Editor: Anthony S. Bakale, CPA
While Treasury and the IRS have been busy issuing various forms of guidance intended to help taxpayers and tax professionals implement provisions of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, the tax community has been analyzing the best course of action for clients on a case-by-case basis. Prior to this guidance, which has provided some clarity, many professionals were left wondering how to apply the CARES Act's changes. Would taxpayers be required to amend returns, could they file for a change of accounting method, or in some cases could they file a superseding return? Understanding when each option is available can allow the taxpayer to maximize the tax benefits.
In addition to its often-discussed changes for qualified improvement property (QIP), the CARES Act included a number of other provisions that could retroactively affect a taxpayer's previously filed return. Some of these changes only apply to certain types of taxpayers, while others apply more broadly. The following discussion mostly focuses on the ability of partnerships to file amended returns and the QIP technical correction under the guidance issued in Rev. Procs. 2020-23 and 2020-25, respectively.
An amended return is often the first thing that comes to mind when an adjustment to a previously filed return is necessary. The Internal Revenue Manual (IRM) defines an amended return as "a return filed after the originally filed return and filed after the expiration of the filing period (including extensions)" (IRM §184.108.40.206.1(1)(d)). However, depending on the type of taxpayer, when the return was filed, and the item requiring an adjustment, the taxpayer might not be permitted to file an amended return. Without guidance from Treasury modifying statutory limitations, not all taxpayers may have been able to take advantage of the CARES Act provisions through the amended return process. A few examples of common situations include the following:
- While most taxpayers can file an amended return at any time within the three-year period of assessment prescribed in Sec. 6501, any partnership that is subject to the centralized partnership audit regime under the Bipartisan Budget Act (BBA) of 2015, P.L. 114-74, (BBA partnership) generally cannot file an amended return for tax years beginning after Dec. 31, 2017. Instead, BBA partnerships file an administrative adjustment request (AAR) pursuant to Sec. 6227, and the partners report the adjustment on their current-year federal income tax returns.
- A taxpayer is also generally prohibited from filing an amended return to change a method of accounting. Regs. Sec. 1.446-1(e)(2)(i) states that "a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner." Regs. Sec. 1.446-1(e)(3)(i) adds that "to secure the Commissioner's consent to a taxpayer's change in method of accounting the taxpayer must file an application on Form 3115 [Application for Change in Accounting Method] . . ."
Change of accounting method
As opposed to going back to amend a prior return, a taxpayer may be able to correct the issue prospectively by filing for a change of accounting method. Sec. 446(a) says, "Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books." A method of accounting is defined in Regs. Sec. 1.446-1(a)(1) to include "not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item." A method of accounting is usually established by the consistent treatment of an item (Regs. Sec. 1.446-1(e)(2)(ii)(a)). The period required to establish a consistent treatment of an item depends upon whether the method used by the taxpayer is permissible or impermissible.
Section 2.01 of Rev. Proc. 2015-13 provides that "[t]he treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed federal income tax returns . . . represents consistent treatment of that item. . . ." It adds that "[i]f a taxpayer treats an item properly in the first federal income tax return that reflects the item, however, it is not necessary for the taxpayer to treat the item consistently in two or more consecutive returns to have adopted a method of accounting." Therefore, a taxpayer that reports an item using a permissible method of accounting will have adopted the permissible method after one year, and a taxpayer that uses an impermissible method for an item has to use that method in two consecutively filed returns before the taxpayer will be considered to have adopted the method of accounting.
As discussed earlier, once a taxpayer has established a method of accounting for an item, it must obtain consent to change methods. When and how a taxpayer must file Form 3115 with the IRS depends on whether the change is considered an automatic or a nonautomatic change. Automatic changes must be filed with the taxpayer's timely filed federal income tax return, including extensions, for the year of change and a copy filed with the IRS no later than the date the taxpayer's original return is filed for the change year. Nonautomatic changes, on the other hand, must be filed with the IRS National Office during the tax year for which the change is requested.
Since the effective date of the technical correction for QIP provided in Section 2307(b) of the CARES Act is retroactive to the exclusion of QIP from 15-year property under Sec. 168(e)(3)(E) by the law known as the Tax Cuts and Jobs Act, P.L. 115-97, taxpayers that filed their 2018 and/or 2019 returns treating QIP as having a 39-year recovery period and not eligible for additional first-year depreciation (bonus depreciation) were unknowingly using an impermissible method of accounting. Under Regs. Secs. 1.446-1(e)(2)(ii)(d)(2)(i) and (ii), changes in computing depreciation related to changes in the recovery period and changes "from not claiming to claiming the additional first year depreciation deduction provided by, for example, section 168(k) . . . provided the taxpayer did not make the election out of the additional first year depreciation deduction" for the class of property are considered a change in accounting method.
Rev. Proc. 2019-43 provides the current list of automatic changes for which the automatic change procedures apply and is effective for any Form 3115 filed on or after Nov. 8, 2019, for a year of change ending on or after March 31, 2019. For a tax year ending before March 31, 2019, see Rev. Proc. 2018-31 and its predecessors. Section 6 of Rev. Procs. 2019-43 and 2018-31 addresses changes to depreciation and/or amortization. More specifically, Section 6.01 (in both revenue procedures) contains the rules regarding a change from an impermissible to a permissible method of accounting for depreciation and amortization. This change applies to taxpayers changing depreciation or amortization for which:
- The taxpayer used an impermissible method in at least two tax years immediately preceding the year of change (however, see an exception discussed later);
- The taxpayer is making a change in method of accounting under Regs. Sec. 1.446-1(e)(2)(ii)(d);
- Depreciation is determined under Sec. 56(a)(1), 56(g)(4)(A), 167, 168, 197, 1400I, or 1400L(c); under Sec. 168 before its amendment in 1986; or under any additional first-year depreciation deduction provisions of the Code (e.g., Sec. 168(k)); and
- The property is owned by the taxpayer at the beginning of the year of change.
An important exception to the first applicability requirement listed above is found in Section 6.01(1)(b) of both revenue procedures. It provides that a taxpayer that does not satisfy this first requirement because the item of property was placed in service in the tax year immediately preceding the year of change may file for a change of accounting method by filing Form 3115, provided the Sec. 481(a) adjustment reported on that Form 3115 includes any adjustment that is attributable to all property subject to the Form 3115. This section goes on to state that the taxpayer may also make the change by filing an amended return if the amended return is filed prior to the date the taxpayer files its return for the tax year immediately following the placed-in-service year.
When deciding whether a change can be implemented by filing Form 3115, keep in mind that the general rules often have exceptions or additional limitations that could apply. Therefore, taxpayers and their professional advisers need to evaluate the availability of an automatic or nonautomatic change and ensure the Form 3115 is filed within the required period.
The IRM defines "superseded returns" as "a return or correspondence filed after the originally filed return and filed within the filing period (including extensions)" (IRM §220.127.116.11.1(1)(d)). These returns, more commonly called "superseding returns," are similar to amended returns in that they adjust previously filed returns, with the distinction being when they are filed. If the taxpayer makes the change on a return filed before the due date, including extensions, the taxpayer may file a superseding return. While the distinction may seem irrelevant at times, there are benefits to filing a superseding return as opposed to an amended return. For example, the process required to file a superseding return, compared with that of an amended return, is generally quicker and easier.
Compare the outcome in Rev. Rul. 86-58 to that of Rev. Rul. 78-256, both related to underpayment of estimated tax. In Rev. Rul. 86-58, a taxpayer's underpayment of estimated tax was calculated on the balance due of $20x reported on the originally filed return and not the balance due of $8x shown on the amended return filed after the due date. In Rev. Rul. 78-256, on the other hand, the underpayment of estimated tax was calculated on the balance due of $1x shown on the taxpayer's superseding return filed before the due date, as opposed to the balance due of $7x shown on the first return the taxpayer filed.
Also, taxpayers may be able to make elections that they could not make on an amended return. Finally, BBA partnerships that cannot file amended returns can file superseding returns (see Rev. Proc. 2019-32).
Application to CARES Act
Without guidance from Treasury and/or the IRS, taxpayers would have been limited to rules discussed above in deciding how to implement CARES Act provisions. Fortunately, guidance was issued that in some cases expanded the options available to taxpayers.
Rev. Proc. 2020-23 addressed the restriction preventing BBA partnerships from filing amended returns by allowing an eligible partnership to file an amended return for tax years beginning in 2018 and 2019 if the partnership files the amended return and furnishes the corresponding Schedules K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., before Sept. 30, 2020. An eligible partnership for purposes of this revenue procedure is any BBA partnership that filed Form 1065, U.S. Return of Partnership Income, and furnished Schedules K-1 for the partnership tax years beginning in 2018 and 2019 before April 8, 2020. An important facet of this revenue procedure that should not be overlooked is that it allows for the amended return to "take into account tax changes brought about by the CARES Act as well as any other tax attributes to which the partnership is entitled by law" (Rev. Proc. 2020-23, §3.02). This appears to allow eligible BBA partnerships to amend 2018 and 2019 returns regardless of the reason.
Rev. Proc. 2020-25 has two components. First, it generally allows a taxpayer to make the change for QIP placed in service after Dec. 31, 2017, in the taxpayer's tax year ending in 2018, 2019, or 2020. Second, it addresses late elections, or revocations or withdrawals of certain elections, under Sec. 168. The following discussion focuses on the first part of the revenue procedure. Taxpayers that qualify for relief under Section 3 of Rev. Proc. 2020-25 can make the change by filing: (1) an amended return, including by an eligible BBA partnership under Rev. Proc. 2020-23, for the tax year the QIP was placed in service; (2) an AAR request for the tax year the QIP was placed in service, in the case of a BBA partnership that chose not to file an amended return as permitted under Rev. Proc. 2020-23 or was ineligible to file an amended return for the tax year the QIP was placed in service; or (3) a Form 3115 with the taxpayer's timely filed return. For a taxpayer to file Form 3115 for this change, Rev. Proc. 2019-43 is modified to include new Section 6.19. This provision is similar to Section 6.01 of Rev. Proc. 2019-43 but does have differences in the applicability rules the taxpayer should consider before filing for a change of accounting method.
The easiest way to examine the potential benefits of Rev. Procs. 2020-23 and 2020-25 is through a couple of examples.
Example 1: A calendar-year taxpayer places QIP in service in 2018. The taxpayer timely filed its 2018 return, for which the due date has now passed, treating the QIP as 39-year property not eligible for bonus depreciation. The taxpayer's 2019 return has not been filed, but its due date has not yet passed.
Regardless of the taxpayer, a superseding 2018 return could not be filed since the due date (including extensions) has passed. Under the general rules discussed earlier, taxpayers other than a BBA partnership may be eligible to make the change by filing either an amended return or a Form 3115. For these taxpayers, a similar result should be available under Rev. Proc. 2020-25.
However, for a BBA partnership, the new guidance could provide an additional opportunity. Under the general rules, a BBA partnership would likely be able to implement the change either by filing an AAR for the 2018 tax year or by filing a Form 3115 with its timely filed 2019 return. Under Rev. Procs. 2020-23 and 2020-25, an eligible BBA partnership could still file either an AAR or a Form 3115, as previously allowed, but may also be able to file an amended Form 1065 for 2018.
While an AAR and amended return would both result in the partnership's changing its income for its 2018 tax year, the amended return option may be preferred for a couple of reasons. First, if the partnership files an AAR for its 2018 tax year in 2020, the benefit of the resulting depreciation change may not be received by the partners until 2021, since the adjustment would not be reported by the partners until they file their 2020 tax return. If, instead, the partnership filed an amended 2018 return, the partners could amend their 2018 tax returns immediately.
Secondly, there remains the question of whether a partner can take full advantage of the AAR adjustment on his or her 2020 return if the partner does not have a sufficient Chapter 1 tax liability before factoring in the adjustment. If the partnership filed an amended return and the partner was unable to utilize the entire deduction on his or her 2018 return, the partner would be able to carry the excess forward to future tax years or, potentially, carry it back, due to the changes in the CARES Act for net operating losses.
In this scenario, partners in a BBA partnership could have the option to report the adjustment on their 2018, 2019, or 2020 return, depending on whether the partnership filed an amended return, a Form 3115, or an AAR, respectively. This is a useful planning opportunity for the partnership and its partners to pick the approach that maximizes the partners' benefit.
Example 2: Assume the same facts as Example 1, except the taxpayer filed its 2019 return continuing to report the QIP consistently with the 2018 return treatment, and the due date for the 2019 return has passed.
Treating the property as 39-year property not eligible for bonus depreciation on the taxpayer's 2019 return would result in the adoption of a method of accounting. Under the general rules, this would prohibit the taxpayer from filing an amended return. The taxpayer would have to file Form 3115 with its 2020 return to adjust depreciation. However, under Rev. Proc. 2020-25 a taxpayer may be eligible to file an amended return for 2018 even though it has established a method of accounting for QIP.
For QIP within the scope of Rev. Proc. 2020-25, Section 3.02(3)(a) provides that taxpayers that are not BBA partnerships can file an amended return by the earlier of (1) Oct. 15, 2021; or (2) the applicable period of limitation on assessment for the tax year of the amended return. BBA partnerships may also be able to file an amended return for 2018 in this scenario, but the time frame in which to do so is limited. Rev. Proc. 2020-23 requires the amended return for 2018 or 2019 to be filed and all Schedules K-1 to be furnished before Sept. 30, 2020, which is only a few weeks after the extended due date of a 2019 return for a calendar-year partnership. As in Example 1, the relief provided expands the options available to taxpayers and should be considered when deciding on the appropriate course of action.
Optimal strategies vary by taxpayer
Taxpayers need to consider all relevant factors when deciding which option to employ in implementing CARES Act and/or non—CARES Act changes. Other factors, such as investor relations, the cost of amending returns, and state tax issues also need to be evaluated during this process. Tax professionals should keep in mind that the best strategy for one taxpayer will not be the best strategy for all taxpayers and that taxpayer-specific circumstances need to be weighed appropriately to ensure that the best approach is used.
Anthony Bakale, CPA, is with Cohen & Company Ltd. in Cleveland.
For additional information about these items, contact Mr. Bakale at firstname.lastname@example.org.
Contributors are members of or associated with Cohen & Company Ltd.