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Funeral Industry Fears Looming Tax Accounting Timing Issues

Posted on Nov. 12, 2019

A funeral and cemetery services provider told the IRS and Treasury that its industry would be particularly harmed without a cost offset provision in regulations implementing the Tax Cuts and Jobs Act’s tax accounting provisions.

In a November 5 comment letter, Services Corp. International (SCI) asked the IRS and Treasury to clarify the continuing effect of tax realization rules, the application of basis rules for real estate, and the potential timing of cost offsets in the wake of the TCJA’s amendments to section 451.

SCI said that it is the largest provider of death care services and products — including embalming, cremation, caskets, and, most notably, burial plots — in North America. The most relevant applications of the new section 451 provisions to the death industry arise out of so-called pre-need contracts, the organization wrote.

While many people only encounter their own death care needs through their executors and loved ones — products and services arranged for and bought after death — others make preparations ahead of time and enter into pre-need contracts.

Section 451(b) requires accrual-method taxpayers to include almost all items of income in a tax year if those items are included on the relevant financial statements for the same year. Section 451(c) codifies Rev. Proc. 2004-34, 2004-1 C.B. 991, as the only treatment for advance payments. The IRS and Treasury released two sets of proposed regulations September 5 addressing the TCJA’s new tax accounting provisions under section 451 for advance payments (REG-104554-18) and for income recognition (REG-104870-18).

Practitioners immediately noted the lack of an offset for cost of goods sold in those proposed regulations, despite several comment requests. There have also been several comments calling for further clarification of the interaction between the section 451(b) rule on income recognition and tax realization rules.

SCI delved into both of those issues and complained that “no other industry would incur greater economic harm if these proposed regulations were adopted in their present form,” though it added that the new section 451 provisions don’t have much effect on at-need transactions, only on pre-need contracts.

Death Realization

A practitioner at a recent meeting of the American Bar Association Section of Taxation gave the example of an installment sale of a burial plot, asking about the potential tax realization of the transaction. SCI took that example and built on it with details from its own contracts.

According to SCI, those pre-need burial plot contracts typically involve partial down payments when the contract is signed and payments of the balance over time with accruing interest. “In the case of a pre-need contract for the sale of a burial plot that is paid for by the customer in installments, the purchaser does not receive the right to be buried in the burial plot until the sales price of the burial plot is paid in full by the customer,” the letter states. A customer who dies before full payment only receives the right to be buried in the plot if his or her estate pays off the balance, it adds.

Notably, SCI’s contracts don’t allow the company to do anything more than keep what it has already received as liquidated damages if the customer cancels. “SCI may not seek specific performance of the contract,” according to the letter, which adds that some of its competitors’ pre-need contracts do provide for specific performance of the sale as a remedy.

All of this boils down to SCI treating its pre-need burial plot sales as fully completed at signing for financial accounting purposes, raising the question whether those uncertain contracts are tax realization events.

SCI read the preamble to the section 451(b) regs as allowing the conclusion that its pre-need burial plot sales aren’t realized until it receives payment — in other words, at each installment payment rather than the entire sale price at contract signing. The company asked the IRS and Treasury if they agree, and requested them to be clearer about that result in the preamble to the final regulations and to add a clarifying example.

In addition to the footnote in the TCJA’s conference committee report declaring that section 451(b) doesn’t require recognition of income that hasn’t been realized, SCI marshaled several court cases and old IRS guidance documents to support the conclusion that there is no realization before the seller has an enforceable right to payment.

Grave Basis

SCI also wanted to be able to apply its basis in the burial plots against those prepayments. Because the plots are real estate interests, the government’s initial response to the cost offset requests invoking inventory rules wouldn’t apply in that context, according to the letter.

Without section 471 inventory rules, only the basis rules of sections 1001 and 1016 would apply, SCI argued. In the real estate context, the IRS has already concluded that a seller in an executory contract can first apply proceeds received in tax years predating completion of the sale before recognizing any excess as income, the company added.

SCI acknowledged that it also has many pre-need inventory sales. It joined the arguments others are making about the appropriateness of cost offsets in non-real-estate settings, including the assertion that the offsets aren’t comparable to accelerated deductions but instead are related to the definition of gross income.

The cost offset issue is especially important to the death care industry because of the common use of trusts to hold payments on pre-need contracts and the great uncertainty regarding the timing of the eventual delivery of the prepaid merchandise, according to SCI. “If [the denial of accelerated cost offsets] is retained in the final regulations, that position would have dire economic consequences for SCI and other members of the death care industry,” the company wrote.

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