Maneuvering through the sec. 381 regulations' accounting method rules.

• Author: Duer, Linda A.

When a tax-free reorganization or liquidation is to occur and the corporate parties to the transaction use different accounting methods, there are a number of issues that must be considered. Regs. Sec. 1.381 (C)(4)-1 (a)(1)(i) requires the carryover of accounting methods to the acquiring corporation from the transferor corporation, unless different accounting methods were used on the transfer date. If different methods were used, the acquiring corporation must follow the regulations to determine the appropriate accounting method. This can prove to be a mine field for the unwary.

Principal Accounting Method

The first step in maneuvering through these regulations is to determine whether the component trades or businesses of the respective parties to the transaction may be treated as separate and distinct or must be integrated into one trade or business after the transaction. If the trades or businesses are operated as separate and distinct within the meaning of Regs. Sec. 1.446-1 (d), each separate trade or business will continue to use the accounting method used before the transaction, unless the acquiring corporation requests an accounting method change from the IRS or the Service prescribes a different accounting method under Regs. Sec. 1.446-1(b)(1).

An exception to this rule exists when a corporation may have only one accounting method for a particular item. If the separate trades or businesses use different accounting methods for this item, the acquiring corporation must use the"principal" accounting method determined under the regulations. The principal accounting method for such item generally is determined by comparing the aggregate amount of the item and related accounts for all parties to the transaction (using a common method) to the aggregate amount of the item and related accounts for those parties (using: a different common method). The accounting method of the group with the greatest aggregate amount of such item and related accounts will be the principal accounting method for that particular item.

If the corporations' component trades or businesses are not operated as separate and distinct, to the extent that different accounting methods were used, the acquiring corporation must adopt the principal overall accounting method determined under the regulations. The principal overall accounting method of an integrated business generally is determined by comparing the total adjusted bases of the assets immediately preceding the...