply with statute No longer No

242 Change to comply with Proposed Regs Yes No

250 Comply with AFS IIR other than cost offset

Yes (early adopt) Yes

251 Comply with AFS IIR implicating single cost offset


252 Change to Deferral Method in Final Regs without cost offset


253 Change to Deferral Method implicating single cost offset


254 Change to Full Inclusion Method in Final Regs


255 Change relating to cost offsets implicating concurrent cost-offset related inventory changes


153 Change resulting from underlying book change

Yes Yes

CMOA Timing Considerations

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CMOA Considerations: 2020 vs. 2021

─ 2020 Considerations─ Return filing status?

─ Compliance level of current income recognition methods with Final Regs?

─ Compliance level of current income recognition methods with Proposed Regs?

─ Quantity and complexity of commercial contracts to perform enforceable right analysis

─ Existence of inventory and ability to comply with cost offset methods

─ Concerns with streamlined procedures potentially “deeming” method change for implicitly-compliant current income recognition methods

─ Imminent rate change considerations

─ Current one-year limited waiver of five-year limitation

─ 2021 Considerations─ What did you do in 2020?

─ Compliance level of current income recognition methods with Final Regs?

─ Quantity and complexity of commercial contracts to perform enforceable right analysis

─ Existence of inventory and ability to comply with cost offset methods

─ Concerns with streamlined procedures potentially “deeming” method change for implicitly-compliant current income recognition methods

─ Impact of rate change on selected income recognition methods that weren’t changed in 2020

─ Current one-year limited waiver of five-year limitation

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• No automatic CMOA available merely to confirm applicability of specified goods exception to an advance payment• Only available automatically to change to Full Inclusion or

Deferral Method• Alternatively, may automatically change to Specified Good

Section 451(c) Method provided in Treas. Reg. §1.451-8(f)• Practice Tip: Consider filing automatic CMOA to comply with

Treas. Reg. §1.451-3 to address treatment of amounts excluded from AP definition as a SG.

• Evaluate and understand whether streamlined procedures may apply to your IR methods, and if so, implications of their application

• Cost-benefit analysis of administratively simpler methods which may not provide the most favorable economic outcomes

Contemporaneous Considerations

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Questions?

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eversheds-sutherland.com© 2017 Eversheds Sutherland (US) LLPAll rights reserved.

Ellen McElroy(202) 383-0948

[email protected]

Mike Resnick(202) 383-0965

[email protected]

Mary Kate Nicholson(202) 383-0192

[email protected]

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