IRS MODIFIES PROCEDURES FOR CHANGE TO ACCRUAL METHOD BY TAXPAYERS NOT REQUIRED TO USE INVENTORIES.

Rev. Proc. 92-75

                               CONTENTS

This revenue procedure provides the exclusive procedures by which certain taxpayers (other than those required to use inventories) may obtain expeditious consent to change their method of accounting to either (1) an overall accrual method, or (2) an accrual method in conjunction with a request to change to a special method (e.g., long-term contract accounting). Taxpayers complying with this revenue procedure will be deemed to have obtained the consent of the Commissioner of Internal Revenue to change to an accrual method. This revenue procedure modifies and supersedes Rev. Proc. 85-37, 1985-2 C.B. 438.

SEC. 2. BACKGROUND

01 Section 446(e) of the Internal Revenue Code and section 1.446-1(e) of the Income Tax Regulations state that, except as otherwise provided, a taxpayer must obtain the consent of the Commissioner to change a method of accounting for federal income tax purposes.

02 Section 1.446-1(e)(3)(i) of the regulations requires that in order to obtain this consent a Form 3115, Application for Change in Accounting Method, generally must be filed within 180 days after the beginning of the taxable year in which the proposed change is to be made.

03 Section 1.446-1(e)(3)(ii) of the regulations authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change its method of accounting in accordance with section 446(e) of the Code.

04 Section 481(a) of the Code requires that those adjustments necessary to prevent amounts from being duplicated or omitted must be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding taxable year.

05 Section 481(c) of the Code and section 1.481-5 of the regulations provide that the adjustments required by section 481(a) must be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer.

SEC. 3. SIGNIFICANT CHANGES

01 Section 4.01 provides that this revenue procedure may be used by (1) taxpayers that employ a hybrid method and desire to change to an overall accrual method, and (2) taxpayers that desire to change to an accrual method in conjunction with a request to change to a special method. Thus, section 3.02(6) of Rev. Proc. 85-37, which precluded taxpayers that desired to change to an accrual method in conjunction with a special method from using Rev. Proc. 85-37, has been deleted.

02 Section 4.02(1) is clarified to provide that the only financial institutions that are prohibited from using this revenue procedure are those described in section 581 or 591 of the Code. Therefore, for example, a bank holding company would be eligible to use this revenue procedure. Section 4.02 prohibits the use of this revenue procedure by financial institutions described in section 581 or 591 of the Code; taxpayers required to use a long-term contract method in accordance with section 460 but that are not in compliance with that section's requirements; taxpayers required to change their method of accounting from the cash method by the provisions of section 448; taxpayers desiring to change from a Category A method (as defined in section 3.06 of Rev. Proc. 92-20, 1992-12 I.R.B. 10) as part of the change to an accrual method; or a corporation that engages in a transaction to which section 381(a) applies within the proposed taxable year of change (as determined without regard to any potential closing of the year under section 381(b)(1)).

03 Section 4.02(13) provides that this revenue procedure does not apply to taxpayers that have, within the last 6 taxable years prior to the year of change, applied to change their method of accounting under the provisions of this revenue procedure or Rev. Proc. 85-37, without effecting the change.

04 Sections 4.04 and 4.05 of Rev. Proc. 85-37, relating to the limitation of the use of net operating loss and credit carryovers, have been deleted.

05 Section 5.04 provides a de minimis rule under which a taxpayer may elect to take a net section 481(a) adjustment into account in the year of change if the adjustment is less than $25,000.

06 Sections 5.05(3) and 5.05(4) provide special procedures under which the net section 481(a) adjustment is or is not taken into account on an accelerated basis. These provisions generally conform to similar provisions found in section 8.03 of Rev. Proc. 92-20.

07 Section 5.06 provides that taxpayers using this revenue procedure and desiring to adopt the recurring item exception (provided in section 461(h)(3) of the Code) as part of the change to an accrual method in the year of change may do so, but only under the provisions of this revenue procedure.

SEC. 4. SCOPE

01 Except as provided in section 4.02 below, this revenue procedure applies to taxpayers (including organizations that are tax exempt pursuant to section 501(a) of the Code) that (1) either desire to change their method of accounting to an overall accrual method or desire to change to an accrual method in conjunction with a request to change to a special method, and (2) either employ the cash method as their overall method of accounting or employ a hybrid method under which certain items of income or expense are reported on the cash method and other items of income or expense are reported on an accrual method (and/or other methods).

02 This revenue procedure does not apply to the following taxpayers:

(1) Financial institutions described in section 581 or 591 of the Code;

(2) Farmers;

(3) Cooperative organizations described in section 501(c)(12), 521, or 1381 of the Code;

(4) Taxpayers required to use an inventory method of accounting in order to clearly determine income. See section 1.471-1 of the regulations and Rev. Proc. 92-74, 1992-38 I.R.B., dated September 21, 1992;

(5) Individual taxpayers, except for activities conducted as a sole proprietorship;

(6) Taxpayers that are required to use a long-term contract method in accordance with section 460 of the Code and that are not in compliance with that section and related administrative guidance;

(7) Taxpayers that are required to change from the cash method pursuant to section 448 of the Code;

(8) Taxpayers that include as a part of the change to an accrual method a change from a Category A method;

(9) A corporation that engages in a transaction to which section 381(a) of the Code applies within the proposed taxable year of change (as determined without regard to any potential closing of the year under section 381(b)(1));

(10) Taxpayers that are "under examination" as defined in section 3.02 of Rev. Proc. 92-20 at the time for filing the Form 3115 with their timely filed federal income tax return or with the National Office;

(11) Taxpayers that at the time for filing the Form 3115 are:

(a) before an appeals office of the Service with respect to an examination of their federal income tax return(s) for any year, unless the taxpayer has obtained an agreement from the appeals officer that there is no objection to the proposed change in method of accounting and attaches the agreement to the Form 3115, or

(b) before any federal court with respect to an income tax issue arising in any taxable year, unless the taxpayer has obtained an agreement from counsel for the government that there is no objection to the proposed change in method of accounting and attaches the agreement to the Form 3115;

(12) Taxpayers that are the subject of a criminal investigation or proceeding concerning (a) directly or indirectly, any issue relating to the taxpayer's federal tax liability for any year, or (b) the possibility of false or fraudulent statements made by the taxpayer with respect to any issue relating to its federal tax liability for any year; or

(13) Taxpayers that have, within the last 6 taxable years prior to the year of change, applied to change their method of accounting under the provisions of this revenue procedure or Rev. Proc. 85-37 without effecting the change.

03 Taxpayers to which this revenue procedure does not apply, and that desire to change their method of accounting to an overall accrual method or to an accrual method in conjunction with a request to change to a special method, must file an application (Form 3115) with the Commissioner in accordance with the requirements of section 1.446-1(e)(3)(i) of the regulations and Rev. Proc. 92-20, or other applicable Code, regulations, or administrative provisions pertaining to the change.

SEC. 5. APPLICATION

01 CONSENT. In accordance with section 1.446-1(e)(3)(ii) of the regulations, with respect to a change to an overall accrual method or to an accrual method in conjunction with a request to change to a special method, the requirement to file an application on Form 3115 within the 180-day period is waived, and under section 1.446- 1(e)(2)(i), the consent of the Commissioner is hereby granted to any taxpayer within the scope of this revenue procedure to change its method of accounting to an overall accrual method or to an accrual method in conjunction with a request to change to a special method. This consent is granted for the taxable year for which a taxpayer requests a change (year of change) by filing a current Form 3115 in the manner described in section 7 of this revenue procedure for a change to an overall accrual method, or in section 8 of this revenue procedure for a change to an accrual method in conjunction with a request to change to a special method, and by otherwise complying with the provisions of this revenue procedure. See section 6 regarding compliance with the provisions of this revenue procedure. In changing to an overall accrual method or an accrual method in conjunction with a special method, the taxpayer must place all items of income and expense on a proper accrual method (other than items covered by the special method).

02 NET SECTION 481(a) ADJUSTMENT. Section 481(a) of the Code prescribes the rules to be followed in computing taxable income in cases in which the taxable income of a taxpayer is computed under a method of accounting different from the method used to compute the taxable income for the preceding taxable year. An adjustment is required to prevent items from being duplicated or omitted by reason of a change in method of accounting. The adjustment, referred to as the "net section 481(a) adjustment," is the net amount of the adjustment required by section 481(a). The net section 481(a) adjustment takes into account the accounts receivable, accounts payable, and any other item determined necessary in order to prevent items from being duplicated or omitted. Any income accrued but not received should not include items that were worthless or partially worthless (within the meaning of section 166(a)) as of the last day of the year preceding the year of change. In addition, the net section 481(a) adjustment should not contain amounts that are unallowable or amounts that are subject to restrictions or limitations by the Code (e.g., charitable contributions under section 170(b)). The net section 481(a) adjustment must be taken into account in computing taxable income in the manner provided in section 5.03 below. The approved change shall be considered to be a change in method of accounting initiated by the taxpayer, and therefore the net section 481(a) adjustment is not restricted to amounts after 1953. Examples of the computation of the net section 481(a) adjustment are as follows:

EXAMPLE 1

As of December 31, 1991, A, a calendar year taxpayer that uses the overall cash method, has the following items of unreported income and undeducted expenses:

      Income, the right to which is fixed and the

(1) The appropriate period (the "section 481(a) adjustment period") for taking the net section 481(a) adjustment (referred to in section 5.02) into account in computing taxable income is generally determined as follows:

(a) If 90 percent or more of the net section 481(a) adjustment is attributable to the taxable year immediately preceding the year of change, the taxpayer must take the entire net section 481(a) adjustment into account in computing taxable income for the year of change. The amount attributable to the taxable year immediately preceding the year of change is the difference between the amount of the net section 481(a) adjustment for the year of change and the amount of the net section 481(a) adjustment that would have been required if the same change in method of accounting had been made in the preceding year.

(b) When subparagraph (a) of this section 5.03(1) does not apply, the taxpayer, in computing taxable income, must take the net section 481(a) adjustment into account ratably over the number of taxable years (not to exceed 6) that the taxpayer has used the method of accounting that is being changed.

(2) In applying section 5.03(1), if a taxpayer's books and records do not contain sufficient information to compute the net section 481(a) adjustment attributable to the taxable year immediately preceding the year of change, the taxpayer may reasonably estimate this amount, attach to the Form 3115 the computations upon which the estimate is based, and attach the following signed statement to the Form 3115:

Under penalties of perjury, I hereby certify that:

(a) the books and records of [name of the taxpayer] do not contain sufficient information to permit a computation of the net section 481(a) adjustment attributable to the taxable year immediately preceding the year of change, and

(b) based on the information that is contained in such records, to the best of my knowledge and belief, 90 percent or more of the net section 481(a) adjustment [indicate either "is" or "is not," as the case may be] attributable to the taxable year immediately preceding the year of change.

(3) For examples of the application of the rules prescribed in this section 5.03 with respect to the section 481(a) adjustment period, see section 8.01 of Rev. Proc. 92-20.

04 SECTION 481(a) ADJUSTMENT PERIOD DE MINIMIS RULE.

If the entire net section 481(a) adjustment is less than $25,000, the taxpayer may elect to use a one-year section 481(a) adjustment period in lieu of the adjustment period otherwise provided by this revenue procedure. The taxpayer must affirmatively state on an attachment to the Form 3115 that it desires to elect this section 5.04 de minimis rule.

05 ACCOUNTS RECEIVABLE.

(1) The net section 481(a) adjustment must not include any account receivable that was worthless or partially worthless as of the last day of the year preceding the year of change. See section 1.166-3 of the regulations.

(2) If, during the section 481(a) adjustment period (see section 5.03), any portion of the accounts receivable included in the net section 481(a) adjustment becomes worthless or partially worthless, such portion, not previously included in gross income, must be included in income in the taxable year it becomes worthless. This condition applies whether the net section 481(a) adjustment is positive or negative. This condition is illustrated by the following example:

EXAMPLE 3

C, a calendar year taxpayer, employs this revenue procedure to change to an overall accrual method in 1992. The net positive section 481(a) adjustment (increase in income) of $60,000 consisted of $120,000, income (accounts receivable as of December 31, 1991), less $60,000, expenses (accounts payable as of December 31, 1991). It is determined that the net section 481(a) adjustment is to be taken into account ratably over six taxable years in computing taxable income.

In 1994, $30,000 of the $120,000 accounts receivable were determined to be worthless. In 1994, C will not have included in gross income $40,000 of the net section 481(a) adjustment ($60,000 less $10,000 included in gross income in both 1992 and 1993). In 1994, C must include in gross income the remaining portion of the accounts receivable determined to be worthless but not previously included in gross income of $20,000 ($30,000 less the $5,000 portion included in gross income in both 1992 and 1993), plus one-fourth of the remaining balance of the net section 481(a) adjustment, $20,000. A total of $25,000 will be included in gross income in 1994.

      Net section 481(a) adjustment                     $60,000

(4) The Commissioner may waive the application of section 5.05(3) upon a showing that the reduction is attributable to a strike, involuntary conversion, or involuntary interruption of the availability of goods. The taxpayer must request the waiver no later than 90 days after the end of the taxable year in which section 5.05(3) would otherwise apply. For the specific procedures to be followed for requesting the waiver, see section 8.03(1) of Rev. Proc. 92-20.

06 RECURRING ITEM EXCEPTION. As part of the change to an overall accrual method or to an accrual method in conjunction with a request to change to a special method, a taxpayer may adopt the recurring item exception for the year of change if the taxpayer is eligible and follows the procedures of section 1.461- 5(d) of the regulations. If the taxpayer is eligible and wishes to adopt this method as specified in section 461(h)(3) of the Code, the amount of the net section 481(a) adjustment must be modified to account for the amount of the additional deduction.

EXAMPLE 4

As of December 31, 1991, D, a calendar year taxpayer that uses the overall cash method, is eligible to adopt the recurring item exception method specified in section 461(h)(3) of the Code, and adopts this method for the year of change. D has the following items of unreported income and undeducted expenses:

      Income, the right to which is fixed

08 APPLICABILITY OF REV. PROC. 92-20. Except as otherwise provided in this revenue procedure, the following principles of Rev. Proc. 92-20 apply to a change in method of accounting made under this revenue procedure to the extent the principles are applicable to an automatic change in method of accounting: (1) section 3 (definitions); and (2) section 8.02 (rules concerning short periods).

09 PROTECTION FOR YEARS PRIOR TO THE YEAR OF CHANGE. If a taxpayer timely files a change in method of accounting to comply with the provisions of this revenue procedure, an examining agent may not propose that the taxpayer change the same method of accounting for a year prior to a year of change required under this revenue procedure. However, the net section 481(a) adjustment is subject to verification by the district director.

10 EXCLUSIVE PROCEDURE. For a taxpayer that qualifies to use this revenue procedure, this is the exclusive procedure available to that taxpayer for obtaining the Commissioner's consent to change to an overall accrual method or to an accrual method in conjunction with a request to change to a special method.

SEC. 6. COMPLIANCE WITH CONDITIONS

If a taxpayer to which this revenue procedure applies changes its method of accounting to an overall accrual method, or to an accrual method in conjunction with a request to change to a special method, without complying with all the conditions of this revenue procedure, the taxpayer will be deemed to have initiated the change in method of accounting without obtaining the consent of the Commissioner as required under section 446(e) of the Code.

SEC. 7. MANNER OF EFFECTING THE CHANGE -- CHANGE TO AN OVERALL ACCRUAL METHOD

01 A taxpayer applying for a change in method of accounting to an overall accrual method pursuant to this revenue procedure must complete and file a current Form 3115 in duplicate. The original must be attached to the taxpayer's timely filed (including extensions) original federal income tax return (including a Form 990 filed on behalf of a tax exempt organization) for the year of change. (Any tax exempt organization that is not required to file a Form 990 or Form 990-T may change to an overall accrual method without notifying the Service of the change.) A copy of the Form 3115 must be filed with the National Office and addressed to the Commissioner of Internal Revenue, Attention: CC:IT&A, P.O. Box 7604, Benjamin Franklin Station, Washington, D.C. 20044, no later than when the original of the Form 3115 is filed with the federal income tax return. For tax exempt organizations required to file Form 990 or Form 990-T, however, the copy of the Form 3115 must be filed with the Commissioner of Internal Revenue, Attention: Records Control Unit: Exempt Organizations Technical Division, E:EO:R:1-RCU, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, no later than when the original of the Form 3115 is filed with the Form 990. No user fee is required for an application filed under this section 7.

02 In addition to including all the information required on the Form 3115, the taxpayer also must attach to the Form 3115 a written statement providing: (1) that it agrees to all of the conditions of Rev. Proc. 92-75 and that it will take the net section 481(a) adjustment into account over the appropriate period required by section 5.03 or 5.04; and (2) the period over which the net section 481(a) adjustment will be taken into account and the basis for such conclusion. A Form 3115 filed pursuant to this revenue procedure will not be acknowledged.

03 If it is found that the taxpayer does not qualify for the change in method of accounting under this revenue procedure, the National Office or the district director will so advise the taxpayer and will provide instructions for effecting the requested change in accounting method.

04 In order to assist in the processing of these changes in method of accounting, reference to this revenue procedure must be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "FILED UNDER REV. PROC. 92-75."

05 The Form 3115 must be signed by or on behalf of the taxpayer requesting the change by an individual with the authority to bind the taxpayer in such matters. For example, an officer must sign on behalf of a corporation, a general partner on behalf of a partnership, a trustee on behalf of a trust, or an individual on behalf of a sole proprietorship. See the signature requirements in the General Instructions for Form 3115. If an agent is authorized to represent the taxpayer before the Service, to receive the original or a copy of correspondence concerning the request, or to perform any other act(s) regarding the application on behalf of the taxpayer, a power of attorney reflecting such authorization(s) should be attached to the application. A taxpayer's representative without a power of attorney to represent the taxpayer will not be given any information regarding the application.

06 If the taxpayer is a member of a consolidated group, a Form 3115 submitted on behalf of the taxpayer must be signed by a duly authorized officer of the common parent. See section 1.1502-77 of the regulations.

SEC. 8. MANNER OF EFFECTING TEE CHANGE -- CHANGE TO AN ACCRUAL METHOD IN CONJUNCTION WITH A REQUEST TO CHANGE TO A SPECIAL METHOD

01 SEPARATE APPLICATION REQUIRED.

(1) Except as provided in section 8.02 below, taxpayers to which this revenue procedure applies, and that desire to change to an accrual method in conjunction with a request to change to a special method, must separately apply to obtain the Commissioner's advance consent to change to the special method. Even though this separate application is required to change to a special method, taxpayers can still use the provisions of this revenue procedure to effect the change to an accrual method pending notification of action on their request to use a special method. Taxpayers that desire to use a special method must follow the provisions of section 1.446-1(e)(3)(i) of the regulations to obtain the Commissioner's consent, unless provisions for effecting the use of a special method are provided for by a specific administrative procedure providing expeditious consent to use the special method (e.g., Rev. Proc. 84-76, 1984-2 C.B. 751, which permits taxpayers to expeditiously obtain the consent of the Commissioner to elect to treat prepaid subscription income under the provisions of section 455 of the Code). See section 8.02 of this revenue procedure.

(2) Taxpayers that change their accounting method under this section 8.01 must complete and file a separate Form 3115 (1) for the change to an accrual method and (2) for the change to the special method. With respect to the change to an accrual method, the taxpayer must follow the procedures set forth in section 7. With respect to the change to the special method, and except as otherwise provided by specific administrative procedures applicable to the particular change, the original current Form 3115 must be filed with the National Office and addressed to the Commissioner of Internal Revenue, Attention: CC:IT&A, P.O. Box 7604, Benjamin Franklin Station, Washington, D.C., 20044, no later than 180 days after the beginning of the year of change. A user fee is required for the application requesting a change to a special method.

(3) In order to assist in the processing of these changes in method of accounting, the taxpayer must type or legibly print the following statement on the top of page 1 of each Form 3115: "CHANGE TO A SPECIAL METHOD OF ACCOUNTING -- REV. PROC. 92-75."

(4) If the taxpayer's Form 3115 is approved, the net section 481(a) adjustment relating to the special method, if applicable, must be determined and taken into account in accordance with the applicable terms and conditions associated with the Commissioner's consent. If the taxpayer's Form 3115 is not approved, the taxpayer may change to an overall accrual method in accordance with the provisions of this revenue procedure.

02 SEPARATE APPLICATION NOT REQUIRED.

(1) If the taxpayer can change to the special method by use of an expeditious consent revenue procedure, the taxpayer does not have to separately apply to obtain the Commissioner's advance consent for either the change to an accrual method or the change to the special method. Taxpayers changing their method under this section 8.02 must complete and file a separate Form 3115 (1) for the change to an accrual method and (2) for the change to the special method. With respect to the change to the special method, the taxpayer must follow the applicable procedures outlined in the relevant expeditious consent revenue procedure. with respect to the change to an accrual method, the taxpayer must follow the procedures set forth in section 7.

(2) In order to assist in the processing of these changes in method of accounting, the taxpayer must type or legibly print the following statement on the top of page 1 of Form 3115: "CHANGE TO A SPECIAL METHOD OF ACCOUNTING -- REV. PROC. 92-75 and [insert number of expeditious change revenue procedure]."

03 Examples of a special method are the use of a long-term contract method, the method of accounting for prepaid subscription income provided in section 455 of the Code, or the method of accounting for advance payments pursuant to either Rev. Proc. 71-21, 1971-2 C.B. 549, or section 1.451-5 of the regulations.

04 The provisions of sections 7.05 and 7.06 above, relating to who must submit and sign the Form 3115, are also applicable to this section 8.

SEC. 9. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention: CC:IT&A, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

SEC. 10. EFFECTIVE DATE

The provisions of this revenue procedure are effective September 21, 1992, the date of its publication. Requests for changes in methods of accounting that qualify under this revenue procedure and are received by the National Office after the effective date will be returned to the taxpayer. Taxpayers that have timely filed a Form 3115 with the National Office prior to the effective date of this revenue procedure may use the automatic provisions of this revenue procedure and will be so notified to this effect by the National Office.

SEC. 11. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 85-37 is modified and, as modified, is superseded.

DRAFTING INFORMATION

The principal author of this revenue procedure is Dan McCubbin of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Robert Weiss on (202) 622-5010 (not a toll-free call).