SECTION 7. AUDIT PROTECTION

FOR TAXABLE YEARS PRIOR TO YEAR OF CHANGE . . . . . . . . . . . . . 25

.01 Change in method of

accounting defined . . . . . . . . . 17

corporations . . . . . . . . . . . . 21 (6) Prior change . . . . . . . . . . . . 21 (7) Section 381(a) transaction . 21 .03 Nonautomatic changes . . . . . . 21

(1) Change not made or

made improperly . . . . . . . . . 25

December 21, 1998 16 1998–51 I.R.B.

(2) Change in sub-method . . . . . 25 (3) Prior year Service-initiated

change . . . . . . . . . . . . . . . . .25 (4) Criminal investigation . . . . .25

secutively 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 § 1.446–1(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, 1990–1 C.B. 57. (3) A change in the characterization of an item may also 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. (4) 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). See § 1.446–1(e)(2)(ii)(b).

.02 Securing permission to make a method change. Sections 446(e) and 1.446-1(e) state 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. Section 1.446– 1(e)(3)(i) requires that, in order to obtain the Commissioner’s consent to a method change, a taxpayer must file a Form 3115, Application for Change in Accounting Method, during the taxable year in which the taxpayer wants to make the proposed change.

.03 Terms and conditions of a method change. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting in accordance with § 446(e). The terms and conditions the Commissioner may prescribe include the year of change, whether the change is to be made with a