New IRS Procedure Allows Tax Deferrals On Prepaid Funeral, Cemetery Contracts
by Leslie J. Schneider, CPA, guest columnist
The Internal Revenue Service's recently announced Revenue Procedure 2004-34 offers accrual-basis cemeteries and funeral homes the opportunity to defer for one year prepayments (outside of trust) toward services to be performed in a future year.
The IRS has had a long-standing policy, embodied in Rev. Proc. 71-21, of allowing accrual-basis taxpayers to defer progress or installment payments from inclusion in income where the payments related to services to be performed in a future taxable year.
However, Rev. Proc. 71-21 allowed deferral only when the cemetery or funeral home was required to perform all of the services covered by advance payments by the end of the year following the year in which it received the money. Thus the typical preneed funeral services contract, as well as preneed cemetery merchandise contracts also covering services such as grave opening and closing, did not qualify for deferrals.
Rev. Proc. 2004-34 eliminates this requirement, though it continues to restrict the deferral option to one year following the year the advance payments were received.
The new revenue procedure might apply in the following typical circumstances for a cemetery or funeral home:
Example 1: An accrual-basis funeral home or combo operator enters into a preneed funeral service contract to provide funeral services upon the client's death.
The client funds the contract through yearly installments paid over five years. The funeral home deposits 80 percent of each installment payment in a preneed trust and retains the balance for operations. In year six, after the contract is fully paid, the client dies.
Under these circumstances, the 80 percent of the annual payments deposited in trust would not be taxed until the client died and services were provided by the funeral home. Rev. Proc. 2004-34 would not change anything with regard to this money placed in trust.
However, in the past, the funeral home had to report as taxable income-in the year received-the portion of the payments not placed in trust (in this example, 20 percent of the money).
Under Rev. Proc. 2004-34, the funeral home is eligible for a one-year tax deferral on the non-trusted portion of each installment payment. In this example, that means 20 percent of each installment payment is eligible for a tax deferment until the next taxable year. As noted above, the 80 percent of each installment payment deposited in a preneed trust is unaffected, because such amounts are not taxable to the funeral home until the client dies.
Example 2: An accrual-basis cemetery enters into a preneed cemetery merchandise contract with a client to provide a casket, a liner, a marker and grave opening and closing services upon the client's death. The client funds the contract through yearly installments paid over five years. The cemetery retains each installment payment for its operations. Ninety percent of each installment is allocated to the casket, liner and marker and 10 percent is allocated to the grave opening and closing services. In year six, after the contract is fully paid, the client dies.
In these circumstances, the portion of the installment payments allocated to merchandise (i.e., 90 percent) would be eligible for tax deferral until the client dies, pursuant to the provisions in Reg. §1.451-5.
However, prior to the issuance of Rev. Proc. 2004-34, the cemetery would have been required to report the 10 percent of each installment payment allocated to opening and closing services as taxable income in the year received. Under the new procedure, the portion of the installment payment allocated to opening and closing services may be deferred until the year after it is received, giving the cemetery a one-year deferral on paying taxes on that portion of each installment.
The portion of the installment payments allocated to merchandise will not be affected by the new procedure, but it is already eligible for deferral under Reg. §1.451-5 until the merchandise is provided to the client.
Some additional points are worth noting. In both examples above, deferral also would be available even if the contracts had been fully prepaid at their inception. However, in that case, deferral for one year would probably leave the cemetery with a much longer period between the recognition of the prepaid income and the delivery of the cemetery services than in the case of an installment sale.
Another significant point is that deferral under Rev. Proc. 2004-34 is only needed when the advance payments would otherwise have been taxable to the funeral home or cemetery upon receipt. When advance payments are placed in the type of trust that prevents them from being taxable to the funeral home or cemetery, Rev. Proc. 2004-34 is not needed and should not be elected.
Also, Rev. Proc. 2004-34 conditions deferral for tax purposes on financial statement conformity. A funeral home or cemetery cannot defer paying taxes on these payments unless its financial statements show that it deferred recognizing the revenue from those payments.
In most cases, if a cemetery or funeral home's financial statements show it is deferring the revenue, the company can qualify for the tax deferral under "automatic consent accounting method" procedures, which simply involve filing a Form 3115 with its federal income tax return. The company would also have to file a copy of Form 3115 with the IRS national office.
A company qualified for tax deferrals under this automatic consent accounting method procedure might even be able to qualify retroactively for the 2003 tax year.
The only instance where this might not be the case is when the installment payments were for a combination of goods and services and the contract did not break down how much of the payment is for goods and how much is for services. In such cases, the funeral home or cemetery would have to file a "regular method" change request for 2004 with the IRS national office. The IRS would then review how the funeral home or cemetery allocated the advance payments between goods and services.
In conclusion, Rev. Proc. 2004-34 may present a valuable opportunity for a limited tax deferral in situations common to the cemetery and funeral home professions. However, the timing is such that companies will need to act promptly if they wish to take advantage of this opportunity for the 2003 tax year. Otherwise, they can wait and make the change for 2004.
Leslie J. Schneider is a partner in the Washington, D.C., law firm of Ivins, Phillips & Barker and has represented members of the cemetery and funeral profession for many years on tax accounting matters. He can be reached at (202) 393-7600 or firstname.lastname@example.org.