Financial Accounting Changes to Comply with ASC 606/IFRS 15 Will Require Companies to Assess the Tax Effect
Companies adopting ASC 606 or IFRS 15, Revenue from Contracts with Customers, (the new standard) for financial accounting purposes will need to consider how changes will affect their tax filings. Any changes made to comply with the new standard should be reviewed: (1) to determine whether the new revenue recognition method is acceptable for tax purposes; and (2) if the company needs to file a federal Form 3115, to request permission from the IRS to change an accounting method.
Accounting impact of financial statement changesThe new financial accounting standards for recognizing revenue are effective for private companies in 2019 (this was mandatory for public companies in 2018). The new standard requires companies to identify the contract, identify the performance obligations, determine and allocate the transaction price, and recognize revenue as the company satisfies the performance obligation. The application of the new standard can affect when revenue is recognized for financial accounting purposes.
Tax impact of financial accounting changes
A company’s tax position may be impacted by adopting ASC 606 or IFRS 15.
For example, a company might delay revenue recognition where a performance obligation requires a company to perform services in the future. For tax purposes, a company would need to analyze the new standard and either:
1. Request a tax accounting method change to conform to the new financial accounting method, or
2. If the new financial accounting method is not acceptable for tax, create a new book-tax adjustment
Complications may arise in the retail or life science industries where companies have significant refund liabilities. How these refund liabilities are treated for financial accounting purposes may also affect how to treat this liability for tax purposes.
Careful planning and analysis will be required to determine what is required and what will be most beneficial from a tax perspective.
The tax procedures to make the change
Oftentimes, tax revenue recognition mirrors a company’s financial accounting revenue recognition. In such a case, there is no book-to-tax adjustment because the financial accounting method is acceptable for tax purposes. However, if the financial accounting revenue recognition method changes under the new standard, and the company wants to change its tax accounting method to follow the new financial accounting method, then the company would need to request permission from the IRS to change its tax accounting method for federal income tax purposes.
The IRS has released a revenue procedure that will help to streamline this process. Revenue Procedure 2018-29 provides consent for automatically changing the taxpayer’s method of accounting for the recognition of income to a method expressly described in the new standard. The revenue procedure grants automatic consent to change to tax accounting methods that conform to the new standard if the tax accounting method change is requested in the same tax year that the taxpayer adopts the new financial accounting revenue standards. However, the proposed method of accounting must be permissible for tax purposes.
The procedure grants automatic consent to taxpayers that want to change their method of accounting for: (1) identifying performance obligations, (2) allocating transaction price to those performance obligations, and/or (3) considering performance obligations satisfied. However, automatic consent is NOT granted for the following related issues:
- Changing how to identify contracts or determine the transaction price, e.g., the inclusion or exclusion of variable consideration
- Making the change in a different year than the year the new standard is adopted
- Changing to a method that is not acceptable for tax purposes
- An automatic change already provided for in other published guidance
- Changing the recognition of income from long-term contracts under § 460, unless the contracts are exempt from the use of the percentage-of-completion method for certain home construction contracts and small taxpayers
The tax accounting method change can be made on a “cut-off basis” or by using a cumulative catch-up § 481(a) adjustment. However, the taxpayer must consistently apply this choice across all affected transactions.
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