By Rene Schaefer, CPA MST
This year brought many accounting and tax changes for both private and public companies. In addition to the changes brought by the Tax Cuts and Jobs Act (TJCA), the new GAAP revenue recognition standards will take effect for non-publicly traded companies for years beginning after December 15, 2018 (unless the company elects to apply these standards earlier).
These revenue recognition standards require companies to evaluate their revenue contracts and obligations to determine the amount of revenue they expect to be entitled to under a customer contract. They will then need to determine if they are required to recognize that revenue for book purposes, either at a point in time or over time depending on the nature of the “performance obligations” within that contract. In some cases, this will require the company to recognize income sooner than the previous standard.
The TCJA has addressed how these new GAAP revenue recognition standards will be treated for tax purposes. The TCJA requires taxpayers to recognize income no later than the tax year in which the income is taken into account as income on an “Applicable Financial Statement” (AFS) or on another financial statement as specified by IRS. It also requires customer contracts with multiple performance obligations to allocate the transaction price in the same manner as used for the financial statements. This has the potential to accelerate revenue for income tax reporting purposes as well, therefore potentially creating a higher tax bill in the year of adoption.
These new tax rules do not apply to any item of income, which allows for a special method of accounting in other areas of the Internal Revenue Code.
An AFS is defined as:
A financial statement certified as being prepared in accordance with generally accepted accounting principles (GAAP) and
- A Form 10-K or annual statement to shareholders required to be filed with the SEC or
- An audited financial statement which is used for credit purposes, reporting to shareholders, partners or other proprietors or to beneficiaries for any other substantial nontax purpose, or filed by the taxpayer with any other federal agency for purposes other than federal tax purposes.
A financial statement made on the basis of international financial reporting standards, and is filed with an agency of a foreign government (similar to the SEC), and has reporting standards not less stringent than required by that agency of a foreign government.
The TCJA rules do not apply to a taxpayer that doesn’t have a financial statement described above (i.e., reviewed or compiled financial statements) or any item of gross income in connection with a mortgage servicing contract. So, if an AFS is not required by the taxpayer, they will not be required to follow the new GAAP rules for tax reporting purposes.
We are waiting on guidance from the IRS regarding the procedures to make the required changes and confirm the change will qualify for automatic IRS consent.
There is an option to elect to follow the new revenue recognition standards even if the taxpayer does not have an AFS. This election must be made for the year the new GAAP standard is adopted and will allow the taxpayer to use either the cut-off basis method or, if the change is negative (reduces income), the adjustment is taken against income in that year. If the change is positive (increases income), the adjustment is taken into income over a four year period.
As companies start to consider the implications of the new GAAP revenue recognition standards, they should also consider the tax effect of these changes, which may result in an increase to income. Please contact your Clark Nuber professional or Rene Schaefer to help you plan for these tax changes ahead.
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