SECTION 4. DEFINITIONS

The following definitions apply solely for purposes of this revenue procedure:

.01 Advance payment. Except as provided in section 4.02 of this revenue procedure, a payment is an “advance payment” if:

(1) the payment is received by the taxpayer in one taxable year;

(2) including the payment in gross income for the taxable year of receipt is a permissible method of accounting for federal income tax purposes (without regard to this revenue procedure);

(3) the payment is included by the taxpayer (in whole or in part) in gross receipts for financial reporting purposes for a subsequent taxable year, whether or not the inclusion is contingent upon a future act by the taxpayer or any other party; and

(4) the payment is solely for: (a) services (other than for service warranty contracts for which the taxpayer uses the accounting method provided in Rev. Proc. 97–38, 1997–2 C.B. 479);

(b) the sale of goods (other than for sales of goods for which the taxpayer uses a deferral method provided in § 1.451– 5(b)(1)(ii)); (c) the use of intellectual property as defined in section 4.03 of this revenue procedure;

(d) the occupancy of space or the use of property if the occupancy or use is ancillary to the provision of services (for example, advance payments for the use of rooms or other quarters in a hotel, booth space at a trade show, campsite space at a mobile home park, and recreational or banquet facilities, or other uses of property, so long as the use is ancillary to the provision of services to the property user);

(e) guaranty or warranty contracts ancillary to the items described in subsections (a), (b), (c), and (d) of this section;

(f) subscriptions (other than for subscriptions for which an election under § 455 is in effect), whether or not provided in a tangible or intangible format;

(g) membership in an organization (other than for memberships for which an election under § 456 is in effect); or

(h) any combination of subsections (a) through (g) of this section.

.02 Exclusions from advance payment. The term “advance payment” does not include:

(1) rent (except for amounts described in section 4.01(4)(c) and (d);

(2) insurance premiums; and (3) payments with respect to financial instruments (for example, debt instruments, deposits, letters of credit, notional principal contracts, options, forwards, futures, foreign currency contracts, credit card

2002–50 I.R.B. 965 December 16, 2002

payer may generally use the methodology used for financial reporting purposes provided that

(a) the methodology used for financial reporting purposes provides a basis for determining how much of the current year’s advance payments are included in gross receipts for financial reporting purposes in the current year; and

(b) the portion of an advance payment not included in gross income in the taxable year of receipt is included in gross income in the next succeeding taxable year.

(3) Acceleration of advance payments. Notwithstanding section 5.02(1) of this revenue procedure, the taxpayer must include in gross income for the taxable year of receipt:

(a) all advance payments if, in that year, the taxpayer either dies or ceases to exist in a transaction other than one to which § 381(a) applies;

(b) advance payments with respect to any one or more of the items listed in section 4.01 of this revenue procedure if, and to the extent that, the taxpayer’s obligation to provide the item or items otherwise ends in that year.

.03 Examples. In each example below, the taxpayer uses an accrual method of accounting and files its returns on a calendar year basis.

(1) On November 1, 2003, A, in the business of giving dancing lessons, receives an advance payment for a 1-year contract commencing on that date and providing for up to 48 individual, 1-hour lessons. A provides eight lessons in 2003 and another 35 lessons in 2004 before the contract expires. For financial reporting purposes, A includes 1/6 of the payment in gross receipts for 2003, and 5/6 of the payment in gross receipts for 2004. A uses the Deferral Method. For federal income tax purposes, A must include 1/6 of the payment in gross income for 2003, and the remaining 5/6 of the payment in gross income for 2004.

(2) Assume the same facts as in Example 1 except that the advance payment is received for a 2-year contract under which up to 96 lessons are provided. A provides eight lessons in 2003, 48 lessons in 2004, and 40 lessons in 2005. For financial reporting purposes, A includes 1/12 of the payment in gross receipts for 2003, 6/12 of the payment in gross receipts for 2004, and 5/12 of the payment in gross receipts for 2005. For federal income tax purposes, A must include 1/12 of the payment in gross income for 2003, and the remaining 11/12 of the payment in gross income for 2004.

(3) On June 1, 2003, B, a landscape architecture firm, receives an advance payment for goods and services that, under the terms of the agreement, must be completed by December 2004. On December 31, 2003, B estimates that 3/4 of the work under the agreement has been completed. For financial reporting purposes, B includes 3/4 of the payment in gross receipts

for 2003 and 1/4 of the payment in gross receipts for 2004. B uses the Deferral Method. For federal income tax purposes, B must include 3/4 of the payment in gross income for 2003, and the remaining 1/4 of the payment in gross income for 2004, regardless of whether B is for any reason unable to complete the job in 2004.

(4) On July 1, 2003, C, in the business of selling and repairing television sets, receives an advance payment for a 2-year contract under which C agrees to repair or replace certain parts in the customer’s television set if those parts fail to function properly. For financial reporting purposes, C includes 1/4 of the payment in gross receipts for 2003, 1/2 of the payment in gross receipts for 2004, and 1/4 of the payment in gross receipts for 2005. C uses the Deferral Method. For federal income tax purposes, C must include 1/4 of the payment in gross income for 2003 and the remaining 3/4 of the payment in gross income for 2004.

(5) D, a video arcade operator, receives payments in 2003 for game tokens that are used by customers to play the video games offered by D . The tokens cannot be redeemed for cash. The tokens are imprinted with the name of the video arcade, but they are not individually marked for identification. For financial reporting purposes, D completed a study that determined that for payments received in the current year, x percent of tokens are expected to be used in the current year, y percent of tokens are expected to be used in the next year, and z percent of tokens are never expected to be used. Based on the study, D includes in gross receipts for 2003 the percentage of the payments for tokens that are used in that year ( x percent) as well as the z percent for tokens that are never expected to be used; D includes the remaining y percent in gross receipts for 2004. D uses the Deferral Method. Because D does not trace which tokens are used in any given taxable year, D may include these payments in gross income in accordance with its financial reporting method, provided that any portion of the payment not included in income in the year of receipt is included in gross income for the next succeeding taxable year. D includes x percent and z percent in gross income for 2003, and D includes y percent in gross income for 2004.

(6) E, in the business of photographic processing, receives advance payments for mailers and certificates that oblige E to process photographic film, prints, or other photographic materials returned in the mailer or with the certificate. E tracks each of the mailers and certificates with unique identifying numbers. On July 20, 2003, E receives payments for 2 mailers; one of the mailers is submitted for film processing and is processed by E on September 1, 2003, and the other is submitted and processed on February 1, 2005. For financial reporting purposes, E includes the payment for the September 1, 2003, processing in gross receipts for 2003 and the payment for the February 1, 2005, processing in gross receipts for 2005. E uses the Deferral Method. For federal income tax purposes, E must include the payment for the September 1, 2003, processing in gross income for 2003 and the payment for the February 1, 2005, processing in gross income for 2004. (7) F, a hair styling salon, receives advance payments from selling gift certificates that may later be redeemed at the salon for hair styling services or hair care products at the face value of the gift certifi

cate. The gift certificates look like standard credit cards, and each certificate has a magnetic strip that, in connection with F ’s computer system, identifies the balance of the gift credit. The gift certificates may not be redeemed for cash, and they have no expiration date. F does not have in place a methodology for determining the extent to which the current year’s advance payments are included in gross receipts for financial reporting purposes for the current year. F may not use the Deferral Method, and F must include the advance payments in gross income for the taxable year of receipt.

(8) G is in the business of compiling and providing business information for a particular industry in an online format accessible over the internet. On September 1, 2003, G receives an advance payment from a subscriber for 1 year of access to its online database. For financial reporting purposes, G includes 1/3 of the payment in gross receipts for 2003 and the remaining 2/3 in gross receipts for 2004. G uses the Deferral Method. For federal income tax purposes, G must include 1/3 of the payment in gross income for 2003 and the remaining 2/3 of the payment in gross income for 2004.

(9) On December 1, 2003, H, in the business of operating a chain of “shopping club” retail stores, receives advance payments for membership fees. Upon payment of the fee, a member receives an identification card that allows access for a 1-year period to H ’s stores, which offer discounted merchandise and services. For financial reporting purposes, H includes 1/12 of the payment in gross receipts for 2003 and 11/12 of the payment in gross receipts for 2004. H uses the Deferral Method. For federal income tax purposes, H must include 1/12 of the payment in gross income for 2003, and the remaining 11/12 of the payment in gross income for 2004.

(10) I, a professional sports franchise, is a member of a sports league that enters into contracts with television networks for the sale of broadcasting rights to the games played between the member teams. The money received under the contracts is divided equally among the member teams. On April 1, 2003, the league enters into a 3-year broadcasting contract. I receives three equal installment payments on October 1 of each contract year, beginning in 2003. For financial reporting purposes, I includes 1/4 of the first installment payment in gross receipts for 2003 and 3/4 in gross receipts for 2004; I includes 1/4 of the second installment in gross receipts for 2004 and 3/4 in gross receipts for 2005; I includes 1/4 of the third installment in gross receipts for 2005 and 3/4 in gross receipts for 2006. I uses the Deferral Method. Under section 4 of this revenue procedure, each installment payment constitutes an “advance payment.” Thus, for federal income tax purposes, I must include 1/4 of the first installment payment in gross income for 2003 and 3/4 in gross income for 2004; 1/4 of the second installment in gross income for 2004 and 3/4 in gross income for 2005; and 1/4 of the third installment in gross income for 2005 and 3/4 in gross income for 2006.

(11) J is a cable television provider that enters into contracts with subscribers to provide cable services for a monthly fee (paid prior to the service month). For those subscribers without a “cable ready” television set, K provides, for an additional monthly charge (also paid prior to the service month), a cable converter box with a remote control. Pursuant to the con

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tax return for the taxpayer’s first taxable year ending on or after [insert date of publication of final revenue procedure]. This amended return must be filed no later than

[insert date 180 days from date of publication of final revenue procedure]. A copy of the Form 3115 must be filed with the national office (see section 6.02(6) of Rev. Proc. 2002–9 for the address) no later than when the taxpayer’s amended return is filed; and

(3) When filing the Form 3115, taxpayers must complete all applicable parts of the form and, in lieu of the label required by section 6.02(4) of Rev. Proc. 2002–9, are instructed to write “Change to [Full Inclusion Method or Deferral Method] under Rev. Proc. [insert rev. proc. number]” at the top of the form.