New procedures for changing accounting periods.

The IRS recently issued Rev. Procs. 2002-37, 2002-38 and 2002-39, which provide new procedures for C corporations, S corporations and other entities to change accounting periods. These procedures will allow a greater number of taxpayers to receive automatic approval to change accounting period. Taxpayers not eligible for automatic approval may also benefit from a more flexible business-purpose test.

Rev. Proc. 2002-37

Under Rev. Proc. 2002-37, if a C corporation fulfills certain requirements, it will be presumed to have established a business purpose necessary to receive automatic approval to change its annual accounting period under Sec. 442. The revenue procedure increases the scope of taxpayers that can receive such approval.

In addition to certain 52-53-week tax-year elections and a Sec. 898 election (which were available under the prior revenue procedure), a corporation that wants to change to or retain a natural business year that satisfies the 25%-gross-receipts test or change to a 52-53-week tax year ending with reference to such natural business year may now generally do so under Rev. Proc. 2002-37.

The revenue procedure decreases the period of time a taxpayer must wait for automatic approval between accounting-period changes from six calendar years to 48 months. It expanded the list of prior changes that the Service will not consider as prior changes for purposes of the 48-month rule to include a change to:

1. A parent's accounting period, to file a consolidated return under Regs. Sec. 1.1501-75(d)(3)(v);

2. A majority shareholder's tax year, to file consolidated financial statements; and

3. A required tax year or an ownership tax year.

Prior to Rev. Proc. 2002-37, corporations with interests in passthrough entities were not eligible to change their accounting periods automatically. Under the new procedure, if a passthrough entity is a partnership owned 50% by each partner and the corporation and the partnership want to change to the tax year of one of the 50% partners, the interest will be disregarded in applying the automatic change procedures.

Certain shareholders of a closely held real estate investment trust, a controlled foreign corporation (CFC), a foreign personal holding company (FPHC) or a passive foreign investment company are also potentially permissible interests under the new procedure, which adds an exception for a de minimis interest. The procedure allows an automatic-change exception for a CFC or an FPHC that wants to change to its required tax year.

Rev. Proc. 2002-37 applies the same terms and conditions applicable to a carryback of a net operating loss (NOL) generated in a short period under the prior procedure, to capital losses generated in the short period. If the capital loss is less than $50,000 or results from a short period of at least nine months and is less than the capital loss for a full 12-month period (beginning with the first day of the short period), the entity would be able to carry the capital loss either forward or back under Sec. 1212.

Finally, the corporation would still be required to file a Form 1128, Application to Adopt, Change or Retain a Tax Year, on or before the due date (including extensions) for filing its Federal income tax return for the short period required to make the change effective.

Rev. Proc. 2002-38

Rev. Proc. 2002-38 lays out the automatic approval procedures for partnerships, S corporations, electing S corporations and personal service corporations (PSCs) to change annual accounting periods. As under Rev. Proc. 2002-37, if a passthrough entity complies with this procedure's requirements, it will be deemed to have established a business purpose and the change in annual accounting period will be automatically approved.

Rev. Proc. 2002-38 has expanded the scope of taxpayers eligible for automatic approval to change their annual accounting period to include:

* A partnership, S corporation, electing S corporation or PSC changing to a natural business year that satisfies the 25%-gross-receipts test, regardless of whether such year results in a greater income deferral than in the present tax year.

* In appropriate circumstances, a partnership, S corporation, electing S corporation or PSC adopting, changing or retaining a 52-53-week tax year ending with reference to the required tax year, natural business year or ownership tax year.

* A partnership, S corporation, electing S corporation or PSC changing from a 52-53-week tax year to a non-52-53-week tax year that ends with reference to the same calendar month, and vice versa.

* A PSC changing its tax year, even if it elects S status for the tax year immediately following a short period.

The procedure clarifies that a partnership, S corporation, electing S corporation or PSC may change automatically to its required tax year. It also allows a partnership required to change its tax year because of a minor percentage change in ownership, to retain its current tax year for one year, as long as the ownership change is less than 10% of all partners' aggregate interests in partnership profits and capital and a reasonable chance exists that at the end of one tax year the change in ownership will be reversed.

Similar to Rev. Proc. 2002-37, Rev. Proc. 2002-38 decreases the time for automatic approval between changes in accounting periods from six calendar years to 48 months. It also provides that a change to or from a 52-53-week tax year ending with reference to the same calendar month or a change to a required or ownership tax year will not be deemed a prior accounting-period change within the most recent 48-month period.

The procedure also expands NOL carryback rules to cover capital losses generated in the short period that resulted fom the change, and extends the period for filing Form 1128 to the due date of the taxpayer's Federal return (including extensions) for the first effective year.

Finally, Rev. Proc. 2002-38 provides audit protection for partnerships, S corporations, electing S corporations and PSCs that change their annual accounting period under this procedure. If the taxpayer fails to implement the change, but does not comply with all of the procedure's applicable provisions or misstates or omits material facts, the taxpayer would not receive audit protection.

Rev. Proc. 2002-39

If a taxpayer is not eligible for automatic approval for a change in accounting period under Rev. Proc. 2002-37 or 2002-38, the taxpayer must request approval. Rev. Proc. 2002-39 explains the procedure. The taxpayer must establish a business purpose for the change in accounting period. Generally, a request to change to the taxpayer's natural business year, required tax year or ownership tax year will be granted without the taxpayer having to meet the facts-and-circumstances test.

The taxpayer's natural business year can be determined using the annual-business-cycle test, seasonal-business test or 25%-gross-receipts test. Under the annual-business-cycle test, the taxpayer's natural business year is deemed to end at (or soon after) the close of the highest peak period of business. This procedure has included a safe harbor under the annual-business-cycle test, stating that one month will be deemed "soon after" for the close of the highest peak period of business.

Under the seasonal-business test, the taxpayer's natural business year is deemed to end at (or soon after) operations end for the season. Rev. Proc. 2002-39 provides a safe harbor, defining insignificant gross receipts as an amount equal to less than 10% of the taxpayer's total gross receipts for the year, and one month will be deemed to meet the soon-after-the-close-of-operations requirement. In addition, taxpayers in existence for fewer than three years can satisfy the annual-business-cycle or seasonal-business test by giving reasonable estimates of gross receipts in place of historical gross receipts. Even if the taxpayer fails to satisfy one of the three tests for showing a natural business year, it could still obtain approval if it shows some nontax reason for the change and accepts additional terms and conditions needed to eliminate substantial distortion created by the change.

A taxpayer requesting approval to change must file Form 1128 no earlier than the day following the end of the first effective year and no later than the due date (including extensions) of the Federal income tax returns for the first effective tax year. Taxpayers are required to pay a user fee for requests to adopt, change or retain an annual accounting period under Rev. Proc. 2002-39.

With the release of these new procedures, which significantly reduce the requirements that taxpayers must meet to change an annual accounting period, tax advisers should once again look at each client's particular situation to determine if a change in year would be appropriate. Taxpayers who meet one of the natural-business-year tests under Rev. Proc. 2002-39 will not be subject to the conditions of Sec. 444, which allow certain entities to elect a tax year other than their required tax year. If a taxpayer meets the natural-business-year test under Rev. Proc. 2002-39, the taxpayer can avoid the cost associated with a Sec. 444 election, while maintaining its current fiscal year or switching to a more favorable fiscal year.

FROM JENNIFER BROOKS, CPA, COHEN & COMPANY, LTD., CLEVELAND, OH

Anthony Bakale, CPA, MT Cohen & Company, CPAs Baker Tilly International Cleveland, OH