Since our last post regarding the impact of Rev. Proc. 2015-20 on the 2014 filing season, we have fielded many questions about whether taxpayers need to file an election out of Rev. Proc. 2015-20. Below we discuss how Rev. Proc. 2015-20 interacts with the general method change procedures and whether it makes sense for a taxpayer to elect out of Rev. Proc. 2015-20.
General Rules for Method Changes and Rev. Proc. 2015-20
In general, taxpayers may make an automatic change in method of accounting if the change is described in Rev. Proc. 2015-14 and the taxpayer meets the eligibility requirements in §5 of Rev. Proc. 2015-13. These eligibility requirements include that the taxpayer has not engaged in a §381(a) transaction during the year of change, that the year of change is not the final year of the trade or business to which the method change applies, and that the taxpayer has not changed the same method of accounting within the prior five years (including the year of change). The IRS can waive these eligibility requirements. For example, the IRS has waived the eligibility requirements for TPR changes through the 2014 tax year. With the expiration of this waiver in 2015, the five-year item eligibility will once again be in force.
Under this rule, if the taxpayer makes a method change for the same item, for example, a change under DCN 184 from capitalizing costs as improvements to expensing them as repairs, the taxpayer would no longer be able to make the same method change within five years under the automatic consent procedures. For the qualifying small taxpayer under Rev. Proc. 2015-20 who does not file a Form 3115 or an election-out statement, this means that the taxpayer will not be able to file an automatic method change within the scope of Rev. Proc. 2015-20 until 2019. (The affected changes include DCNs 184-193, 205, and 206. Some changes under DCNs 200 and 207 are affected. Though not within the scope of Rev. Proc. 2015-20, filing a Form 3115 for DCN 196 makes the taxpayer ineligible for relief under Rev. Proc. 2015-20.)
Consider a qualifying small taxpayer under Rev. Proc. 2015-20 who has not filed any TPR Forms 3115 and has not filed an election out statement. The IRS will view the taxpayer as having adopted the TPR in 2014 with a §481(a) adjustment of zero. Because the taxpayer has already taken pre-2014 TPR §481(a) adjustments into account, even if the taxpayer files a non-automatic method change in 2016 to comply with the TPR, their §481(a) adjustment is limited to costs paid or incurred during the 2014 and 2015 tax years. The same limitation on the §481(a) adjustment applies even if the taxpayer waits until 2019 to file an automatic method change for affected TPR DCNs. For small taxpayers, this limited §481(a) adjustment presents a more difficult problem than the five-year prior item change rule.
This difficulty lies in how Forms 3115 are treated on exam. An examining agent is free to adjust the amount of a §481(a) adjustment. If the examining agent wants to reject a Form 3115 on exam, however, the agent has to put in a request for Technical Advice from the IRS National Office. Since challenging an invalid Form 3115 is discretionary on the IRS’s part, the most likely resolution of this situation is for an examining agent to adjust the §481(a) adjustment to include only amounts paid or incurred after January 1, 2014. If the IRS takes this approach, however, it may also open an opportunity for qualifying small taxpayers who face unfavorable §481(a) adjustments for pre-2014 years.
Under Rev. Proc. 2015-20, qualifying small taxpayers do not receive back year audit protection. Once the pre-2014 tax years have been closed by the statute of limitations, however, it is arguable that the IRS is limited to post-2013 TPR-related §481(a) adjustments when a taxpayer automatically qualifies for the relief provisions of Rev. Proc. 2015-20. Unfortunately, since this approach would require a practitioner to take a return filing position contrary to a regulation (presumably without a good faith challenge to the validity of the regulations and perhaps without a reasonable basis as well), it may not meet ethical or professional standards even with disclosure.
Given these different scenarios, how should a tax practitioner approach electing out of Rev. Proc. 2015-20?
First, practitioners should assess whether a taxpayer appears to have pre-2014 favorable, TPR-related adjustments by examining the fixed asset ledger and supporting records. If so, the taxpayer should be advised to elect out of Rev. Proc. 2015-20 to preserve these adjustments when filing a later method change. If the practitioner determines that the taxpayer appears to have pre-2014, TPR-related deficiencies, on the other hand, the taxpayer should be advised on the choice between filing under Rev. Proc. 2015-20 or Rev. Procs. 2015-13 and 2015-14 and how it relates to back year audit protection.
Second, the type of entity should be considered. Calendar-year corporations, (both C and S), will no longer be able to file an amended or superseding return under regulation §301.9100-2 to elect out of Rev. Proc. 2015-20 after the extended filing deadline of September 15th. Calendar year individuals and partnerships will be able to use this regulation to elect out of Rev. Proc. 2015-20 until October 15. Finally, if it is too late in the filing season to re-examine corporate returns, practitioners should ponder how the IRS’s approach to this issue might evolve and how the practitioner community might successfully challenge the scenarios we have described above. At the present time, electing out of Rev. Proc. 2015-20 is not required, but it appears to be the best way to preserve pre-2014 favorable, TPR-related §481(a) adjustments.
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