The 2017 tax reform act amended Section 451 to provide that an accrual-method taxpayer (1) under Section 451(b), must recognize an item of gross income under the all-events test no later than when the item is taken into account as revenue in the taxpayer’s applicable financial statement (AFS inclusion rule) and (2) under Section 451(c), may defer certain advance payments for a limited time beyond the tax year of receipt.
In December 2021, the IRS and Treasury issued final regulations under Sections 451 and 1275 implementing these provisions, including ordering rules for specified fees relating to debt instruments. The regulations generally apply for tax years beginning on or after January 1, 2021. See the Insight Final regulations issued on the Section 451 all-events test and advance payments.
The IRS has released Rev. Proc. 2021-34 and Rev. Proc. 2021-35, which provide procedures for taxpayers to change their methods of accounting to comply with the Section 451 amendments and the final regulations. Rev. Proc. 2021-34 amends Rev. Proc. 2019-43, the description of automatic method changes and their terms and conditions, and Rev. Proc. 2015-13, the general method change procedures. Rev. Proc. 2021-35 amends Rev. Proc. 2013-26, dealing with the proportional method of accounting for original issue discount (OID).
For consideration: Taxpayers impacted by the final regulations may need to make accounting method changes to comply with the Section 451 regulations under these new procedures. Some taxpayers with methods that comply with the regulations nonetheless may want to make method changes for 2020 to change to alternative, more favorable methods allowed under the regulations. For example, a taxpayer with a present method of accounting of following the AFS inclusion rule may want to change to a method of accounting to defer income for which there is no enforceable right to payment under a contract or to use the cost offset method.
Unlike other recent accounting method change guidance, for example relating to bonus depreciation, taxpayers generally may not change their methods to comply with the Section 451 regulations on amended income tax returns but must follow the standard method change procedural rules that require changes to be made prospectively. Most method changes to comply with the Section 451 regulations may be made under the automatic procedures with audit protection.