On May 10, 2018, the IRS released Rev. Proc. 2018-29, which provides procedural guidance for the implementation of tax accounting method changes related to taxpayers’ adoption of the new revenue recognition standard for financial reporting purposes under ASC 606. Designed to reduce compliance costs, burden and administrative complexity, Rev. Proc. 2018-29 provides a brand new automatic consent method change under which a taxpayer that has adopted the new standard may make a corresponding change in its method of accounting for federal income tax purposes to identify performance obligations, to allocate transaction price to performance obligations and/or to consider performance obligations satisfied, provided the new method of accounting is otherwise permissible under the Internal Revenue Code. This automatic change is only available to be made for the taxable year in which the taxpayer adopts the new standard for financial accounting purposes. The automatic change is made by filing a Form 3115, Application for Change in Accounting Method, on or before the due date (including extensions) of the federal income tax return for the year of the change, and there is no IRS user fee. While this automatic change is welcome relief for taxpayers, the IRS recognizes that complexity remains and requests comments on future guidance that may be necessary as taxpayers begin to comply with both the new standards and the amended section 451 rules.
On May 28, 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standard Board (IASB) jointly announced new ﬁnancial accounting standards for recognizing revenue, titled “Revenue from Contracts with Customers (Topic 606).” The new standards are eﬀective for publicly-traded entities, certain not-for-proﬁt entities and certain employee beneﬁt plans for annual reporting periods beginning after December 15, 2017. For all other entities, the new standards are eﬀective for annual reporting periods beginning after December 15, 2018. Early adoption is allowed for reporting periods beginning after December 15, 2016.
Under the new standard, a taxpayer generally recognizes revenue for financial accounting purposes when the taxpayer satisfies a performance obligation by transferring a promised good or service to a customer. 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 obligation; and (v) recognize revenue as the entity satisfies a performance obligation.
On June 15, 2015, the Treasury Department and the IRS issued Notice 2015-40, which requested comments on federal tax accounting issues related to the adoption of the new standards, including whether the new standards are permissible methods of accounting for federal income tax purposes, the types of accounting method change requests that might result from adopting the new standards and whether the current procedures for obtaining IRS consent to change a method of accounting are adequate to accommodate those requests. Subsequently, on March 28, 2017, the IRS issued Notice 2017-17 seeking to invite comments on a proposed revenue procedure that, if ﬁnalized, will provide procedures by which a taxpayer may request IRS consent to change a method of accounting for recognizing income when the change is made for the same taxable year for which the taxpayer adopts the new ﬁnancial accounting revenue recognition standards and the change is made as a result of, or directly related to, the adoption of the new revenue recognition standards.
Automatic Change Procedure
In Rev. Proc. 2018-29, the IRS and Treasury Department favorably adopt several suggestions submitted by commenters in response to Notice 2017-17. The revenue procedure allows for more book-tax conformity and allows taxpayers to easily file accounting method changes in connection with adopting the new standards.
Rev. Proc. 2018-29 prescribes a brand new automatic change #231 under section 16.11 of Rev. Proc. 2017-30, which has since been superseded by Rev. Proc. 2018-31. The automatic 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:
- Identifying the performance obligation
- Allocating transaction price to performance obligations
- Considering performance obligations satisfied
The revenue procedure specifically excludes from its scope any changes 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 standard.
Importantly, Rev. Proc. 2018-29 applies only to accounting method changes filed for the taxable year in which the taxpayer adopts ASC 606. It is therefore imperative for taxpayers that have already implemented the standard (or are currently in the process of implementing) to examine whether any tax accounting method changes are necessary in order to prepare and file such method changes under the automatic procedures in the proper taxable year. Otherwise, if a taxpayer files an accounting method change related to ASC 606 in a non-implementation year, it may need to do so under the non-automatic consent provisions under Rev. Proc. 2015-13, which generally requires a filing fee starting at $9,500. This automatic change #231 has a limited shelf life, as it can only be made in the taxpayer’s first, second or third taxable year ending on or after May 10, 2018.
Additionally, a taxpayer can only make a change under Rev. Proc. 2018-29 if the taxpayer’s new method of accounting is otherwise permissible under the Internal Revenue Code. Thus, taxpayers must carefully examine their fact patterns to determine whether their ASC 606 treatment is consistent with the requirements of the section 451 or other guidance. For accrual method taxpayers with applicable financial statements, this means that the new method must be permissible under the amended section 451 rules. As amended by the Tax Cuts and Jobs Act of 2017 and effective for tax years beginning on or after December 31, 2017, section 451(b) generally provides that for an accrual method taxpayer, the all events test with respect to any item of gross income (or portion thereof) shall not be treated as met any later than when such item (or portion thereof) is taken into account as revenue in the taxpayer’s applicable financial statement or such other financial statement as the Secretary may specify. New section 451(c) provides an elective method of accounting to use a one-year deferral method for an accrual method taxpayer that receives an advance payment during the taxable year. That said, Rev. Proc. 2018-29 specifically states that it is not intended to provide guidance for taxpayers changing their method of accounting to comply with amended section 451 and that the IRS and Treasury Department expect to provide guidance in the future to assist taxpayers in that regard. Rev. Proc. 2018-29 also expressly stipulates that the automatic consent granted for a change made under the procedure 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. Accordingly, taxpayers looking for confirmation from the IRS that their proposed method of accounting is proper may need to explore whether obtaining a private letter ruling is possible.
Rev. Proc. 2018-29 provides taxpayers with several simplifying procedures to assist with the implementation of the new standard. For instance, a taxpayer has the choice of implementing the change with a section 481(a) “catch up” adjustment or on a cut-off basis. The option of implementation of a section 481(a) adjustment can be helpful for taxpayers faced with the acceleration of revenue as a result of the new standard, as any taxpayer-unfavorable section 481(a) adjustments are included in income ratably over four years, beginning with the year of change. Furthermore, this method change #231 departs from a typical automatic Form 3115 request by permitting taxpayers making this change to complete a reduced set of questions and dispensing with the requirement to mail a duplicate copy of the automatic Form 3115 to the IRS Covington, Kentucky office.
Request for Comments
Rev. Proc. 2018-29 requests comments on any aspects of the revenue procedure, as well as any issues regarding conformity between the new book standard and tax revenue recognition rules. Further, the revenue procedure requests feedback related to the interaction between ASC 606 and the amended revenue recognition rules under the tax reform bill. In particular, Treasury and the IRS specifically seek comments on the following issues:
- What additional change in accounting method requests do taxpayers anticipate requesting due to ASC 606?
- What additional procedural guidance might be helpful as a result of ASC 606?
- What industry-specific guidance might be helpful as a result of ASC 606?
- What change in method of accounting requests do taxpayers anticipate filing due to the interplay of ASC 606 with amended section 451(b) or (c)?
- As taxpayers transition to amended section 451, what procedural guidance might be helpful?
- As taxpayers transition to amended section 451, what industry-specific guidance might be helpful?
Additional specifics regarding how to submit comments are provided in Section 4 of the revenue procedure.