Substantial changes to accounting method for taxpayers under examination

Accounting method for taxpayers under examination

Revenue procedures released late last week contain substantial changes to the procedures for filing accounting method changes affecting taxpayers under examination—changes that are effective immediately.

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Overview

The IRS on Friday, January 16 released Rev. Proc. 2015-13, which provides revised procedures to obtain the consent of the Commissioner of Internal Revenue to change a method of accounting, and Rev. Proc. 2015-14, which provides the updated list of automatic accounting method changes. Rev. Proc. 2015 -13 provides the procedures for filing both automatic method changes and non-automatic method changes.

These procedures are effective immediately, with some limited transition relief.

A Form 3115, Application for Change in Accounting Method, for a year of change ending on or after May 31, 2014 (either the original non- automatic Form 3115 or the copy of the automatic Form 3115) that was not filed by January 16, 2015, is now, in most cases, subject to the new procedures and terms and conditions in Rev. Proc. 2015-13.

The most significant change made to the procedures and terms and conditions applies to a taxpayer that is under examination and preparing to file Forms 3115. This edition of TaxNewFlash addresses changes that may have immediate impact to those taxpayers. Additional information on the new procedural rules, and on new and expanded automatic accounting method changes, will be provided in future reports from KPMG.

For a taxpayer not under examination, the terms and conditions have not significantly changed. The taxpayer will continue to receive audit protection upon the filing of Form 3115 and a one-year pick up of any negative (taxpayer favorable) section 481(a) amount or a four-year spread period of any positive section 481(a) amount.

Taxpayers under examination

For a taxpayer under examination, Rev. Proc. 2015-13 has significantly revised the rules for filing Forms 3115.

Under prior procedures—Rev. Proc. 97-27 for non-automatic changes and Rev. Proc. 2011-14 for automatic changes—a taxpayer under examination could not file a Form 3115 unless it filed in a “window period” (either the 90-day window or 120-day window), received director consent, filed an automatic change that did not provide audit protection, or had an issue pending.

Now, a taxpayer under examination can file a Form 3115 at any time. However, a taxpayer under examination will not receive audit protection unless it meets one of the six listed exceptions, summarized below (audit protection precludes an examining agent from making an adjustment for a year prior to the year of change on the Form 3115).

In addition, a taxpayer under examination that does not meet one of the first five listed exceptions will have only a two-year spread period for any “positive” (taxpayer unfavorable) section 481(a) adjustment amount, instead of a four-year spread period.

Importantly, because a taxpayer under examination can now file an accounting method change at any time, the IRS’s former practice of temporarily waiving the under examination scope limitation for changes filed in response to new guidance may no longer be necessary. The trade-off for allowing additional changes while under examination, however, is that the taxpayer is generally subject to less favorable terms and conditions. For example, this change immediately affects a taxpayer under examination that is preparing to file an automatic change under the tangible property regulations (Rev. Proc. 2014-16) or disposition regulations (Rev. Proc. 2014-54) that is not eligible to use the transition relief.

Six exceptions for audit protection

The following exceptions allow a taxpayer under examination to receive audit protection and a four-year spread of any positive section 481(a) adjustment:

  • Three-month window (replaces the previous 90-day window)—A taxpayer under examination for 12 consecutive months may file in a period that begins two months before the extended due date for filing the taxpayer’s federal income return and ends one month after the extended due date, providing the issue is not under consideration in an examination. Slightly modified rules apply to short periods and to a controlled foreign corporation (CFC); a CFC’s controlling domestic shareholders that are under examination must be under examination for at least 24 consecutive months.
  • 120-day window (essentially the same rule as under prior procedures, except for CFCs)—A taxpayer under examination may file within a 120-day period following the date an examination ends, regardless of whether a subsequent examination has commenced, providing the issue is not under consideration in an examination. However, a CFC can no longer use this window period.
  • Present method not before the director—This is a new option if the taxpayer is changing from a clearly permissible method, or changing from an impermissible method adopted subsequent to the year(s) under examination.
  • New member of consolidated group in CAP—This is a new option allowing a corporation that becomes a member (when the corporation is not itself under examination) of a consolidated group that is under examination because it participates in the Compliance Assurance Process to file a Form 3115, provided the issue is not under consideration in an examination.
  • Change resulting in a negative section 481(a) adjustment—This is a new option allowing a taxpayer with a negative section 481(a) adjustment in the year of change and in the years under examination (the taxpayer must determine whether the change would have resulted in a negative section 481(a) adjustment in each tax year under examination if the change in method of accounting for that item had been made in the tax year(s) under examination) to file a Form 3115 and receive audit protection.

Rev. Proc. 2015-13 also provides that taxpayers under examination will receive audit protection with a two-year spread of any positive section 481(a) adjustment in the following situation:

  • No examination imposed change and item not under consideration—This new option allows a taxpayer that is under examination (for one or more tax years on the date it files a Form 3115) to receive audit protection, if by the earliest date that any of the taxpayer’s exams ends, the examining agent has not proposed an adjustment for the same item that is the subject of the Form 3115 for the tax year(s) under examination, and the method is not an issue under consideration. There are special additional provisions for CFCs that require giving the examining agent a 90-day notice period during which the agent may propose an adjustment.

Finally, as in the prior automatic consent procedures (Rev Proc. 2011-14), specific automatic accounting method changes listed in Rev. Proc. 2015-14 do not provide audit protection. The automatic accounting method changes that do not provide audit protection generally require that the change be made on a cut-off basis, without a section 481(a) adjustment.

Transition rules

Under the transition rules, a taxpayer that is within the 90-day window in the prior procedures—the taxpayer is in the first 90-days of its tax year, has been under examination for at least 12 consecutive months, and the item for which it wishes to make an accounting method change is not an issue under consideration in the examination—on January 16, 2015, can file a Form 3115 by March 2, 2015, choose to make the change effective for its 2014 tax year, and apply the terms and conditions of either Rev. Proc. 97-27 or Rev. Proc. 2011-14.

The transition rules are clear that this relief applies to non-automatic changes but not clear as to automatic changes. However, IRS officials have informally indicated they intended this rule to apply to automatic changes, although they acknowledged a correction may be needed to reflect this intent.

The transition relief provides an opportunity for a taxpayer that qualifies to use this window period to file Forms 3115—especially for automatic method changes under the tangible property regulations or dispositions regulations—when the “under examination” scope limitations had been waived under the prior procedures.

For example, a calendar year taxpayer under examination for the last 12 consecutive months may file an automatic change for its 2014 tax year during the first 90 days of 2015 under the terms and conditions of Rev. Proc. 2011-14 (note a non-automatic change may be filed for 2014 tax years ending on or after November 30, 2014, and on or before January 16, 2015, under Rev. Proc. 97-27). However, a taxpayer filing an automatic or non-automatic change for its 2015 tax year would be subject to the terms and conditions of Rev. Proc. 2015-13.

 

For more information, contact a tax professional with KPMG’s Washington National Tax:

Eric Lucas | +1 (202) 533 3023 | ejlucas@kpmg.com

Carol Conjura | +1 (202) 533 3040 | cconjura@kpmg.com

Karen Messner | +1 (202) 533 3041 |kmessner@kpmg.com

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