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Rev. proc. 92-20, relating to changes in methods of accounting.

On October 21, 1992, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Rev. Proc. 92-20, relating to changes in methods of accounting. The comments were prepared under the aegis of the Institute's Federal Tax Committee, whose chair is David F. Nitschke of Amerada Hess Corporation. Also contributing to the preparation of the comments were Paul Cherecwich, Jr. of Thiokol Corporation, a primary drafter of the submission, and Donald A. Alder of Dean Witter Financial Services Group, who is chair of TEI's Federal Tax Subcommittee on Tax Accounting, Methods, and Financial Reporting.

The Internal Revenue Service has released Revenue Procedure 92-20 (1992-12 I.R.B. 10), relating to changes in accounting methods, to update and supersede Revenue Procedure 84-74 (1984-2 C.B. 736). The stated purpose of the revenue procedure is to encourage prompt compliance with proper tax accounting principles and to discourage taxpayers from delaying the filing of applications for permission to change from impermissible methods. TEI believes that the new procedure improves some aspects of the process for obtaining changes in accounting methods, but believes further changes should be made. Thus, some of our comments concern procedures contained in the predecessors to Rev. Proc. 92-20.


Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 4,700 members are employed by more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promote the uniform and equitable enforcement of tax laws, and to reduce the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the revenue procedure for accounting method changes.


The objectives of Rev. Proc. 92-20 are to provide rules that "encourage voluntary compliance" and are relatively easy for taxpayers to follow. Through a gradation of incentives, the new rules provide strong inducements for taxpayers both voluntarily and quickly to change impermissible methods of accounting. The graded incentives assure less favorable treatment for taxpayers compelled to change accounting methods upon examination. Furthermore, the rules provide various window periods within which voluntary method changes may be secured, following contact for examination but before a compulsory change imposed by the Commissioner.

In a departure from Rev. Proc. 84-74, the IRS in the new procedure has abandoned the "clearly erroneous" standard in defining Category A methods. By eliminating the clearly erroneous standard, the IRS has removed one source of uncertainty for taxpayers. Although this particular change is welcome, TEI believes that the overall tone and emphasis of the graded incentives contained in the new procedure is weighted far too much in favor of a punitive "stick" approach, rather than a proper balance of "carrot" and "stick" incentives. Thus, the procedure provides clear guidelines for securing consent of the Commissioner where an accounting method falls within one of the enumerated categories of methods -- thereby clarifying the disposition of the various categories of voluntary accounting method changes (i.e., "year of change" and income adjustment spread period). The procedure, however, assigns precious little weight to the concept of substantial compliance.(1) The task of distinguishing among permissible and erroneous methods remains a factual undertaking, subject to misinterpretations and errors.

Indeed, noncompliance with required accounting methods is frequently a result of unintentional misinterpretation of the law (or facts) or is attributable to a lack of timely published guidance from the IRS.(2) Rev. Proc. 92-20 raises the stakes for taxpayers' misapprehending (or, indeed, not being aware of) the propriety of an accounting method and, thus, contradicts IRS's goal of increasing voluntary changes of accounting method. Taxpayers may choose, should they discover that they are using a questionable method after the various voluntary change windows close, to perpetuate use of that method rather than face the uncertain terms and conditions that may be imposed by an examining agent or appeals officer. The incentive to defer making changes for methods discovered to be erroneous may be particularly acute for coordinated examination program (CEP) taxpayers whose only hope for consideration of a method change in a non-adversarial setting is to take advantage of the 120- or 30-day windows.(2)

Specific Comments

1. Definitions. Paragraph 3.02 of Rev. Proc. 92-20 states that a taxpayer is under examination when it has been contacted "in any manner" by a representative of the IRS. Since most large taxpayers are under continuous audit as part of the CEP program (and thus are in constant contact with the examination team), they are effectively precluded from using the 90-day window of paragraphs 6.02 and 6.03. TEI believes that the definition of "under examination" for a CEP taxpayer should be modified. Specifically, TEI recommends that an examination of a particular year or years be deemed to commence with the opening conference with the case manager or team coordinator. This approach would be consistent with Rev. Proc. 85-26 (1985-1 C.B. 580). (Under current examination practice, the District Director advises a CEP taxpayer by letter of its rights under Rev. Proc. 85-26 to make additional disclosures under section 6662 and sets the date on which that procedure's 10-day disclosure window begins.) Thus, CEP taxpayers should be permitted to avail themselves of the 90-day window.

Paragraph 3.02 also states that an examination is considered to end when a taxpayer requests consideration by an appeals officer or by a federal court. TEI recommends that language be clarified to state that the examination is deemed to end on the date the taxpayer files its protest or files a petition in Tax Court.

2. "Designated A" Methods. Paragraph 3.07 of Rev. Proc. 92-20 defines a "Designated A" method of accounting as a Category A method that has been classified as a "Designated A" method in the Internal Revenue Bulletin. For six years following designation, an accounting method change from a "Designated A" method is subject to special rules contained in section 7 of the procedure. No Category A methods have been "designated" under the revenue procedure.

TEI believes that the "designation" of Category A methods should be extremely limited. Designation should be reserved for statutorily imposed methods for which no dispute exists concerning the application of the method. In particular, the Commissioner should refrain from designating Category A methods that arise from interpretative regulations or even legislative regulations that are not expressly prescribed by a statute's legislative history. Taxpayers should not be punished for failing to anticipate how the IRS would interpret the specifics of a complex or vague legislative mandate.

Under Rev. Proc. 92-20, the special procedures for changing from a Designated A method are the exclusive means to adopt a change. It is unclear, however, which set of procedures applies to requests for changes that are pending at the time the "designating" document is published in the Internal Revenue Bulletin. Any delay between the effective date of the required use of an accounting method and the date the method is designated will create uncertainty in the minds of taxpayers and potentially retard voluntary changes.

In addition, since Supreme Court rulings interpreting the tax laws are generally retroactive, designation of methods resolved through Supreme Court decision should be eschewed. Indeed, the very fact that a method of accounting requires adjudication by the Supreme Court is evidence that a substantial interpretative dispute exists between taxpayers and the IRS concerning the propriety of the method. In cases involving accounting method changes that are required as a result of a decision by the Supreme Court, a grace period for filing the request for change and automatic consent of the Commissioner would be proper. TEI recommends that taxpayers be permitted to file a request for voluntary change to obtain a prospective spread for positive income adjustments for a period of up to one taxable year following the issuance of IRS guidance implementing a U.S. Supreme Court decision on an accounting method. In the event that the IRS has already raised the accounting method issue through a written, proposed adjustment (i.e., the issuance of a Form 5701) prior to a taxpayer's filing of such a request, the IRS should permit positive adjustments to be spread beginning with the most recent year under examination. At a minimum, the IRS should clarify the effect of a Supreme Court decision occurring during the various window periods under the revenue procedure.

3. Designated B Methods. The revenue procedure declares that accounting methods deemed impermissible by revenue ruling or a court ruling (i.e., a Category B method) may be converted to a Category A method -- i.e., an accounting method that violates a statute (enacted by Congress), a regulation (promulgated after notice and comment period), or is contrary to a Supreme Court decision -- when two years elapse following designation of the method as a "Designated B." The designation process converts what heretofore had been an arguably proper method of accounting into an improper method. The concept of designating certain accounting methods unacceptable and requiring different terms and conditions for changes in method first appeared in Rev. Proc. 80-51.(4) Thus, while designation is not a new concept, the inability of CEP taxpayers under Rev. Proc. 92-20 to make voluntary changes (because of overlapping audit cycles), obtain prospective-only adjustments, or select the new method raises serious issues of due process and fairness because of the lack of notice that a method is to be designated. Issues that have been designated as improper Category B methods have generally emerged through the examination process. The taxpayer's method, however, may have been accepted, customary, or even the preferred industry accounting practice. Although some IRS personnel may perfervidly believe that the method fails to clearly reflect income, widespread industry practice and generally accepted accounting principles suggest otherwise. This is not to suggest that the IRS cannot challenge such methods (that is the subject of another letter), but to propose that, when longstanding accounting practices are to be upended, the sounder approach to tax administration involves the promulgation of proposed regulations with a comment period and the prospective application of the permissible methods.

Under Rev. Proc. 84-74, the designation of Category B methods as improper was not unduly onerous so long as taxpayers had the right to voluntarily change methods (prior to an issue's being raised on examination) and to secure a prospective spread of any positive adjustment. Under Rev. Proc. 92-20, however, a taxpayer under continuous examination that employs a Category B method that is newly designated must weigh a number of unpleasant options to determine the best time to file a request for change. To say that the CEP taxpayer should file Form 3115 immediately is to ignore the requirement imposed under paragraph 6.06 that the taxpayer obtain the consent from the District Director -- a requirement likely to produce an outcome most favorable to the fisc (i.e., a prospective spread for negative adjustments and retroactive examination changes for positive adjustments). TEI believes that employing the designation process in this fashion would be highly improper.(5)

4. Application Procedures

a. Consent of Appeals Officer or Government Counsel. Special procedures apply when a taxpayer's return is under consideration by an appeals office or federal court. Paragraph 4.02 requires that an appeals officer give written consent to any application for change in method under Rev. Proc. 92-20. A similar rule in paragraph 4.03 requires written consent of the government's counsel if any of the taxpayer's returns are before a federal court.(6) The procedure states that if an issue is not pending with respect to the method of accounting that is the subject of the proposed change, the appeals officer (or counsel) will ordinarily give permission to file for the proposed change. The potential use of the consent requirement as a bargaining chip in the appeals or litigation process will be perceived as a significant threat by most taxpayers. Thus, the consent requirement may undermine the stated goal of obtaining voluntary compliance in changes to accounting methods.

The purpose of the consent requirement is presumably to ensure that no issue is pending in appeals or court concerning the proposed change in method and to apprise the appeals and litigation counsel of the application. The Commissioner's approval of accounting method changes is generally conditioned on the absence of an issue with respect to the method of accounting in a year preceding the year of change. Thus, TEI recommends that the procedure be revised to require a separate affirmation by the taxpayer on Form 3115 that no issue is pending in respect of the proposed change. If the National Office desires advance confirmation that no issue exists, the name and telephone number of the appeals officer or government counsel should be incorporated into the Form 3115. In addition, a courtesy copy of Form 3115 should be provided by the taxpayer to the appeals officer or IRS counsel at the time of application.(7)

b. Administrative Requirement. TEI also objects to the imposition of the consent requirement on administrative grounds. All too often a taxpayer's protest may languish in limbo for months between the filing date and its assignment to an appeals officer. The delay, particularly for CEP taxpayers, is often exacerbated by the opportunity afforded the revenue agent to review and rebut the assertions made in the taxpayer's protest. Paragraph 10.03(2) provides a 45-day period within which a taxpayer may perfect the application for change in accounting method following receipt of a notice from the National Office. If the consent requirement is retained, TEI believes it proper for the Commissioner to provide an exception to the 45-day period for delays caused by her representatives in providing necessary information to complete an application.

5. Thirty-Day Window. Taxpayers under examination for a continuous period of 18 months may use a special window to file an application for change in accounting method within 30 days of the beginning of the taxable year. To be eligible for the 30-day window period under paragraph 6.04, however, a taxpayer must not have received written notice "specifically citing the method or sub-method to be changed." This written notice may be provided by disclosure of IRS's examination plan, issuance of information document requests, notification of proposed adjustment, or income tax examination changes.

TEI believes that the standard for notification is far too broad. Examination plans are often stated as broadly as possible, such as "review inventory accounting", or "investigate spare parts activity." TEI is concerned that overbroad descriptions will be considered to be "specifically cited," even when they do not give taxpayers meaningful notice that the treatment of specific items will be challenged. To avoid disputes over when an issue is raised, thereby precluding use of the 30-day window, TEI believes that, at a minimum, a notice of proposed adjustment on Form 5701 should be required to provide adequate notice that an issue has been raised.(8) Examination plans or other documents should not be considered as raising an issue. TEI recommends that the result reached in TAM 9237010 (May 29, 1992) -- which concludes that an information document request (IDR) concerning a method of accounting does not constitute adequate notice -- should be both expanded (so that an IDR does not constitute the "raising of an issue") and made broadly applicable to all taxpayers.

6. Terms and Conditions of Change. Paragraph 10.01 of the procedure states that taxpayers are not guaranteed to receive any of the terms and conditions set forth in the procedure "in situations in which it would not be in the best interest of sound tax administration to permit the requested change." This statement appears to undermine the purpose of the procedure. If the IRS invokes this paragraph with any degree of frequency, the entire structure of the procedure's graded incentives will become superfluous. Again, taxpayers may choose to perpetuate an erroneous method rather than risk the uncertainty of the terms and conditions for an approved change in method.

7. LIFO Inventory Method Changes. While we believe it is proper for the IRS to announce in Rev. Proc. 92-20 the policies that have governed private ruling practice on LIFO method changes, we wholeheartedly disagree with many of those policies.(9) TEI believes that all LIFO inventory method changes should be permitted on a current-year, cut-off basis regardless of whether a taxpayer has been contacted for examination. At a minimum, all LIFO Category B method or sub-method changes should be effected on a prospective, cut-off basis. The proper application of LIFO to any particular taxpayer requires a facts-and-circumstances inquiry that involves informed and practical judgment. The absence of bright-line rules for the application of LIFO suggests that -- unless the taxpayer's method is so clearly erroneous that it is not in conformity with the section 472 regulations -- it is improper for the IRS to impose any condition for a change in method other than adoption of a cut-off method. If the IRS identifies particular applications of the LIFO method that arguably fail to properly reflect income, the appropriate means of resolving such a tax policy issue is to amend the LIFO regulations and provide clear, authoritative guidance concerning the prohibited method.(10)

Finally, imposing a section 481(a) adjustment either for the full amount of the LIFO reserve or for the difference in the reserve amounts under a 10-year look-back approach is unduly harsh and burdensome. In many if not all cases, records will not exist to support a recomputation of the LIFO inventory layers for the 10-year period preceding the year under examination. Even where reasonable estimates may be employed to recalculate the LIFO inventory layers under the 10-year recomputation approach, the requirement that the earliest year under examination be treated as the year-of-change implies that CEP taxpayers may have many more than 10 years of LIFO reserve "recapture."

8. Elimination of "No Offset Rule." Rev. Proc. 84-74 restricted the use of net operating loss and tax credit carryovers in conjunction with the calculation of the section 481(a) adjustment arising from certain accounting method changes. Rev. Proc. 92-20 eliminates these unnecessary restrictions. Although the changes in Rev. Proc. 92-20 are a noteworthy improvement, we believe the IRS should update other guidance to confirm that the policy evinced in Rev. Proc. 92-20 applies in all cases. For example, Notice 88-78 (concerning changes in method to conform to the uniform capitalization rules) contains rules similar to Rev. Proc. 84-74 restricting the use of loss or credit carryovers to reduce the tax liability arising from the section 481(a) adjustment. Similarly, Rev. Proc. 90-63 (concerning changes in method to accounting for package design costs) contains similar guidance. TEI recommends that the IRS adopt a consistent policy for all accounting method changes giving rise to section 481(a) adjustments.

9. Time-Value Rate. Under one of two procedures for changing from a "Designated A" Method of accounting, a taxpayer is required to calculate an "additional amount" to be paid as a tax in connection with a prospective-only change. Paragraph 7.03(4)(c)(ii)(B) defines the applicable time-value rate to use in such calculations as the "average of the highest underpayment rate" in effect for the years in question. We suggest that a weighted average rate is more appropriate.

10. Accelerated Section 481 Adjustments. Under paragraph 8.03 of the procedure, certain situations will cause an acceleration of the section 481 adjustment amount. In particular, if the change in accounting method involves inventory valuation methods, a substantial inventory reduction occurring during the section 481(a) adjustment period will accelerate the income adjustment unless the taxpayer demonstrates that the reduction is due to a strike, involuntary conversion, or other involuntary circumstances. To secure the benefit of the exception for involuntary reductions in inventory, a taxpayer is required to submit a ruling request with the Commissioner. TEI questions why a factual determination must be resolved by the National Office. The determination of a factual issues is generally resolved in the field. If a higher level of review beyond the examination case manager is warranted (and we are not certain it is necessary assuming the taxpayer retains its right of appeal), perhaps the District Chief of Examination or even the District Director (without delegation) should be empowered to make the determination.


We are pleased to have had the opportunity to submit our views on Rev. Proc. 92-20. If you have any questions about TEI's position please feel free to call either David F. Nitschke of Amerada Hess Corporation, chair of TEI's Federal Tax Committee, at (908) 750-6782 or Jeffery P. Rasmussen of the Institute's professional tax staff at 638-5601. (1) In particular, taxpayers establishing substantial compliance with the uniform capitalization rules should not be penalized with the more burdensome Category A method change requirements for relatively minor adjustments to their overall cost accounting calculations. The detailed level of records required to adjust the uniform capitalization calculations simply may not exist. (2) This is especially the case where there is a delay in guidance critical to the implementation of a statutory change or where there is a substantial enough dispute between taxpayers and the government to require litigation to resolve the accounting treatment. (3) Taxpayers under examination for a continuous period of 18 months may make an application for change of accounting method without the consent of the District Director during the first 30 days of any tax year. Furthermore, all taxpayers may file a request for change in method without the consent of the District Director during a 120-day period following the close of an examination. Should the IRS's large-case "currency" initiative prove successful, the 90-day window will open up for CEP taxpayers as well. Under the current backlog of cases, however, audit cycles commonly overlap so that CEP taxpayers are under continuous audit. (4) Paragraph 5.12(2), 1980-2 C.B. 818, 824. (5) To imply, as the Revenue Procedure does, that a Revenue Ruling or other designating document that establishes a Designated Category B accounting method is, following a lapse of two years, equivalent to a Supreme Court decision, act of Congress, or even regulations lawfully promulgated pursuant to the Administrative Procedures Act constitutes regulatory effrontery. (6) Both rules have been carried over from Rev. Proc. 84-74. (7) The proposals to notify the appeals officer (or IRS litigation counsel) and include the name and phone number of the appeals officer (or counsel) are similar to the requirements imposed under paragraph 10.06 where a taxpayer seeks to avail itself of the 120- or 30-day window periods. (8) See, for example, Rev. Proc. 90-36, 1990-2 C.B. 357, suggesting that an improper method of accounting becomes a pending issue when a Form 5701, Notice of Proposed Adjustment, is issued. (9) Thus, we disagree with the requirement in Announcement 91-173, as modified by paragraph 9.01 of Rev. Proc. 92-20, that all bargain purchases of inventory must be treated as a separate pool for LIFO, and that taxpayers that used a different method must "recapture" the bargain element through a section 481(a) adjustment and a "voluntary" change in method. Although the IRS prevailed in Hamilton Industries, 91 T.C. No. 9 (1991) (appeal pending), Judge Wells in footnote 6 of his opinion expressly declined to announce a per se rule that all bargain purchases would require a separate LIFO pool. (10) The most current example of the difficult judgments confronting the IRS and taxpayers in applying the LIFO method involves the components-of-cost method. In a letter dated July 31, 1992, to Leonard Podolin of the American Institute of Certified Public Accountants, the IRS acknowledged that not all applications of the components-of-cost LIFO method distort income. Thus, some taxpayers' methods will survive scrutiny while others may be compelled to litigate or accept large section 481(a) adjustments as a result of seemingly minor deviations from approaches deemed acceptable by the IRS.

Until the publication of authoritative guidance, taxpayers face a conundrum: Should they come forward and work with the ERS to define the proper scope and application of the method -- risking a substantial section 481(a) adjustment -- or should they await promulgation of definitive authority? Taxpayers will likely not voluntarily change their methods of accounting unless they know with certainty (1) that their method is erroneous, (2) what alternatives are acceptable to the government, and (3) what the cost (defined broadly to include taxes, interest, and costs of compliance) of the change will be. As explained in the text, the application of the LIFO method is unique to each taxpayer. Thus, taxpayers may in good faith believe that their application of LIFO will be sustained. If the IRS were to announce that the cut-off approach would be employed for all LIFO method changes, taxpayers may be induced to discuss their applications of the accounting method with representatives of the IRS.
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Publication:Tax Executive
Date:Nov 1, 1992
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