Tax method accounting change required for change in book recognition on Multiple-Deliverable contracts.

• Author: Anderson, Kevin D.

Taxpayers using the one-year deferral method under Rev. Proc. 2004-34 to recognize advance payments on multiple-deliverable contracts (MDCs) for federal income tax purposes should note that a change in the underlying revenue recognition method used for book purposes could trigger a tax accounting method change in the year of the change. In Chief Counsel Advice (CCA) 201151022, the IRS discusses the rationale behind this method change and outlines the appropriate steps for obtaining the IRS's consent to use the revised book method in determining the inclusion of advance payments in gross income under Rev. Proc. 2004-34.

The Facts

In the CCA, a taxpayer provides goods, services, and other applicable items under an MDC, which requires the taxpayer to provide bundled products and services to customers in exchange for advance payments. The goods and services are provided at different points in time and over different time periods. For financial statement purposes, the taxpayer presently defers the advance payments until the MDC is fully complete, that is, until all goods and services are provided. For federal income tax purposes, the taxpayer also properly defers the advance payments under Rev. Proc. 2004-34. Under Rev. Proc. 2004-34, accrual-basis taxpayers are permitted to defer all or part of certain advance payments by (1) including the advance payment in gross income for the tax year of receipt to the extent recognized in revenues in its applicable financial statement for that tax year, and (2) including the remaining amount of the advance payment in gross income for the next succeeding tax year.

The CCA explains that, in the tax year beginning Jan. 1, 2011, the taxpayer adopts new FASB standards for income recognition from MDCs for financial statement purposes. The new FASB standards are Accounting Standards Update (ASU) No. 2009-13 and ASU No. 2009-14, both effective for fiscal years beginning on or after June 15, 2010.

Before these standards were issued, if a separate deliverable was not subject to valuation under vendor-specific objective evidence (VSOE) or third-party evidence (TPE), income from delivered and undelivered elements was combined into one unit of accounting. Income attributable to that unit was then deferred and recognized as the undelivered elements were delivered. Although the actual deferral period varied depending on the products making up the MDC, income could be deferred until all items were delivered under a given...