Changing times: IRS updates "automatic" method change program.

• Author: Atkinson, James L.

Introduction

In Rev. Proc. 2008-52, (1) the Internal Revenue Service updated the procedures for obtaining automatic IRS consent to change a method of accounting. This revision is likely to be the first in a series of changes in the way in which the IRS administers the accounting method change program. In addition to some procedural changes, the revenue procedure expands the list of accounting methods that may be changed automatically without prior IRS National Office review and approval. The new "automatics" include a number of high-profile tax accounting issues, including the treatment of nonshareholder contributions to capital and the accrual of year-end performance and incentive bonuses.

The opportunity to alter the manner in which these payments are treated for tax purposes, without first submitting the change for National Office review, provides taxpayers with a number of opportunities. This article provides an overview of the revised procedures by which taxpayers obtain automatic consent to change an accounting method and highlights the most significant modifications and additions to the list of those changes eligible for these procedures.

As a threshold matter, taxpayers must remain alert ot a potential pitfall inherent in these procedures. "Automatic consent" simply means that the IRS is providing the consent required by section 446(e) if and only if the taxpayer fully complies with the procedural and substantive requirements set forth in Rev. Proc. 2008-52. The revenue procedure does not allow taxpayers to make the enumerated method changes without IRS consent. Statutorily, the IRS lacks the authority to go quite that far. (2) Instead, Rev. Proc. 2008-52 simply provides that if, and only if, a taxpayer fully complies with the published procedures, the IRS is providing the required consent without the need for prior review by the National Office.

This is a critical distinction, because where the taxpayer makes a method change purportedly in reliance on Rev. Proc. 2008-52 but fails to fully satisfy the document's requirements, the taxpayer will have made the method change, but will have failed to obtain the consent required by section 446(e) of the Internal Revenue Code) As a result, because the taxpayer will have made an unauthorized method change, the IRS may require the taxpayer to return to its prior method and assess any resulting deficiency (with intent), effective as early as the earliest open year, even if the former method is otherwise improper. (4)

For this reason, in seeking to make an "automatic" method change pursuant to Rev. Proc. 2008-52, taxpayers should ensure not only that all of the procedural requirements of that document are fully satisfied, but also that the method to which the taxpayer is changing does in fact fall within the scope of those eligible for automatic consent. In some sense, taxpayers should think of "automatic consent" as being only "conditional consent."

The difficulty in receiving only what amounts to conditional consent is that the taxpayer has no way of ensuring that the IRS agrees that the taxpayer is entitled to make the proposed method change, and that the proposed method change is in fact within the scope of the automatic consent procedures. Because a significant percentage of the Forms 3115 filed under the automatic consent procedures are not thoroughly reviewed (if at all) by the National Office, the taxpayer may unintentionally and unknowingly fail to meet the requirements of Rev. Proc. 2008-52, and in doing so make an unauthorized method change. The taxpayer will realize it has made an unauthorized method change only if the issue is raised on audit, but at that point will be unable to take the corrective steps that would have been possible had the method change request been reviewed and approved by the National Office before being implemented.

Unfortunately, there is no readily available means of avoiding this pitfall, beyond careful attention to the requirements of Rev. Proc. 2008-52. Generally, where automatic consent is available, the taxpayer may not voluntarily obtain prior review and approval by the National Office. Even under the substantially revised procedures that have been proposed by the National Office, (5) the taxpayer would be unable to voluntarily request prior consideration and approval by the National Office with respect to many of the method changes that are eligible to be made automatically. The National Office's rationale for this procedural tightrope is based on the fundamental purpose underlying the automatic consent procedures, namely, the need to reduce its own resources dedicated to considering accounting method change requests. In the National Office's view, providing written confirmation that the taxpayer is eligible to make the proposed change, that the proposed change is within the scope of Rev. Proc. 2008-52, etc., would defeat one of the principal goals of this program.

Accordingly, while the continued expansion of the automatic consent program generally represents good news for taxpayers, the foregoing pitfalls should be kept in mind in making an "automatic" method change, and scrupulous attention must be paid to what otherwise appear to be routine procedures.

The Procedures: A Brief Overview

The basic procedures for obtaining IRS consent to change an accounting method remain relatively unchanged from the prior incarnation of these rules in Rev. Proc. 2002-9. (6) After first ensuring that the proposed method to which the taxpayer is changing is described in the Appendix to Rev. Proc. 2008-52 (Appendix), the taxpayer must prepare a Form 3115, Application for a Change in Accounting Method, in duplicate. The original copy is attached to the taxpayer's timely filed (including extensions) federal income tax return. The second signed copy is submitted to the appropriate division of the IRS National Office. For most changes, the signed copy is submitted to the Associate Chief Counsel (Income Tax & Accounting) (IT&A).

Although not necessarily a change from the IRS's current view, the new revenue procedure is more explicit than Rev. Proc. 2002-9 that the Form 3115 must be "accurate and complete as to all information required" by the revenue procedure. Section 6.02(c) includes a list of the specific information that must be included on the Form 3115. The sharpening of this instruction advances the National Office's efforts to counteract the practice of filing "skeletal 3115s," which sometimes contain little more than the taxpayer's identifying information, a statement that the taxpayer is changing to a method of accounting that clearly reflects income, and a statement that the section 481 adjustment will be determined later. Taxpayers and IT&A in particular have engaged in a robust debate over the use of such skeletal filings.

IT&A has made it increasingly clear over the last few years that an incomplete Form 3115 does not satisfy the applicable procedures for obtaining either automatic consent or prior-consent to change a method of accounting. In its view, the National Office has the discretion to determine that a Form 3115 that is not full and complete at the time of filing is a nullity, having no effect for purposes of obtaining IRS consent under section 446(e). If (as is typical) this occurs late in the taxable year, the taxpayer may not have time to submit a second, more complete submission before the end of the year, thereby losing the opportunity to make the...