Advance Payments: Potential for Longer Term Deferral under Newly Issued Regulations, Repeal of Regulation §1.451-5

Back in July, the IRS formally removed regulation §1.451-5 from the Code of Federal Regulation. The regulation had permitted some companies to defer taxes for multiple tax years for certain types of payments received in advance of delivering goods or services to customers.  The IRS noted that these rules were “no longer necessary” after the enactment of the 2017 Tax Cuts and Jobs Act (the Act), which overhauled Section 451 by codifying existing IRS guidance under Revenue Procedure 2004-34 and allowed companies to defer taxes on all or a portion of customer advance payments for up to one tax year.  Congress observed at the time, in its conference report to the new law, that the new provision is “intended to override any deferral method” for payments advanced by customers under rules in place before the effective date of the Act.  For some taxpayers, though, the change could result in significant taxes being paid sooner than under the old rules.

While newly issued regulations (see our article “IRS Releases Section 451(c) Advance Payment Proposed Regulations for Accrual Method Taxpayers Providing a One Year Deferral”) generally mirror rules under Revenue Procedure 2004-34, there appears to be one additional – and possibly material – exception added to the regulations that didn’t appear in the revenue procedure and may benefit taxpayers in certain industries.  Specifically, newly proposed regulation 1.451-8(b)(ii)(H) excludes from the one-year deferral under the general advance payment rule for “payments received in a taxable year earlier than the taxable year immediately preceding the taxable year of the contractual delivery date for a specified good”.  A “specified good” is defined as one that the taxpayer does not have on hand (or available through its normal source of supply) of a substantially similar kind, and in sufficient quantity, to satisfy a contract to transfer the good to a customer, and further, all the revenue from the sale is recognized in an applicable financial statement (think certified audited financial statement), in the year of delivery.

In the preamble to the regulations, the Department of the Treasury and the IRS have determined that the exclusion noted above is appropriate for certain goods for which a taxpayer requires a customer to make an upfront payment, if the contracted delivery month and year of the good occurs at least two taxable years after an upfront payment and the other requirements in 8(b)(ii)(H) are met.  The types of goods being contemplated appear to include goods requiring “a significant amount of capital to produce and may require considerable time from development to deliver,” as is typically found in the aerospace industry.

Unfortunately, with the removal of the regulations under §1.451-5, and no other specific guidance in the newly drafted proposed regulations, it’s not clear how or when to apply income deferral to potentially longer-term customer contracts where there’s a period of time two years or greater between receipt of an advance payment and the delivery of the goods or service.  In addition, it’s not clear whether any special guidance, if issued, will apply only to certain industries, like aerospace, or whether other businesses with products that would qualify as a “specified good” would also qualify.  It would seem additional guidance from the IRS is required.

We at Schneider Downs will continue to monitor this area for changes. In the meantime, if you have any questions, please don’t hesitate to call.