IRS Clarifies ‘Recurring Item’ For Accrual Method Businesses

by apexcpas | Jul 4, 2018 | Tax Planning

The IRS has clarified the treatment of certain liabilities under the Internal Revenue Code’s recurring-item exception to the economic performance requirement of the all-events test.

Under the all-events test, an accrual method business can accrue a liability in the year in which the liability is fixed and determinable and economic performance has occurred.

Under the recurring-item exception, discussed in IRC Section 461(h)(3), a business can accrue a liability in the year it is fixed and determinable, regardless of economic performance. However, the business must satisfy certain conditions, including that the liability is either:

Not material or
Better matched to the related income in the earlier year.

In a new ruling, the IRS has clarified the “not material” and “better matching” requirements in the context of a one-year lease liability and a one-year service contract liability.

For service contract-type liabilities, the recurring-item exception applies differently depending on whether the contract is for the provision of services, as distinguished from insurance or warranty-type contracts.

For liabilities arising out of the provision of services to the business, the company must satisfy either the “not material” or the “better matching” requirement.

For liabilities arising out of the provision of insurance, warranty or similar service contract liabilities, the “better matching” requirement is deemed to be met.
A business wishing to change its accounting method to conform to the new ruling must follow the automatic change in accounting method provisions in Revenue Procedure 2011-14.