On May 10, 2018, the Internal Revenue Service (IRS) issued Rev. Proc. 2018-29, 2018-21 I.R.B. 1, which provides automatic accounting method change procedures for taxpayers seeking to align methods of income recognition for tax purposes with methods of revenue recognition under ASC 606, a recently-effective financial accounting standard issued by FASB and IASB. Despite the direct interplay between a taxpayer’s implementation of ASC 606 and recent statutory changes under § 451(b) of the Internal Revenue Code (Code) regarding the timing of income recognition for tax purposes, Rev. Proc. 2018-29 explicitly provides that the guidance is limited to accounting method changes in connection with a taxpayer’s implementation of ASC 606, and the revenue procedure does not provide any guidance relating to the amendments made to § 451. Further, adoption of ASC 606 includes a comprehensive review of revenue recognition practices for financial accounting purposes. As part of this review, accounting method changes have been identified, both because of ASC 606 implementation but also incident to ASC 606 implementation. Commentators suggested that taxpayers also be permitted to make such subsidiary changes when making accounting method changes involving ASC 606 implementation. Unfortunately, Rev. Proc. 2018-29 does not encompass such subsidiary accounting method changes. In fact, the revenue procedure lists changes that are outside of the scope of the revenue procedure, including changes in contract identification and/or transaction price determinations, and changes involving long-term contracts under § 460. Regardless of the missed opportunity to provide more comprehensive guidance, Rev. Proc. 2018-29 does provide new automatic accounting method change guidance for taxpayers seeking to align their income recognition for tax purposes with their new book changes arising due to changes in financial accounting methods under ASC 606.
Nearly four years ago, FASB and IASB announced newly effective revenue recognition standards in ASC 606. The new standards took effect for publicly traded entities, certain not-for-profit entities, and certain employee benefit plans for annual reporting periods beginning after December 15, 2017, i.e., 2018 for calendar year taxpayers. All other entities are required to adopt the new standards for annual reporting periods beginning after December 15, 2018. The new revenue recognition standards drastically changed how entities recognized revenue for financial accounting purposes, focusing on entities’ recognition of revenue to depict the transfer of 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. In particular, the new financial accounting guidance provides five sequential steps for entities to address: (1) identifying the contracts with customers; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligation; and (5) recognizing revenue as the entity satisfies a performance obligation. Aware of the impact of ASC 606, the IRS issued Notice 2017-17 soliciting comments on a proposed revenue procedure that would provide the procedures for a taxpayer to request consent to change its method of accounting for recognizing income as the taxpayer adopts the new revenue recognition standard for financial accounting purposes. The IRS received comments from taxpayers and practitioners, including requests for: (1) relief regarding the impact of changes in income recognition as a result of changes for financial accounting purposes as ASC 606 was adopted; (2) automatic accounting method change guidance; (3) guidance on the recognition of advance payments; and (4) the ability to make such accounting method changes either with a § 481(a) adjustment or on a cut-off basis.
Rev. Proc. 2018-29
The revenue procedure provides an automatic change in method of accounting for a taxpayer seeking to change its method of accounting for income recognition for federal income tax purposes to a method under the new revenue recognition financial accounting standards for identifying performance obligations, allocating transaction price to performance obligations, and/or considering performance obligations satisfied. Noticeably absent, the automatic change provided does not include a change that addresses the other two steps required by ASC 606: the manner in which the taxpayer identifies contracts, or determining the transaction price. At the ABA Section of Tax Mid-Year meeting in Washington, DC, representatives from the Department of Treasury noted that while their office was working diligently to release guidance quickly, and while they could get comfortable with providing an automatic change for the three steps of ASC 606 addressed by the change in the revenue procedure, they simply could not get comfortable with the other two steps as available automatic accounting method changes. They did note that the other two steps may become available in the future, but in order to release the guidance quickly, they did not include the additional steps currently.
The revenue procedure further provides that a taxpayer may request an automatic accounting method change if the taxpayer’s new method of accounting is otherwise permissible for federal income tax purposes and the change is being made for the taxable year in which the taxpayer is adopting the new financial accounting revenue recognition standard required by ASC 606. The former is particularly challenging in light of the changes made to § 451(b) of the Code and the lack of guidance issued to date regarding such change. At the ABA meeting, representatives from the IRS National Office indicated that guidance on § 451(b) is in progress and forthcoming, but could offer no estimate as to the timing of its release. They did echo the language of Rev. Proc. 2018-29 stating that this revenue procedure and new automatic change in method of accounting address only taxpayers implementing ASC 606, not providing any guidance on § 451. However, until guidance is released addressing § 451(b), it will not be clear that a taxpayer’s new method of accounting is otherwise permissible for federal income tax purposes.
In addition to the aforementioned changes to which this new automatic change does not apply, Rev. Proc. 2018-29 also provides that the change does not apply to any change in method of accounting that qualifies under another automatic change provision described in Rev. Proc. 2018-31. This provision, in particular, narrows the applicability of this revenue procedure and reflects the lack of understanding of the breadth of the new financial accounting standard. Because of the scope of the new financial accounting standard, companies have identified a number of income recognition accounting method changes as well as other changes that are not directly attributable to ASC 606 implementation. Nonetheless, under Rev. Proc. 2018-29, such accounting method changes are not available. Further, the automatic accounting method change procedures available under Rev. Proc. 2018-29 are inapplicable to any change in method of accounting for income from a long-term contract under § 460(f), unless the long-term contract is excepted from required use of the percentage-of-completion method by § 460(e)(1).With respect to timing, Rev. Proc. 2018-29 provides that the accounting method change may be made only in the taxpayer’s first, second, or third taxable year ending on or after May 10, 2018. It is important to note, this timing requirement must be interpreted together with the requirement that the accounting method change is being made for the taxable year in which the taxpayer adopts the new revenue recognition standards for financial accounting purposes.
Despite these limitations, Rev. Proc. 2018-29 does provide certain benefits to taxpayers. For example, taxpayers making an automatic accounting method change may implement the change either with a § 481(a) adjustment or on a cut-off basis. Due to the considerable undertaking that ASC 606 implementation has been for many companies, there is a substantial diversity of impact and burden from both a book and a tax perspective. Companies that do not have the information readily available to support an adjustment will benefit from the ability to make the change on a cut-off basis. The revenue procedure also allows taxpayers that have filed a non-automatic method change related to ASC 606 implementation that is still pending with the IRS National Office on May 10, 2018, to convert such change under the new automatic procedures provided in Rev. Proc. 2015-13.
As is the case with the majority of recent guidance released by the IRS and Treasury post-tax reform, the government concludes Rev. Proc. 2018-29 with a request for comments from taxpayers. Particularly, the government requests comments regarding any aspects of Rev. Proc. 2018-29 and issues concerning conformity between implementation of the new financial accounting standards and the revised Code and regulations. The government also requests comments regarding any additional changes in accounting methods that taxpayers anticipate making due to implementation of the new financial accounting standard, what additional procedural guidance might be helpful to assist in such implementation, and whether there is any industry-specific guidance that would be helpful. Additionally, and rather interestingly since such topic was not addressed in this guidance, the government requests guidance on future guidance that would be needed to assist taxpayers complying with § 451(b) and (c). Based on the degree that taxpayer’s comments to Notice 2017-17 were incorporated into Rev. Proc. 2018-29, taxpayers should seek to influence future guidance similarly, especially to assist in shaping guidance related to § 451(b) and its interplay with the new financial accounting standards.
Eversheds Sutherland Observation: While helpful that the IRS has provided taxpayers with an automatic change in method of accounting related to ASC 606 implementation, it is unfortunate that the change has been so narrowly construed. By limiting the availability of accounting method changes under its new guidance, the IRS has missed an opportunity to secure broader compliance from taxpayers. Perhaps the IRS may subsequently expand the scope of available automatic accounting method changes; however, currently permissible changes are limited. Taxpayers seeking to take advantage of this new guidance should carefully review any possible accounting method changes to ensure they are within the scope of this revenue procedure.