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.