Requests for changes in accounting methods made easier.
Accounting Method Changes
Changes in tax accounting methods affect when a taxpayer reports income or takes a deduction. Accounting method changes do not include corrections of mathematical, posting or computational errors, but do include changes that do not "permanently affect the taxpayer's lifetime taxable income," if the change could affect the year in which the taxable income is reported. For example, a change in accounting method would arise if a taxpayer changes the treatment of a receipt from a customer from recognizing the cash as an item of income to treating this receipt as merely a deposit with no current income recognition. Because of the potential timing differences, if a taxpayer wishes to change its accounting method, it must first receive IRS consent. This is done by filing Form 3115, requesting permission for the change; this filing (and its concomitant $900 user fee) is not necessary when the Service has provided an automatic procedure. In deciding whether to approve the proposed change, the IRS considers whether the new method will create or shift profits or losses between the businesses the taxpayer operates, as well as whether the method will clearly reflect income.
Who Can File Form 3115?
Generally speaking, any taxpayer can request a change in its accounting method. However, if the taxpayer is already under examination by the Service, this request will generally be rejected. (For purposes of filing Form 3115, "under examination" means that the taxpayer has been contacted in any manner by the Service for the purpose of scheduling any type of examination of any of its Federal income tax returns.) In addition, if the taxpayer's case is already in appeals or in Federal court and the taxpayer's accounting method is an issue under consideration, the request for accounting method change will generally be denied. However, under any of these circumstances, the district director may consent to the filing of the change request.
Two exceptions to the "under examination" prohibition exist. The first is when a taxpayer has been under "continuous examination" (defined as being under examination for at least 12 consecutive months as of the first day of the tax year for which the change is requested). The second is when the taxpayer had been under an examination that had concluded and is now subject to a subsequent IRS audit. In either case, the taxpayer has specifically defined timelines or windows during which a Form 3115 can be filed.
When Can Form 3115 Be Filed?
Under Rev. Proc. 92-20, a taxpayer had to file Form 3115 within the first 180 days of the tax year for which the accounting method change was requested. Now, the taxpayer can file the request for change at any time during the tax year. However, the Service still recommends that Form 3115 be filed as soon as possible, to allow sufficient time to consider and decide on the proposed change before the due date of the taxpayer's return. If IRS approval has not been received by the return's original due date, the taxpayer may have to file an amended return if consent to the change is subsequently granted.
If the taxpayer has been under continuous examination," it can file Form 3115 during the first 90 days of the tax year for which the change is requested. While a similar "window" was available under Rev. Proc. 92-20, Rev. Proc. 97-27 gives the taxpayer more flexibility by shortening the period required in order to be considered under "continuous" audit from 18 months to 12 months and by lengthening the window for Form 3115 filing from the first 30 days to the first 90 days of the change year.
For the taxpayer that has one IRS audit completed, but is now subject to a different examination, the request for change in accounting method can be filed during the 120 days following the completion of the first audit. This 120-day window is not available if the taxpayer's accounting method is an issue in the subsequent examination.
While creating or expanding some windows for the filing of the request for accounting method change, Rev. Proc. 97-27 did eliminate one window that had been available under Rev. Proc. 92-20. Previously, a taxpayer could file Form 3115 during the 90-day period beginning on the day after the beginning of the examination. This opportunity no longer exists. The practical effect of this is that any adjustments to income that arises as a result of the IRS audit will have to be taken immediately by the taxpayer rather than being spread over Rev. Proc. 97-27's regular four-year adjustment period. Also eliminated was the 90-day "post-affiliation" window for a parent under examination to change the accounting method on behalf of new members of a consolidated group not otherwise considered to be under IRS audit.
Changes in accounting methods will usually result in positive (additions) or negative (reductions) adjustments to taxable income under Sec. 481 (a).
Example: Taxpayer X wishes to change from cash-basis to accrual accounting. If X has accounts receivable (i.e., income earned but not yet recognized under the cash basis, due to the fact it has not yet been received) of $150,000 and accounts payable (i.e., expenses incurred but not yet deducted since they have not yet been paid) of $200,000, a negative Sec. 481(a) adjustment of $50,000 (additional accrual revenue less additional accrual expenses) would be required.
Under the old rules, the Sec. 481(a) adjustment period depended on the type (positive or negative) and classification of the change. Under the new revenue procedure, the adjustment period is the same for an changes -- four years, beginning with the year of the change. Thus, in the example, the $50,000 decrease in income would be spread over the change year and the following three years. However, the de minimis rule available under the old procedure remains unchanged. If the total Sec. 481(a) adjustment (whether positive or negative) is $25,000 or less, the taxpayer can elect to take the entire adjustment in the year of change. An obvious strategy would be for taxpayers to make this election for negative adjustments to get the benefit of the adjustment in one year, but to use the regular adjustment period to spread out any positive adjustments (increasing income) over four years.
Another possible benefit can be derived from the flexibility available from the transition period for implementation of the new revenue procedure. As noted above, Rev. Proc. 97-27 is effective for Forms 3115 filed after May 14,1997. However, for any Form 3115 filed on or before Dec. 31, 1997, the taxpayer may request that the terms and conditions of Rev. Proc. 92-20 be applied. This would be favorable for a taxpayer with a positive Category B method change (i.e., a change from a permissible method of accounting that results in a net increase in income); that taxpayer would then be able to spread that positive adjustment over the six-year Sec. 481 (a) period provided by Rev. Proc. 92-20. It would also benefit a taxpayer with a negative Category A method adjustment (i.e., a change from an impermissible accounting method that results in a net decrease in income); under Rev. Proc. 92-20, the entire adjustment could be taken in the year of the change, regardless of its amount (that is, no de minimis test need be met).
If, as a result of an IRS audit, the taxpayer's accounting method is found not to clearly reflect income, any positive adjustment must be taken entirely in the earliest year under examination. This provides an incentive for taxpayers to change their questionable accounting methods before being contacted by the Service. Not only will the taxpayer usually be required to make an earlier adjustment to income (i.e., in the first year under examination rather than the year in which the change is requested), but because Rev. Proc. 97-27 is not available to a taxpayer under examination, the taxpayer will not be able to spread the resulting adjustment over four years. As noted previously, the window that was available under Rev. Proc. 92-20 to file Form 3115 during the first 90 days after an IRS audit begins has been eliminated; taxpayers no longer have this grace period available to them.
In general, a request for a change in accounting method will not affect tax years prior to the year of change; the Service will usually not require a taxpayer to go back and change its accounting method for any earlier tax years. However, if the taxpayer withdraws its request, has its Form 3115 rejected, decides not to implement the requested and approved change, or has misstated or omitted material facts, these prior years can be attacked by the IRS.
As would be expected, even if a change in accounting method has been approved by the Service under Rev. Proc. 97-27, the taxpayer may still be forced to change its method if such a change is necessary for the taxpayer to be in compliance with legislation, a Supreme Court decision, temporary or final regulations, revenue rulings or procedures, notices or other published statements by the Service, or changes in material facts.
Rev. Proc. 97-27 represents a substantial simplification of the procedures for obtaining IRS consent to changes in accounting methods for Federal tax purposes. After this third major, comprehensive revision in 13 years of the rules on these types of requests, the IRS has finally succeeded in making them easier for taxpayers and, hopefully, enhancing voluntary compliance.
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|Author:||Sherman, W. Richard|
|Publication:||The Tax Adviser|
|Date:||Oct 1, 1997|
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