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When are advance payments includible in income? Proposed revenue procedure clears up ambiguities.

An IRS proposed revenue procedure will allow certain taxpayers using the accrual method of accounting to defer inclusion of specified advance payments in gross income. CPAs should examine notice 2002-79 in case the rules become final so as to be able to advise eligible clients.


IRC section 451 provides that an item of gross income is reported in the tax year in which a taxpayer receives it. Under regulations section 1.451-1(a), income is includible in gross income under the accrual method when all the events have occurred that fix the right to receive it and the amount can be determined with reasonable accuracy. In the absence of a contingency affecting a taxpayer's right to income, the test is satisfied when the earliest of these has occurred: (1) the income is received, (2) the income is due or (3) the required performance or events have taken place.

In certain circumstances, revenue procedure 71-21 allows accrual-method taxpayers to defer inclusion of payments received (or amounts due and payable) in one tax year if attributable to services to be performed by the end of the next.

However, taxpayers and the IRS frequently disagree about whether advance payments are for services, nonservices or a mixture of both. Payments for nonservices and certain mixtures of services and nonservices do not qualify for deferral. In addition, it is unclear whether advance payments received under a series of agreements or a renewable agreement are within the procedure's scope.


The proposed guidance would expand revenue procedure 71-21's scope to include advance payments (1) for certain nonservices and mixed services/nonservices and (2) received under an agreement or series of agreements with a term extending beyond the end of the next succeeding year. It applies to accrual-method taxpayers that receive advance payments properly includible in income under section 451 in the year received but included for financial reporting purposes in a subsequent year. The procedure explains the meaning of "advance payment" in this context.

Under the proposed procedure, a taxpayermay report in taxable income either (1) the full amount of advance payments in the year received (the full-inclusion method) or (2) such payments in the year received, to the extent included for financial-reporting purposes, with the remainder reported in the next succeeding tax year (the deferral method). A taxpayer cannot defer income to a tax year later than the next succeeding tax year. Advance payments need not relate to services expected to be provided in the next succeeding year to be deferred.


Generally, a taxpayer that wants to change its treatment of advance payments to either the full-inclusion or deferral method may obtain automatic consent under revenue procedure 2002-9 (as modified by revenue procedure 2002-19, announcement 2002-17 and revenue procedure 2002-54), ignoring section 4.02.

If made final, the procedure would be effective for tax years ending on or after its date of publication.

For more information, see The Tax Clinic, edited by David Madden, in the June 2003 issue of The Tax Adviser.

Notice to readers: Members of the AICPA tax section may subscribe to The Tax AdViser at a reduced price. Contact Judy Smith at 202-434-9270 for a subscription to the magazine or to become a member of the tax section.
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Title Annotation:from The Tax Adviser
Author:Laffie, Lesli S.
Publication:Journal of Accountancy
Date:Jun 1, 2003
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