An advance payment is money received by a business before delivering goods or services. For federal income tax purposes, these payments are generally taxable in the year received. This rule always applies if your business uses the cash method of accounting. However, accrual‑basis businesses may qualify for favorable tax deferral treatment.
Tax Deferral Privilege
Accrual‑basis businesses can elect to postpone reporting all or part of an eligible advance payment until the following year. To qualify, the payment must:
- Be at least partially included in revenue for a later year under your business’s applicable financial statement (AFS), or treated as earned in a later year if no AFS exists.
- Be received for goods, services, or other eligible items listed in IRS guidance.
For example, if your accrual‑basis business received advance payments in 2025, you may elect to defer reporting some or all of that income until 2026.
What Is an AFS?
An AFS (Applicable Financial Statement) can be:
- An audited financial statement used for credit or financial reporting.
- Certain reports submitted to federal or state agencies.
- SEC filings such as a 10‑K or annual report.
If your business doesn’t have an AFS, the deferral method requires including the portion treated as earned in the year received, with the remainder reported the following year.
Eligible Advance Payments
Advance payments that may qualify for deferral include:
- Services
- Sale of goods
- Gift cards
- Use of intellectual property
- Sale or use of computer software
- Warranty contracts
- Subscriptions
Payments not eligible include rents (with some exceptions), certain insurance premiums, payments for financial instruments, and other exclusions specified by the IRS.
Examples of Deferral
- With an AFS: A tennis facility receives payment in November 2025 for 48 lessons over a year. Eight lessons occur in 2025, so one‑sixth of the payment is taxable in 2025, and five‑sixths in 2026.
- Without an AFS: An online security company receives payment in September 2025 for two years of services. Four months are earned in 2025, so one‑sixth of the payment is taxable in 2025, and the remainder in 2026.
Can Your Business Benefit?
Advance payment rules are complex. Professional guidance can help determine eligibility and calculate potential tax savings.