On Jan. 16, 2015, the IRS issued two new revenue procedures that update and revise the general procedures for taxpayers to obtain consent to voluntarily change an accounting method for federal income tax purposes. Highlights of some of the more significant modifications are summarized below.
A taxpayer typically must secure IRS consent before changing a method of accounting for federal income tax purposes. In general, IRS consent is procured by filing Form 3115, Application for Change in Accounting Method. Prior to the issuance of the new guidance, the rules governing the accounting method change consent process were found in Rev. Proc. 97-27 (non-automatic method changes) and Rev. Proc. 2011-14 (automatic method changes). These procedures were intended to encourage taxpayers using non-compliant tax accounting method(s) to voluntarily change to permissible method(s) by providing favorable terms and conditions, including a four-year spread for an unfavorable (i.e., positive) section 481(a) adjustment, and audit protection that prevents the IRS from raising the same issue in an earlier year.
Rev. Proc. 2015-13 provides the general procedures to obtain either non-automatic or automatic IRS consent to change an accounting method. This new revenue procedure modifies and consolidates guidance previously contained in the separate automatic and non-automatic procedures referenced above.
Rev. Proc. 2015-14 provides the list of changes eligible for the automatic change procedures. The new list includes the automatic changes formerly in the Appendix of Rev. Proc. 2014-11 and in subsequently issued guidance; it also revises several existing automatic changes and adds new automatic changes. Revisions to existing automatic changes include certain changes for research and experimental expenditures, overall changes from cash to accrual method, advance payments, and long-term contracts. New automatic changes were added for items impacting certain banks, insurance companies, and mark-to-market method taxpayers.
Effective date and transition rules – In general, the new procedures are effective for Forms 3115 filed on or after Jan. 16, 2015 (i.e., immediately). However, temporary transition relief permits automatic accounting method changes to be filed under either the new procedures or the old procedures for a 2014 tax year ended on or after May 31, 2014, and on or before Jan. 31, 2015. Taxpayers under exam that are adversely affected by the new procedures (discussed below) may wish to file their 2014 automatic method change application(s) under the old procedures, assuming they meet the eligibility requirements, in order to obtain audit protection for prior tax years. Non-automatic changes filed after March 2, 2015, must file Form 3115 under the new procedures. Taxpayers with an advance consent Form 3115 pending at the IRS National Office that is now eligible for automatic consent under the new procedures may convert the filing to an automatic change provided they contact the IRS national office prior to the later of March 31, 2015, or the issuance of the ruling letter for the requested change.
Significant changes for taxpayers under exam – Although the method change procedures for taxpayers not under federal exam remain largely unchanged under the new rules, material revisions were made to the terms and conditions governing accounting method changes filed by taxpayers that are under federal exam. Under the old procedures, a taxpayer under exam generally could not file a voluntary Form 3115 unless it was filed: (1) within the 90-day window, (2) within the 120-day window, (3) with the consent of the director, or (4) for an issue pending without audit protection. However, under three of the four exceptions (the two window periods and pursuant to director consent) taxpayers filing Form 3115 while under exam were granted audit protection for the changed item, meaning the IRS could not raise the same issue for a prior tax year under exam. Conversely, under the new procedures, a taxpayer under exam and outside a window period generally may file Form 3115 at any time without having to obtain director consent, provided all the other terms and conditions are met. However, the tradeoff is the change generally must be made without audit protection, unless the taxpayer qualifies for one of the exceptions outlined below. Absent audit protection, the IRS may propose an exam adjustment and/or involuntarily change to a taxpayer’s accounting method for the same item in a prior open tax year, and potentially impose interest and penalties as well. Consequently, many taxpayers filing Form 3115 while they are under exam may find the terms and conditions of the new procedures to be less favorable than those imposed under the old procedures.
The following is a summary of the six exceptions where a taxpayer under exam may file Form 3115 and obtain audit protection under the new accounting method change procedures:
- Change filed in the “three-month window.” Under this new window period, which replaces the former 90-day window, a taxpayer under examination for at least 12 consecutive months as of the first day of the three-month window may file Form 3115 during the window period and receive audit protection, provided the method of accounting is not an issue under consideration by the IRS. In contrast to the old 90-day window that commenced on the first day of the tax year and ended 90 days thereafter (i.e., the first 90 days of the taxpayer’s tax year), the new three-month window begins on the fifteenth day of the seventh month of the taxpayer’s taxable year and ends on the fifteenth day of the tenth month of the taxpayer’s taxable year. The window period is modified for a short tax year and different eligibility requirements apply to foreign corporations (e.g., must be under exam for at least 24 consecutive months rather than 12 consecutive months).
- Change filed in the “120-day window.” Under this window period, which is unchanged from the old procedures for most taxpayers, Form 3115 may be filed within the 120-day period following the date an exam ends, regardless of whether a subsequent examination has commenced, provided the item being changed is not an issue under consideration by the IRS. A taxpayer filing under this exception will receive audit protection. However, foreign corporations are no longer eligible to use the 120-day window under the new procedures.
For a taxpayer under exam and outside a window period, the above-described issue pending exception (no audit protection) and the director consent exception (with audit protection) that existed under the old method change procedures were eliminated and replaced with the following exceptions that permit Form 3115 to be filed with audit protection:
- Present method not before the director. Under this new exception, a taxpayer under exam may file Form 3115 and receive audit protection if the taxpayer is changing an item (1) from a clearly permissible method or (2) from an impermissible method adopted in a tax year subsequent to the year(s) under exam.
- Change resulting in a negative § 481(a) adjustment. Under this new exception, where the method change results in a negative (i.e., favorable) § 481(a) adjustment in the year of change and in each of the years under exam (assuming the change had been made for those years), the taxpayer may file Form 3115 and receive audit protection. Note that this exception essentially requires the taxpayer to compute a § 481(a) adjustment for each of the tax years under exam, as well as for the change year, a potentially significant administrative burden, depending on the complexity of the calculation and the availability of prior year records.
- Change resulting in a positive § 481(a) adjustment and no exam adjustment. This new exception permits a taxpayer under exam for one or more tax years on the date it files a Form 3115 with a positive (i.e., unfavorable) § 481(a) adjustment to receive audit protection, provided the IRS has not proposed an adjustment for the item covered by the Form 3115 by the earliest date that any of the exams ends, and the item is not an issue under consideration by the IRS. Thus, audit protection is only received upon the closing of an exam, rather than on the (earlier) date the Form 3115 is filed, and the audit protection only covers the period subsequent to the closed audit year and prior to the Form 3115 year of change. Consequently, where multiple exams are underway and a later audit cycle closes before an earlier audit cycle, the audit protection will only apply to the years of the closed audit cycle, and not to the earlier years still under exam. Moreover, under this exception, the positive § 481(a) adjustment spread period is reduced to two years (from four years). Note that foreign corporations must meet additional compliance requirements under this exception (e.g., 90-day notice). Given these unfavorable terms and conditions, eligible taxpayers may wish to forgo this option and wait for a window period to open or the exam(s) to close.
- New member of a consolidated group in Compliance Assurance Process (CAP). Under this new exception, a corporation not under exam and that becomes a member of a consolidated group that is under exam by virtue of its participation in the CAP may file Form 3115 for the tax year in which it became a member and receive audit protection, provided the item is not an issue under consideration in an exam.
§ 481(a) positive adjustment spread period changes – Under the new procedures, the one-year spread period for a negative § 481(a) adjustment remains unchanged. However, the four-year spread period generally applicable to a positive § 481(a) adjustment has been modified in certain circumstances as follows:
- Technical termination of a partnership – shortened spread period. Under the new method change procedures, a partnership technical termination has been added to the existing list of transactions deemed to constitute the cessation of a trade or business, meaning any remaining positive § 481(a) adjustment is required to be recognized by the terminated partnership entirely in the tax year of the technical termination, rather than over the remaining year(s) of the spread period.
- Election of one-year spread period for eligible acquisition transaction. This election allows the transaction parties to allocate the entire § 481(a) adjustment to the seller, thus freeing the acquirer from the burden of tracking and reporting any remaining § 481(a) adjustment. However, note the election is irrevocable and applies to all accounting method changes made by the taxpayer for the year of change.
- Two-year spread period for certain taxpayers under exam. As noted above, the § 481(a) adjustment spread period for a positive § 481(a) adjustment is reduced to two years (versus four years) for a taxpayer under exam and outside a window period that files Form 3115 to change a method that is not clearly permissible and for which the IRS has not proposed an adjustment.
- De minimis § 481(a) adjustment amount increased. Under a de minimis provision designed to reduce the administrative burden of implementing voluntary tax accounting method changes, a “de minimis” positive adjustment may be spread over one year (versus four years) at the taxpayer’s election. The new procedures increase the de minimis threshold to $50,000 from $25,000.
Ogden copy for all automatic changes – Taxpayers are now required to file the duplicate copy of Form 3115 with the IRS in Ogden, Utah, for all automatic method changes. Advance consent changes continue to be filed with the IRS National Office in Washington, DC.
In light of the significant revisions made to the procedures governing accounting method changes (particularly for taxpayers under exam) and the fact that the rules are generally effective immediately, taxpayers in the process of filing method changes, including those implementing the recently enacted tangible property regulations, should review the new revenue procedures and assess the implications to their filings. In particular, taxpayers planning on filing an advance consent method change under the previous 90-day window provisions to address an uncertain tax position potentially requiring a reserve should assess the impact of the new procedures on their year-end tax provision reporting requirements. Similarly, eligible small taxpayers evaluating whether to implement the tangible property regulations using the simplified procedures under Rev. Proc. 2015-20 should assess the impact of the new accounting method change procedures, particularly if they are affected by the revisions made to the audit protection and/or the § 481(a) adjustment spread period provisions.
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