Alert: IRS Removes Regulations on Advance Payments

On July 15, 2019, the IRS issued final regulations to remove existing regulations regarding advance payments for goods and long-term contracts. These final regulations apply for taxable years ending on or after July 15, 2019 and affect accrual method taxpayers who receive advance payments for goods, including those that may be inventoried.

The IRS removed Section 1.451-5, allowing accrual method taxpayers to defer the inclusion of income for advance payments for goods no later than when the advance payments were recognized in gross receipts under the taxpayer’s method of accounting for financial reporting purposes.

New section 451(c) requires an accrual method taxpayer that receives any advance payment during the taxable year to include it in income in the taxable year of receipt or make an election to:

  • Include any portion of the advance payment in income in the taxable year of receipt to the extent required under new section 451(b); and
  • Include the remaining portion of the advance payment in income in the following taxable year.

Taxable income computed under such an election would be treated as a method of accounting and shall be effective from the first taxable year unless the taxpayer secures the consent of the Secretary to revoke.

Exception applies for inventoried goods if there is an agreement to sell, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements:

  • The advance payments are accounted under the alternative method;
  • A substantial advance payment is received on the agreement;
  • Substantially similar goods are in hand, or available through normal source of supply, to satisfy the agreement.

If these conditions are met, all advance payments received by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered.

Jeffrey G. Cohen Jeffrey G. Cohen, CPA is the Partner-in-Charge of Tax Services at Grassi. With over 30 years of experience, Jeff specializes in serving companies within the Manufacturing and Distribution Industry, with an emphasis on the Food & Beverage and Pharmaceutical sectors. A leading tax expert in the New York Metropolitan area, Jeff has enabled his clients to realize significant tax savings through proper Income and... Read full bio

Bhupali Nayak Bhupali Nayak is a Tax Principal at Grassi and brings over 20 years of accounting experience to the firm and works primarily with clients in the manufacturing & distribution and professional services industries. She provides expertise in tax compliance and has experience in audit and business management, as well as projection. She is also looking to become more involved with M&A transactions and international... Read full bio

Categories: Tax