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    Deferred Revenue

    Taxpayer sells computer software, and provides ongoing software support services that its customers renew on an annual basis. For many years, taxpayer has recognized revenue from these support services contracts in the year of receipt, even though some of the services won't be earned until the subsequent tax year.

    Should this taxpayer file for a change in accounting method, and elect to defer this revenue? Would it be permissable to take the change all in one year? For example, at the end of year X1, the amount that would have been deferred revenue on the balance sheet was $100,000; at the end of year X2, it would have been $150,000; at the end of year X3, it would have been $200,000. When/how should taxpayer apply for to change its method?

    #2
    Your "taxpayer" can apply for an overall change of accounting method, from the cash basis to the accrual basis, by submitting F-3115. That change is NOT one of the many "automatic" changes allowed, so it would require approval. If the taxpayer is an individual, I would rate his chance of success as very low. If he just wants to change his method of accounting for this one item, his chance of getting it approved is probably better, but is by no means assured. The deferral method for certain advance payments, other than rent, is an allowable method, but I don't know if a change to this method is one of the many "automatic" changes allowed. You can find out by reading the instructions for F-3115. Each of the automatic changes has a corresponding number assigned.

    If your client is an individual, and he applies for a change and it's denied, he can always form a corporation. He then transfers the software support business into the corp, and it adopts the accrual method of accounting in it's first return. If the business is already a corporation, the change is much more difficult, and expensive, to bring about.
    Roland Slugg
    "I do what I can."

    Comment


      #3
      Constructive Receipt

      Without getting into the features of the 3115, I'm wondering whether the IRS will even approve such a request, as it appears the
      situation is one of constructive receipt.

      Even if the company has a history of costs associated with this collected revenue and desired to establish a liability (reserve), they
      would only be entitled to deduct those post FY costs that were actually incurred by the due date of the tax return.

      Comment


        #4
        Buzzardbreath, I believe you misread the OP. He was asking if the revenue can be deferred, not if a reserve can be established for deducting yet-to-be-incurred expenses related to that income.

        Certain types of advance receipts, other than rent, can be reported by accrual-basis taxpayers using the deferred income method. (Regs ยง1.451-5)
        Roland Slugg
        "I do what I can."

        Comment


          #5
          Constructive Receipt

          I did go on a tangent about accruing expenses instead of deferring revenue. Thanks, Sluggo, and for anyone reading my prior post, please disregard.

          To find my error, however, I had to read the original post. I think it is a gallant effort to try and defer some of this revenue, but how can this taxpayer get beyond the IRS doctrine of "constructive receipt?"

          Comment


            #6
            Originally posted by buzzardbreath
            I think it is a gallant effort to try and defer some of this revenue, but how can this taxpayer get beyond the IRS doctrine of "constructive receipt?"
            This has nothing to do with the doctrine of constructive receipt. The T/P, the IRS and even you would agree that if a taxpayer receives payments in advance for service contracts covering a 2-year period, that he has actual, not constructive receipt of that income. Some kinds of income, such as wages and rents, are taxable when received ... period! The Regs, however, explicitly specify an exception for certain advance payments, and the kind described in the OP is one of them. See the Regs cited in a previous reply. As also stated above, twice, the election to defer can only be made by an accrual basis taxpayer. However, it may be possible (although doubtful IMO) to obtain IRS permission to change to the accrual basis for this one item. If that doesn't work, and if the benefit would be sufficient to justify doing so, then the T/P may wish to form a new corporation, yada, yada, as also suggested above.

            Is it a gallant effort to try ... or an exercise in futility? Perhaps Howco will let us all know ... some day.
            Roland Slugg
            "I do what I can."

            Comment

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