Accounting methods, whether general (like cash or accrual) or specialized (e.g., long-term contract methods), are pivotal for financial reporting. This guide provides a quick reference for the process of changing accounting methods, encompassing IRS consent, Form 3115 submission, and key considerations.
A change of accounting method includes a change in the overall plan of accounting for income and deductions; or a change in the treatment of any material item used in the overall accounting plan.
Identifying a change involves evaluating material items, irrespective of their dollar value. A material item, irrespective of its dollar value, is determined by the timing of inclusion or deduction. The taxpayer must decide whether the practice permanently changes the amount of the taxpayer's lifetime income. If the practice does not permanently affect the taxpayer's lifetime income, but it could change the tax year in which the income is reported, then the item involves timing and will be considered a material item.
A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax. Also, a change in method of accounting does not include adjustment of any item of income or deduction that does not involve the proper time for the inclusion of the item of income or the taking of a deduction. A change in method of accounting also does not include a change in treatment resulting from a change in underlying facts.
Taxpayers typically need IRS consent before altering accounting methods for federal income tax purposes. The IRS provides automatic consent for changes listed in its 'List of Automatic Accounting Changes,' while others require advance or non-automatic consent.
Applying for a Change on Form 3115
To initiate a change, submit Form 3115, 'Application for Change in Accounting Method,' seeking IRS consent. Completing the form accurately is crucial, including details on affected items, potential duplications, and computations for adjustments. For multiple changes, file separate forms unless IRS guidance allows inclusion on a single form.
Consideration of an IRC 481(a) adjustment or a change using the cut-off method is necessary when changing accounting methods. A taxpayer that changes its method of accounting must compute an adjustment, called a section 481(a) adjustment, to prevent income or deductions from being duplicated or omitted because of the accounting method change. A taxpayer computes the section 481(a) adjustment by determining taxable income as though it had used the new method of accounting for all prior years.
A section 481(a) adjustment can be positive or negative. The IRS allows most positive section 481(a) adjustments to be taken into account over a four year period, while negative section 481(a) adjustments are taken into account in the year of change.
Under a cut-off method, only the items arising on or after the beginning of the year of change (or other operative date) are taken into account under the new method of accounting. Any items arising before the year of change (or other operative date) continue to be taken into account under the taxpayer's former method of accounting. The cut-off method does not duplicate or omit any amounts from income; therefore, an IRC 481(a) adjustment is not necessary or required.
The Form 3115 must be signed by, or on behalf of, the taxpayer requesting the accounting method change by an individual who has personal knowledge of the facts of, and authority to bind the taxpayer in, such matters.
The two types of IRS procedures and requirements for Form 3115 depend on whether automatic consent and advance or non-automatic consent.
1. Automatic Consent Process
Most taxpayers making a change of accounting method identified in the IRS List of Automatic Changes must file Form 3115, Application for Change in Accounting Method, in duplicate. The taxpayer should attach the original Form 3115 to a timely (including extensions) federal income tax return for the year of change. The taxpayer should file a signed copy of Form 3115 with the IRS at the Ogden, Utah Service Center. The signed copy should be filed no earlier than the first day of the year of change and no later than when the original Form 3115 is filed with the federal income tax return for the year of change.
2. Advance or Non-automatic Requests
Taxpayers not eligible for automatic change procedures or those seeking a change in the final year of their trade or business can request advance or non-automatic consent.
To do so, file Form 3115 with the appropriate user fee at the IRS National Office during the requested year of change, unless other guidance specifies otherwise. Upon approval, taxpayers receive a letter ruling.
This quick reference aims to simplify the process of navigating accounting method changes. For further details or specific queries, refer to IRS guidelines or seek professional advice.
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