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IRS rulings: cutting through the red tape.


The Internal Revenue Service receives thousands of formal ruling requests for changes in accounting methods or periods, but many of them are unnecessary and can easily be avoided. Under a new initiative, the service has published a number of revenue procedures that allow taxpayers to avoid the formal ruling process for some changes.

In the past, those seeking such changes--and in some cases those who wanted to adopt or retain an accounting period -- had to file a formal ruling request with the IRS commissioner using either Form 1128, Application for Change in Accounting Period, or Form 3115, Application for Change in Accounting Method. Taxpayers that qualify under the new procedures must still file the appropriate forms but need not request rulings.

The IRS returns unnecessary ruling requests and refunds any accompanying user fees, but practitioners who are aware of the service's expeditious approval procedures can prevent delays for their clients. This article highlights some of the more common procedures.


C corporations: Revenue procedure 84-34, 1984-1 C.B. 508. Section 1.442-1(c)(2) of the income tax regulations allows many C corporations to change their accounting periods automatically. This procedure expands the group eligible for an automatic change by omitting the 80% annualization requirement found in that section and providing terms and conditions to follow whenever taxpayers have a net operating loss in the short period.

A C corporation can use this procedure as long as it

* Has not changed its tax year within the past 10 years.

* Is not a member of a partnership, beneficiary of a trust or estate or shareholder of a domestic international sales corporation (DISC).

* Is not a DISC.

* Is not an S corporation and does not elect this status for the year immediately following the change in accounting period.

* Is not a foreign corporation that meets the stock ownership requirements of a foreign personal holding company.

* Is not a controlled foreign corporation.

* Is not a tax-exempt organization.

* Is not a cooperative.

Section 4.02 of the procedure describes compliance requirements. Section 6 describes how the change should be effected.

Partnerships, S corporations and personal service corporations: Revenue procedure 87-32, 1987-2 C.B. 396. No formal ruling request is necessary in these circumstances:

* An adoption of or change by one of these entities to an accounting period that is its required tax year (usually the calendar year) is automatic as long as the entity is not terminating its IRC section 444 election and follows the special notification guidelines in section 5 of this procedure.

* A taxpayer terminating its section 444 election and changing to its required tax year must follow the procedures described in section 1.444-1T(a)(5) of the regulations.

Section 4 of the procedure describes provisions that allow expenditious approval for use of other than a required tax year. They apply to one of these entities if it is not

* A taxpayer that has already used these provisions in the past six years (unless it is an S corporation using them in the first tax year in which it no longer meets the ownership tax year test described below).

* A PSC seeking to change its tax year that elects S status for the tax year following the short tax year.

* A partner in a partnership, a beneficiary of a trust or estate, a U.S. shareholder of a controlled foreign corporation or a shareholder of a DISC as of the dates that are listed in the procedure.

Section 4 describes two expeditious approval tests. The ownership tax year test allows an S corporation to use a fiscal tax year if the same year is used by shareholders holding more than one-half of the issued and outstanding stock (as of the first day of the tax year to which the request relates) or if these shareholders also are changing to the tax year desired by the S corporation.

The second test, the natural business year-25% test, may be used by a partnership, S corporation or PSC only for a change to an accounting period other than its required tax year and if the desired year results in a shorter deferral of income period for partners or shareholders. The test requires the taxpayer's gross receipts for a specified two-month period to equal or exceed 25% of the gross receipts for each of three consecutive 12-month periods. The method for making this computation is located in section 4.01(1) of the procedure.

Section 4.02(2) outlines compliance requirements for these tests.

Filing. A taxpayer changing accounting periods under either of these two revenue procedures must file form 1128 (or Form 2553, Election by a Small Business Corporation, for a newly electing S corporation using revenue procedure 87-32) with the IRS service center where it files its income tax returns.


Change in overall method from the cash receipts and disbursements to the accrual method: Revenue procedures 85-36, 1985-2 C.B. 434 and 85-37, 1985-2 C.B. 438. Section 1.448-1T(h)(1) of the regulations contains procedures for taxpayers that are required statutorily to change to the accrual method and, thus, need not make a formal ruling request. Approval generally is automatic if the proper regulations and procedures are followed.

Other taxpayers may be able to use the revenue procedures mentioned above for expeditious approval of changes in accounting method. Those that use inventories should refer to procedure 85-36, and all others to procedure 85-37.

The following taxpayers are not eligible to use either procedure:

* Financial institutions.

* Cooperatives.

* Farmers.

* Manufacturers subject to the uniform capitalization requirements of IRC section 263A.

* Individuals, except for activities conducted as a sole proprietor.

* Taxpayers seeking to use another method of accounting in conjunction with the accrual method.

* Taxpayers that are under IRS examination or that have been contacted about scheduling an examination; that are before an IRS appeals office; that are before a federal court on a federal income tax issue; or that are the subject of a criminal investigation or proceeding.

Taxpayers changing to the overall accrual method must compute an adjustment under IRC section 481(a) to prevent items from being duplicated or omitted when the change is made. This adjustment increases or decreases income and is spread over a period of years. Section 4 of both procedures discusses computation of the adjustment, the spread period and any limitations on the use of the adjustment. The maximum spread period is six years for revenue procedure 85-37 and three years for revenue procedure 85-36.

Section 6 of both procedures describes how to make the change.

Discontinuance of the last-in, first-out (Lifo) inventory method: Revenue procedure 88-15, 1988-1 C.B. 683. This procedure may not be used by a taxpayer that

* Did not file form 970 to elect Lifo.

* Is a cooperative seeking to justify a section 481(a) adjustment spread period of more than one tax year.

* In certain situations, issues non-conforming financial statements in violation of IRC section 472(g).

* Filed a form 3115 to discontinue use of Lifo for an earlier tax year and did not effect the change in accounting method.

* In certain situations, had a "termination event," as described in revenue procedure 79-23, 1979-1 C.B. 564 or any other applicable revenue ruling or revenue procedure.

* In certain situations, is under IRS examination or has been notified of a possible examination; is before an IRS appeals office; is before a federal court because of a federal income tax issue; or is subject to a criminal investigation or proceeding.

* Uses an impermissible method of determining costs incurred in the production or acquisition of inventory property for the preceding tax year (particularly taxpayers whose methods violate IRC section 263A and its regulations).

Alternative accounting methods available to taxpayers discontinuing Lifo are limited to those permitted under section 4.02 of the procedure:

* The identification method is either the first-in, first-out method or the specific identification method.

* The valuation method is

1. Cost.

2. Cost or market, whichever is lower.

3. Market (if the taxpayer is a securities dealer).

4. The "farm-price method" or the "unit-livestock method" (if the taxpayer is a farmer permitted to use such methods).

5. The retail method, reduced to approximate cost or approximate cost or market, whichever is lowest (but only if the taxpayer is a retail merchant).

The inventory methods taxpayers can use are detailed in section 4.02(1) of the procedure. Those changing methods must use the new method for all their tax books and records and reports to shareholders, partners or other proprietors or beneficiaries, including financial statements and statements for credit purposes. However, costs required to be capitalized under section 1.263A-1T of the temporary regulations need not be capitalized in determining the cost of inventoriable goods in reports to shareholders, partners or other proprietors or beneficiaries. Also, once the Lifo method is discontinued, it cannot be reelected for 10 years, beginning with the year of the change.

Taxpayers changing accounting methods must compute an IRC section 481(a) adjustment. The adjustment's spread period, determined using section 5.02 of this procedure, cannot exceed six tax years. Section 5 of the procedure also contains limitations on the use of the adjustment.

Change in method for reporting interest income from series E or EE U.S. savings bonds: Revenue procedure 89-46, 1989-33 I.R.B. 28. This procedure applies to taxpayers that have elected under IRC section 454 to report as income the increase in savings bonds' redemption price each tax year and now want to report this income in the tax year in which bonds are redeemed, disposed of or mature, whichever is earlier. Taxpayers can't change methods again for five years following the year in which this change is made.

Section 5 of the procedure describes how to make the change. No IRC section 481(a) adjustment is made. This procedure generally is effective for tax years ending after December 30, 1988.

Filing. Taxpayers seeking to change accounting methods using any of these revenue procedures must file an original form 3115 with their timely filed tax returns for the year of change. All but those using revenue procedure 89-46 also must file a copy of form 3115 with the IRS national office in Washington, D.C., no later than 270 days after the beginning of the tax year in which the change is to be made. The procedures describe information that must be included.


The IRS is considering issuing an even wider variety of expeditious approval procedures, which may further diminish the need for formal rulings on accounting methods and periods. Expanded use of these procedures helps taxpayers make timely business decisions, prevents filing delays and enables the IRS to make more efficient use of its resources.

Wendy MacDonald, CPA, assistant branch chief with the Treasury Department's Office of Chief Counsel (income tax and accounting), Washington, D.C., describes expeditious approval procedures for changes in accounting periods or methods.
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Author:MacDonald, Wendy
Publication:Journal of Accountancy
Date:Nov 1, 1989
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