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TAX CLINIC

contract and reduces its transaction attributes such as NOLs, credits, etc.) purposes in 2022, as ownership of the
price by 10% when computing its for Taxpayer because it results in lower goods passed to the customer in 2022.
AFS revenue. Taxpayer incurs $30 revenue and taxable income. However, The result to Taxpayer in 2022 is gross
of costs on the contract in 2021 and that benefit comes with the require- income for tax purposes of $32.
computes its AFS revenue to be $45, ment that Taxpayer evaluate each Observations: By electing to
which is the total contract price, less contract at the end of each year to de- use the cost-offset method, Taxpayer
the amount anticipated to be uncol- termine the amount to which it has an was able to defer revenue of $12 (the
lectible, multiplied by the ratio of enforceable right — a challenging task cost-of-goods-in-progress offset) to
costs incurred over estimated total if contracts are customized or volumi- 2022, which is a favorable outcome and
costs to deliver (($100 − $10) × ($30 nous. Taxpayer may find that the rela- mirrors closely (but not exactly) the
÷ $60)). For tax purposes, Taxpayer tive simplicity of the alternative method computation of income for AFS pur-
currently recognizes revenue equal may be preferable, even though it is poses. However, the cost-offset method
to its AFS. not the most tax-advantaged method. must be applied to all items of income
Under either scenario, Taxpayer will be eligible for the method in the taxpayer’s
Analysis: Under the final regula- required to make adjustments to AFS trade or business and allocated on an
tions, Taxpayer may choose to use revenue to increase the transaction item-by-item basis. Such computations
either the AFS income-inclusion rule price by the amounts anticipated to may be difficult or time-consuming and
or the alternative method to determine be uncollectible. even costly to Taxpayer. The use of the
the amount of revenue to accelerate as cost-offset method is optional, so Tax-
AFS revenue under Sec. 451(b). If it Example 3: In 2021, Taxpayer enters payer may choose to simply recognize
chooses to use the general rule, then into a contract with its customer $20 of revenue in 2021, without the
Taxpayer would increase the transac- to manufacture and deliver goods offset, to simplify its tax calculations.
tion price by the amount anticipated to with a total contract price of $100,
be uncollectible, and it would reduce billable upon delivery. In its AFS, Closing thoughts
the transaction price by the amount to Taxpayer recognizes $11 of costs The final regulations and associated
which it does not have an enforceable associated with the contract in 2021 procedural guidance are intricate and
right. In this case, because the customer and $47 in 2022. Taxpayer includes contain many options and choices
could cancel the contract on the last $20 in its AFS revenue in 2021. for taxpayers, as well as traps for the
day of the year and would only be re- Taxpayer properly applies its inven- unwary. With the current procedural
quired to reimburse the $30, Taxpayer tory tax accounting methods and guidance, most taxpayers have one
would adjust its 2021 taxable income incurs $12 of costs for tax purposes chance in the year beginning on or after
to be $30 ($45 + $5 – $20) and have a in 2021 and $48 in 2022. Taxpayer Jan. 1, 2021, to complete the analysis
favorable book-tax adjustment of $15. implements the final regulations and take steps such as automatic meth-
If Taxpayer instead implements the and chooses to adopt the cost-offset od changes. Beginning a detailed analy-
final regulations using the alternative method beginning in 2021. sis early will allow taxpayers the time
method, it will only make an adjust- and flexibility to make those choices
ment for the amount anticipated to Analysis: Taxpayer reduces the and to perform complex computations
be uncollectible and would recognize $20 AFS inclusion amount by the $12 or make required tax filings.
revenue of $50 for tax purposes in 2021 cost-of-goods-in-progress offset, which From Don Reiris, CPA, J.D., LL.M.;
($45 + $5) and an unfavorable book-tax results in the recognition of $8 of rev- Caleb Cordonnier, CPA; and Pinky
adjustment of $5. enue for tax purposes in 2021. Taxpayer Shodhan, CPA, J.D., LL.M., Washington,
Observations: Taxpayer has a is not entitled to a COGS deduction D.C. ■
decision to make when implementing for tax purposes in 2021 because it
the final regulations: It may use either retains title to the goods in 2021. Tax-
the AFS income-inclusion rule or the payer receives the $100 upon delivery
alternative method to determine its of the goods in 2022. This amount is Editor
AFS revenue inclusion. On the surface, reduced by the prior (2021) tax inclu-
using the AFS income-inclusion rule sion amount of $8, which results in the Greg Fairbanks, J.D., LL.M., is a tax
and reducing revenue based on the recognition of $92 of revenue for tax managing director with Grant Thornton
enforceable rights adjustment may be purposes in 2022. Taxpayer is entitled LLP in Washington, D.C.
beneficial (depending upon other tax to a $60 COGS deduction for tax

34 February 2022 The Tax Adviser