Washington Tax Alert November 14, 2011 (Deferral method for advance payments)
Washington Tax Alert from Don Barnes, [email protected]
November 14, 2011
Under the deferral method for advance payments permitted by Rev. Proc. 2004-34, a taxpayer includes the advance payment in gross income in the year of receipt to the extent the taxpayer includes the advance payment in revenues in its audited financial statements for that taxable year (or, if the taxpayer does not have audited financial statements, to the extent the advance payment is earned in the year of receipt). The balance of the advance payment is included in gross income in the following taxable year.
If a taxpayer with audited financial statements subsequently changes its method of accounting for the advance payments for financial accounting purposes, the taxpayer changes its method of accounting for tax purposes because the deferral method requires book/tax conformity in the year of receipt. The taxpayer is required to obtain the Commissioner’s consent to make this change. The Service permits taxpayers to make this change automatically by attaching a statement (not a Form 3115) to their tax returns for the year of change and providing certain information. See Rev. Proc. 2011-14, Appendix § 15.11. In addition, taxpayers with audited financial statements can make the change even if they have changed their method of accounting for advance payments during the preceding five taxable years. Id., Appendix § 15.11(3).
The Service recently issued guidance to examining agents that the Director will consent to accounting method changes under Rev. Proc. 2011-14, Appendix § 15.11, by taxpayers under examination. If taxpayers under examination have made accounting method changes under Appendix § 15.11 without obtaining the consent of the Director, examining agents have been instructed not to disallow the method change for the first or second taxable year ending after April 29, 2010. After this two-year period, method changes under Appendix § 15.11 by taxpayers under examination (and not in a “window” period) are subject to disallowance unless the taxpayer obtains the Director’s consent.
Furthermore, the guidance issued to examining agents indicates that taxpayers should be treated as making an unauthorized accounting method change — and therefore the accounting method change is subject to disallowance — if the taxpayer fails to attach the statement containing all the information required by Rev. Proc. 2011-14, Appendix § 15.11, to its tax return.