The Tax Cuts and Jobs Act (TCJA) contains a provision that generally ties revenue recognition for book purposes to income reporting for tax purposes, for tax years starting after 2017. This narrow section of the law could have a major impact on certain industries, especially as companies implement the updated revenue recognition standard under U.S. Generally Accepted Accounting Principles (GAAP).
Recognizing Revenue Under GAAP
Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, went into effect for public companies this year; it will go into effect for private companies next year. The updated standard requires businesses to use a single model for calculating the top line in their income statements under GAAP, as opposed to following various industry-specific models.
The standard doesn't change the underlying economics of a business's revenue streams. But it may change the timing of when companies record revenue in their financial statements. The standard introduces the concept of "performance obligations" in contracts with customers and requires revenue to be recorded only when these obligations are satisfied. It could mean revenue is recorded right away or in increments over time, depending on the transaction.
The changes will be most apparent for complex, long-term contracts.
Matching Book and Tax Records
Starting in 2018, the TCJA modifies Section 451 of the Internal Revenue Code to require a business which issues "applicable financial statement" generally to recognize revenue for tax purposes no later than when it's recognized for financial reporting purposes. Under Sec. 451(b), taxpayers that use the accrual method of accounting will meet the "all events test" no later than the taxable year in which the item is taken into account as revenue in a taxpayer's "applicable financial statement." An exception to this rule applies, however, with respect to any item of gross income for which the taxpayer uses a special method of accounting provided under the income tax provisions of the Internal Revenue Code.
The TCJA also added Sec. 451(c), referred to as the "rule for advance payments." At a high level, the rule can require businesses to recognize taxable income even earlier than when it's recognized for book purposes if the company receives a so-called "advance payment."
Some companies delivering complex products can receive payments from customers years before they build and deliver the product. Under ASU 2014-09, a business can't recognize revenue until it's completed its performance obligations in the contract, even if an amount has been paid in advance. However, under Sec. 451(c), companies may be taxed before they recognize revenue on their financial statements from contracts that call for advance payments.
Will The Changes Affect Your Business?
Changes in the TCJA, combined with the new revenue recognition rules under GAAP, will cause some companies to recognize taxable income sooner than in the past. In some industries, this could mean significantly accelerated tax bills. However, others won't experience any noticeable differences. Blair, Bohlé & Whitsitt can help you evaluate how the accounting rule and tax law changes will affect your company, based on its unique circumstances.