Update: Tax Change to Receiving Advance Payments

It’s doubtful that Bret Michaels was exhibiting any sort of clairvoyant talent and was actually referring to the Tax Cuts and Jobs Act of 2017 (the Act) when he crooned that “every rose has its thorn” some 30 years ago, but the “rose” of the new tax law – while providing many positives – is certainly not exempt from its “thorns.” While the Act has reduced corporate and individual income tax rates, amendments to Treasury Regulation 1.451 (Reg 1.451-1), are increasing the upfront cash tax expense. Under the new regulations taxpayers may now be required to accelerate the recognition of income, which is resulting in higher taxes owed upfront.

Pre 2017 tax overhaul, Reg 1.451-1(a) stated that, for accrual basis taxpayers, "Income is includible in gross income when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. All the events that fix the right to receive income generally occur when: (1) the payment is earned through performance, (2) payment is due to the taxpayer, or (3) payment is received by the taxpayer, whichever happens earliest." (Rev Rul 2003-10, 2003-1 C.B. 288). However, Revenue Procedure 2004-34 allowed a taxpayer to defer revenue, if not earned through performance, to the succeeding tax year after the year in which the payment was received under the Deferral Method.

Under the Act, beginning on January 1, 2018, Reg 1.451-1 has been amended, and now requires an accrual basis taxpayer to treat the all-events test for a particular item of gross income as met no later than when the item is taken into account as revenue in the taxpayer’s applicable financial statement or any other financial statement the IRS prescribes, with the remainder being recognized in the following tax year. Additionally, the amended Section 451(c) overrides the deferral method provided by 1.451-5. The all events test will be met as the receipts are reported as revenue on the taxpayer's applicable financial statement and no deferral will be permitted.  The new revenue recognition standard pursuant to ASC 606 (effective for non-public entities for the year ended December 31, 2019) may accelerate income recognition for financial reporting purposes.  Accordingly, this may accelerate income recognition for tax reporting as well. 

Keep in mind this change is only a timing difference. Corporations will still be able to enjoy the 21% tax rate, and individuals with domestic qualified business income from a trade or business – which most manufactures are – will see their effective tax rate lowered to 29.6% with the section 199A deduction.

Schneider Downs tax advisors will continue to monitor additional proposals, changes and technical corrections to the Act. If you have questions, please contact us.