Taxpayers Should Be Proactive When Filing Accounting Method Changes

Editor: Greg A. Fairbanks, J.D., LL.M.

A sigh of relief usually follows when a tax practitioner informs a client that a particular accounting method change request can be filed under the automatic accounting method change procedures. That is because Rev. Proc. 2008-52, §6.02(3), allows a taxpayer to file an automatic accounting method change request as late as the extended due date for the taxpayer’s federal income tax return for the year of change.

A taxpayer does not, however, have to wait until the extended due date of its tax return to do so because Rev. Proc. 2008-52 also allows taxpayers to file an automatic accounting method change request as early as the first day of the year of change. While it is understandable why taxpayers (and their service providers) routinely wait until the last minute to complete and file automatic accounting method change requests, there are numerous reasons to file such requests as early as possible.

Among these reasons is the possibility that a taxpayer will come under IRS examination before it has the opportunity to file its accounting method change request. For the same reason, taxpayers planning on filing nonautomatic accounting method change requests (under Rev. Proc. 97-27) need not wait until the last day of their tax years to file accounting method change requests.

Both Rev. Proc. 2008-52 and Rev. Proc. 97-27 provide that a taxpayer under examination may file a request for a change in accounting method only if it meets the requirements of: (1) the 90-day window (described below); (2) the 120-day window; or (3) the director consent provisions. In order for a taxpayer to use either the 90-day or the 120-day window, the issue for which the accounting method change is being requested must not be “an issue under consideration.” The determination of whether an issue is under consideration may present significant challenges.

This item discusses the difficulties that arise when trying to determine whether an issue is under consideration for purposes of the 90-day or 120-day windows. Specifically, it examines a recently released technical advice memorandum that illustrates the complex nature of this problem in the context of a nonautomatic accounting method change request.

Issue Under Consideration

The IRS National Office discussed the “issue under consideration” topic in a recent technical advice memorandum (TAM 200843031). The IRS stated that a taxpayer was not allowed to file a request for a nonautomatic change in method of accounting for royalty expenses under Sec. 263A because the treatment of royalty expenses was considered an issue under consideration.

The taxpayer in the TAM was under examination at the time it filed a request to change its method of accounting for royalty expenses under Sec. 263A. The taxpayer sought to file using the 90-day window. Prior to filing the request, the taxpayer received an information document request (IDR) that asked for both “yearend inventory workpapers” and “year-end 263A workpapers” for several years. The IRS examining agents argued that the taxpayer was not allowed to file its request for change in accounting method because the treatment of royalty expenses under Sec. 263A was an issue under consideration by the IRS at the time the taxpayer filed the request. The taxpayer disagreed.

A taxpayer generally may not request a change in accounting method if the taxpayer is under examination (Rev. Prov. 97-27, §6.01(1)). Rev. Proc. 97-27 and Rev. Proc. 2008-52 provide several exceptions to this rule, one of which is known as the 90-day window and another as the 120-day window. This item focuses on the 90-day window.

Section 6.01(2) of Rev. Proc. 97-27 describes the 90-day window. It provides that a taxpayer under examination may request a change in accounting method if the taxpayer has been under examination for at least 12 consecutive months as of the first day of the tax year, and if the taxpayer files the request within the first 90 days of that tax year. A taxpayer may not, however, use the 90-day window if the method of accounting (for which the taxpayer seeks consent) is an issue under consideration.

Section 3.08(1) of Rev. Proc. 97-27 provides that a particular method of accounting is an issue under consideration if:

1. The taxpayer receives written notification from the examining agent; and
2. The written notice specifically cites the treatment of an item as an issue under consideration.

Rev. Proc. 97-27 provides two examples illustrating when an item would be an issue under consideration. The first provides that a taxpayer’s LIFO pooling methodology is not an issue under consideration as a result of an examination plan that broadly identifies LIFO as a matter to be examined. The second example, however, provides that a taxpayer’s method of determining costs to be inventoried under Sec. 263A is an issue under consideration as a result of an IDR that requests documentation supporting the costs included in the taxpayer’s costs to be capitalized to inventory.

The taxpayer in TAM 200843031 argued that in order for an item to be an issue under consideration, the written notification to the taxpayer must:

1. Refer to a class or type of revenue or expense to which a method of accounting applies; and
2. Specifically cite the manner in which the taxpayer accounts for that item.

The taxpayer argued further that where the class of accounting methods identified is particularly broad in comparison to the matters purportedly placed under consideration, the specificity required under Rev. Proc. 97-27, §3.08(1), has not been satisfied.

The IRS rejected the taxpayer’s arguments. First, the IRS stated that the IDR did refer to a particular class or type of expense by referring to costs capitalized to inventory under Sec. 263A. The TAM states that the IRS is not obliged to refer to a specific cost within the Sec. 263A calculation in order to place that item under consideration. By asking for the taxpayer’s year-end Sec. 263A workpapers, the IRS contended that they would reasonably expect to receive workpapers that contain information supporting how the taxpayer identifies costs and adds them to tax basis inventory for purposes of Sec. 263A. The IRS differentiated between a cost and an item, in this case pointing out that the item is not the cost capitalized to inventory but the method of identifying those costs.

Second, the IRS stated that it did not need to specifically cite in a written notice the way a taxpayer treats an item in order to place that item under consideration. The TAM states that by providing written notice that the “treatment of an item” is an issue under consideration, the IRS is giving the required notice that the taxpayer’s method of accounting for the costs associated with that item is an issue under consideration. The TAM goes on to state that there is no requirement under Rev. Proc. 97-27, §3.08, to explicitly or correctly cite the particular method of accounting that the taxpayer is actually or purportedly applying to the item.

Third, the TAM stated that the IRS was not required to identify a specific submethod under Sec. 263A in order to place the taxpayer’s method of treating royalty expenses under consideration. The IRS argued that the taxpayer categorizes the method of identifying costs required to be capitalized to inventory under Sec. 263A as a submethod of its method of capitalizing actual costs to inventory under Sec. 263A. The IRS asserted, however, that the method of determining costs required to be capitalized under Sec. 263A is not a submethod but rather one of two required allocations—the first being the allocation of costs to various activities (including production activities) and the second being the allocation of costs assigned to production activities to inventory items produced by the taxpayer during the year.

Citing the treatment of costs under Sec. 263A in an IDR would include both methods of allocation because the taxpayer’s method of accounting for capitalizing costs to inventory under Sec. 263A would include both its method of determining costs required to be capitalized and its method of allocating costs required to be capitalized to inventory.

Conclusion

Given the IRS’s interpretation in this TAM of what constitutes an item under consideration for purposes of the 90-day or 120-day window, if a taxpayer is planning on filing an accounting method change request and is not currently under exam, it would be advantageous to file that method change with the IRS National Office as soon as it can be completed rather than waiting until the time the return is filed. By the time the return is filed, the taxpayer could potentially be under IRS examination and will be afforded only the methods of filing for an accounting method change described in Rev. Proc. 2008-52, §6.03, which are the 90-day window, the 120-day window, and filing with director consent (which involves obtaining the director’s consent and attaching a signed statement to the Form 3115, Application for Change in Accounting Method). Not only are the procedures for filing under one of these methods more cumbersome, but ultimately the taxpayer may not be able to make the method change at all.

Taxpayers and practitioners alike would certainly agree that it is better to avoid going through the process of identifying an issue under consideration and filing under one of the window periods altogether in order to file a Form 3115 to change a method of accounting. In this case, if the information is available, it is better to be safe than sorry.

EditorNotes

Greg A. Fairbanks, J.D., LL.M., is a tax manager with Grant Thornton LLP in Washington, DC.

For additional information about these items, contact Mr. Fairbanks at (202) 521-1503 or greg.fairbanks@gt.com.

Unless otherwise noted, contributors are members of or associated with Grant Thornton LLP.