Editor: Mark Heroux, J.D.
On May 10, 2018, the IRS issued Rev. Proc. 2018-29, which provides guidance for requesting an automatic change in method of accounting related to the adoption of revenue recognition standards under FASB Accounting Standards Codification (ASC) Topic 606, Revenue From Contracts With Customers. Under the new procedures, taxpayers that implement Topic 606 for financial reporting purposes may change certain of their tax revenue recognition methods to conform to the new book methods, provided the new methods are otherwise permissible under current federal income tax law. This taxpayer may make the automatic change only for the year the taxpayer adopts the new standard for financial accounting purposes and may make it either on a cutoff (prospective) basis or with a Sec. 481(a) (catch-up) adjustment. However, the automatic change does not apply to Sec. 451 revenue recognition changes provided in P.L. 115-97, the law known as the Tax Cuts and Jobs Act (TCJA) (the IRS will address those changes in future guidance). This discussion highlights some of the key provisions and potential implications of the new automatic method change procedures.
New financial accounting standard
On May 28, 2014, FASB issued new financial accounting standards for recognizing revenue from contracts with customers. For most taxpayers, the new standards are effective for annual reporting periods beginning after Dec. 15, 2018. However, publicly traded entities, certain not-for-profit entities, and certain employee benefit plans must implement the standards one year earlier (i.e., for annual reporting periods beginning after Dec. 15, 2017). The new financial reporting standards apply a five-step analysis 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).
Under the new standards, revenue from contracts with customers generally is recognized using the following five-step process:
1. Identify the contract with a customer;
2. Identify the performance obligations in the contract;
3. Determine the transaction price;
4. Allocate the transaction price to the performance obligations; and
5. Recognize revenue as the performance obligations are satisfied.
Notice 2017-17 proposed automatic accounting method change procedures
On March 28, 2017, the IRS issued Notice 2017-17, which provides proposed procedures to request automatic consent to change a method of accounting for recognizing revenue related to the adoption of Topic 606 and requesting comments regarding various technical and implementation issues associated with adopting the new standards. Rev. Proc. 2018-29 provides revised final procedures incorporating some of the suggestions submitted by commenters in response to Notice 2017-17, such as permitting more book-tax conformity, providing simplified tax compliance procedures to reduce the administrative burden of implementing tax accounting method changes related to the new standards, and allowing taxpayers the option of making the accounting method change on either a cutoff basis or with a Sec. 481(a) adjustment. (For more on Notice 2017-17, see Meade, "Tax Clinic: Accounting Method Change Procedures Under the New Revenue Recognition Standards," (October 2017).)
Rev. Proc. 2018-29 final automatic accounting method change procedures
Rev. Proc. 2018-29 adds new Section 16.11 to the "List of Automatic Changes" contained in recently issued Rev. Procs. 2017-30 and 2018-31. Under the new procedures, changes to tax revenue recognition methods related to the adoption of Topic 606 are limited to changes for: (1) identifying performance obligations; (2) allocating transaction price to performance obligations; and/or (3) considering performance obligations satisfied (i.e., steps 2, 4, and 5 of the five-step process discussed above). For purposes of the second change (allocating transaction price to performance obligations), the new procedures indicate that taxpayers may generally follow the book-allocation method adopted under the new standards, thus adopting one of the suggestions in comment letters submitted in response to Notice 2017-17, to reduce complexity and the administrative burden associated with book/tax differences resulting from implementation of the new standards.
Conversely, provisions taxpayers are likely to view less favorably include:
Permissible tax method: The changes may be made only if the taxpayer's new tax method is otherwise permissible under Sec. 451 or other guidance, including amendments made to Sec. 451 under the TCJA. These amendments relate to the application of the all-events test and an elective method of accounting for certain advance payments. They contain many ambiguities and complexities requiring clarification and guidance from the tax authorities that they have not yet provided. Thus, taxpayers looking to follow the new standards for tax purposes must first determine whether their proposed tax revenue recognition method conforms to Sec. 451 (as amended) and may need to do so prior to the issuance of the forthcoming IRS guidance.
Limited time to file: As noted previously, changes may be made only for the year the taxpayer adopts the new standards for financial accounting purposes (i.e., the first, second, or third tax year ending on or after May 10, 2018). Presumably, taxpayers that fail to file otherwise automatic method changes within the prescribed time frame will be required to apply for consent under the more onerous and costly advance consent procedures.
Excluded changes: Several methods that are ineligible for the new automatic procedures are expected to affect a broad array of taxpayers in many industries. These taxpayers will likely have to either request consent under the generally less favorable nonautomatic method change procedures or establish processes to track and report any book/tax differences arising from adoption of the new standards. These excluded changes include those in the taxpayer's manner of:
- Identifying contracts or determining the transaction price, including the treatment of variable consideration, under the new standards (i.e., steps 1 and 3 of the five-step process discussed above); and
- Accounting for income from long-term contracts subject to Sec. 460, except for contracts exempt from use of the percentage-of-completion method (i.e., certain home construction contracts and small taxpayers described in Sec. 460).
No ruling protection: 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 methods is correct for tax purposes. Thus, the IRS may challenge changes made under the new procedures on exam, and taxpayers should therefore be prepared to support their new methods of accounting with the appropriate legal authority, a task likely complicated for many by the current lack of guidance on complying with amended Sec. 451.
Reduced compliance burden
As noted, Rev. Proc. 2018-29 contains several favorable provisions intended to simplify and reduce the compliance burden of implementing tax changes related to the new book revenue recognition standards, including:
Elective cutoff method: Changes requested under the new procedures may be implemented with either a Sec. 481(a) adjustment or on a cutoff basis. For changes made on a cutoff basis, the taxpayer must allocate any payment allocations prior to the year of change using the taxpayer's former method of accounting and implement all changes made under the new procedures using the cutoff method. A member of a consolidated group must implement all such changes with respect to its intercompany transactions on a cutoff basis but may elect either the cutoff method or a Sec. 481(a) adjustment for other transactions.
Reduced filing requirements: Certain lines of Form 3115, Application for Change in Accounting Method, are not required to be completed, and the requirement to file a duplicate copy of Form 3115 with the IRS National Office is waived. A single Form 3115 may be filed for multiple changes requested under the new procedures, provided the Sec. 481(a) adjustment for each change is separately stated and not netted with the other adjustments.
"Same change" eligibility rule temporarily inapplicable: The rule prohibiting filing an automatic method change if the same item was changed within the past five tax years (including the year of change) is waived for changes filed for a taxpayer's first, second, or third tax year ending on or after May 10, 2018. This provision may be particularly useful for many taxpayers that might be required to make multiple changes for the same revenue item because, for example, they are subject to different effective dates for complying with amended Sec. 451 (i.e., 2018 tax year) and adopting the new standards under Topic 606 (i.e., 2019 tax year).
Limited time to convert a nonautomatic Form 3115: Taxpayers that filed a nonautomatic Form 3115 requesting changes covered in the new procedures prior to May 10, 2018, that was still pending with the IRS as of that date may refile the application as an automatic change, provided they:
- Otherwise meet the automatic change eligibility rules;
- Notify the IRS before the later of June 11, 2018, or the issuance date of a ruling letter granting or denying consent for the change (if any); and
- File the automatic Form 3115, along with a copy of the National Office letter sent acknowledging the taxpayer's request to convert, by the earlier of 30 days after the date of the National Office's letter acknowledging the conversion request or the due date of the original Form 3115.
The highly anticipated new procedures are welcome news in that they incorporate several of the more significant requests for simplification from the Notice 2017-17 comment letters, such as permitting otherwise nonautomatic changes to be made using favorable automatic change procedures, providing taxpayers the flexibility to implement changes using either a cutoff method or with a Sec. 481(a) adjustment, reducing compliance requirements and temporarily waiving the "same change" eligibility rule. However, significant complexity, uncertainty, and/or compliance requirements likely remain for many taxpayers implementing method changes related to the new revenue recognition standards, particularly for those awaiting guidance in applying newly amended Sec. 451 or needing to make method changes that are ineligible for the automatic change procedures, such as taxpayers that receive variable consideration as part of the transaction price or that report income from long-term contracts subject to the percentage-of-completion method under Sec. 460.
As noted, the IRS has stated its intention to issue guidance in complying with amended Sec. 451 and, as evidenced by the request for comments contained in Rev. Proc. 2018-29, is aware that taxpayers will encounter additional issues requiring implementation assistance as they begin to adopt the new standards. However, notwithstanding the current lack of guidance, taxpayers must act soon to complete all the tasks necessary to file Form 3115 within the limited period allowed under the new procedures (i.e., they must implement tax method changes in the same year they adopt the new standards). Therefore, taxpayers are advised to begin the process of assessing the impact of the new revenue standards and tax law on their current tax revenue recognition methods so they are prepared to implement any necessary accounting method changes within the time frame specified in the final procedures.
Mark Heroux, J.D., is a principal with the National Tax Services Group at Baker Tilly Virchow Krause LLP in Chicago.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.