Accounting Methods—Adoption and Changes, written by James E. Connor, J.D., Jennifer D. Kennedy, CPA, Dennis L. Tingey, J.D., CPA, and L. Michelle Carlone, CPA, of PricewaterhouseCoopers LLP, provides taxpayers with guidance when adopting or changing an accounting method. In the first year of operation, or in the first year in which a new line of business begins, a taxpayer generally may adopt any accounting method that clearly reflects income without obtaining special IRS permission. Thereafter, the Commissioner's consent generally must be obtained before a taxpayer may change to another method of accounting.
This Portfolio outlines the principles for determining whether an issue involves the accounting method rules. The Portfolio also examines the accounting method changes for which “automatic consent” is available, the procedures taxpayers must follow when requesting the Commissioner's consent to change a method of accounting, the adjustments that must be made as a result of the change, and any effects the adjustments will have on net tax liability. In addition, the Portfolio discusses the implications of certain merger transactions on accounting method issues as well as the impact accounting method changes can have for other purposes of the Code.
Accounting Methods—Adoption and Changes allows you to benefit from:
This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which cover every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.
Detailed Analysis
I. Introduction
A. General Introduction
B. Adoptions of Accounting Methods - General Discussion
C. Method Changes
1. General Discussion
2. Types of Accounting Method Changes
a. In General
b. Voluntary Changes
(1) General Discussion
(2) Automatic Changes
(3) Non-Automatic Method Changes
(4) Changes Not Subject to General Accounting Method Rules
c. Statutorily Mandated Changes
d. Changes Required Because of § 381 Transactions
e. Involuntary Method Changes
f. Unauthorized Changes
3. The Step-by-Step Approach Used in this Portfolio
a. Introduction
b. The Steps
II. Determining Whether the Issue Involves the Accounting Method Rules
A. Introduction
B. General Rules
1. Concept of “Method of Accountingâ€
2. Timing
3. Consistency
4. Books and Records
C. Non-Accounting Method Changes
1. In General
2. Change in Underlying Facts
3. Correction of an Error
III. Adopting an Accounting Method
A. General Rules
B. Change in Form of Business - New Accounting Methods
C. How to Adopt an Accounting Method
1. General Rules
2. Methods with Special Procedural Requirements
D. Binding Effect of Adoption
1. In General.
2. Proper Method
3. Improper Method
4. Examples
IV. Non-automatic Accounting Method Changes
B. Can the Request for Accounting Method Change Be Filed?
1. Situations in Which the Right to File Form 3115 Is Restricted
2. “Window Periods†During Which a Method Change Can Be Requested While Under Examination
a. General Discussion
b. The 90-Day Window Period
c. The 120-Day Window Period
C. Will the IRS National Office Grant the Requested Change?
2. Methods to Which the IRS Will Not Grant Method Changes
D. Special Considerations for LIFO Inventory Changes
1. Introduction
2. Determining Whether a Change Is a LIFO Inventory Change
b. Examples of Changes Not Treated as LIFO Method Changes
c. Examples of Non-Automatic LIFO Method Changes
3. Treatment of Voluntary Method Change
E. Terms and Conditions Imposed upon Grant of Change in Accounting Method
2. Additional Terms and Conditions
a. Conformity
b. Computation of Earnings and Profits
c. Alternative Minimum Tax
F. Procedural Requirements of Filing Form 3115
1. Manner of Requesting Permission to Change Accounting Methods
a. Form 3115
b. Multiple Forms 3115
c. User Fees
2. Time for Filing Form 3115
3. Estimated Tax Payments While the Form 3115 Is Pending
4. Method Changes Not Acted Upon by Tax Return's Due Date
G. Processing of the Form 3115 by the IRS National Office
H. Strategic Considerations
2. Changes from Proper Methods of Accounting
3. Changes from Improper Methods
4. Changes from “Gray Area†Methods
V. Automatic Accounting Method Changes
1. History of Automatic Accounting Method Changes
2. Use of Automatic Method Change Procedure Is Mandatory
3. Advantages of Automatic Change Procedures
B. Qualifications for Automatic Accounting Method Changes
1. Types of Changes that Are Potentially Automatic Method Changes
2. Facts that Preclude Automatic Method Changes
b. Generic Scope Restrictions
(1) Under Examination
(a) General Rules
(b) Additional Situations in Which Taxpayers Can File Automatic Method Changes While Under Examination
(i) Changes Lacking Audit Protection
(ii) Changes for an Issue Pending
(2) Before IRS Appeals Office or Before a Federal Court
(3) Partnerships and S Corporations
(4) Previous Changes
(5) Section 381(a) Transaction in Year of Change
c. Scope Restrictions for Specific Method Changes
C. Consequences of Making a Method Change Automatically
1. Terms and Conditions Required for Automatic Method Change
b. Year of Change
c. Section 481(a) Adjustment and Spread Period
(1) In General
(2) Negative § 481(a) Adjustments
(3) Positive § 481(a) Adjustments
d. NOL Carryback Restriction for Taxpayers Subject to Criminal Investigation
e. Change Treated as Initiated by the Taxpayer
2. Audit Protection
D. Procedural Rules for Automatic Accounting Method Changes
1. Manner of Filing
2. Time Frame for Filing
3. Where to File the National Office Copy of Form 3115
4. No User Fee
5. Single Application for Certain Taxpayers
6. Statements Required to Be Attached to Application
a. Statement if Under Exam and Filing in a Window Period
b. Statement if Under Exam and Filing with Director Consent
c. Additional Statements May Be Required for Certain Method Changes
E. IRS National Office Review and Director Review
2. National Office Review
3. Director Review
F. Significant Automatic Accounting Method Changes
1. Automatic Depreciation Method Changes
2. Automatic Method Changes for Costs to Create or Acquire an Intangible Asset
3. Automatic Method Changes from the Hybrid Method to the Accrual Method Under Rev. Proc. 2002-9
4. Automatic Accounting Method Changes for Advance Payments
5. Automatic Method Change for LIFO Termination
VI. Statutorily Mandated Changes
A. General Discussion
B. Examples of Statutorily Mandated Changes
1. Limitation of Use of Non-Accrual Experience Method
2. Cash to Accrual
b. Definition of Gross Receipts
3. Section 263A Exception for Small Retailers
4. Change to the Specific Charge-Off Method for Large Banks
VII. Section 381 Changes
B. Overall Accounting Methods
2. Separate Trades or Businesses
3. Integrated Trades or Businesses
b. Same Methods
c. Different Methods
d. Treatment of § 481(a) Adjustment
e. Examples
C. Accounting Method for Separate Items
D. Inventory Changes
2. Separate Component Trades or Businesses
3. Integrated Component Trades or Businesses
VIII. Involuntary Changes
B. Involuntary Changes in Accounting Method
1. Accounting Method Changes
2. Special Considerations for LIFO Inventory Changes
3. Non-Accounting Method Change
C. Reduction of Tax on § 481(a) Adjustment
1. Computing the Tax Liability if § 481(b) Applies
2. Recomputation for Past Years Under New Accounting Method - § 481(b)(2)
3. Special Rules - § 481(b)(3)
D. Pre-1954 Balance Excluded from § 481(a) Adjustment in IRS-Initiated Changes
2. Exclusion of Pre-1954 Balance from Net § 481(a) Adjustment
b. Computing the Pre-1954 Balance
c. Voluntary Method Changes
IX. Unauthorized Changes
A. Consent Requirement
B. IRS May Accept or Reject Change on Examination
C. Acceptance on Audit Does Not Necessarily Constitute Permission to Change Accounting Methods
D. Considerations Before Making an Unauthorized Change
X. Accounting Method Changes Not Governed by § 446
B. Common Examples of Accounting Methods Not Governed by § 446
1. Deduction for Research and Experimental Expenditures
2. Prepaid Subscription Income
3. Anticipated Returns of Newspapers, Paperbacks, Etc.
C. Year-by-Year or Project-Specific Timing Elections
2. Depreciation Elections
3. Section 59(e) Elections
4. Section 263(a) - Simplifying Conventions
5. OID Election
6. Developers’ Common Area Costs
XI. Non-Timing Issues
B. Consequences of Changing Treatment of a Non-Timing Issue
XII. Transition to New Accounting Method - Section 481(a) Adjustment Mechanism and Other Change Mechanisms
B. Section 481 Adjustment Mechanism
1. Method Change Causes Duplications or Omissions
2. The § 481(a) Adjustment
3. Impact of Inventory Calculation on § 481(a) Adjustment
4. Inclusion of Adjustment in Income
b. Multiple Changes - Separate Businesses - Consolidated Returns
c. Spread Period May Be Shortened
(1) De Minimis Rule
(2) Cooperatives
(3) Subsequent Events Cause Acceleration of Adjustment
(a) Cessation of Trade or Business
(i) In General
(ii) Section 381 Transfers
(iii) Transfers Pursuant to § 351 Within a Consolidated Group
(b) Subsequent LIFO Elections - Possible Acceleration
(c) Election of S Corporation Status After LIFO Inventory Termination
d. Short Period as a Separate Taxable Year
e. Effect on Earnings and Profits and Alternative Minimum Tax
C. The Cut-Off Change - How It Operates, and When It Applies
1. Research and Experimental Costs.
3. Modified § 481(a) Adjustment - Cut-Off Method
D. The “Suspense Account†Change
XIII. Miscellaneous Issues
A. Interaction Between § 481 and Mitigation Provisions - § § 1311–1314
B. Interaction Between the Research Credit and the Accounting Method Change Rules
C. Interaction with Other Provisions of the Code
Working Papers
Table of Worksheets
Additional Resources:
Worksheet 1 Form 3115 Annotations
Worksheet 2 Sample Transmittal Letter to Accompany Form 3115*
Worksheet 3 Fact Pattern and Sample Form 3115, Application for Change in Accounting Method, for Change to Recognize Revenue Upon Delivery of Goods
Worksheet 4 Fact Pattern and Sample Form 3115, Application for Change in Accounting Method, for Software Development Costs
Worksheet 5 Sample Delegation of Power of Attorney; Sample Declaration of Taxpayer's Representative; Sample Form 2848, Power of Attorney and Declaration of Representative*
Worksheet 6 Schedule of Common Problems With Form 3115 Submissions
Worksheet 7 Schedule of Common Problems With Form 2848, Power of Attorney and Declaration of Representative, Accompanying Form 3115
Worksheet 8 Sample Letter Requesting Director Consent
Worksheet 9 Sample IRS Letter Requesting Information on Pending Method Change Request
Worksheet 10 Sample Letter to IRS Containing Requested Supplemental Information With Attestation Clause
Worksheet 11 Sample IRS Letter Granting Permission to Change Accounting Method
Worksheet 12 List of Current Automatic Accounting Method Change Procedures1
Worksheet 13 Excerpt from IRS Publication 538, Accounting Periods and Methods
Bibliography
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