Automatic tax-year-change procedures modified for C corporations. (Accounting Methods & Periods).

Sec. 442 final regulations substantially modify the procedures by which C corporations effect an automatic change in their tax year. The final regulations defer the automatic change procedures exclusively to administrative pronouncements issued by the Commissioner and completely remove these procedures From the regulations. While these changes are generally Favorable, they do impose a new book-conFormity requirement that did not exist under the previous regulatory rules.

Background

For many years, Regs. Sec. 1.442-1(c) set forth the general procedures for automatic corporate tax-year changes. Under this regulation, a C corporation could change its tax year automatically if:

1. It did not change its tax year at any time within the last 10 calendar years;

2. It did not have a net operating loss (NOL) in the short year, required by the change;

3. Annualized taxable income for a short period was at least 80% of taxable income for a full tax year immediately preceding the short year;

4. A change did not result in a change in any special status of the corporation (i.e., personal holding company, exempt organization, etc.); and

5. The corporation did not attempt to make an S election for a tax year immediately following a short year.

A C corporation meeting these requirements could change its tax year without requesting the IRS's permission. It simply filed a statement with the District Director's office at which it regularly filed its returns, and the change was granted automatically.

For C corporations that could not meet all the requirements, the Service provided administrative procedures granting year changes under more lenient conditions, but imposed a book-conformity requirement not present in Regs. Sec. 1.442-1(c).

The most recent pronouncement, Rev. Proc. 2000-11, reduced the restriction on prior-year changes from 10 to six years and allowed an automatic change even when the corporation had an NOL in the short period. To effect a change under Rev. Proc. 2000-11, the corporation had to file an expedited Form 1128 on or before the short-period return's due date.

New Procedures for Automatic Changes

Last year the IRS issued proposed regulations under Sec. 442 that substantially modified the procedures for automatic tax-year changes for C corporations. These regulations, finalized earlier this year, are effective for tax years ending on or after May 17, 2002. They completely remove the automatic-change procedures from the regulations and defer them to IRS administrative pronouncements. The Service issued Rev. Proc. 2002-37 concurrently with the final regulations, which is now the exclusive authority for a C corporation to obtain an automatic tax-year change.

Rev. Proc. 2002-37 generally allows a C corporation to automatically change its tax year if the entity has not changed its tax year at any time within a 48-month period ending with the close of a proposed tax year. However, this 48-month restriction does not apply to changes:

1. By subsidiary corporations, required under the consolidated-return regulations;

2. By certain nonconsolidated subsidiary corporations, to match the tax year of a majority shareholder;

3. To or from a 52-53-week tax year ending with reference to the same month of the previous tax year;

4. To a required or an ownership tax year.

A corporation could not apply for an automatic tax-year change under Rev. Proc. 2002-37 if it has a significant interest in certain passthrough entities as of the end of the short period resulting from the proposed change, or if it is a shareholder in certain foreign sales corporations (FSCs) or interest-charge domestic international sales corporations (IC-DISCs).

In addition, certain corporations cannot apply for an automatic year change under Rev. Proc. 2002-37.These corporations include FSCs, IC-DISCs, S corporations, electing S corporations, personal service corporations, controlled foreign corporations (CFCs), personal CFCs, certain tax-exempt organizations, possessions corporations, certain cooperative associations and certain corporations with required tax years. Corporations ineligible to apply under this pronouncement may be able to do so for tax-year changes under other IRS pronouncements.

A corporation with an NOL for the short period resulting from a tax-year change can apply for an automatic year change under Rev. Proc. 2002-37. However, generally, it cannot carry back an NOL, a capital loss or a general business credit from the short period. The Service will waive this ban if capital losses and NOLs are either (1) $50,000 or less or (2) resulting from a short period of nine months or longer and are less than the loss for a full 12-month period beginning with the first day of the short period.

Example: Corporation A has historically maintained a calendar tax year. In 2002, A qualifies for and elects to change its tax year to a September 30th fiscal year under Rev. Proc. 2002-37. It has a $55,000 NOL for the nine-month period ending Sept. 30, 2002 and a $57,000 NOL for the 12-month period ending Dec. 31, 2002.

A would be required to file a short-period return for the nine months ending Sept. 30, 2002. A could carry back the $55,000 NOL reflected on the short-period return, because it meets the nine-month/12-month exception. A could carry forward the $55,000 NOL on the short-period return if the 12-month loss was $54,000 instead of $57,000.

Rev. Proc. 2002-37 also imposes a book-conformity requirement that while present in prior IRS pronouncements, was not a condition of automatic corporate tax-year changes under former Regs. Sec. 1.442-1(c). Under the former regulation, a corporation could have obtained automatic approval to adopt a tax year different from the fiscal year used for financial reporting purposes, provided it met Sec. 446's general recordkeeping requirements.

The final regulation conditions the automatic-year change on whether the corporation computes its income and keeps its books (including financial statements and reports to creditors) on a requested tax-year basis. The required book-conformity is significant, because it eliminates most corporations' ability to obtain an automatic change not also used for financial-reporting purposes. In the final regulations, the requirement does not apply to books and records maintained solely for foreign-law purposes or to tax-year requests when the year is a required year for tax purposes.

To file for an automatic-year change under Rev. Proc. 2002-37, a corporation must file Form 1128, Application to Adopt, Change, or Retain a Tax-Year, which, as in the past, expedited filing procedures for corporations filing under the automatic-change provisions. A corporation must file the form by the due date (including extensions) for filing the short-period return required by the change.

Conclusion

The Sec. 442 final regulations defer the automatic-year change procedures for C corporations to IRS administrative pronouncements. In conjunction with the final regulations, the Service issued Rev. Proc. 2002-37, which now provides the exclusive authority for a C corporation to obtain an automatic tax-year change. While these new procedures are generally less restrictive than the former regulations, they impose a new book-conformity requirement that did not exist under the previous rules. C corporations seeking to change their tax year should examine the new procedures to determine it they can make an automatic change.

FROM DAVID A. THORNTON, CPA, COLUMBUS, OHIO