Change in Accounting Method for Tax

Advance or Automatic Consent for Accounting Method Change
Curated by
Robert Recchia, J.D., M.B.A., C.P.A., Sr. Content Management Analyst, Wolters Kluwer
Taxpayers cannot change from an established accounting method to a different method unless they first obtain the IRS’s consent for the change. The two types of IRS consent are automatic consent and advance or non-automatic consent.
Accounting Method Change Consent Procedures
The IRS has issued procedures[1] that taxpayers must follow to receive the IRS’s consent for an accounting method change. The procedures apply to both changes qualifying for automatic consent and advance consent.
The IRS has compiled a list of accounting method changes that are eligible for automatic consent. The IRS List of Automatic Changes[2] includes information on over 150 accounting method changes. A taxpayer that is eligible to make an automatic change of accounting method and follows all the stated procedures will automatically receive the IRS’s consent for the change.
Comment
The current List of Automatic Changes[3] was released in February 2022. It is generally effective for Forms 3115 filed on or after January 31, 2022, for a year of change ending on or after May 31, 2021. The former List of Automatic Changes[4] is generally effective for Forms 3115 filed before January 31, 2022, for a year of change ending before May 31, 2021.
If a taxpayer wants to make a change of accounting method that is not on the IRS’s List of Automatic Changes, the request for the change is an advance or non-automatic consent request. A taxpayer following the advance or non-automatic consent procedure will receive a letter ruling if the IRS approves the change.
Compliance Note
Taxpayers must file an application[5] on Form 3115, Application for Change in Accounting Method, for both automatic and advance or non-automatic consent requests for an accounting method change. Taxpayers making advance or non-automatic consent requests for an accounting method change must submit a user fee with their Form 3115. For more information, see Changing Accounting Methods Using Form 3115.
The IRS will not grant its consent for a requested change unless the taxpayer agrees to the IRS’s terms and conditions for the change. See “Terms and Conditions for an Accounting Method Change,” below. These terms and conditions are the year of change, whether the change is to be made with a section 481(a) adjustment or on a cut-off basis, and the section 481(a) adjustment period. For a discussion of section 481(a) adjustments, see Section 481(a) Adjustments After an Accounting Method Change.
A taxpayer that receives the IRS’s consent to a change of accounting method can generally rely on the consent. However, the taxpayer may be required to change or modify[6] that method of accounting if the situation under which consent was granted changes. The IRS can also review a taxpayer’s compliance with the consent procedures.
A taxpayer that timely files Form 3115, Application for Change in Accounting Method, with the National Office and complies with all provisions of the IRS consent procedures generally receives audit protection[7] for tax years before the year of change. Audit protection means that the IRS will not require the taxpayer to change its method of accounting for the same item that is the subject of the Form 3115 for a tax year prior to the year of change. For more information, see “Audit Protection for Years Before Year of Accounting Method Change,” below.
Failure to obtain IRS consent to change accounting methods. If a taxpayer does not file a request to change an accounting method, the absence of IRS consent[8] to a change does not:
(1) prevent the IRS from imposing a penalty or addition to tax; or
(2) reduce the amount of any penalty or addition to tax that is imposed.
A taxpayer who uses an improper accounting method and fails to request a change to a proper method cannot assert that using the improper method was not negligent because the IRS did not consent to a change to a proper method. The lack of IRS consent to an accounting method change when no request for the change was made is no defense to penalties or additions to tax for using an improper method.
Automatic Accounting Method Change Requests
Taxpayers must satisfy a number of requirements to request the IRS’s consent for an accounting method change under the automatic change procedures. A taxpayer can request automatic consent[9] if:
(1) the change is on the IRS List of Automatic Changes[10] as of the date the taxpayer files the application on Form 3115;
(2) the taxpayer meets all the requirements for the change, as of the date taxpayer files Form 3115;
(3) the taxpayer does not engage in certain corporate liquidation or reorganization transactions[11] within the requested year of change;
(4) the requested year of change is not the final year of the taxpayer’s trade or business;
(5) the taxpayer has not made or requested an overall accounting method change during any of the five tax years ending with the year of change (prior five-year overall method change); and
(6) the taxpayer has not made or requested an accounting change for the same item during any of the five tax years ending with the year of change (prior five-year item change).
Five-year overall method change. Generally, a taxpayer cannot request the IRS’s consent to change its overall accounting method under the automatic change procedures if the taxpayer changed its overall accounting method, or applied for consent to change its overall accounting method, within the last five tax years including the year of change. It does not matter whether the taxpayer actually implemented the change. However, a taxpayer that changed its overall accounting method during the last five tax years may obtain automatic consent to change a method of accounting for a specific item.
Five-year item change. Generally, a taxpayer cannot request the IRS’s consent to change its method of accounting for a specific item under the automatic change procedures if the taxpayer changed its method of accounting for the same item, or applied for consent to change its accounting method for the same item, within the last five tax years including the year of change. It does not matter whether the taxpayer actually implemented the change. However, exceptions apply where certain LIFO inventory sub-methods are being changed and where the change in the method of accounting for a specific item is required as part of another accounting method change that is allowed.
Application procedures. A taxpayer making an automatic change of accounting method that follows all the stated procedures, including properly completing and filing Form 3115, Application for Change in Accounting Method, will automatically receive the IRS’s consent for the change. For a discussion of the application procedures, see Changing Accounting Methods Using Form 3115.
Advance or Non-automatic Accounting Method Change Requests
Nearly every taxpayer can request the IRS’s consent for an accounting method change under the advance or non-automatic change procedures. A taxpayer can request advance consent[12] if:
(1) the taxpayer is not eligible to use the automatic change procedures to make the change, as of the date that the taxpayer files the application on Form 3115; and
(2) the requested year of change is not the final year of the taxpayer’s trade business.
Application procedures. Taxpayers making advance or non-automatic consent requests for an accounting method change must file an application[13] on Form 3115, Application for Change in Accounting Method, and submit a user fee with their Form 3115. A taxpayer following the advance or non-automatic consent procedures will receive a letter ruling if the IRS approves the change. For a discussion of the application procedures, see Changing Accounting Methods Using Form 3115.
Terms and Conditions for an Accounting Method Change
The IRS can dictate the terms and conditions[14] that must be met in order to receive its consent for a change in accounting method. These terms and conditions are the year of change, whether the change is to be made with a section 481(a) adjustment or on a cut-off basis, and the section 481(a) adjustment period.
A taxpayer who receives the IRS’s consent for an accounting method change must implement the change according to the general terms and conditions in the IRS consent procedure[15] and:
(1) the terms and conditions in the IRS List of Automatic Changes[16] , for an automatic change; and
(2) the terms and conditions in the letter ruling for the change, for a non-automatic change.
Comment
The IRS can impose different terms and conditions in the letter ruling for a non-automatic change than the general terms and conditions in the IRS consent procedure[17] based on the particular facts of the taxpayer’s situation.
Change implemented on cut-off basis. The IRS can require certain accounting method changes to be made without a section 481 adjustment, using a cut-off method. Under a cut-off method[18] , only items arising on or after the beginning of the year of change, or other operative date, are accounted for under the new method of accounting.
Section 481(a) adjustment period. Under the general terms and conditions, a taxpayer making a change of accounting method under the IRS consent procedure[19] must take the section 481(a)[20] adjustment into account over the following adjustment periods:
(1) one tax year for a negative adjustment, which is the year of change; and
(2) four tax years for a positive adjustment, which is the year of change and the next three tax years.
A taxpayer must use a different section 481(a) adjustment period if required by the IRS in the letter ruling for a non-automatic change, or if a different adjustment period is provided in the IRS consent procedure[21] , the IRS List of Automatic Changes[22] , or other published guidance. The IRS consent procedure details several situations where a change must be implemented with a shortened section 481(a) adjustment period or an accelerated adjustment period. For more information, see Section 481(a) Adjustments After an Accounting Method Change.
Taxpayer under examination. A taxpayer contacted for examination and required by the IRS to change its method of accounting typically will receive less favorable terms and conditions and may also be subject to penalties. A taxpayer required to make an involuntary accounting method change must take a positive section 481(a) adjustment into account in the earliest tax year under examination[23] with a one-year adjustment period.
Effect of IRS Consent to Accounting Method Change
A taxpayer that receives the IRS’s consent to a change of accounting method can generally rely on the consent. However, the taxpayer may be required to change or modify[24] that method for the following reasons:
· the enactment of legislation;
· a decision of the U.S. Supreme Court;
· the issuance of temporary or final regulations;
· the issuance of a revenue ruling, revenue procedure, notice or other statement published in the Internal Revenue Bulletin;
· the issuance of written notice to the taxpayer that the change in method of accounting was granted in error or is not in compliance with the current views of the IRS; or
· a change in the material facts on which the consent was based.
Except in rare or unusual circumstances, a taxpayer that changes its accounting method, and is subsequently required to change or modify that accounting method, will not have to apply the required change or modification retroactively if:
· the taxpayer complied with all the applicable provisions of the IRS consent procedure[25] ;
· the taxpayer did not misstate or omit material facts;
· the material facts on which the consent was based have not changed;
· the applicable law has not changed; and
· the taxpayer to whom consent was granted acted in good faith in relying on the consent, and applying the change or modification retroactively would be to the taxpayer’s detriment.
Audit Protection for Years Before Year of Accounting Method Change
A taxpayer that timely files a Form 3115, Application for Change in Accounting Method, and complies with all provisions of the IRS consent procedures generally receives audit protection[26] for tax years before the year of change. Audit protection means that the IRS will not require the taxpayer to change its method of accounting for the same item that is the subject of the Form 3115 for a tax year prior to the year of change.
Exceptions to audit protection The IRS will not grant audit protection[27] and may require the taxpayer to change its method of accounting for years prior to the year of change in the following situations:
(1) taxpayers under examination;
(2) a change lacking audit protection;
(3) a change not made or made improperly;
(4) a change in a sub-method of accounting;
(5) a change on behalf of a controlled foreign corporation (CFC)[28] or 10/50 corporation[29] ;
(6) a pending or future criminal investigation; and
(7) an issue under consideration.
Taxpayers under examination. The IRS may require the taxpayer to change its method of accounting for the same item that is the subject of a Form 3115 for tax years prior to the requested year of change if the taxpayer is under examination on the date the taxpayer files the Form 3115. However, under the following exceptions, taxpayers may receive audit protection for:
· changes filed during certain window periods if the change was not an issue under consideration in the examination on the date that the Form 3115 was filed;
· changes from a clearly permissible accounting method or from a clearly impermissible method that was adopted after the tax years under examination; or
· changes that result in a negative section 481(a) adjustment for the year of change and would have resulted in negative adjustments for the tax years under examination if the change had been made for those years.
Change lacking audit protection. The IRS may change a taxpayer’s method of accounting for the same item that is the subject of a Form 3115 for tax years prior to the requested year of change if the description of the change in the List of Automatic Changes, or other guidance published in the Internal Revenue Bulletin, provides that the change is not subject to the audit protection provisions.
Change not made or made improperly. The IRS may change a taxpayer’s method of accounting for the same item for tax years prior to the year of change if:
(1) the taxpayer withdraws or does not perfect its request for the change;
(2) the National Office denies the request;
(3) the taxpayer declines to implement the change in method of accounting under the terms and conditions of the consent agreement and the voluntary change procedure;
(4) the taxpayer implements the change but does not comply with the terms and conditions contained in the consent agreement and the voluntary change procedure; or
(5) the National Office modifies or revokes the ruling retroactively because there has been a misstatement or an omission of material facts.
Change in sub-method. The IRS may change a taxpayer’s method of accounting for the same item for tax years prior to the year of change if the taxpayer is changing a sub-method of accounting within the method. For example, an examining agent may propose to terminate the taxpayer’s use of the LIFO inventory method during a prior tax year even though the taxpayer changes its method of valuing increments in the current year. In addition, a taxpayer that changes a LIFO inventory sub-method within five years of adopting or changing to the LIFO inventory method does not receive audit protection.
Change on behalf of CFC or 10/50 corporation. The IRS may change a method of accounting for the same item for tax years prior to the year of change where the change was made on behalf of a controlled foreign corporation (CFC)[30] or 10/50 corporation[31] and any of the corporation’s domestic corporate shareholders computed amounts of foreign taxes deemed paid in excess of a certain average threshold.
Criminal investigation. The IRS may change a taxpayer’s method of accounting for the same item for tax years prior to the year of change if there is any pending or future criminal investigation or proceeding concerning:
(1) directly or indirectly, any issue relating to the taxpayer’s federal tax liability for any tax year before the year of change; or
(2) the possibility of false or fraudulent statements made by the taxpayer with respect to any issue relating to its federal tax liability for any tax year before the year of change.
Issue under consideration. The IRS may change a taxpayer’s method of accounting for the same item that is the subject of a Form 3115 for tax years prior to the requested year of change if the taxpayer’s method of accounting for the same item is an issue under consideration as of the date the taxpayer filed the Form 3115.
IRS Review of Application and Compliance
IRS review of taxpayer’s application. Any application filed under the IRS consent procedure[32] may be reviewed by the IRS National Office. If the National Office reviews an application and determines that the application on Form 3115 is not properly completed or if supplemental information is needed, the IRS notifies the taxpayer. The notification specifies the information that needs to be provided, and the taxpayer is given 21 calendar days for a non-automatic change or 30 calendar days for an automatic change to furnish the necessary information. The IRS reserves the right to impose shorter reply periods if subsequent requests for additional information are made. Taxpayers may receive an extension of the 21-day or 30-day period to furnish information, not to exceed 15 calendar days for a non-automatic change or 30 calendar days for an automatic change. A request for an extension must be made in writing within the 21-day or 30-day period. If the extension request is denied, there is no right of appeal.
If the National Office tentatively determines that the taxpayer’s request for a change in accounting method does not comply with all the applicable provisions for an automatic change, or that a request to change an accounting method filed under the non-automatic change procedures may be denied, the National Office notifies the taxpayer of its tentative adverse determination and offers the taxpayer a conference of right, if the taxpayer has requested a conference.
IRS review of taxpayer compliance. The IRS must apply a change in accounting method[33] that was made in compliance with all the procedures in determining the taxpayer’s liability, unless the IRS director recommends that the change should be modified or revoked. The IRS director determines if the accounting method change complies with all the procedures, including whether:
· the facts and representations on which the change was based reflect an accurate statement of the material facts;
· the amount of the section 481(a) adjustment was properly determined;
· the change in accounting method was implemented in compliance with all the applicable provisions;
· there has been any change in the material facts on which the change was based during the period the accounting method for which consent was granted was used; and
· there has been any change in the applicable law during the period the accounting method for which consent was granted was used.
If the IRS director recommends that a change in accounting method, other than the adjustment, made in compliance with all the applicable provisions should be modified or revoked, the director will forward the matter to the IRS National Office for consideration before any further action is taken. Referral to the National Office is treated as a request for technical advice.
Citations
1. REVPROC2015-13
2. REVPROC2022-14
3. REVPROC2022-14
4. REVPROC2019-43
5. §1.446-1(e)(3)(i)
6. REVPROC2015-13
7. REVPROC2015-13
8. §446(f)
9. REVPROC2015-13
10. REVPROC2022-14
11. §381(a)
12. REVPROC2015-13
13. §1.446-1(e)(3)(i)
14. §1.446-1(e)(3)(ii)
15. REVPROC2015-13
16. REVPROC2022-14
17. REVPROC2015-13
18. REVPROC2015-13
19. REVPROC2015-13
20. §481(a)
21. REVPROC2015-13
22. REVPROC2022-14
23. REVPROC2015-13
24. REVPROC2015-13
25. REVPROC2015-13
26. REVPROC2015-13
27. REVPROC2015-13
28. §957
29. §904(d)(4)
30. §957
31. §904(d)(4)
32. REVPROC2015-13
33. REVPROC2015-13