Part IV—Section 481(a) Adjustment

Line 25. Ordinarily, an adjustment under section 481(a) is required for accounting method changes. The section 481(a) adjustment period is generally 1 tax year (year of change) for a negative section 481(a) adjustment and 4 tax years (year of

change and next 3 tax years) for a positive section 481(a) adjustment. However, when an applicant is under examination, the section 481(a) adjustment period is 2 tax years (year of change and next tax year) for a positive section 481(a) adjustment for a requested accounting method change unless one of the following categories described on line 7b applies: 3-month window, 120-day window period, method not before the director, or CAP.

For some accounting method changes, there may be special rules relating to the section 481(a) adjustment period. See, for example, section 16.10(4)(b)(iv)(D) of Rev. Proc. 2022-14 pertaining to certain section 451 cost offset accounting method changes resulting from concurrent cost-offset related inventory method changes.

Also, for certain accounting method changes, the applicant must make the change on a cut-off basis or modified cut-off basis. See, for example, Regulations section 1.446-1(e)(2)(ii) (d) (5)(iii) . In those cases, there is no section 481(a) adjustment. Under a cut-off basis, only the items arising on or after the beginning of the year of change are accounted for under the new method of accounting. Any items arising before the year of change continue to be accounted for under the applicant's former accounting method.

For a change in accounting method for accruing a foreign income tax expense, do not compute a section 481(a) adjustment. Instead, apply the modified cut-off rules in Regulations section 1.905-1(d)(5). Attach a statement showing, for each separate statutory or residual grouping, the upward and downward adjustment (accounted for in the currency in which the foreign tax liability is denominated) that is required by Regulations section 1.905-1(d)(5)(ii). Provide a separate upward and downward adjustment for foreign income taxes for which the foreign tax credit is disallowed and to which section 275(a)(4) does not apply. See Regulations section 1.905-1(d)(5) and the examples in Regulations section 1.905-1(d)(6) for additional information.

If multiple items are being changed on one Form 3115 and at least one item is changed on a cut-off basis or modified cut-off basis and another item is changed with a section 481(a) adjustment, check both “Yes” and “No” and attach a statement identifying which item(s) is being made on a cut-off basis or modified cut-off basis.

An eligible terminated S corporation (as defined in section 481(d)(2)) that is required to change an accounting method as a result of a revocation of its S corporation election must take into account the resulting positive or negative section 481(a) adjustment ratably during the 6-year period beginning with the year of change. In addition, an eligible terminated S corporation that is permitted to continue to use the cash method after the revocation of its S corporation election and that changes to an overall accrual method for the C corporation’s first tax year after such revocation may take into account the resulting positive or negative adjustment required by section 481(a)(2) ratably during the 6-year period beginning with the year of change. See Rev. Proc. 2018-44, 2018-37 I.R.B. 426. Section 481(d)(2) defines an eligible terminated S corporation as any C corporation that (1) was an S corporation on December 21, 2017; (2) revokes its S corporation election after December 21, 2017, but before December 22, 2019; and (3) has the same owners of stock in identical proportions on December 22, 2017, and the revocation date.

If the accounting method change is an automatic change in functional currency under section 985 (see section 29.01 of Rev. Proc. 2022-14), the adjustments required under Regulations section 1.985-5 must be made on the last day of the tax year ending before the year of change. Any gain or loss that must be recognized under Regulations section 1.985-5 is included in income or earning and profits on the last day of the tax year

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ending before the year of change, and is not subject to section 481. Attach a statement showing the adjustment required under Regulations section 1.985-5. The statement should include the amount of the adjustment required pursuant to Regulations section 1.985-5, a summary of the computation of such adjustment, and an explanation of any other adjustments required by Regulations section 1.985-5.

Except if instructed differently, you must attach a statement showing the (net) section 481(a) adjustment for each change in method for each applicant included on Form 3115. Include a summary of how the (net) section 481(a) adjustment was computed and an explanation of the methodology used to determine it. The summary of computation and explanation must be sufficient to demonstrate that the (net) section 481(a) adjustment is computed correctly. If the applicant is a CFC or 10/50 corporation, or a trade or business of a CFC or 10/50 corporation, and its functional currency is not the U.S. dollar, state the (net) section 481(a) adjustment in that functional currency. The statement may be combined with the information requested on the fourth line on page 1 (list the applicants and their identification numbers) and on line 24 (user fee).

Section 481(a) adjustments (or components of section