Pitfalls and opportunities of automatic accounting method changes.
For a taxpayer with inventory, the automatic change from the cash or hybrid method to the accrual method under Section 5.01 of Rev. Proc. 98-60 is limited to small resellers, small resellers with de minimis production activities or resellers eligible to use the simplified resale method under Kegs. Sec. 1.263A-3(d), provided that (1) the taxpayer "adopts" a proper inventory method under Sec. 471 and (2) a taxpayer subject to Sec. 263A and eligible to use the simplified resale method under Regs. Sec. 1.263A-3(d) "adopts" a proper method under that section. Rev. Proc. 98-60 is designed to allow taxpayers not in compliance with Sec. 263A to automatically change to a method that both tends to overcapitalize costs and is easily verifiable by the IRS.
In general, a "small reseller" is defined in Regs. Sec. 1.263A-3(b)(2) as a reseller whose average annual gross receipts for the three tax years immediately preceding the year of change do not exceed $10 million. Production activities are defined in Regs. Sec. 1.263A-3(a)(2)(iii)(A) as de minimis if:
* The gross receipts from the sale of the property produced by the reseller are less than 10% of the trade or business's total gross receipts; and
* The labor costs allocable to the trade or business's production activities are less than 10% of the reseller's total labor costs allocable to its trade or business.
The use of the term "adopt" ppears to be misplaced. A taxpayer may adopt any permissible method in the first year of its existence or, if later, the first year it has an item. Indeed, if it is the first year a taxpayer has inventories, the adoption of an inventory method is not subject to the procedures governing accounting method changes, as this does not involve a "change" in method of accounting; see Regs. Sec. 1.446-1(e)(1). However, it would generally be a change in method (rather than an adoption) when a taxpayer desires to begin using an inventory method in a year subsequent to the second year the taxpayer is required to use an inventory method; see Rev. Rul. 90-38.
Despite this confusing use of terms, the Service appears to interpret "adopts" in the context of Section 5.01 of Rev. Proc. 98-60 as either "uses" or "changes to." Accordingly, a small reseller with inventories changing from a cash or hybrid method to an accrual method would generally be permitted to change automatically to a proper inventory method under Sec. 471; a reseller subject to Sec. 263A would also generally be permitted to change automatically to a proper inventory method under Sec. 471, with cost determined under the simplified resale method. Further, a reseller using a hybrid method under which it properly accounted for purchases and sales of inventory under Sec. 471 (with cost determined under Regs. Sec. 1.263A-3(d)), but that accounted for another item or items under the cash method, would also be eligible to automatically change from the cash or hybrid method to the accrual method, because it currently uses a proper inventory method under Secs. 471 and 263A.
A taxpayer required or wanting to use a special method of accounting is not eligible to change from a cash or a hybrid method to an accrual method under Section. 5.01 of Rev. Proc. 9860, unless the taxpayer is permitted to change automatically to the special method under another section of Rev. Proc. 98-60. A special method includes the treatment of advance payments under either Rev. Proc. 71-21 or Regs. Sec. 1.451-5, use of the installment method of accounting under Sec. 453, or use of a long-term contract method under Sec. 460. A nonqualifying taxpayer would be required to file Form 3115, Application for Change in Accounting Method, under the provisions of Rev. Proc. 97-27; however, only one user fee would be required. In addition, a change to an accrual method to accelerate the accrual of deductions for salary or bonuses received by employees within 2 1/2 months after the end of a taxpayer's year-end is not a change to the accrual method in conjunction with a change to a special method of accounting. This change is not a change to a special method; Regs. Sec. 1.461-4(d)(2)(iii) provides that the economic performance requirement is satisfied to the extent any amount is otherwise deductible under Sec. 404. Temp. Regs. Sec. 1.404-1T, Q&A-2, provides that salary under an employment contract or a bonus under a year-end bonus declaration is not considered paid under a plan, method or arrangement deferring the receipt of compensation, to the extent such salary or bonus is received by the employee on or before the end of the applicable 2 1/2-month period beyond the end of the taxpayer's year-end; see Avon Products, 97 F3d 1435 (Fed. Cir. 1996).
In addition, if a taxpayer mistakenly files Form 3115 to change from cash to accrual along with deferring advance payments under Rev. Proc. 98-60, it will not be granted relief under Regs. Sec. 301.9100-2 for the portion of the change related to the special method, unless the Form 3115 was otherwise timely filed under Rev. Proc. 97-27.
Same Prior Change Defined
Section 4.02(6) of Rev. Proc. 98-60 provides that a taxpayer is not eligible to make a change automatically if it has either made a change in the same accounting method (with or without the Service's consent) or applied to change the same accounting method without effecting the change (whether, for example, the application to change was withdrawn, not perfected, not granted or denied), within the last five tax years (including the change year).
The IRS National Office has been interpreting a change to the link-chain method and a change to the inventory price index computation method as a change in the same method of accounting (i.e., the LIFO indexing method). Under this interpretation, changes involving different LIFO submethods would not be considered to be the same change. Therefore, a change involving the valuation of LIFO increments would not be considered the same as a change involving LIFO pooling,nor would it be considered the same as a change involving a LIFO indexing method, because such changes involve different LIFO submethods. In addition, a change to discontinue the LIFO inventory method is not viewed as the same as a change within the LIFO inventory method. Therefore, a taxpayer that initially requested a change from one LIFO inventory submethod to another is still eligible to automatically discontinue the LIFO inventory method under Rev. Proc. 98-60 (provided the taxpayer timely files a Form 3115 and is otherwise eligible to change its method of accounting under Rev. Proc. 98-60).
Choice of Tax Change Year
Because Rev. Proc. 98-60 permits a taxpayer to automatically change its method of accounting by attaching a Form 3115 to a timely filed tax return (taking into account any extensions) for the change year, a taxpayer filing under Rev. Proc. 98-60 has the option of filing the Form 3115 either for the preceding tax year for which a return has not yet been filed or for the current tax year. For any particular year, Form 3115 may be filed at any time on or after the first day of the change year through the day the taxpayer timely files (including extensions) its original Federal income tax return for the change year. Thus, taxpayers desiring to change to a more favorable accounting method, with a negative Sec. 481(a) adjustment, may change their method for the 1998 tax year under Rev. Proc. 98-60, if they have not yet filed their tax returns for that year. Conversely, taxpayers desiring audit protection for the use of an erroneous accounting method that understates taxable income may file a Form 3115 under Rev. Proc. 98-60 to obtain audit protection for earlier years, but defer implementation of the method change to the current tax year (e.g., calendar year 1999).
Example: For a calendar-year taxpayer, from Jan. 1,1999 until the date the taxpayer timely files its tax return for 1998, including extensions (i.e., generally, Sept. 15, 1999), the taxpayer may file an accounting method change for either the 1998 or the 1999 tax year. In either case, the taxpayer must send a copy of Form 3115 to the IRS National Office and attach the original to its timely filed tax return for the change year.
FROM FRANK J. KALIS, JR., CPA, AND PAUL K. GIBBS, CPA, WASHINGTON, DC
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|Author:||Gibbs, Paul K.|
|Publication:||The Tax Adviser|
|Date:||Jun 1, 1999|
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