Maneuvering through the sec. 381 regulations' accounting method rules.
Principal Accounting Method
The first step in maneuvering through these regulations is to determine whether the component trades or businesses of the respective parties to the transaction may be treated as separate and distinct or must be integrated into one trade or business after the transaction. If the trades or businesses are operated as separate and distinct within the meaning of Regs. Sec. 1.446-1 (d), each separate trade or business will continue to use the accounting method used before the transaction, unless the acquiring corporation requests an accounting method change from the IRS or the Service prescribes a different accounting method under Regs. Sec. 1.446-1(b)(1).
An exception to this rule exists when a corporation may have only one accounting method for a particular item. If the separate trades or businesses use different accounting methods for this item, the acquiring corporation must use the"principal" accounting method determined under the regulations. The principal accounting method for such item generally is determined by comparing the aggregate amount of the item and related accounts for all parties to the transaction (using a common method) to the aggregate amount of the item and related accounts for those parties (using: a different common method). The accounting method of the group with the greatest aggregate amount of such item and related accounts will be the principal accounting method for that particular item.
If the corporations' component trades or businesses are not operated as separate and distinct, to the extent that different accounting methods were used, the acquiring corporation must adopt the principal overall accounting method determined under the regulations. The principal overall accounting method of an integrated business generally is determined by comparing the total adjusted bases of the assets immediately preceding the transfer date and the gross receipts for a representative period (usually, the most recent 12 months ending on the transfer date) of the component trades or businesses to be integrated.
A change to a principal accounting method is treated as if the corporation whose method must be changed had initiated the change; advance IRS consent is not required. However, the entire Sec. 481(a) adjustment must be recognized by the acquiring corporation in the tax year that includes the transfer date. On the other hand, if this adjustment increases taxable income, the resulting tax should be computed under Sec. 481(b)(1)'s three-year allocation rule. In addition, according to current IRS National Office practice, there will be no audit protection for open tax years with respect to an improper accounting method.
No Principal Method
If the principal accounting method cannot be determined or if it does not clearly reflect the acquiring corporation's income, the acquiring corporation must submit a ruling request to the IRS National Office within 90 days after the transfer date to determine the appropriate accounting method. However, an automatic extension of 90 days will be granted under Rev. Proc. 83-77. This determination cannot be obtained by filing Form 3115, Application for Change in Accounting Method, under Rev. Proc. 92-20. Accordingly, the normal $3,650 user fee for a ruling request applies, instead of the $900 fee for most Forms 3115.
Observation: If the old methods were proper, a ruling should not be required merely to allow the taxpayer to continue to use one of these proper methods. As a practical matter, if the previous permissible methods were the cash and accrual methods and the taxpayer used the accrual method for the integrated trade or business without obtaining a ruling, an IRS agent most likely would not raise the issue in the event of a later examination.
Current IRS National Office practice requires the taxpayer to reflect the entire Sec. 481 (a) adjustment caused by the method change in the tax year that includes the transfer date. This was the result in Letter Ruling 9530028, in which the taxpayer requested a determination of the principal accounting method after a statutory merger.
In unofficial and informal discussions with IRS National Office personnel, it was acknowledged that a reading of Regs. Sec. 1.381(c)(4)-1(d)(1)(iii) could reasonably be interpreted to provide a spread of the Sec 481(a) adjustment. Nevertheless, the present National Office practice is not to allow this spread--despite contrary language in Rev. Proc. 83-77. There also will be no audit protection for open years with respect to an improper accounting method.
Making a determination of the potential accounting method changes should be a consideration early in the pretransaction planning process. If it appears that there will be a material tax cost associated with a required method change under the Sec. 381 regulations, the taxpayer should be advised to apply for an accounting method change by filing Form 3115 under the relevant revenue procedure and, if business considerations permit, defer the tax-free reorganization or liquidation until the tax year following the year of change Thus, it would not be necessary to attach the statement referred to in Form 3115, line 19:
Attach a statement addressing whether the applicant has entered (or is considering entering) into a transaction (for example, a reorganization or merger) to which section 381 (c)(4) or (5) applies during ; the tax year of change. Also include in the statement an explanation of any changes in method of accounting that resulted (or will result) from the transaction(s).
In some situations, it may be more beneficial to allow the change to occur by operation of the regulations (e.g., when the principal method can be determined and the resulting Sec. 481(a) adjustment is negative). However, it is better to plan for this event than to find out about it after the transaction has already been consummated.
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|Author:||Duer, Linda A.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1997|
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