TCJA Changes to § 451: New Tax Automatic Accounting Methods for Revenue Recognition

On November 29, 2018, the IRS released Rev. Proc. 2018-60, which provides a new automatic change to comply with §451(b) for tax years beginning after December 31, 2017.[1] The change is applicable to taxpayers who are changing to recognize revenue under § 451(b) and/or have not adopted the ASC 606 method under Rev. Proc. 2018-29.

The TCJA amended §451 of the Internal Revenue Code to provide that the all events test (used to determine when revenue is fixed and determinable with reasonable accuracy) with respect to income shall be treated as met no later than when taken into account within a taxpayer’s applicable financial statements. Essentially, §451(b) now states that taxpayers may not defer revenue at any time if it has already been recognized for bookkeeping purposes. If a taxpayer necessitated a change in accounting method to comply with this new revenue recognition rule, there was no automatic accounting method change prescribed by the IRS…until now.

Section 451(b)(4) describes the allocation of the transaction price when there are multiple performance obligations within a contract, an attempt by the tax writers to use ASC 606 language within the new tax revenue recognition rules. As a result of ASC 606, taxpayers may potentially be recognizing revenue earlier than they did prior to the implementation of ASC 606. Prior to the TCJA amendments, this earlier recognition for financial accounting purposes may not have met the fixed and determinable analysis for tax recognition, but new §451(b) states that tax must recognize at this earlier time since financial accounting has recognized revenue. Earlier this year, the release of Rev. Proc. 2018-29 provided  guidance on how to comply specifically with some of the ASC 606 changes; however, Rev. Proc. 2018-29 deliberately lacked guidance relating to the §451 changes under TCJA. Most taxpayers who may have had changes as a result of ASC 606 chose to wait until the §451 accounting method change was released and can now take action.

To alleviate compliance burdens, the Service has prescribed a “Short Form 3115” requiring only a limited number of sections to be completed within the Form 3115.  Additionally, there is no requirement to file the duplicate copy with the IRS Service Center; taxpayers only need to attach the original Form 3115 to the timely filed tax return. Taxpayers will still receive audit protection with the filing of the Form 3115.

For the first tax year beginning after December 31, 2017, taxpayers may qualify to make the change in accounting method to comply with §451(b) using streamlined procedures if the change results in a zero §481(a) adjustment or they are a small business taxpayer (<$25M gross receipts per §448). This essentially allows taxpayers to effectuate the change on their tax return without any Form 3115 attached. These taxpayers may still file a Form 3115 to maintain records of a change in method of accounting, make permissible concurrent changes, and most importantly, receive audit protection which is explicitly not granted if changing their method under the streamlined procedures.

Whether as a result of ASC 606 implementation, TCJA changes to §451, or both, all taxpayers should be reviewing their tax accounting methods for revenue recognition to ensure compliance with § 451. Please reach out to your Cherry Bekaert C/AM team tax advisor who will assist in the reviewing of revenue recognition accounting methods and can prepare, review, and file any necessary changes to tax accounting methods identified.

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[1] In the case of income from a debt instrument having original issue discount, the change applies for tax years beginning after December 31, 2018.