Practical advice on current issues: new directives from the LMSB.

• Author: Tull, Cory
• Position: Large and mid-size business

The IRS Large and Mid-Size Business (LMSB) Division has issued several new directives related to issues targeted under its issue-tiering strategy. The directives, each dated September 15, 2009, relate to the Tier I mixed service costs issue and two Tier II issues: contractual allowances in the health care industry and the super completed contract method of accounting.

Contractual Allowance Issue

LMSB-4-0909-036 moves the Tier II issue on contractual allowances in the health care industry from active to monitoring status. According to the directive, the IRS will continue to monitor the issue using guidance under Technical Advice Memorandum (TAM) 200619020, released on May 12, 2006, and the first contractual allowance Industry Director Directive (IDD) LMSB-04-0807-056, issued on September 10, 2007.

Super Completed Contract Method

LMSB-04-0209-006 updates and supersedes a previous IDD (LMSB-04-0207-012) that the IRS issued on March 13, 2007. The current IDD is intended to provide guidance pending the issuance of final regulations under Sec. 460 expanding the home construction contract exemption and amending rules for taxpayer-initiated changes in accounting method.

In the IDD, the IRS describes taxpayers' misuse of the completed contract method (CCM) of accounting as "a growing trend within the residential construction industry." The IRS provides five scenarios to illustrate the following two key misuses:

* Taxpayers improperly treat residential land sales contracts and long-term construction contracts (including contracts for subcontract work for common improvements) as home construction contracts eligible for the CCM.

* Taxpayers postpone recognition that a contract is considered complete to improperly defer income (and expenses) under the CCM.

The IDD directs that the improper use of the CCM should be raised as an audit issue in cases involving residential land developers, homebuilders, and/or their subcontractors. The IDD also directs revenue agents to limit examinations of the issue to contract deferrals that extend beyond two tax years after taxpayers entered into the contracts. However, the IRS notes that this guidance does not allow taxpayers a deferral of income for two years. Instead, it merely provides direction to examiners as to which contracts to examine.

Finally, the IDD provides audit techniques that examiners should follow in investigating the issue, as well as several pro forma information document requests (IDRs) and Forms...