Change of accounting method: living with one's errors.

A recent TAM seems to require that a taxpayer that erroneously changes its method of accounting without the IRS's consent secure the Service's consent to return to the method from which it erroneously changed.

In Letter Ruling (TAM) 9421003, the IRS considered whether a taxpayer may file amended returns under Rev. Rul. 58-74 to claim deductions for software development costs mistakenly capitalized in prior tax years. In 1969, a natural gas distributor began currently expensing all of its software development costs under Rev. Proc. 69-21; it continued this practice for 16 tax years. In 1985, the taxpayer inadvertently began capitalizing and amortizing software development costs for projects expected to cost $100,000 or more; projects expected to cost less than $100,000 continued to be currently expensed. The taxpayer discovered its error in 1992 while preparing its 1991 return and attempted to file amended returns to correct its "posting error." The examining agent challenged this taxpayer's action.

The IRS National Office determined that the taxpayer did not make a posting error by capitalizing the software development costs; there was no error in transferring an original entry to a ledger. Instead, the taxpayer established a method of accounting for software development costs under Regs. Sec. 1.446 1(e)(2)(iii) because of its consistent treatment of a material item for several tax years.

TAM 9421003 provides insight for taxpayers that unilaterally attempt to change from one accounting method to another and back again. The ruling also clarifies how the Service interprets Rev. Rul. 90-38 as it relates to establishing methods of accounting. In Rev. Rul. 90-38, the IRS ruled that a taxpayer that accounted erroneously for an item that involved the timing of a deduction on its first two Federal income tax returns had established a method of accounting under Regs. Sec. 1.446-1(e)(2)(iii). TAM 9421003 clarifies that Rev. Rul. 90-38 applies to a taxpayer that unilaterally changes its method of accounting to an erroneous treatment and uses such treatment on two or more consecutive returns. Under these circumstances, the Service's position is that a taxpayer may not file amended returns to change back to the prior method of accounting. This position yields a puzzling result: The taxpayer must secure IRS consent under Sec. 446(e) to change back to the method from which it erroneously changed without consent in violation of Sec. 446(e).