Is a change in characterization an accounting-method change?

• Author: Rancher, Jessica

Taxpayers periodically assess the validity of their tax positions. Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, has made this assessment even more detailed, and the questions have become more probing. This increased awareness has many companies in a quandary as to how to address uncertain tax positions. While the issue is not new, taxpayers still are asking: Is a change in characterization an accounting-method change?

Effect of Classification

Whether the treatment of an item is classified as an accounting method is pivotal, because such classification dictates how changes in the method can be made. If the treatment is deemed an accounting method, the taxpayer must seek IRS permission before computing taxable income under a new method; see Sec. 446(e).The Service automatically grants consent for certain method changes, but Form 3115, Application for Change in Accounting Method, generally still must be filed to request the change; see Rev. Proc. 2002-9.

In determining whether to file Form 3115, a taxpayer should consider the likelihood that the request will be approved. Also, taxpayers under audit might, depending on the circumstances, be restricted by the rules applicable to method changes while under audit. Another issue is whether the company can take a financial statement benefit for a position. There are many strategic issues to consider; at the forefront is whether a method change exists.

The uncertainty as to whether treatment of an item is an accounting method is particularly problematic if the treatment is erroneous. If the treatment is an accounting method, the taxpayer, by filing Form 3115 at the appropriate time, can secure audit protection with a current year of change and a spread of the unfavorable Sec. 481(a) adjustment; see Rev. Proc. 2002-9. However, if a taxpayer files Form 3115 and the IRS determines that the treatment is not an accounting method, it generally will adjust taxable income in prior open years. In light of this risk, the taxpayer needs to undertake prudent analysis and consideration of the potential positions.

What Is an Accounting Method?

Accounting methods often are thought of as the overall method of accounting employed (e.g., the overall accrual accounting method). But an accounting method can be any method that affects the timing of income or deductions. Strictly speaking, a change in accounting method includes a change in the treatment of any...