SECTION 6. COMPUTATION OF

SECTION 481(a) ADJUSTMENT

.01 In general . A taxpayer changing a method of accounting under this revenue procedure is required to take into account any applicable § 481(a) adjust

2003–1 C.B. 373 [67 FR 77701]), the Service and Treasury Department advised taxpayers not to seek to change a method of accounting in reliance on rules contained in the notice of proposed rulemaking until the rules were published as final regulations. The Service and Treasury Department are aware that some taxpayers have made an unauthorized change in method of accounting for an item the treatment of which is provided for in the final regulations. The Service and Treasury Department have determined that it is not appropriate for taxpayers that have made an unauthorized change in method of accounting for an item the treatment of which is provided for in the final regulations to obtain automatic consent under this revenue procedure without correcting such unauthorized change. Therefore, a taxpayer that made an unauthorized change in method of accounting for an item the treatment of which is provided for in the final regulations is eligible to use the automatic consent procedures provided in this revenue procedure only if the taxpayer amends prior federal income tax returns to correct the unauthorized change in method of accounting. However, as a matter of administrative grace, the Service and Treasury Department have limited the application of this section 5.03 to certain taxpayers described in section 5.03(2) of this revenue procedure.

(2) This section 5.03 applies to a taxpayer that —

(a) in a taxable year for which the due date of the federal income tax return (including extensions, regardless of whether such extension is automatic and whether or not actually requested) is after January 24, 2002 (i) made any unauthorized change in method of accounting for an item the treatment of which is provided for in the final regulations; or

(ii) impermissibly changed the treatment of an item that is provided for in the final regulations in the taxpayer’s first taxable year ending on or after December 31, 2003, but has only used such treatment on one federal income tax return; or

(b) made an unauthorized change in method of accounting to a method of accounting that is provided in the final regulations in a taxable year for which the due date of the federal income tax return (including extensions, regardless

of whether such extension is automatic and whether or not actually requested) is on or before January 24, 2002, and for which the statute of limitations has not yet expired, if the taxpayer wishes to use the automatic consent procedures to obtain the Commissioner’s consent to change to the same method of accounting to which the taxpayer previously made the unauthorized change.

(3) A taxpayer described in section 5.03(2)(a)(i) of this revenue procedure is eligible to use the automatic consent procedures to obtain the Commissioner’s consent to change to a method of accounting provided in the final regulations only if the taxpayer changes back to the prior method of accounting ( i.e., the method of accounting used for an item prior to making the unauthorized change for the item) for each item referred to in section 5.03(2)(a) of this revenue procedure by amending its federal income tax returns for all of the preceding taxable years in which the unauthorized method (or methods) was used.

(4) A taxpayer described in section 5.03(2)(a)(ii) of this revenue procedure is eligible to use the automatic consent procedures to obtain the Commissioner’s consent to change to a method of accounting provided in the final regulations only if the taxpayer amends its federal income tax return for the preceding taxable year in which the unauthorized treatment was used to change the treatment of each item referred to in section 5.03(2)(a) of this revenue procedure to a treatment consistent with the taxpayer’s historic method of accounting ( i.e., the method of accounting used for an item prior to changing the treatment of the item).

(5) A taxpayer described in section 5.03(2)(b) of this revenue procedure is eligible to use the automatic consent procedures to obtain the Commissioner’s consent to change to the same method of accounting provided in the final regulations to which the taxpayer previously made the unauthorized change only if the taxpayer changes back to its prior method of accounting for the item ( i.e., the method of accounting used for the item prior to making the unauthorized change for the item) by amending its federal income tax returns for all of the preceding taxable years in which the unauthorized method was used.

January 10, 2005 305 2005–2 I.R.B.

ment as provided in §§ 1.263(a)–4(p)(3) and 1.263(a)–5(n)(3). The § 481(a) adjustment is computed as of the first day of the taxpayer’s second taxable year ending on or after December 31, 2003, and, as provided in the final regulations, takes into account only amounts paid or incurred in taxable years ending on or after January 24, 2002. Thus, the § 481(a) adjustment is computed by taking into account only amounts paid or incurred in the period beginning with the first day of the taxable year that includes January 24, 2002, and ending with the last day of the first taxable year ending on or after December 31, 2003. The amount of the § 481(a) adjustment must include (i) as a reduction of taxable income, any amounts paid or incurred in the period beginning with the first day of the taxable year that includes January 24, 2002, and ending with the last day of the first taxable year ending on or after December 31, 2003, that were capitalized under the taxpayer’s present method of accounting and are currently deductible under the taxpayer’s proposed method of accounting, reduced by the amount of such capitalized costs recovered through amortization or depreciation under the taxpayer’s present method of accounting, (ii) as an increase to taxable income, any amounts paid or incurred in the period beginning with the first day of the taxable year that includes January 24, 2002, and ending with the last day of the first taxable year ending on or after December 31, 2003, that were currently deducted under the taxpayer’s present method of accounting and are capitalized under the taxpayer’s proposed method of accounting, reduced by the amount of capitalized costs that would have been recovered through amortization or depreciation if the taxpayer’s proposed method of accounting had been applied in taxable years ending on or after January 24, 2002, and (iii) as an increase or a reduction to taxable income, as appropriate, any other adjustments required as a result of the change in method of accounting. If under its present method of accounting a taxpayer capitalized costs incurred prior to the first taxable year that includes January 24, 2002, the taxpayer must continue to treat amortization or depreciation deductions attributable to those costs in accordance with the taxpayer’s present

method of accounting. Thus, for example, a taxpayer that files its federal income tax return on a calendar year basis continues to amortize or depreciate in 2004 an intangible created in 2001, even though the taxpayer has changed to a method of accounting provided in the final regulations under which the entire cost of the intangible would be currently deductible if incurred in 2004.

.02 Reporting the section 481(a) adjust- ment on Form 3115 .

(1) Netting . For purposes of determining the adjustment period under section 2.05(2) of Rev. Proc. 2002–9, the § 481(a) adjustment is determined separately for each change in method of accounting being made under this revenue procedure. Thus, a positive adjustment attributable to a change in one method may not be netted against a negative adjustment attributable to a change in another method. However, in determining the adjustment attributable to a change in method, a taxpayer must net positive § 481(a) adjustments and negative § 481(a) adjustments resulting from that change in method ( e.g., if a taxpayer changes to a method of applying the 12-month rule to prepaid amounts, the taxpayer must net the resulting negative § 481(a) adjustment with the positive § 481(a) adjustment that results from including those amounts in inventory pursuant to the taxpayer’s existing § 263A method of accounting for inventory).

(2) Itemized listing on Form 3115 . The taxpayer must include on Form 3115, Part IV, line 25, the total § 481(a) adjustment for all changes in methods of accounting being made. If the taxpayer is making more than one change in method of accounting under the final regulations, the taxpayer must include on an attachment to Form 3115 (a) the information required by Part IV, line 25 for each change in method of accounting (including the amount of the § 481(a) adjustment for each change in method of accounting);

(b) the information required by Part II, line 12 of Form 3115 that is associated with each change; and

(c) the citation to the paragraph of the final regulations that provides for each proposed method of accounting ( e.g., § 1.263(a)–4(d)(6) or § 1.263(a)–4(f)).

.03 Example : Y, a calendar year taxpayer that uses an accrual method of accounting, is a service provider not required to maintain inventories. Y wishes to change to a method of accounting provided in the final regulations for taxable year 2004, which is Y’s second taxable year ending on or after December 31, 2003. Y incurred and capitalized $100x in taxable year 2001, $200x in taxable year 2002, and $250x in taxable year 2003. In addition, Y incurred $300x in taxable year 2004. The $100x, $200x, and $250x capitalized and depreciated by Y in 2001, 2002, and 2003 all relate to the same method of accounting and would be currently deductible under the final regulations if the amounts had been incurred on or after December 31, 2003. Y claimed a depreciation deduction of $10x in each of the taxable years 2001, 2002, and 2003 with respect to the $100x incurred and capitalized in 2001, a depreciation deduction of $20x in each of the taxable years 2002 and 2003 with respect to the $200x incurred and capitalized in 2002, and a depreciation deduction of $25x in taxable year 2003 with respect to the $250x incurred and capitalized in 2003. For taxable year 2004, Y may apply for an automatic change in method of accounting with respect to the method under which the amounts had been capitalized. Y’s section 481(a) adjustment is a decrease in income of $385x ($160x relating to amounts capitalized in 2002 ($200x - $40 ($20 for 2002 and $20 for 2003)) + $225x relating to amounts capitalized in 2003 ($250x - $25x)). Y must continue to use its present method of accounting for the amount capitalized in 2001. Y uses its new method of accounting for the amount incurred in 2004.