The same week as the IRS released the annual revised general purpose automatic method change list revenue procedure the agency decided to release the revenue procedure outlining how taxpayers may request a change of accounting method related to the GAAP changes taking place under ASC 606, Revenue from Contracts with Customers.  The change procedures are contained in Revenue Procedure 2018-29.

While this procedure is generally good news, it most clearly does not mean that the IRS is going allow the use of methods provided under ASC 606 without regard to whether the method is otherwise allowable under the IRC.  The taxpayer will have to make its own determination regarding whether or not conforming tax and book methods in their situation is actually allowed under the IRC.

In the second paragraph of the procedure the IRS notes that this procedure does not deal with the other major GAAP/tax accounting method issue for 2018 found in the new revenue conformity provision at IRC §451(b) and (c) added by the Tax Cuts and Jobs Act, noting the agency is working on additional guidance to deal with that issue.

The Financial Accounting Standards Board (FASB) issued the reboot of revenue recognition rules for U.S. GAAP (ASU 2014-09) at the same time the International Accounting Standards Board (ISB) issued the identical IFRS 15.  ASC 606 takes effect for:

• Annual reporting periods beginning after December 15, 2017 for publicly traded-entities along with certain not-for-profit entities and certain employee benefit plans and
• Annual reporting periods beginning after December 15, 2018 for all other entities.

The IRS Revenue Procedure summarizes the new revenue reporting standard issued by FASB as follows:

Under the New Standards, an entity will recognize revenue for promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services based on the following five sequential steps: (i) identify the contracts with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations; and (v) recognize revenue as the entity satisfies a performance obligation.

The IRS had issued Notice 2017-17 asking for comments on dealing with this change and what accounting change options would be desirable and possible.  The IRS notes that commenters indicated there would be significant impact for taxpayers “in the technology and construction industries and service providers with warranty and repair service contracts.”

In response to comments received, the IRS indicates the agency made the following adjustments in the final guidance found in this revenue procedure:

Specifically, this revenue procedure creates new automatic accounting method change procedures, applies rules similar to the small business exception in the proposed revenue procedure in Notice 2017-17 to more taxpayers, and provides taxpayers the option of implementing the accounting method change on either a cut-off basis or with a § 481(a) adjustment.

A new Section 16.11 is added to the list of automatic accounting method changes that was published the day before in Revenue Procedure 2018-31 [1] , titled “Changes in the timing of recognition of income due to the New Standards.” [2]

The new automatic method change lists the following in its applicability section at 16.11(2):

This change applies to a taxpayer that wants to change its method of accounting for the recognition of income for federal income tax purposes to a method under the New Standards for: (i) identifying performance obligations, (ii) allocating transaction price to performance obligations, and/or (iii) considering performance obligations satisfied. A taxpayer may request a change under this section 16.11 only if the taxpayer’s new method of accounting is otherwise permissible for federal income tax purposes and the change in method of accounting is made for the taxable year in which the taxpayer adopts the New Standards for financial accounting purposes. A taxpayer’s allocation of transaction price to performance obligations to comply with the New Standards under this section 16.11 is deemed to be an allocation based on objective criteria. See section 5.02(4)(c) of Rev. Proc. 2004-34, 2004-1 C.B. 991, as modified and clarified by Rev. Proc. 2011-18, 2011-5 I.R.B. 443, and Rev. Proc. 2013-29, 2013-33 I.R.B. 141, and as modified by Rev. Proc. 2011-14, 2011-4 I.R.B. 330.

However, the procedure does outline situations for which this procedure cannot be used at Section 16.11(3):

This change does not apply to:

(a) a change in the manner in which the taxpayer identifies contracts or determines the transaction price, including the inclusion and exclusion of variable consideration in the transaction price, under the New Standards;

(b) a change in method of accounting for recognizing income that is made in a year that is different from the year that the taxpayer adopts the New Standards;

(c) a change in method of accounting that does not comply with §451 or other guidance;

(d) any change in method of accounting that qualifies under another automatic change described in the List of Automatic Changes provided in this revenue procedure (or any successor), even if it is described in section 16.11(2) of this revenue procedure, and otherwise satisfies the requirements of paragraphs 5.01(1)(a)-(d) of Rev. Proc. 2015-13, 2015-5 I.R.B. 419 (or any successor). The taxpayer must request such change(s) in method of accounting by applying the automatic change procedures in Section 6 of Rev. Proc. 2015-13 (or any successor) and the respective section of Rev. Proc. 2017-30 (or any successor); or

(e) any change in the method of accounting for income from a long-term contract, as defined in §460(f), unless the long-term contract is excepted from required use of the percentage-of-completion method by §460(e)(1).

The IRS is going to grant taxpayers three years in which to decide if they wish to request a qualifying automatic change.  Section 16.11(04) provides “[t]he change under this section 16.11 may only be made in the taxpayer’s first, second, or third taxable year ending on or after May 10, 2018.”

The revenue procedure gives all taxpayers the option of implementing the change on either the cut-off basis or by using the standard §481(a) adjustment periods (normally 4 years for a positive change and 1 year for a negative one).  The notice goes on to provide the following rules for a taxpayer wishing to use the cut-off method:

If the taxpayer implements the change on a cut-off basis, (i) the taxpayer must allocate any payment allocations prior to the year of change using the taxpayer’s former method of accounting, (ii) all changes made under this section 16.11 must be implemented using a cut-off basis, and (iii) a § 481(a) adjustment is neither permitted nor required.

As well, the use of a cut-off method is mandated for all intercompany transactions for members of a consolidated group, avoiding a mismatch where the positive adjustment side would be spread over 4 years with the negative side picked up immediately.  The revenue procedure provides:

Notwithstanding anything to the contrary in this section 16.11(5)(a), if a taxpayer is a member of a consolidated group (within the meaning of § 1.1502-1(h)), then the member must implement all changes with respect to its intercompany transactions (within the meaning of § 1.1502-13(b)(1)(i)) under this section 16.11 on a cut-off basis and can apply the first two sentences of this section 16.11(5)(a) to all other transactions. See § 1.1502-17(b)(2); section 7.02 of Rev. Proc. 2015-13.

The application will be available using simplified Form 3115 filing requirements.  Section 16.11(5)(b) provides:

A taxpayer making a change under this section 16.11 is required to complete only the following information on Form 3115 (Rev. December 2015):

(i) The identification section of page 1 (above Part I);

(ii) The signature section at the bottom of page 1;

(iii) Part I;

(iv) Part II, all lines except lines 13,16c, and 19; and

(v) Part IV, all lines. For a taxpayer making a change under this section 16.11 using a §481(a) adjustment, the statement required for Line 26 of Form 3115 should list a description of each change, the §481(a) adjustment for each change (or a statement  that the change is being made on a cut-off basis) and, if applicable, a description of where the item’s §481(a) adjustment is reflected on the federal income tax return (line number (or schedule)).

In addition, the requirement to file the duplicate copy, under section 6.03(1)(a) of Rev. Proc. 2015-13, is waived.

This method will not allow taxpayers to change to a method of accounting that otherwise is at odds with the requirements of any provisions of the IRC, as Section 16.11(3)(c) noted.  Because of this, the IRS notes that there is no ruling on the acceptability of the actual method used when the request to change methods under this Revenue Procedure is made. 

As Section 16.11(7) provides:

The consent granted under section 9 of Rev. Proc. 2015-13 for a change made under this section 16.11 is not a determination by the Commissioner that the new method of accounting is a permissible method of accounting and does not create any presumption that the allocation method is a permissible method of accounting under any provision of the Code. Further, the consent granted under section 9 of Rev. Proc. 2015-13 for a change made under this section 16.11 is not a determination that the amount of income included in taxable income using an allocation method described in the New Standards is correct. The Director will ascertain whether the new method of accounting is a permissible method of accounting and whether the allocation method is permissible under the Code (for example, a method that is permitted under § 451).

Section 16.11(8) does allow a taxpayer to file a single Form 3115 to obtain permission to make multiple method changes under this procedure, but if a §481(a) adjustment is used the amount of the §481(a) adjustment must be disclosed for each change and the taxpayer may not net the positive and negative adjustments to come up with a single §481(a) adjustment.

The designated change number (DCN) for this change is 231—that number is to be provided in the appropriate location on the Form 3115.

This is not necessarily the end of the guidance on ASC 606’s interaction with tax accounting methods—the IRS continues to ask for comments on the following issues related to ASC 606:

1. What additional change in accounting method requests do taxpayers anticipate requesting due to the New Standards?

2. What additional procedural guidance might be helpful as a result of the New Standards?

3. What industry-specific guidance might be helpful as a result of the New Standards?

A large portion of taxpayers that are looking at the issue of accounting method changes to reduce book/tax differences following the adoption of ASC 606 likely have “applicable financial statements” as defined in IRC §451(b)(3).  Such a statement is the first of the following financial statements a taxpayer may have produced for a tax year:

(A) a financial statement which is certified as being prepared in accordance with generally accepted accounting principles and 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,

(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),

(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 United States Securities and Exchange Commission 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).

IRC §451(b)(1), as added to the IRC by the Tax Cuts and Jobs Act, requires a taxpayer with such an applicable financial statement who is reporting on the accrual basis of accounting for tax purposes to treat the “all events test” of IRC §451 to be met no later than when such revenue is taken into account for such an applicable financial statement or any other statement produced by the taxpayer that the IRS specifies will count for these purposes.

As well, IRC §451(c) provides an election for a taxpayer to use the special advance payment method of accounting that was previously allowed under a separate revenue procedure.

The IRS is asking for comments on guidance to be issued for these §451(b) and (c) changes.  Specifically, the agency is asking:

1. What change in method of accounting requests do taxpayers anticipate filing due to the interplay of the New Standards with amended § 451(b) or (c)?

2. As taxpayers transition to amended § 451, what procedural guidance might be helpful?

3. As taxpayers transition to amended § 451, what industry-specific guidance might be helpful?

[1] No, it’s not a typo on the revenue procedure number.  The general procedure, despite being published a day earlier actually has a higher number than this specific procedure.

[2] Revenue Procedure 2018-29, Section 3.01