Automatic consent to Sec. 174 accounting method changes modified

Editor: Susan M. Grais, CPA, J.D., LL.M.

In Rev. Proc. 2024-34, the IRS amended Section 7 of Rev. Proc. 2024-23 to modify the procedures under Sec. 446 for obtaining the IRS’s automatic consent for an accounting method change for specified research or experimental expenditures paid or incurred in tax years beginning after Dec. 31, 2021. The modifications apply to method changes made (1) to comply with Sec. 174 or (2) to rely on the interim guidance in Notice 2023-63, as amended by Notice 2024-12. These modifications respond to concerns that taxpayers and their representatives raised about the operation of the method change rules for Sec. 174, as technical and procedural guidance was released over the fall and winter of 2023 and the spring of 2024.

Specifically, Rev. Proc. 2024-34 modifies the eligibility rules in Section 7.01(5)(a) of Rev. Proc. 2024-23, so that the restrictions on automatic change eligibility in Sections 5.01(1)(d) and (f) of Rev. Proc. 2015-13 do not apply to a change that is made under Section 7.01(1)(a) of Rev. Proc. 2024-23 for a tax year beginning in 2022 or 2023. The restrictions on automatic change eligibility in Section 5.01(1)(d) of Rev. Proc. 2015-13 generally prevent a taxpayer from making a change if the requested year of change is the final year of the taxpayer’s trade or business. The restrictions on automatic change eligibility in Section 5.01(1)(f) of Rev. Proc. 2015-13 generally prevent a taxpayer from making a change for the same item during the five tax years ending with the year of change.

Rev. Proc. 2024-34 also modifies the rules in Section 7.01(5)(b) of Rev. Proc. 2024-23 that allow taxpayers to make successive tax year changes. Under Rev. Proc. 2024-34, a taxpayer may make a change under Section 7.01(1)(a) of Rev. Proc. 2024-23 for a tax year beginning in 2022 or 2023, regardless of whether the taxpayer made a change for the same item in a previous tax year beginning in 2022 or 2023. The prior rule on successive changes only referred to a taxpayer making a change for the same item in its second tax year beginning after Dec. 31, 2021.

Additionally, Rev. Proc. 2024-34 modifies the rules on limited audit protection in Section 7.01(6) of Rev. Proc. 2024-23. Under the modified rules, taxpayers that did not make the accounting method change to comply with Sec. 174 for the first tax year beginning after Dec. 31, 2021, will not receive audit protection for a change made in any tax year beginning in 2022 or 2023 (except for the first tax year beginning after Dec. 31, 2021) for expenditures paid or incurred in the first tax year beginning after Dec. 31, 2021. The prior rule only excluded audit protection for the second tax year beginning after Dec. 31, 2021, for taxpayers that did not change their method to comply with Sec. 174 for the first tax year beginning after Dec. 31, 2021.

Implications

The modification to Section 7.01(5)(a) of Rev. Proc. 2024-23 is particularly helpful to taxpayers that (1) had a short tax year in either 2022 or 2023; (2) made a change to comply with Sec. 174 in their first tax year beginning after Dec. 31, 2021; and (3) seek to refine their method in their third tax year, beginning in 2023. Without the modification, those taxpayers would have had to file a method change under the nonautomatic change procedures, as the waiver of the five-year same-item restriction for using the automatic change procedure would not have applied.

The modification to Section 7.01(5)(a) of Rev. Proc. 2024-23 also makes it possible for corporate taxpayers in their final year of trade or business in 2023 to make a change to apply the rules in Section 7 of Notice 2023-63, which addresses the treatment of unamortized Sec. 174 expenses in a corporate termination, to the year in which the corporate termination occurs. Without this modification, taxpayers may not have been eligible to make a change to apply the rules of Section 7 of Notice 2023-63 for the termination year without requests for relief from both the filing deadline for nonautomatic method changes and the restriction on requesting a change in the final year of the trade or business under Section 5.01(2)(b) of Rev. Proc. 2015-13.

The modifications to Section 7.01(5)(b) of Rev. Proc. 2024-23 on successive changes similarly support a taxpayer with short tax years in 2022 or 2023 making changes to refine its method under Sec. 174 by expanding the provision to cover changes made in 2022 or 2023, regardless of whether the tax year is beyond the taxpayer’s second tax year beginning after Dec. 31, 2021.

The revisions to Section 7.01(6) of Rev. Proc. 2024-23, which addresses audit protection for changes to the treatment of Sec. 174 expenses, retain the restriction on audit protection for expenditures paid or incurred in tax years beginning before Jan. 1, 2022. The revisions also expand the restriction to changes for any tax year beginning in 2022 or 2023 (other than the first tax year beginning after Dec. 31, 2021), if a taxpayer did not change its method to comply with Sec. 174 for its first tax year beginning after Dec. 31, 2021. Therefore, a taxpayer with short tax years will not receive audit protection for its treatment of expenditures paid or incurred in its first tax year beginning after Dec. 31, 2021, if it (1) did not make a change to comply with Sec. 174 in that year and (2) makes a change in any tax year beginning in 2022 or 2023.

A taxpayer, however, will receive audit protection for its treatment of expenditures paid or incurred after Dec. 31, 2021, if it files a method change to comply with Sec. 174 for the first time in 2024. A taxpayer in this situation (no prior Sec. 174 change and a change filed for a tax year after 2023) will not be restricted from using the automatic change procedure and will receive audit protection for its treatment of Sec. 174 costs for tax years beginning after Dec. 31, 2021. Taxpayers that made accounting method changes to comply with Sec. 174 or rely on the interim guidance in Notice 2023-63, as amended by Notice 2024-12, in tax years beginning in 2022 or 2023, or for which 2024 will be the last year of their trade or business, will be subject to the eligibility restrictions in Sections 5.01(1) (d) and (f) of Rev. Proc. 2015-13 for accounting method changes made for a tax year beginning in 2024.

Editor Notes

Susan M. Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. For additional information about these items, contact Grais at susan.grais@ey.com. Contributors are members of or associated with Ernst & Young LLP.

The views expressed are those of the authors and are not necessarily those of Ernst & Young LLP or other members of the global EY organization. This information is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide accounting, tax, or other professional advice.