Income Received in Advance Is Taxable upon Receipt

BACKGROUND Section 451 of the IRC provides that an item of gross income is reported in the taxation year in which a taxpayer receives it. Pursuant to paragraph 1.451-1(a), income is included in gross income on an accrual basis of accounting when all the events that determine entitlement to receive have occurred and the amount can be determined with reasonable accuracy. In the absence of a contingency affecting a taxpayer`s entitlement to income, the test is met if the first of these events occurred: (1) the income is received, (2) the income is due, or (3) the required return(s) or events occurred. Rental income is any payment received or accumulated for the occupation of real estate or the use of personal property. Rental income is usually included in gross income if it is actually or constructively. Taxpayers who, on a cash basis, report income for the year received, regardless of when it was earned. The proposed Regulations also include examples showing that advance payments for loyalty or reward points, coupons, airline miles and other similar agreements treated as separate performance obligations may be eligible for deferral treatment. This is good news for taxpayers in the retail and transportation sectors. The addition of these examples is the result of the different treatment of these items for financial statement purposes under the new accounting standard for revenue recognition (p.B. FASB Accounting Standards Codification Topic 606, Revenue from Contracts with Customers). Under the new standard, many taxpayers now treat these items as future income rather than expenses payable, placing them within the scope.

Section 1.451-8. Taxpayers should look for similar changes as a result of the new standard. However, taxpayers and the IRS often disagree on whether upfront payments apply to services, non-services, or a combination of the two. Payments for non-services and certain combinations of services and non-services are not eligible for deferral. In addition, it is not clear whether advance payments received under a number of agreements or a revolving agreement fall within the scope of the procedure. Prepaid membership fees received one year in advance from a car club were included in a taxpayer`s income because they are held under a legal claim without limiting their disposition. The draft regulation incorporates the more detailed provisions of Rev. Proc. 2004-34 to determine whether the recognition of advance payments should be accelerated. Under the proposed rules, taxpayers are required not to include in their income the amount of all advance payments previously recorded in the taxation year in which the taxpayer dies or ceases to exist in the course of a transaction, other than a transaction to which paragraph 381(a) applies. Similarly, if the taxpayer`s obligation with respect to advance payments is met or otherwise terminated, the associated income must be included in the income.

There are some exceptions to the general rule. If the obligation ends because the taxpayer has entered into a transaction in accordance with § 381, the acceleration rule does not apply. If the taxpayer`s obligation ends because it has carried out a transaction under Article 351 in which substantially all of the assets have been transferred to another member of the same consolidated group, the acceleration rule shall not apply as long as the acquirer applies and applies the deferral method. The long-awaited regulatory proposals in section 451(c) generally codify the special rules for advance payments under Rev. Proc. 2004-34, provide specific examples of certain advance payments treated as separate performance obligations, provide an exclusion for advance payments for certain goods, and align many elements of definition with the proposed provisions under section 451(b). However, some questions remain unanswered. Until the final provisions have been published in accordance with § 451 (c), taxpayers with advance payments may continue to rely on Rev. Proc. 2004-34 by applying the transitional guidelines in accordance with Communication 2018-35 or by opting for the adoption of prop.

Regs. Section 1.451-8 for taxation years beginning after December 31, 2017. Taxpayers may wish to review their treatment of advance payments to find ways to apply the proposed new rules. In particular, taxpayers who apply the Topic 606 revenue recognition standard and process certain upfront payments such as loyalty or reward points, coupons, airline miles and other similar agreements as separate performance obligations may have a new way of deferring revenues for upfront payments. . . .