Electing to defer advance payments under Rev. Proc. 2004-34.

• Author: Spaletta, Pam

Sec. 451 generally requires taxpayers to recognize all gross income in the year received. Rev. Proc. 71-21 (which intended to reconcile financial and tax treatments for certain services) allowed a one-year deferral for accrual-basis taxpayers that received advance payments for services in specific, limited situations. However, considerable controversy arose as to the definition of advance payments for services and the treatment of payments received under renewable agreements.

In Rev. Proc. 2004-34, the IRS expanded Rev. Proc. 71-21's scope. It permits accrual-basis taxpayers to defer recognizing advance payments for tax purposes, including those that blend services and nonservices and those with terms that extend beyond the succeeding tax year. (Cash-method taxpayers considering a change to the accrual method may also benefit.) Rev. Proc. 2004-34 describes the procedure for making the election.

This item outlines the basic factors revolved in calculating a deferral and, thus, determining whether an election is in a taxpayer's best interest. (This item does not summarize all of Rev. Proc. 2004-34's requirements.) To make this determination, the taxpayer would calculate the immediate and projected future tax effects of the deferral election.

The Rules

Under Rev. Proc. 2000-34, Section 4.01 (3), taxpayers who receive payments for any of the following may be eligible to make the election:

* Services;

* Merchandise (if not already deferred under Regs. Sec. 1.451-5(b) (1)(ii));

* Use of intellectual property;

* Occupancy or use of property, if ancillary to the provision of services;

* Sale, lease or license of computer software;

* Guarantee or warranty contracts ancillary to items(s);

* Subscriptions, if Sec. 455 is not elected; and

* Membership in an organization, if Sec. 456 is not elected.

This includes, for example, professional service firms and others offering services to consumers; software firms and Internet service providers; insurance administrators; and membership organizations. The following are not eligible: rent (unless ancillary to services provided for sale/lease of software or occupancy/use of property), insurance premiums, and payments (1) with respect to financial instruments; (2) for service warranty contracts for which income is recognized over the contract's life (in accordance with Rev. Proc. 97-38); (3) to which Sec. 83 applies (i.e., property transferred for the performance of services); and (4) to foreign nonresident...