Adjustments Required by Changes in Method of Accounting

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[TD 8608]

RIN 1545-AS93

Adjustments Required by Changes in Method of Accounting

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

requirements for changes in method of accounting. These regulations

clarify the Commissioner's authority to prescribe terms and conditions

for effecting a change in method of accounting. The regulations affect

taxpayers changing a method of accounting for federal income tax

purposes.

DATES: These regulations are effective August 4, 1995. For dates of

applicability see Secs. 1.446-1(e)(3)(iii) and 1.481-5.

FOR FURTHER INFORMATION CONTACT: Cheryl Oseekey, (202) 622-4970 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On December 28, 1994, the IRS published a notice of proposed

rulemaking in the Federal Register (59 FR 66825), relating to the

requirements for changes in method of accounting. That document

proposed clarifying amendments to the regulations under sections 446

and 481. No public hearing was requested or held.

Two comments responding to this notice were received. After

consideration of the comments, the amendments proposed by IA-42-93 are

adopted with minor editorial revisions by this Treasury decision.

Summary of Comments

The notice of proposed rulemaking proposes to conform the existing

regulations under sections 446(e) and 481(c) to long-standing IRS

administrative practices regarding the use of adjustment periods under

section 481(a) and the use of a cut-off method. Under the general rule

of the proposed regulations, any section 481(a) adjustment attributable

to a voluntary or an involuntary change in method of accounting is

taken into account in the taxable year of change, whether the

adjustment increases or decreases taxable income. However, the

regulations also propose to amend Secs. 1.446-1(e)(3) and 1.481-5 to

clarify the Commissioner's authority to prescribe the terms and

conditions for effecting a change in method of accounting. Under the

regulations, the terms and conditions that may be prescribed by the

Commissioner include the taxable year or years in which a section

481(a) adjustment is taken into account and the use of a cut-off method

to effect a change in method of accounting.

Two comments were received in response to the notice. The comments

questioned IRS authority to require the use of a cut-off method, and

whether to require it is sound administrative practice. After

considering the comments, the IRS and the Treasury Department continue

to believe that the IRS has the authority under section 446(e) to

impose a cut-off method, and that it is consistent with section 481(a).

Furthermore, the IRS and the Treasury Department believe that requiring

a change in method of accounting on a cut-off basis in appropriate

circumstances is administratively sound. For example, the application

of a cut-off method to effect a change within the last-in, first-out

(LIFO) inventory method is justified on the basis of simplicity because

it eliminates the need to revalue LIFO increments.

The amendments proposed by IA-42-93 are adopted by this Treasury

decision.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It has also been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information

The principal author of these regulations is Rosemary DeLeone,

Office of Assistant Chief Counsel (Income Tax and Accounting), IRS.

However, other personnel from the IRS and Treasury Department

participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

[[Page 40078]]

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by

revising the entry for section 1.446-1 and by adding the following

citations in numerical order to read as follows:

Authority: 26 U.S.C. 7805. * * *

Section 1.446-1 also issued under 26 U.S.C. 446 and 461(h). * *

*

Section 1.481-1 also issued under 26 U.S.C. 481.

Section 1.481-2 also issued under 26 U.S.C. 481.

Section 1.481-3 also issued under 26 U.S.C. 481.

Section 1.481-4 also issued under 26 U.S.C. 481.

Section 1.481-5 also issued under 26 U.S.C. 481. * * *

Par. 2. Section 1.446-1 is amended by revising paragraph (e)(3) to

read as follows:

Sec. 1.446-1 General rule for methods of accounting.

* * * * *

(e) * * *

(3)(i) Except as otherwise provided under the authority of

paragraph (e)(3)(ii) of this section, to secure the Commissioner's

consent to a taxpayer's change in method of accounting the taxpayer

must file an application on Form 3115 with the Commissioner within 180

days after the beginning of the taxable year in which the taxpayer

desires to make the change in method of accounting. To the extent

applicable, the taxpayer must furnish all information requested on the

Form 3115. This information includes all classes of items that will be

treated differently under the new method of accounting, any amounts

that will be duplicated or omitted as a result of the proposed change,

and the taxpayer's computation of any adjustments necessary to prevent

such duplications or omissions. The Commissioner may require such other

information as may be necessary to determine whether the proposed

change will be permitted. Permission to change a taxpayer's method of

accounting will not be granted unless the taxpayer agrees to the

Commissioner's prescribed terms and conditions for effecting the

change, including the taxable year or years in which any adjustment

necessary to prevent amounts from being duplicated or omitted is to be

taken into account. See section 481 and the regulations thereunder,

relating to certain adjustments resulting from accounting method

changes, and section 472 and the regulations thereunder, relating to

adjustments for changes to and from the last-in, first-out inventory

method.

(ii) Notwithstanding the provisions of paragraph (e)(3)(i) of this

section, the Commissioner may prescribe administrative procedures under

which taxpayers will be permitted to change their method of accounting.

The administrative procedures shall prescribe those terms and

conditions necessary to obtain the Commissioner's consent to effect the

change and to prevent amounts from being duplicated or omitted. The

terms and conditions that may be prescribed by the Commissioner may

include terms and conditions that require the change in method of

accounting to be effected on a cut-off basis or by an adjustment under

section 481(a) to be taken into account in the taxable year or years

prescribed by the Commissioner.

(iii) This paragraph (e)(3) is effective for Consent Agreements

signed on or after December 27, 1994. For Consent Agreements signed

before December 27, 1994, see Sec. 1.446-1(e)(3) (as contained in the

26 CFR part 1 edition revised as of April 1, 1995).

Par. 3. Section 1.481-1 is amended as follows:

1. Paragraph (a)(2) is amended by adding the phrase ``(hereinafter

referred to as pre-1954 years)'' to the end of the paragraph.

2. The third sentence of paragraph (c)(1) is amended by removing

``pre-1954 Code years'' and replacing it with ``pre-1954 years''.

3. Paragraphs (c) (2), (3), and (4) are revised.

4. Paragraphs (c) (6) and (7) are removed.

5. Paragraph (d) is revised.

6. Paragraph (e) is removed.

The revised paragraphs read as follows:

Sec. 1.481-1 Adjustments in general.

* * * * *

(c) * * *

(2) If a change in method of accounting is voluntary (i.e.,

initiated by the taxpayer), the entire amount of the adjustments

required by section 481(a) is generally taken into account in computing

taxable income in the taxable year of the change, regardless of whether

the adjustments increase or decrease taxable income. See, however,

Secs. 1.446-1(e)(3) and 1.481-4 which provide that the Commissioner may

prescribe the taxable year or years in which the adjustments are taken

into account.

(3) If the change in method of accounting is involuntary (i.e., not

initiated by the taxpayer), then only the amount of the adjustments

required by section 481(a) that is attributable to taxable years

beginning after December 31, 1953, and ending after August 16, 1954,

(hereinafter referred to as post-1953 years) is taken into account.

This amount is generally taken into account in computing taxable income

in the taxable year of the change, regardless of whether the

adjustments increase or decrease taxable income. See, however,

Secs. 1.446-1(e)(3) and 1.481-4 which provide that the Commissioner may

prescribe the taxable year or years in which the adjustments are taken

into account. See also Sec. 1.481-3 for rules relating to adjustments

attributable to pre-1954 years.

(4) For any adjustments attributable to post-1953 years that are

taken into account entirely in the year of change and that increase

taxable income by more than $3,000, the limitations on tax provided in

section 481(b) (1) or (2) apply. See Sec. 1.481-2 for rules relating to

the limitations on tax provided by sections 481(b) (1) and (2).

* * * * *

(d) Any adjustments required under section 481(a) that are taken

into account during a taxable year must be properly taken into account

for purposes of computing gross income, adjusted gross income, or

taxable income in determining the amount of any item of gain, loss,

deduction, or credit that depends on gross income, adjusted gross

income, or taxable income.

Par. 4. Section 1.481-2 is amended as follows:

1. The first and second sentences of paragraph (a) are revised.

2. The first sentence of paragraph (b) introductory text is

revised.

3. The first sentence of paragraph (c)(1) is revised.

4. The first sentence of paragraph (c)(2) is amended by removing

``subparagraph (1) of this paragraph'' and replacing it with

``paragraph (c)(1) of this section''.

5. Paragraph (c)(3) introductory text is amended by removing

``subparagraph (1) of this paragraph'' and replacing it with

``paragraph (c)(1) of this section''.

6. Paragraph (c)(4) is revised.

7. Paragraph (c)(6) is amended by removing ``Internal Revenue Code

of 1954'' and replacing it with ``Internal Revenue Code of 1986''.

8. The second sentence of paragraph (d) is amended by removing

``Internal Revenue Code of 1954'' and replacing it with ``Internal

Revenue Code of 1986''.

9. Example (1) of paragraph (d) is amended by removing ``pre-1954

Code

[[Page 40079]]

years'' and replacing it with ``pre-1954 years'' in each place that it

appears.

The revised paragraphs read as follows:

Sec. 1.481-2 Limitation on tax.

(a) Three-year allocation. Section 481(b)(1) provides a limitation

on the tax under chapter 1 of the Internal Revenue Code for the taxable

year of change that is attributable to the adjustments required under

section 481(a) and Sec. 1.481-1 if the entire amount of the adjustments

is taken into account in the year of change. If such adjustments

increase the taxpayer's taxable income for the taxable year of the

change by more than $3,000, then the tax for such taxable year that is

attributable to the adjustments shall not exceed the lesser of the tax

attributable to taking such adjustments into account in computing

taxable income for the taxable year of the change under section 481(a)

and Sec. 1.481-1, or the aggregate of the increases in tax that would

result if the adjustments were included ratably in the taxable year of

the change and the two preceding taxable years. * * *

(b) Allocation under new method of accounting. Section 481(b)(2)

provides a second alternative limitation on the tax for the taxable

year of change under chapter 1 of the Internal Revenue Code that is

attributable to the adjustments required under section 481(a) and

Sec. 1.481-1 where such adjustments increase taxable income for the

taxable year of change by more than $3,000. * * *

(c) Rules for computation of tax. (1) The first step in determining

whether either of the limitations described in section 481(b) (1) or

(2) applies is to compute the increase in tax for the taxable year of

the change that is attributable to the increase in taxable income for

such year resulting solely from the adjustments required under section

481(a) and Sec. 1.481-1.

* * * * *

(4) The tax for the taxable year of the change shall be the tax for

such year, computed without taking any of the adjustments referred to

in paragraph (c)(1) of this section into account, increased by the

smallest of the following amounts--

(i) The amount of tax for the taxable year of the change

attributable solely to taking into account the entire amount of the

adjustments required by section 481(a) and Sec. 1.481-1;

(ii) The sum of the increases in tax liability for the taxable year

of the change and the two immediately preceding taxable years that

would have resulted solely from taking into account one-third of the

amount of such adjustments required for each of such years as though

such amounts had been properly attributable to such years (computed in

accordance with paragraph (c)(2) of this section); or

(iii) The net increase in tax attributable to allocating such

adjustments under the new method of accounting (computed in accordance

with paragraph (c)(3) of this section).

* * * * *

Sec. 1.481-3 [Amended]

Par. 5. Section 1.481-3 is amended as follows:

1. The language ``pre-1954 Code years'' is removed and the language

``pre-1954 years'' is added in its place in the section heading and the

first, second and third sentences of the section.

2. Remove the last sentence of the section.

Sec. 1.481-4 [Removed]

Par. 6. Section 1.481-4 is removed.

Sec. 1.481-5 [Redesignated as Sec. 1.481-4]

Par. 7. Section 1.481-5 is redesignated as Sec. 1.481-4 and is

revised to read as follows:

Sec. 1.481-4 Adjustments taken into account with consent.

(a) In addition to the terms and conditions prescribed by the

Commissioner under Sec. 1.446-1(e)(3) for effecting a change in method

of accounting, including the taxable year or years in which the amount

of the adjustments required by section 481(a) is to be taken into

account, or the methods of allocation described in section 481(b), a

taxpayer may request approval of an alternative method of allocating

the amount of the adjustments under section 481. See section 481(c).

Requests for approval of an alternative method of allocation shall set

forth in detail the facts and circumstances upon which the taxpayer

bases its request. Permission will be granted only if the taxpayer and

the Commissioner agree to the terms and conditions under which the

allocation is to be effected. See Sec. 1.446-1(e) for the rules

regarding how to secure the Commissioner's consent to a change in

method of accounting.

(b) An agreement to the terms and conditions of a change in method

of accounting under Sec. 1.446-1(e)(3), including the taxable year or

years prescribed by the Commissioner under that section (or an

alternative method described in paragraph (a) of this section) for

taking the amount of the adjustments under section 481(a) into account,

shall be in writing and shall be signed by the Commissioner and the

taxpayer. It shall set forth the items to be adjusted, the amount of

the adjustments, the taxable year or years for which the adjustments

are to be taken into account, and the amount of the adjustments

allocable to each year. The agreement shall be binding on the parties

except upon a showing of fraud, malfeasance, or misrepresentation of

material fact.

Par. 8. Section 1.481-5 is added to read as follows:

Sec. 1.481-5 Effective dates.

Sections 1.481-1, 1.481-2, 1.481-3, and 1.481-4 are effective for

Consent Agreements signed on or after December 27, 1994. For Consent

Agreements signed before December 27, 1994, see Secs. 1.481-1, 1.481-2,

1.481-3, 1.481-4, and 1.481-5 (as contained in the 26 CFR part 1

edition revised as of April 1, 1995).

Sec. 1.481-6 [Removed]

Par. 9. Section 1.481-6 is removed.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: July 26, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 95-19283 Filed 8-4-95; 8:45 am]

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