Updated List of Automatic Accounting Method Changes and Proposed Regulations for Eligible Terminated S CorporationsPosted: November 20, 2019
The IRS and Treasury have started off the month of November by issuing two pieces of guidance related to accounting methods. One, Rev. Proc. 2019-43, updates the list of automatic accounting method changes previously provided in Rev. Proc. 2018-31. The other consists of proposed regulations under Section 481(d), providing guidance for eligible terminated S corporations to use a six-year spread period for any favorable or unfavorable Section 481(a) adjustments related to an overall accounting method change from the cash method to an accrual method due to the termination of its S corporation election.
Rev. Proc. 2019-43
Most of the changes incorporated in Rev. Proc. 2019-43 primarily relate to housekeeping items, such as the consolidation of additional automatic changes that were released after Rev. Proc. 2018-31 was issued, including the revenue recognition changes resulting from ASC 606 and Section 451(b). Rev. Proc. 2019-43 also includes several updates to procedural items, such as referencing the Form 3115 revised in December 2018, noting that the duplicate copy of an automatic change application must be filed with Ogden, Utah, and removing temporary waivers of eligibility rules that have expired. However, two unexpected, and substantive changes, have been made to the automatic changes for sale, lease, or financing transactions under Section 6.03 of Rev. Proc. 2019-43 and tenant construction allowances under Section 6.08, which are favorable to taxpayers.
The automatic sale, lease, or financing method change permits a taxpayer to change from an improper method of treating property as sold, leased, financed, or purchased, to the proper method. Previously, this automatic change was made on a cut-off method, meaning that the proposed method could only be applied to new transactions entered into during or after the year of change. If a taxpayer wanted to make the change with a Section 481(a) “catch-up” adjustment, a non-automatic application had to be submitted with a signed representation from the counterparty to the transaction, so that the IRS could confirm the taxpayer’s proposed method was consistent with the counterparty’s treatment of the transaction. Rev. Proc. 2019-43 changes this to permit the automatic change to be made with a Section 481(a) adjustment and requires that the taxpayer must only submit a statement with the Form 3115 that provides the name of the counterparty to the transaction as of the beginning of the year of change. Further, the automatic change used to be made without audit protection, which allowed for the possibility of the IRS making a change under exam for the same item for a taxable year prior to the year of change. Now, under Rev. Proc. 2019-43, the taxpayer will receive audit protection. The revised change does note that the consent granted to make the change is not a determination by the IRS that the taxpayer has properly characterized the transaction or that the proposed characterization is permissible. Upon audit, the IRS may determine whether the characterization of the transaction is permissible.
The automatic change for tenant construction allowances permits a change from improperly treating the taxpayer as having a depreciable interest in the property subject to the tenant construction allowances to properly not having a depreciable interest, or vice versa. Previously, this automatic change was also made on a cut-off method, and if a taxpayer wanted to make the change with a Section 481(a) adjustment, a non-automatic application had to be submitted along with certain details of the tenant construction allowance. Further, taxpayers were required to submit a signed representation from the counterparty so that the IRS could confirm the taxpayer’s proposed method was consistent between the parties. Rev. Proc. 2019-43 still requires that the taxpayer provide certain details of the tenant construction allowance but permits the automatic change to be made with a Section 481(a) adjustment. Similar to the updated automatic change for sale, lease or financing transactions, the taxpayer is required to only submit the name of the lessor/lessee, and will now receive audit protection. The revised change does note that the consent granted to make the change is not a determination by the IRS that the taxpayer has properly determined whether it has, or does not have, a depreciable interest in the property subject to the tenant construction allowance or that the proposed determination of the party that has the depreciable interest is permissible. Upon audit, the IRS may determine whether the taxpayer’s determination is permissible.
These changes in Rev. Proc. 2019-43 will be very helpful and permit more taxpayers to file automatic accounting method changes for tax, which is important as taxpayers are implementing the new lease standards in ASC 842 and IFRS 16. A discussion of these financial standards is outside the scope of this article, but in general, they require taxpayers to evaluate their treatment of leases, and will result in substantial changes in the presentation of operating leases for lessees, requiring them to recognize the assets and liabilities on the balance sheet. In implementing the new financial guidance, we expect that taxpayers may also determine that the tax treatment of their leases may need to be changed, including in situations where the present method is not permissible for tax. The new lease financial standards are effective for public companies in 2019, and for all other companies in 2020. Because of the financial changes, it is likely that IRS scrutiny of the tax treatment of leases will increase. As such, this is an area that taxpayers should be focusing on, if they have not already done so.
Rev. Proc. 2019-43 is effective for Forms 3115 filed on or after November 8, 2019, for a year of change ending on or after March 31, 2019. Any automatic accounting method changes that have been prepared, but not yet filed, for a year of change ending March 31, 2019, or later should be revisited to double check that no modifications are necessary to conform to Rev. Proc. 2019-43, and to update the citations to the new revenue procedure.
Proposed regulations under Section 481(d)
One of the small business provisions in the 2017 tax reform bill known as the Tax Cuts and Jobs Act (TCJA) provides an eligible terminated S corporation (ETSC) a six-year spread period of any Section 481(a) adjustment necessary in making an overall accounting method change from the cash method to an accrual method attributable to the revocation of its S corporation election. An S corporation may generally use either method of accounting, assuming the sale of inventory is not an income-producing factor for the taxpayer, while a C corporation with over $26,000,000 of average annual gross receipts in 2019 under Section 448(c) is required to use an accrual method (note that the limitation may be adjusted yearly for inflation; see “Inflation Adjustments Impact Qualified Small Businesses,” November 2019). Specifically, this six-year spread period is available for an ETSC (a corporation that was an S corporation on December 21, 2017 and during the two-year period beginning December 22, 2017, revokes its S corporation election). The owners of the stock on the date of the S corporation revocation must be the same owners in identical proportions as on December 21, 2017, the date of the TCJA enactment. The proposed regulation Section 1.481-5 provides rules relating to the qualification and requirements a corporation must meet to be an ETSC. The six-year spread period is longer than the periods generally provided for accounting method changes, which is usually four-years for an adjustment that increases income, and a one-year pickup in the year of change for an adjustment that decreases income. Note that the two-year period for revoking S corporation status is quickly approaching, so S corporations that intend to revoke their election and take advantage of this extended spread period for their method change must take action by December 21, 2019.
This proposed regulation package also provides rules relating to distributions of money by an ETSC after the post-termination transition period, and revises current regulations to extend the treatment of distributions of money during the post-termination transition period to all shareholders of the corporation and to update and clarify the allocation of current earnings and profits to distributions of money and other property under regulations of Sections 316, 1371 and 1377. These rules are beyond the scope of this alert.
If you have any questions, please contact a member of the Accounting Methods group. The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues and filing accounting method change requests with the IRS.
Tax Managing DIrector
Tax Managing Director