Changes in book recognition of advance payments may require changes in tax accounting method.

• Author: Hong, Betty

The Sec. 446 regulations have long established that a taxpayer that changes its book method of accounting must secure the IRS's consent before applying its new book method of accounting for tax purposes. In cases where a taxpayer accounts for certain items for tax purposes by using the same methods of accounting as for financial reporting (book), this principle could be easily overlooked. Unless the taxpayer takes steps to change its method of accounting for tax purposes, the taxpayer must generally continue to use the previous method for tax purposes and record a book-tax difference on its federal income tax return.

Based on Chief Counsel Advice (CCA) 201011009, issued in 2010, taxpayers using the one-year deferral method under Rev. Proc. 2004-34 to recognize advance payments must be mindful of any changes in the underlying revenue recognition method used for book purposes. For taxpayers in such situations, Rev. Proc. 2011-14, which provides the exclusive procedures for obtaining automatic consent for a change in method of accounting, recently introduced a new automatic consent method change for taxpayers wishing to use the new book method of recognizing advance payments in revenues for purposes of determining the extent to which advance payments are included in gross income under Rev. Proc. 2004-34.

General Rules and Analysis

The question raised in CCA 201011009 is whether a taxpayer that previously elected to defer advance payments under Rev. Proc. 2004-34 is required to obtain consent under Sec. 446(e) if the taxpayer subsequently changes its applicable financial statements for deferred advance payments. Sec. 446(e) generally requires a taxpayer that changes the method of accounting on the basis of which it regularly keeps its books to secure the consent of the IRS before computing taxable income under the new method. Similarly, Regs. Sec. 1.446-1(e) (2)(i) provides as follows: "[A] taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner." As discussed below, the facts and rationale of CCA 201011009 demonstrate how this regulation may pose a trap for the unwary.

In the CCA, an accrual-method taxpayer was engaged in the business of providing services to clients and received advance payments from its customers for services that the taxpayer would provide over a 15-month period. For book purposes, the...