Letter rulings may indicate favorable change in IRS position on advance payments.

In recent months, the IRS has attempted to impose more requirements on businesses wishing to change their accounting method to start deferring income related to advance payments for services under Rev. Proc. 71-21. The result of these additional requirements has been that fewer businesses have been allowed to make accounting method changes.

Rev. Proc. 71-21 allows deferral of advance payments for services if the services are provided no later than the end of the tax year following the year of receipt of payment, and the income is deferred for financial statement purposes. Specifically, the IRS National Office has been taking the position that renewable contracts do not meet the requirement that the services must be contractually required to be provided by the closc of the next tax year. The Service also has been taking the position that if the services can be performed by third partics, the advance payments do not qualify for deferral under Rev. Proc. 71-21.

Recently released Letter Rulings 9348035 and 9348044 may indicate that the IRS has relaxed its position, at least with respect to the renewability of contracts. As noted, the IRS National Office's previous position was that if a contract was renewable, it did not satisfy Rev. Proc.71-21's requirement that the services must be provided by the end of the tax year following the year of receipt. This position was based on the rationale that when a contract was renewcd, it extended the term of the original contract, making it possible that the contract could extend beyond the year after the year of receipt of the advance payment. In the letter rulings, however, the Service allowed the deferral of advance payments under Rev. Proc. 71-21 even though the one-month contracts were renewable. The rulings stated that the terms of the renewal contracts (e.g., price) were independent of the terms of the initial contracts.

These two letter rulings seem to indicate a favorable change in the IRS's previous position. If the Service continues to use the analysis used in these rulings, it appears it will no longer require nonrenewability to qualify for a method change under Rev. Proc. 71-21. However, the letter rulings did not address the question of whether the taxpayer, and not a subcontractor, must perform all the services under the contract. A strong argument can be made that this "no subcontractor" requirement is not supported by the language of Rev. Proc. 71-21.

From Vicki Howe, J.D., Rich Garrett, CPA, and Jim Connor, J.D., Washington, D.C.