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Regulation Issued on Advanced Payments for Goods and Services

November 9, 2022

In December 2020, the IRS issued final regulations to clarify matters on the changes that the Tax Cuts and Jobs Act of 2017 (TCJA) made on the income recognition for accrual method taxpayers on advanced payments for goods and services. The regulations are effective for tax years beginning on or after January 1, 2021.

Background

Prior to TCJA, income was recognized under the following conditions (commonly referred to as the all-events test):

1) all events that fix the right to receive the income had occurred; AND

2) amount may be determined with reasonable accuracy

These left a door open for companies to defer advance payment received for extended period of time. Under the TCJA requirement, taxpayers are required to recognize gross income no later than the tax year that income is taken into account for financial accounting purposes, or no later than one year after the receipt of the payment, whichever is earlier.

Recognition of Advance Payments Received

Advance payment is a payment received for goods and services to be provided in the year subsequent of the receipt.

With the final regulations, accrual method taxpayers are required to include advance payments in gross income in the tax year of receipt (full inclusion method). However, taxpayers may also elect to include advance payments in gross income in the tax year following the year of receipt to the extent the income is not included in revenue in the taxpayer’s applicable financial statement in the year of receipt (deferral method).

Cost-offset method The final regulations also added an optional advance payment cost-offset method. The cost-offset method may be used by taxpayers to reduce advance payment included in income by offsetting incurred inventory costs before the related inventory is transferred. The portion reduced by the cost offset is deferred and included in income in the taxable year in which inventory ownership is transferred. Ref:



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