06 December 2018 IRS issues procedure to obtain automatic consent to change an accounting method to comply with certain rules under Section 451 Note: This Tax Alert was updated on February 6, 2019, to reflect clarification to the scope of Revenue Procedure 2018-60 as published in CCA 201852019 The IRS issued Revenue Procedure 2018-60 for taxpayers to obtain automatic consent of the Commissioner to change accounting methods to comply with certain rules under Section 451, as amended by Pub. L. No. 115-97 (referred to the Tax Cuts and Jobs Act). Revenue Procedure 2018-60 adds new Section 16.12 to Revenue Procedure 2018-31, which allows accrual method taxpayers with audited financial statements (AFS) to change their accounting method for the recognition of income to a method that complies with Section 451(b)(1)(A) or, if not also adopting ASC 606/IFRS 15 (the New Standards) 1 for the year of change, to an accounting method that complies with Section 451(b)(4). Section 451(b)(1)(A) provides that for an accrual method taxpayer, the all events test (as defined in Section 451(b)(1)(C)) with respect to any item of gross income (or portion thereof) may not be treated as met any later than when such item (or portion thereof) is taken into account as revenue in the taxpayer's AFS. Under Section 451(b)(1)(C)(codification of the long standing all-events test), the all events test is met with respect to any item of gross income if all the events have occurred that fix the right to receive such income and the amount of such income can be determined with reasonable accuracy. Section 451(b)(4) provides that, in the case of a contract that contains multiple performance obligations, the allocation of the transaction price to each performance obligation is equal to the amount allocated to each performance obligation for purposes of including such item in revenue in the taxpayer's AFS. Section 16.12 applies to tax years beginning after December 31, 2017. However, for income from debt instruments with original issue discount (OID), Section 16.12 applies to tax years beginning after December 31, 2018. Taxpayers making a change only under Section 16.12 are allowed to file a "short Form 3115". Section 16.12(4) of Revenue Procedure 2018-60 provides the specific information required. The Section 481(a) adjustment for each item being changed and a description of where the adjustment is reflected on the federal income tax return is required. The requirement to file a duplicate copy of Form 3115 with the IRS in Covington, KY is waived. Section 16.12 also provides a "streamlined" procedure for certain taxpayers to make an accounting method change described in Section 16.12(2) (a change to comply with Section 451(b)(1)(A) or Section 451(b)(4)) in the taxpayer's first tax year beginning after December 31, 2017, provided one of the following requirements is met:
If a taxpayer uses the streamlined method to make an accounting method change, the taxpayer does not have to file Form 3115 or attach a statement to the return for the year of change. However, the taxpayer also will not receive audit protection. A taxpayer that wants to make one or more concurrent changes under Section 16.12 may generally file a single Form 3115. A taxpayer making changes under Section 16.12 concurrently is required to implement the change to comply with Section 451(b)(4) first. A taxpayer making the change to comply with Section 451(b)(1)(A) concurrently with the changes to adopt the New Standards under Section 16.11 of Revenue Procedure 2018-31 (as provided by Revenue Procedure 2018-29 and as modified by Revenue Procedure 2018-49) must implement the changes under Section 16.11 first. A taxpayer, however, may not use the streamlined method procedures if the taxpayer wants to make a concurrent automatic change. Generally, the "five-year eligibility rule" of Revenue Procedure 2015-13 does not apply to a change under Section 16.12 for a taxpayer's first, second, or third tax year beginning after December 31, 2017 (in the case of income from a debt instrument having OID, the five-year rule does not apply for a taxpayer's first, second, or third tax year beginning after December 31, 2018). However, for a change made under the streamlined method change procedures, the five-year eligibility rule does not apply to a taxpayer's first tax year beginning after December 31, 2017. Revenue Procedure 2018-60 also modifies the procedures in Section 15.01 of Revenue Procedure 2018-31 for taxpayers that want to change their overall method of accounting from the cash method to an accrual method. In particular, Revenue Procedure 2018-60 clarifies that such taxpayers must use the procedures in Section 16.11 (as provided by Revenue Procedure 2018-29 and as modified by Revenue Procedure 2018-49) for changes to comply with Section 451(b)(4) made for the same year such taxpayers change to methods under the New Standards. Additionally, Revenue Procedure 2018-60 modifies Section 15.01 of Revenue Procedure 2018-31 to require taxpayers that want to make a change in overall method and a change in the timing of recognition of income due to the New Standards to file such changes on the same Form 3115. The five-year eligibility rule of Revenue Procedure 2015-13 does not apply to a change in overall method for a taxpayer's first, second, or third tax year beginning after December 31, 2017. The IRS will return any non-automatic Form 3115 that was filed with the IRS on or before November 29, 2018, for a tax year beginning after December 31, 2017, that is covered by new Section 16.12 and is pending with the IRS on November 29, 2018. A timely resubmitted Form 3115 will be considered filed as of the date the taxpayer originally filed the Form 3115 under the non-automatic change procedures. Revenue Procedure 2018-60 provides the anticipated procedures under which a taxpayer can change certain methods of accounting in conjunction with efforts to comply with the new Section 451 rules. To ease the administrative burden on taxpayers, Revenue Procedure 2018-60 introduces new automatic changes, reduced filing requirements, and waives certain eligibility requirements for a limited time. Please also see the attached flow-chart that can aid in determining whether a taxpayer qualifies to make a change under these new procedures. As noted above, a taxpayer within the scope of new Section 16.12 of Revenue Procedure 2018-31 may change its method of accounting: 1) to treat an item of gross income, or portion thereof, as meeting the all events test no later than when such item, or portion thereof, is taken into account as revenue in its AFS under Section 451(b)(1)(A) and/or 2) to comply with Section 451(b)(4) (regarding allocation of transaction price) if the taxpayer is not adopting the New Standards for the year of change. Because Section 451(b)(1)(A) references the all events test (as defined in Section 451(b)(1)(C)), it appears the automatic change under Section 16.12 applies broadly, such that a taxpayer can use the automatic change under Section 16.12 to change its treatment of an item of gross income to comply with the rules under Section 451(b)(1)(A), as well as correct its application of the all events test under Section 451(b)(1)(C). In general, for taxpayers making a change under Section 16.12, taxpayers only need to complete certain portions of the Form 3115. However, the rules also waive the requirement that a duplicate copy of the Form 3115 be filed with the IRS in Covington, KY. While the waiving of such requirement does relieve some administrative burden, there are consequences with respect to when audit protection is afforded to a taxpayer. Generally, audit protection is afforded to a taxpayer (if otherwise eligible) with a timely filed Form 3115 (which, for an automatic change, would be afforded with the filing of the duplicate copy if such copy is filed before the filing of the original Form 3115 with the tax return for the year of change). If no duplicate copy is filed, taxpayers are restricted from receiving audit protection until the original Form 3115 is filed with the return. This could be a significant consequence for some taxpayers. For example, if a taxpayer presently is not applying the all events test correctly to an item of income, but wishes to file a change under Section 16.12 to comply with the rules of Section 451(b)(1)(A) because such item will always be recognized in book revenues first, such taxpayer would desire audit protection for prior years (i.e., protection for its incorrect application of the all events test). As the procedures indicate, the requirement is "waived"; the guidance suggests a taxpayer still may file the duplicate copy. Taxpayers should assess when audit protection is desired before deciding how to effectuate the new automatic changes. The new streamlined method change procedures apply either to 1) small taxpayers or 2) large taxpayers making changes under new Section 16.12 where the Section 481(a) adjustment for each change is zero. To qualify under 2), the requirements provide that Section 481(a) adjustments (in the case of multiple changes) cannot be netted (i.e., each Section 481(a) adjustment for each change must be zero), making qualification potentially more challenging. Further, no audit protection is afforded for taxpayers filing under the streamlined procedures (however, audit protection may be less of a concern if able to qualify). Taxpayers qualifying to use the streamlined procedures can still choose to file Forms 3115 (e.g., for certain small taxpayers desiring audit protection). Taxpayers not required to adopt the New Standards until 2019 tax years (i.e., private companies) may still need to file accounting method changes for 2018 tax years in order to comply with the new Section 451 rules, including the allocation rules in Section 451(b)(4). Such taxpayers should conduct a proper analysis to ensure compliance for 2018. Once the New Standards are adopted, further method changes may be required in order to change methods as necessary in conjunction with the adoption of the New Standards. Additionally, where concurrent changes are made for 2018 tax years (as noted above), certain changes must be implemented before others as generally taxpayers are required to adopt the New Standards or comply with Section 451(b)(4) prior to complying with Section 451(b)(1)(A)). Revenue Procedure 2018-60 restates the rules regarding OID bonds — generally, providing that in the case of income from debt instruments that have OID, the rules of Section 451(b) apply for tax years beginning after December 31, 2018. However, it does not address the general application of Section 451(b) to other financial transactions, including whether Section 451(b) overrides the regulatory regime for taxing de minimis OID that permits the deferral of such income. The lack of guidance may indicate that de minimis OID, which is technically not OID, is not covered by Section 451(b).
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