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TAX CLINIC

a taxpayer may reduce AFS revenue
Taxpayers may want to review contracts otherwise required to be recognized
for which income is accelerated under Sec. under Sec. 451(b) (AFS income
inclusion) for amounts that the taxpayer
451(b) to evaluate whether the contract terms would not have an enforceable right
provide for an enforceable right to payment to recover if the customer terminated
under applicable law. the contract on the last day of the tax
year. The determination of whether
the taxpayer has an enforceable right
to recover is governed by the terms of
Dec. 31, 2017, and before Jan. 1, 2021, contracts with customers, FASB Ac- the contract and applicable law and
if they (1) apply all the rules in the final counting Standards Codification (ASC) includes amounts recoverable in equity
regulations under both Secs. 451(b) Topic 606, Revenue From Contracts With and liquidated damages. As quantifying
and 451(c) consistently and in their en- Customers, and the similarly titled Inter- the amount to which the taxpayer does
tirety and (2) continue to apply all the national Financial Reporting Standard not have an enforceable right may
rules to all later tax years. At present, (IFRS) 15, which generally result in the be burdensome, a taxpayer may wish
early adoption of the final regulations acceleration of revenue recognition for to forgo adjusting the AFS income
generally would apply only to fiscal- financial statement purposes. Therefore, inclusion for these amounts. Either
year taxpayers. many accrual-method taxpayers must approach is a method of accounting
This item first summarizes the accelerate tax revenue to a year earlier that a taxpayer must apply to all income
TCJA’s changes to Sec. 451 and then than would have been required under items that are subject to Sec. 451(b) for
discusses the opportunities the Decem- the previous revenue recognition rules. each trade or business (see Regs. Secs.
ber 2020 final regulations may provide New Sec. 451(c) codifies, in part, 1.451-3(b)(2)(ii) and 1.451-3(l)(1)).
to reduce income acceleration. the deferral provisions of Rev. Proc. Observation: Taxpayers may want
2004-34, which before the TCJA gener- to review contracts for which income
The TCJA’s changes ally governed the federal income tax is accelerated under Sec. 451(b) to
Prior to the TCJA, a taxpayer using an treatment of certain advance payments evaluate whether the contract terms
accrual method of accounting generally such as for goods, services, licenses, and provide for an enforceable right to
included an item in income when all the subscriptions. Sec. 451(c)(1)(A) pro- payment under applicable law. Taxpayers
events had occurred that fixed the right vides the general rule that an accrual- may be able to defer income if, for
to receive the income and the amount method taxpayer must include an example, unbilled revenue is recognized
thereof could be determined with rea- advance payment in gross income in the as AFS revenue but the taxpayer’s right
sonable accuracy (the all-events test). tax year of receipt. However, Sec. 451(c) to payment is not enforceable under
The all-events test generally was con- (1)(B) permits a taxpayer to elect to in- applicable law.
sidered met at the earliest of when the clude a portion of the advance payment Cost-offset method: The
item of income was due, paid, or earned. in gross income in the tax year follow- optional cost-offset method in the
New Sec. 451(b), added by the ing the year of receipt to the extent the final regulations allows taxpayers to
TCJA, provides that certain accrual- income is not included in revenue in the reduce income by offsetting incurred
method taxpayers meet the all-events taxpayer’s AFS in the year of receipt. inventory costs against AFS revenue
test no later than when an item of gross that is otherwise required to be
income is taken into account as revenue Potential income acceleration recognized under Sec. 451(b) and/or
in the taxpayer’s applicable financial mitigation opportunities Sec. 451(c) before the related inventory
statement (AFS) (the AFS-inclusion As discussed below, the final regula- is transferred.
rule). Accordingly, Sec. 451(b) effective- tions issued in December 2020 may Under the AFS cost-offset method,
ly requires taxpayers to include an item provide some opportunities to mitigate a taxpayer determines the amount of
in gross income at the earliest of when the income-acceleration effect of Sec. gross income includible under Sec.
the item is due, paid, earned, or taken 451(b) and Sec. 451(c), including by 451(b) for tax years before the year in
into account as revenue in its AFS. This using the enforceable-right provision which ownership of inventory transfers
change in tax law coincided with the and the cost-offset method. to a customer (year of sale), by reducing
issuance of new financial accounting Enforceable-right provision: the amount of income the taxpayer oth-
standards for recognizing revenue from Under the enforceable-right provision, erwise would be required to take into

20 July 2022 The Tax Adviser