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Tax implications of the revenue recognition standard

The good news is that the new revenue recognition standard represents a single model to replace industry-specific — and often inconsistent — rules. The not-so-good news is that the tax implications of this development can be perplexing.

Today, contractors usually account for a contract as a single performance obligation. Under the new standard, however, within certain contracts two or more distinct performance obligations may be identified that must be accounted for separately.

Suppose, for example, that a contract calls for you to construct a building and to supply and install certain equipment. Depending on the facts and circumstances, the contract may be divided into two performance obligations. This would require you to allocate the transaction price between construction and equipment installation, and to recognize revenue from each separately.

The new standard may also affect accounting for long-term contracts. Typically, contractors use the percentage-of-completion method to recognize revenue over the life of a project. Under the new standard, revenue is recognized when control of a good or service is transferred to the customer. Depending on several factors, control may be transferred when the contract is complete or it may be transferred gradually over the life of a contract.

Other areas potentially affected by the new standard include contract-related costs, change orders, collectability, uninstalled materials, claims and warranties.

Here are a few more examples of how the new revenue recognition standard may affect taxes and tax planning.

Acceleration of taxable income. Under certain circumstances, revenue recognition for tax purposes is required to align with its treatment for financial reporting purposes.

So, if application of the new standard accelerates revenue recognition for financial reporting purposes, it may also accelerate recognition of taxable income. Suppose, for example, that your contracts call for advance payments. Generally, for tax purposes, advance payments are included in taxable income in the year they’re received. But there’s a limited exception. This limited exception allows you to defer tax on advance payments for goods and services for one year, to the extent they are deferred in your audited financial statements.

In some cases, the new standard’s “transfer of control” model may require you to accelerate revenue from advance payments into the year they’re received. If this happens, taxable income related to those payments will similarly be accelerated.

Percentage-of-completion method. With certain exceptions, the tax code requires contractors to account for long-term contracts using the percentage-of-completion method. But the new standard may require adjustments to that treatment for financial reporting purposes.

If the tax and financial reporting treatments diverge, applying the new standard may create a book vs. tax income difference (or alter an existing book-tax difference) that must be tracked and reported on your tax returns.

Changes in tax accounting methods. If the new standard requires you to change an accounting method for financial reporting purposes, it may be necessary or desirable to make a similar change to the corresponding tax accounting method. Changing a tax accounting method requires you to file Form 3115, “Application for Change in Accounting Method.” Depending on the nature of the change, approval may be automatic or it may require advance consent from the IRS.

System changes. As just described, adoption of the new revenue recognition standard may cause you to change your tax accounting methods, or it may create (or alter) differences between book and tax income. Either way, you must ensure that you have updated systems, policies, processes and controls in place in order to gather the data you need for both financial and tax reporting and to track any book-tax differences.

If you fail to prepare …

We’re reminded of the adage, “If you fail to prepare, you prepare to fail.” Although it’s as old as the hills, that saying certainly applies to the new revenue recognition standard. Don’t wait to take a deeper dive into what this means for your tax returns and financial statements — lay out the groundwork your company needs today to successfully address revenue recognition tomorrow.

Start today

The new revenue recognition standard will have an impact on essentially every company. Organizations should begin now by becoming familiar with the new standard, assessing the rules on specific issues that impact them, and implementing an effective and efficient plan. Contact your Rehmann advisor or call 866.799.9580.

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