Prop. regs. on mid-contract change in taxpayer under long-term contract method.

• Author: Madden, David

Proposed regulations released on Feb. 15, 2001 addressed the tax treatment of a change in taxpayer prior to completion of a long-term contract accounted for under a long-term contract method. A mid-contract change occurs when a transaction makes a new taxpayer responsible for reporting the income from a long-term contract.

Sec. 460

Sec. 460 and the regulations there-under provide specific accounting methods for determining income from long-term contracts. In general, a contract begun in one year and completed in a subsequent year is a long-term contract. The specific accounting methods include the percentage-of-completion method (PCM), the completed-contract method (CCM) and the percentage-of-completion/capitalized-cost method (PCCM).

Background

In 1990, Treasury and the IRS issued proposed regulations addressing the treatment of mid-contract changes in taxpayers, for purposes of applying the look-back method (which applied a step-in-the-shoes approach). They subsequently withdrew the proposed regulations.

Final Sec. 460 regulations, issued on Jan. 10, 2001, reserved for future guidance provisions dealing with mid-contract changes in taxpayer.

Overview

The newly issued proposed regulations would divide the rules into two categories based on the type of transaction. The two categories appear to respond to criticism of the withdrawn proposed regulations that the step-in-the-shoes approach applied to all contract transferees was inappropriate in the case of taxable dispositions.

Prop. Regs. Sec. 1.460-4(k) would apply if, before completion of a long-term contract accounted for under Sec. 460, a transaction transpires that makes a new taxpayer responsible for reporting the income from the same contract. In addition to such a mid-contract change in taxpayer, under the proposed regulations, a change in status to or from a taxable to tax-exempt entity or foreign to domestic entity would constitute a change in taxpayer. A contract would stand as the same contract if the terms were not substantially changed in connection with the transaction.

The proposed regulations would characterize the entity that was an original party to the long-term contract (and, therefore, the transferor of the contract) as the "old taxpayer" and the entity made responsible for reporting the income from the same contract (the transferee) as the "new taxpayer." For this purpose, an "old taxpayer" would include any predecessors of the old taxpayer.

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