SECTION 15. PAPERWORK — Internal Revenue Bulletin 1998-51

REDUCTION ACT . . . . . . . . . . . . . . 27

DRAFTING INFORMATION . . . . . . 27

APPENDIX (TABLE OF CONTENTS) . . . . . . . . . . . . . . . . . . . 27

1998–51 I.R.B. 17 December 21, 1998

§ 481(a) adjustment or on a cut-off basis, and the § 481(a) adjustment period.

.04 No retroactive method change. Unless specifically authorized by the Commissioner, a taxpayer may not request, or otherwise make, a retroactive change in method of accounting, regardless of whether the change is from a permissible or an impermissible method. See generally Rev. Rul. 90–38.

.05 Method change with a § 481(a) ad- justment.

(1) Need for adjustment. 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 § 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.

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 § 481(a) adjustment of $20,000 ($120,000 accounts receivable less $100,000 accounts payable) is required as a result of the change.

(2) Adjustment period. Section 481(c) and §§ 1.446–1(e)(3)(ii) and 1.481–4 provide that the adjustment required by § 481(a) may be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer. Generally, in the absence of such an agreement, the § 481(a) adjustment is taken into account completely in the year of change, subject to § 481(b) which limits the amount of tax where the § 481(a) adjustment is substantial. However, under the Commissioner’s authority in § 1.446–1(e)(3)(ii) to prescribe terms

and conditions for changes in methods of accounting, this revenue procedure provides specific adjustment periods that are intended to achieve an appropriate balance between the goals of mitigating distortions of income that result from accounting method changes and providing appropriate incentives for voluntary compliance.

(1) Sections 1.446–1(d)(1) and (2) provide that when a taxpayer has two or more separate and distinct trades or businesses, a different method of accounting may be used for each trade or business provided the method of accounting used for each trade or business clearly reflects the overall income of the taxpayer as well as that of each particular trade or business. No trade or business is separate and distinct unless a complete and separable set of books and records is kept for that trade or business.

.06 Method change using a cut-off method. The Commissioner may determine that certain changes in methods of accounting will be made without a § 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, § 263A (which generally applies to costs incurred after December 31, 1986, for noninventory property), § 461(h) (which generally applies to amounts incurred on or after July 18, 1984), and § 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 § 481(a) adjustment is necessary.

(2) Section 1.446–1(d)(3) provides that if, by reason of maintaining different methods of accounting, there is a creation or shifting of profits or losses between the trades or businesses of the taxpayer (for example, through inventory adjustments, sales, purchases, or expenses) so that income of the taxpayer is not clearly reflected, the trades or businesses of the taxpayer are not separate and distinct.

.09 Penalties. Any otherwise applicable penalty for the failure of a taxpayer to change its method of accounting (for example, the accuracy-related penalty under § 6662 or the fraud penalty under § 6663) may be imposed if the taxpayer does not timely file a request to change a method of accounting. See § 446(f). Additionally, the taxpayer’s return preparer may also be subject to the preparer penalty under § 6694. However, penalties will not be imposed when a taxpayer changes from an impermissible method of accounting to a permissible one by complying with all applicable provisions of this revenue procedure.

.10 Change made as part of an examination. 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 its income, the computation of taxable income must be made in a manner that, in the opinion of the Commissioner, does clearly reflect income. If a taxpayer under examination is not eligible to change a method of accounting under this revenue procedure, the change may be made by the district director. A change resulting in a positive § 481(a) adjustment will ordinarily be made in the earliest taxable year under examination with a one-year § 481(a) adjustment period.

.11 Significant changes. Significant changes to Rev. Proc. 97–37 include:

(1) Section 4.02(6) clarifies that the year of change is included within the fiveyear prohibition regarding prior changes;

(2) Section 6.02(2) clarifies that the automatic extension of 6 months from the due date of the return provided in § 301.9100-2 is applicable;

(3) Section 9.01 clarifies that the district director is to ascertain if a change in method of accounting was made in compliance with all the applicable provisions of this revenue procedure;

(4) Section 10.04 clarifies that an ap

.07 Consistency and clear reflection of income. Methods of accounting should clearly reflect income on a continuing basis, and the Internal Revenue Service exercises its discretion under §§ 446(e) and 481(c) in a manner that generally minimizes distortions of income across taxable years and on an annual basis.

.08 Separate trades or businesses.

December 21, 1998 18 1998–51 I.R.B.

plication reviewed and changed by the national office is subject to review by the district director as provided in section 9 of this revenue procedure;

(5) Section 13.03 provides that the effective date of this revenue procedure is December 21, 1998, for applications or copies of applications filed with the national office under section 2.01 or 2.02 of the APPENDIX;

(6) Section 2.01 of the APPENDIX provides that this revenue procedure is the exclusive procedure for making that change, includes property for which excess depreciation was claimed, excludes property for which depreciation is determined under § 1.167(a)–11, and requires additional information for any public utility property;

(7) Section 2.02 of the APPENDIX requires additional information for any public utility property;

(8) Section 3.01 of the APPENDIX is modified to provide that the change does not apply to a taxpayer that wants to change to the capitalization method for costs of developing (or modifying) any package design that has an ascertainable useful life;

(9) Section 10.01 of the APPENDIX provides that a taxpayer is not required to file a Form 3115 to re-elect the LIFO inventory method after a period of five taxable years beginning with the year of change;

(10) Section 10.04 of the APPENDIX provides that a taxpayer wanting to make an IPIC change where a bulk bargain purchase previously occurred must first comply with Hamilton Industries, Inc. v. Commissioner, 97 T.C. 120 (1991), and compute a § 481(a) adjustment for the bargain purchase part of the change;

(11) The following changes in methods of accounting have been added to the APPENDIX of this revenue procedure:

(a) Section 1.02 of the APPENDIX regarding Year 2000 costs;

(b) Section 2A.01 of the APPENDIX regarding research and experimental expenditures;

(d) Section 5.04 of the APPENDIX regarding the Rule of 78s;

(e) Section 8.05 of the APPENDIX regarding cooperative advertising;

(f) Section 9.02 of the APPENDIX regarding estimating inventory shrinkage;

(g) Section 10A.01 of the APPENDIX regarding the mark-to-market method of accounting for a taxpayer’s first taxable year ending after July 22, 1998; and (h) Section 12.02 of the APPENDIX regarding pool of debt instruments for the taxpayer’s first taxable year beginning after August 5, 1997.