As you may remember, there were a lot of changes to the U.S. tax law at the end of December 2017. Those changes were enacted by the so-called Tax Cuts and Jobs Act. One of those changes was the addition of Internal Revenue Code section 451(b). This rule requires accrual method taxpayers who file “applicable financial statements” to recognize certain items of income for federal income tax purposes no later than when they recognize such income on those financial statements.

Section 451(b) could affect the timing of a sponsor’s tax recognition of certain of its revenue (e.g., credit card late fees), and could affect the timing of a noteholder’s tax recognition of income items from an investment in a note (e.g., discount). It is not uncommon to see securitization offering documents contain some tax disclosure regarding this new rule. On September 5, 2019, the IRS issued proposed regulations providing guidance on the application of these rules.

The proposed regulations address a variety of matters, including certain items of income relating to debt instruments. The proposed regulations clarify that Internal Revenue Code section 451(b) does not apply where special methods of accounting are used for federal income tax purposes, including hedging transactions, mark-to-market accounting and REMIC inducement fees. According to the proposed regulations, included in the special methods of accounting for which Internal Revenue Code section 451(b) will not require acceleration of income inclusion on the basis of a financial statement are the general special tax accounting rules for debt instruments such as original issue discount, de minimis original issue discount, market discount, de minimis market discount, contingent payment debt instruments and variable rate debt instruments. However, the proposed regulations provide that certain payments to a lender that are otherwise not treated as “fees” for federal income tax purposes but instead are treated as amounts that reduce the debt instrument’s issue price and are recovered as income over time, must be included as income of the lender in the year of receipt if those payments are treated as fees on the lender’s applicable financial statement.