SECTION 12. ORIGINAL — Internal Revenue Bulletin 2002-3

DISCOUNT (§§ 1272, 1273)

.01 Changing from the § 585 reserve method to the § 166 specific charge-off method .

.01 De minimis original issue discount (OID) .

(1) Description of change and scope .

ing under section 11.01 of this APPENDIX is the amount of the bank’s reserve for bad debts as of the close of the taxable year immediately before the year of change. However, the amount of the § 481(a) adjustment does not include the amount of a bank’s pre–1988 reserves (as described in § 593(g)(2)(A)(ii), without taking into account § 593(g)(2)(B)) if the bank changed in a prior year from the § 593 reserve method to the § 585 reserve method and § 593(g) applied to that change. The deemed liquidation of a bank occurring solely because its parent makes a QSSS election does not accelerate the § 481(a) adjustment. In accordance with section 5.04(3)(c) of this revenue procedure, a bank that ceases to be a bank under § 581 must accelerate its § 481(a) adjustment.

(3) Change from § 585 required when electing S corporation status . A bank electing S corporation status (or a bank for which a QSSS election is filed) cannot use the § 585 reserve method. The filing by a bank of a Form 2553 ( Election by a Small Business Corporation ) or the filing by a bank’s parent of a QSSS election with respect to the bank will constitute an agreement by the bank to change its method of accounting for bad debts from the § 585 reserve method to the § 166 specific charge-off method effective as of the taxable year for which the S corporation election or QSSS election is effective (year of change) in accordance with all of the applicable provisions of this revenue procedure (including section 6 of this revenue procedure, which requires filing a Form 3115 in duplicate). The § 481(a) adjustment is recognized built-in gain under §1374. See § 1.1374– 4(d). .02 Reserved .

SECTION 11A. INCOME FROM SOURCES WITHIN THE UNITED STATES (§ 861)

.01 Transactions involving computer programs . This change applies to a taxpayer that wishes to change its method of accounting for transactions involving computer programs to conform to the provisions of § 1.861–18(i)(4). This change applies only to transactions occurring pursuant to contracts entered into on or after December 31, 1998, or, in the case of a taxpayer making an election under

(a) Applicability . This change applies to a taxpayer that wants to change to the principal-reduction method of accounting described in section 5 of Rev. Proc. 97–39 (1997–2 C.B. 485). The principal-reduction method of accounting is an aggregate method of accounting for de minimis OID (discount) on certain loans originated by the taxpayer.

(b) Scope limitations inapplicable . A taxpayer that wants to make this change is not subject to the scope limitations in section 4.02 of this revenue procedure.

(c) Description . The principalreduction method of accounting is a permissible method for use by taxpayers to account for discount on one or more categories of loans described in section 4.02 or 4.03 of Rev. Proc. 97–39. If the principal-reduction method is used to account for any loans in a category of loans, the method must be used for the entire category of loans. The principalreduction method applies only to loans described in section 3 of Rev. Proc. 97–39. (2) Manner of making the change .

(a) This change is made using a cutoff method and applies only to loans described in section 3 of Rev. Proc. 97–39 that were acquired on or after the

(a) Applicability . This change applies to a bank (as defined in § 581, including a bank for which a qualified subchapter S subsidiary (QSSS) election is filed) that wants to change its method of accounting for bad debts from the § 585 reserve method to the § 166 specific charge-off method.

(b) Certain scope limitations inap- plicable . A bank that changed from the § 593 reserve method under § 593(g) to the § 585 reserve method will not be prohibited under section 4.02(6) of this revenue procedure from changing its method of accounting for bad debts under section 11.01 of this APPENDIX solely because of the § 593(g) change. A bank for which a QSSS election is filed will not be prohibited under section 4.02(7) of this revenue procedure from changing its method of accounting for bad debts under section 11.01 of this APPENDIX solely because of the deemed liquidation of the bank arising from a QSSS election.

(2) Section 481(a) adjustment . Generally, the amount of the § 481(a) adjustment for a change in method of account

2002–3 I.R.B. 372 January 22, 2002

on such obligations, regardless of the holder’s overall method of accounting. Section 1281 applies to all types of interest income, including acquisition discount, original issue discount (OID), and stated interest. See S. Rep. No. 99–313, 99th Cong., 2d Sess. 903 (1986), 1986–3 (Vol. 3) C.B. 903.

(c) Section 1283(a)(1) generally defines a short-term obligation as any bond, debenture, note, certificate, or other evidence of indebtedness that matures in one year or less from its issue date.

(d) Under §§ 1281(a) and 1283(c), a holder of a short-term obligation subject to § 1281 must include in gross income an amount equal to the sum of the daily portions of the acquisition discount or OID, whichever is applicable, on the obligation for each day during the taxable year that the obligation is held by the holder. See § 1283(b), as modified by § 1283(c), to determine the daily portions of acquisition discount or OID. In addition, § 1281(a) requires the holder to include in gross income any stated interest that is payable on the short-term obligation (other than stated interest taken into account to determine the amount of the acquisition discount or OID) as it accrues.

(2) Section 481(a) adjustment period . A taxpayer must take the entire § 481(a) adjustment into account in computing taxable income for the year of change.

.02 Stated interest on short-term loans of cash method banks .

first day of the year of change. See section 2.06 of this revenue procedure.

(b) The taxpayer must maintain books and records sufficient to satisfy the director that old and new loans have been adequately segregated.

(3) Additional requirements . On a statement attached to the application, the taxpayer must:

(a) identify the categories of loans to which the new method will apply; and

(b) describe any “additional categories” permitted under section 4.03 of Rev. Proc. 97–39.

(4) No audit protection . A taxpayer does not receive audit protection under section 7 of this revenue procedure in connection with this change.

.02 Reserved .

SECTION 12A. MARKET DISCOUNT BONDS (§ 1278)

.01 Revocation of § 1278(b) election.

(1) Description of change and scope . This change applies to a taxpayer that wants to change its method of accounting for market discount bonds by revoking its § 1278(b) election. Under § 1278(b), a taxpayer may elect a method of accounting under which market discount is currently included in gross income for the taxable years to which the discount is attributable. See Rev. Proc. 92–67 (1992–2 C.B. 429), for the procedures to make a § 1278(b) election (including a deemed § 1278(b) election). The procedures for revoking a § 1278(b) election were formerly provided in section 7 of Rev. Proc. 92–67.

(2) Revocation of election . The revocation of a § 1278(b) election applies to all market discount bonds that are held by the taxpayer on the first day of the first taxable year for which the revocation is effective (year of change), and to all market discount bonds that are subsequently acquired by the taxpayer. If a § 1278(b) election is revoked, then, for purposes of § 1276(a), accrued market discount with respect to any bond previously subject to the election means accrued market discount as defined in § 1276(b) less any market discount included in income while the bond was subject to the § 1278(b) election.

(3) Manner of making the change . This change is made using a cut-off method and applies only to market dis

count accruing on or after the first day of the year of change. Market discount accruing on a bond prior to the year of change was currently included in income and market discount accruing on the bond on and after the first day of the year of change is included in income generally upon disposition of the bond. See § 1276(a). Because cut-off treatment is prescribed for this change, the basis of any bond, adjusted for amounts previously included in income during the period of the election, is not affected by the revocation.

(4) Additional requirements . On a statement attached to the application, the taxpayer must provide:

(a) the reason(s) for revoking the § 1278(b) election (or deemed § 1278(b) election);

(b) a description of the method by which, and the date on which, the taxpayer made the § 1278(b) election (or deemed § 1278(b) election) that is being revoked; and

(c) a statement that, after the revocation, the taxpayer will not make a constant interest rate election for any bond that has been subject to the § 1278(b) election (or deemed § 1278(b) election) being revoked and for which a constant interest rate election was not effective in the year of acquisition.

(5) Audit protection . A taxpayer receives audit protection under section 7 of this revenue procedure in connection with this change. However, the audit protection applicable to this change does not preclude the Commissioner from examining the method used by the taxpayer to determine the amount of accrued market discount under § 1276(b) for a taxable year prior to the year of change.

.02 Reserved .