IRS-initiated accounting method changes.

The Service recently released Notice 98-31, providing a proposed revenue procedure outlining procedures under Sec. 446(b) for IRS-initiated accounting method changes. While Rev. Proc. 97-27 indicates that accounting method changes made by the Service generally receive less favorable terms than voluntary changes, the IRS has heretofore provided little guidance on nonvoluntary accounting method changes.

Notice 98-31 provides procedures for accounting method changes that the Service initiates and procedures that it uses for accounting method issues it raises and resolves on a non-accounting method change basis. While the proposed revenue procedure sets forth procedures for "timing issues" before Examination, Appeals and Federal courts, it does not alter the authority of Appeals or government counsel to settle cases based on litigation hazards.

Examinations

Notice 98-31 states that an examining agent proposing an adjustment with respect to a timing issue will treat the issue as an accounting method change. The term "timing issue" means any issue about the propriety of a taxpayer's accounting method treatment for an income or expense item. The change in the treatment of such timing issue will generally require a Sec. 481(a) adjustment. Only in rare and unusual circumstances will an agent make a change using the cut-off method (e.g., the taxpayer's books and records do not contain sufficient information to compute the Sec. 481(a) adjustment). The agent is instructed to make the change in the earliest tax year under examination, with a one-year Sec. 481(a) adjustment period (in the year of change).

The notice also indicates that, to be consistent with the policy of encouraging voluntary compliance with proper tax accounting principles, the agent will not initiate an accounting method change if the change places the taxpayer in a more favorable position.

Appeals and Counsel for the Government

Accounting Method Change. An Appeals officer or government counsel has flexibility in resolving a timing issue. The notice details this flexibility, but notes that it does not alter the authority of Appeals or counsel to resolve or settle any issues. An Appeals officer or government counsel may resolve a timing issue by changing the taxpayer's accounting method using compromise terms and conditions. Possible terms and conditions are:

* Year of change (agreeing to a later year of change);

* Amount of the Sec. 481(a) adjustment (agreeing to a reduced adjustment); or

* Sec. 481(a) adjustment period (agreeing to a longer adjustment period).

Non-accounting Method Change. An Appeals officer or government counsel may resolve a timing issue on a non-accounting method change basis using either an alternative-timing or a time-value-of-money resolution. For example, under the alternative-timing resolution, the Service and the taxpayer may agree to capitalize certain costs incurred only for the period under examination. Costs incurred prior to the examination period and subsequently incurred will continue to be deducted according to the taxpayer's current method of accounting.

A timing issue may also be resolved by using the time-value-of-money approach. Under this approach, a taxpayer is not required to change its accounting method, but agrees to pay the government a "specified amount" that approximates the time-value-of money benefit the taxpayer derives from using this accounting method. The time-value-of-money amount is not considered interest and cannot be deducted or capitalized.

Notice 98-31 provides further examples for both the alternative-timing resolution and the time-value-of-money approach.

Procedural Matters

An examining agent, Appeals officer or government counsel changing a taxpayer's accounting method will provide notification that a timing issue is being treated as an accounting method change. This notification must be in writing and contain the following:

* A statement that a timing issue is being treated as an accounting method change;

* A clearly labeled Sec. 481(a) adjustment; and

* A description of the new accounting method.

In addition, generally, a closing agreement is executed, which finalizes, the IRS-initiated accounting method change. The content of the closing agreement is detailed in the notice and varies depending on whether the change is an accounting method change or a non-accounting method change. An issue that may be addressed in the closing agreement is whether the taxpayer is required to file amended returns to reflect the change for any affected succeeding years. If the Service does not require amended returns, the notice indicates that the taxpayer should file such returns. For example, when the IRS uses the alternative-timing resolution (items capitalized only for the examination years), any returns filed subsequent to the examination years may have to be amended to prevent duplication of any expense.

The notice indicates that any timing issue resolved on a non-accounting method change basis does not preclude the Service from changing the taxpayer's accounting method in any open tax year for any item not covered by the dosing agreement.

The revenue procedure will generally be effective 90 days after it is published in the Internal Revenue Bulletin.

From Richard A. Gentle, CPA, Elkhart, IN