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606 Prompts New Tax Regulations

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Organizations might be aware of the changes in revenue recognition on financial statements required by ASC 606. However, they might not yet know about the Tax Cuts and Jobs Act of 2017 recognition changes that affect their ability to defer taxable income.

As of Jan. 1, 2019, most calendar year-end nonpublic business entities have adopted the new revenue recognition rules under Accounting Standards Codification (ASC) 606, “Revenue From Contracts With Customers.” Now those companies are going through their first financial statement audits under the new rules, which can have far-reaching consequences for financial statement reporting and income tax filings.
When the rules were first released in 2014, many companies faced having to complete their analyses of contracts and revenue streams twice – first when they implemented the new standard for financial reporting purposes and again when they completed their tax filing to determine if the reporting was somehow different, requiring the recording of a deferred tax asset or liability because the tax rules remained unchanged.
Now that the rules have been around for a while, organizations might be aware of the changes in revenue recognition on financial statements required by ASC 606. However, they might not yet know about the Tax Cuts and Jobs Act of 2017 (TCJA) recognition changes that affect their ability to defer taxable income.

Register: Learn how recent IRS guidance will affect entities adopting ASC 606 and recognize common issues with adoption of the new rules for certain types of contracts [Webcast | CPE]

TCJA amends revenue recognition for tax purposes
In December 2017, the TCJA amended IRC Section 451, the general tax rules for income inclusion, to provide that a taxpayer that uses the accrual method generally must recognize items of gross income (or portions thereof) for tax purposes no later than they are recognized as revenue on the taxpayer’s applicable financial statements. Because of the change, many organizations no longer will be able to defer certain items of income beyond when they are recorded for financial reporting purposes. These rules also adopted the same principles for identifying performance obligations and generally follow financial reporting for the allocation of the transaction price. The change in law generally allowed taxpayers to follow their financial statements for the recognition of revenue.
  IRS and Treasury issue proposed rules on TCJA revenue recognition provisions
On Sept. 6, 2019, the IRS and the U.S. Department of the Treasury released much-anticipated revenue recognition proposed regulations under IRC Section 451(b). The proposed regulations define several terms relevant to the new revenue recognition rules regarding what determines revenue and what constitutes transaction price. The following items are not considered in the determination of revenue for tax purposes:
  • Amounts collected on behalf of third parties
  • Consideration contingent on the occurrence or nonoccurrence of a future event
  • Reductions for accrued expenses under Section 461 or costs of goods sold under Section 471
  • Revenue accounted for under a special method of accounting
These proposed rules will be effective for tax years beginning on or after they are published as final in the Federal Register but allow for early adoption.
IRS streamlines the accounting method change process
The new rule in Section 451 might require earlier recognition of some taxable income items, which would result in a change in accounting method. The IRS has released several pieces of guidance on accounting method change issues and procedures in these circumstances.
One such piece of guidance, Revenue Procedure (Rev. Proc.) 2018-29, allows taxpayers to change their methods of accounting for revenue recognition to a method that uses the new ASC 606 standards for identifying performance obligations, allocating transaction price to performance obligations, or considering performance obligations satisfied. The procedure allows an automatic method change for the year in which the taxpayer adopts ASC 606 for financial accounting purposes. Method changes outside the year ASC 606 is adopted will need IRS approval.
In December 2018, the IRS issued Rev. Proc. 2018-60 to provide new automatic method procedures that taxpayers can use to implement the new rules under Section 451. The new automatic method change is available to accrual taxpayers that either:
  • Want to change their method of accounting to recognize revenue no later than when it is recognized for book purposes
  • Are not adopting ASC 606 in the year of change and want to allocate the transaction price to performance obligations consistent with the rules under Section 451
Rev. Proc. 2018-60 also permits certain taxpayers to use streamlined method change procedures. The streamlined method generally is available only if 1) the taxpayer has average aggregate annual gross receipts of $25 million or less for the three prior taxable years, or 2) no adjustment to taxable income is required to prevent amounts from being duplicated or omitted as a result of Section 451 compliance.
For taxpayers that qualify, the Form 3115, “Application for Change in Accounting Method,” filing requirement is waived, and they need file only their federal income tax returns. Taxpayers opting out of filing a Form 3115, though, also forfeit audit protection on this issue.
The latest guidance to be issued relates to the proposed regulations under Section 451. Rev. Proc. 2019-37 allows taxpayers to file Form 3115 under the automatic method change rules to adopt the proposed regulations.
Taxpayers will need to evaluate all the guidance to determine which pieces of guidance apply to them for the year of change under ASC 606 and Section 451.
Act accordingly
Many organizations already have taken the necessary steps to change accounting methods to comply with ASC 606 for financial reporting purposes. They also must be aware that additional steps might be required to make an accounting method change to comply with the tax rules. Even those taxpayers that qualify for the streamlined procedures must consider whether the administrative ease is worth giving up the audit protection that comes from filing Form 3115.
It is anticipated that changes in the tax law and the new proposed regulations will affect most accrual basis taxpayers that have an applicable financial statement. Taxpayers should evaluate the impact that these rules might have on revenue recognition to assess if a method change would be beneficial or required.

Written by Glenn E. Richards, CPA, a Partner at Crowe and David L. Strong, CPA, a managing director at Crowe.

For a deeper dive into ASC 606, including IRS guidance and tax implications, join Crowe for a Dec. 12, 2019, webinar.