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Global Tax Insights

What You Didn’t Know About Advance Payments

November 10, 2015

If your business receives advance payments for goods and services, you might be able to defer some of the income to save on tax.

Does your business receive advance payments for subscriptions, warranty contracts or intellectual property (IP) licenses — or other goods and services? Or does it sell gift cards? If so, you might be eligible to defer some of that income to 2016 — reducing your 2015 tax liability.

An Exception to the Rule

Although the general rule is that advance payments must be included in taxable income in the year you receive them, there are certain circumstances when you can defer a portion of the income. Specifically, if for the year you receive the advance payment you defer a portion of the income on an “applicable financial statement,” you can defer that same amount for income tax purposes.

However, this tax break is available only for the first year. Whatever income from the advance payment that isn’t recognized in the first year must be recognized in the following year for tax purposes, even if you don’t recognize it all at that time for financial reporting purposes.

What Is an “Applicable” Financial Statement?

To be considered “applicable,” a financial statement generally must either be audited by an independent CPA or be filed with the SEC. However, not having such a statement doesn’t necessarily mean you can’t defer income from advance payments. You can still defer such income as long as you have a reasonable method for calculating the portion of advance payments that you earned in the first year.

For instance, let’s say you sell gift cards but don’t have an applicable financial statement. If you have a method for tracking when gift cards are redeemed, you may still be able to defer a portion of the income. In the first year, you potentially could recognize income only for the gift cards that your tracking shows were redeemed that year.

Year-End Planning

If you’ve received advance payments in 2015, it’s worthwhile to explore whether a portion of the income could be deferred to 2016. In addition to the examples we’ve already mentioned, other advance payments that can qualify for this tax-advantaged treatment include those for IP leases; computer software sales, leases and licenses; and certain organization memberships.

But you also need to look at your overall tax situation this year and next. If your business is booming and you think you could be in a higher tax bracket next year, then recognizing all of your income from advance payments in 2015 could save you taxes over the two-year period. Please contact us for help determining the strategy that is best for you.

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