Proposed rev. proc. on advance payments clears up ambiguities.

• Author: Madden, David

In Notice 2002-79, the IRS proposed a revenue procedure to allow certain taxpayers using the accrual method of accounting to defer the inclusion of certain advance payments in gross income in limited situations. If finalized, this revenue procedure will modify and supersede Rev. Proc. 71-21.

Background

In general, Sec. 451 provides that the amount of any item of gross income is included in income in the tax year in which it is received by a taxpayer. According to Regs. Sec. 1.451-1(a), income is includible in gross income, under the accrual method, when all the events have occurred that fix the right to receive such income and the amount can be determined with reasonable accuracy. As interpreted by the courts and the Service, in the absence of a contingency affecting a taxpayer's right to income, the all-events test is satisfied on the earliest of when (1) the income is received, (2) the income is due or (3) the required performance or events have occurred; see, e.g., Schlude, 372 US 128 (1963) and Rev. Rul. 84-31.

Under certain circumstances, Rev. Proc. 71-21 allows accrual-method taxpayers to defer the inclusion of payments received (or amounts due and payable) in one tax year if the payments are attributable to services to be performed by the end of the next succeeding tax year. The revenue procedure was designed to reconcile the tax and financial accounting treatment of payments received for services to be performed by the end of the next succeeding tax year, without permitting an extended income deferral for tax purposes.

Considerable controversy exists as to Rev. Proc. 71-21's scope. Specifically, taxpayers and the IRS frequently disagree about whether advance payments are for services, nonservices or a mixture of both. This distinction is important, as payments for nonservices and certain mixtures of services and nonservices do not qualify for deferral. In addition, it is unclear whether advance payments received under a series of agreements or a renewable agreement are within the revenue procedure's scope.

Proposed Rev. Proc.

To reduce controversy, the Service issued the proposed revenue procedure, which would expand the scope of Rev. Proc. 71-21 to include:

* Advance payments for certain nonservices and mixed services/nonservices; and

* Advance payments received under an agreement or series of agreements, with a term extending beyond the end of the next succeeding year.

The proposed revenue procedure applies to accrual-method...