IRS provides transitional guidance on advance payments

Authored by Kathleen Meade

Notice 2018-35 (April 30, 2018) provides transitional guidance relating to the treatment of advance payments under Rev. Proc. 2004-34, which was modified by Pub. L. No. 115-97 (the Act) enacted on Dec. 22, 2017. The Treasury Department and the IRS expect to issue future guidance regarding the treatment of advance payments to implement the new provisions. However, until such guidance is issued, taxpayers receiving advance payments, including those without applicable financial statements, may continue to rely on Rev. Proc. 2004-34.

Background

Rev. Proc. 2004-34 provides a deferral method of accounting for the treatment of advance payments for goods, services and other items. Under the deferral method, an advance payment is included in gross income for the taxable year of receipt to the extent recognized in revenue in a taxpayer’s applicable financial statement for that taxable year or earned (for taxpayers without an applicable financial statement) in that taxable year, and the remaining amount of the advance payment is included in the next succeeding taxable year after the taxable year in which the payment is received.

New section 451(c), effective generally for taxable years beginning after Dec. 31, 2017, contains a deferral method rule similar to Rev. Proc. 2004-34, except that it applies only to taxpayers that have an AFS or “such other financial statement as the Secretary may specify,” and defines eligible advance payments to include only goods, services “or such other items as may be identified by the Secretary,” rather than the nine advance payment categories described in section 4.01(3) of Rev. Proc. 2004-34.

Transitional guidance

As noted, while the Treasury and IRS expect to issue guidance to implement the changes made to advance payments by the Act, taxpayers may continue to rely on Rev. Proc. 2004-34 for the treatment of advance payments until such guidance becomes effective. Although the IRS will not challenge a taxpayer’s use of Rev. Proc. 2004-34 during the transition period, it will continue to verify on examination that taxpayers are properly applying Rev. Proc. 2004-34. In addition, section 16.07 of Rev. Proc. 2017-30 will be modified to provide a waiver of the eligibility rule in section 5.01(1)(f) of Rev. Proc. 2015-13 to enable taxpayers to make an automatic change to an advance payments method of accounting permitted under Rev. Proc. 2004-34 even if they made an accounting method change for this same item within the past five tax years.

In addition, the Notice contains a request for comments to be submitted by May 14, 2018, regarding suggestions for future guidance under section 451(b) and (c), particularly with regard to whether:

  • taxpayers without an applicable financial statement may continue to use the deferral method provided in Rev. Proc. 2004-34
  • clarity is needed for the definition of an applicable financial statement under section 451(b)(3)
  • the definition of applicable financial statement under section 451(b) and (c) should be the same as the definition in section 4.06 of Rev. Proc. 2004-34
  • 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
  • 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
  • any new procedural rules for changing a method of accounting for advance payments would be appropriate and helpful
  • procedures expanding the rules of section 451(c) to apply to additional taxpayers and types of income are needed

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