Overview of Modifications to Income 

Recognition under Section 451

by Public Law 115-97

Prepared by the Staff of the Joint Committee on Taxation

April 2019
Overview

 Public Law 115-97 made two changes to the income recognition rules for 

accrual method taxpayers:

 New section 451(b) –

 Modifies the all events test to provide that sales, gross receipts, and other items are 

included in income no later than the taxable year in which such income is included as 

revenue for book purposes

 Overrides certain special rules for bonds and other debt instruments and provides 

that such items are instead subject to the all events test (as modified)

 New section 451(c) – Advance payments may only be deferred using the oneyear deferral method

 Effective for taxable years beginning after December 31, 2017

 However, in the case of income from a debt instrument with original issue 

discount (“OID”), the changes are effective for taxable years beginning after 

December 31, 2018

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Background

 Determining whether gross income is subject to tax generally is a two step 

process

 Step 1: Section 61 (realization)

 Does the taxpayer have gross income (e.g., has the taxpayer entered into a 

transaction)?

 Gross income generally includes all items that are clearly realized accessions to 

wealth in any form

 Step 2: Section 451 (recognition)

 When should the taxpayer recognize such gross income?

 Generally determined under the taxpayer’s overall method of accounting:

 Cash method

 Accrual method

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Background: Realization

 Gross income generally includes all items that are clearly realized 

accessions to wealth in any form

 Generally a factual determination

 To have a “clearly realized accession to wealth” generally requires that 

there be a transaction involving the taxpayer

 For certain situations, the Code prescribes the time at which 

realization is deemed to occur

 For example, taxpayers that mark to market securities are deemed to have 

sold such securities on the last day of the tax year and must include in 

taxable income the resulting deemed gain or loss

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Background: Gross Income for Businesses 

Involving the Sale of Property

 For businesses involving the sale of property, gross income for the 

taxable year generally is equal to total sales less the cost of goods 

sold

 Total sales: Amount determined under taxpayer’s method of accounting for 

sales and/or gross receipts (i.e., section 451)

 Cost of goods sold: Amount determined under taxpayer’s method of 

accounting for:

 Liabilities to provide property to others under the economic performance rules of section 461(h)

 Inventory under sections 471 and 472

 Direct and indirect costs incurred to produce and/or acquire the property under the uniform 

capitalization rules under section 263A

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Background: Cash Method

 Taxpayer generally recognizes items of income when actually or constructively 

received

 Public Law 115-97 expanded the universe of taxpayers eligible to use the cash 

method to include:

 Businesses (excluding tax shelters) with average annual gross receipts that do not exceed 

$25 million (over the prior three taxable years)

 Businesses with average annual gross receipts in excess of $25 million (over the prior 

three taxable years) that are not required to maintain inventories and that are:

 Qualified personal service corporations

 S corporations

 Partnerships that do not have a C corporation partner

 Sole proprietorships

 Farming businesses that are not a C corporation (or that do not have a C corporation partner)

 All other businesses generally are required to use an accrual method

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Background: Accrual Method

 Taxpayer generally recognizes items of income when all the events have occurred that 

fix the right to receive the income and the amount can be determined with reasonable 

accuracy (the “all events test”)

 Taxpayers generally have a fixed right to receive income upon the earlier of when an 

amount is:

 Due

 Paid

 Earned

 For services, when an amount may be considered earned depends on the type of 

services provided:

 Severable services: as each separate portion of the services is provided

 Severable services generally are those performed on a regular basis over a period of time and for which 

performance may be considered partially complete upon the completion of interim tasks, deliverables, or 

milestones (for example, periodic cleaning or janitorial services provided at regular intervals)

 Non-severable services: when all services have been provided

 Non-severable services generally are those which cannot be separated into components and are 

performed as a single task to meet the needs of the customer (for example, certain construction services)

 Special methods of accounting that provide an exception to the all events test may 

apply (for example, long-term contracts subject to section 460)

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Background: Accrual Method

 Taxpayer receiving an advance payment for goods or services 

generally includes such payment in income in the year of receipt 

under the all events test

 However, prior to Public Law 115-97, the taxpayer could elect to 

apply special deferral rules:

 One-year deferral

 Deferral may not exceed the income deferred for book purposes

 Rev. Proc. 2004-34

 Two-year deferral

 Only applicable to substantial advance payments for inventoriable goods

 Treas. Reg. sec. 1.451-5(c)

 Multiyear deferral

 Only applicable to an advance payment for goods

 Treas. Reg. sec. 1.451-5(b)(1)(ii)

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Background: Changes to Book Accounting

 For reporting periods beginning after December 15, 2017, the generally 

accepted accounting principles (“GAAP”) for revenue recognition also 

changed

 Effective for reporting periods beginning after December 15, 2018, for 

nonpublic companies

 Published in Accounting Standards Update No. 2014-09 and codified in 

Accounting Standards Codification (“ASC”) 606, Revenue Recognition

 Specifically, the changes affect the GAAP rules for determining:

 The amount of revenue to which a company expects to be entitled (i.e., 

realization)

 The timing of when such amount is included in revenue in the company’s financial 

statements (i.e., recognition)

 The revised GAAP rules generally result in the acceleration of revenue 

related to long-term arrangements and contingent future events

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Overview

 Public Law 115-97 made two changes to the income recognition rules for 

accrual method taxpayers:

 New section 451(b) –

 Modifies the all events test to provide that sales, gross receipts, and other items are 

included in income no later than the taxable year in which such income is included as 

revenue for book purposes

 Overrides certain special rules for bonds and other debt instruments and provides 

that such items are instead subject to the all events test (as modified)

 New section 451(c) – Advance payments may only be deferred using the oneyear deferral method

 Public Law 115-97 did not change:

 Tax realization principles under section 61

 Income recognition rules for:

 Cash method taxpayers

 Accrual method taxpayers that do not have an applicable financial statement

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Scope

 Section 451(b) and (c) are only applicable to taxpayers that:

 Are required to use an accrual method, and

 Have an applicable financial statement (“AFS”)

 An AFS generally includes (in order of priority):

 Audited annual financial statement filed with the Securities and Exchange Commission 

(“SEC”)

 Audited financial statement used for

 Credit purposes

 Reporting to shareholders, partners, beneficiaries, or other proprietors, or to beneficiaries

 Any other substantial nontax purpose

 Audited financial statement filed with any other Federal agency for nontax purposes (but 

only if none of the above statements exist)

 Financial statement prepared using international accounting standards and filed with a 

foreign agency similar to the SEC with similar reporting requirements

 Financial statement filed with any other regulatory or governmental body specified by the 

Secretary of the Treasury (but only if none of the above statements exist)

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Deferral of Advance Payments

 Taxpayers may defer including all or a portion of an advance 

payment for goods or services in income until the following tax year 

if such amount is also deferred for book purposes

 Generally codifies the one-year deferral method previously 

provided in Rev. Proc. 2004-34 for advance payments for goods 

and services

 Treasury may issue guidance applying section 451(c) to advance 

payments for other items as well

 However, the statute prescribes a list of items for which a one-year 

deferral is not available (see appendix for the list)

 Repeals the two-year and multiyear deferral methods

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Deferral of Advance Payments: Example

 Taxpayer agrees to manufacture 500 widgets at a price of 

$10 each for a customer

 Taxpayer receives a prepayment of $5,000 in Year 1

 Taxpayer manufactures the widgets during Year 2 and

Year 3

 Taxpayer delivers all 500 widgets to the customer in Year 3

 Taxpayer’s financial statements include the $5,000 in revenue 

during Year 3

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Deferral of Advance Payments: Example 

(cont’d)

 Under the all events test (absent a special rule allowing deferral): 

Taxpayer recognizes $5,000 in income in Year 1 (i.e., in the year of 

receipt)

 Under the prior-law rules for advance payments, Taxpayer could select 

from two potential methods:

 Rev. Proc. 2004-34 (one-year deferral method): Taxpayer recognizes $5,000 

in income in Year 2 (i.e., in the year following receipt of the advance payment), 

or

 Treas. Reg. sec. 1.451-5(c) (two-year deferral method): Taxpayer recognizes 

$5,000 in income in Year 3 (i.e., in the year included in revenue for book 

purposes)

 Under new section 451(c) (one-year deferral method): Taxpayer 

recognizes $5,000 in income in Year 2 (i.e., in the year following receipt of 

the advance payment)

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Modification of the All Events Test

 Taxpayers must include sales, gross receipts, and other items in 

gross income no later than the taxable year in which such 

income is included in revenue for book purposes

 Generally amends the all events test to include a fourth prong 

such that income is recognized upon the earlier of when the 

amount is:

 Due

 Paid

 Earned

 Included in revenue in the taxpayer’s financial statement

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Modification of the All Events Test: Example 

(Severable Services)

 Taxpayer enters into a one-year contract to provide cleaning 

services twice per month for $100 per cleaning service

 Taxpayer invoices the customer and receives payment of $200 after 

the end of each month

 Taxpayer provides cleaning services 10 times during Year 1 and 14 

times during Year 2

 Taxpayer receives payment of $800 in Year 1 and $1,600 in

Year 2

 Taxpayer includes in revenue in its financial statement $1,000 in 

Year 1 and $1,400 in Year 2

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Modification of the All Events Test: Example 

(Severable Services - continued)

 Under the prior-law all events test:

 Taxpayer recognizes income upon the earlier of:

 Due (i.e., after the end of each month in which cleaning services are 

provided)

 Paid (i.e., after the end of each month in which cleaning services are 

provided)

 Earned (i.e., each time cleaning services are provided)

 Year 1: Taxpayer recognizes $1,000 in income (10 cleaning services 

times $100 per service) as the income is earned each time cleaning 

services are provided

 Year 2: Taxpayer recognizes $1,400 in income (14 cleaning services 

times $100 per service) as the income is earned each time cleaning 

services are provided

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Modification of the All Events Test: Example 

(Severable Services - continued)

 Under the modified all events test:

 Taxpayer recognizes income upon the earlier of:

 Due (i.e., after the end of each month in which cleaning services are provided)

 Paid (i.e., after the end of each month in which cleaning services are provided)

 Earned (i.e., each time cleaning services are provided)

 Included in revenue in the taxpayer’s financial statement (i.e., each time cleaning 

services are provided)

 Year 1: Taxpayer recognizes $1,000 in income (10 cleaning services times 

$100 per service) as the income is earned each time cleaning services are 

provided

 Year 2: Taxpayer recognizes $1,400 in income (14 cleaning services times 

$100 per service) as the income is earned each time cleaning services are 

provided

 Taxpayer’s income recognition timing is not affected by new section 451(b)

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Modification of the All Events Test: Example 

(Non-Severable Services)

 Taxpayer provides construction services for $100,000

 Taxpayer begins providing the construction services in Year 1 

and the work is completed in Year 2

 Taxpayer is entitled to bill and collects from the customer 

$50,000 in Year 1 when construction begins and $50,000 in 

Year 2 when construction is complete

 Taxpayer includes in revenue in its financial statement 

$60,000 in Year 1 and $40,000 in Year 2

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Modification of the All Events Test: Example 

(Non-Severable Services - continued)

 Under the prior-law all events test:

 Taxpayer recognizes income for Year 1 upon the earlier of:

 Due (i.e., when construction begins)

 Paid (i.e., upon receipt of the first payment)

 Earned (i.e., when the construction services are complete)

 Year 1: Taxpayer recognizes $50,000 in income (the 

amount due in Year 1) upon receipt of the first payment

 Year 2: Taxpayer recognizes the remaining $50,000 in 

income (the amount not previously recognized in Year

1) when the construction services are complete

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Modification of the All Events Test: Example 

(Non-Severable Services - continued)

 Under the modified all events test:

 Taxpayer recognizes income for Year 1 upon the earlier of:

 Due (i.e., when construction begins)

 Paid (i.e., upon receipt of the first payment)

 Earned (i.e., when the construction services are complete)

 Included in revenue in the taxpayer’s financial statement (i.e., based on the amount of 

construction services performed to date)

 Year 1: Taxpayer recognizes $60,000 in income (the amount included in 

revenue in the Taxpayer’s financial statements in Year 1) 

 Year 2: Taxpayer recognizes $40,000 in income (the amount not previously 

recognized in Year 1) when the construction services are complete

 Taxpayer’s income recognition timing is accelerated by new section 451(b)

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Interaction with Debt Instrument Rules

 Taxpayers must include certain income items related to bonds and other 

debt instruments in gross income under the all events test (as modified)

 Generally results in the taxpayer including such items in income upfront (when 

the income is also recognized in the financial statements) rather than including 

the items in income over time

 Affected income items include:

 Original issue discount (section 1272)

 Market discount that is taken into account as income as it ratably accrues 

(section 1278(b))

 Stripped bonds (section 1286)

 Common examples of affected items include various fees associated with 

credit cards, such as late-payment fees, cash-advance fees, and 

interchange fees

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Additional Resources

 Joint Committee on Taxation, General Explanation of Public Law 115-97

(JCS-1-18), December 2018, pp. 148-171.

 Notice 2018-35 (allows taxpayers to continue to rely on Rev. Proc. 2004-

34 until guidance under new section 451(c) is published)

 Notice 2018-80 (announcement of intent to issue proposed regulation that 

provides that accrued market discount is not subject to new section 451(b))

 Rev. Proc. 2018-60 (provides automatic consent procedures for taxpayers 

changing their method of accounting to comply with new section 451(b))

 REG-104872-18 (proposed regulation to repeal the two-year deferral 

and multiyear deferral methods previously provided for advance payments 

in Treas. Reg. sec. 1.451-5)

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Appendix

 Advance payments for the following items are excluded from the 

one-year deferral method:

 Rent

 Insurance premiums governed by Subchapter L

 Payments with respect to financial instruments

 Payments with respect to warranty or guarantee contracts under which a third 

party is the primary obligor

 Payments subject to sections 871(a), 881, 1441, or 1442

 Payments in property to which section 83 applies

 Any other payment identified by the Secretary of the Treasury

 This is consistent with the items previously excluded from the oneyear deferral method under Rev. Proc. 2004-34

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