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IRS releases favorable sec. 263A accounting method change guidance.

The Sec. 263A final regulations issued in August 1993 withdrew Notice 88-78, which had provided taxpayers with guidance on accounting method changes relating to failure to properly implement Sec. 263A. Substitute guidance was not issued in the regulations; further, the intended effective date for revocation of Notice 88-78 was not made clear. As a result, taxpayers have faced uncertainties as to what terms and conditions would apply with respect to Sec. 263A accounting method change requests either pending at the IRS National office at that time or filed subsequently.

Notice 88-78 had provided in part that a net positive Sec. 481 (a) adjustment resulting from a Sec. 263A method change request must be included in taxable income in the year of change. In addition, the positive adjustment was not permitted to offset net operating loss (NOL) or credit carryovers. Negative adjustments were to be taken into account over a period not exceeding six years.

The terms and conditions of Notice 88-78 were a precursor to the Designated A methods later provided under Rev. Proc. 92-20. In comparison to regular Category A methods, Designated A method change requests are subject to harsher terms and conditions. Once a method has been announced as Designated A, it remains subject to these stricter conditions for a period of six years; in year 7, the Designated A method reverts back to a Category A method.

Recently issued Notice 94-24 revokes the provisions of Notice 88-78 in two separate phases:

* For tax years beginning after Dec. 31, 1992, method change requests filed for failure to properly implement Sec. 263A by taxpayers not under exam are to be treated as Category A method change requests. Retroactive revocation is premised on the expiration of the six-year Designated A period Sec. 263A was enacted as part of the Tax Reform Act of 1986), even though the method was never announced as such.

* Notice 88-78 is revoked in its entirety for tax years beginning after Dec. 31, 1993 for all taxpayers. Therefore, taxpayers under exam will remain subject to the more restrictive terms for tax years beginning before Jan. 1, 1994; these terms require the inclusion of the positive Sec. 481(a) adjustment in taxable income in the year of change, with no NOL or credit carryover offset.

Taxpayers affected by the retroactive revocation already may have received permission to change accounting methods pursuant to the terms and conditions in Notice 88-78. These taxpayers have until june 20, 1994 to request a revised consent agreement that would treat the requested Sec. 263A change as a Category A method. This will result in a permitted three-year spread of a positive Sec. 481(a) adjustment and the ability to offset NOL and credit carryovers in the year of change.

After the repeal of Notice 88-78, taxpayers filing accounting method change requests for the failure to properly implement Sec. 263A will receive Category A method treatment. The year of change for taxpayers not under exam, as well as taxpayers filing under the 120-day window, 30-day window or 90-day postaffiliation window, is the current year for which a Form 3115, Application for Change in Accounting Method, is considered timely filed. Taxpayers under exam and filing under the 90-day window will be required to change their method beginning in the earliest year under examination.

Taxpayers that have adopted a method of accounting pursuant to the Sec. 263A temporary regulations and related notices may be required to change their method of accounting in order to comply with the final regulations. In addition, taxpayers may want to adopt certain simplified methods and elections provided under the final regulations. it is anticipated that IRS guidance will be released permitting expedited procedures for taxpayers with these type of Sec. 263A method change requests.
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Author:Mace, Joyce
Publication:The Tax Adviser
Date:Jul 1, 1994
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