Category: Corporations; Accounting Periods
& Methods; Tax Returns, Examinations & IRS Procedure Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com Facts Taxpayer (TP) is an S corporation engaged in the business of industrial construction. TP uses the cash method of accounting for tax purposes and the percentage of completion method for financial statement purposes. TP maintains its books on a fiscal year ending July 31. For the three fiscal years ended 7/92, TP's average gross receipts exceeded $10 million. Accordingly, §460 requires the taxpayer to adopt the percentage of completion method of accounting for long term contracts for the period ending July 31, 1993. Issues 1. Is the change to percentage of completion made under §446 and is a §481(a) adjustment required? 2. It appears that Form 3115 must be filed within 180 days after the beginning of the year of change. Since that date has passed, what are the taxpayer's options? Findings 1. The change described above is clearly subject to §446, but it appears that no §481(a) adjustment is created by the change. 2. Since the date for requesting permission to change methods is passed, it appears that the taxpayer has two options: a) pursue relief from the 180-day rule under §9100; or b) file the return for 7/31/93 based on the cash method of accounting and amend the return on the same day under an automatic procedure available for taxpayers who inadvertently fail to adopt §460 on a timely basis. Both these options involve some risk and some out-of-pocket costs.Discussion §§446 and 481(a) As we discussed, the IRS has provided on three occasions simplified methods of adopting §460 (Notice 87-61, Notice 88-66, and Notice 89-15), and the deadlines for taking advantage of these simplified procedures have passed. Absent special guidance for changes under §460, TP is subject to Revenue Procedure 92-20, 1992-12 I.R.B. 10, which provides generalized procedures and deadlines for changing accounting methods in circumstances for which no special guidance has been issued. Under Rev. Proc. 92-20, Form 3115 must be filed within 180 days after the beginning of the year of change. In the context of accounting method changes under §460, there are numerous references in the tax literature to the "cut-off" method of changing accounting methods. Under the "cut-off" method, items occurring after the cut-off date are accounted for under the new method. Items occurring before the cut-off continue to be accounted for under the old method. Under the "cut-off" method, there is no §481(a) adjustment. The "cut-off" method is distinctly different from most accounting method changes with which I am familiar. With most accounting method changes, the switch from one method to another occurs on a given date, usually the beginning of a tax year, and there are transactions which straddle the two periods. An adjustment is required under §481(a) in order to prevent exclusion or double counting of income or expenses related to transactions which straddle two periods with disparate accounting methods. Under the "cut-off" method, the problem does not exist since the new accounting method is given effect only for transactions after a given date. Thus, there are no transactions which straddle periods with disparate accounting methods, and there is no need for a §481(a) adjustment. Examination of the effective dates of §460 reveals why the "cut-off" is method is used in that context. Recall that §460 was made applicable to contracts entered into after a certain date. Given the transactional focus of the effective dates of §460, the "cut-off" method is a natural fit. TP is concerned with §460(e) which shields certain small taxpayers from imposition of the general rules of §460. §460(e) provides that §460 shall not apply to contracts entered into prior to the tax year in which average gross receipts for the prior three years exceed $10 million. Again, §460 maintains its transactional focus. Since contracts entered into prior to the year of change will be accounted for under TP's regular method of accounting, there is no need for an adjustment under §481(a). Options The regulations under §9100 provide a means of obtaining relief for taxpayers who inadvertently miss non-statutory deadlines. Since the 180-day rule appears to be an administratively created deadline, §9100 may provide a means of getting permission to use §460 for 7/31/93 notwithstanding having missed the deadline. At this point I have not researched this matter, but I urge you to explore this alternative. If you need further assistance, please let me know. If successful, TP would presumably be allowed to file for a change of accounting under the normal Rev. Proc. 92-20 rules. Note that a $500 fee is involved under 92-20. From my experience, getting §9100 relief is uncertain, very time consuming, and annoying. I have not checked this out, but I suspect there may be a fee required. More importantly, §9100 requires someone (probably you) to formally admit having missed a deadline. Obviously, in a worst-case scenario such an admission could be very damaging. A second alternative is provided by Notice 89-15. There is an automatic procedure for taxpayers who inadvertently failed to adopt §460 on timely basis. Assuming that the years in question are not statute-barred, one simply amends the affected returns and complies with certain notice requirements. In this case, however, TP has not yet filed a return using a method other than that required by §460. In order to use Notice 89-15, it seems that you might consider filing the 7/93 return on the cash method of accounting and simultaneously filing an amended return under Notice 89-15 to give effect to §460. It seems to me that if you go this route, both the original and the amended return should be filed prior to the due date of the original return without extensions. It would appear that the down-side risk here is possible imposition of accuracy related and/or negligence penalties based on the original filing. |
