Rev. Proc. 70-21

Section 1. Purpose

The purpose of this Revenue Procedure is to implement an administrative decision, made by the Commissioner of Internal Revenue in the exercise of his discretion under section 446 of the Internal Revenue Code of 1954, to allow accrual method taxpayers in certain specified and limited circumstances to defer the inclusion in gross income for Federal income tax purposes of payments received (or amounts due and payable) in one taxable year for services to be performed by the end of the next succeeding taxable year. Amounts due and payable should, for purposes of this Revenue Procedure, be treated as payments received.

Sec. 2. Background

In general, payments received for services to be performed in the future are required to be included in gross income in the taxable year of receipt. However, many problems have arisen in connection with the tax accounting treatment of payments received by accrual method taxpayers in one taxable year for services to be performed by them in the next succeeding taxable year.

Sec. 3. Permissible Methods

.01 An accrual method taxpayer who receives a payment for services to be performed by him in the future and who includes such payment in gross income in the year of receipt is using a proper method of accounting.

.02 An accrual method taxpayer who, pursuant to an agreement (written or otherwise), receives a payment in one taxable year for services, where all of the services under such agreement are required by the agreement as it exists at the end of the taxable year of receipt to be performed by him before the end of the next succeeding taxable year, may include such payment in gross income as earned through the performance of the services, except as provided in sections 3.05, 3.06, and 3.09. However, if the inclusion in income of payments received is properly deferred under the preceding sentence and for any reason a portion of such services is not performed by the end of the next succeeding taxable year, the amount allocable to the services not so performed must be included in gross income in such next succeeding year, regardless of when such services are performed.

.03 A payment received by an accrual method taxpayer pursuant to an agreement for the performance by him of services must be included in his gross income in the taxable year of receipt if under the terms of the agreement as it exists at the end of such year:

(a) Any portion of the services is to be performed by him after the end of the taxable year immediately succeeding the year of receipt; or (b) Any portion of the services is to be performed by him at an unspecified future date which may be after the end of the taxable year immediately succeeding the year of receipt, except as provided in section 3.04.

.04 A payment received for bus or streetcar tokens or transportation tickets with open dates by an accrual method taxpayer in the business of furnishing such transportation may be included in his gross income in accordance with generally accepted industry accounting practices, provided that such payment is included in gross income no later than the taxable year subsequent to the year of receipt.

.05 Where an agreement requires the performance with respect to property of a contingent service (including for this purpose the replacement of parts or materials where the obligation to replace is incidental to an agreement providing for the performance of personal services), advance payments received with respect to such agreement may be deferred from inclusion in gross income in the year of receipt only if the property to be serviced is not sold, leased, built, installed, constructed or manufactured by the taxpayer. The amount of such advance payment which is earned in a taxable year through the performance of services may be determined (i) on a statistical basis if adequate data is available to the taxpayer; (ii) on a straight-line ratable basis over the time period of the agreement if it is not unreasonable to anticipate at the end of the taxable year of receipt that a substantially ratable portion of the services will be performed in the next succeeding taxable year; or (iii) by the use of any other basis that results in a clear reflection of income.

.06 This Revenue Procedure has no application to amounts received under guaranty or warranty contracts, or to prepaid rent or prepaid interest.

.07 For purposes of this Revenue Procedure, the term "agreement" includes other agreements, written or otherwise, between the taxpayer and the person for whose benefit the performance under the first agreement is to be rendered if such other agreements provide for rendition of substantially similar performance over a period of time that is substantially consecutive to that of the first agreement.

.08 For purposes of sections 3.05 and 3.07, the term "taxpayer" includes another person if the taxpayer and such other person are owned or controlled directly or indirectly by the same interests within the meaning of section 482 of the Code and section 1.482-1(a) of the Income Tax Regulations.

.09 The amount of any advance payment includible in the taxable year of receipt under the foregoing rules shall be no less than the amount of such payment included for purposes of all reports (including consolidated financial statements) to shareholders, partners, other proprietors, beneficiaries, and for credit purposes.

.10 The above rules may be illustrated in part as follows: (1) On November 1, 1970, A, a calendar year accrual method taxpayer in the business of giving dancing lessons, receives a payment for a one-year contract commencing on that date which provides for 48 individual, one-hour lessons. Eight lessons are provided in 1970. Under the method prescribed in section 3.02, A must include 1/6 of the payment in income for 1970, and 5/6 of such payment in 1971, regardless of whether A is for any reason unable to give all the lessons under the contract by the end of 1971.

(2) Assume the same facts as in Example 1 except that the payment is received for a two-year contract commencing on November 1, 1970, under which 96 lessons are provided. The taxpayer must include the entire payment in his gross income in 1970 since a portion of the services may be performed in 1972.

(3) On June 1, 1970, B, a calendar year accrual method taxpayer who is a landscape architect, receives a payment for services which, under the terms of the agreement, must be completed by December 1971. On December 31, 1970, B estimates that 3/4 of the work under the agreement has been completed. Under the method prescribed in section 3.02, B must include 3/4 of the payment in 1970. The remaining 1/4 of such payment must be included in 1971, regardless of whether B is for any reason unable to complete the job in 1971.

(4) In 1970, C, a calendar year accrual method taxpayer in the television repair business, receives payments for one-year contracts under which C agrees to repair or replace certain parts in the customer's television set if such parts fail to function properly. The television sets to be serviced under C's contracts were not sold by C or by a person related to C within the meaning of section 3.08. Therefore, the requirement of section 3.05 is satisfied, and C may adopt the method prescribed in section 3.02. Under such method C must include such payments in income over the period earned in accordance with one of the bases prescribed in section 3.05, provided that any portion of the payments not included in income in 1970 must be included in income in 1971.

(5) In 1970, D, a calendar year accrual method taxpayer in the business of manufacturing, selling, and servicing television sets, receives payments for television sets sold with one-year service contracts. Since the property to be serviced is sold by D, the requirement of section 3.05 is not satisfied. Thus, D may not adopt the method prescribed in section 3.02, and the entire amount of the payments received in 1970 is includible in his gross income for such taxable year.

.11 If a taxpayer has adopted the method prescribed in section 3.02, and if in a taxable year the taxpayer dies, ceases to exist in a transaction other than one to which section 381(a) of the Code applies, or his liability to perform the services otherwise ends, then all payments not included in his gross income in a preceding taxable year must be included in his gross income for such taxable year.

.12 The deferral of the inclusion in income of amounts in accordance with the foregoing principles will be treated as an acceptable method of accounting under section 446 of the Code as long as the method is consistently used by the taxpayer.

Sec. 4. Books and Records

Taxpayers who defer the inclusion in income of amounts in accordance with the foregoing principles must maintain adequate books and records so that the amount deferred on the income tax return for any year can be verified from such books and records.

Sec. 5. Procedure

.01 Any change by a taxpayer from his present method of including amounts in gross income to the method prescribed in section 3.02 of this Revenue Procedure is a change in method of accounting to which section 446 and section 481 of the Code apply.

.02 Taxpayers desiring to change to the method of accounting prescribed in section 3.02 of this Revenue Procedure may request permission to do so by filing Form 3115 (Application for Change in Accounting Method) with the Commissioner of Internal Revenue, Washington, D.C. 20224, in accordance with section 1.446-1(e)(3) of the Income Tax Regulations. In approving any such change, the Commissioner will apply the principles set forth in Revenue Procedure 64-16, C.B. 1964-1 (Part I), 677.

.03 In lieu of filing Form 3115 under section 1.446-1(e)(3) of the Income Tax Regulations, a taxpayer may file his application, Form 3115, under Revenue Procedure 64-16, supra, for the last taxable year for which an income tax return has not been filed, provided the taxpayer agrees in writing to treat any such changes in accordance with section 1 of Revenue Procedure 64-16.

Sec. 6. Effect on Other Documents

For the effect of this Revenue Procedure on Revenue Ruling 60-85, C.B. 1960-1, 181; Revenue Ruling 65-141, C.B. 1965-1, 210; and Revenue Ruling 68-44, C.B. 1968-1, 191, see Revenue Ruling 70-445, page 101, this Bulletin.

Sec. 7. Inquiries

Inquiries concerning the application of this Revenue Procedure should refer to its number and be addressed to Assistant Commissioner (Technical), Attention: T:I:C, Washington, D.C. 20224.