Revenue Ruling 82-38’s Limit on Deferring Income

Revenue Ruling 82-38 is guidance from the Internal Revenue Service for businesses using the accrual method of accounting. It addresses how to treat advance payments received for services to be performed in the future, establishing a boundary on the ability to defer this income for tax purposes. For accrual-basis taxpayers, income is generally reported when it is earned, not when cash is received. While its specific rules have been superseded, Revenue Ruling 82-38 provides historical context for understanding the evolution of tax rules for prepaid service contracts.

The General Deferral Method for Advance Payments

To understand the historical impact of Revenue Ruling 82-38, one must first be familiar with the foundational tax principle it interprets. For businesses that use an accrual method of accounting, the timing of income recognition is governed by the “all events test.” This test dictates that income is recognized when all events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. This generally happens when payment is due, payment is received, or the service is performed, whichever is earliest.

For many years, the prevailing guidance on this topic was Revenue Procedure 71-21. This procedure created a practical exception to the general rule of immediate income recognition for advance payments. It established what is known as the one-year deferral method, which allowed a business to postpone reporting unearned income to the next tax year.

Under this method, a business could include a portion of an advance payment in income in the year it was received, to the extent services were provided in that year. The remaining unearned portion could be deferred, but it had to be included in income in the very next taxable year, regardless of whether all the services had been completed by that time. This provided a way to better match income recognition with the period in which the related services were rendered, but only for a limited time.

The Historical Limitation from Revenue Ruling 82-38

Revenue Ruling 82-38 introduced a limitation to the one-year deferral method available at the time. The ruling established a strict “all-or-nothing” rule: if a service agreement allowed for any portion of the services to be performed after the end of the taxable year following the year of receipt, the entire advance payment was disqualified from deferral. In such cases, the full amount had to be included in gross income in the year the payment was received.

This created a bright-line test that looked at the entire contract. The mere possibility of performing services beyond the one-year deferral window was enough to make the entire advance payment taxable upon receipt.

Relevance Under Current Tax Law

The principles governing advance payments have evolved since Revenue Ruling 82-38 was issued. The one-year deferral concept was carried forward for many years by Revenue Procedure 2004-34. However, this revenue procedure is now obsolete for tax years beginning on or after January 1, 2021.

The Tax Cuts and Jobs Act of 2017 (TCJA) added Section 451(c) to the Internal Revenue Code, which provides the statutory authority for the deferral of advance payments. This section codifies the one-year deferral method, making it a formal part of the tax law rather than just an administrative exception.

The final regulations for Section 451(c) reject the “all-or-nothing” logic of Revenue Ruling 82-38. Instead of disqualifying an entire payment if any part of the contract is too long, the current rules require taxpayers to allocate the payment to each separate performance obligation. If a contract includes services that will be completed within the one-year deferral window and others that will not, only the income allocated to the longer-term services must be recognized immediately. The portion related to the short-term services can still be deferred.