IRS Streamlines Process for Revenue Recognition Method Changes 

By David J. Silagi, CPA
| 3/12/2019
Since 2014, financial services organizations across the country have been adjusting their policies and procedures to comply with new standards for revenue recognition. Now the IRS has released some guidance that can help them make the changes in accounting method necessary to satisfy new rules for tax accounting.
Although financial services organizations are well aware of the changes in revenue recognition on financial statements required by Accounting Standards Codification (ASC) 606, “Revenue From Contracts With Customers,” they might not yet know about the recognition changes on the tax side that were made by the Tax Cuts and Jobs Act (TCJA) that affect their ability to defer taxable income. 

The TCJA amends revenue recognition for tax purposes
The TCJA amended IRC Section 451, “General Rule for Taxable Year of Inclusion,” to provide that an accrual-method taxpayer 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 financial statements. As a result of the amendment, financial services organizations no longer will be able to defer certain items of income beyond when they are recorded for book purposes.

The IRS streamlines some changes in accounting method
The new rule in Section 451 likely 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. 

Revenue Procedure 2018-31, for example, includes an updated list of changes to which the automatic change processes apply. The list now includes Section 451-related changes to: 
  • Accrual of interest on nonperforming loans
  • State or local income or franchise tax refunds
  • Credit card annual, late, and advance fees
Under other guidance, the list also covers taxpayers changing their method 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 list allows an automatic method change for the year in which the taxpayer adopts ASC 606 for financial accounting purposes.

In late 2018, the IRS issued Revenue Procedure 2018-60, which modifies Revenue Procedure 2018-31 to provide new automatic method procedures that taxpayers can use to implement 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
Revenue Procedure 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 for the three prior taxable years of $25 million or less, or 2) no adjustment to taxable income is required to prevent amounts from being duplicated or omitted as a result of Section 451 compliance. 

The Form 3115, “Application for Change in Accounting Method,” filing requirement is waived for qualifying taxpayers; they need only file their federal income tax returns. Opting out of Form 3115, though, also forfeits audit protection on this issue. Alternatively, taxpayers can file a so-called short Form 3115, which requires less information be completed than the standard form.

Act accordingly
Many financial services organizations have already taken the necessary steps to change accounting methods to comply with ASC 606. They also must be aware that additional steps probably will be required to comply with Section 451. Even taxpayers that qualify for the streamlined procedures must weigh whether the administrative ease is worth giving up the audit protection that comes from filing Form 3115.

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Brent Felten
Brent Felten
Partner, Washington National Tax