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Carl Giardino[/caption]
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Patrick Quinn[/caption]
Editor’s note: Part I two weeks ago gave an overview of the new accounting rules and their potential impact on income taxes. Part II last week and Part III below give examples of how the rules apply in various business situations.
Fixed-price contracts in the new standard should not produce any inconsistencies between financial reporting and tax considerations. Contracts with variable consideration, on the other hand, are a different story. Under ASC Topic 606, entities measure variable consideration using estimates to quantify the amount of revenue expected to be received. Entities use estimates when it is probable that a significant reversal of revenue will not occur upon resolution of the contingencies or uncertainties causing the variable consideration. Situations that might produce variable consideration include the seller’s right to incentives or bonuses, or the seller’s concessions for discounts, credits, rebates, refunds or penalties.
When the seller estimates variable consideration, the seller may not necessarily have a fixed right to receive the revenue under the benefits and burdens test or under the performance test for tax purposes. Former financial-reporting standards did not permit revenue recognition with the existence of contingencies, which comported with tax rules. A fundamental inconsistency is now introduced with the new financial-reporting standards.
CHECK WITH IRS
The new accounting standards may precipitate a deluge of applications to change accounting methods for tax purposes. Such changes can be either automatic or require IRS consent (using Form 3115 for either type) before an entity can change its overall tax method of accounting or its tax method of accounting for a material item. The related regulations and guidance may require any entity that experiences a change resulting from the new financial-reporting standards to secure IRS consent, where tax conformity is desired. The only instance where this would not be the case is when the underlying facts of the change in recognition occurs, such as a situation where the customer changes the timing or other aspects of the agreement.
If an entity has the wherewithal to maintain a tax-accounting method that corresponds to the former financial-reporting standards (e.g., maintain a second set of books), there is no requirement for conformity as long as the former method continues to result in a clear reflection of income and conforms with the all-events test for tax purposes. This option is likely to be more burdensome to taxpayers, so many will probably prefer conformity. One instance where this could get a little more complicated is when the taxpayer is deferring income recognition for advance payments (pursuant to Rev. Proc. 2004-34).
On March 28, the IRS indicated in Notice 2017-17 that applications for changes in accounting methods for ASC Topic 606 may be governed by its so-called “automatic” consent procedures, which would help with timing constraints to make these filings. But implicitly this suggests that a pervasive filing requirement is expected, churning unpleasant memories involving the filing campaign under the tangible property regulations.
Carl Giardino is a managing director in the Tax Group at CBIZ Tofias. Patrick Quinn is a shareholder in the Accounting and Auditing Group at CBIZ Tofias.
