Taxable Year of Income Inclusion Under an Accrual Method of Accounting, 47191-47210 [2019-19325]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 84, Number 174 (Monday, September 9, 2019)]
[Proposed Rules]
[Pages 47191-47210]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-19325]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-104870-18]
RIN 1545-BO68


Taxable Year of Income Inclusion Under an Accrual Method of 
Accounting

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding the 
timing of income inclusion under section 451 of the Internal Revenue 
Code (Code). The proposed regulations reflect changes made by the Tax 
Cuts and Jobs Act. These proposed regulations affect taxpayers that use 
an accrual method of accounting and have an applicable financial 
statement.

[[Page 47192]]


DATES: Written or electronic comments and requests for a public hearing 
must be received by November 8, 2019.

ADDRESSES: Send submissions to Internal Revenue Service, CC:PA:LPD:PR 
(REG-104870-18), Room 5205, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to Courier's Desk, 
Internal Revenue Service, CC:PA:LPD:PR (REG-104870-18), 1111 
Constitution Avenue NW, Washington, DC 20224. Alternatively, persons 
may submit comments electronically via the Federal eRulemaking Portal 
at https://www.regulations.gov (IRS REG-104870-18).

FOR FURTHER INFORMATION CONTACT:  Concerning Sec. Sec.  1.446-2, 1.451-
3(d)(2), 1.451-3(i), 1.1275-2(l), and any other provisions within the 
jurisdiction of the Associate Chief Counsel (Financial Institutions and 
Products), Charles Culmer, (202) 317-4528; concerning the rest of the 
proposed regulations, Charles Gorham, (202) 317-5091; concerning 
submissions of comments and requests for a public hearing, Regina L. 
Johnson, (202) 317-6091 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to 26 CFR part 1 under 
section 451(b). On December 22, 2017, section 451(b) was amended by 
section 13221 of the Tax Cuts and Jobs Act, Public Law 115-97 (131 
Stat. 2054) (the Act) to provide that, for a taxpayer using an accrual 
method of accounting, the all events test with respect to any item of 
gross income (or portion thereof) is not treated as met any later than 
when the item (or portion thereof) is included in revenue for financial 
accounting purposes on an applicable financial statement (AFS) or other 
financial statement specified by the Secretary. The amendments made to 
section 451(b) do not change the time at which income subject to the 
all events test is taken into income for accrual method taxpayers 
without an AFS or other specified financial statement. Unless otherwise 
indicated, all references to section 451(b) hereinafter are references 
to section 451(b), as amended by the Act.
    In general, section 451 provides that the amount of any item of 
gross income is included in gross income for the taxable year in which 
it is received by the taxpayer, unless, under the method of accounting 
used in computing taxable income, the amount is to be properly 
accounted for as of a different period. Under Sec.  1.451-1, accrual 
method taxpayers generally include items of income in gross income in 
the taxable year when all the events occur that fix the right to 
receive the income and the amount of the income can be determined with 
reasonable accuracy (the all events test). All the events that fix the 
right to receive income occur when (1) the required performance takes 
place, (2) payment is due, or (3) payment is made, whichever happens 
first. Revenue Ruling 2003-10 (2003-1 CB 288); Revenue Ruling 84-31 
(1984-1 CB 127); Revenue Ruling 80-308 (1980-2 CB 162).
    On April 12, 2018, the Treasury Department and the IRS issued 
Notice 2018-35 (2018-18 IRB 520) requesting, in part, comments on 
future guidance under section 451(b). The record of public comments 
received in response to Notice 2018-35 may be requested by sending an 
email to [email protected]. This document provides 
guidance on the application of section 451(b) taking into account 
comments that were received regarding section 451(b). The application 
of section 451(c) is addressed in separate guidance published in the 
same issue of the Federal Register as these proposed regulations.

Explanation of Provisions

    The proposed regulations describe and clarify the statutory 
requirements of section 451(b) by providing new Sec.  1.451-3.

1. Applicability of Section 451(b)(1)

    Section 451(b)(1) generally provides that, for an accrual method 
taxpayer with an AFS or other specified financial statement, the all 
events test with respect to any item of gross income, or portion 
thereof, is not treated as met any later than when such item, or 
portion thereof, has been taken into account as revenue in an AFS or 
other specified financial statement (the AFS income inclusion rule). 
The AFS income inclusion rule generally increases financial accounting 
and tax accounting conformity. On May 28, 2014, the Financial 
Accounting Standards Board (FASB) and the International Accounting 
Standards Board (IASB) jointly announced new financial accounting 
standards for revenue recognition, titled ``Revenue from Contracts with 
Customers (Topic 606).'' See ASC Topic 606 and IASB International 
Financial Reporting Standard (IFRS) 15 (New Standards). Under the New 
Standards, items of income may be included as revenue in an AFS earlier 
than they would have been included in income under the all events test 
prior to the Act.
A. Taxpayers Subject to the AFS Income Inclusion Rule
    The proposed regulations clarify how the AFS income inclusion rule 
applies to accrual method taxpayers with an AFS. Some taxpayers use an 
accrual method of accounting for all applicable items of income 
(overall accrual method taxpayers) and others use an accrual method of 
accounting for only some items of income. Both types of taxpayers 
(collectively, accrual method taxpayers) compute taxable income, at 
least in part, under an accrual method. Accordingly, proposed Sec.  
1.451-3(b) provides that the AFS income inclusion rule generally 
applies to accrual method taxpayers with an AFS when the timing of 
income inclusion for one or more items of income is determined using 
the all events test.
    The proposed regulations do not include special rules regarding the 
applicability of the AFS income inclusion rule to foreign persons. The 
Treasury Department and the IRS are aware that applying the AFS income 
inclusion rule to a controlled foreign corporation (CFC) may create 
mismatches between the CFC's taxable income for U.S. Federal and 
foreign tax purposes. As a result, certain taxpayers may lose the 
ability to credit foreign taxes imposed on a CFC's income, particularly 
where such taxes relate to amounts includible in gross income under 
section 951A and are therefore ineligible to be carried back or forward 
under section 904(c). Comments are requested regarding whether special 
rules are needed to address the applicability of the AFS income 
inclusion rule to foreign persons, including whether and how the rules 
for determining the taxable income of a CFC can be adjusted to better 
align the U.S. Federal and foreign income tax bases.
B. Exceptions to the AFS Income Inclusion Rule
    Proposed Sec.  1.451-3(d)(1) clarifies that the AFS income 
inclusion rule applies only to taxpayers that have one or more AFS 
covering the entire taxable year. This approach is consistent with the 
exception in section 451(b)(1)(B)(i), which provides that the AFS 
income inclusion rule does not apply to taxpayers without an AFS for a 
taxable year. In addition, some accrual method taxpayers may have an 
AFS in one taxable year and no AFS in another taxable year. To address 
this situation, the proposed regulations provide that the AFS income 
inclusion rule applies on a year-by-year basis and, therefore, an 
accrual method taxpayer with an

[[Page 47193]]

AFS in one taxable year that does not have an AFS in another taxable 
year must apply the AFS income inclusion rule in the taxable year that 
it has an AFS, and does not apply the rule in the taxable year in which 
it does not have an AFS.
    Consistent with section 451(b)(1)(B)(ii), proposed Sec.  1.451-
3(d)(2) also provides that the AFS income inclusion rule does not apply 
to items of income in connection with a mortgage servicing contract. A 
letter addressed to the Treasury Department indicated that it is 
unclear whether this exclusion can be applied to income relating to 
interest rate lock commitments (IRLCs) entered into by mortgage 
lenders. The proposed regulations do not address this issue because 
section 475 generally would require mortgage lenders to include income 
relating to IRLCs in taxable income in accordance with the mark-to-
market method of accounting. As a result, a mortgage lender generally 
would not apply section 451(b) to determine when income relating to 
IRLCs is includible in income.
C. Transactions Treated Differently for Federal Income Tax and AFS 
Purposes
    Except as provided in proposed Sec.  1.451-3(e), proposed Sec.  
1.451-3(e) clarifies that the AFS income inclusion rule does not change 
the treatment of a transaction for Federal income tax purposes. The 
treatment of a transaction or event in a taxable year may be different 
for Federal income tax and AFS purposes. For example, a rental 
agreement that is treated as a lease for Federal income tax purposes 
may be treated as a sale or financing for AFS purposes, or vice versa. 
Similarly, a transaction that is deemed to occur (for example, under a 
mark-to-market method) for AFS purposes may not be deemed to occur for 
Federal income tax purposes. The AFS income inclusion rule generally 
was not intended to require taxpayers to recharacterize a transaction 
for Federal income tax purposes to conform to the characterization of 
the transaction in the taxpayer's AFS. As stated in the Conference 
Report, ``The provision does not revise the rules associated with when 
an item is realized for Federal income tax purposes and, accordingly, 
does not require the recognition of income in situations where the 
Federal income tax realization event has not yet occurred.'' H.R. Rep. 
No. 115-466, at 428 fn. 872 (2017) (Conf. Rep.).
    However, as also stated in the Conference Report, the AFS income 
inclusion rule was intended to include unbilled receivables for 
partially performed services:

    ``Under the provision, an accrual method taxpayer with an 
applicable financial statement will include an item in income under 
section 451 upon the earlier of when the all events test is met or 
when the taxpayer includes such item in revenue in an applicable 
financial statement. For example, under the provision, any unbilled 
receivables for partially performed services must be recognized to 
the extent the amounts are taken into income for financial statement 
purposes.''

H.R. Rep. No. 115-466, at 428 fn. 874 (2017) (Conf. Rep.). Commenters 
suggested that the intent to include unbilled receivables conflicts 
with the intent to not change the treatment of a transaction to match 
the taxpayer's AFS treatment. The Treasury Department and the IRS do 
not agree. In applying the AFS income inclusion rule to unbilled 
receivables, a taxpayer is not changing the treatment of the 
transaction when it includes in income amounts included in its AFS. 
Moreover, these proposed regulations also apply to unbilled receivables 
for the sale of goods because there is no distinction in section 451(b) 
between unbilled receivables for services and unbilled receivables for 
the sale of goods, and service providers and sellers of goods that are 
including unbilled receivables in revenue for AFS purposes should be 
treated similarly for Federal income tax purposes under section 451(b). 
Accordingly, the proposed regulations provide that the AFS inclusion 
rule applies to unbilled receivables included in revenue for AFS 
purposes related to both services and goods.
    Commenters raised concerns about the interaction between sections 
61 and 461 with the AFS income inclusion rule. For AFS purposes, 
taxpayers may be required to include variable consideration when 
determining the transaction price of a contract. Under the New 
Standards, variable consideration includes items such as discounts, 
rebates, refunds, credits, price concessions, incentives, performance 
bonuses, penalties, and other similar items. Variable consideration may 
also include promised consideration that taxpayers are not yet entitled 
to under the contract because it is contingent on the occurrence or 
nonoccurrence of a future event. For Federal income tax purposes, these 
items of variable consideration may be contingent future income under 
section 61 or liabilities subject to section 461. Section 451(b) could 
be read to accelerate the timing of contingent future income and 
liabilities to match their inclusion in revenue for AFS purposes. 
However, section 451(b) was intended to change only the timing of 
income to ensure that those items of income are not included later than 
when they are included for AFS purposes. See H.R. Rep. No. 115-466, at 
428 fn. 874 (2017) (Conf. Rep.) and Joint Committee on Taxation, 
General Explanation of Public Law 115-97 (JCS-1-18) at 166 (Dec. 20, 
2018). Accordingly, proposed Sec.  1.451-3(c)(6) provides that the 
transaction price that is used to determine whether an amount has been 
included in revenue does not include items to which a taxpayer's 
entitlement is contingent on the occurrence or nonoccurrence of a 
future event, reductions for amounts subject to section 461 (including 
allowances, adjustments, rebates, chargebacks, refunds, rewards, and 
amounts included in the cost of goods sold), and amounts collected for 
third parties. However, in order to reduce compliance burden and 
prevent abuse and undue administrative burden, proposed Sec.  1.451-
3(c)(6) presumes that an amount included in the transaction price for 
AFS purposes is not contingent future income unless, upon examination 
of all of the facts and circumstances existing at the end of the 
taxable year, it can be established to the satisfaction of the 
Commissioner that the amount is contingent on the occurrence or 
nonoccurrence of a future event.
    In addition, section 451(b) was intended to accelerate income 
inclusion when (i) the taxpayer's customer controls the asset that is 
created or enhanced, or (ii) the taxpayer has a right to partial 
payment, even when a contract requires delivery, acceptance, and title 
transfer before a taxpayer can bill its customer. See Examples 2 and 4 
of the Joint Committee on Taxation, General Explanation of Public Law 
115-97 (JCS-1-18) at 162-163 (Dec. 20, 2018). Accordingly, proposed 
Sec.  1.451-3(c)(6)(ii) provides that an amount included in the 
transaction price for AFS purposes may not be treated as contingent on 
the occurrence or nonoccurrence of a future event if the taxpayer has 
been paid or has an equitable, contractual, or other right to partial 
payment for performance completed to date. Additionally, proposed Sec.  
1.451-3(c)(6)(iii) provides that transaction price may not be reduced 
for amounts subject to section 461, including, in the case of credit 
card transactions, reward amounts.
    Comments are requested on the interaction among sections 61, 461, 
and 451(b), and specific situations in which future contingent income 
and liabilities might be included in revenue for AFS purposes. Comments 
are requested, for

[[Page 47194]]

example, on the applicability of the proposed rules to escalating 
rental agreements not subject to section 467, where amounts included in 
revenue in an AFS as rent for one year of a multi-year rental agreement 
exceed actual rent received for that year. Specifically, does the 
excess of the amount included in revenue as rent over the amount of 
actual rent in a particular year represent a contingency or merely an 
allocation of the overall transaction price? Comments are requested on 
the extent to which certain contract terms might affect the result. 
Comments also are requested on the proposed presumption that the AFS 
income inclusion rule should apply when an item is included in revenue 
in an AFS and what a taxpayer should be required to demonstrate in 
order to successfully rebut the presumption. Finally, comments are 
requested on how reassessments of variable consideration after the 
taxable year of the commencement of the contract should be treated for 
Federal income tax purposes.
D. Interaction With Exclusion Provisions and Effect on Non-Recognition 
Transactions
    Commenters noted that the AFS income inclusion rule may appear to 
overturn numerous exclusion provisions and adversely affect the 
treatment of non-recognition transactions in the Code. For example, the 
AFS income inclusion rule could be read to apply to a transaction that 
is treated as a sale of property with profit or loss for AFS purposes 
but that is treated as a reorganization under section 368 for Federal 
income tax purposes. The proposed regulations clarify that the AFS 
income inclusion rule does not change the applicability of any 
exclusion provision, or the treatment of non-recognition transactions, 
in the Code, the Income Tax Regulations, or other guidance published in 
the Internal Revenue Bulletin, consistent with Congressional intent 
that the provision does not revise the rules associated with the time 
at which an item is realized for Federal income tax purposes. H.R. Rep. 
No. 115-466, at 428 fn. 872 (2017) (Conf. Rep.) and Joint Committee on 
Taxation, General Explanation of Public Law 115-97 (JCS-1-18) at 166 
(Dec. 20, 2018).
E. Special Methods of Accounting
    Section 451(b)(2) provides that the AFS income inclusion rule does 
not apply to any item of gross income for which the taxpayer uses a 
special method of accounting provided under any provision of Chapter 1, 
other than any provision of part V of subchapter P. Commenters raised 
questions about the interaction between the AFS income inclusion rule 
and special methods of accounting. In response, proposed Sec.  1.451-
3(b) amplifies the meaning of the term ``special method of accounting'' 
and, except as provided in proposed Sec.  1.451-3(b), provides that the 
AFS income inclusion rule does not apply to any item of income, or 
portion of an item of income, when the timing of income inclusion is 
determined under a required or permitted special method of accounting 
used for Federal income tax purposes. The proposed regulations also 
clarify that when a taxpayer uses a special method of accounting, the 
special method of accounting determines the timing of the income 
inclusion. The proposed regulations provide a non-exclusive list of 
examples of special methods of accounting. In addition, the proposed 
regulations make clear that because the AFS income inclusion rule 
affects the time at which the all events test is met, the rule applies 
only to items of income that are subject to the all events test. For a 
discussion of special methods of accounting under the provisions of 
part V of subchapter P (relating to income from certain debt 
instruments), see section 7 of this preamble.

2. Application of the AFS Income Inclusion Rule to Multi-Year Contracts

    Section 451(b) does not address how to apply the AFS income 
inclusion rule and all events test to a multi-year contract. Proposed 
Sec.  1.451-3(k) provides that a taxpayer with a multi-year contract 
applies the all events test by applying a cumulative approach 
reflecting amounts previously included under section 451 rather than an 
annualized approach.
    An annualized approach would look at payments received in each 
taxable year in isolation and compare the amounts included in the 
taxpayer's AFS and under the all events test to determine whether an 
amount should be included for Federal income tax purposes. This 
approach would generally result in an overall acceleration of income 
relative to income included in revenue for AFS purposes, could cause 
amounts to be included for Federal income tax purposes earlier than 
under a contract's terms, and could result in double counting of 
income. Section 451(b)(1) does not require this treatment.
    A cumulative approach better reflects the economic reality of a 
multi-year transaction. Accordingly, the proposed regulations require 
taxpayers to take into account the cumulative amounts previously 
included in prior taxable years in determining a given contract year's 
income inclusions under section 451(b)(1). Comments are requested 
regarding the treatment of multi-year contracts under the AFS income 
inclusion rule.

3. Applicable Financial Statement (AFS)

    The proposed regulations describe and clarify the definition of AFS 
under section 451(b)(3). Section 451(b)(3) generally defines AFS to 
mean financial statements prepared according to generally accepted 
accounting principles (GAAP financial statements), certain financial 
statements prepared according to international financial reporting 
standards (IFRS financial statements), and financial statements filed 
with certain regulatory or government bodies. Section 451(b)(1)(A)(ii) 
provides the Secretary with authority to specify other financial 
statements for purposes of section 451(b)(1).
    The list of financial statements qualifying as an AFS under section 
451(b)(3) is similar, but not identical, to the list of financial 
statements in Revenue Procedure 2004-34 (2004-1 CB 991). The general 
priority for identifying the AFS in section 451(b)(3)(A) through (C) is 
similar to the priority provided in Revenue Procedure 2004-34. Certain 
financial statements that have traditionally been treated as AFS under 
Revenue Procedure 2004-34, such as IFRS financial statements used for 
(1) credit purposes, (2) reporting to shareholders, partners, or other 
proprietors or to beneficiaries, and (3) any other substantial nontax 
purposes, are not expressly included in section 451(b)(3). However, the 
legislative history indicates that Congress intended for Revenue 
Procedure 2004-34 to be followed. See H.R. Rep. No. 115-466, at 429 
(2017) (Conf. Rep.). Accordingly, proposed Sec.  1.451-3(c)(1) is 
generally consistent with the list of AFS from Revenue Procedure 2004-
34.
    The proposed regulations also clarify the financial statements 
filed with certain regulatory or government bodies that qualify as an 
AFS under section 451(b)(3)(C), which is similar to section 4.06(3) of 
Revenue Procedure 2004-34. The proposed regulations clarify that 
financial statements that are filed with a state government or state 
agency, or a self-regulatory organization, also qualify as an AFS under 
section 451(b)(3)(C). For example, the Financial Industry Regulatory 
Authority and state agencies that regulate insurance companies or 
public utilities are agencies requiring reports that qualify as an AFS.
    Proposed Sec.  1.451-3(h) addresses various issues relating to how 
financial

[[Page 47195]]

results are reported for certain taxpayers. These proposed regulations 
propose rules consistent with the rules provided in Sec.  1.56-1 
because Congress indicated a desire for rules similar to those found in 
Revenue Procedure 2004-34 and the rules in Revenue Procedure 2004-34 
follow certain rules in Sec.  1.56-1. See IRS Announcement 2004-48 
(2004-22 IRB 998).
    Section 451(b)(5) and proposed Sec.  1.451-3(h)(1), (2), and (3) 
provide that, for purposes of the general rule in section 451(b)(1), if 
the financial results of a taxpayer are reported on the AFS, as defined 
in section 451(b)(3), for a group of entities, such statement shall be 
treated as the AFS of the taxpayer. When a consolidated or combined AFS 
or other financial statement lists items separately for each member 
taxpayer, the amount of revenue attributable to a particular taxpayer 
is determined based on its respective separately stated item. If the 
amounts are aggregated, however, the taxpayer must rely on the source 
documents that were used to create the group's AFS to determine its 
percentage of each aggregated item reported on the consolidated or 
combined AFS. The source documents should be used to determine the 
taxpayer's respective share of revenue on the AFS, so as to properly 
reflect the correct amount of gross income under section 451(b).
    Proposed Sec.  1.451-3(h)(4) provides guidance for taxpayers with a 
financial reporting period that is different than the taxpayer's 
taxable year. The proposed regulations provide that the taxpayer must 
use one of three permissible methods in order to determine whether an 
item of income has been included in revenue on an AFS. Under one method 
a taxpayer uses the accounting principles used to create its AFS to 
determine the items of income to be reported in revenue as if its 
financial reporting period coincided with its taxable year. Under the 
second method a taxpayer makes a reasonable estimate of revenue for the 
pro rata portion of the taxable year for which the financial statement 
year and taxable year do not align. Under the third method, if a 
taxpayer's financial accounting year ends five or more months after the 
end of its taxable year, the taxpayer computes revenue based on the 
revenue reported on the AFS for the financial accounting year ending 
within its taxable year.
    Proposed Sec.  1.451-3(h)(5) provides guidance on a restatement of 
a taxpayer's financial statements. The rules generally provide that the 
taxpayer must determine the reason for the restatement of the AFS. For 
example, if a taxpayer restates revenue on an AFS and such restatement 
changes the time at which an item of income or a portion thereof is 
taken into account as revenue on the AFS, the change constitutes a 
change in method of accounting under section 446. This rule is 
consistent with current practice regarding the determination of a 
change in method of accounting.
    The regulations under section 6001 require a taxpayer to keep books 
and records sufficient to establish the amount of gross income, 
deductions, credits, or other matters required to be shown in an income 
tax return, which includes the identification of items includible in 
gross income under section 451. This requirement includes any books and 
records sufficient to establish a taxpayer's calculation of income when 
its financial results are included in an AFS of a group of entities.

4. Revenue in an AFS

    Proposed Sec.  1.451-3(c)(4) defines the term revenue for purposes 
of section 451(b)(1) broadly to include all items of income under 
section 61 (gains, profits, and income for Federal income tax 
purposes). This definition is consistent with the current application 
of the all events test under Sec.  1.451-1(a) and ensures greater 
financial accounting and tax accounting conformity.
    One commenter discussed the effect of the New Standards on sections 
451(b) and (c). The commenter noted that, under the New Standards, 
certain revenue may be included earlier than under section 451 prior to 
amendment by the Act. The commenter also noted that an amount booked to 
retained earnings should be treated as revenue for purposes of section 
451(b) even though that amount may not be shown as book revenue for 
financial accounting purposes. A narrow reading of the term revenue 
could result in items of income that are taken into account on an AFS 
and that otherwise would be required to be included in gross income 
escaping section 451(b) altogether. For example, taxpayers may include 
items, or portions of items, in other comprehensive income on an AFS 
that are excluded from the revenue line(s) on the AFS. Accordingly, a 
broad reading of revenue ensures that the correct amount of income that 
is taken into account in an AFS is subject to section 451(b).
    Multiple commenters proposed allowing a cost offset when income is 
included under the AFS income inclusion rule. For example, one 
commenter suggested that, in determining the amount of income to 
include under section 451(b), taxpayers selling goods should reduce AFS 
revenue by the cost of goods sold associated with a sale that does not 
presently reduce AFS revenue. The commenter acknowledged that costs are 
not taken into account for Federal income tax purposes until the all 
events test is satisfied, which includes the economic performance rules 
under section 461. Because of the resulting inconsistency with sections 
461 and 471, these regulations do not follow the commenter's suggestion 
that a cost offset or cost of goods sold reduction should apply without 
regard to the economic performance rules of section 461 and inventory 
accounting rules of section 471.
    Congress has addressed various cost recovery mechanisms in the 
past. In 1955, Congress repealed the reserve method for estimated 
expenses under section 462 of the Code. See An Act to Repeal Sections 
452 and 462 of the Internal Revenue Code of 1954, Public Law 84-74, 
section 1(b) (1955). Section 462 of the Code was a companion to section 
452, which allowed taxpayers to report certain types of prepaid income 
over time. In the Senate Report discussing the repeal of sections 452 
and 462, Congress noted that ``the problem presented by section 462 is 
that of the timing of deductions when a taxpayer changes accounting 
methods.'' S. Rep. 84-372, at 4 (1955). The Senate noted that taxpayers 
would be entitled to the deductions even without section 462. In 
addition, section 462 increased the possibility of distortions of 
income because expenses were being deducted when the amount had not yet 
been incurred.
    Thirty years later, Congress repealed the use of the reserve method 
for determining losses from bad debts under section 166 in the Tax 
Reform Act of 1986. In repealing the reserve method, Congress noted 
that this method was inconsistent with the rules for other deductions 
under the all events test and could result in deductions being allowed 
for Federal income tax purposes for losses that may never occur. S. 
Rep. No. 99-313, at 155 (1986). Moreover, ``if a deduction is allowed 
prior to the taxable year in which the loss occurs, the value of the 
deduction to the taxpayer will be overstated.'' S. Rep. No. 99-313, at 
155 (1986).
    These proposed regulations do not allow a cost offset provision 
because similar potential distortions of income could result. An 
allowance to account for future cost of goods sold, for future 
estimated costs, or other cost offsets also is inconsistent with 
sections 461 (in particular section 461(h)), 263A, and

[[Page 47196]]

471, and the regulations under those sections. In addition, these 
proposed regulations do not allow a cost offset provision because there 
is nothing in the statute or legislative history that indicates that in 
amending section 451 Congress intended to change sections 461, 263A or 
471, and the regulations under those sections. See also, General 
Explanation of Public Law 115-97 (JCS-1-18) at 150-151, and 164-165 
(Dec. 20, 2018).
    Nevertheless, the Treasury Department and the IRS continue to 
consider whether any exceptions are an appropriate use of the 
Secretary's authority under section 461(h) or 460. To facilitate 
further consideration of any potential exceptions, detailed comments 
that specifically address the following issues are requested:
    1. Under what authority would it be appropriate for the Secretary 
to permit a taxpayer to use a book percentage-of-completion method 
(PCM) as its tax method? When inventory is involved, what limitations 
could be instituted to ensure that book PCM could not be used to 
recover costs related to inventoriable goods prior to the time when 
such costs could be recovered under sections 471 and 263A? Under what 
specific authority would it be appropriate to permit a book PCM method 
to be used to recover costs related to inventoriable goods?
    2. Would elective use of book PCM for tax purposes provide an 
appropriate cost offset? Would such a method be characterized as one 
that reports contract revenue according to a taxpayer's book method, 
while accounting for costs, including nondeductible costs, as 
deductions under the Code? If not, how would such a method account for 
costs for Federal income tax purposes?
    3. Rather than make book PCM elective, would it be appropriate for 
the definition of ``unique item'' for purposes of section 460 to be 
expanded?
    4. Section 460 requires use of the look-back method to compensate 
for improper acceleration or deferral of income under PCM. It also 
requires that all contract income be reported no later than the year 
following contract completion. Would elective use of a PCM under 
section 460 without these provisions invite abuse? If so, how could 
such abuse be prevented?

5. Allocation of Transaction Price

    The proposed regulations describe and clarify the allocation of 
transaction price under section 451(b)(4). Section 451(b)(4) provides 
that, in the case of a contract with multiple performance obligations, 
the allocation of the transaction price to each performance obligation 
shall be equal to the amount allocated to each performance obligation 
for purposes of including such item in revenue in the AFS of the 
taxpayer. Consistent with the definition of performance obligation 
found in the New Standards, proposed Sec.  1.451-3(c)(3) defines 
``performance obligation'' to mean a promise in a contract with a 
customer to transfer to the customer either a good or service (or a 
bundle of goods or services) that is distinct, or a series of distinct 
goods or services that are substantially the same and that have the 
same pattern of transfer to the customer. See ASC Topic 606 and IFRS 
15.
    Comments are requested on allocation of the transaction price (i) 
to performance obligations that are not contractually based, (ii) for 
arrangements that include both income subject to section 451 and long-
term contracts subject to section 460, and (iii) when the income 
realization event for Federal income tax purposes differs from the 
income realization event for AFS purposes.

6. Taxpayers Including Income Over Time for AFS Purposes

    Commenters proposed allowing taxpayers that include items of income 
as revenue in an AFS over a period of time under the New Standards (AFS 
over-time method) to follow that method for Federal income tax 
purposes. Allowing taxpayers to follow their AFS over-time method for 
Federal income tax purposes would potentially defer income beyond what 
is permitted under section 451(b), section 451(c), and the all events 
test. The AFS income inclusion rule operates only to accelerate income 
inclusion; the AFS income inclusion rule can never cause income 
inclusion to occur later than when the all events test is satisfied. 
Allowing taxpayers to follow their AFS over-time method for Federal 
income tax purposes may also affect the treatment of costs in a manner 
that is inconsistent with sections 461 and 471. However, the Treasury 
Department and the IRS continue to study the commenters' proposal and 
request additional comments on this issue. Specifically, additional 
comments are requested regarding: The size of taxpayers likely to be 
affected; the industries likely to be affected; the number of taxpayers 
likely to be affected; the compliance burden and administrative 
complexity likely to be avoided; and the degree to which an over-time 
method under the New Standards accelerates or defers income relative to 
the all events test and the AFS income inclusion rule.

7. Rules for Certain Debt Instruments

A. Credit Card Fees and Other Fees
    The Treasury Department and the IRS have treated certain credit 
card fees associated with pools of credit card receivables as creating 
or increasing original issue discount (OID) on those pools. See Revenue 
Procedure 2004-33 (2004-1 CB 989) (the IRS will not challenge the 
treatment of late fees as creating or increasing OID); Revenue 
Procedure 2005-47 (2005-2 CB 269) (the IRS will not challenge the 
treatment of cash advance fees as creating or increasing OID); Revenue 
Procedure 2013-26 (2013-22 IRB 1160) (safe harbor method of accounting 
for OID on a pool of credit card receivables for purposes of section 
1272(a)(6)); and Chief Counsel Notice CC-2010-018 (Sept. 27, 2010) (as 
a result of the Tax Court's decision in Capital One Financial Corp. and 
Subsidiaries v. Commissioner, 133 T.C. 136 (2009), the IRS will no 
longer challenge or litigate the issue of whether interchange fee 
income creates or increases OID).
    With the enactment of section 451(b), however, Congress expressed 
its intention to overturn the tax treatment of those credit card fees 
as OID, including the use of the OID timing rules, and subject them to 
the all events test. The Conference Report to the Act states, 
``[section 451(b)] directs accrual method taxpayers with an applicable 
financial statement to apply the income recognition rules under section 
451 before applying the special rules under part V of subchapter P . . 
.'' (which includes the OID rules). H.R. Rep. No. 115-466, at 428 
(2017) (Conf. Rep.). In particular, the legislative history describes 
the treatment of credit card late fees, credit card cash advance fees, 
and interchange fees as creating or increasing OID for Federal tax 
purposes and lists these fees as examples of amounts to which section 
451(b), as amended, would apply. Id. at 427, 429. These three credit 
card fees are not generally treated as discount for AFS purposes.
    Congress clearly expressed its intention to overturn the tax 
treatment of credit card late fees, cash advance fees, and interchange 
fees (specified credit card fees) and to subject these fees to the all 
events test as modified by section 451(b). Id. at 429. The legislative 
history quoted in the preceding paragraph further suggests that 
Congress intended that other fees associated with a lending transaction 
that might otherwise be accounted for in

[[Page 47197]]

calculating OID are to be subjected to the AFS income inclusion rule 
before the application of the OID rules. Based on the legislative 
history, however, taxpayers have stated that section 451(b) was not 
intended to affect the application of the general OID timing rules to 
OID other than with respect to items not treated as discount for 
financial reporting purposes, such as the specified credit card fees. 
Id. at 427-429. Moreover, taxpayers have stated that the application of 
section 451(b) to OID other than items not treated as discount for 
financial reporting purposes would result in significant administrative 
burden and very little additional tax revenue. The Treasury Department 
and the IRS agree with commenters on this issue. Therefore, in the 
absence of a clear indication in the legislative history that Congress 
intended for section 451(b) to override the general timing rules for 
OID, and in order to reduce administrative burden, the proposed section 
451(b) regulations would not apply to determine the time at which OID 
generally is includible in income. See Sec.  1.451-3(c)(5)(ix) of the 
proposed regulations.
    The proposed regulations contain two provisions that implement 
Congressional intent regarding the treatment of fees, including the 
specified credit card fees. First, under proposed Sec.  1.451-3(i), if 
a fee is not treated by a taxpayer as discount or as an adjustment to 
the yield of a debt instrument over the life of the instrument (such as 
points) in its AFS and the fee otherwise would be treated as creating 
or increasing OID for Federal income tax purposes (specified fee), then 
the rules in the proposed regulations under section 451(b) apply before 
the rules in sections 1271 through 1275 and the regulations thereunder. 
For example, proposed Sec.  1.451-3(i) applies to the specified credit 
card fees. Second, proposed Sec.  1.1275-2(l) includes a proposed 
amendment to the final regulations under section 1275 to clarify that 
an item of income that is subject to the timing rules in the proposed 
regulations under section 451(b) (such as the specified credit card 
fees) is not taken into account in determining the amount of OID (if 
any) on the debt instrument. Removing specified fees and specified 
credit card fees from the calculation of OID will permit taxpayers to 
apply only the rules of section 451(b) to these fees, without also 
having to apply the rules relevant to OID. In addition, the Treasury 
Department and the IRS propose to obsolete Revenue Procedure 2004-33, 
Revenue Procedure 2005-47, Revenue Procedure 2013-26, and Chief Counsel 
Notice CC-2010-018. The Treasury Department and the IRS request 
comments on the proposed obsolescence of these documents.
B. Market Discount
    Taxpayers requested guidance as to whether market discount is 
includible in income under section 451(b). The Treasury Department and 
the IRS previously announced that proposed regulations would provide 
that accrued market discount is not includible in income under section 
451(b). Notice 2018-80 (2018 IRB 609), issued September 27, 2018.
    A bond is generally treated as having market discount when the 
principal amount of the bond exceeds the holder's basis immediately 
after it was acquired by the holder. Under section 1276(a), market 
discount is includible in income only upon disposition of a market 
discount bond at a gain or the receipt of a partial principal payment, 
unless the holder of the bond elects otherwise. In each case, the 
market discount inclusion is limited to accrued market discount as 
defined in section 1276(b). In general, the timing rules for income 
inclusion in section 1276 are a codification of the pre-1984 timing 
rules for market discount and confirm that the all events test 
generally does not determine when accrued market discount is includible 
in income. The proposed regulations therefore include the market 
discount rules on the list of special methods of accounting to which 
section 451(b) does not apply.

Statement of Availability of IRS Documents

    The IRS notices, revenue rulings, and revenue procedures cited in 
this preamble are published in the Internal Revenue Bulletin (or 
Cumulative Bulletin) and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at https://www.irs.gov.

Proposed Applicability Date

    These regulations are proposed generally to apply to taxable years 
beginning on or after the date the final regulations are published in 
the Federal Register. However, in the case of a specified fee, proposed 
Sec.  1.451-3(i)(2) is proposed to apply for a taxpayer's first taxable 
year beginning one year after the date the Treasury decision adopting 
these regulations as final is published in the Federal Register. In 
general, this delayed effective date for specified fees is provided 
because the treatment of these fees is unclear for tax purposes (and in 
some cases for financial reporting purposes). This additional time will 
allow the Treasury Department and the IRS to determine the types of 
fees that should be subject to section 451(b), which will provide 
taxpayers with more certainty in complying with section 451(b) and will 
help to minimize controversies with the IRS with respect to fees.
    Until the date the Treasury decision adopting these regulations as 
final regulations is published in the Federal Register, a taxpayer may 
rely on these proposed regulations (other than the proposed regulations 
relating to specified fees) for taxable years beginning after December 
31, 2017, provided that the taxpayer: (1) Applies all the applicable 
rules contained in these proposed regulations (other than those 
applicable to specified fees), and (2) consistently applies these 
proposed regulations to all items of income during the taxable year 
(other than specified fees). Until the date the Treasury decision 
adopting these regulations as final regulations is published in the 
Federal Register, in the case of specified credit card fees, a taxpayer 
may rely on these proposed regulations for taxable years beginning 
after December 31, 2018, provided that the taxpayer: (1) Applies all 
the applicable rules contained in these proposed regulations for 
specified credit card fees, and (2) consistently applies these proposed 
regulations to all items of income during the taxable year (other than 
specified fees).

Special Analyses

I. Regulatory Planning and Review

    Executive Orders 13771, 13563, and 12866 direct agencies to assess 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits, including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity. Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, reducing costs, harmonizing rules, and promoting flexibility. 
The Executive Order 13771 designation for any final rule resulting from 
the proposed regulation will be informed by comments received. The 
preliminary Executive Order 13771 designation for this proposed rule is 
regulatory.
    The proposed regulation has been designated by the Office of 
Information and Regulatory Affairs (OIRA) as subject to review under 
Executive Order 12866 pursuant to the Memorandum of

[[Page 47198]]

Agreement (MOA, April 11, 2018) between the Treasury Department and the 
Office of Management and Budget regarding review of tax regulations. 
The Office of Information and Regulatory Affairs has designated these 
proposed regulations as significant under section 1(b) of the MOA. 
Accordingly, these proposed regulations have been reviewed by OIRA.
1. Background
    In plain language, section 451 of the Internal Revenue Code (the 
``Code'') and the proposed regulations deal with differences between 
when income is recognized for Federal tax purposes and when it is 
recognized on businesses' financial accounting statements. The recently 
enacted section 451(b) more closely aligns the timing rules of the tax 
system with general financial accounting standards.
    Under section 451(a) of the Code, any item of gross income is 
required to be included as income by the taxpayer (``recognized'') when 
it is received by the taxpayer unless, under the taxpayer's method of 
accounting, the income is properly accounted for in a different period. 
For this purpose, businesses and individuals are generally required to 
use the accounting method that is used regularly to keep their 
financial records. This may be a cash receipts and disbursements 
accounting method, under which income is recognized when payment is 
actually or constructively received, or it may be an accounting system 
based on income and expense accrual principles. Certain corporations 
and some partnerships are required to use an accrual method, and 
generally taxpayers employing inventories in their trade or business 
must use an accrual method with regard to purchases and sales of 
inventory.
    Current regulations require taxpayers using an accrual accounting 
method to report income in the taxable year in which all events that 
fix the right to receive such income have occurred, provided the amount 
can be determined with reasonable accuracy. Under IRS guidance, this 
``all events test'' is met upon the earliest of when (i) payment is 
earned through performance by the taxpayer (e.g., provision of the 
contracted goods or services), (ii) payment is due to the taxpayer, or 
(iii) payment is received by the taxpayer.
    In contrast, U.S. generally accepted accounting principles 
(``GAAP'') and international financial reporting standards (``IFRS''), 
having different purposes from tax law, may often dictate alternative 
rules as regards the timing of revenue recognition. Differences between 
these financial accounting standards and the Code in the timing of 
revenue recognition may arise for a number of reasons. For example, 
under certain circumstances, financial accounting rules may require 
revenue to be recognized when the costs of providing goods or services 
pursuant to a contract are incurred, while the all events test may not 
be satisfied until the contract obligation is fulfilled. If meeting the 
taxpayer's performance obligation occurs over more than a single 
accounting period, then this timing pattern can result in a disparity 
between the year in which the associated revenue is booked for 
financial accounting purposes and the year in which the associated 
taxable gross income is recognized.
    Congress enacted new section 451(b) in part because conformity in 
the timing of income recognition between the accrual system of 
accounting and the tax system (``book-tax conformity'') will generally 
``promote simplification and reduced compliance costs.'' See Senate 
Budget Explanation of the Bill (2017-11-20) at p. 161.
    Section 451(b) applies only to taxpayers that use the accrual 
method and have an Applicable Financial Statement (``AFS''). In plain 
language, an AFS is a financial statement certified as having been 
prepared under GAAP or IFRS. All publicly traded U.S. corporations 
possess an AFS, as do many privately held corporations and 
partnerships, which may have such certified accounting statements for 
credit purposes or for shareholder or partner reporting purposes. The 
income recognition rules for accrual-method taxpayers without an AFS 
and cash-method taxpayers are not altered by the enactment of section 
451(b) or by the proposed regulations. The Treasury Department and the 
IRS project that there were approximately 3.1 million tax-reporting 
entities in taxable year 2016 that used an accrual method of 
accounting. They further project that fewer than 10 percent of these, 
or approximately 296,000 entities had an AFS, and thus could have been 
affected by section 451(b) and the proposed regulations had these been 
in effect in taxable year 2016.
    For these taxpayers, Section 451(b) modifies the all-events test by 
stating that the test is not met for any item of income any later than 
when it is taken into account as revenue in an AFS or other designated 
financial statement (the ``AFS income inclusion rule''). Thus, this new 
rule requires taxpayers to recognize income upon the earlier of when 
the all-events test is met or when the taxpayer includes the amount in 
revenue (broadly defined) in its AFS (``AFS income inclusion rule''). 
The AFS income inclusion rule operates only in one direction--to 
accelerate in time the recognition of gross income for tax purposes. 
This acceleration occurs in situations where income has been recognized 
for financial accounting purposes before the all events test has been 
satisfied.
2. Need for the Proposed Regulations
    The proposed regulations deliver certainty and clarity to taxpayers 
affected by the Act's introduction of the new section 451(b) and allow 
them to comply with the new statutory provision with a higher level of 
confidence.
    The Treasury Department and IRS published a Notice in April 2018, 
requesting public comments regarding the application of the AFS income 
inclusion rule, the meaning of various concepts and terms used in 
section 451(b), and other implementation issues not explicitly 
addressed in the statute. As explained earlier in this Preamble, the 
proposed regulations address the comments and questions subsequently 
raised by the public.
3. Overview of the Proposed Regulations
    The proposed regulations include applicability and definitional 
guidance regarding section 451(b). Specifically, the proposed 
regulations: (1) Clarify how the AFS inclusion rule applies to multi-
year contracts; (2) describe and clarify the definition of an AFS for a 
group of entities; (3) define the meaning of the term revenue in an 
AFS; (4) define a transaction price and clarify how that price is to be 
allocated to separate performance obligations in a contract with 
multiple obligations; and (5) describe and clarify rules for 
transactions involving certain debt instruments.
4. Economic Analysis
A. Baseline
    The Treasury Department and the IRS have assessed the benefits and 
costs of the proposed regulations relative to a no-action baseline 
reflecting anticipated Federal income tax-related behavior in the 
absence of these proposed regulations.
B. Summary of Economic Effects
    The proposed regulations provide increased certainty, clarity, and 
consistency in the application of section 451(b) by providing 
definitions and clarifications regarding the statute's terms and rules. 
In the absence of such guidance, the chances that different taxpayers 
would interpret the statute differently would be exacerbated.

[[Page 47199]]

Similarly situated taxpayers might interpret the statutory provisions 
pertaining to the recognition of income differently, with one taxpayer 
pursuing a project that another comparable taxpayer might decline to 
make because of different interpretations of how the income would be 
treated under section 451(b). If this second taxpayer's activity were 
more profitable, an economic loss arises. Even in situations where 
taxpayers would generally adopt similar interpretations of the Code 
under the baseline, the lack of guidance increases opportunities for 
that interpretation to differ from what Congress intended. In this 
case, guidance provides value by bringing economic decisions closer in 
line with Congressional intent. In the context of economic activity by 
businesses that are subject to section 451(b) or that interact with 
such businesses, the proposed regulations thus help to ensure that 
similar economic activities, representing similar timing of income, are 
taxed similarly, thereby improving U.S. economic performance.
    The Treasury Department and the IRS have not undertaken 
quantitative estimates of these possible efficiency gains because any 
such quantitative estimates would be highly uncertain. For example, the 
proposed regulations include provisions to clarify how income should be 
included from multi-year contracts. The Treasury Department and the IRS 
do not have readily available data or models to determine how 
businesses might apply the AFS inclusion rule to multi-year contracts 
in the absence of the proposed regulations or under alternative 
regulatory approaches. Furthermore, even in the event that most 
businesses could be presumed to adopt a particular treatment under the 
baseline, the Treasury Department and the IRS further do not have 
readily available data or models of the volume or pattern of their 
multi-year contract payments and they thus cannot project with any 
degree of precision the differences in tax treatment taxpayers would 
experience between the proposed regulations and the baseline or 
alternative regulatory approaches. Such differences are a key component 
of the marginal effective tax rate that these contracts would 
experience, which in turn would determine how economic activity would 
be affected by the proposed regulations relative to the baseline or 
alternative regulatory approaches.
    The Treasury Department and the IRS further project that issuance 
of the proposed regulations will reduce compliance and enforcement 
costs relative to the baseline because the enhanced certainty and 
clarity they provide should make it easier for businesses to calculate 
their tax liability relative to the baseline. Greater efficiencies 
should also result from the promulgation of the proposed regulations, 
relative to the baseline, by reducing taxpayer disputes with the IRS 
that otherwise would have to be dealt with through sub-regulatory 
guidance or resolved through increased litigation. By providing greater 
certainty of how the law will be applied, the Treasury Department and 
the IRS project that the proposed regulations will reduce these 
implementation costs. The Treasury Department and the IRS have not made 
a quantitative estimate of the reduction in compliance and enforcement 
costs resulting from the proposed regulations. They have not made such 
an estimate in part because models of compliance cost are not currently 
available to provide a reasonably precise estimate of compliance costs 
in the absence of the proposed regulations.
    With these limitations in mind, part II.4.C of this Special 
Analyses section explains the rationale behind the approaches taken by 
the proposed regulations and qualitatively evaluates the alternatives 
considered.
    The Treasury Department and the IRS solicit comments on the 
economic effects of the proposed regulations.
C. Economic Effects of Specific Provisions
    The proposed regulations embody certain regulatory decisions that 
reflect the regulatory discretion of the Treasury Department and the 
IRS. These decisions specify more fully how the AFS income inclusion 
rule is to be implemented.
    The Treasury Department and IRS solicit comments on the economics 
of each of the items discussed below and of any other items of the 
proposed regulations not discussed in this section. The Treasury 
Department and the IRS particularly solicit comments that provide data, 
other evidence, or models that could enhance the rigor of the process 
by which the final regulations might be developed.
i. Application of the AFS Income Inclusion Rule to Multi-Year Contracts
    The proposed regulations clarify how section 451(b) applies to 
multi-year contracts. The Treasury Department and the IRS considered 
two alternative approaches for such contracts: (i) An annualized 
approach and (ii) a cumulative approach. Under an annualized approach, 
for each year under the contract a taxpayer would compare the income 
included as revenue in its AFS for that year and the gross income 
recognized under the all events test for that same year to determine 
its gross income inclusion, with the proviso that the total amount of 
gross income recognized under the contract is not to exceed the total 
contract price. In contrast, under a cumulative approach, in each year 
a taxpayer would compare the cumulative amount of revenue included in 
its AFS up to and including that year with the cumulative amount of 
gross income recognized under the all events test up to and including 
that year.
    Example 4 of the proposed regulations, the summary table of which 
is reproduced in the first three rows of the following table, shows the 
treatment of gross income under a cumulative approach. The fourth row 
in this table shows the treatment of gross income under the annualized 
approach.

----------------------------------------------------------------------------------------------------------------
                                       2018            2019            2020            2021            Total
----------------------------------------------------------------------------------------------------------------
Payments........................            $25x            $25x            $25x            $25x           $100x
AFS Revenue.....................             50x              0x             20x             30x            100x
Gross Income (cumulative).......             50x              0x             25x             25x            100x
Gross Income (annualized).......             50x             25x             25x              0x            100x
----------------------------------------------------------------------------------------------------------------

    An annualized approach could accelerate the recognition of taxable 
income to a greater degree than what is reflected in revenue for AFS 
purposes. In this example, such an approach would ignore in 2019 the 
fact that cumulative AFS revenue of $50x had been recognized as taxable 
gross income in 2018. Accordingly, the annualized approach would 
require that an additional $25x of income be recognized in 2019, since 
a payment of that amount was received in that year. In effect, an 
annualized approach would accelerate the recognition of $25x from 2021 
to

[[Page 47200]]

2019 relative to gross income recognition under the cumulative AFS 
income inclusion rule.
    The Treasury Department and IRS concluded that the extent of 
acceleration of income that may occur when using an annualized approach 
would be excessive relative to the cumulative approach when considered 
against the intents and purposes of the statute. The proposed 
regulations therefore adopt the cumulative approach.
ii. Applicable Financial Statement Covering a Group of Entities
    The proposed regulations provide rules for taxpayers whose 
financial results are included on an AFS covering a group of entities. 
These rules specify that, if a taxpayer's financial results are 
reported on the AFS for a group of entities, the taxpayer's AFS is the 
group's AFS. However, if the taxpayer also reports financial results on 
a separate AFS that is of equal or higher priority, then the separate 
AFS is the taxpayer's AFS. The rules also specify how a taxpayer using 
a group AFS is to determine the amount of revenue allocated to the 
taxpayer. The Treasury Department and the IRS considered as an 
alternative not providing substantive rules on how taxpayers should 
apply the AFS income inclusion rule when their financial results are 
included in an AFS for a group of entities. This alternative was 
rejected because it would have increased compliance burdens and 
potentially led to similarly situated taxpayers applying the AFS income 
inclusion rule differently.
    The Code does not specify how the AFS income inclusion rule is to 
function whenever the AFS accounting period and the taxable year do not 
coincide. The proposed regulations do not adopt a single, one-size-
fits-all approach, but rather provide taxpayers three separate options 
for addressing this situation. A change from one option to another, 
however, would be considered a change in method of accounting requiring 
the permission of the IRS. By providing taxpayers with several options, 
the proposed regulations will minimize taxpayer compliance costs when 
dealing with non-congruent tax and financial accounting periods 
relative to an alternative approach of specifying a single option, with 
no significant revenue implications or effects on economic decisions.
iii. Revenue in an AFS
    The proposed regulations describe and clarify the definition of 
revenue to broadly include all items of income under section 61. 
Because this definition of revenue is based on tax principles, there 
may be items of revenue included in this definition that adjust 
retained earnings on financial statements but are not reflected in the 
revenue line on such financial statements. The Treasury Department and 
the IRS considered and rejected a narrower definition of revenue or a 
definition that was tied to the AFS definition of revenue. The 
definition of revenue advanced in the proposed regulations is 
consistent with the current application of the all events test under 
Sec.  1.451-1(a) and ensures that all financial statement items are 
taken into account for tax purposes. In contrast, a narrow definition 
of revenue would allow, or even encourage, taxpayers to avoid the AFS 
income inclusion rule by not classifying an item as revenue on their 
financial statement.
iv. Allocation of Transaction Price
    Section 451(b)(4) specifies that, in the case of a contract which 
contains multiple performance obligations, the allocation of the 
transaction price to each obligation is determined using the allocation 
used in the AFS. The Code, however, does not define either transaction 
price or performance obligation, thus the proposed regulation defines 
these terms. The proposed regulations clarify that a transaction price 
does not include amounts collected on behalf of third parties. 
Transaction price also does not include amounts that are contingent on 
the occurrence or non-occurrence of a future event. Without these 
exclusions, section 451(b) could be used to override other provisions 
of the Code concerning the definition of what constitutes gross income. 
This result would be at odds with the purpose of section 451, which is 
not to determine the existence or the amount of gross income, but 
rather to determine the timing of its recognition. Consequently, 
alternatives to these rules were not considered here.
    Amounts included in the transaction price for an AFS are presumed 
to be not contingent, unless the taxpayer demonstrates otherwise. The 
Treasury Department and the IRS project that this rule will lead to 
reduced compliance burden for taxpayers, and reduced administrative 
costs for taxpayers and IRS and should lead to fewer taxpayer disputes 
on this issue relative to an alternative presumption regarding possible 
contingent amounts.
v. Rules for Certain Debt Instruments
    Section 451(b)(2) states that the AFS inclusion rule does not apply 
to items of gross income for which a taxpayer uses a special method of 
accounting provided under the Code. However, the Code does not apply 
this exception to special accounting rules that apply to original issue 
discount (``OID''), market discount, and certain other items with 
respect to debt instruments under part V of Subchapter P of the Code.
    The proposed regulations implement this provision regarding special 
methods of accounting, and clarify the effect of section 451(b) on the 
excepted Subchapter P rules.
    The proposed regulations implement this provision by providing a 
non-exhaustive list of special methods of accounting, and by clarifying 
how section 451(b) applies to certain credit card receivables. The 
proposed regulations specifically except from section 451(b) the timing 
rules for accrued market discount on bonds and the general OID timing 
rules, as well as the timing rules for OID determined with respect to 
special debt instruments (contingent payment and variable rate debt 
instruments, certain hedged debt instruments, and inflation-indexed 
debt instruments). Nevertheless, following the legislative history of 
the Act (see Conference Report, p. 276), the proposed regulations 
provide that credit card late fees, credit card cash advance fees, and 
interchange fees are subject to the AFS income inclusion rule. The 
proposed regulations further specify that if these credit card fees are 
subject to a taxpayer's AFS, they are not to be taken into account in 
determining whether a debt instrument associated with them has OID. 
Existing rules continue to apply to these items for taxpayers not 
possessing an AFS. The Treasury Department and the IRS expect that this 
treatment will provide a straightforward application of section 451(b) 
consistent with Congressional intent without unnecessarily complicating 
OID calculations and adding to taxpayer compliance burdens.
    The Treasury Department and the IRS considered and rejected a 
broader application of the AFS income inclusion rule to include all 
amounts determined under the OID and market discount accounting 
methods, even in cases where the items are treated as discount or as an 
adjustment to the yield of a debt instrument over the life of the 
instrument in its AFS for financial reporting purposes. The proposed 
regulations do not subject these amounts to the AFS income inclusion 
rule because these special accounting methods do not generally rely on 
the all events test to determine the timing of income inclusion and 
these current special accounting methods provide workable income-
recognition timing

[[Page 47201]]

rules that appropriately measure income. The Treasury Department and 
the IRS expect that subjecting these items to the AFS income inclusion 
rule of section 451(b) would disrupt and complicate current tax 
accounting practices with no general economic benefit.

II. Paperwork Reduction Act

    These proposed regulations do not impose any additional information 
collection requirements in the form of reporting, recordkeeping 
requirements or third-party disclosure requirements. However, because 
section 451(b) and the proposed regulations provide methods of 
accounting affecting the timing of income inclusion, the consent of the 
Commissioner under section 446(e) is required before using such method. 
The IRS expects that these taxpayers will request this consent by 
filing Form 3115, Application for Change in Accounting Method. Filing 
of Form 3115 (for taxpayers who are required to do so or who elect 
certain methods of accounting described in the proposed regulations) is 
the sole collection of information requirement imposed by the statute 
and the proposed regulations. See subsequent paragraphs for a 
description of taxpayers who would be required to change the method of 
accounting under the statute and the proposed regulations.
    For purposes of the Paperwork Reduction Act, the reporting burden 
associated with these collections of information will be reflected in 
the IRS Form 3115 Paperwork Reduction Act Submissions (OMB control 
number 1545-0074 for individual income tax returns; OMB control number 
1545-0123 for business taxpayers). On December 17, 2018, the Treasury 
Department and the IRS published Revenue Procedure 2018-60, 2018-51 IRB 
1045, which provides procedures for taxpayers to make a change in 
method of accounting to comply with section 451(b)(1)(A) and/or (b)(4). 
Taxpayers are able to request these section 451 changes using reduced 
filing requirements, such as by filing a short Form 3115, or for 
certain taxpayers, by using a streamlined method change procedure that 
involves not filing a Form 3115. See also the revenue procedure 
accompanying these regulations for similar simplified method change 
procedures to make a change in method of accounting to comply with 
these proposed regulations.
    In 2018, the IRS released and invited comment on a draft of Form 
3115 in order to give members of the public the opportunity to benefit 
from certain specific provisions made to the Code. The IRS received no 
comments on the forms during the comment period. Consequently, the IRS 
made the forms available in January 2019 for use by the public. The IRS 
notes that Form 3115 applies to changes of accounting methods generally 
and is therefore broader than section 451(b).
    Additionally, proposed Sec.  1.451-3(h) provides additional methods 
of accounting that require a taxpayer to request consent of the 
Commissioner under section 446(e) before using such method. Under 
proposed Sec.  1.451-3(h)(4)(iii), for a taxpayer with a financial 
accounting year that is different from its tax accounting year, a 
change in the method by which the taxpayer computes its revenue is a 
change in method of accounting. Under proposed Sec.  1.451-3(h)(5), a 
restatement of an AFS that changes the timing of which an item of 
income, or portion thereof, is taken into account in revenue on the AFS 
is also a change in method of accounting. The Treasury Department and 
the IRS expect that taxpayers will request this consent by filing Form 
3115.
    For a taxpayer with an AFS required to comply with section 451(b) 
and/or proposed Sec.  1.451-3, a change in the taxpayer's revenue 
recognition policies for financial accounting purposes requires the 
taxpayer to seek the consent of the Commissioner under section 446(e) 
to use the method for Federal income tax purposes. See proposed Sec.  
1.451-3(l). The reporting burden associated with the collection of 
information for a statement in lieu of the Form 3115 will be reflected 
in the Paperwork Reduction Act Submission associated with Revenue 
Procedure 2018-31, 2018-22 IRB 637 (or successor) (OMB control number 
1545-1551). See the revenue procedure accompanying these proposed 
regulations.
    The current status of the Paperwork Reduction Act submissions that 
will be revised as a result of the information collections in the 
proposed regulations is provided in the accompanying table. As 
described above, the reporting burdens associated with the information 
collections in the proposed regulations are included in the aggregated 
burden estimates for OMB control numbers 1545-0074 (in the case of 
individual filers of Form 3115), 1545-0123 (in the case of business 
filers of Form 3115), and 1545-1551 (in the case of filers subject to 
Revenue Procedure 2018-31). The overall burden estimates associated 
with the OMB control numbers below are aggregate amounts that relate to 
the entire package of forms associated with the applicable OMB control 
number and will in the future include, but not isolate, the estimated 
burden of the tax forms that will be created or revised as a result of 
the information collections in the proposed regulations. These numbers 
are therefore unrelated to the future calculations needed to assess the 
burden imposed by the proposed regulations. These burdens have been 
reported for other income tax regulations that rely on the same 
information collections and the Treasury Department and the IRS urge 
readers to recognize that these numbers are duplicates and to guard 
against overcounting the burdens imposed by tax provisions prior to the 
Act. No burden estimates specific to the forms affected by the proposed 
regulations are currently available. The Treasury Department and the 
IRS have not estimated the burden, including that of any new 
information collections, related to the requirements under the proposed 
regulations. For the OMB control numbers discussed in the preceding 
paragraphs, the Treasury Department and the IRS estimate PRA burdens on 
a taxpayer-type basis rather than a provision-specific basis. Those 
estimates capture both changes made by the Act and those that arise out 
of discretionary authority exercised in the proposed regulations (when 
final) and other regulations that affect the compliance burden for that 
form.
    The Treasury Department and IRS request comment on all aspects of 
information collection burdens related to the proposed regulations, 
including estimates for how much time it would take to comply with the 
paperwork burdens described above for each relevant form and ways for 
the IRS to minimize the paperwork burden. In addition, when available, 
drafts of IRS forms are posted for comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.htm. IRS forms are available at https://www.irs.gov/forms-instructions. Forms will not be finalized until after 
they have been approved by OMB under the PRA.

[[Page 47202]]

[GRAPHIC] [TIFF OMITTED] TP09SE19.000

D. Regulatory Flexibility Act
    It is hereby certified that these regulations will not have a 
significant economic impact on a substantial number of small entities 
within the meaning of section 601(6) of the Regulatory Flexibility Act 
(5 U.S.C. chapter 6).
    New section 451(b) of the Act requires that an item of income be 
included in gross income for tax purposes no later than when the item 
is counted as revenue in an applicable financial statement. This 
typically moves the recognition of income forward by a year or two 
compared to previous law. These proposed regulations provide general 
guidance on the rule, including the scope of the rule, exceptions to 
the rule, definitions of key terms, and examples demonstrating 
applicability of the rule.
    The Treasury Department and the IRS have estimated the number of 
small business entities that may be affected by the statute and these 
proposed regulations. The statute and proposed regulations affect only 
those business entities that (i) use an accrual method of accounting, 
and (ii) have an applicable financial statement.
    Regarding an accrual method of accounting, many small business 
entities use the cash receipts and disbursements method of accounting 
(cash method), as opposed to an accrual method, and thus are not 
subject to this provision. The percent of returns that use an accrual 
method of accounting, by entity types and for entities with gross 
receipts not greater than $25 million, are shown in the accompanying 
table.

[[Page 47203]]



                          Total Returns and Returns Using Accrual Method of Accounting
                                               [Taxable Year 2016]
----------------------------------------------------------------------------------------------------------------
                            Entities with gross receipts not greater than $25 million
-----------------------------------------------------------------------------------------------------------------
                                                                                   Returns using    Percent of
                                                                                    an accrual    returns  using
                             Entity                                Total returns     method of        accrual
                                                                    (thousands)     accounting       method of
                                                                                    (thousands)     accounting
----------------------------------------------------------------------------------------------------------------
C corporations..................................................           1,567             700              45
S corporations..................................................           4,551           1,140              25
Partnerships....................................................           3,743             860              23
Sole proprietors and LLCs.......................................          25,524             358               1
                                                                 -----------------------------------------------
    All entities................................................          35,385           3,058               9
----------------------------------------------------------------------------------------------------------------
Source: Internal Revenue Service, Statistics of Income.

    The Treasury Department and the IRS next examined the second 
condition, that only entities with an Applicable Financial Statement 
(``AFS'') are affected by the statute and the proposed regulations. The 
Treasury Department and the IRS do not have readily available data to 
measure the prevalence of entities with an AFS. However, Schedule M-3, 
which is used to reconcile an entity's net income or loss for tax 
purposes with its book income or loss, reports whether an entity has a 
certified audited income statement. Unfortunately for the current 
exercise, the Schedule M-3 is required to be filed only by entities 
possessing at least $10 million of assets. Nevertheless, it is this 
population that is far more likely to possess an AFS. Furthermore, data 
are currently available only for electronic filers.
    For taxable year 2016, approximately 87 percent of accrual-method 
entities filing Forms 1120, 1120-S, and 1065 with gross receipts of $25 
million or less were filers of electronic tax forms. About 11 percent, 
or 265,000 of these returns, included a Schedule M-3. About 40 percent 
of the returns with Schedule M-3, or 106,000, indicated they had a 
certified audited income statement.\1\ Based on the assumption that 
filers of paper tax forms have the same incidence as electronic filers 
and that entities that do not file a Schedule M-3 generally do not have 
an AFS, then the Treasury Department and the IRS estimate that roughly 
122,000 (=106,000/0.87) entities with gross receipts of $25 million or 
less are accrual-method entities that have an AFS. If 5 percent of 
entities that do not file a Schedule M-3 also have an AFS then 
approximately 247,000 entities with gross receipts of $25 million or 
less are potentially affected by the proposed regulations. These 
estimates of affected filing entities are reproduced in the following 
table.
---------------------------------------------------------------------------

    \1\ Data are based on estimates from the IRS's Research, Applied 
Analytics and Statistics Division using data from the Compliance 
Data Warehouse.

           Corporation and Partnership Returns Using An Accrual Method of Accounting Taxable Year 2016
                                             [Thousands of returns]
----------------------------------------------------------------------------------------------------------------
                            Entities with gross receipts not greater than $25 million
-----------------------------------------------------------------------------------------------------------------
                                                                      E-Filed       Paper-Filed
                                                                      returns         returns      Total returns
----------------------------------------------------------------------------------------------------------------
Returns.........................................................           2,441             361           2,802
Returns with a Schedule M-3.....................................             265            * 39           * 374
Returns with a Schedule M-3 and an audited income statement.....             106            * 16           * 122
Returns without a Schedule M-3..................................           2,176           * 322         * 2,498
Returns without a Schedule M-3, but with an audited income                ** 109           ** 16          ** 125
 statement......................................................
Returns with an audited income statement........................          ** 215           ** 32          ** 247
----------------------------------------------------------------------------------------------------------------
* Estimates are obtained by assuming paper-filed returns are similar to e-filed returns as regards the incidence
  of a filing entity having a Schedule M-3 and an audited income statement.
** Estimates are obtained by assuming that 5% of returns without a Schedule M-3 have an audited income
  statement. This compares with approximately 40% of returns with a Schedule M-3 having such a statement.
Source: Non-italic entries are estimates taken from the IRS's Research, Applied Analytics and Statistics
  Division using data from the Compliance Data Warehouse. The total number of accrual method returns of
  corporations and partnerships (2,802,000) differs slightly from that reported in the earlier table (2,700,000)
  due to the use of different data sources for the two estimates. Italicized entries are additional estimates
  obtained in the manner indicated in the table notes.

    This rule would not have a significant economic impact on small 
entities affected. The costs to comply with these proposed regulations 
are not significant. Taxpayers needing to make method changes pursuant 
to section 451(b) or the proposed regulations will be required to file 
a Form 3115. The Treasury Department and the IRS have provided 
streamlined procedures for certain taxpayers to change their method of 
accounting to comply with section 451(b), and plan to provide 
streamlined procedures for taxpayers to change to the methods of 
accounting described in these proposed regulations. See Revenue 
Procedure 2018-60, and the revenue procedure accompanying these 
regulations. Under the streamlined procedures, certain taxpayers would 
either complete only a portion of the

[[Page 47204]]

Form 3115 or would not complete the Form 3115 at all to comply with 
section 451(b). The streamlined method change procedures are available 
to taxpayers (other than a tax shelter) who satisfy the gross receipts 
test under section 448(c) and for taxpayers making such a method change 
which results in a zero section 481(a) adjustment. (For tax years 
beginning in 2018, an entity satisfied the gross receipts test if its 
average annual gross receipts was $25 million or less. For tax years 
beginning in 2019, this threshold increased to $26 million or less.) In 
addition, the Treasury Department and the IRS plan to issue a 
streamlined procedure, using a short Form 3115, for taxpayers using a 
section 451(b) method who have a change in their AFS for revenue 
recognition that requires a method change for tax purposes. See the 
revenue procedure accompanying these regulations.
    As noted in the revenue procedure accompanying these regulations, 
the estimated cumulative annual reporting and/or recordkeeping burden 
for the statutory method changes described under OMB control number 
1545-1551, before publication of the revenue procedure, is 27,336 
respondents, and a total annual reporting and/or recordkeeping burden 
of 30,580 hours. The estimated annual burden per respondent/
recordkeeper under OMB control number 1545-1551 before publication of 
this revenue procedure varies from \1/6\ hour to 8\1/2\ hours, 
depending on individual circumstances, with an estimated average of 
1\1/4\ hours. The estimated cumulative annual reporting and/or 
recordkeeping burden for the method changes described under OMB control 
number 1545-1551 after that revenue procedure is accounted for is 
27,346 respondents, and a total annual reporting and/or recordkeeping 
burden is 31,479 hours, leaving the average reporting and recordkeeping 
burden essentially unchanged. These burdens are essentially unaffected 
by these proposed regulations.
    Notwithstanding this certification, the Treasury Department and the 
IRS invite comments from the public about the impact of this proposed 
rule on small entities.
    Pursuant to section 7805(f), these regulations will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

IV. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. In 2018, that threshold is approximately $150 million. This 
rule does not include any Federal mandate that may result in 
expenditures by state, local, or tribal governments, or by the private 
sector in excess of that threshold.

V. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This rule does not have federalism 
implications and does not impose substantial direct compliance costs on 
state and local governments or preempt state law within the meaning of 
the Executive Order.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed rules. All comments will be available at https://www.regulations.gov or upon request. A public hearing will be scheduled 
if requested in writing by any person that timely submits written 
comments. If a public hearing is scheduled, notice of the date, time, 
and place for the public hearing will be published in the Federal 
Register.

Drafting Information

    The principal author of these proposed regulations is Charles 
Gorham, IRS Office of the Associate Chief Counsel (Income Tax and 
Accounting). However, other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read, in part, as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
    Section 1.451-3 also issued under 26 U.S.C. 451(b)(1)(A)(ii) and 
(b)(3)(C).
* * * * *


Sec.  1.446-1   [Amended]

0
Par. 2. Section 1.446-1 is amended by adding ``(See Sec.  1.451-1 for 
rules relating to the taxable year of inclusion.)'' between the first 
and second sentences of paragraph (c)(1)(ii)(A).
0
Par. 3. Section 1.446-2 is amended by removing ``or'' at the end of 
paragraph (a)(2)(i)(E), removing the period at the end of paragraph 
(a)(2)(i)(F) and adding in its place ``; or'' and adding paragraph 
(a)(2)(i)(G).
    The addition reads as follows:


Sec.  1.446-2  Method of accounting for interest.

    (a) * * *
    (2) * * *
    (i) * * *
    (G) Section 1.451-3(i) (special ordering rule for specified fees).
* * * * *


Sec.  1.451-1   [Amended]

0
Par. 4. Section 1.451-1 is amended by:
0
a. Adding ``(the all events test)'' to the end of the second sentence 
of paragraph (a);
0
b. Redesignating paragraphs (b) through (g) as (d) through (i); and
0
c. Adding new paragraphs (b) and reserved (c).
    The additions read as follows:


Sec.  1.451-1  General rule for taxable year of inclusion.

* * * * *
    (b) Special rule for timing of income inclusion for taxpayers with 
an applicable financial statement using an accrual method of 
accounting. For the timing of income inclusion with respect to 
taxpayers with an applicable financial statement using an accrual 
method of accounting, see also Sec.  1.451-3.
    (c) [Reserved]
* * * * *
0
Par. 5. Section 1.451-3 is added to read as follows:

[[Page 47205]]

Sec.  1.451-3  Timing of income inclusion for taxpayers with an 
applicable financial statement using an accrual method of accounting.

    (a) Table of contents. This paragraph (a) lists captioned 
paragraphs contained in Sec.  1.451-3.

Sec.  1.451-3 Timing of income inclusion for taxpayers with an 
applicable financial statement using an accrual method of 
accounting.
    (a) Table of contents.
    (b) General rule.
    (c) Definitions.
    (1) Applicable financial statement.
    (i) GAAP Statements.
    (ii) IFRS Statements.
    (iii) Other Statements.
    (iv) Additional rules for determining priority.
    (2) Equity method.
    (3) Performance obligation.
    (4) Revenue.
    (5) Special method of accounting.
    (6) Transaction price.
    (d) Exceptions to the AFS income inclusion rule.
    (e) No change in the treatment of a transaction.
    (f) No change to exclusion provisions and non-recognition 
treatments.
    (g) Contracts with multiple performance obligations.
    (1) In general.
    (2) Example.
    (h) Additional AFS issues.
    (1) AFS covering groups of entities.
    (i) In general.
    (ii) Example.
    (2) Separately stated items.
    (3) Non-separately stated items.
    (4) Computation of revenue when the AFS covers mismatched 
reportable periods
    (i) In general.
    (ii) Permissible methods to determine revenue.
    (iii) Method of accounting.
    (5) Restatement of AFS.
    (i) Special ordering rule for certain items of income with 
respect to debt instruments.
    (1) In general.
    (2) Specified fees.
    (3) Example.
    (j) Treatment of adjustments to deferred revenue in an AFS.
    (1) In general.
    (2) Example.
    (k) Cumulative rule for multi-year contracts.
    (l) Methods of accounting
    (1) In general.
    (2) Transition rule for changes in method of accounting.
    (i) In general.
    (ii) Special rules for OID.
    (iii) Qualified change in method of accounting.
    (m) Examples.
    (1) Example 1. Mismatched reportable periods.
    (2) Example 2. Provision of installation services.
    (3) Example 3. Provision of goods.
    (4) Example 4. Provision of services included in AFS without 
deferral of advance payments under section 451(c)(1)(B).
    (5) Example 5. Provision of services included in AFS with 
deferral of advance payments under section 451(c)(1)(B).
    (6) Example 6. Sale of goods with AFS revenue adjustments.
    (7) Example 7. Chargebacks.
    (8) Example 8. Sale of property using a special method of 
accounting.
    (9) Example 9. Non-recognition provisions not changed for 
Federal income tax purposes.
    (n) Applicability date.
    (1) In general.
    (2) Delayed application with respect to certain fees.
    (3) Early application of this section.
    (i) In general.
    (ii) Certain fees.
    (A) Specified credit card fees.
    (B) Specified fees.

    (b) General rule. If a taxpayer has an applicable financial 
statement (AFS), the all events test under Sec.  1.451-1(a) with 
respect to any item of gross income, or portion thereof, is met no 
later than when that item, or portion thereof, is taken into account as 
revenue in the taxpayer's AFS (the AFS income inclusion rule). Except 
as provided in paragraph (i) of this section for certain items of 
income with respect to debt instruments, the AFS income inclusion rule 
does not apply to any item of gross income, or portion thereof, when 
the timing of income for that item, or portion thereof, is determined 
using a special method of accounting, as defined in paragraph (c)(5) of 
this section. If a special method of accounting is used, income is 
taken into account as prescribed by that special method of accounting. 
See, however, paragraph (d) of this section for exceptions for 
taxpayers without an AFS and income in connection with a mortgage 
servicing contract.
    (c) Definitions. For purposes of this section, the following 
definitions apply:
    (1) Applicable financial statement. Subject to the rules in 
paragraph (c)(1)(iv) of this section, applicable financial statement 
(AFS) means the taxpayer's financial statement listed in paragraphs 
(c)(1)(i) through (iii) of this section that has the highest priority, 
including priority within paragraphs (c)(1)(i)(B) and (c)(1)(ii)(B) of 
this section. The financial statements are, in order of descending 
priority:
    (i) GAAP Statements. A financial statement that is certified as 
being prepared in accordance with generally accepted accounting 
principles (GAAP) and is:
    (A) A Form 10-K (or successor form), or annual statement to 
shareholders, filed with the United States Securities and Exchange 
Commission (SEC);
    (B) An audited financial statement of the taxpayer that is used 
for:
    (1) Credit purposes;
    (2) Reporting to shareholders, partners, or other proprietors, or 
to beneficiaries; or
    (3) Any other substantial non-tax purpose; or
    (C) A financial statement, other than a tax return, filed with the 
Federal government or any Federal agency, other than the SEC or the 
Internal Revenue Service;
    (ii) IFRS Statements. A financial statement that is certified as 
being prepared in accordance with international financial reporting 
standards (IFRS) and is:
    (A) Filed by the taxpayer with an agency of a foreign government 
that is equivalent to the SEC, and has reporting standards not less 
stringent than the standards required by the SEC;
    (B) An audited financial statement of the taxpayer that is used 
for:
    (1) Credit purposes;
    (2) Reporting to shareholders, partners, or other proprietors, or 
to beneficiaries; or
    (3) Any other substantial non-tax purpose; or
    (C) A financial statement, other than a tax return, filed with the 
Federal government or any Federal agency, other than the SEC or the 
Internal Revenue Service, or a foreign government or agency of a 
foreign government, other than an agency that is equivalent to the SEC 
or the Internal Revenue Service; or
    (iii) Other Statements. A financial statement, other than a tax 
return, filed with the Federal government or any Federal agency, a 
state government or state agency, or a self-regulatory organization 
(for example, a financial statement filed with a state agency that 
regulates insurance companies or the Financial Industry Regulatory 
Authority). Additional financial statements included in this paragraph 
(c)(1)(iii) may be provided in guidance published in the Internal 
Revenue Bulletin (see Sec.  601.601(d) of this chapter).
    (iv) Additional rules for determining priority. If a taxpayer 
restates revenue in an AFS prior to the date that the taxpayer files 
its Federal income tax return for such taxable year, for purposes of 
determining priority, the restated AFS must be used instead of the 
original AFS. A taxpayer with different financial accounting and 
taxable years that is required to file both annual financial statements 
and periodic financial statements covering less than a year with a 
government agency must use the annual statement filed with the agency 
to determine priority.

[[Page 47206]]

    (2) Equity method. Equity method means a method of accounting for 
financial accounting purposes under which an investment is initially 
recorded at cost and subsequently increased or decreased in carrying 
value by the investor's proportionate share of income and losses and 
such income or losses are reported as separate items on the investor's 
statement of income.
    (3) Performance obligation. Performance obligation means a promise 
in a contract with a customer to transfer to the customer either a good 
or service, or a combination of both, that is distinct; or a series of 
distinct goods or services, or a combination of both, that are 
substantially the same and that have the same pattern of transfer to 
the customer.
    (4) Revenue. Revenue means all transaction price amounts includible 
in gross income under section 61. The characterization of a transaction 
price in the AFS is not determinative of whether it is taken into 
account as revenue in a taxpayer's AFS. For example, any transaction 
price amount that is reported as other comprehensive income in an AFS 
is taken into account as revenue in an AFS.
    (5) Special method of accounting. Special method of accounting 
means a method of accounting permitted or required under any provision 
of the Code, the Income Tax Regulations, or other guidance published in 
the Internal Revenue Bulletin (see Sec.  601.601(d) of this chapter) 
under which an item of income is taken into account in a taxable year 
other than the taxable year in which the all events test is met. See, 
however, paragraph (i) of this section relating to certain items of 
income with respect to debt instruments. The following are examples of 
special methods of accounting to which the AFS income inclusion rule 
generally does not apply:
    (i) The crop method of accounting under sections 61 and 162;
    (ii) Methods of accounting provided in sections 453 through 460;
    (iii) Methods of accounting for hedging transactions under Sec.  
1.446-4;
    (iv) Methods of accounting for REMIC inducement fees under Sec.  
1.446-6;
    (v) Methods of accounting for gain on shares in a money market fund 
under Sec.  1.446-7;
    (vi) Methods of accounting for certain rental payments under 
section 467;
    (vii) The mark-to-market method of accounting under section 475;
    (viii) Timing rules for income and gain associated with a 
transaction that is integrated under Sec.  1.988-5, and income and gain 
under the nonfunctional currency contingent payment debt instrument 
rules in Sec.  1.988-6;
    (ix) Except as otherwise provided in paragraph (i) of this section, 
timing rules for original issue discount (OID) under section 811(b)(3) 
or 1272 (and the regulations under section 1272), income under the 
contingent payment debt instrument rules in Sec.  1.1275-4, income 
under the variable rate debt instrument rules in Sec.  1.1275-5, income 
and gain associated with a transaction that is integrated under Sec.  
1.1275-6, and income under the inflation-indexed debt instrument rules 
in Sec.  1.1275-7;
    (x) Timing rules for de minimis OID under Sec.  1.1273-1(d) and for 
de minimis market discount (as defined in section 1278(a)(2)(C));
    (xi) Timing rules for accrued market discount under sections 1276 
and 1278(b); and
    (xii) Methods of accounting provided in sections 1502 and 1503 and 
the regulations thereunder, including the method of accounting relating 
to intercompany transactions under Sec.  1.1502-13.
    (6) Transaction price. The transaction price means the gross amount 
of consideration to which a taxpayer expects to be entitled for AFS 
purposes in exchange for transferring promised goods, services, or 
other property, including amounts referred to in paragraph (i) of this 
section, but not including:
    (i) Amounts collected on behalf of third parties (for example, some 
sales taxes) that are otherwise not income to the taxpayer;
    (ii) Increases in consideration to which a taxpayer's entitlement 
is contingent on the occurrence or nonoccurrence of a future event (for 
example, bonuses contingent on performance and insurance contract 
commissions contingent on renewal) for the period in which the amount 
is contingent. Amounts included in the transaction price for AFS 
purposes are presumed to not be contingent on the occurrence or 
nonoccurrence of a future event, unless, upon examination of all the 
facts and circumstances existing at the end of the taxable year, it can 
be established to the satisfaction of the Commissioner that the amount 
is contingent on the occurrence or nonoccurrence of a future event. An 
amount included in the transaction price for AFS purposes that is 
actually or constructively received, that is due and payable, or for 
which the taxpayer has an enforceable right to payment for performance 
completed to date, however, will not be treated as contingent on the 
occurrence or nonoccurrence of a future event; or
    (iii) Reductions for amounts subject to section 461, including 
allowances, adjustments, rebates, chargebacks, refunds, rewards (for 
example, estimated redemption costs associated with loyalty programs), 
and amounts included in costs of goods sold.
    (d) Exceptions to the AFS income inclusion rule. The AFS income 
inclusion rule does not apply unless all of the taxpayer's taxable year 
is covered by an AFS. In addition, the AFS income inclusion rule does 
not apply to any item of income in connection with a mortgage servicing 
contract.
    (e) No change in the treatment of a transaction. Except as provided 
in paragraph (i)(2) of this section, the AFS income inclusion rule does 
not change the treatment of a transaction for Federal income tax 
purposes. The following are examples of transactions where the 
treatment for AFS purposes does not change the treatment of the 
transaction for Federal income tax purposes:
    (1) A transaction treated as a lease, license, or similar 
transaction for Federal income tax purposes that is treated as a sale 
or financing for AFS purposes, and vice versa;
    (2) A transaction that is not required to be marked-to-market for 
Federal income tax purposes but that is marked-to-market for AFS 
purposes;
    (3) Asset sale and liquidation treatment under section 336(e) or 
338(h)(10);
    (4) A distribution of a corporation or the allocable share of 
partnership items or an income inclusion under section 951, 951A, or 
1293(a) for Federal income tax purposes that is accounted for under the 
equity method for AFS purposes;
    (5) A distribution of previously taxed earnings and profits of a 
foreign corporation; and
    (6) A deposit or conduit payment for Federal income tax purposes 
that is treated as revenue for AFS purposes.
    (f) No change to exclusion provisions and the treatment of non-
recognition transactions. The AFS income inclusion rule does not change 
the applicability of any exclusion provision, or the treatment of non-
recognition transactions, in the Code, the Income Tax Regulations, or 
other guidance published in the Internal Revenue Bulletin (see Sec.  
601.601(d) of this chapter). The following are examples of exclusion 
provisions and non-recognition transactions that are not affected by 
the AFS income inclusion rule:
    (1) Any non-recognition transaction, within the meaning of section 
7701(a)(45), (for example, a liquidation

[[Page 47207]]

described in sections 332 and 337, an exchange described in section 
351, a distribution described in section 355, a reorganization 
described in section 368, a contribution described in section 721, or 
transactions described in sections 1031 through 1045); and
    (2) Items specifically excluded from income under sections 101 
through 140.
    (g) Contracts with multiple performance obligations--(1) In 
general. For purposes of this section, if a taxpayer's contract with a 
customer has more than one performance obligation, transaction price is 
allocated to performance obligations as transaction price is allocated 
to performance obligations in the taxpayer's AFS.

    (2) Example. Taxpayer A, a manufacturer and servicer of airplane 
parts, is a calendar-year accrual method taxpayer with an AFS. In 
2018, A enters into a $100x contract to sell airplane parts and to 
service those parts, as necessary, in 2018, 2019, and 2020. For AFS 
purposes, A allocates $40x of the total contract price to the 
delivery of parts in 2018, $10x to the provision of services in 
2018, $20x to the provision of services in 2019, and $30x to the 
provision of services in 2020. In 2018, A delivers parts and 
provides services. On its 2018 AFS, A includes the $40x for the 
delivery of parts and the $10x for the provision of services in 
revenue. Under paragraph (g)(1) of this section, because the 
contract involves multiple performance obligations, A must use its 
transaction price AFS allocation to determine whether income from 
the sale of airplane parts and services are included in revenue in 
its AFS for purposes of this section. Accordingly, under the AFS 
income inclusion rule in paragraph (b) of this section, for the $40x 
sale of airplane parts and the $10x provision of services in 2018 
the all events test is not met any later than A's 2018 taxable year.

    (h) Additional AFS issues--(1) AFS covering groups of entities--(i) 
In general. For purposes of this section, if a taxpayer's financial 
results are reported on the AFS for a group of entities, the taxpayer's 
AFS is the group's AFS. However, if the taxpayer's financial results 
are also reported on a separate AFS that is of equal or higher priority 
to the group's AFS under paragraph (c)(1) of this section, then the 
taxpayer's AFS is the separate AFS.

    (ii) Example. Taxpayer B, a reseller of computers and 
electronics, is a calendar-year accrual method taxpayer. In 2018, 
B's financial results are included in its parent corporation's 
consolidated Form 10-K filed with the SEC, but it files a separate 
Federal income tax return. Under paragraph (h)(1) of this section, 
because its financial results are reported on the AFS for its parent 
corporation, B must use its parent corporation's consolidated Form 
10-K as its AFS. Accordingly, under the AFS income inclusion rule in 
paragraph (b) of this section, for the sale of computers and 
electronics the all events test is not met any later than when the 
sale is included in its parent corporation's consolidated Form 10-K.

    (2) Separately stated items. If a group's AFS is treated as the 
taxpayer's AFS, the taxpayer must look to any separately stated items 
to determine the amount of revenue allocated to the taxpayer.
    (3) Non-separately stated items. If a group's AFS does not 
separately state items, the portion of the revenue allocable to the 
taxpayer is determined by relying on the source documents that were 
used to create the group's AFS.
    (4) Computation of revenue when the AFS covers mismatched 
reportable periods--(i) In general. If a taxpayer's AFS is prepared on 
the basis of a financial accounting year that differs from the 
taxpayer's taxable year, the taxpayer must use one of the permissible 
methods listed in paragraph (h)(4)(ii) of this section to determine 
revenue for purposes of the AFS income inclusion rule.
    (ii) Permissible methods to determine revenue. For purposes of 
paragraph (h)(4)(i) of this section, a taxpayer must use one of the 
following methods to determine revenue for the taxable year in order to 
apply the AFS income inclusion rule:
    (A) The taxpayer computes revenue by using the accounting 
principles used to create its AFS to determine whether an item would be 
included in revenue in an AFS for the taxable year as if its financial 
reporting period was the same as its taxable year, for example, by 
conducting an interim closing of its books.
    (B) The taxpayer computes revenue by including a pro rata portion 
of the revenue for each financial accounting year that includes any 
part of the taxpayer's taxable year. If the taxpayer's AFS for part of 
the taxable year is not available by the due date of the return (with 
extension), the taxpayer must make a reasonable estimate of revenue for 
the pro rata portion of the taxable year for which an AFS is not yet 
available. See Sec.  1.451-1(a) for adjustments after actual amounts 
are determined.
    (C) If a taxpayer's financial accounting year ends five or more 
months after the end of its taxable year, the taxpayer computes revenue 
for Federal income tax purposes based on the revenue reported on the 
AFS prepared for the financial accounting year ending within the 
taxpayer's taxable year. For purposes of this paragraph (h)(4)(ii)(C), 
if a taxpayer uses a 52-53 week year for financial accounting or 
Federal income tax purposes, the last day of such year shall be deemed 
to occur on the last day of the calendar month ending closest to the 
end of such year.
    (iii) Method of accounting. A change in the method of computing 
revenue under this paragraph (h)(4) is a change in method of accounting 
under section 446. A taxpayer may change its method of accounting only 
with the consent of the Commissioner as required under section 446(e) 
and the corresponding regulations.
    (5) Restatement of AFS. If a taxpayer restates revenue on an AFS 
and such restatement changes the timing of when an item of income, or a 
portion thereof, is taken into account as revenue on the AFS, the 
change constitutes a change in method of accounting under section 446. 
A taxpayer may change its method of accounting only with the consent of 
the Commissioner as required under section 446(e) and the corresponding 
regulations. If a taxpayer restates revenue on an AFS to correct an 
error or the restatement results in a change in the estimate of the 
taxpayer's pro rata portion of revenue under paragraph (h)(4)(ii)(B) of 
this section, see Sec.  1.451-1(a).
    (i) Special ordering rule for certain items of income with respect 
to debt instruments--(1) In general. If an item of income, or portion 
thereof, with respect to a debt instrument is described in paragraph 
(i)(2) of this section, the rules of this section apply before the 
rules in sections 1271 through 1275 and Sec. Sec.  1.1271-1 through 
1.1275-7 (OID rules). Therefore, an item of income, or portion thereof, 
described in paragraph (i)(2) of this section may not be taken into 
income later than when that item, or portion thereof, is taken into 
account as revenue in the taxpayer's AFS, regardless of whether the 
timing of income inclusion for that item is normally determined using a 
special method of accounting. See also Sec.  1.1275-2(l) for the 
treatment of the items described in paragraph (i)(2) of this section 
under the OID rules.
    (2) Specified fees. Paragraph (i)(1) of this section applies to 
fees (specified fees) that are not treated as discount or as an 
adjustment to the yield of a debt instrument over the life of the 
instrument (such as points) in the taxpayer's AFS and, but for 
paragraph (i) of this section and Sec.  1.1275-2(l), would be treated 
as creating or increasing OID for Federal income tax purposes. For 
example, the following specified fees (specified credit card fees) are 
described in this paragraph (i)(2):
    (i) A payment of additional interest or a similar charge provided 
with respect to amounts that are not paid when due on a credit card 
account (for example, credit card late fees);

[[Page 47208]]

    (ii) Amounts charged under a credit card agreement when the 
cardholder uses the credit card to conduct a cash advance transaction 
(for example, credit card cash advance fees); and
    (iii) Amounts a credit or debit card issuer is entitled to upon a 
purchase of goods or services by one of its cardholders (for example, 
interchange fees, which are sometimes labeled merchant discount in 
certain private label credit card transactions).

    (3) Example. Taxpayer C, a credit card issuer, is a calendar-
year accrual method taxpayer with an AFS. In 2019, a cardholder uses 
C's credit card to purchase $100 of merchandise from a merchant and 
the cardholder earns a reward of 1% of the purchase price of $100 
($1) as part of C's cardholder loyalty program. Upon purchase, C 
becomes entitled to an interchange fee equal to 2% of the purchase 
price of $100 ($2). In 2019, C reports the $2 of interchange fees as 
revenue in its AFS. C's $2 of interchange fees is described in 
paragraph (i)(2)(iii) of this section. Under paragraph (i)(1) of 
this section, C must apply the rules in this section before applying 
the OID rules. See also Sec.  1.1275-2(l). Therefore, C's $2 of 
interchange fees is included in taxable income in 2019, the year it 
is included as revenue in C's AFS. Under paragraph (c)(6)(iii) of 
this section, the $2 of interchange revenue is not reduced by the $1 
reward. Even if C reports interchange fees net of rewards in its AFS 
for 2019 ($2 of interchange fee minus $1 reward liability), under 
paragraph (c)(6) of this section, C includes $2 of interchange 
revenue in taxable income in 2019. See Sec. Sec.  162 and 461(h) for 
the treatment of the reward by C.

    (j) Treatment of adjustments to deferred revenue in an AFS--(1) In 
general. For purposes of this section, if a taxpayer treats an item of 
income as deferred revenue in its AFS and writes down or adjusts that 
item, or portion thereof, to an equity account (for example, retained 
earnings) or otherwise writes down or adjusts that item of deferred 
revenue in a subsequent taxable year, revenue for that subsequent 
taxable year includes that item, or portion thereof, that is written 
down or adjusted.

    (2) Example. Taxpayer D, a remanufacturer of industrial 
equipment, is a calendar-year accrual method taxpayer with an AFS. 
In 2018, D enters into a contract with a customer to remanufacture 
equipment in 2019 and 2020 for $100x. The contract is not a long-
term contract under section 460. In its 2018 AFS, D treats the $100x 
as deferred revenue. In 2019, all the stock of D is acquired by an 
unrelated third party. In its 2019 AFS, D adjusts deferred revenue 
to $90x (the expected cost to provide the services) by charging $10x 
($100x - $90x = $10x) to retained earnings. In its 2019 AFS, D 
includes $50x of the $90x of deferred revenue in revenue. Under 
paragraph (j)(1) of this section, D's adjustment to deferred revenue 
in 2019 is treated as revenue under paragraph (c)(4) of this section 
in 2019. Therefore, under the AFS income inclusion rule in paragraph 
(b) of this section, D is treated as including $60x ($50x + $10x = 
$60x) in revenue in its 2019 AFS, and the all events test is met for 
that $60x no later than D's 2019 taxable year.

    (k) Cumulative rule for multi-year contracts. In the case of a 
multi-year contract, a taxpayer must take into account the cumulative 
amounts included in income in prior taxable years on the contract, if 
any, in order to determine the amount to be included for the taxable 
years remaining in the contract. For purposes of this paragraph (k), 
multi-year contract means a contract that spans more than one taxable 
year.
    (l) Methods of accounting--(1) In general. A change in the method 
of recognizing revenue in an AFS that changes or could change the 
timing of the recognition of income for Federal income tax purposes is 
a change in method of accounting under section 446. A taxpayer may 
change its method of accounting only with the consent of the 
Commissioner as required under section 446(e) and the corresponding 
regulations. Accordingly, a taxpayer that changes the method of 
accounting used to recognize revenue in its AFS is required to secure 
consent of the Commissioner before computing income using this new 
method for Federal income tax purposes.
    (2) Transition rule for changes in method of accounting--(i) In 
general. Except as provided in paragraph (l)(2)(ii) of this section, a 
taxpayer that makes a qualified change in method of accounting for the 
taxpayer's first taxable year beginning after December 31, 2017, is 
treated as making a change in method initiated by the taxpayer for 
purposes of section 481(a)(2). A taxpayer obtains the consent of the 
Commissioner to make a qualified change in method of accounting by 
using the applicable administrative procedures that govern voluntary 
automatic changes in method of accounting under section 446(e). See 
section Sec.  1.446-1(e)(3).
    (ii) Special rules for OID and specified fees. The rules of 
paragraph (l)(2)(i) of this section apply to a qualified change in 
method of accounting required under section 451(b) and paragraph (i) of 
this section for the taxpayer's first taxable year beginning after 
December 31, 2018, if the change relates to a specified credit card fee 
(as defined in paragraph (i)(2) of this section). The rules of 
paragraph (l)(2)(i) of this section apply to a qualified change in 
method of accounting required under section 451(b) and paragraph (i) of 
this section for the taxpayer's first taxable year beginning one year 
after the date the Treasury decision adopting these regulations as 
final is published in the Federal Register, if the change relates to a 
specified fee (as defined in paragraph (i)(2) of this section) other 
than a specified credit card fee. For purposes of this paragraph 
(l)(2)(ii), the section 481(a) adjustment period for any adjustment 
under section 481(a) for a qualified change in method of accounting 
required under section 451(b) and paragraph (i) of this section is six 
taxable years.
    (iii) Qualified change in method of accounting. For purposes of 
paragraph (l)(2) of this section, a qualified change in method of 
accounting means any change in method of accounting that is required by 
section 13221 of the Tax Cuts and Jobs Act, Public Law 115-97 (131 
Stat. 2054) (TCJA), or was prohibited under the Internal Revenue Code 
of 1986 prior to TCJA section 13221 and is now permitted as a result of 
TCJA section 13221.
    (m) Examples. The following examples illustrate the provisions of 
this section:

    (1) Example 1. Mismatched reportable periods. Taxpayer A is a 
calendar-year accrual method taxpayer with an AFS. For AFS purposes, 
A's financial results are reported on a June 30 fiscal year. Using 
the method described in paragraph (h)(4)(ii)(A) of this section, for 
the taxable year 2018, A uses the financial results reported on its 
June 30, 2018, AFS to determine whether an item of income was taken 
into account as revenue in A's AFS from January 1, 2018, through 
June 30, 2018, and uses its June 30, 2019, AFS to determine whether 
an item of income is taken into account as revenue in A's AFS from 
July 1, 2018, through December 31, 2018.
    (2) Example 2. Provision of installation services. Taxpayer B is 
a calendar-year accrual method taxpayer with an AFS. In 2018, B 
enters into a contract with a customer to provide manufacturing 
equipment installation services for $100,000. Throughout the 
contract, the customer retains control of the equipment. B has an 
enforceable right to payment for services partially performed. The 
contract is not a long-term contract under section 460. B begins 
providing the installation services in 2018 and completes the 
installation services in 2019. Under the contract, B bills the 
customer $50,000 in 2018 when installation begins. B includes 
$60,000 in revenue in its 2018 AFS and $40,000 in revenue in its 
2019 AFS. Under the AFS income inclusion rule in paragraph (b) of 
this section, because $60,000 of revenue from the installation 
services is included in B's 2018 AFS, the all events test for that 
$60,000 of income is met in B's 2018 taxable year.
    (3) Example 3. Provision of goods. Taxpayer C is a calendar-year 
accrual method taxpayer with an AFS. In 2018, C enters into

[[Page 47209]]

a contract with a customer to provide 50 customized computers for 
$80,000. Under the contract, C can bill $80,000 after the customer 
accepts delivery of the computers. However, because of the 
customization, the contract provides that C can be paid for work 
performed to date, even if the contract is not completed for reasons 
other than C's failure to perform. C delivers all of the computers 
in 2018. Customer accepts delivery of the computers and C bills the 
customer in 2019. C includes all $80,000 in revenue in its 2018 AFS. 
Under the AFS income inclusion rule in paragraph (b) of this 
section, because $80,000 of revenue from the provision of goods is 
included in C's 2018 AFS, the all events test for that $80,000 of 
income is met in C's 2018 taxable year. Under paragraph (c)(6)(ii) 
of this section, the limitation on C's ability to bill until after 
the customer accepts delivery of the computers is not a future event 
that restricts C's enforceable right to payment for the goods.
    (4) Example 4. Provision of services included in AFS without 
deferral of advance payments under section 451(c)(1)(B). Taxpayer D, 
an engineering services provider, is a calendar-year accrual method 
taxpayer with an AFS. In 2018, D enters into a contract with a 
customer to provide services for four years for a total of $100x. 
Under the contract, D receives $25x each year of the contract. D 
does not elect to defer advance payments under section 451(c)(1)(B). 
For AFS purposes, D reports $50x, $0, $20x, and $30x of revenue from 
the contract in 2018, 2019, 2020, and 2021, respectively. Under 
paragraph (g)(1) of this section, the allocation of the transaction 
price in D's AFS is used to determine when all or part of that item 
is taken into account for purposes of paragraph (b) of this section. 
In 2018, D includes all of the $25x payment in income from the 
contract under the all events test. In addition, under paragraph (b) 
of this section, because $50x of revenue from the provision of 
services is included in D's 2018 AFS, the all events test for that 
portion of the provision of services is not met later than D's 2018 
taxable year. Therefore, D must include the additional $25x ($50x-
$25x = $25x) reported on the AFS as income in 2018. In 2019, under 
paragraph (k) of this section, D includes $0 of the $25x payment in 
income from the contract because the payment received in 2019 
relates to income included in 2018. In 2020, D includes all of the 
$25x payment in income from the contract under the all events test. 
In 2021, D includes the remaining $25x payment in income under the 
contract under the all events test. This example is summarized in 
the table below:

----------------------------------------------------------------------------------------------------------------
                                       2018            2019            2020            2021            Total
----------------------------------------------------------------------------------------------------------------
Payments........................            $25x            $25x            $25x            $25x           $100x
AFS Revenue.....................             50x               0             20x             30x            100x
Income..........................             50x               0             25x             25x            100x
----------------------------------------------------------------------------------------------------------------

    (5) Example 5. Provision of services included in AFS with 
deferral of advance payments under section 451(c)(1)(B). The facts 
are the same as in Example 4 in paragraph (m)(4) of this section, 
except D elects to defer advance payments under section 
451(c)(1)(B). Under paragraph (g)(1) of this section, the allocation 
of the transaction price in D's AFS is used to determine when all or 
part of that item is taken into account for purposes of paragraph 
(b) of this section. In 2018, D includes all of the $25x payment in 
income from the contract under the all events test. In addition, 
under paragraph (b) of this section, because $50x of revenue from 
the provision of services is included in D's 2018 AFS, the all 
events test for that portion of the provision of services is not met 
later than D's 2018 taxable year. Therefore, D must include an 
additional $25x ($50x--$25x = $25x) of income in 2018. In 2019, 
under paragraph (k) of this section, D includes $0 of the $25x 
payment in income from the contract because the payment received in 
2019 relates to income included in 2018. In 2020, D includes $20x of 
the $25x payment in income from the contract under the deferral 
method for advance payments under section 451(c)(1)(B). In 2021, D 
includes the $5x that was deferred in 2020 under the deferral method 
for advance payments under section 451(c)(1)(B) and the remaining 
$25x payment in income under the contract under the all events test. 
This example is summarized in the table below:

----------------------------------------------------------------------------------------------------------------
                                       2018            2019            2020            2021            Total
----------------------------------------------------------------------------------------------------------------
Payments........................            $25x            $25x            $25x            $25x           $100x
AFS Revenue.....................             50x               0             20x             30x            100x
Income..........................             50x               0             20x             30x            100x
----------------------------------------------------------------------------------------------------------------

    (6) Example 6. Sale of goods with AFS revenue adjustments. 
Taxpayer E, a manufacturer of automobile parts, is a calendar-year 
accrual method taxpayer with an AFS. E normally sells parts for $10 
per part with a 2% bonus if the parts are delivered on time. 
Traditionally, 5% of parts sold are returned. In 2018, E enters a 
contract to sell 1,000 parts to a customer for $10 per part, for a 
total of $10,000 (1,000 x $10 = $10,000). The contract also provides 
that E will receive a 2% bonus if it delivers all the parts to the 
customer by February 1, 2019. E delivers 500 parts to the customer 
on December 31, 2018. On December 31, 2018, the additional 500 parts 
were scheduled for shipment to the customer on January 4, 2019. For 
AFS purposes, E expects to earn the 2% bonus and to have 5% of the 
parts returned. In its 2018 AFS, E reports $4,850 ($5,000 + $100--
$250 = $4,850) of revenue from the contract, including a $100 (2% x 
$5,000 = $100) adjustment for the expected bonus and a $250 (5% x 
$5,000 = $250) adjustment for anticipated returns. Under paragraph 
(c)(6)(iii) of this section, E's transaction price does not include 
anticipated returns. See Sec.  1.461-4(g)(3) for rules on when the 
return liability is incurred. Under paragraph (c)(6)(ii) of this 
section, the performance bonus is presumed not to be contingent on 
the occurrence or nonoccurrence of a future event. However, at the 
end of the year, all parts have yet to be delivered within the 
February 1, 2019 deadline. Under the contract, E has no right to 
payment of the bonus at the end of the year. Therefore, the 
presumption is rebutted. In addition, under paragraph (g)(1) of this 
section, the allocation of the transaction price in E's AFS is used 
to determine when all or part of that item is taken into account for 
purposes of paragraph (b) of this section. Accordingly, under 
paragraph (b) of this section, because $5,000 of revenue from the 
sale of parts is taken into account in E's 2018 AFS, the all events 
test for $5,000 of income allocated to those parts is met in E's 
2018 taxable year.
    (7) Example 7. Chargebacks. Taxpayer F, a manufacturer of 
pharmaceuticals, is a calendar-year accrual method taxpayer with an 
AFS. In addition to billing the wholesaler for the sale of the 
pharmaceutical at the wholesale acquisition cost under the contract, 
F generally credits or pays wholesalers a chargeback of 40% of the 
wholesale acquisition cost for sales made by those wholesalers to 
qualifying customers. In 2018, F enters into a contract to sell 
1,000 units to W, a wholesaler, for $10 per unit, totaling $10,000 
(1,000 x $10 = $10,000). The contract also provides that F will 
issue a 40% chargeback for sales by W to certain qualifying 
customers. F delivers 600 units to W on December 31, 2018, and bills 
W $6,000 under the contract. For AFS purposes, F adjusts its revenue 
by 40% for all sales to W for anticipated chargebacks. As such, in 
its 2018 AFS, F reports $3,600 ($6,000 - $2,400 = $3,600) of revenue 
from the contract with W, decreasing revenue by $2,400 (40% x $6,000 
= $2,400) for anticipated chargeback claims. For Federal income tax 
purposes, under paragraph (c)(6)(iii) of this section, F's 2018 
revenue is $6,000 because F's revenue is not reduced for anticipated 
chargebacks.
    (8) Example 8. Sale of property using a special method of 
accounting. Taxpayer G, a

[[Page 47210]]

provider of financial services, is a calendar-year accrual method 
taxpayer with an AFS. In 2018, G sells a building for $100x, payable 
in five annual payments of $20x starting in 2018. In its 2018 AFS, G 
reports all $100x of revenue from the sale of the building. For 
Federal income tax purposes, G uses the installment method under 
section 453 for the sale of the building. Under paragraph (c)(5) of 
this section, the installment method under section 453 is a special 
method of accounting because it requires income to be taken into 
account in a taxable year other than the taxable year in which the 
all events test is met. Therefore, under paragraph (b) of this 
section, this section does not apply to G's sale of the building 
because it is using a special method of accounting and the income is 
taken into account as prescribed in section 453.
    (9) Example 9. Non-recognition provisions not changed for 
Federal income tax purposes. Taxpayer H (Distributing) is a 
calendar-year accrual method C corporation with an AFS. On December 
31, 2018, Distributing (i) contributes assets to a wholly owned 
subsidiary (Controlled) in exchange for Controlled stock and $100x, 
and (ii) distributes all of Controlled's stock pro rata to its 
shareholders. The transaction qualifies as a reorganization under 
section 368(a)(1)(D) and a distribution to which section 355 applies 
(D reorganization). Distributing's realized gain on the transferred 
assets for book and tax purposes is $150x. On January 15, 2019, in 
pursuance of the plan of reorganization, Distributing distributes 
the $100x to its shareholders. Consequently, no gain to Distributing 
is recognized under section 361(b)(1)(A). On Distributing's 2018 
AFS, Distributing recognizes revenue of $150x related to the D 
reorganization. Under paragraph (f) of this section, nothing in 
section 451(b) or this section changes the applicability of any 
deferral, non-recognition, or exclusion provision of the Code, the 
Income Tax Regulations, or other guidance published in the Internal 
Revenue Bulletin. Section 361 provides that Distributing does not 
recognize any gain from the D reorganization. Pursuant to paragraph 
(f) of this section, nothing in section 451(b) or this section would 
change the result that Distributing does not recognize gain on 
Distributing's (i) contribution of assets to Controlled, (ii) 
receipt of Controlled stock and cash, and (iii) distribution of 
Controlled stock and cash to Distributing's shareholders.
    (10) Example 10. Insurance contract renewals. The taxpayer, an 
insurance agent, is engaged by an insurance carrier to sell 
insurance. By written binding contract between the taxpayer and the 
insurance carrier, the taxpayer is entitled to receive a $50 
commission from the insurance carrier at the time a policy is sold 
to a customer. The written binding contract also provides that the 
taxpayer is entitled to receive an additional $25 commission each 
time a policy is renewed. The taxpayer sells 1,000 one-year policies 
in year one, of which 800 are renewed in year two and 700 are 
renewed in year three. The taxpayer does not have any ongoing 
obligation to provide additional services to the insurance carrier 
or the customers after the initial sale of the policy. The taxpayer 
includes $86,000 in revenue in its AFS for year one, which includes 
$50,000 of consideration for policies sold in year one and an 
estimate of $36,000 of consideration for the policies expected to be 
renewed in years two and three. Under paragraph (c)(6)(ii) of this 
section, because the taxpayer is able to demonstrate by written 
binding contract that the amounts related to future insurance 
contract renewals are contingent on the occurrence of a future event 
(that is the customer contract renewal), the taxpayer's transaction 
price from commissions is $50,000 ($50 * 1,000) in year one, $20,000 
($25 * 800) in year two, and $17,500 ($25 * 700) in year three.

    (n) Applicability date--(1) In general. Except as provided in 
paragraph (n)(2) of this section, these regulations are proposed to 
apply for taxable years beginning after the date the Treasury decision 
adopting these regulations as final is published in the Federal 
Register.
    (2) Delayed application with respect to certain fees. 
Notwithstanding paragraph (n)(1) of this section, paragraph (i)(2) of 
this section is proposed to apply to specified fees (as defined in 
paragraph (i)(2) of this section) other than specified credit card fees 
(as defined in paragraph (i)(2) of this section) for taxable years 
beginning one year after the date the Treasury decision adopting these 
regulations as final is published in the Federal Register.
    (3) Early application of this section--(i) In general. Except as 
provided in paragraph (n)(3)(ii) of this section, until the date the 
Treasury decision adopting these regulations as final regulations is 
published in the Federal Register, a taxpayer may rely on these 
proposed regulations for taxable years beginning after December 31, 
2017, if the taxpayer applies all the applicable rules contained in 
these proposed regulations (other than those applicable to specified 
fees), and consistently applies these proposed regulations to all items 
of income during the taxable year (other than specified fees).
    (ii) Certain fees--(A) Specified credit card fees. Until the date 
the Treasury decision adopting these regulations as final regulations 
is published in the Federal Register, in the case of a specified credit 
card fee, a taxpayer may rely on these proposed regulations for taxable 
years beginning after December 31, 2018, if the taxpayer applies all 
the applicable rules contained in these proposed regulations for a 
specified credit card fee, and consistently applies these proposed 
regulations to all items of income during the taxable year (other than 
specified fees that are not specified credit card fees).
    (B) Specified fees. Paragraph (n)(3)(i) of this section does not 
apply to specified fees that are not specified credit card fees.
0
Par. 6. Section 1.1275-2 is amended by adding paragraph (l) to read as 
follows:


Sec.  1.1275-2  Special rules relating to debt instruments.

* * * * *
    (l) OID rule for income item subject to section 451(b)--(1) In 
general. Notwithstanding any other rule in sections 1271 through 1275 
and Sec. Sec.  1.1271-1 through 1.1275-7, if, and to the extent, a 
taxpayer's item of income with respect to a debt instrument is subject 
to the timing rules in Sec.  1.451-3(i) (including credit card late 
fees, credit card cash advance fees, or interchange fees), then the 
taxpayer does not take the item into account to determine whether the 
debt instrument has any OID. As a result, the taxpayer does not treat 
the item as creating or increasing any OID on the debt instrument.
    (2) Applicability dates--(i) In general. Except as provided in 
paragraphs (l)(2)(ii) and (iii) of this section, paragraph (l)(1) of 
this section applies for taxable years beginning after the date the 
Treasury decision adopting these regulations as final is published in 
the Federal Register.
    (ii) Early adoption. Until the date the Treasury decision adopting 
these regulations as final regulations is published in the Federal 
Register, a taxpayer may rely on these proposed regulations for taxable 
years beginning after December 31, 2018, for a specified credit card 
fee as defined in Sec.  1.451-3(i)(2), if applied consistently to all 
specified credit card fees subject to Sec.  1.451-3(i).
    (iii) Applicability date for purposes of accounting method changes. 
Paragraph (l)(1) of this section will not apply for purposes of 
applying section 13221(e) of the Tax Cuts and Jobs Act, Public Law 115-
97 (131 Stat. 2054) to determine the section 481(a) adjustment period 
for any adjustment under section 481(a) for a qualified change in 
method of accounting required under section 451(b) and Sec.  1.451-3(i) 
for the items subject to Sec.  1.451-3(i).

Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2019-19325 Filed 9-5-19; 4:15 pm]
 BILLING CODE 4830-01-P