IRS issues updated list of automatic method changes

To change a method of accounting for federal income tax purposes, taxpayers must generally obtain IRS consent by filing Form 3115 (Application for Change in Accounting Method) for the year of change. Although IRS consent must generally be obtained in advance, the IRS has provided that certain (generally routine) method changes are made under more favorable “automatic” consent procedures. On May 5, 2016, the IRS released Rev. Proc. 2016-29, containing an updated list of method changes eligible for the automatic consent procedures that supersedes the current list in Rev. Proc. 2015-14. The new guidance, which is effective immediately, includes significant changes and time-sensitive transition rules that tax professionals should be aware of when requesting tax accounting method changes going forward.

Key changes

New automatic changes added: The following three changes, which were previously subject to the advance consent procedures, may now be made under the more favorable automatic accounting method change rules.

  1. Section 10.01, change for start-up expenditures under section 195; 
  2. Section 12.14, change for interest capitalization under section 263A; and 
  3. Section 21.17, certain changes within the retail inventory method under section 471. 

Automatic change expanded: The scope of section 21.05, relating to changes from impermissible methods of inventory identification and valuation, is expanded to permit changes from impermissible method(s) under section 471, rather than being limited to only the impermissible methods described in sections 1.471-2(f)(1) through (5). Thus, more taxpayers will be able to avail themselves of the favorable automatic change procedures to implement this commonly requested change in method of accounting.

Automatic changes reclassified as non-automatic changes: Conversely, the following three changes are no longer eligible for the automatic change procedures and must now be requested pursuant to the more onerous and costly advance consent provisions under Rev. Proc. 2015-13.

  1. Section 6.01, change from impermissible to permissible methods of depreciation or amortization for any property for which the taxpayer has claimed a federal income tax credit;
  2. Section 11.08 change from capitalizing to deducting repair and maintenance costs for which the taxpayer has claimed a federal income tax credit or elected to apply section 168(k)(4);
  3. Section 18.01 change for long-term contract(s) to the percentage-of-completion method described in section 1.460-4(b).

Obsolete tangible property changes removed: Ten method changes pertaining to tangible property have been revised or eliminated. The following two changes are modified to delete references to obsolete Prop. Reg. section 1.168(i)-8.

  1. Section 6.10, late partial disposition elections under section 168, and
  2. Section 6.12, partial dispositions of tangible depreciable assets subject to an IRS exam adjustment.

The following eight method changes are obsolete under current tax law and are, therefore, deleted from the list of automatic changes:

  1. Section 6.08, depreciation of cable TV fiber optics under the safe harbor method of accounting provided in Rev. Proc. 2003-63;
  2. Section 6.27, depreciation of leasehold improvements under section 1.167(a)-4T;
  3. Section 6.28, change from a permissible to another permissible method of accounting for depreciation of MACRS property under sections 1.168(i)-1T, 1.168(i)-7T, and 1.168(i)-8T, and Prop. Reg. sections 1.168(i)-1, 1.168(i)-7, and 1.168(i)-8;
  4. Section 6.29, dispositions of a building or structural component under section 1.168(i)-8T and Prop. Reg. section 1.168(i)-8;
  5. Section 6.30, dispositions of tangible depreciable assets (other than a building or its structural components) under section 1.168(i)-8T and Prop. Reg. section 1.168(i)-8;
  6. Section 6.31, dispositions of tangible depreciable assets in a general asset account under section 1.168(i)-1T and Prop. Reg. section 1.168(i)-1;
  7. Section 6.32, general asset account elections under section 1.168(i)-1, section 1.168(i)-1T, and Prop. Reg. section 1.168(i)-1; and
  8. Section 10.11(3)(b), changes for tangible property under the temporary tangible property regulations.

Revisions to automatic change eligibility rule waivers: Automatic changes are generally subject to the “eligibility rules” outlined in section 5.01(1) of Rev. Proc. 2015-13. The IRS may waive one or more of these eligibility rules for specific changes under certain circumstances (e.g., to facilitate changes to comply with new tax rules). Under the new revenue procedure, eligibility rule waivers were modified, added, or extended for the following automatic method changes.

Waiver period revised for remodel-refresh safe harbor changes. The eligibility rules in sections 5.01(1)(d) and (f) of Rev. Proc. 2015-13 (i.e., pertaining to changes made in final year or a trade or business and change(s) to same item in the five prior tax years) do not apply to the following two changes for any taxable year beginning after Dec. 31, 2013, and ending before Dec. 31, 2016. Previously, these eligibility rules did not apply to these changes for the first or second taxable year beginning after Dec. 31, 2013:

  1. Section 6.20, the revocation of a partial disposition election that must be made under the remodel-refresh safe harbor described in Rev. Proc. 2015-56;
  2. Section 11.10, the remodel-refresh safe harbor described in Rev. Proc. 2015-56.

Waiver added for changes to comply with section 267(a)(3). Section 13.01, pertaining to changes to comply with the requirements of section 267, is modified to provide that the eligibility rules in sections 5.01(1)(e) and (f) of Rev. Proc. 2015-13 (i.e., pertaining to change(s) to overall method or same item in the five prior tax years) do not apply to changes to comply with section 267(a)(3).

Waiver period extended one year for certain depreciation and tangible property changes: The waiver of the eligibility rule in section 5.01(1)(f) of Rev. Proc. 2015-13 (i.e., pertaining to change(s) to the same item in the five prior tax years) is extended one year to any taxable year beginning before Jan. 1, 2016, for the following six method changes:

  1. Section 6.13, depreciation of leasehold improvements under section 1.167(a)-4;
  2. Section 6.14, change from a permissible to another permissible method of accounting for depreciation of MACRS property under sections 1.168(i)-1, 1.168(i)-7, and 1.168(i)-8;
  3. Section 6.15, dispositions of a building or structural component under § 1.168(i)-8;
  4. Section 6.16, dispositions of tangible depreciable assets (other than a building or its structural components) under section 1.168(i)-8; 
  5. Section 6.17, dispositions of tangible depreciable assets in a general asset account under section 1.168(i)-1; and
  6. Section 11.08, changes for tangible property under the final tangible property regulations.

Effective date. The revenue procedure is generally effective for an automatic Form 3115 filed on or after May 5, 2016, for a year of change ending on or after Sept. 30, 2015.

Transition rules. The revenue procedure provides the following transition relief for a limited period of time in order to mitigate the administrative burden and potentially adverse impact of the new guidance on affected taxpayers.

Transition rule for converting an advance consent request to an automatic change. If a taxpayer properly filed a Form 3115 under the non-automatic/advance consent procedures before May 5, 2016, for any of the changes listed above, and the Form 3115 is pending with the national office on May 5, 2016, the taxpayer may choose to convert the advance consent request to an automatic change.

The taxpayer must notify the national office contact person of the taxpayer’s intent to convert the change in method of accounting to the automatic change procedures before the later of (a) June 6, 2016, or (b) the issuance of a letter ruling granting or denying consent for the change. The national office will send a letter to the taxpayer acknowledging its request and will return the user fee submitted with the Form 3115. In addition, the taxpayer must resubmit a Form 3115 that conforms to the automatic change procedures and attach a copy of the national office acknowledgement letter to the IRS in Covington, Ky., by the earlier of (a) the 30th calendar day after the date of the national office’s letter acknowledging the taxpayer’s request or (b) the date the taxpayer is required to file the duplicate copy of the Form 3115 in Covington, Ky.

Transition rules for automatic changes reclassified as non-automatic changes. The transition rules are as follows for the three changes described above that are no longer eligible for the automatic change procedures:
For changes under section 6.01 (change from impermissible to permissible methods of depreciation or amortization for any property for which the taxpayer has claimed a federal income tax credit) and section 11.08 (change from capitalizing to deducting repair and maintenance costs for which the taxpayer has claimed a federal income tax credit or elected to apply section 168(k)(4)), the taxpayer may make the change(s) under the automatic change procedures if the original or the duplicate copy of Form 3115 were properly filed before May 5, 2016, under the automatic change procedures. Otherwise, the change(s) must be requested pursuant to the non-automatic change procedures, although the change may be effected for the taxpayer’s last taxable year ending before May 5, 2016, provided the Form 3115 is filed on or before the extended due date of the federal income tax return for the taxpayer’s last taxable year ending before May 5, 2016, regardless of whether the taxpayer actually extended the due date of the return. Thus, an advance consent method change may still be effected for the 2015 tax year under this special transition rule.

These same transition rules also apply to the change described in section 18.01 (change for long-term contract(s) to the percentage-of-completion method), except that the applicable transition date is June 6, 2016, rather than May 5, 2016.

Implications. Taxpayers in the process of filing method change applications (Form 3115) should review Rev. Proc. 2016-29, which is generally effective immediately, and ensure they are filing under the correct method change procedures (automatic or advance consent) and, if appropriate, evaluate the impact of the guidance on their taxable income estimates and projections (e.g., if the change is implemented in an earlier or later tax year under the new guidance). In particular, taxpayers who may benefit from the transition rules must act quickly to meet the specified deadlines (e.g., June 6, 2016, or the extended due date of the federal income tax return for the last taxable year ending before May 5, 2016). Finally, be aware that many of the automatic change sections have been renumbered and therefore existing Form 3115 disclosure statement templates may need to be updated to reflect the new citations under Rev. Proc. 2016-29 even if no changes have been made to the change procedures, terms, and conditions for a particular automatic change. Note that no changes were made to the existing designated change numbers.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.