Accounting for advance payments in acquisitive transactions

Receipt of an advance payment for goods or services generally results in taxation of the income at the time of receipt, but, in some circumstances, income recognition may be deferred. The advance payment also arguably creates a liability that is satisfied upon the recipient fulfilling its contractual obligation to deliver goods or perform services. A great deal of controversy surrounds the tax consequences of the assumption by a buyer of the obligation associated with an advance payment as part of the sale of assets that constitutes a trade or business. First, it is not clear under current authority what the tax consequences of the assumption of that liability by the buyer are. A second issue relates to whether and when the seller and the buyer should recognize income from an advance payment. The character of the obligation related to an advance payment and the tax consequences of transferring the obligation as part of an asset sale of a business are explored in this article. The article concludes that the uncertain tax consequences result from insufficient and inconsistent guidance and proposes alternatives the Department of the Treasury and the Internal Revenue Service should consider for issuing regulations.