SECTION 6. APPEALS AND

COUNSEL FOR THE GOVERNMENT DISCRETION TO RESOLVE ACCOUNTING METHOD ISSUES

(a) Treating an accounting method issue as a method change . An appeals officer or counsel for the government resolving an accounting method issue may treat the issue as a change in method of accounting.

(b) Selection of new method of accounting . Except as provided in section 2.06 of this revenue procedure, an appeals officer or counsel for the government changing a taxpayer’s method of accounting will select a new method of accounting by properly applying the law to the facts. The appeals officer or counsel for the government will not put the taxpayer on an improper method of accounting in order to reflect the hazards of litigation.

(c) Terms and conditions of change . An appeals officer or counsel for the government changing a taxpayer’s method of accounting may agree to terms and conditions that differ from those ordinarily applicable to an Examination-imposed accounting method change, including the following (or any combination thereof):

(i) Year of change . An appeals officer or counsel for the government may compromise the year of change (for example, by agreeing to a later year of change). However, an appeals officer or counsel for the government changing a taxpayer’s method of accounting ordinarily will not defer the year of change to

See section 10.01 of this revenue procedure for an example of the application of section 5 of this revenue procedure.

.02 Requirement to Treat an Account- ing Method Issue as a Method Change . 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.

.03 Selection of New Method of Accounting . Except as provided in section 2.06 of this revenue procedure, 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.

Example . A taxpayer held long-term zero coupon bonds during the taxable year under examination but did not include any original issue discount (OID) in income for that year. The examining agent determines that the taxpayer should have included OID in income for that year under § 1272. Accordingly, the examining agent will change the taxpayer’s method of accounting to include the OID in income in accordance with § 1272 and the regulations thereunder. The examining agent will not impose a method of accounting that is designed to take into account litigation hazards (for example, a method that only requires the accrual of an arbitrary percentage of the OID that would otherwise accrue during the year under § 1272 and the regulations thereunder).

.01 Authority to Resolve Accounting Method Issues . An appeals officer or counsel for the government may resolve an accounting method issue (as defined by section 3.01 of this revenue procedure) when it is in the interest of the government to do so. See P–8-47.

.02 Types of Resolutions .

(1) In general . An appeals officer or counsel for the government may resolve an accounting method issue by using any of the means described in section 6 of this revenue procedure, or any other means deemed appropriate under the circumstances, to reflect the hazards of litigation. See sections 10.02 through 10.04 of this revenue procedure for examples of the application of section 6 of this revenue procedure.

(2) Accounting method changes .

.04 Terms and Conditions of Change .

(b) the taxpayer’s existing method of accounting does not have a material effect for the taxable year in which the change would otherwise be imposed; or

(c) there are taxable years for which the statute of limitations has expired following the taxable year in which the change would otherwise be imposed.

An examining agent will not defer the year of change in order to reflect the hazards of litigation. Moreover, an examining agent will not defer the year of change to later than the most recent year under examination on the date of the agreement finalizing the change.

(2) Section 481(a) adjustment . An examining agent changing a taxpayer’s method of accounting ordinarily will impose a § 481(a) adjustment, subject to a computation of tax under § 481(b)(if applicable). 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 section 3.09 of Revenue Procedure 97–27 (1997–1 C.B. 680), or a change in method of accounting for intercompany transactions, see § 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., § 174. In addition, an examining agent may use a cut-off method to make a change in appropriate circumstances. For example, the examining agent may use a cut-off method to make a change if the agent determines that the taxpayer’s books and records do not contain sufficient information to compute a § 481(a) adjustment and the adjustment cannot be reasonably estimated. Finally, an examining agent will not make a change on a cut-off method in order to reflect the hazards of litigation.

(3) Spread of § 481(a) adjustment . The § 481(a) adjustment, whether positive or negative, will be taken into account entirely in the year of change.

(1) Year of change . 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. For example, an examining agent may defer the year of change if the examining agent determines that:

(a) the taxpayer’s books and records do not contain sufficient information to compute a § 481(a) adjustment for the taxable year in which the change would otherwise be imposed and the adjustment cannot be reasonably estimated;

April 1, 2002 683 2002-13 I.R.B.

(A) Hypothetical underpayment (overpayment) . The hypothetical underpayment (overpayment) for each taxable year before Appeals or a federal court is equal to the net increase or decrease in taxable income (including the § 481(a) adjustment) that would have been reflected on the return for the taxable year if the Service had changed the taxpayer’s method of accounting (in the earliest taxable year before Appeals or a federal court, or, if later, the first taxable year the method is considered impermissible), multiplied by the applicable tax rate for the taxable year of the underpayment (overpayment). For this purpose, only adjustments associated with the change are taken into account. The applicable tax rate is the highest rate of income tax applicable to the taxpayer (for example, the highest rate in effect under § 1 for individuals or § 11 for corporations).

(B) Applicable time-value rate . The applicable time-value rate generally equals an average of the quarterly underpayment rates in effect under § 6621(a) for the applicable period. However, for a taxpayer that would be entitled to a deduction under § 163(a) for the specified amount if the specified amount were treated as interest arising from the underpayment of tax, the applicable time-value rate is computed at a reduced rate equaling an average of the quarterly underpayment rates in effect under § 6621(a) for the applicable period, multiplied by the excess of 100% over the applicable tax rate for the taxable year of the underpayment (overpayment).

(C) Applicable period . The applicable period begins on the due date (without regard to extensions) of the return for the taxable year of the underpayment (overpayment) and ends on the date on which the specified amount is paid.

(D) Processing of specified amount . The Appeals Officer or government counsel resolving the issue should forward checks in payment of specified amounts to:

Internal Revenue Service 201 W. Riverside Blvd Manual Deposit Unit Stop 31, Unit 21 Covington, KY 41019 Attn: Manager, Manual Deposit Unit.

later than the most recent taxable year under examination on the date of the agreement finalizing the change, and, in no event, will defer the year of change to later than the taxable year that includes the date of the agreement finalizing the change;

(ii) Section 481(a) adjustment . An appeals officer or counsel for the government may make the change using a § 481(a) adjustment or a cut-off method. If a § 481(a) adjustment is used, the appeals officer or counsel for the government may compromise the amount of the § 481(a) adjustment (for example, by agreeing to a reduced § 481(a) adjustment). If the appeals officer or counsel for the government agrees to compromise the amount of the § 481(a) adjustment, the agreement must be in writing; and

(iii) Spread of the § 481(a) adjust- ment . An appeals officer or counsel for the government may compromise the § 481(a) adjustment period (for example, by agreeing to a longer § 481(a) adjustment period).

(3) Alternative-timing resolution . In lieu of changing a taxpayer’s method of accounting, an appeals officer or counsel for the government may resolve an accounting method issue by agreeing to alternative timing for all or some of the items arising during, or prior to and during, the taxable years before Appeals or a federal court. The resolution of an accounting method issue on an alternative-timing basis for certain items will not affect the taxpayer’s method of accounting for any items not covered by the resolution.

Example . The Service and the taxpayer agree that the taxpayer will capitalize the inventoriable costs incurred during 1999 that were deducted under the taxpayer’s method of accounting. The taxpayer’s inventoriable costs covered by the agreement must be capitalized and accounted for under the taxpayer’s inventory method. The inventoriable costs that are not covered by the agreement (that is, those costs incurred in taxable years prior and subsequent to 1999) are not affected by the resolution and thus, consistent with the taxpayer’s method of accounting, must continue to be deducted.

(4) Time-value of money resolution .

(a) In general . In lieu of changing a taxpayer’s method of accounting, an appeals officer or counsel for the government may resolve an accounting method issue by agreeing that the taxpayer will pay the government a “specified amount” that approximates the time-value-of

money benefit the taxpayer has derived from using its method of accounting for the taxable years before appeals or a federal court (instead of the method of accounting determined by the appeals officer or counsel for the government to be the proper method of accounting), reduced by an appropriate factor to reflect the hazards of litigation. If the sum of the time-value-of-money benefit (detriment) computed with respect to each taxable year is negative, the specified amount will be zero and no refund will be made to the taxpayer. The specified amount is not interest under § 163(a), and may not be deducted or capitalized under any provision of the Code. In appropriate circumstances, however, the computation of the specified amount may be tax affected to reflect the approximate effect of a hypothetical tax deduction, as demonstrated in the sample computation. See section 6.02(4)(b)(ii)(B) of this revenue procedure. The specified amount will be treated as a miscellaneous payment as described in the Internal Revenue Manual.

(b) Computation of specified amount .

(i) In general . An appeals officer or counsel for the government may use any reasonable manner to compute the specified amount, including the sample computation described in section 6.02(4)(b)(ii) of this revenue procedure, or a computation that takes into account the taxpayer’s actual tax rates and tax attributes.

(ii) Sample computation . Under the sample computation, the specified amount equals the sum of the time-valueof-money benefit (detriment) computed with respect to each taxable year before Appeals or a federal court. The timevalue-of-money benefit (detriment) with respect to each taxable year before Appeals or a federal court equals the “hypothetical underpayment (overpayment)” (as defined in section 6.02(4)(b)(ii)(A) of this revenue procedure), multiplied by the “applicable timevalue rate” (as defined in section 6.02(4)(b)(ii)(B) of this revenue procedure), compounded daily for the “applicable period” (as defined in section 6.02(4)(b)(ii)(C) of this revenue procedure).

2002-13 I.R.B. 684 April 1, 2002

the rules and procedures of the court and should include the information outlined in the Model Closing Agreement for Settlement on an Accounting Method Change Basis attached as APPENDIX A of this revenue procedure.

.03 Implementing a Service-imposed Method Change .

(1) Years before the Service . 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 § 481(a) adjustment required as a result of the change), and any collateral adjustments to taxable income or tax liability resulting from the change.

(2) Succeeding years for which returns have been filed . If a Service-imposed accounting method change is finalized by a closing agreement, the Service may require that the taxpayer file amended returns to reflect the change for any affected succeeding taxable years for which a federal income tax return has been filed as of the date of the agreement. The amended returns must include the adjustments to taxable income and any collateral adjustments to taxable income or tax liability resulting from the change necessary to reflect the new method. The Service may require that the amended returns be filed prior to execution of the closing agreement finalizing the change. If the Service does not require the amended returns, the taxpayer should file such amended returns. If the Service does not require the amended returns and the taxpayer does not file the amended returns, the Service should make the adjustments necessary to reflect the change for affected succeeding taxable years if and when it examines the returns for those years. A taxpayer that files an amended return using the new method prior to the date a Service-imposed change becomes final must continue to use the new method on all subsequent returns, unless the taxpayer obtains the consent of the Commissioner to change from the new method or the Service changes the taxpayer from the new method on subsequent examination. See Rev. Rul. 90–38. A taxpayer eligible to

The Manager of the Manual Deposit Unit should be notified by telephone, at (859) 292–5790, that the payment will be sent. The transmittal memorandum should state that the payment is a “Rev. Proc. 2002–18 Specified Amount” payment and should specify the name and TIN of the taxpayer, the type of taxpayer (LMSB, SBSE, W&I), and the year(s) to which the payment pertains.