Taxable income must be computed under the method of accounting regularly used by the taxpayer in keeping its books. An accounting method is a set of rules used to determine when and how income and expenses are taken into account for federal income tax purposes. A taxpayer filing its first return may adopt any permissible method of accounting. This method is binding typically after a year; but the taxpayer may elect to change to another permissible method. However, it must secure the consent of the Commissioner before changing [IRC section 446(e) and Treas. Reg. 1.446-1(e)].

On August 12, 2021, the IRS issued a 70-page Revenue Procedure (Rev. Proc. 2021-34) that modifies and amplifies Rev. Proc. 2019-43 to provide procedures to obtain automatic consent of the Commissioner to change methods of accounting to comply with:

• Rules relating to the taxable year of inclusion in gross income under IRC Section 451(b).

• Rules relating to the use of the deferral method for advance payments under IRC Section 451(c).

• Rules clarifying that an item of income that is subject to the timing rules under IRC Section 451(b), such as specified credit card fees, is not taken into account in determining the amount of original issue discount (OID) on a debt instrument.

These rules are generally applicable for taxable years beginning on or after January 1, 2021.

Rev. Proc. 2019-43 is a 377-page document that contains the current list of automatic changes. It was issued on November 8, 2019 and amplifies, modifies and mostly supersedes the 2018 list of automatic accounting method changes enumerated in Revenue Procedure 2018-31. This includes but not limited to advances made by lawyer on behalf of clients, materials and supplies, repair and maintenance costs, computer software expenditures, changes from incorrect to correct depreciation methods, startup expenditures and organizational expenditures, capital expenditures, deferred compensation, and advance rentals.

Background

IRC Section 451 provides the general rule on finding the appropriate year to include taxable income. Treasury Regulation Section 1.451-1(a) provides that accrual method taxpayers generally include an item of gross income in the tax year that all events occur that fixes the right to receive the income and the amount is determinable with reasonable accuracy (the “all events” test Income Inclusion Rule). All the events that fix the right to receive income occur when (1) the service is performed or the merchandise is delivered and accepted, (2) payment is due, or (3) payment is received, whichever comes first.

The Tax Cuts and Jobs Act (TCJA) amended Section 451(b) to codify the “all events” test by providing that:

• For a taxpayer using an accrual method of accounting, the all events test for any item of gross income, or portion thereof, is met no later than when that item, or portion thereof, is taken into account as revenue in an applicable financial statement (AFS Income Inclusion Rule).

As a result, for accrual method taxpayers, income should be recognized at the earlier of when the all events test is met or when an income item, or a portion of an income item, is taken into account as revenue in the taxpayer’s AFS.

• Credit card late fees, credit card cash advance fees, and interchange fees be subject to the AFS Income Inclusion Rule instead of the original issue discount (OID) timing rules, which is the way those fees have been historically treated for federal income tax purposes.

The TCJA amended Section 451(c) to provide that an accrual method taxpayer may use the deferral method of accounting in Section 451(c) for advance payments.

The Department of Treasury and the IRS published on September 9, 2019 proposed regulations and issued on December 30, 2020 final regulations under Sections 1.451-3, 1-451-8, and 1-1275-2(I) to clarify the TCJA changes.

Actions to Take

A taxpayer who wants to change its accounting method to comply with final regulations under Sections 1.451-3, 1-451-8, and 1-1275-2(I), as applicable, must secure the consent of the Commissioner before changing a method of accounting [IRC Section 446(e) and Treas. Reg. 1.446-1(e)]. The taxpayer may follow the automatic consent procedures to obtain the IRS’ consent.

The taxpayer requests that consent or notifies the IRS of the adoption of a method of accounting by filing Form 3115, Application for Change in Accounting Method, during the taxable year in which the taxpayer desires to make the proposed change [Treas. Reg. 1.446-1(e)(3)(i)].

If a taxpayer uses the automatic consent procedure to request a change in accounting method, for the consent to be effective, the taxpayer must comply with all the terms and conditions of the applicable revenue procedure.

The change in method of accounting indicated on the Form 3115 is automatically granted if the taxpayer properly files the application for an automatic consent. It doesn’t matter whether the taxpayer actually implemented on the tax return the changes requested on the Form 3115 or not (TC Memo 2015-99, May 27, 2015).

Mathieu Aimlon, CPA, Expert-comptable diplômé, France (non inscrit), is a principal at Aimlon CPA P.C., which provides comprehensive accounting, auditing, and tax services to businesses and nonprofit organizations throughout the United States and in France.