Accounting Methods: 174 Options for Federal Income Tax Reporting

Transcription

1 Accounting Methods: 174 Options for Federal Income Tax Reporting Edward K Zollars Phoenix, Arizona Nichols Patrick CPE, Inc. ed@tzlcpas.com 2 1

2 Accounting Methods BACKGROUND 3 446(e) (e) Requirement respecting change of accounting method Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary. 4 2

3 446(e) (e) Requirement respecting change of accounting method Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary (e) (e) Requirement respecting change of accounting method Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary. 6 3

4 446(e) (e) Requirement respecting change of accounting method Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary. 7 Form

5 IRS Streamlining Revenue Procedure automatic changes Revenue Procedure Revenue Procedure Revenue Procedure Revenue Procedure Revenue Procedure Ad hoc additional provisions added 9 IRS Streamlining Revenue Procedure automatic changes Revenue Procedure Revenue Rulings Procedure Later in Time Specify Effect on Earlier Rulings and Revenue Generally Procedure Take Precedence Revenue Procedure Revenue Procedure Ad hoc additional provisions added 10 5

6 Accounting Methods INTRODUCTION

7 Accounting Method Definition 13 IRC 446(a) Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. 14 7

8 IRC 446(a) Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books

9 17 IRC 446(b) If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income. 18 9

10 IRC 446(b) If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income. 19 IRC 446(b) If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income

11 Accounting Methods & Clients

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13 Methods in General Impact timing of recognition, not ultimate amount Item is a method even if disallowed under the IRC Unlike an error, is repeated 25 Beyond Clearly Reflect May have statutory limitations beyond clearly reflect For example: 448 limitation on cash basis C corporations only (does not apply to S corporations, partnerships without C partners, etc.) Personal service corporations exemption $5 million revenue cap 26 13

14 448 Limitation on Cash Method of Accounting (a) General rule Except as otherwise provided in this section, in the case of a-- (1) C corporation, (2) partnership which has a C corporation as a partner, or (3) tax shelter, taxable income shall not be computed under the cash receipts and disbursements method of accounting Limitation on Cash Method of Accounting (a) General rule Except as otherwise provided in this section, in the case of a-- More Specific IRC Section Overrides (1) C corporation, (2) partnership which has a C corporation as a partner, or (3) tax shelter, General Provision taxable income shall not be computed under the cash receipts and disbursements method of accounting

15 Example Taxpayer receives a bill for $500 for utilities on 12/5/13, pays the bill on 12/28/13. Bills client for $1,000 of services on 12/15/13 and client pays entire bill on 1/10/ Income Tax Reporting Cash Basis Revenue recognized - $0 Expense recognized - $500 Net loss for year ($500) Accrual Basis Revenue recognized - $1,000 Expense recognized $500 Net income for year $

16 2014 Income Tax Reporting Cash Basis Revenue recognized - $1,000 Expense recognized - $0 Net income for year $1,000 Accrual Basis Revenue recognized - $0 Expense recognized - $0 Net income for year - $0 31 Combined Income Tax Reporting Cash Basis Revenue recognized - $1,000 Expense recognized - $500 Net income for two years $500 Accrual Basis Revenue recognized - $1,000 Expense recognized - $500 Net income for year - $

17 Goals of Course 33 Accounting Methods GENERAL RULES 34 17

18 IRC Subtitle A, Chapter 1, Subchapter E, Part II General Rules 446 General Rule for Methods of Accounting 451 General Rule for Taxable Year of Inclusion 461 General Rule for Taxable Year of Deduction 471 General Rule for Inventories 35 Overarching Limitation 482 Allocation of income and deductions among taxpayers Issue of items between related taxpayers 36 18

19 General Rules 446 GENERAL RULES FOR METHODS OF ACCOUNTING 37 IRC 446(a) Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books

20 IRC 446(a) Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books (e) (e) Requirement respecting change of accounting method Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary

21 What is a Method of Accounting? 41 What is a Method of Accounting? Reg (a) Gives Definition 42 21

22 Reg (a) The term "method of accounting" includes not only the overall method of accounting of the taxpayer but also the accounting treatment of any item. 43 Reg (a) The term "method of accounting" includes not only the overall method of accounting of the taxpayer but also the accounting treatment of any item

23 Reg (a) The term "method of accounting" includes not only the overall method of accounting of the taxpayer but also the accounting treatment of any item. 45 Reg (a) Examples of Methods 46 23

24 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 47 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 48 24

25 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 49 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 50 25

26 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 51 Reg (a) Examples of Methods Examples of such over-all methods are the cash receipts and disbursements method, an accrual method, combinations of such methods, and combinations of the foregoing with various methods provided for the accounting treatment of special items 52 26

27 Reg (a) Examples of Methods These methods of accounting for special items include the accounting treatment prescribed for research and experimental expenditures, soil and water conservation expenditures, depreciation, net operating losses, etc. 53 Reg (a) Examples of Methods These methods of accounting for special items include the accounting treatment prescribed for research and experimental expenditures, soil and water conservation expenditures, depreciation, net operating losses, etc

28 Reg (a) Examples of Methods These methods of accounting for special items include the accounting treatment prescribed for research and experimental expenditures, soil and water conservation expenditures, depreciation, net operating losses, etc. 55 Reg (a) Examples of Methods These methods of accounting for special items include the accounting treatment prescribed for research and experimental expenditures, soil and water conservation expenditures, depreciation, net operating losses, etc

29 Reg (a) Primacy of Taxpayers Books Except for deviations permitted or required by such special accounting treatment, taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. 57 Reg (a) Primacy of Taxpayers Books Except for deviations permitted or required by such special accounting treatment, taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books

30 Reg (a) Primacy of Taxpayers Books Except for deviations permitted or required by such special accounting treatment, taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. 59 Reg (a) Primacy of Taxpayers Books Except for deviations permitted or required by such special accounting treatment, taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books

31 How Does a Taxpayer Establish an Accounting Method? 61 How Does a Taxpayer Establish an Accounting Method? Reg Gives Details 62 31

32 Initially Establishment Reg (c)(2)(ii) (ii) No method of accounting will be regarded as clearly reflecting income unless all items of gross profit and deductions are treated with consistency from year to year. 63 Initial Establishment Reg (c)(2)(ii) (ii) No method of accounting will be regarded as clearly reflecting income unless all items of gross profit and deductions are treated with consistency from year to year

33 Initial Establishment Reg (c)(2)(ii) (ii) No method of accounting will be regarded as clearly reflecting income unless all To items Start: of Make gross Your profit Choice and deductions are treated with consistency from year to year. 65 Initial Establishment Reg (c)(2)(ii) (ii) No method of accounting will be regarded as clearly reflecting income unless No Form all items 3115 of or gross Other profit IRS Permission and deductions are treated with consistency from year to year

34 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. 67 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time

35 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. 69 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time

36 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. 71 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time

37 Initial Establishment Reg (e)(1) (1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. 73 General Rules 451 GENERAL RULE FOR TAXABLE YEAR OF INCLUSION 74 37

38 Governs Income Structure Subsection (a) provides general rule Subsections (b) through (i) contains separate special rules impacting income recognition 76 38

39 451(a) General Rule The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period (a) General Rule The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period

40 451(a) General Rule The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period Topics Cash Basis Constructive Receipt Accrual Method Mandated Accrual Method per

41 Cash Basis Recognition governed by Reg (a) Under the cash receipts and disbursements method of accounting, such an amount is includible in gross income when actually or constructively received. 81 Cash Basis Recognition governed by Reg (a) Under the cash receipts and disbursements method of accounting, such an amount is includible in gross income when actually or constructively received

42 Cash Basis Recognition governed by Reg (a) Under the cash receipts and disbursements method of accounting, such an amount is includible in gross income when actually or constructively received. 83 Cash Basis Recognition governed by Reg (a) Under the cash receipts and disbursements method of accounting, such an amount is includible in gross income when actually or constructively received

43 Cash Basis Recognition governed by Reg (a) Under First the to cash Occur receipts Triggers and Inclusion disbursements method of accounting, such an amount is includible in gross income when actually or constructively received. 85 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 86 43

44 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 87 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 88 44

45 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 89 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 90 45

46 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 91 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 92 46

47 Constructive Receipt Reg Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions 93 Not Substantial Restrictions (1) A requirement that the deposit or account, and the earnings thereon, must be withdrawn in multiples of even amounts; 94 47

48 Not Substantial Restrictions (2) The fact that the taxpayer would, by withdrawing the earnings during the taxable year, receive earnings that are not substantially less in comparison with the earnings for the corresponding period to which the taxpayer would be entitled had he left the account on deposit until a later date (for example, if an amount equal to three months' interest must be forfeited upon withdrawal or redemption before maturity of a one year or less certificate of deposit, time deposit, bonus plan, or other deposit arrangement then the earnings payable on premature withdrawal or redemption would be substantially less when compared with the earnings available at maturity); 95 Not Substantial Restrictions (3) A requirement that the earnings may be withdrawn only upon a withdrawal of all or part of the deposit or account. However, the mere fact that such institutions may pay earnings on withdrawals, total or partial, made during the last three business days of any calendar month ending a regular quarterly or semiannual earnings period at the applicable rate calculated to the end of such calendar month shall not constitute constructive receipt of income by any depositor or account holder in any such institution who has not made a withdrawal during such period; 96 48

49 Not Substantial Restrictions (4) A requirement that a notice of intention to withdraw must be given in advance of the withdrawal. In any case when the rate of earnings payable in respect of such a deposit or account depends on the amount of notice of intention to withdraw that is given, earnings at the maximum rate are constructively received during the taxable year regardless of how long the deposit or account was held during the year or whether, in fact, any notice of intention to withdraw is given during the year However, if in the taxable year of withdrawal the depositor or account holder receives a lower rate of earnings because he failed to give the required notice of intention to withdraw, he shall be allowed an ordinary loss in such taxable year in an amount equal to the difference between the amount of earnings previously included in gross income and the amount of earnings actually received. See section 165 and the regulations thereunder. 97 Substantial Restriction Shiner v. Turnoy, 114 AFTR 2d , USDC ED IL, 7/11/14 Update recent case Back of check stated endorsing check released all claims No constructive receipt applied to check 98 49

50 Examples of Constructive Receipt Amounts payable with respect to interest coupons which have matured and are payable but which have not been cashed are constructively received in the taxable year during which the coupons mature, unless it can be shown that there are no funds available for payment of the interest during such year. 99 Examples of Constructive Receipt Dividends on corporate stock are constructively received when unqualifiedly made subject to the demand of the shareholder. However, if a dividend is declared payable on December 31 and the corporation followed its usual practice of paying the dividends by checks mailed so that the shareholders would not receive them until January of the following year, such dividends are not considered to have been constructively received in December

51 Accrual Basis Reg (a) Governed by right to receive income Fact not yet received in cash not relevant 101 Reg (a) Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy

52 Reg (a) Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. 103 Reg (a) Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy

53 Reg (a) Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. 105 Mandatory Accrual Merchandise is a significant income producing factor Large C corporations and tax shelters under

54 Inventory Rule (c)(2)(i) (i) In any case in which it is necessary to use an inventory the accrual method of accounting must be used with regard to purchases and sales unless otherwise authorized under subdivision (ii) of this subparagraph 107 Inventory Rule (c)(2)(i) (i) In any case in which it is necessary to use an inventory the accrual method of accounting must be used with regard to purchases and sales unless otherwise authorized under subdivision (ii) of this subparagraph

55 When Is It Necessary to Use Inventories? 109 When Is It Necessary to Use Inventories? Reg (a) Gives Details

56 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. 111 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor

57 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. 113 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor

58 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor. 115 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor

59 Reg In order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor C Corporation/Tax Shelter Unless exempt otherwise, the following must use accrual basis C corporation; Partnership with a C corporation partner Tax shelter

60 Tax Shelter Definition 119 Tax Shelter Definition 448(d)(3) defines by reference to IRC 461(i)(3) with potential exclusion for S corporations required to file notice with State agency 461(i)(3) defines a shelter as Enterprise other than a C corporation that has to register interests with agency Syndicate (reference to 1256(e)(3)(B) Tax shelter (reference to 6662(d)(2)(C)(ii))

61 Syndicate The term "syndicate" means any partnership or other entity (other than a corporation which is not an S corporation) if more than 35 percent of the losses of such entity during the taxable year are allocable to limited partners or limited entrepreneurs (within the meaning of section 464(e)(2)). 121 Syndicate The term "syndicate" means any partnership or other entity (other than a corporation which is not an S corporation) if more than 35 percent of the losses of such entity during the taxable year are allocable to limited partners or limited entrepreneurs (within the meaning of section 464(e)(2))

62 Syndicate The term "syndicate" means any partnership or other entity (other than a corporation which is not an S corporation) if more than 35 percent of the losses of such entity during the taxable year are allocable to limited partners or limited entrepreneurs (within the meaning of section 464(e)(2)). 123 Limited Entrepreneurs 464(e) The term "limited entrepreneur" means a person who (A) has an interest in an enterprise other than as a limited partner, and (B) does not actively participate in the management of such enterprise

63 6662 Tax Shelter Tax Shelter For purposes of clause (i), the term "tax shelter" means -- (I) a partnership or other entity,(ii) any investment plan or arrangement, or (III) any other plan or arrangement, if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax

64 Exceptions if Not a Tax Shelter 448(b) Farming or tree raising business Qualified personal service corporations Entities with gross receipts of less than $5,000,000 Always met test in past and Average revenue for past three years is less than $5,000,000 Use expanded controlled group test 127 Contingencies Under all events test recognize only when future contingent event occurs Must recognize if Liability admitted by debtor Debtor creditworthy and Amount can be reasonably estimated

65 Advance Payment for Services Receipt generally triggers recognition Can elect to use method outlined in Revenue Procedure , as modified by later rulings if Received under agreement requiring all services to be performed by end of following year Reflect deferral in applicable financial statement Get IRS approval to change method 129 Advance Payment Merchandise or Construction Reported at earlier of When properly includable under taxpayer s tax method of accounting or When reflected in taxpayer s applicable financial statement [Reg (b)]

66 Deposits Security deposits Taxpayer must return unless applied Liability to return must be real Cannot defer deposits that represent amounts guaranteeing payments of amounts owed to taxpayer 131 General Rules 461 GENERAL RULE FOR YEAR OF DEDUCTION

67 Deductions 133 Cash Basis Reg (a) Under the cash receipts and disbursements method of accounting, amounts representing allowable deductions shall, as a general rule, be taken into account for the taxable year in which paid

68 Cash Basis Reg (a) Under the cash receipts and disbursements method of accounting, amounts representing allowable deductions shall, as a general rule, be taken into account for the taxable year in which paid. 135 Cash Basis Reg (a) If an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which made

69 Cash Basis Reg (a) If an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which made. 137 Cash Basis Reg (a) If an expenditure results in the creation of an asset having a useful life which extends substantially beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which made

70 Accrual Basis All events test of Reg (a)(2) Fact of the liability must be established and Amount of liability must be able to be determined with reasonable accuracy Otherwise must wait to deduct expense until both tests met 139 Contested Liability 461(f) (f) Contested liabilities If (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of subsection (h), then the deduction shall be allowed for the taxable year of the transfer

71 Contested Liability 461(f) (f) Contested liabilities If (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of subsection (h), then the deduction shall be allowed for the taxable year of the transfer. 141 Contested Liability 461(f) (f) Contested liabilities If (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of subsection (h), then the deduction shall be allowed for the taxable year of the transfer

72 Contested Liability 461(f) (f) Contested liabilities If (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of subsection (h), then the deduction shall be allowed for the taxable year of the transfer. 143 Contested Liability 461(f) (f) Contested liabilities If (1) the taxpayer contests an asserted liability, (2) the taxpayer transfers money or other property to provide for the satisfaction of the asserted liability, (3) the contest with respect to the asserted liability exists after the time of the transfer, and (4) but for the fact that the asserted liability is contested, a deduction would be allowed for the taxable year of the transfer (or for an earlier taxable year) determined after application of subsection (h), then the deduction shall be allowed for the taxable year of the transfer

73 Related Cash Basis Taxpayer IRC 267(a)(2) If (A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and (B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b), then any deduction allowable under this chapter in respect of such amount shall be allowable as of the day as of which such amount is includible in the gross income of the person to whom the payment is made (or, if later, as of the day on which it would be so allowable but for this paragraph). 145 Related Cash Basis Taxpayer IRC 267(a)(2) If (A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and (B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b), then any deduction allowable under this chapter in respect of such amount shall be allowable as of the day as of which such amount is includible in the gross income of the person to whom the payment is made (or, if later, as of the day on which it would be so allowable but for this paragraph)

74 Related Cash Basis Taxpayer IRC 267(a)(2) If (A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and (B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b), then any deduction allowable under this chapter in respect of such amount shall be allowable as of the day as of which such amount is includible in the gross income of the person to whom the payment is made (or, if later, as of the day on which it would be so allowable but for this paragraph). 147 Related Cash Basis Taxpayer IRC 267(a)(2) If (A) by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not (unless paid) includible in the gross income of such person, and (B) at the close of the taxable year of the taxpayer for which (but for this paragraph) the amount would be deductible under this chapter, both the taxpayer and the person to whom the payment is to be made are persons specified in any of the paragraphs of subsection (b), then any deduction allowable under this chapter in respect of such amount shall be allowable as of the day as of which such amount is includible in the gross income of the person to whom the payment is made (or, if later, as of the day on which it would be so allowable but for this paragraph)

75 Related Individuals 267(b) Members of a family 149 Related Individuals 267(b) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual

76 Related Individuals 267(b) Two corporations which are members of the same controlled group 151 Related Individuals 267(b) A grantor and a fiduciary of any trust

77 Related Individuals 267(b) A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts 153 Related Individuals 267(b) A fiduciary of a trust and a beneficiary of such trust

78 Related Individuals 267(b) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts 155 Related Individuals 267(b) A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust

79 Related Individuals 267(b) A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual 157 Related Individuals 267(b) A corporation and a partnership if the same persons own-- (A) more than 50 percent in value of the outstanding stock of the corporation, and (B) more than 50 percent of the capital interest, or the profits interest, in the partnership

80 Related Individuals 267(b) A corporation and a partnership if the same persons own-- (A) more than 50 percent in value of the outstanding stock of the corporation, and (B) more than 50 percent of the capital interest, or the profits interest, in the partnership 159 Related Individuals 267(b) An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation

81 Related Individuals 267(b) An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation 161 Related Individuals 267(b) Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate

82 Passthrough Entities 267(e) In the case of any amount paid or incurred by, to, or on behalf of, a pass-thru entity, for purposes of applying subsection (a)(2)-- (A) such entity, (B) in the case of-- (i) a partnership, any person who owns (directly or indirectly) any capital interest or profits interest of such partnership, or (ii) an S corporation, any person who owns (directly or indirectly) any of the stock of such corporation, (C) any person who owns (directly or indirectly) any capital interest or profits interest of a partnership in which such entity owns (directly or indirectly) any capital interest or profits interest, and (D) any person related (within the meaning of subsection (b) of this section or section 707(b)(1)) to a person described in subparagraph (B) or (C), shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C) shall apply to a transaction only if such transaction is related either to the operations of the partnership described in such subparagraph or to an interest in such partnership. 163 Passthrough Entities 267(e) In the case of any amount paid or incurred by, to, or on behalf of, a pass-thru entity, for purposes of applying subsection (a)(2)-- (A) such entity, (B) in the case of-- (i) a partnership, any person who owns (directly or indirectly) any capital interest or profits interest of such partnership, or (ii) an S corporation, any person who owns (directly or indirectly) any of the stock of such corporation, (C) any person who owns (directly or indirectly) any capital interest or profits interest of a partnership in which such entity owns (directly or indirectly) any capital interest or profits interest, and (D) any person related (within the meaning of subsection (b) of this section or section 707(b)(1)) to a person described in subparagraph (B) or (C), shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C) shall apply to a transaction only if such transaction is related either to the operations of the partnership described in such subparagraph or to an interest in such partnership

83 Passthrough Entities 267(e) In the case of any amount paid or incurred by, to, or on behalf of, a pass-thru entity, for purposes of applying subsection (a)(2)-- (A) such entity, (B) in the case of-- (i) a partnership, any person who owns (directly or indirectly) any capital interest or profits interest of such partnership, or (ii) an S corporation, any person who owns (directly or indirectly) any of the stock of such corporation, (C) any person who owns (directly or indirectly) any capital interest or profits interest of a partnership in which such entity owns (directly or indirectly) any capital interest or profits interest, and (D) any person related (within the meaning of subsection (b) of this section or section 707(b)(1)) to a person described in subparagraph (B) or (C), shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C) shall apply to a transaction only if such transaction is related either to the operations of the partnership described in such subparagraph or to an interest in such partnership. 165 Passthrough Entities 267(e) In the case of any amount paid or incurred by, to, or on behalf of, a pass-thru entity, for purposes of applying subsection (a)(2)-- (A) such entity, (B) in the case of-- (i) a partnership, any person who owns (directly or indirectly) any capital interest or profits interest of such partnership, or (ii) an S corporation, any person who owns (directly or indirectly) any of the stock of such corporation, (C) any person who owns (directly or indirectly) any capital interest or profits interest of a partnership in which such entity owns (directly or indirectly) any capital interest or profits interest, and (D) any person related (within the meaning of subsection (b) of this section or section 707(b)(1)) to a person described in subparagraph (B) or (C), shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C) shall apply to a transaction only if such transaction is related either to the operations of the partnership described in such subparagraph or to an interest in such partnership

84 Passthrough Entities 267(e) In the case of any amount paid or incurred by, to, or on behalf of, a pass-thru entity, for purposes of applying subsection (a)(2)-- (A) such entity, (B) in the case of-- (i) a partnership, any person who owns (directly or indirectly) any capital interest or profits interest of such partnership, or (ii) an S corporation, any person who owns (directly or indirectly) any of the stock of such corporation, (C) any person who owns (directly or indirectly) any capital interest or profits interest of a partnership in which such entity owns (directly or indirectly) any capital interest or profits interest, and (D) any person related (within the meaning of subsection (b) of this section or section 707(b)(1)) to a person described in subparagraph (B) or (C), shall be treated as persons specified in a paragraph of subsection (b). Subparagraph (C) shall apply to a transaction only if such transaction is related either to the operations of the partnership described in such subparagraph or to an interest in such partnership. 167 General Rules 471-GENERAL RULE FOR INVENTORIES

85 Cash Basis Revenue Procedures Rev. Proc Less than $1,000,000 average gross sales Account for materials and supplies under Reg No limit on type of business (essentially exempted from 471) Rev. Proc Average gross receipts less than $10,000,000 Account for materials and supplies under Reg List of prohibited business types C corporations still must meet 448 tests 169 General Rules 482 ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS

86 IRC 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible. 171 IRC 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible

87 IRC 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible. 173 IRC 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible

88 IRC 482 In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible. 175 Penalties ( 6662) 20% Penalty [ 6662(e)] U.S. Taxation of International Transactions Price is 200% more or 50% less of correct figure Underpayment > $5,000 ($10,000 for non-phc C corporations) 50% Penalty [ 6662(h)] No reasonable cause exception Claimed value 200% or more of correct value

89 Accounting Methods SPECIAL RULES 177 Previously Covered 448 C corporation/tax shelter limits on cash basis Cash basis revenue procedures [Rev. Proc and ]

90 Installment Method 179 IRC 453 (a) General rule Except as otherwise provided in this section, income from an installment sale shall be taken into account for purposes of this title under the installment method

91 IRC 453 (a) General rule Except as otherwise provided in this section, income from an installment sale shall be taken into account for purposes of this title under the installment method. 181 IRC 453 (c) Installment method defined For purposes of this section, the term installment method means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price

92 IRC 453 (c) Installment method defined For purposes of this section, the term installment method means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price. 183 IRC 453 (c) Installment method defined For purposes of this section, the term installment method means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price

93 IRC 453 (c) Installment method defined For purposes of this section, the term installment method means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price. 185 (d) Election out IRC 453 (1) In general Subsection (a) shall not apply to any disposition if the taxpayer elects to have subsection (a) not apply to such disposition. (2) Time and manner for making election Except as otherwise provided by regulations, an election under paragraph (1) with respect to a disposition may be made only on or before the due date prescribed by law (including extensions) for filing the taxpayer's return of the tax imposed by this chapter for the taxable year in which the disposition occurs. Such an election shall be made in the manner prescribed by regulations. (3) Election revocable only with consent An election under paragraph (1) with respect to any disposition may be revoked only with the consent of the Secretary

94 (d) Election out IRC 453 (1) In general Subsection (a) shall not apply to any disposition if the taxpayer elects to have subsection (a) not apply to such disposition. (2) Time and manner for making election Except as otherwise provided by regulations, an election under paragraph (1) with respect to a disposition may be made only on or before the due date prescribed by law (including extensions) for filing the taxpayer's return of the tax imposed by this chapter for the taxable year in which the disposition occurs. Such an election shall be made in the manner prescribed by regulations. (3) Election revocable only with consent An election under paragraph (1) with respect to any disposition may be revoked only with the consent of the Secretary. 187 Late Election Before Extended Due Date Six Month Rule found in Reg (b) Effectively meant to not penalize those who don t wait until October 15 to file Only for a late election, not for reversing already made election After Extended Due Date Governed by Reg. 15a.453-1(d)(3)(ii) Examples found at Rev. Proc

95 Six Month Rule Reg (b) Automatic 6-month extension. An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose due dates are the due date of the return or the due date of the return including extensions provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6- month extension period. This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions 189 Six Month Rule Reg (b) Automatic 6-month extension. An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose due dates are the due date of the return or the due date of the return including extensions provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6- month extension period. This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions

96 Six Month Rule Reg (b) Automatic 6-month extension. An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose due dates are the due date of the return or the due date of the return including extensions provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6- month extension period. This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions 191 Six Month Rule Reg (b) Automatic 6-month extension. An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose due dates are the due date of the return or the due date of the return including extensions provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6- month extension period. This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions

97 Rev. Proc Examples In 1985, taxpayer A sold real estate for cash and an installment note. Under the terms of the note, A is to receive monthly payments until On A's 1985 federal income tax return, A used the installment method to report only part of the gain from the sale. A reported this gain as a long-term capital gain. In the Tax Reform Act of 1986, Congress eliminated the 60 percent net capital gain deduction and reduced the maximum effective tax rate on the taxable income of individuals to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. Because of this increase in the maximum effective tax rate, A in 1987 properly requested permission from the IRS to elect out of the installment method of reporting the gain on the 1985 sale and to report the entire gain from that sale on an amended 1985 federal income tax return. 193 Rev. Proc Examples In 1985, taxpayer A sold real estate for cash and an installment note. Under the terms of the note, A is to receive monthly payments until On A's 1985 federal income tax return, A used the installment method to report only part of the gain from the sale. A reported this gain as a long-term capital gain. In the Tax Reform Act of 1986, Congress eliminated the 60 percent net capital gain deduction and reduced the maximum effective tax rate on the taxable income of individuals to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. Because of this increase in the maximum effective tax rate, A in 1987 properly requested permission from the IRS to elect out of the installment method of reporting the gain on the 1985 sale and to report the entire gain from that sale on an amended 1985 federal income tax return

98 Rev. Proc Examples In 1985, taxpayer A sold real estate for cash and an installment note. Under the terms of the note, A is to receive monthly payments until On A's 1985 federal income tax return, A used the installment method to report only part of the gain from the sale. A reported this gain as a long-term capital gain. In the Tax Reform Act of 1986, Congress eliminated the 60 percent net capital gain deduction and reduced the maximum effective tax rate on the taxable income of individuals to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. A in 1987 properly requested permission from the IRS to elect out of the installment method of reporting the gain on the 1985 sale and to report the entire gain from that sale on an amended 1985 federal income tax return. 195 Rev. Proc Examples In 1985, taxpayer A sold real estate for cash and an installment note. Under the terms of the note, A is to receive monthly payments until On A's 1985 federal income tax return, A used the installment method to report only part of the gain from the sale. A reported this gain as a long-term capital gain. In the Tax Reform Act of 1986, Congress eliminated the 60 percent net capital gain deduction and reduced the maximum effective tax rate on the taxable income of individuals to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. A in 1987 properly requested permission from the IRS to elect out of the installment method of reporting the gain on the 1985 sale and to report the entire gain from that sale on an amended 1985 federal income tax return

99 Rev. Proc Examples 197 Rev. Proc Examples When A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453-1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method

100 Rev. Proc Examples When A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453-1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method. 199 Rev. Proc Examples When A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453-1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method

101 Rev. Proc Examples When A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453-1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method. 201 Rev. Proc Examples When A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453-1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method

102 Rev. Proc Examples In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale. On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. 203 Rev. Proc Examples In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale. On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request

103 Rev. Proc Examples In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale. On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. 205 Rev. Proc Examples In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale. On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request

104 Rev. Proc Examples In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale. On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. 207 Rev. Proc Examples

105 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method. 209 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method

106 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method. 211 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method

107 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method. 213 Rev. Proc Examples When C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake Generally and within a reasonable Professional time after the Must return was Admit filed, C properly requested permission from the National Office of the IRS to make the election out of the installment He/She method of reporting Made the an gain Error. on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request. If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method

108 Contingent Selling Price Reg. 15a.453-1(c)(1) Unless the taxpayer otherwise elects in the manner prescribed in paragraph (d)(3) of this section, contingent payment sales are to be reported on the installment method. As used in this section, the term "contingent payment sale" means a sale or other disposition of property in which the aggregate selling price cannot be determined by the close of the taxable year in which such sale or other disposition occurs. 215 Contingent Selling Price Reg. 15a.453-1(c)(1) Unless the taxpayer otherwise elects in the manner prescribed in paragraph (d)(3) of this section, contingent payment sales are to be reported on the installment method. As used in this section, the term "contingent payment sale" means a sale or other disposition of property in which the aggregate selling price cannot be determined by the close of the taxable year in which such sale or other disposition occurs

109 Contingent Selling Price Reg. 15a.453-1(c)(1) Unless the taxpayer otherwise elects in the manner prescribed in paragraph (d)(3) of this section, contingent payment sales are to be reported on the installment method. As used in this section, the term "contingent payment sale" means a sale or other disposition of property in which the aggregate selling price cannot be determined by the close of the taxable year in which such sale or other disposition occurs. 217 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) A contingent payment sale will be treated as having a stated maximum selling price if, under the terms of the agreement, the maximum amount of sale proceeds that may be received by the taxpayer can be determined as of the end of the taxable year in which the sale or other disposition occurs. The stated maximum selling price shall be determined by assuming that all of the contingencies contemplated by the agreement are met or otherwise resolved in a manner that will maximize the selling price and accelerate payments to the earliest date or dates permitted under the agreement

110 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) A contingent payment sale will be treated as having a stated maximum selling price if, under the terms of the agreement, the maximum amount of sale proceeds that may be received by the taxpayer can be determined as of the end of the taxable year in which the sale or other disposition occurs. The stated maximum selling price shall be determined by assuming that all of the contingencies contemplated by the agreement are met or otherwise resolved in a manner that will maximize the selling price and accelerate payments to the earliest date or dates permitted under the agreement. 219 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) A contingent payment sale will be treated as having a stated maximum selling price if, under the terms of the agreement, the maximum amount of sale proceeds that may be received by the taxpayer can be determined as of the end of the taxable year in which the sale or other disposition occurs. The stated maximum selling price shall be determined by assuming that all of the contingencies contemplated by the agreement are met or otherwise resolved in a manner that will maximize the selling price and accelerate payments to the earliest date or dates permitted under the agreement

111 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) A contingent payment sale will be treated as having a stated maximum selling price if, under the terms of the agreement, the maximum amount of sale proceeds that may be received by the taxpayer can be determined as of the end of the taxable year in which the sale or other disposition occurs. The stated maximum selling price shall be determined by assuming that all of the contingencies contemplated by the agreement are met or otherwise resolved in a manner that will maximize the selling price and accelerate payments to the earliest date or dates permitted under the agreement. 221 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) A contingent payment sale will be treated as having a stated maximum selling price if, under the terms of the agreement, the maximum amount of sale proceeds that may be received by the taxpayer can be determined as of the end of the taxable year in which the sale or other disposition occurs. The stated maximum selling price shall be determined by assuming that all of the contingencies contemplated by the agreement are met or otherwise resolved in a manner that will maximize the selling price and accelerate payments to the earliest date or dates permitted under the agreement

112 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) Except as provided in paragraph (c)(2)(ii) and (7) of this section (relating to certain payment recomputations), the taxpayer's basis shall be allocated to payments received and to be received under a stated maximum selling price agreement by treating the stated maximum selling price as the selling price for purposes of paragraph (b) of this section Maximum Selling Price Reg. 15a.453-1(c)(2)(i) The stated maximum selling price, as initially determined, shall thereafter be treated as the selling price unless and until that maximum amount is reduced, whether pursuant to the terms of the original agreement, by subsequent amendment, by application of the payment recharacterization rule (described in paragraph (c)(2)(ii) of this section), or by a subsequent supervening event such as bankruptcy of the obligor. When the maximum amount is subsequently reduced, the gross profit ratio will be recomputed with respect to payments received in or after the taxable year in which an event requiring reduction occurs

113 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) The stated maximum selling price, as initially determined, shall thereafter be treated as the selling price unless and until that maximum amount is reduced, whether pursuant to the terms of the original agreement, by subsequent amendment, by application of the payment recharacterization rule (described in paragraph (c)(2)(ii) of this section), or by a subsequent supervening event such as bankruptcy of the obligor. When the maximum amount is subsequently reduced, the gross profit ratio will be recomputed with respect to payments received in or after the taxable year in which an event requiring reduction occurs. 225 Maximum Selling Price Reg. 15a.453-1(c)(2)(i) The stated maximum selling price, as initially determined, shall thereafter be treated as the selling price unless and until that maximum amount is reduced, whether pursuant to the terms of the original agreement, by subsequent amendment, by application of the payment recharacterization rule (described in paragraph (c)(2)(ii) of this section), or by a subsequent supervening event such as bankruptcy of the obligor. When the maximum amount is subsequently reduced, the gross profit ratio will be recomputed with respect to payments received in or after the taxable year in which an event requiring reduction occurs

114 No Maximum Selling Price? If maximum number of years, basis recovered ratably over that period [Reg. 15a.453-1(c)(3)] 227 No Maximum Selling Price? If neither maximum payment or maximum period can be determined Will be scrutinized to see if truly rental or royalty If deemed truly a sale Recover basis over 15 years subject to limits [Reg. 15a.453-1(c)(4)] Alternative show method that would avoid substantial distortion (with IRS permission) [Reg. 15a.453-1(c)(4)]

115 460 Long Term Contracts Definition Generally building, installation, contracting or manufacturing contract not completed in year entered into [ 460(f)(1)] Manufacturing contract has additional requirements [ 460(f)(2)] Unique items not normally carried in finished goods inventory or Items requiring more than 12 months to complete 229 Percentage of Completion Generally required for long term contracts Determined using cost to cost method [ 460(b)(1)(A) & Reg (b)(1)] Optional methods (choose no more than one) Simplified method [ 460(b)(3)] 10% deferral method [ 460(b)(5)]

116 Exceptions to PCM Home construction contracts Small construction contractor Less than $10 million average annual gross receipts and Contract less than 2 years from start date 231 Look Back Rule

117 Completed Contract Limitations on Deductions for Certain Farming Expenses

118 Excess Prepaid Farm Supplies The term "excess prepaid farm supplies" means the prepaid farm supplies for the taxable year to the extent the amount of such supplies exceeds 50 percent of the deductible farming expenses for the taxable year (other than prepaid farm supplies). 235 Farm Supplies Feed, seed, fertilizer, or similar items [ 464(a)] Certain poultry [ 464(b)]

119 Timing of Deduction Excess prepaid not allowed as deduction until used Exceptions for qualified farm related taxpayer if Aggregate prepaid farm supplies for prior 3 years are than 50% of aggregate of deductible farm expenses for the 3 years or Excess exists due to change in business operation directly attributable to extraordinary circumstances 237 Accounting Methods 481(A) ADJUSTMENT SPREAD PERIOD

120 IRS Permission 239 IRS Permission Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder

121 IRS Permission Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder. 241 IRS Permission Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping his books shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder

122 IRS Permission Except as otherwise expressly provided in chapter 1 of the Code and the regulations thereunder, a taxpayer who changes the method of accounting employed in keeping Exception his books shall, for Automatic before computing Changes his income upon such new method for purposes of taxation, secure the consent of the Commissioner. Consent must be secured whether or not such method is proper or is permitted under the Internal Revenue Code or the regulations thereunder. 243 Change

123 Reg (e)(2)(ii) Cash to Accrual To or from long-term methods One basis of inventory valuation to another Change in treatment of material item or expense 245 Does Not Include

124 Does Not Include Does not include: Correction of mathematical errors Correction of posting errors Errors in computing tax liability 247 Timing Issue

125 Cumulative Effect 249 IRC 481 Adjustment

126 481 Adjustment Methods Record in Year of Change Negative adjustments Allocate over Four Years Default for most positive adjustments Cumulative change to taxable income reflected over four years ¼ in year of change Balance evenly over next three years 251 Repairs Example Page

127 Repairs Example Change from dollar trigger for capitalization to functional test under final regulations $800,000 of capitalized repairs Under new method would have been charged off in prior years Adjustment - $800,000 negative Take as expense in year of change 253 Bonus Error Example

128 Bonus Error Example Had been accruing bonus not paid until May 1 of following year Not an allowed method violates 461 provisions In prior year accrued $160,000 adjustment Spread adjustment over four years - $40,000 per year 255 Bonus Error Example Had been accruing bonus not paid until May 1 of following year Even though method not allowed, Not an IRS allowed permission method is still violates required 461 for provisions the change. In prior year accrued $160,000 adjustment Spread adjustment over four years - $40,000 per year

129 Accounting Methods 481(A) ADJUSTMENT CUT OFF METHOD 257 Cut-Off Method Just pick up new items under the revised method Continue to report old items under old method Used where IRS mandates its use

130 No Longer Small Contractor Problem 259 No Longer Small Contractor Problem Changing to percentage of completion method is cut-off recognized change

131 Revenue Trigger Example Year 1 - $6 million average $ 6 million Year 2 - $9 million average $7.5 million Year 3 - $12 million average $9 million Year 4 - $11 million average $10.7 million (remember it s a 3 year average) 261 Cut Off Changes Currently 20 listed in Rev. Proc Subject to change at any time

132 Cut Off Changes Commodity Credit Loans Amortizable Bond Premium Sale, Lease, or Financing Transactions Various items dealing with fixed assets, depreciation, repairs, etc. R & D Expenditures Distributor Commissions Multi-Year Service Warranty Contracts Crop Method to Overall Cash Method for Farmers Prepaid Subscription Income Ratable Accrual of Real Estate Taxes 263 Cut Off Changes Replacement Cost for Auto Dealer s Parts Inventory Rolling Average Method for Inventories Three items dealing with LIFO inventories Market Discount Bonds

133 Accounting Methods REVENUE PROCEDURE AND Automatic Changes

134 Automatic Changes 267 Automatic Changes Began with Rev. Proc automatic changes Form 3115 still required but Send copy to National Office when return filed Attach to return Provided audit protection No user fee required

135 Audit Protection Section 7 Rev Proc Except as provided in sections 4.02(7)(b), 6.03(5), 6.03(6), 6.04, 6.05, 7.02 or the APPENDIX of this revenue procedure or in any other guidance published in the IRB, when a taxpayer timely files a copy of the application with the national office or, if applicable the Ogden office, under section 6.02(3) of this revenue procedure in compliance with all the applicable provisions of this revenue procedure, the Service will not require the taxpayer to change its method of accounting for the same item for a taxable year prior to the year of change. 269 Major Exceptions Change not made properly Prior year IRS initiated change Matter under criminal investigation

136 Revenue Procedure Latest in series of revisions to automatic accounting method change procedures Added to list of automatic changes, folded in ad hoc items added in after Revenue Procedures and IRS continues to make as necessary additions to list (repair/capitalization change ruling for instance) D Energy Efficient Deduction

137 179D Energy Efficient Deduction Designated Change 152 Section 8.04 of Appendix to Rev. Proc [p. 6-2, 6F-100] Change to expensing qualified 179D property 273 Gift Cards for Returned Merchandise

138 Gift Cards for Returned Merchandise Automatic Change 156 Section of Appendix to Revenue Procedure [p. 6-3, 6F-157] Gift cards issued as refunds treated as cash refund followed by sale of gift card 275 Advanced Payments Applicable Financial Statements

139 Advanced Payments Applicable Financial Statements Automatic Change 130 Section of Appendix to Revenue Procedure [p. 6-4, 6F-143] Change in the applicable financial statement for Revenue Procedure No Form 3115 required, no five year rule Waives lack of permission grant 277 California Franchise Tax

140 California Franchise Tax Automatic Change 154 Section of Appendix to Revenue Procedure [p. 6-5, 6F-157] Method consistent with Revenue Ruling Franchise tax for current year based on income of prior year 461(d) overrides standard treatment ignore law changes since December 31, Modifications Repair & maintenance costs Impermissible to permissible method of accounting for depreciation or amortization Sale lease or financing transactions Disposition of structural components of a building or tangible personal property

141 Modifications Change in overall method from cash method to accrual method Timing of incurring liabilities for bonuses Small taxpayer cash basis rules Change from LIFO inventory method Change in functional currency 281 Taxpayers Under Examination

142 Taxpayers Under Examination 120 period ends on notification case returned to examining agent by appeals and then resets when resumed examination ends Joint Committee on Taxation review Issues under consideration JCT review with accounting method 283 Terms and Conditions

143 Terms and Conditions Foreign Division of Domestic Corporation or Partnership State 481(a) adjustment in functional currency Treat adjustment in same manner as income or expense that was offset in prior year(s) Taking adjustment beginning in year of change Records of foreign entity Form General Application Procedures

144 General Application Procedures Consent Controlled Foreign Corporation or 10/50 Corporation Filing requirement Ogden stand in for national office in some cases Before Appeals or federal court change allowed but no audit protection Multiple 287 Multiple Concurrent Changes

145 Multiple Concurrent Changes Officially limited circumstances prior, but IRS had allowed multiple Some cases allowed to separate positive and negative adjustments 289 Changes of Interest

146 Attorney s Advances Section 3.01 Appendix Revenue Procedure p. 6F-53 Change to treat as loan to conform to Boccardo v. United States, 12 Ct. Cl. 184 and Cannelo v. Commissioner, 53 TC 217 (affd CA9) 291 Restaurant Smallwares Section 3.03 p. 6F-54 Restaurant to expense smallwares when made available for use Includes table top items, bar supplies, food preparation utensils & tools, storage supplies, service items, small appliances Must be on site & available to be used otherwise a capitalized supply

147 Materials & Supplies Section 3.05 Appendix, p. 6F-55 Conform materials to Reg Note potentially impacted by changes made by (now delayed per Notice ) repair regulations T If have changed to temporary regulations can use Revenue Procedure automatic change procedure 293 Repair & Maintenance Section 3.06 Appendix, p. 6F-56 Again, impacted by changes made in repair/capitalization regulations Revenue Procedures and implement final regulations changes

148 Bad Debts Section 4.01 Appendix, p. 6F-58 Discover client not using charge-off, can switch automatically 295 Depreciation

149 Depreciation Impermissible to permissible Section 6.01, p. 6F-59, Method 7 Four conditions Used erroneous method for at least two years Wants to change accounting method Depreciation/amortization determined under applicable IRC section Owned by taxpayer at beginning of year 297 Depreciation

150 Depreciation 299 Depreciation Section 6.01(b) provides choice for properly acquired in prior year Use the Form 3115 method and include in 481(a) adjustment or Amend prior year s return to claim proper amount of depreciation

151 Depreciation Does not apply to some property Property held by tax-exempt organization subject to 1016(a)(3) If must use 263A on costs unless concurrently changes to comply with UNICAP Change in claiming bonus depreciation Property subject to income forecast method under 167(g) 301 Depreciation Does not apply to some property 1250 property being reclassified to asset class that does not include 1250 property Use changes in hands of taxpayer Depreciation determined in accordance with ADR Change in repair vs. capitalization From one permissible method to another

152 Depreciation Does not apply to some property Change from non-depreciable to depreciable when a simultaneous election is made Any other change in accounting, even if triggered by change in depreciation Change in depreciation using transition rules for old 168 Change in placed in service date 303 Additional Requirements

153 Additional Requirements Change to permissible method Attach statement Detailed description of former and proposed method of depreciation (not just MACRS) Description of taxpayer s activities Statement of law supporting new classification Statement of year placed in service Agreement on any public utility property 305 Additional Requirements Attach statement Retail motor fuels property statement Special statement for 1250 to 1245 property

154 307 Must adjust basis of assets and prior depreciation Must take into account any depreciation required to be capitalized

155 Allowed Allowable 309 Allowed vs. Allowable Section 6.01(6) discussion Issue involves gain on sale calculation

156 More than One Asset 311 More than One Asset Section 6.01(7) page 6F-67 Can separately treat positive and negative 481(a) adjustments Can combine with change to UNICAP under Section or on single Form 3115 Also can combine with changes for Modern golf course greens (Section 6.04) Tire costs (Section 6.05) Gas pump canopies (Section 6.06) Utility assets (Section 6.07)

157 Copy to Ogden 313 Copy to Ogden Section 6.01(8) Filed in lieu of filing with the National Office Filed No earlier than first day of year of change No later than date original Form 3115 filed with tax return

158 Permissible to Permissible Depreciation 315 Permissible to Permissible Depreciation Section 6.02 Appendix, p. 6F-68, change number 8 Covers depreciation methods under 56(g)(4)(A)(iv) (AMT pre-1981) or Other than 168 depreciation (that is, not under ACRS or MACRS)

159 Repairs Regulation Issues Temporary Revision to Revenue Procedure Revenue Procedure (Section Tangible Property Revenue Procedure Implementing new tangible property repair/capitalization regulations under 263(a) 317 Revenue Procedure

160 Revenue Procedure Revenue Procedure

161 Revenue Procedure Revenue Procedure Leasehold Improvements 6.28 Permissible methods of depreciation for MACRS assets (General Asset Accounts) 6.29 Disposition of a Building or Structural Component 6.30 Disposition of Tangible Depreciable Assets Other Than a Building

162 Revenue Procedure Dispositions of Tangible Depreciable Assets in a General Asset Account 6.32 General Asset Account Elections 6.33 Late Partial Disposition Election 6.34 Revocation of General Asset Election 323 Revenue Procedure Partial Dispositions of Tangible Depreciable Assets to Which IRS s Adjustment Pertains 6.36 Depreciation of Leasehold Improvements 6.37 Permissible to Permissible Method of Accounting for Depreciation of MACRS Property

163 Sale, Lease or Financing 325 Sale, Lease or Financing Section 6.03 Appendix, p. 6F-72, change 10 Covers both lessor/seller and lessee/buyer situations Note no audit protection offered

164 Assets Disposed Of Impermissible Depreciation 327 Assets Disposed Of Impermissible Depreciation Section 6.17, p. 6F-82, method number 107 Deals with allowed vs. allowable problem

165 IRC 1016(a)(2) Basis reduced to the extent of the amount (A)allowed as deductions in computing taxable income under this subtitle or prior income tax laws, but not less than the amount allowable under this subtitle or prior income tax laws 329 IRC 1016(a)(2) Basis reduced to the extent of the amount (A)allowed as deductions in computing taxable income under this subtitle or prior income tax laws, but not less than the amount allowable under this subtitle or prior income tax laws

166 IRC 1016(a)(2) Basis reduced to the extent of the amount (A)allowed as deductions in computing taxable income under this subtitle or prior income tax laws, but not less than the amount allowable under this subtitle or prior income tax laws 331 Exclusions Property held by tax exempts Revoking or making an election related to depreciation Previously expensed Property to which a nonrecognition provision applies (with potential exception for certain 1031 or 1033 transactions)

167 Making the Election Can be made via an amended return with Form 3115 attached (Section 6.17(3), p. 6F-83) 481 adjustment taken into effect in the year of change (no four year spread) Ogden copy in lieu of national office copy (6.17(9)) 333 Related Parties Section 12.01, p. 6F-117, Change 26 Deal with taxpayer who has not been respecting 267 limitations

168 Cash to Accrual Method Section Appendix, p. 6F-120, Change number 122 for taxpayer not subject to 448 ($5 million C corporation) or not making election for first 448 year 123 for taxpayer making election in first 448 year (fulfills requirement to print Automatic Change to Accrual Method Section 448 required by regulation) 335 Cash to Accrual Method If also request special accounting methods that need permission, may file a single Form 3115 rather than having to split out the automatic from non-automatic Taxpayer must indicate items for which the recurring item exception will be used (Section 14.01(4)(c))

169 Small Business Switch to Cash Basis 337 Small Business Switch to Cash Basis Section Appendix, p. 6F-125, change number 33 Taxpayers using Revenue Procedure or to change to cash method Must make concurrent change to treat inventoriable items as nonincidental materials and supplies

170 Small Business Switch to Cash Basis Section Appendix, p. 6F-161 $1 million rule change number 50 $1 million to $10 million rule change Retentions

171 Retentions Section Appendix, page 6F-143, method 130 Applies only to contractors who are using 460 methods (PCM or completed contract) Small construction contractors or Home construction contractors 341 Savings Bonds Interest

172 Savings Bonds Interest Section Appendix, p. 6F-146, change 131 Taxpayer previously elected to report interest on E, EE or I bonds as redemption price increases Now wishes to defer until bond disposed of 343 Savings Bonds Interest Cut-off basis change effective for any increase after the beginning of year of change Statement in lieu of Form 3115 allowed to authorize change

173 Savings Bonds Interest Statement contains Designated change number of 131 Taxpayer name & EIN Year of change (both beginning and ending dates) Series E, EE or I U.S. savings bonds for which the change is requested Agreement to report Interest on new bonds at disposition Interest on old bonds at disposition, adjusted for prior interest reported 345 Percentage of Completion

174 Percentage of Completion Section 18.01, p. 6F-148, change 41 Not required to use 460 but wants to use PCM No audit protection provided May want to use if facing likelihood of going over $10 million limit in future with higher rates 347 Year of Deduction Taxes

175 Year of Deduction - Taxes Section 19.02, p. 6F-151, change 43 Can change to Treat as deductible in year paid Use recurring item exception under 461(h)(3) Revoke ratable accrual election under 461(c) Cannot be used to get around 461(d) 349 Year of Deduction - Taxes Section 19.08, p. 6F-156, change 149 Change to make ratable accrual election under 461(c) Special rules Cut off basis applied Statement filed in lieu of Form

176 Year of Deduction - Taxes Statement Automatic change number 149 Name and EIN Year of change (both beginning and ending dates) Information described in Reg (c)(3)(ii)(a) through f) Treated as granting consent required under 461(c)(2)(B) (f) Mark to Market

177 475(f) Mark to Market Section Appendix, p. 6F-179, change 64 Requirements Commodities dealer, securities trader or commodities trader that has made a valid election under 475(e) or (f) Uses valid method of accounting Year of change is year of election (f) Mark to Market Election under Revenue Procedure Due date of return for year preceding year of change Does not consider extensions, whether or not applied for Attached to prior year s return or extension

178 475(f) Mark to Market Election under Revenue Procedure Due date of return for year preceding year of change Does not consider extensions, whether or not applied for Attached to prior year s return or extension (f) Mark to Market Election under Revenue Procedure Due date of return for year preceding year of change Does not consider extensions, whether or not applied for Attached to prior year s return or extension

179 475(f) Mark to Market Election under Revenue Procedure Due date of return for year preceding year of change Does not consider extensions, whether or not applied for Attached to prior year s return or extension (f) Mark to Market Election under Revenue Procedure Due date of return for year preceding year of change Does not consider extensions, whether or not applied for Attached to prior year s return or extension

180 Accounting Methods FORM 3115 AND INSTRUCTIONS

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191 381 Change Specific Sections Schedule B Change to Deferral Method for Advance Payments Schedule C LIFO Part I General LIFO Information Part II Change in Pooling of Inventories

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