Revenue recognition: Time to implement the final regulations.

• Author: Reiris, Don

The quest to properly report revenue for federal income tax purposes continues as 2021 tax filings will provide yet another opportunity for taxpayers to assess and adjust their revenue recognition methods. In 2018, the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, amended the Sec. 451 statutory provisions, which substantially modified long-standing revenue recognition rules. Further, late in 2020, the IRS released final revenue recognition regulations under Sec. 451 that provided much-needed clarity on how taxpayers should apply the new Sec. 451 provisions. Lastly, in 2021, Treasury and the IRS released Rev. Proc. 2021-34, providing the required procedural guidance needed for taxpayers to comply with Sec. 451 and the final revenue recognition regulations issued thereunder.

Changes to revenue recognition

The new revenue recognition rules provided under the TCJA contained many significant changes for taxpayers. Among such changes are the following:

* Sec. 451(b) effectively modified the "all-events test" to require accrual-method taxpayers to recognize revenue at the earliest of when revenue is due, earned, received, or recognized in an applicable financial statement (later termed the AFS income-inclusion rule in the final regulations). This is significant, as the manner in which revenue is recognized for financial statement purposes was also modified under FASB Accounting Standards Codification Topic 606, Revenue From Contracts With Customers, and IFRS 15 (the new standards). These new financial statement rules often resulted in an acceleration of revenue, which, in turn, could result in an acceleration of taxable income. Lastly, it is important to note that Sec. 451(b) should not be construed as simple book/tax conformity because application of the provision is much more complicated than a conformity rule.

* Sec. 451(c) codified and modified the deferral method for advance payments permitted under Rev. Proc. 2004-34. It is important to note that the final regulations obsolete Rev. Proc. 2004-34 for tax years beginning on or after Jan. 1, 2021. As such, taxpayers need to assess the application of Sec. 451(c), and the regulations thereunder, to their particular facts and circumstances to determine their ability to defer revenue recognition relating to advance payments.

Final regulations

As one might expect, the new provisions provided under the TCJA left taxpayers with many questions relating to their proper application. In addition, taxpayers with newfound acceleration of taxable income under Sec. 451(b) were looking for some form of relief from the AFS income-inclusion rule. Treasury responded to taxpayers' concerns by issuing final regulations under Sec. 451 at the end of 2020. These regulations are generally required to be implemented by taxpayers no later than tax years beginning on or after Jan. 1, 2021.

Perhaps two of the most significant opportunities are contained in Regs. Sec. 1.451-3 and relate to contractual enforceable right provisions and an optional cost-of-goods offset.

* Enforceable right: Under the enforceable-right rule, taxpayers may exclude from taxable income (and, accordingly, Sec. 451(b) recognition) amounts to which the taxpayer does not have an enforceable right to recover if the taxpayer's customer were to terminate the contract to which the income relates on the last day of the tax year. The determination of whether the taxpayer has an enforceable right is governed by the contract and applicable federal, state, or international law. As such, taxpayers need to possess a thorough understanding of the facts surrounding a transaction as well as how federal, state, or international law is applied to the contractual terms of that...