Rev Proc 2018-40, 2018-34 IRB; IR 2018-160
IRS has provided the procedures by which a small business taxpayer may obtain automatic consent to change its method of accounting to a new method established under the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), which increased the availability of the cash method of accounting and eased qualification for the small business exception to certain accounting rules.
Background on changing accounting methods. Code Sec. 446(a) and Reg § 1.446-1(a)(1) provide that taxable income is computed under the method of accounting the taxpayer regularly uses to compute income in keeping the taxpayer’s books. Reg § 1.446-1(a)(4) requires a taxpayer to maintain accounting records that include the taxpayer’s regular books of account and other records and data necessary to support the entries on the taxpayer’s books of account and on the taxpayer’s return. A taxpayer using an accrual method of accounting accrues income when the right to receive income is fixed and the amount can be determined with reasonable accuracy (the all events test). (Reg § 1.451-1(a))
In most cases, a taxpayer that wishes to change its method of accounting must apply for and secure the prior consent of IRS. (Code Sec. 446(e)) However, for some accounting method changes, IRS provides an automatic procedure for obtaining its consent to the change. IRS issued an updated list of accounting changes to which its automatic change procedures apply in May 2018 (Rev Proc 2018-31, 2018-22 IRB).
When a taxpayer changes its accounting method, Code Sec. 481(a) adjustments are generally required to be made to prevent items from being duplicated or omitted. (Reg. § 1.446-1(e)(3)(i)) However, in limited circumstances, a “cut-off” method can be used instead, where only the items arising on or after the beginning of the year of change are accounted for under the new accounting method.
Background on TCJA accounting method changes. The TCJA made significant changes to tax accounting rules under the Code. These changes include:
- . . . allowing the cash method of accounting to be used by taxpayers (other than tax shelters) that satisfy a $25 million (as annually adjusted for inflation) gross receipts test (the “gross receipts test”; generally, gross receipts for the 3-tax-year period ending with the prior tax year not in excess of $25 million), regardless of whether the purchase, production, or sale of merchandise is an income-producing factor, including farming businesses owned by corporations; (Code Sec. 447 and Code Sec. 448, as amended)
- . . . allowing taxpayers that meet the gross receipts test to use an accounting method for inventories that either (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer’s financial accounting treatment of inventories; (Code Sec. 471, as amended)
- . . . exempting producers or re-sellers that meet the gross receipts test from the application of the UNICAP rules; (Code Sec. 263A, as amended) and
- . . . exempting certain construction companies that meet the gross receipts test from the requirement to use the percentage-of-completion (PCM) method for long-term contracts. (Code Sec. 460(e), as amended)
The above changes generally apply to tax years beginning after Dec. 31, 2017, except that the amendments to Code Sec. 460 apply to contracts entered into after Dec. 31, 2017, in tax years ending after that date.
The TCJA specified that a taxpayer’s use of one of the first three provisions listed above will result in a change in the taxpayer’s accounting method under Code Sec. 481.
Automatic consent procedures updated. The new Rev Proc specifies that a taxpayer that wants to change to one or more of the new TCJA-permitted methods of accounting described below (“new methods”) must, if eligible, use the automatic change procedures in Rev Proc 2015-13 and Rev Proc 2018-31 (or any successors), as modified. (Rev Proc 2018-40, Section 3.01)
The new Rev Proc modifies Rev Proc 2018-31 to add the following new provisions:
- “Small business taxpayer changing to overall cash method” applies to a “small business taxpayer” (i.e., one that meets the gross receipts test) that wants to change its overall method of accounting from an overall accrual method of accounting to the overall cash method of accounting for a trade or business, and that is otherwise not prohibited from using the overall cash method or required to use another overall method of accounting. Section 15.18 also provides a list of taxpayers to which this change doesn’t apply (e.g., certain banks and farming businesses), and sets out a special rule under which a small business taxpayer using the cash method must take amounts attributable to “open accounts receivable” (defined as any receivable that is due in full in 120 days or less and not subject to Code Sec. 475) in income upon actual or constructive receipt. (Rev Proc 2018-31, Section 15.18, as added by Rev Proc 2018-40, Section 3.02(1))
- “Small business taxpayer exception from requirement to capitalize costs under § 263A,” applies to a small business taxpayer that capitalizes costs under Code Sec. 263A and wants to change to a method of accounting that no longer capitalizes costs under Code Sec. 263A, except for a small business taxpayer that chooses to no longer capitalize costs under Code Sec. 263A for home construction contracts (see Section 19.01, below). (Rev Proc 2018-31, Section 12.16, as added by Rev Proc 2018-40, Section 3.02(2))
- “Small business exception from requirement to account for inventories under § 471,” applies to a small business taxpayer that wants to change its Code Sec. 471 method of accounting for inventory items to either: (a) treating inventory as non-incidental materials and supplies under Reg. § 1.162-3; or (b) conforming to the taxpayer’s method of accounting reflected in its applicable financial statements, as defined in Reg. § 451(b)(3), with respect to the tax year, or if the taxpayer does not have an applicable financial statement for the tax year, conforming to the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures. Section 22.19 also provides that consent granted for a change to (b), above, does not constitute a determination, or create a presumption, that the proposed inventory method of accounting is permissible. (Rev Proc 2018-31, Section 22.19, as added by Rev Proc 2018-40, Section 3.02(3))
- “Small business taxpayer exceptions from requirement to account for certain long-term contracts under § 460 or to capitalize costs under § 263A for certain home construction contracts,” applies to a taxpayer that, beginning in the year of change, qualifies as a small business taxpayer and (a) wants to change its method of accounting for exempt long-term construction contracts described in Code Sec. 460(e)(1)(B) from the PCM method described in Reg. § 1.460-4(b) to an exempt contract method of accounting described in Reg. § 1.460-4(c), or (b) chooses to stop capitalizing costs under Code Sec. 263A for home construction contracts defined in Code Sec. 460(e)(1)(A). This change is made on a cut-off basis, and no Code Sec. 481(a) adjustment is permitted or required. (Rev Proc 2018-31, Section 19.01, as added by Rev Proc 2018-40, Section 3.02(4))
The eligibility rule in Rev Proc 2015-13, Section 5.01(1)(f) (which generally precludes a taxpayer from using the automatic change procedures to change the treatment of the same item more than once within a 5-year period), does not apply to any of the new methods for a taxpayer’s first, second, or third tax year beginning after Dec. 31, 2017.
The new methods are also subject to reduced filing requirements, in that only a partial Form 3115, Application for Change in Accounting Method, needs to be filed. A taxpayer concurrently changing to more than one of the first three new methods listed above can make these changes concurrently on a single Form 3115, provided that the taxpayer enters the designated automatic accounting method change numbers for the changes on the appropriate line of the form.
The new methods apply for tax years beginning after Dec. 31, 2017, except for the Section 19.01 change, which applies to exempt long-term contracts described in Code Sec. 460(e)(1) that are entered into after Dec. 31, 2017, in tax years ending after Dec. 31, 2017. (Rev Proc 2018-40, Section 3)
Other changes. The new Rev Proc also makes a number of other modifications to Rev Proc 2018-31, reflecting that accounting method changes under Section 12.01(1)(a)(i) (relating to small resellers), Section 15.03(1) (certain changes to the overall cash method), and Section 22.03(1) (the small taxpayer exception from having to account for inventories under Code Sec. 471) are no longer available for tax years beginning after Dec. 31, 2017, and referring taxpayers to one of the new methods. (Rev Proc 2018-40, Section 4)
Treatment of existing Sec. 481(a) adjustment. The new Rev Proc provides that, if a taxpayer is taking into account a Code Sec. 481(a) adjustment resulting from a prior, but related, change in method of accounting at the time it changes to one of the new methods, the taxpayer may choose to either (i) account for the prior Code Sec. 481(a) adjustment separately from the Code Sec. 481(a) adjustment required by a change to one of the new methods; or (ii) combine or net the two amounts. Any taxpayer choosing to combine or net the Code Sec. 481(a) adjustments must indicate this choice in the statement required on Line 26 of Form 3115. (Rev Proc 2018-40, Section 3.03)
Transition rule. If before Aug. 3, 2018, a taxpayer properly filed a Form 3115 under the non-automatic change procedures in Rev Proc 2015-13 requesting IRS’s consent for a change to one of the new methods, and the Form 3115 is pending with the IRS national office on Aug. 3, 2018, the taxpayer may choose to make the change in method of accounting under the automatic change procedures in Rev Proc 2015-13 if the taxpayer is otherwise eligible to use the new Rev Proc and the automatic change procedures in Rev Proc 2015-13. The taxpayer must notify the national office contact person for the Form 3115 (if unknown, see Rev Proc 2018-1, Section 9.08(6) or any successor) of the taxpayer’s intent to make the change in method of accounting under the automatic change procedures in Rev Proc 2015-13 before the later of (a) Sept. 2, 2018, or (b) the issuance of a letter ruling granting or denying consent for the change. IRS will send an acknowledgment of the request and return the user fee submitted with the Form 3115 if the taxpayer makes a timely notification. (Rev Proc 2018-40, Section 4)
A taxpayer converting a Form 3115 to the automatic change procedures in Rev Proc 2015-13 for a change to a new method must resubmit a Form 3115 that conforms to the automatic change procedures, with a copy of the IRS acknowledgment attached, by the earlier of (a) the 30th calendar day after the date of the acknowledgment, or (b) the date the taxpayer is required to file the duplicate copy of the Form 3115 under Rev Proc 2015-13, Section 6.03(1)(a)(i)(B). The duplicate copy of the timely resubmitted Form 3115 will be considered filed as of the date the taxpayer originally filed the converted Form 3115 under the non-automatic change procedures in Rev Proc 2015-13. (Rev Proc 2018-40, Section 5)
Effective date. The new Rev Proc is generally effective for tax years beginning after Dec. 31, 2017, but for method changes under Section 3.02(4) (involving exempt long-term contracts), it is effective for exempt long-term contracts entered into after Dec. 31, 2017, in tax years ending after Dec. 31, 2017. (Rev Proc 2018-40, Section 6)
References: For accounting method changes, see FTC 2d/FIN ¶G-2100 et seq.; United States Tax Reporter ¶4464.21.
