4.11.6  Changes in Accounting Methods

4.11.6.1  (05-13-2005)
References for Changes in Accounting Methods

  1. The following references are for Changes in Accounting Methods:

    • IRC section 446 - General Rule for Methods of Accounting

    • IRC section 481 - Adjustments Required by Changes in Method of Accounting

    • Treas. Regs. 1.446 and 1.481

    • IRM 4.2.3 - Examination Techniques

    • LMSB Change in Accounting Method Site: http://lmsb.irs.gov/hp/pftg/change_method/

    • Rev. Ruling 90-38 - Although the Commissioner is authorized to consent to a retroactive accounting method change, a taxpayer does not have a right to a retroactive change, regardless of whether the change is from a permissible or impermissible method.

    • Rev. Proc. 97-27 - This advance consent (voluntary change) revenue procedure provides the general procedures under Treas. Reg. 1.446-1(c) for obtaining the consent of the Commissioner of Internal Revenue to change a method of accounting for federal income tax purposes. Rev. Proc. 97-27 was modified by Rev. Proc. 2002-19.

    • Rev. Proc. 2002-9 - This automatic consent (voluntary change) revenue procedure provides the procedures by which a taxpayer may obtain automatic consent to change the methods of accounting described in the Appendix. Pronouncements issued subsequent to the publication of Rev. Proc. 2002-9 that refer to this revenue procedure have modified it to include in its Appendix other methods of accounting. Prior automatic consent procedures include Rev. Proc. 97-37, Rev. Proc. 98-60 and Rev. Proc. 99-49. Rev. Proc. 2002-9 was modified by Rev. Proc. 2002-19 and Rev. Proc. 2002–54.

    • Rev. Proc. 2002-18 - This revenue procedure provides the procedures under IRC section 446(b) and Treas. Reg. section 1.446-1(b) for changes in method of accounting imposed by the Service (involuntary changes). Examiners should refer to this procedure when raising an accounting method change issue during an examination. This revenue procedure also provides the procedures that the Service (other than examiners) may use for accounting method issues resolved by the Service on a non-accounting method change basis. This revenue procedure is effective for examiner's reports issued on or after July 1, 2002.

    • Rev. Proc. 2002-19 - This revenue procedure modifies Rev. Proc. 97-27 and Rev. Proc. 2002-9 to provide new procedures for obtaining consent for a change of accounting method. This procedure introduced a method change without audit protection for an "issue pending" for a tax year under examination, and shortened the spread period for a taxpayer-favorable (negative) IRC section 481(a) adjustment.

    • Publication 538 (Rev. 3/2004) - Accounting Periods & Methods

      Note:

      Changes in taxpayer accounting methods is a highly technical area. This chapter is designed to provide a brief overview and is not meant to be the exclusive research tool.

4.11.6.2  (05-13-2005)
Overview for Changes in Accounting Methods

  1. The term "method of accounting" is not specifically defined in the Code or regulations. In general, an accounting method is a set of rules used to determine when and how income and expenses are taken into account for federal income tax purposes.

  2. Taxable income must be computed under the method of accounting regularly used by the taxpayer in keeping its books. However, variations between financial and tax reporting are allowed where other IRC requirements, such as IRC sections 162 and 263, are met and the method of accounting clearly reflects income. If no method of accounting has been regularly employed or if the method employed does not clearly reflect income, the computation will be made under a method that, in the opinion of the Commissioner, clearly reflects income. A method of accounting will not be regarded as clearly reflecting income unless all items of income and expenses are treated with reasonable consistency. However, consistency alone is not the sole criteria for an accurate determination of income. Key concepts in determining what constitutes a method of accounting are (1) timing and (2) consistency.

  3. Timing: Treas. Reg. 1.446-1T(e)(2)(ii)(a) provides that a change in the method of accounting includes a change in the overall plan of accounting, as well as a change in the treatment of any material item. A material item is any item which involves the proper time for inclusion of the item in income or the taking of a deduction. In determining whether a practice involves the proper time for inclusion of an item in income or taking of a deduction, the relevant question is generally whether the practice permanently changes the amount of taxable income over a taxpayer's lifetime. If the practice does not permanently change taxable income over a taxpayer's lifetime, but does or could change the taxable year in which taxable income is reported, it involves timing and is therefore a method of accounting. See Rev. Proc. 91-31. Generally, if the issue involves when an item is deductible or included in income, as opposed to whether, the issue involves timing, and may be a method of accounting.

  4. Consistency: Treas. Reg. 1.446-1T(e)(2)(ii)(a) further provides that although a method of accounting may exist without a pattern of consistent treatment of an item, a method of accounting is not established in most instances without consistent treatment. The treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed tax returns (without regard to any change in status of the method as permissible or impermissible) represents consistent treatment of that item for purposes of Treas. Reg. 1.446-1T(e)(2)(ii)(a). If a taxpayer treats an item properly in the first return that reflects the item, however, it is not necessary for the taxpayer to treat the item consistently in two or more consecutive tax returns to have adopted a method of accounting. If a taxpayer has adopted a method of accounting under these rules, the taxpayer may not change the method by amending its prior income tax return(s). See Rev. Rul. 90-38.

  5. A change in the characterization of an item may constitute a change in method of accounting if the change has the effect of shifting income from one period to another. For example, a change from treating an item as income to treating the item as a deposit is a change in method of accounting. See Rev. Proc. 91-31.

  6. A change in method of accounting does not include correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion, or investment credit). Likewise, a change in method of accounting does not include a change in treatment resulting from a change in underlying facts. See Treas. Reg. 1.446-1T(e)(2)(ii)(b).

  7. The following is a non-exclusive list of accounting method issue areas commonly encountered by examiners:

    • Capitalization issues - IRC sections 263(a) and 263A relative to inventory, tangible assets and intangible assets,

    • Accounting for liabilities that involve timing - IRC section 461(h),

    • Accounting for when income is recognized - IRC section 451,

    • Depreciation method change issues involving changes in recovery periods, conventions, or depreciation methods. (See Chief Counsel Notice 2004–007 and field guidance for depreciation changes posted on the LMSB Change in Accounting Method Site.)

    • Inventory valuation issues including LIFO inventory - IRC sections 471 and IRC section 472,

    • Accrual to Cash - Rev. Proc. 2002-28 and

    • Accounting for long-term contracts - IRC section 460

4.11.6.3  (05-13-2005)
Adoption of a Method of Accounting

  1. A taxpayer filing its first return may adopt any permissible method of accounting. See Treas. Reg. 1.446-1(e)(1). Once the taxpayer adopts a proper method of accounting by filing its return using such method, it may not adopt a different method of accounting by the filing of an amended return.

  2. However, a taxpayer filing its first return using an improper method of accounting may change to a proper method by the filing of an amended return. The amended return MUST be filed prior to the filing of the next year's return. See Rev. Rul. 72-491, 1972-2 C.B. 104.

  3. Two returns filed for consecutive years using an improper method, establishes a method of accounting from which consent to change is required. Amended returns may not be used to change such method. See Rev. Proc. 90-38.

4.11.6.4  (05-13-2005)
Requirement To Secure Consent To Make A Method Change

  1. IRC section 446(e) and Treas. Reg. 1.446-1(e) state that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing from an "adopted" or "established " method of accounting for federal income tax purposes. Treas. Reg. 1.446-1(e)(3)(i) requires that, in order to obtain the Commissioner's consent to make a method change, a taxpayer must file a Form 3115, Application for Change in Accounting Method, during the taxable year in which the taxpayer desires to make the proposed change. See also Rev. Proc. 97-27, section 5.01 and Rev. Proc. 2002-9, section 6.02.

  2. Unless specifically authorized by the Commissioner, a taxpayer may not make a retroactive change in method of accounting, regardless of whether the change is from a permissible or an impermissible method. See Rev. Rul. 90-38.

4.11.6.5  (05-13-2005)
IRC Section 481 and "Cut-off" Method

  1. Whenever a change in method of accounting is either imposed on or initiated by a taxpayer, there is a possibility for duplication or omission of income or deductions relating to transactions occurring in a year prior to the year of change.

4.11.6.5.1  (05-13-2005)
IRC Section 481(a) Concept

  1. A change in method of accounting generally requires an adjustment under IRC section 481(a). IRC section 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding taxable year. When there is a change in method of accounting to which IRC section 481(a) is applied, income for the taxable year preceding the year of change must be determined under the method of accounting that was then employed, and income for the year of change and the following taxable years must be determined under the new method of accounting as if the new method had always been used.

4.11.6.5.2  (05-13-2005)
IRC Section 481(a) Adjustments

  1. The IRC section 481(a) adjustment is computed as of the beginning of the taxable year for which the method is being changed (year of change). Simply stated, the adjustment represents the cumulative difference (without regard to the statute of limitations) between the present and proposed methods. The IRC section 481(a) adjustment may increase income (positive adjustment) or decrease income (negative adjustment). In addition to the following example, see Exhibit (1) for a more detailed example of computing an adjustment under IRC section 481(a).

    Example:

    A taxpayer that is not required to use inventories uses the overall cash receipts and disbursements method and changes to an overall accrual method. The taxpayer has $120,000 of income earned but not yet received (accounts receivable) and $100,000 of expenses incurred but not yet paid (accounts payable) as of the end of the taxable year preceding the year of change. A positive IRC section 481(a) adjustment of $20,000 ($120,000 accounts receivable less $100,000 accounts payable) is required as a result of the change.

4.11.6.5.3  (05-13-2005)
Spread Periods for IRC Section 481(a) Adjustments

  1. A net positive IRC section 481(a) adjustment increases income and may be referred to as a "taxpayer-unfavorable" adjustment. A net negative IRC section 481(a) adjustment decreases income and may be referred to as a "taxpayer-favorable" adjustment. When a taxpayer uses a voluntary method change procedure (e.g., Rev. Proc. 97-27) or a regulation provision, generally a net negative IRC section 481(a) adjustment is taken into account in the year of change (pursuant to Rev. Proc. 2002-19 effective for years ending on or after December 31, 2001). A net positive IRC section 481(a) adjustment is taken into account over four years starting with the year of change. When the Service imposes a method change (involuntary method change) as a result of an examination, in general the entire net positive or negative IRC section 481(a) adjustment is taken into account in the year of change. See Rev. Proc. 2002-18 for involuntary method change procedures.

4.11.6.5.4  (05-13-2005)
Mandatory IRC Section 481(b) Tax Limitation Computation

  1. When the Service imposes a method change (involuntary method change) as a result of an examination and there is a net positive IRC section 481(a) adjustment in excess of $3,000, it is mandatory that IRC section 481(b) be applied. IRC section 481(b) provides a limitation on the tax under Chapter 1 of the Internal Revenue Code for the taxable year of change that is attributable to the adjustments required under IRC section 481(a) and Treas. Reg. section 1.481-1 if the entire amount of the adjustment is taken into account in the year of change. See Exhibit (2) for an example of tax computation under IRC section 481(b).

4.11.6.5.5  (05-13-2005)
Method Change Using the "Cut-off" Method

  1. The Commissioner may determine that certain changes in method of accounting will be made without an IRC section 481(a) adjustment using a " cut-off" method. Under a cut-off method, only the items arising on or after the beginning of the year of change (or other operative date) are accounted for under the new method of accounting. Any items arising before the year of change (or other operative date) continue to be accounted for under the taxpayer's former method of accounting. See, for example, IRC section 263A (which generally applies to costs incurred after December 31, 1986, for non-inventory property), IRC section 461(h) (which generally applies to amounts incurred on or after July 18, 1984), and IRC section 1.446-3 (which applies to notional principal contracts entered into on or after December 13, 1993). Because no items are duplicated or omitted from income when a cut-off method is used to effect a change in accounting method, no IRC section 481(a) adjustment is necessary. The cut-off may be used in a taxpayer-initiated method change only where specifically allowed or required by statute, regulation or by the Commissioner in published guidance.

4.11.6.6  (05-13-2005)
Procedures for Obtaining Consent

  1. A taxpayer may use the following procedures to obtain the required consent to change its method of accounting:

    1. Special procedures established by statutes, regulations or IRS publications

    2. Automatic consent procedures (Rev. Proc. 2002-9 and successors)

    3. Advance consent procedures (Rev. Proc. 97-27 and successors)

  2. Exhibit (3) summarizes the differences between the advance consent procedure and the automatic consent procedure.

  3. Exhibit (4) summarizes the citation for key terms and concepts used in the voluntary method change arena.

4.11.6.6.1  (05-13-2005)
Special Procedures Established by Statute, Regulations or IRS Publications

  1. Normally, a taxpayer uses the general automatic consent procedures (Rev. Proc. 2002-9 and successors) or the general advance consent procedures (Rev. Proc. 97-27 and successors) to request consent to change its method of accounting. In some instances, however, a statute, regulation or IRS publication may establish unique procedures, terms and conditions for obtaining consent to change a method of accounting. For example see IRC sections 174, 263A, 448, and 460 and the related treasury regulations. Thus, it is important that the examiner determine the authority being used to support the change in method of accounting.

4.11.6.6.2  (05-13-2005)
Voluntary Change - Advance Consent (Rev. Proc. 97-27 and Successors)

  1. Rev. Proc. 97-27 contains procedures for obtaining advance consent to change a method of accounting. In general, these procedures apply to all accounting method changes initiated by a taxpayer, except those accounting method changes that must be made under the automatic consent procedures (Rev. Proc. 2002-9 or successors) or special procedures established by statutes, regulations or IRS publications.

  2. The "advance consent" Revenue Procedure 97-27:

    1. Is effective for Forms 3115 filed on or after May 15, 1997.

    2. Requires payment of user fee.

    3. Requires Form 3115 to be filed with the Commissioner during year of change. For example, a calendar year taxpayer must file the Form 3115 from January 1st through December 31st of the year of change.

    4. Provides that taxpayer receive accounting method change ruling letter (consent) prior to implementing a method change.

    5. For years ending on or after December 31, 2001, the IRC section 481(a) adjustment period is four taxable years for a net positive adjustment for an accounting method change, and one taxable year for a net negative adjustment for an accounting method change. See Rev. Proc. 2002-19.

4.11.6.6.3  (05-13-2005)
Voluntary Change - Automatic Consent (Rev. Proc. 2002-9 and Successors)

  1. Rev. Proc. 2002-9 contains general procedures for obtaining automatic consent to change certain methods of accounting which are described in the Appendix of Rev. Proc. 2002-9 or subsequent pronouncements. These procedures are the exclusive procedures for obtaining consent to make any of these specific accounting method changes.

  2. The "automatic consent" Revenue Procedure 2002-9:

    1. Is effective for taxable years ending on or after December 31, 2001.

    2. Requires no user fee,

    3. Requires timely duplicate filing of the Form 3115,

      (i) The original Form 3115 must be attached to the timely filed (including extensions) return for the year of change. A copy of Form 3115 must be filed with Office of Chief Counsel no earlier than the first day of year of change, and no later than the date the original Form 3115 is filed with the timely filed federal Income Tax return. For example, a calendar year taxpayer who files its year X1 return (with proper extensions) on September 1, X2 may file a copy of the Form 3115 with the Office of Chief Counsel during the year of change, or no later than September 1, X2 to obtain consent to the change for the year X1.
      (ii) Under certain circumstances, an automatic six-month extension to file Form 3115 is granted from the due date of the return (excluding extensions) - [See Rev. Proc. 2002-9 section 6.02(2)(b)(i)].

    4. Provides that, if the taxpayer fully complies with the provisions of the revenue procedure, the taxpayer is "deemed" to have been granted consent for the requested method change and, if applicable, receives audit protection for years prior to year of change. See Rev. Proc. 2002-9 section 7,

    5. For taxable years ending on or after December 31, 2001, the IRC section 481(a) adjustment period is four taxable years for a net positive adjustment for an accounting method change, and one taxable year for a net negative adjustment for an accounting method change. See Rev. Proc. 2002-19,

  3. In determining whether an automatic method change was properly made, the examiner should first consider the automatic change revenue procedure in effect for the year the taxpayer made the change to verify the specific method change is included in the Appendix of the procedure. If not, the examiner should then check to see if the change was addressed in any subsequent pronouncement that modified the automatic consent procedure. Finally, the examiner should verify the taxpayer properly followed the terms and conditions for that specific change in the applicable procedures.

4.11.6.6.4  (05-13-2005)
Audit Protection Resulting from a Voluntary Method Change

  1. Most accounting method changes are granted with audit protection, which means that the Service will not require the taxpayer to change its method of accounting for the same item for a taxable year prior to the year of change. For example, a taxpayer has been using an impermissible method of accounting for several years for certain items. In 2003, the taxpayer files an application under Rev. Proc. 2002-9 to change to a proper method of accounting for such items. If the change is made with audit protection, the Service would not be able to propose an adjustment for the improper method of accounting for such items in an examination of an earlier taxable year. Rev. Proc. 97-27 section 9; Rev. Proc. 2002-9 section 7.

  2. The Service has provided specific exceptions to audit protection in some pronouncements. See, for example, the automatic consent procedures (Rev. Proc. 2002-9) which indicate that audit protection is not granted for specified method changes. Examiners should determine what method change was made and determine if audit protection was granted for that specific method change.

4.11.6.6.5  (05-13-2005)
Scope Limitations for Voluntary Method Changes

  1. In general - The scope limitations are the rules within a voluntary method change procedure that indicate when (in what circumstances) the taxpayer may or may not use such guidance to request a voluntary method change. For example, a scope limitation generally prohibits taxpayers from requesting consent for a method change once they have been contacted for examination. This scope limitation is subject to several exceptions, as discussed in (3), below.

  2. Waiver of scope limitations - In some instances, the scope limitations that would otherwise apply to a voluntary method change request may be waived by statute, regulation, or IRS publication. A scope limitation waiver may be limited to certain circumstances or to certain taxable years. For example, some procedures may indicate that scope limitations are waived unless the accounting method to be changed is an "issue under consideration," while other procedures may indicate that scope limitations are waived only for a certain taxable year or years. Accordingly, examiners need to review carefully the applicable guidance to determine the nature and extent of scope limitations applicable to a given voluntary method change request. See, for example, Treas. Reg. section 1.263(a)-4(p)(2); section 1.263(a)-5(n)(2); and Rev. Proc. 2004-23 section 4.01(1).

  3. Taxpayers under examination - The general rule (scope limitation) is that a taxpayer may not request a voluntary method change while under examination for any year. However, this general rule has the following exceptions:

    1. 90-day window - The taxpayer may file a Form 3115 within the first 90 days of a taxable year if (1) the taxpayer has been under examination for at least 12 consecutive months as of the first day of the taxable year, and (2) the method which the taxpayer seeks to change is not an issue under consideration or an issue that has been placed in suspense. This window allows taxpayers under continuous examination an opportunity to use the voluntary change procedures.

    2. 120-day window - The taxpayer may file a Form 3115 within the 120-day period following the date an examination ends, provided the change requested is not an issue under consideration or an issue that has been placed in suspense at the time the form is filed.

    3. Consent of director - If the taxpayer is under examination and is not in one of the two windows described above, they may request the examiner's permission (director consent) to submit a Form 3115. The team/group manager, as delegated by the director, will normally consent to the filing of the application unless the method of accounting to be changed would ordinarily be included as an item of adjustment in the year(s) for which the taxpayer is under examination. For example, a taxpayer changing from a proper method of accounting (to go to another proper method) would normally receive director consent because its proper method of accounting would not be an item of adjustment.

    4. Changes lacking audit protection - If a method change is (i) eligible for the automatic consent procedures (listed in the appendix of Rev. Proc. 2002-9 or elsewhere), and (ii) the description of the change indicates that the change is made without audit protection (for example, Rev. Proc. 2002-9, appendix section 4B.01), then the taxpayer may make the change, even if it is under examination. This allows the taxpayer to get on a proper method on a going-forward basis, but does not preclude the agent from pursuing the method as an audit issue in the back years, because no audit protection is given.

    5. Issue pending - A taxpayer under examination may make a voluntary change on a prospective basis without the benefit of audit protection for prior years if, at the time the Form 3115 is filed, the accounting method is an "issue pending" for any taxable year under examination. For this purpose, an issue is pending for any taxable year under examination if the Service has given the taxpayer written notification indicating an adjustment is being made or will be proposed with respect to the taxpayer's method of accounting. The issue pending exception was added by Rev. Proc. 2002-19.

4.11.6.6.6  (05-13-2005)
"Issue Under Consideration"

  1. "Issue under consideration" is a relevant concept when a taxpayer desires to make a voluntary method change and use the 90-day or 120-day windows found in the scope limitations of Rev. Proc. 97-27 or Rev. Proc. 2002-9. A taxpayer's method of accounting for an item is an issue under consideration for the taxable years under examination if the taxpayer receives written notification (for example, by examination plan, information document request (IDR), or notification of proposed adjustments or income tax examination changes) from the examining agent(s) specifically citing the treatment of the item as an issue under consideration. See Rev. Proc. 97-27 or Rev. Proc. 2002-9 for examples of what is an issue under consideration.

4.11.6.6.7  (05-13-2005)
Director Consent to File Form 3115 While Under Examination

  1. Nature of "director consent." The "director consent" provision allows a taxpayer under examination to file a Form 3115 (by obtaining "director consent" for such filing) when the taxpayer would otherwise be prohibited from filing a Form 3115.

    1. Director consent is consent to the filing of a Form 3115; it does not constitute approval of the method change request itself.

    2. Director consent does not constitute the consent of the Commissioner under IRC section 446(e) to change a method of accounting.

  2. When should the "Consent" be granted? The "Consent" should be granted in the following circumstances:

    1. When a change is requested from an impermissible method of accounting where the impermissible method was adopted in a year subsequent to the year(s) under examination; or

    2. When the taxpayer wants to change from a permissible method of accounting; or,

    3. When the examiner does not intend to raise a method of accounting issue for years under examination for the accounting method change requested by the taxpayer.

  3. How is a request for director consent processed? An examiner faced with a request for director consent from a taxpayer should do the following:

    1. If a taxpayer under examination wants to obtain the "Consent " to file a Form 3115, the taxpayer should be asked to put the request in writing.

    2. A copy of the Form 3115 (if available) that is the subject of the taxpayer's request should be attached to the taxpayer's request.

    3. If not otherwise provided on the Form 3115 presented, the taxpayer should be requested to provide the following information with the request:
      (1) Description of the method of accounting the taxpayer is changing from.
      (2) Description of the method of accounting the taxpayer is changing to.
      (3) The tax years currently under examination.
      (4) The examiner's name and telephone number.
      (5) The year of change requested by the taxpayer.
      (6) The reason(s) for requesting the method change.
      (7) The entity for which the method change is being requested (e.g. Parent or specific subsidiary)
      (8) What authority is being used by the taxpayer for the requested method change (e.g. Rev. Proc. 97-27, Rev. Proc. 2002-9, regulation, etc.)
      (9) If Rev. Proc. 2002-9 is being used, the specific Appendix section that is the basis for the method change requested including the assigned method change number found in the instructions to the Form 3115.
      (10) If a pronouncement is the authority (such as a Rev. Proc., Rev. Rul, or regulation section, etc.) the specific cite to such pronouncement should be obtained. (e.g., Rev. Rul. 2002-46)

    4. The request should be processed as expeditiously as possible as this involves coordination between the taxpayer, Area office, or National Office Chief Counsel.

    5. The request should be routed through the examiner to the team manager or group manager with the Form 3115 and a completed Summary Worksheet (see Exhibit 5) with a recommendation of response ("objection" or "non-objection" ). Note that each area may establish its own procedure as to the physical flow of the request from the taxpayer.

    6. If there are questions about the request, call your Area's technical coordinator or the LMSB Change in Accounting Method (CAM) Technical Advisor.

  4. Who should sign the "letter" ? In response to a taxpayer's request for "consent of director" , the Service will provide a written letter of "objection" or "non-objection" to the filing of a Form 3115. Each Area may establish its own procedure as to who may sign the letter. The team/group manager has been delegated authority to sign the letter as follows:

    1. The SBSE Delegation Order 4.40 includes group manager level for signing the letters.

    2. The LMSB Delegation Order 029-193 includes the team manager level for signing the letters.

    3. See Exhibit (6) for a pro forma "non-objection" letter.

    4. See Exhibit (7) for a pro forma "objection" letter.

  5. What is the physical flow of the response letter to the taxpayer? Each Area may establish its own procedure as to the physical flow of the letter to the taxpayer. The following is a recommended procedure:

    1. Once the response letter is signed, it should be routed to the examiner from the team manager/group manager.

    2. Then the signed response letter is given or sent to the taxpayer by the examiner.

  6. What should the examiner do about closing the current years? The request for "consent of director" to file a Form 3115 in the current year should have no impact on the conduct of the examination of the selected filed returns.

    1. In "Non-objection" situations, the year of change is generally a year not yet filed. Accordingly, if there is a question or issue identified for the year of change, the historical file should be documented or an information report for such year of change should be prepared.

    2. If there is an "Objection" to the filing of a Form 3115, the current years would be closed when the necessary method change issues have been completed and reported in the Revenue Agent Report (RAR) pursuant to Rev. Proc. 2002-18.

  7. What happens if the examination function objects? If the examination function properly objects to a request, the change in method of accounting may not be made under either Rev. Proc. 97-27 or Rev. Proc. 2002-9.

    1. Taxpayer may request technical advice under Rev. Proc. 2004-2 (or any successor) to determine if the "objection" was proper.

    2. Generally, "objection" indicates the issue will be raised as part of the examination. Accordingly, the method change is made by the examiner in the RAR. A change resulting in a IRC section 481(a) adjustment will ordinarily be made in the earliest taxable year under examination with a one year IRC section 481(a) adjustment period. See Rev. Proc. 2002-18 section 5.

  8. What if there are concerns with the requested change? After review of the Form 3115, the examiner may have questions or concerns with the request, such as:

    1. The examiner believes the taxpayer is using the wrong pronouncement (e.g. Rev. Proc. 2002-9 instead of Rev. Proc. 97-27 or vice versa) to request such method change.

    2. The examiner is aware that the National Office Chief Counsel is not processing, or is rejecting, such accounting method change requests; or

    3. The examiner believes the taxpayer is changing to an improper accounting method.


    The examiner should advise the taxpayer of the concern and document the fact that the taxpayer was advised of the concern. If a non-objection letter is otherwise appropriate, issue the non-objection letter.

    1. The examiner should document the historical file, or file an information report, so the concerns are considered in examination of the year of change.

    2. If the request was made pursuant to an "advance consent " procedure, the examiner may contact the Chief Counsel attorney assigned to the request to discuss the concerns.

    3. The examiner may include in the non-objection letter the concerns that have been identified.

  9. Circumstances which may occur relative to a request for "Consent" :

    1. National Office Chief Counsel personnel may call the taxpayer or examiner to confirm information or verify that the taxpayer has secured a non-objection letter. Effective coordination between the examiner, taxpayer and the National Office person is necessary to ensure that the appropriate letter, if applicable, is processed timely.

    2. Generally, the taxpayer is required to obtain the consent of the director prior to filing the Form 3115. However, the taxpayer may be in a hurry to process the Form 3115 to meet the timely filing requirement. Thus, the taxpayer may want to file their Form 3115 before receiving the "non-objection " letter from the examiner. If the situation is not egregious, advise the taxpayer to file its Form 3115 without the letter and indicate on such Form 3115 that the "non-objection" letter is in the process of being obtained.

    3. For Forms 3115 filed using Rev. Proc. 97-27, the examiner may call National Office Chief Counsel at (202) 622-4780 to obtain the name and number of the technician assigned; the status of Form 3115; or to discuss any concern(s) relative to the Form 3115 filed.

    4. For Forms 3115 filed under Rev. Proc 2002-9 the examiner may call National Office Chief Counsel at (202) 622-4780 to verify that the Form 3115 has been filed.

    5. If an examiner has any questions, he or she may call the LMSB Technical Advisor for Change in Accounting Methods.

4.11.6.6.8  (05-13-2005)
Compliance Responsibilities Regarding Voluntary Changes

  1. Responsibilities for Pre-filing - An examiner has the following responsibilities with respect to a request from a taxpayer under examination that desires to file a Form 3115 to make a voluntary change in accounting method in a year not yet filed.
    (a) Ascertain:

    • Whether the 90-day window or 120-day window applies

    • Whether the issue is under consideration

    • Whether the issue is pending (if yes, audit protection does not apply)

    • Whether director consent should be issued - see IRM section 4.11.6.6.7

    • Whether specific guidance applies to the requested change (e.g., Rev. Rul. 2002-46, Rev. Proc. 2004-34, etc.) and whether the taxpayer has used the proper procedure


    (b) The Examiner may coordinate with Chief Counsel regarding:

    • Whether the 90-day window or 120-day window applies

    • Whether there is an issue under consideration

    • Whether there is an issue pending

    • Whether the director will consent (e.g., incidences where the Form 3115 is filed simultaneously with headquarters and the examiner)

  2. Responsibilities for Post-filing - An examiner should consider the following as potential areas of inquiry when examining a tax return in which a taxpayer has implemented a change in accounting method under a voluntary method change procedure.
    (a) Rev. Proc. 97-27 filing:

    • Was the ruling letter granting consent to the change followed?

    • Did the taxpayer change to a proper method of accounting?

    • Is the IRC section 481(a) amount correct?
      > May correct without a Technical Advice Memorandum (TAM)

    • A TAM is necessary if it is determined by the examiner that the ruling letter should be revoked or modified.


    (b) Rev. Proc. 2002-9 filing:

    • Was the change within the scope of the Rev. Proc.?

    • Did the taxpayer fully comply with the procedure?

    • Does this change lack audit protection?

    • Did the taxpayer change to a proper method as specified in the Appendix?

    • Is the IRC section 481(a) amount correctly computed?
      > May purify the method change as an examination adjustment when deemed appropriate.
      > If the method change is invalid, may raise an unauthorized method change issue.

    • TAM is necessary if a method change was made in compliance, but the examiner believes the method change should be revoked or modified.

4.11.6.7  (05-13-2005)
Procedures for Implementing Involuntary (Service-imposed) Change

  1. Rev. Proc. 2002-18 provides the general procedures for changes in method of accounting imposed by the Service. This revenue procedure provides terms and conditions, for a Service-imposed change in method of accounting, that are intended to encourage taxpayers to voluntarily request a change from an impermissible method of accounting prior to being contacted for examination. Under this approach, a taxpayer that is contacted for examination and required to change its method of accounting by the Service ("involuntary change" ) generally receives less favorable terms and conditions when the change results in a positive 481(a) adjustment than the taxpayer would have received if it had filed an application to change its method of accounting ("voluntary change" ) before the taxpayer was contacted for examination. For example, an involuntary change generally is made with an earlier year of change and a shorter 481(a) adjustment period for a positive adjustment, and a voluntary change generally is made with a current year of change and a longer 481(a) adjustment period for a positive adjustment.

4.11.6.7.1  (05-13-2005)
Effect of Rev. Proc. 2002-18 on Authority of Examination, Appeals and Counsel

  1. Revenue procedure 2002-18 sets forth procedures for Examination, Appeals, and Counsel for the government to resolve accounting method issues. It does not alter Examination's authority to examine the returns of a taxpayer. It provides parameters for Examination to resolve accounting method issues, but does not limit or expand Examination's authority to resolve any issues under any applicable Delegation Order (e.g., Delegation Order No. 236, Application of Appeals Settlement to Coordinated Examination Program Taxpayers, and Delegation Order No. 247, Authority of Examination Case Managers to Accept Settlement Offers and Execute Closing Agreements on Industry Specialization Program and International Field Assistance Program Issues). This revenue procedure also does not alter or limit the authority of Appeals or Counsel for the government to resolve or settle any issues.

4.11.6.7.2  (05-13-2005)
Circumstances When a Service-imposed Method Change May Be Encountered

  1. Examiners will be faced with potential accounting method change issues in three situations:

    1. The examiner determines that the accounting method used by the taxpayer does not clearly reflect income or is improper - IRC section 446(b) issue.

    2. The taxpayer has changed their method of accounting without obtaining the consent of the Commissioner - IRC section 446(e) issue.

    3. The taxpayer has filed an amended return or claim (formal or informal) which constitutes a "retroactive" change in accounting method. - IRC section 446(e) issue. See Rev. Rul. 90-38.

4.11.6.7.3  (05-13-2005)
IRC Section 446(b) - Accounting Method Used Does Not Clearly Reflect Income

  1. Sections 446(b) and 1.446-1(b)(1) provide that if a taxpayer does not regularly employ a method of accounting that clearly reflects income, the computation of taxable income must be made in the manner that, in the opinion of the Commissioner, does clearly reflect income. The Commissioner has broad discretion in determining whether a taxpayer's method of accounting clearly reflects income, and the Commissioner's determination must be upheld unless it is clearly unlawful. Once the Commissioner has determined that a taxpayer's method of accounting does not clearly reflect income, the Commissioner has broad discretion in selecting a method of accounting which properly reflects income. The selection may be challenged only upon showing an abuse of discretion by the Commissioner. The Commissioner does not have discretion to require a taxpayer to change from a method of accounting that clearly reflects income to a method that, in the Commissioner's view, more clearly reflects income.

  2. Accordingly, the first determination that the examiner must make is whether or not the accounting method being used (adopted) for an item by the taxpayer is permissible. The examiner must first make a concerted effort to understand what accounting method is being used by the taxpayer for the item(s) in question. This determination may entail having the taxpayer walk the examiner through transactions, journal entries, or other books and records. Generally, examples of journal entries shown by the taxpayer based upon hypothetical data should be verified with actual transactional data including actual journal entries that are contained in the books and records. After the examiner acquires an understanding of the taxpayer's transactions and accounting method for items, the examiner needs to ascertain what accounting treatment(s) is (are) permissible based upon Service position.

  3. Generally, there are established Service positions as to what are proper methods of accounting for items. However, if the examiner is unable to ascertain Service position or if there is no official Service position and the examiner believes there is an accounting method issue, the examiner may consider seeking advice (formal or informal) from local field counsel, the Office of Chief Counsel, or LMSB Technical Advisors.

  4. If the accounting method used for item(s) by the taxpayer is impermissible, the examiner may propose an adjustment with respect to that method only by changing the taxpayer's method of accounting pursuant to Rev. Proc. 2002-18, in order to place the taxpayer on a proper method of accounting for such item(s).

4.11.6.7.4  (05-13-2005)
IRC Section 446(e) - Taxpayer Changed Method Without Obtaining Prior Consent

  1. IRC section 446(e) provides that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. The Commissioner may require a taxpayer that has changed a method of accounting without the Commissioner's consent to change back to its former method. The commissioner may do so even when the taxpayer changed from an impermissible to a permissible method. The change back to the former method may be made in the taxable year the taxpayer changed without consent, or if that year is closed by the running of the period of limitations, in the earliest open year. For example, the Service may change a taxpayer back to its former impermissible method of accounting if the taxpayer changed to a permissible method of accounting without the Commissioner's consent and miscalculated the IRC section 481(a) adjustment, even where the statute of limitations has expired for the year of change. See Rev. Proc. 2002–18, section 2.06.

  2. While the examiner may allow an unauthorized method change, such action should only be taken as an exception. The examiner, using professional judgement, should consider the following factors when applying the exception:

    1. Benefit to taxpayer/Cost to government- The examiner should quantify the time-value-of-money benefit the taxpayer will receive by allowing the taxpayer's non-compliance with the consent requirements. Specifically, the examiner should determine the impact (including restricted interest computations) of not moving the year of change from the earliest year under examination to the current year. The supposition that the method change the taxpayer made without consent may have been granted if the taxpayer had complied with the consent requirements should not be a consideration.

    2. Jurisdiction of oversight - The examiner should determine the proper procedure the taxpayer should have followed to implement the change, and what the taxpayer circumvented by making the unauthorized change. For example, if the taxpayer should have followed Rev. Proc. 97-27, the taxpayer would have paid a fee (e.g., $1,200) and received a ruling letter with terms and conditions specified by Chief Counsel. . In addition, the taxpayer did not put the Service on notice that the change has been made, nor make representations regarding that change, by filing a Form 3115.

    3. Utilization of resources- The examiner should analyze the impact on the examination for expending the time and resources required for the necessary compliance oversight of the unauthorized method change as opposed to other potential areas of examination.

    4. Fairness to all - The examiner should consider the disparity that results if the taxpayer's unauthorized change in method of accounting is allowed while the similarly situated taxpayer not under examination must file a Form 3115 and make the change in a later year. Also, the examiner should consider any negative impact on compliance (by representatives and taxpayers) that may result from the examiner's action.

  3. The examiner should fully explain in the workpapers the rationale for proposing or not proposing the unauthorized method change issue. If a change in method of accounting issue is not proposed, the examiner should document that all items are treated in a manner that prevents the duplication or omission of items of income or deduction. The examiner should contact the CAM Technical Advisors for assistance in addressing these arguments if necessary.

4.11.6.7.5  (05-13-2005)
IRC Section 446(e) - Taxpayer Files Amended Return or Claim (formal or informal) to Make "Retroactive" Change in Accounting Method

  1. Error correction or retroactive accounting method change? Often, during the conduct of an examination, the examining agent will encounter a claim (formal or informal) requesting an adjustment. The examiner should carefully review such claim to determine whether the claim constitutes (i) the correction of an error in taxable year(s) under examination, or (ii) a request for a retroactive change in method of accounting for a year under examination.

  2. When should examination impose a retroactive accounting method change proposed by the taxpayer?

    1. Taxpayer's existing method of accounting is impermissible. If the claim constitutes a request for a retroactive change in method of accounting, the examiner should determine whether the taxpayer's existing method of accounting is permissible. If the taxpayer's existing method of accounting is permissible, the examiner should NOT impose the method change requested by the taxpayer in an RAR. Rather, the examiner should advise the taxpayer to request consent to make the method change on a prospective basis in the current year. Stated another way, the examiner should not impose retroactive changes from one permissible method to another; these "permissible to permissible" changes should be initiated by the taxpayer under the voluntary method change procedures (Rev. Proc. 97-27 and Rev. Proc. 2002-9).

    2. If the taxpayer's existing method of accounting is impermissible, the examiner should consider the following factors in determining whether to impose a retroactive method change requested by the taxpayer.
      (i) Is the change the product of Service initiated examination activity? In general, the Service should make a taxpayer-requested method change when the adjustment is fairly considered the product of Service-initiated examination activity. In making this determination, the examiner should consider all relevant facts and circumstances, including whether the examiner has submitted request(s) for extensive information for an item, and whether the taxpayer has substantially and appropriately complied with any such requests.

      Note:


      (1) Activities undertaken in response to a taxpayer claim (formal or informal) are not considered to be "Service-initiated examination activity."
      (2) Activities undertaken to review a taxpayer-initiated method change (authorized or unauthorized) for a year under examination are not considered to be "Service-initiated" examination activity.
      (3) As a general matter, the examining agent, in his/her discretion, determines the scope of an examination. Accordingly, the examining agent has wide discretion in choosing what sort of examination activities to initiate.


      (ii) Is an item substantially similar to an item for which the Service has initiated examination activity? To the extent the examiner or taxpayer identifies item(s) which are "substantially similar" to an item for which the Service has initiated examination activity, these item(s) should be included in any proposed method change.

      Note:


      (1) An item is "substantially similar" if it is governed by the same subsection of the Code and/or regulations AND relates to the same type of expenditure, income item or property for which the Service is imposing a change in method of accounting for the taxable period.
      (2) Imposing a method change for a " substantially similar" item generally does not require a substantial amount of additional audit resources because the item involves the same legal authority and accounting entries as other items for which the Service has already initiated examination activity under the audit plan. Accordingly, if imposing the method change requested by the taxpayer would divert substantial resources from the focus of the planned examination, the change probably does not involve a "substantially similar" item.

  3. Declining to impose a retroactive accounting method change requested by taxpayer. Generally, it is not appropriate for a taxpayer to obtain more advantageous terms and conditions by requesting a change in accounting method after being contacted for examination. In addition, routine consideration of taxpayer requests for retroactive method changes would consume substantial examination resources and thereby impede the Service's enforcement efforts. The Service's refusal to make taxpayer-requested retroactive method changes is consistent with equitable tax administration, since the taxpayer chooses the original method of accounting and may change from an impermissible method on a prospective basis by filing a Form 3115.

    If questions exist, the examiner should contact the CAM Technical Advisor. If the examiner deems it necessary to decline to initiate an accounting method change, the examiner should recommend that the taxpayer request consent to make a voluntary method change pursuant to the appropriate administrative procedure. In addition, the examiner should coordinate with the taxpayer and provide the " director consent," if necessary, to facilitate the taxpayer's request.

  4. Change in Service's position. Where the Service has changed its position with respect to a particular method of accounting (i.e., it recognizes the permissibility of a method which it previously viewed as impermissible), a taxpayer may request that the examiner allow a change to the previously controverted method in the years under examination via formal or informal claim. Whether to allow a retroactive change based on a change in position is a determination that is appropriately made at the National Office Chief Counsel level. In at least one "unique and extraordinary " circumstance, retroactive change has been allowed within a specified time period. See Rev. Proc. 91-31 (allowed retroactive change in reaction to the decision in Indianapolis Power & Light, 493 U.S. 203 (1990)). The determination as to whether and when such changes should be allowed should not be made by the examiner, as such a practice would result in disparate treatment (differing determinations and differing terms of change) among taxpayers under examination and disparate treatment between taxpayers under examination and those not under examination. Examiners may contact the CAM Technical Advisor and submit a request for technical advice if warranted.

  5. Correction of an error. Where an examiner determines that an error correction is necessary and it is not a method change issue, the examiner should make such error correction for the years under examination regardless if the adjustment is positive or negative.

4.11.6.7.6  (05-13-2005)
Terms of an Involuntary Change Imposed By the Examiner

  1. Using professional judgment in accordance with auditing standards, an examining agent will make findings of fact and apply Service position on issues of law to determine whether an issue is an accounting method issue and whether the taxpayer's method of accounting is permissible. The term "accounting method issue" means an issue regarding whether the taxpayer's accounting treatment of an item is proper, but only if changing the taxpayer's treatment of such item could constitute a change in method of accounting. See Treas. Reg. 1.446-1(e)(2) and Rev. Proc. 2002–18, sections 2.01 and 3.01.

  2. An examining agent who determines that a taxpayer's method of accounting is impermissible, or that a taxpayer changed its method of accounting without obtaining the consent of the Commissioner may propose an adjustment with respect to that method only by changing the taxpayer's method of accounting. Failure to recognize and properly treat an accounting method issue as a change in method of accounting can result in a permanent overstatement or understatement of a taxpayer's lifetime taxable income. See Rev. Proc. 2002-18, section 5.02

  3. An examining agent changing a taxpayer's method of accounting will select a new method of accounting by properly applying the law to the facts determined by the agent. The method selected must be a proper method of accounting and will not be a method contrived to reflect the hazards of litigation. See Rev. Proc. 2002-18, section 5.03

  4. An examining agent changing a taxpayer's method of accounting will make the change in a year under examination. Ordinarily, the change will be made in the earliest taxable year under examination, or, if later, the first taxable year the method is considered to be impermissible. However, in appropriate circumstances, an examining agent may defer the year of change to a later taxable year. See Rev. Proc. 2002-18 section 5.04(1).

  5. An examining agent changing a taxpayer's method of accounting ordinarily will impose a 481(a) adjustment, subject to a computation of tax under IRC section 481(b) (if applicable). See Exhibits (1, 2). However, an examining agent should use a cut-off method to make a change (other than a change within the LIFO inventory method as defined in Rev. Proc. 97-27 section 3.09, or a change in method of accounting for intercompany transactions (see Treas. Reg. 1.1502-13) when a statute, regulation or administrative pronouncement of the Service effective for the year of change directs that the change be made using a cut-off method. See, e.g., IRC section 174. In addition, an examining agent may use a cut-off method to make a change in appropriate circumstances. See Rev. Proc. 2002-18 section 5.04(2).

  6. The IRC section 481(a) adjustment, whether positive or negative, will be taken into account entirely in the year of change. See Rev. Proc. 2002–18, section 5.04(3).

4.11.6.7.7  (05-13-2005)
Finalization of a Service-imposed Method Change

  1. An examining agent changing a taxpayer's method of accounting will provide written notice that an accounting method issue is being treated as an accounting method change. Resolution of an accounting method issue without notice will not establish a new method of accounting. Written notice is a statement in the RAR that a method change is being proposed pursuant to IRC section 446 and 481. To implement a Service-imposed method change, it is recommended that the taxpayer and the Service execute a closing agreement in which the taxpayer agrees to the change and the terms and conditions of the change. If the taxpayer and the Service execute a closing agreement finalizing the change, the notice will be provided in the closing agreement. Rev. Proc. 2002-18 provides a model closing agreement. Such closing agreement is not mandatory.

  2. The written notice must include:

    1. A statement that the accounting method issue is being treated as an accounting method change or a clearly labeled IRC section 481(a) adjustment; and

    2. A description of the new method of accounting.

  3. If the taxpayer and the Service execute a closing agreement, the change is final as of the date of the agreement (unless otherwise provided by a federal court). In the absence of such an agreement, a Service-imposed accounting method change is final only upon the expiration of the period of limitations for filing a claim for refund under 6511 for the year of change or the date of a final court order requiring the change.

  4. The Service should make the adjustments necessary to effect a Service-imposed accounting method change to the taxpayer's returns for the taxable years under examination, before Appeals, or before a federal court. These adjustments include the adjustments to taxable income necessary to reflect the new method (including the IRC section 481(a) adjustment required as a result of the change), and any collateral adjustments to taxable income or tax liability resulting from the change.

  5. If the taxpayer does not use the new method on any return filed prior to the date a Service-imposed change becomes final, and does not file amended returns to reflect the change, the Service should make the adjustments necessary to reflect the change for the affected taxable years if and when it examines those returns.

Exhibit 4.11.6-1  (05-13-2005)
IRC Section 481(a) Adjustment Calculation

When a change in method of accounting occurs, the tax accounts of the taxpayer are restated on the first day of the year of change as if the taxpayer had always used the new method of accounting, and the new method of accounting is used to determine income from that day forward. The tax accounts at the close of the preceding tax year remain as determined under the old method, which is also used to determine taxable income for that year.
As a result of the mismatch between the old and new methods, some items may be treated in inconsistent ways under the old and new accounting methods, which could distort the lifetime income of the taxpayer. For example, a taxpayer switching from cash to accrual would establish an accounts payable on the first day of the year of change for its expenses incurred on credit. An omitted deduction would occur, because the expenses were not deductible under the cash method when incurred and will not be deductible under the accrual method when they are paid.
To address this problem IRC section 481 requires that the taxpayer take into account any adjustments required to offset duplications or omissions of income or expense that result from a change in method of accounting.
         
  Distortion Offsetting adjustment  
  Omitted deduction Negative IRC § 481 adjustment amount  
  Omitted income Positive IRC § 481 adjustment  
  Duplicated deduction Positive IRC § 481 adjustment  
  Duplicated income Negative IRC § 481 adjustment  
    Net IRC § 481 adjustment  
         
Philip L Firetag v. Commissioner , 86 AFTR Par. 2000-5503, (4th Cir. 2000)
Earthquake Sound Corp. v. Commissioner, T.C. Memo. 2000-112
Suzy's Zoo v. Commissioner , 114 T.C. No. 1 (2000)
Rankin v. Commissioner , 138 F.2d. 1286, 1288 (9th Cir. 1998)
National life Ins. Co. v. Commissioner, 103 F.3d 5, 7 (2d /cir. 1996)
Primo Pants Co. v. Commissioner , 78 T.C. 705, 723 (1982)
Graff Chevrolet Company v. Commissioner, 343 F.2d 568, 572 (5th Cir. 1965)
The following illustrates the computation of the IRC section 481(a) adjustment due to the change from accounting for and deducting workers compensation when incurred to accounting for and deducting such items in the year paid. This method change is necessary to change to a proper method of accounting pursuant to IRC section 461(h). The adjustment is the duplicated expense caused by the difference in balance sheet account amounts per return (old accounting method) and as corrected (new accounting method) on the first day of the year of change.
Example of the required calculation under § 481(a)
Assume that calendar year 2001 is the earliest year under exam. This would be the year of change
Account   1/1/2001 12/31/2001
Workers Compensation (accrued not paid) $1,000,000 $1,500,000
FACTS
T/P’s accounting practice since 1988 has been to deduct when accrued.
T/P paid $1,000,000 in 2001 – which was accrued and deducted in 2000.
T/P accrued and deducted $1,500,000 in 2001 – which will be paid in 2002.
LAW
The tax accounting rule is to deduct only when paid.
A "timing issue" is involved because the issue is when an item is deductible, not if an item is deductible.
A Change in Accounting Method is necessary to deduct when paid and not when accrued.
SOLUTION
A "Service Initiated" change in accounting method is made during exam.
The "NEW" accounting method begins as of 1/1/2001 – the earliest year under examination
All payments for worker’s compensation made after 1/1/2001 are deducted when paid.
Payments made after 1/1/2001 that were accrued and deducted prior to 1/1/2001 will result in a double deduction.
An adjustment is required pursuant to IRC § 481(a) to prevent the double deduction.
The § 481(a) adjustment is $1,000,000 – the balance sheet amount at the beginning of the year of change. The current year adjustment is $500,000 – the difference between the balances at the beginning and the end of the year. These amounts are separately and clearly identified in the RAR.

Exhibit 4.11.6-2  (05-13-2005)
IRC Section 481(b) Tax Limitation Computation

If such adjustments increase the taxpayer's taxable income for the year of the change by more than $ 3,000, then the tax for such year that is attributable to the adjustments shall not exceed the lesser of:
1. The tax attributable to taking such adjustments into account in computing taxable income for the taxable year of the change under IRC § 481(a) and Treas. Reg. 1.481-1, or
2. The aggregate of the increases in tax that would result if the adjustments were included ratably in the taxable year of the change and the two preceding taxable years.
  Note: While this IRC § 481(b) may limit the tax, it does not change the year in which the tax is due. This computation is mandatory for examiners changing a taxpayer’s method of accounting.
IRC § 481(b)(2) provides a second alternative limitation on the tax for the taxable year of change. If the taxpayer establishes from his books and records what its taxable income would have been under the new method of accounting for one or more consecutive taxable years immediately preceding the taxable year of the change, then the tax attributable to the IRC § 481(a) adjustments shall not exceed the smallest of the following amounts:
1. The tax attributable to taking the adjustments into account in computing taxable income for the taxable year of the change under IRC § 481(a) and Treas. Reg. 1.481-1;
2. The tax attributable to such adjustments computed under the 3-year allocation provided in IRC § 481(b)(1), if applicable; or
3. The net increase in the taxes that would result from allocating that portion of the adjustments to the one or more consecutive preceding taxable years under the new method of accounting and from allocating the balance thereof to the taxable year of the change.
Steps for computing the tax.
1. Compute the increase in tax for the year of the change that is attributable to the adjustments required under IRC § 481(a). Calculate this increase by taking the difference in tax that would be due in the year of change with the IRC § 481(a) adjustment and the tax computed for such year without the IRC § 481(a) adjustment.
2. Compute the tax attributable to the IRC § 481(a) adjustments for the taxable year of the change and the two preceding taxable years as if an amount equal to one-third of the net amount of such adjustments had been received or accrued in each of such taxable years. Calculate this increase by taking the excess of the tax for such year computed with the allocation of one-third of the net adjustments to such taxable year over the tax computed without the allocation of any part of the adjustments to such year.
3. If taxpayer satisfies the conditions set forth in IRC § 481(b)(2), compute the tax attributable to the IRC § 481(a) adjustments for the taxable year of the change and the consecutive taxable year or years immediately preceding the taxable year of the change for which the taxpayer can establish his taxable income under the new method of accounting. Calculate this increase by taking the excess of the tax for such year computed with the allocation of the net adjustments to such taxable year over the tax computed without the allocation of any part of the adjustments to such year.
For the purpose of computing the increase in taxes, net operating loss under IRC § 172 or capital loss carryback or carryover under IRC § 1212 should be considered. This would include the net increase or decrease in tax attributable to any taxable year preceding the year of change to which no adjustment is allocated under IRC § 481(b)(1) or (2), but which is affected by a net operating loss or by a capital loss carryback or carryover determined with reference to taxable years to which the adjustments under IRC § 481(b)(1) or (2) are allocated.
S Corporations and IRC § 481
In the case of a change in method of accounting by an S Corporation, the adjustments required by IRC § 481(a) shall be made on the S Corporation's return. However, the limitations on tax under IRC § 481(b) shall apply to the individual shareholders. IRC § 481(b) applies to a shareholder of an electing small business corporation whose taxable income is increased by more than $3,000 as a result of such adjustments to the corporation's ordinary income.
Partnership returns and IRC § 481
In the case of a change in method of accounting by a partnership, the adjustments required by IRC § 481(a) shall be made on the partnership return. However, the limitations on tax under IRC § 481(b) shall apply at the partner level. IRC § 481(b) applies to a partner whose income is increased by more than $3,000 as a result of a IRC § 481(a) adjustment to the partnership's ordinary income.

Exhibit 4.11.6-3  (05-13-2005)
Summary of Differences Between Voluntary Method Change Procedures

Rev. Proc. 97-27 Rev. Proc. 2002-9
"Advance consent" or "formal consent" "Automatic consent"
Applies to all changes other than changes subject to the automatic consent procedures. Applies only to certain changes designated for automatic consent. (These changes are consolidated in the APPENDIX of the most recent version of the automatic consent procedures (currently Rev. Proc. 2002-9) and include changes allowed pursuant to subsequent pronouncements. For new automatic changes that are not yet included in the APPENDIX, see the Change in Accounting Method TA website.)
A taxpayer using the automatic procedures for a change that is not eligible for automatic consent does not receive consent under IRC § 446(e). The taxpayer must amend its returns to go back to the old method and then seek consent under Rev. Proc. 97-27
Taxpayer gets a consent letter. Taxpayer does not get a consent letter.
National Office reviews change request before issuing the consent letter. No review is conducted before consent is granted. "Post-consent" review may be conducted by the National Office (if the Form 3115 is selected) or by examiners (if taxpayer is audited).
If "post-consent" review indicates that taxpayer has not complied with all the procedures, terms and conditions, the National Office or the examiner may require the taxpayer to make the appropriate modifications, or may revoke the method change consent.
Taxpayer must wait to receive its consent letter before filing. Taxpayer gets automatic consent and may file on the new method without waiting. (Consent is only valid, however, to the extent that the taxpayer complies with the terms and conditions of Rev. Proc. 2002-9.)
One Form 3115 filed with National Office. Two Forms 3115 required: a copy of Form 3115 is filed with National Office, and original is attached to a timely filed return for the year of change.
Taxpayer must file during the year of change Taxpayer has through the extended due date of the return for the year of change to complete its filing.
Taxpayer filing is acknowledged. Taxpayer gets no acknowledgement of filing.
User fee is charged No user fee is required

Exhibit 4.11.6-4  (05-13-2005)
Summary of Citations for Key Terms and Concepts

Summary of Citations for Key Terms and Concepts
Rev. Proc. 97-27 and Rev. Proc. 2002-9
(As modified and amplified by Rev. Proc. 2002-19)
Terms and Concepts Rev. Proc. 97-27 Ref: Section Rev. Proc. 2002-9 Ref: Section
Change in method of accounting defined 2.01 2.01
No retroactive method change 2.04 2.04
Method change IRC section 481(a) adjustment 2.05 2.05
Method change cut-off 2.06 2.06
Applicable provisions defined --- 3.02
Under Examination 3.07 3.08
Examination begins 3.07(1)(a) 3.08(1)(a)
Examination ends 3.07(1)(a)(i)-(iii) 3.08(1)(a)(i)-(iii)
Issue under consideration 3.08 3.09
Scope limitations * 4.02 * 4.02 *
IRC section 481(a) adjustment period * 5.02(3) * 5.04 *
90-day Window 6.01(2) 6.03(2)
120-day window 6.01(3) 6.03(3)
Consent of Director 6.01(4) 6.03(4)
Changes lacking audit protection --- 6.03(5)
Issue Pending * 6.01(5) * 6.03(6) *
Compliance with revenue procedure 8.03 9.02
Audit Protection 9 7
Review by the Director 11 9
         
*As modified and amplified by Rev. Proc. 2002–19 for years ending on or after 12/31/2001.
         

Exhibit 4.11.6-5  (05-13-2005)
Summary Worksheet for Method Change Requests Pursuant to " Consent of Director" Provisions of Rev. Proc. 97-27, Rev. Proc. 99-49 and Rev. Proc. 2002-9

Date: ______________
Taxpayer Name: ______________________________________________
Form: _______________          
Address: ___________________________________________________
EIN:_______________________        
Taxpayer Contact Person: ___________________________ TEL.# _______________________
               
Manager: ___________________ TEL.# _______________________
               
Examiner: __________________ TEL.# _______________________
Years under exam currently : _____________________________________
Year of change requested: ____________      
Applicable Revenue Procedure: _________________________________
For Rev. Proc. 2002-9 (only) Change #: ____________________________
Regulation or Code Section ___________ Rev. Rul. ________________
               
Taxpayer is requesting a change in accounting method from _____________
____________________________________ and is requesting a change to
___________________________________________________________
               
Is the method of accounting to be changed a change from an impermissible method that was adopted subsequent to the years under examination?
(If yes, a non-objection letter is appropriate.)    
Yes:_______ No:_______        
               
If yes, please explain: __________________________________________
___________________________________________________________
___________________________________________________________
               
Is the method of accounting to be changed a result of an unauthorized method change made in a year under exam? (If yes, an objection letter is appropriate.)
Yes:_______ No:_______        
               
If yes, please explain: __________________________________________
___________________________________________________________
___________________________________________________________
               
Is the method of accounting to be changed a type that would ordinarily be included as an adjustment issue for the years under examination? (If yes, an objection letter is appropriate.)
               
Yes:_______ No:_______        
               
If yes, please explain: __________________________________________
___________________________________________________________
___________________________________________________________
               
Do you otherwise object to the taxpayer using subsection 6.01(4) of Revenue Procedure 97-27 (or Section 6.03(4) of Rev. Proc. 2002-9) to request a method change for the year indicated above?
               
Yes:_______ No:_______        
               
If yes, please explain: __________________________________________
___________________________________________________________
___________________________________________________________
               
Is this request being made pursuant to Section 6.03(5) of Rev. Proc. 2002-9 or Section 6.03(6) of Rev. Proc. 2002-9 as modified by Rev. Proc. 2002-19 or Section 6.01(5) of Rev. Proc. 97-27 as modified by Rev. Proc. 2002-19?
               
Yes:_______ No:_______        
               
If yes, then the"Director's consent" provision is not applicable. Please indicate which provision is being used by the taxpayer. ___________________________________________________________

Exhibit 4.11.6-6  (05-13-2005)
"Non-Objection" Letter

Example of "Non-Objection" Letter
Taxpayer Name: ______________________________________________ (If only for a specific subsidiary, note the name of such subsidiary)
                 
Address: ___________________________________________________
EIN: __________________          
Date: _________________          
                 
Dear Taxpayer:          
                 
This letter grants consent to the filing of an application for consent to a change in accounting method as described below pursuant to [insert Rev. Proc. 97-27 section 6.01(4) or Rev. Proc. 2002-9 section 6.03(4) of ], subject to the terms and conditions contained therein. This letter does not grant or constitute consent to a change in accounting method, and cannot be relied upon to establish implicit or explicit consent to a change in accounting method.
                 
Currently, the taxable years ended _________ through ______________ for your Form(s) __________ are under examination.
                 
The year of change requested by you is the year-ended ________________
                 
You are requesting to change from ________________________________ ____________________________________ to ____________________ ___________________________________________________________
                 
This letter is not a determination as to whether or not the method change(s) requested is (are) within the scope of (insert Rev. Proc. 97-27 or Rev. Proc. 2002-9).
                 
If you have any questions concerning this matter, please call _____________ at ________________
                 
Sincerely,            
                 
                 
Title                
                 

Exhibit 4.11.6-7  (05-13-2005)
"Objection" Letter

Example of "Objection" Letter
Taxpayer Name: ______________________________________________ (If only for a specific subsidiary, note the name of such subsidiary)
                 
Address: ___________________________________________________
EIN: __________________          
Date: _________________          
                 
Dear Taxpayer:          
                 
This is in response to your request for a change in accounting method pursuant to [Rev. Proc. 97-27 section 6.01(4), or Rev. Proc. 2002-9 section 6.03(4). Currently, the taxable years ended ___________________ through ________________ for your Form(s) ______________________________ are under examination.
                 
The year of change requested by you is the year ended ________________
                 
You are requesting to change from ________________________________
_______________________________ to _________________________
___________________________________________________________
                 
We do object to your filing of this request for a change in accounting method. [We object because the method of accounting to be changed is an item of adjustment for the years currently under examination] or [We object because this request is not a "Director's Consent " Request]
                 
If you have any questions concerning this matter, please call _____________ at _______________
                 
Sincerely,            
                 
                 
Title                

More Internal Revenue Manual