Upcoming “three-month window” for accounting method changes

Calendar-year taxpayers under examination by the Internal Revenue Service (IRS) that are eligible to voluntarily change a method of accounting under the “three-month window” period exception and wish to take advantage of this favorable exception must file Form 3115, Application for Change in Accounting Method, during that “window,” which begins July 15, 2016, (i.e., the 15th day of the seventh month of the taxpayer’s tax year) and ends Oct. 15, 2016 (i.e., the 15th day of the tenth month of the taxpayer’s tax year).

Audit protection benefits

For taxpayers under exam that wish to voluntarily change from an impermissible method with a positive (unfavorable) § 481(a) adjustment, the three-month window is especially important because such changes must generally be made without the audit protection benefits that prevent the IRS from raising the same issue in an earlier year and permit a four-year spread of a positive § 481(a) adjustment. Provided the 2015 income tax return has not been filed, the three-month window can typically be applied to automatic changes filed for either 2015 or 2016 and to advance consent changes for 2016.

Common automatic 3115s with positive/unfavorable section 481(a) adjustment:

  • Section 263A inventory UNICAP. See section 12.01 and 12.02 of Rev. Proc. 2016-29.
  • Inventory valuation (reserves and write-downs). See section 21.05 of Rev. Proc. 2016-29.
  • Depreciation. See section 6.01 of Rev. Proc. 2016-29.
  • Section 467 rental agreements. See section 20.01 of Rev. Proc. 2016-29.
  • Section 267 related-party transaction expenses. See section 13.01 of Rev. Proc. 2016-29.
  • Bonus and professional service liabilities not fixed as of year-end. See sections 19.01(2) and 19.06, respectively, of Rev. Proc. 2016-29.
  • Prepaid expenses for non-payment liabilities such as rent and service contracts. See section 11.05 of Rev. Proc. 2016-29. 

Eligibility requirements

In general, a taxpayer under examination may file a Form 3115 under Rev. Proc. 2015-13, but generally does not receive audit protection for the change unless it qualifies for an exception, one of which is the three-month window. Pursuant to this exception, a taxpayer under examination may file Form 3115 during the three-month window and obtain audit protection benefits, provided (1) the taxpayer has been under examination for at least 12 consecutive months as of the first day of the three-month window, (2) the method of accounting the taxpayer is changing is not an issue under consideration in an IRS exam at the time of filing, and (3) the change is otherwise eligible for audit protection under Rev. Proc. 2015-13 and, in the case of an automatic change, the applicable section of Rev. Proc. 2016-29. Special rules apply for a short tax year and for foreign corporations.