In May, the IRS issued procedures for requesting an automatic accounting method change related to the adoption of the revenue recognition standard under ASC 606. Revised procedures issued Sept. 19, 2018, clarify that the new procedures also apply to early adopters of ASC 606. Under the new procedures, taxpayers that implement ASC 606 for financial reporting purposes may change certain tax revenue recognition methods to conform to the new book method(s), provided the new method(s) are otherwise permissible under current federal income tax law. This automatic change may only be made for the year the taxpayer adopts the new standard for financial accounting purposes, may be made either on a cutoff (prospective) basis or with a section 481(a) (catch-up) adjustment, and does not apply to tax-reform-related section 451 revenue recognition changes, which will be addressed in future guidance. Some key provisions and possible implications of the new procedures are highlighted below.
New financial accounting standard
The Financial Accounting Standards Board (FASB) issued a new financial accounting standard in May 2014 for recognizing revenue from contracts with customers. While the new standard became effective for annual reporting periods for the majority of taxpayers after Dec. 15, 2018, publicly traded entities, certain not-for-profit entities and certain employee benefit plans had to implement the standard one year earlier (i.e., for annual reporting periods beginning after Dec. 15, 2017).
The new financial reporting standard applies the following five-step process to all contracts with customers to transfer goods and services (other than leases, insurance, financial instruments, guarantees and nonmonetary exchanges between entities in the same line of business).
- Identify the contract(s) with a customer,
- Identify the performance obligation(s) in the contract,
- Determine the transaction price,
- Allocate the transaction price to the performance obligations and, finally,
- Recognize revenue as the performance obligation(s) are satisfied.
Automatic tax accounting method change procedures
The procedures incorporate several favorable provisions designed to permit flexibility and reduce compliance costs to implement the new revenue recognition standard, including allowing more book-tax conformity, providing simplified compliance procedures to reduce the administrative burden of implementing these new changes, and allowing taxpayers the option of making the accounting method change on either a cutoff basis or with a section 481(a) adjustment. However, the scope of changes that may be made under the automatic procedures is limited to the following: (1) identifying performance obligations, (2) allocating transaction price to performance obligations, and/or (3) considering performance obligations satisfied (i.e., steps two, four and five of the abovementioned five-step process). Conversely, tax method changes related to steps one and three are not covered by the new procedures. Similarly, changes in accounting for income from long-term contracts subject to section 460 are excluded from the scope of the automatic procedures, except for contracts exempted from use of the percentage-of-completion method (i.e., certain home construction contracts and small taxpayers described in section 460). Taxpayers who wish to make such changes will therefore be required to either file Form 3115 under the more onerous advance consent procedures or establish processes to track and report any book/tax differences that come from adopting the new standards.
Significantly, the procedures state that covered method changes may only be made if the taxpayer’s new tax method is otherwise permissible under section 451 or other guidance, including TCJA amendments made to section 451 related to the application of the all-events test and the elective deferral method of accounting for certain advance payments. Because some parts of the new section 451 rules are vague and complex, the IRS said it will provide clarification in future guidance. However, the automatic procedures apply only to changes made for the year the taxpayer adopts the new standard for financial accounting purposes in a taxable year ending on or before May 10, 2021, so taxpayers may need to act prior to the forthcoming IRS guidance. Finally, taxpayers should be aware that IRS consent granted under the new procedures does not include rulings that the new method of accounting and/or new allocation method are permissible methods, nor that the amount of income determined using the new method(s) is correct for tax purposes. Thus, changes made under the new procedures may be challenged on exam, and taxpayers should be prepared to support their new accounting methods with the appropriate legal authority, a task likely complicated by the current lack of guidance.
Simplified tax compliance
Several provisions in the procedures are intended to reduce the burden of implementing the new revenue standard, including allowing taxpayers to combine multiple changes on a single Form 3115, eliminating the requirement to file a duplicate Form 3115 with the IRS national office, temporarily waiving the eligibility requirement prohibiting taxpayers from making an automatic change if the same change was made within the prior five tax years, and permitting taxpayers to re-file a pending non-automatic Form 3115 for changes covered in the new procedures as an automatic change.
While the newly issued procedures provide guidance and simplification to taxpayers implementing tax changes in connection with the new revenue standard, significant complexity and uncertainty remain, particularly for taxpayers ineligible for the automatic procedures or requiring additional clarification regarding TCJA section 451 amendments, which has yet to be issued. In spite of the current lack of guidance, taxpayers should begin assessing how their current tax revenue recognition methods are affected by the new revenue standards and tax law so they are prepared to make necessary changes within the final procedures’ specified time frame.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.