New rules for requesting accounting method changes.

The IRS recently released proposed and temporary regulations extending the deadline far filing applications for accounting method changes. Regs. Secs. 1.446-(e)(3)(1) and 601.204(b) previously required a taxpayer to file Form 3115, Application for Change in Accounting Method, with the Service in the first 180 days of the tax year in which the change was to take effect. The amended regulations provide that a taxpayer is required to file Form 3115 by the last day of the tax year in which the change is to take effect.

The IRS also has released Rev. Proc. 97-27, revising the procedures for requesting permission for accounting method changes; this revenue procedure modifies and supersedes Rev. Proc. 9220. Rev. Proc. 97-27 includes significant changes, including categories of changes, the 90 day window, the 30-day window, the consent requirement for taxpayers before an appeals office and the Sec. 4X1(a) adjustment periods.

Categories of Changes

Rev. Proc. 92-20 described four categories of accounting methods from which a taxpayer might request a change: Category A, Category B, Designated A and Designated B. The category of method from which a taxpayer was changing determined (among other things) the applicable period for taking into account the net Sec. 481 (a) adjustment and the ability to request permission for an accounting method change by a taxpayer already under examination.

Rev. Proc. 97-27 eliminates the classifications of accounting methods provided by Rev. Proc. 92-20. Under Rev. Proc. 97-27, all changes in accounting methods will be treated similarly, regardless of whether the change is from an accepted method of accounting or a prohibited method.

Taxpayers Under Examination

Under Rev. Proc. 92-20, a taxpayer generally could not request a change from an impermissible method of accounting while under examination,if the impermissible method from which the taxpayer wished to change was adopted during a year under examination and the method was impermissible when adopted. However, a taxpayer could request a change while under examination with the consent of the district director. The district director could provide consent if the method of accounting to be changed would not be included as an adjustment item in the years for which the taxpayer was under examination. In all other circumstances, a taxpayer could request a change only during the 30-day, 90-day or 120-day window periods.

The rules for requesting a change of accounting method while under examination under Rev. Proc. 97-27 are similar to the rules provided by Rev. Proc. 92-20, with certain changes. Among the changes are the elimination of the 90-day window and an extension of the 30-day window to 90 days.

Before an Appeals Office

Under Rev. Proc. 92-20, a taxpayer could not request a change in accounting method while any of its returns were under consideration by an appeals office, unless the taxpayer obtained a written agreement from the appeals officer indicating that the appeals office did not object to the change. Under Rev. Proc. 97-27, a taxpayer must merely attach a statement to Form 3115, indicating that the change in accounting method requested is not an issue under consideration by the appeals office; the appeals officer's consent is not required.

Taxpayer Before a Federal Court

If any of a taxpayer's returns were before a Federal court, the taxpayer could not request a change in accounting method under Rev. Proc. 92-20, unless the taxpayer obtained a written agreement from IRS counsel that it did not object to the change. Under Rev. Proc. 97-27, a taxpayer must merely attach a statement to Form 3115 indicating that the change in accounting method requested is not an issue under consideration by the Federal court; IRS counsel's consent is not required.

90-Day Window Period

Under Rev. Proc. 92-20, taxpayers had a 90-day window at the beginning of an examination in which to request permission to change accounting method (other than a Designated A method). If the taxpayer was changing from a Category A method and had a positive Sec. 481 (a) adjustment, the year of change was the earliest tax year under examination and the Sec. 481(a) adjustment was taken into account ratably over three tax years, beginning with the year of change. If there was a negative Sec. 481(a) adjustment, the year of change was the tax year for which the Form 3115 was timely filed and the Sec. 481(a) adjustment was taken into account in the year of change.

If the taxpayer was changing from a Category B method and had a positive Sec. 481(a) adjustment, the year of change was the year for which the Form 3115 was timely filed and the Sec. 481(a) adjustment was taken into account in the year of change. If there was a negative Sec. 481(a) adjustment, the year of change remained the year for which the Form 3115 was timely filed and the Sec. 481(a3 adjustment was taken into account ratably over six tax years, beginning with the year of change.

Rev. Proc. 97-27 eliminates the 90-day window of Rev. Proc. 92-20 for requesting permission for a change after a taxpayer has been contacted for examination.

120-Day Window Period

Under Rev. Proc. 92-20, a taxpayer under examination could request a change in accounting method during the 120-day period following the date an examination ended, even if a subsequent examination had already begun. The 120-day window was not available when the method of accounting was an item of adjustment from a previous examination, when the method of accounting issue was placed in suspense by the Service, or when the taxpayer had received written notification from the examiner citing the method of accounting as an issue. The year of change for applications filed during the 120-day window was the tax year that included the first day of the window.

If the taxpayer was changing from a Category A method and had a positive Sec. 481(a) adjustment, the taxpayer was required to take the net Sec. 481 (a) adjustment into account ratably over three years beginning with the year of change. If there was a negative Sec. 481(a) adjustment, the entire net Sec. 481(a) adjustment was required to be taken into account in the year of change.

If the taxpayer was changing from a Category B method and had a positive or negative Sec. 481(a) adjustment, the taxpayer was required to take the net Sec. 481(a) adjustment into account ratably over six years, beginning with the year of change.

Rev. Proc. 97-27 also provides a 120-day window, with similar rules as to when it is available. The Sec. 481 (a) adjustment period, however, will be the same as provided by Rev. Proc. 97-27. Generally, the Sec. 481(a) adjustment will be taken into account ratably over four years, beginning with the year of change.

30-Day Window Period

Rev. Proc. 92-20 provided for a 30-day window to request permission to change accounting method at the beginning of every tax year for a taxpayer that was under continuous examination (defined then as 18 consecutive months). The 30-day window was not available if the taxpayer had received written notification from the examiner, specifically citing the method to be changed as an issue under consideration. The year of change for applications filed during the 30-day window was the tax year that included the first day of the 30-day window.

If the taxpayer was changing from a Category A method and had a positive Sec. 481(a) adjustment, the taxpayer was required to take the net Sec. 481 (a) adjustment into account ratably over three years beginning with the year of change. If there was a negative Sec. 481(a) adjustment, the entire net Sec. 481(a) adjustment was required to be taken into account in the year of change. If the taxpayer was changing from a Category B method and had a positive or negative Sec. 481(a) adjustment, the taxpayer was required to take: the net Sec. 481(a) adjustment into account ratably over six years, beginning with the year of change.

Rev. Proc. 97-27 has extended the window to 90 days and reduced the number of consecutive months that a taxpayer is required to be under examination from 18 to 12 months. As was previously the case with the 30-day window under Rev. Proc. 92-20, the 90-day window is not available if the method of accounting to be changed has been identified as an issue under consideration.

Under Rev. Proc. 97-27, the Sec. 481(a) adjustment period will be the same as under the general principles discussed below. Generally, the Sec. 481(a) adjustment will be taken into account ratably over four years, beginning with the year of change.

Sec. 481(a) Adjustment Period

Under Rev. Proc. 92-20, the Sec. 481(a) adjustment period generally relied on the category of accounting method from which the taxpayer was changing and whether the resulting Sec. 481(a) adjustment was positive or negative.

If a taxpayer was changing from a Category A method that resulted in a positive Sec. 481(a) adjustment, the taxpayer was required to take the net Sec. 481(a) adjustment into account ratably over three tax years beginning with the year of change. If there was a negative Sec. 481(a) adjustment, the taxpayer was required to take the entire adjustment into account in the year of change.

A change from a Category B method resulted in the recognition of the Sec. 481(a) adjustment ratably over six years, beginning with the year of change, regardless of whether the Sec. 481(a) adjustment was positive or negative.

Under Rev. Proc. 97-27, the Sec. 481(a) adjustment period is generally: four tax years, beginning with the year of change. The adjustment period is the same for positive and negative adjustments. However, as was the case under Rev. Proc. 97-20, changes within the LIFO inventory method must generally be made using a cut-off method.

There are a number of exceptions to the four-year adjustment period under Rev. Proc. 97-27. A de minimis rule allows a taxpayer to elect to use a one-year adjustment period if the entire Sec. 481(a) adjustment is less than $25,000. Cooperatives within the meaning of Sec. 1381 (a) generally must take the entire Sec. 481(a) adjustment into account in the year of change. Finally, a taxpayer that ceases to engage in a trade or business must take the remainder of any Sec. 481(a) adjustment into account in the year of termination. A taxpayer is treated as ceasing to engage in a trade or business if the operations of the trade or business cease or substantially all of its assets are transferred to another taxpayer. Exceptions to accelerating the Sec. 481(a) adjustment are provided for certain transfers (1) under Sec. 381(a) and (2) pursuant to Sec. 351 within a consolidated group.

Effective Date

Rev. Proc. 97-27 is effective for Forms 3115 filed on or after May 15, 1997. However, there are several transitional rules.

If a taxpayer filed a Form 3115 under Rev. Proc. 92-20 prior to May 15, 1997, for a tax year ending on or after that date, the taxpayer may apply the terms and conditions in Rev. Proc. 97-27 exclusive of the year of change. However, the IRS National Office will apply the terms and conditions of Rev. Proc. 92-20 unless, prior to the earlier of June 15,1997 or issuance of the letter granting or denying the change, the taxpayer notifies the National Office of its request to apply the terms and conditions of Rev. Proc. 97-27.

If a taxpayer files Form 3115 prior to Dec. 31,1997 under Rev. Proc. 9727, the taxpayer may request that the terms and conditions (exclusive of the year of change) of Rev. Proc. 92-20 apply. If, on May 15,1997, the taxpayer is within a window period described in Rev. Proc. 92-20, the taxpayer may file a Form 3115 under the terms and conditions of Rev. Proc. 92-20 for the remainder of that window period.

Summary

In some cases, the new rules in Rev. Proc. 97-27 are more favorable than the prior rules in Rev. Proc. 92-20. In other situations, Rev. Proc. 92-20's rules may be more beneficial (see the chart on page 541 for a comparison of the general rules). During the transition period, tax practitioners should consider the transitional rules in determining whether the rules of Rev. Proc. 97-27 or 92-20 should be applied.

FROM MICHAEL W. GRANBERG, CPA, OAK BROOK, ILL.

Filling Requests for Changes in Accounting Methods:
Comparison of Rev. Proc. 92-20 With Rev. 97-27

                        Not under examination

Rev. Proc. 92-20:       Allowable
 Category A

Sec. 481 (a)            Positive adjustment: 3 years
 adjustment period      Negative adjustment: Year of change

Year of change          Year Form 3115 is timely filed

Rev. Proc. 92-20:       Allowable
 Category B

Sec. 481 (a)            Positive adjustment: 6 years
 adjustment period      Negative adjustment: 6 years

Year of change          Year Form 3115 is timely filed

Rev. Proc. 92-20:       Allowable
 Category A

Sec. 481 (a)            Positive adjustment: Year of change
 adjustment period      Negative adjustment: 3 years

Year of change          Year Form 3115 is timely filed(2)

Rev. Proc. 92-20:       Same as Category B, if request
 Category B              filed within a 2 years of designation

Sec. 481 (a)            Same as Category A, if request
 adjustment period       filed after 2 years of designation

Rev. Proc. 92-20:       Allowable
 Category B

Sec. 481 (a)            Positive adjustment: 4 years
 adjustment period      Negative adjustment: 4 years

Year of change          Year Form 3115 is timely filed

                        Under examination

Rev. Proc. 92-20:       Allowable: 30-, 90- or 120-day
 Category A              window(1)

Sec. 481 (a)            Positive adjustment: 3 years
 adjustment period      Negative adjustment: Year of change

Year of change          90-day window: Earliest year under
                         examination unless negative
                         adjustment, then year Form 3115
                         is timely filed
                        30-, 120-day window: Tax year
                         including first day of window

Rev. Proc. 92-20:       Allowable: 30-, 90- or 120-day window(1)
 Category B

Sec. 481 (a)            Positive adjustment:
 adjustment period      [] 90-day window: Year of change
                        [] 30-, 120-day window: 6 years
                        Negative adjustment: 6 years

Year of change          90-day window: Year Form 3115
                         is timely filed
                        30-, 120-day window: Tax year
                         including first day of window

Rev. Proc. 92-20:       Allowable: 30-, 120-day window
 Category A

Sec. 481 (a)            Positive adjustment: Year of change
 adjustment period      Negative adjustment: 3 years

Year of change          Tax year including first day of
                        window(2)

Rev. Proc. 92-20:       Same as Category B, if request
 Category B              filed within a 2 years of designation

Sec. 481 (a)            Same as Category A, if request
 adjustment period       filed after 2 years of designation

Rev. Proc. 92-20:       Allowable: 90-, 120-day window
 Category B

Sec. 481 (a)            Positive adjustment: 4 years
 adjustment period      Negative adjustment: 4 years

Year of change          Year Form 3115 is timely filed

                        Before Federal court or appeals office

Rev. Proc. 92-20:       Allowable with written consent
 Category A

Sec. 481 (a)            Positive adjustment: 3 years
 adjustment period      Negative adjustment: Year of change

Year of change          Year Form 3115 is timely filed

Rev. Proc. 92-20:       Allowable with written consent
 Category B

Sec. 481 (a)            Positive adjustment: 6 years
 adjustment period      Negative adjustment: 6 years

Year of change          Year Form 3115 is timely filed

Rev. Proc. 92-20:       Allowable with written consent
 Category A

Sec. 481 (a)            Positive adjustment: Year of change
 adjustment period      Negative adjustment: 3 years

Year of change          Year Form 3115 is timely filed(2)

Rev. Proc. 92-20:       Same as Category B, if request
 Category B              filed within a 2 years of designation

Sec. 481 (a)            Same as Category A, if request
 adjustment period       filed after 2 years of designation

Rev. Proc. 92-20:       Allowable with written consent
 Category B

Sec. 481 (a)            Positive adjustment: 4 years
 adjustment period      Negative adjustment: 4 years

Year of change          Year Form 3115 is timely filed

(1) Change from Category A method not allowed if the taxpayer is under examination for the year in which the taxpayer adopted the method, and the method was an impermissible method with respect to the taxpayer in the year of adoption.

(2) Retroactive adjustment allowed with the filing of amended return.