[Federal Register Volume 59, Number 248 (Wednesday, December 28, 1994)]
[Unknown Section]
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From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31531]


[Federal Register: December 28, 1994]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[IA-42-93]
RIN 1545-AS93


Adjustments Required by Changes in Method of Accounting

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed amendments to the regulations 
under sections 446(e) and 481 of the Internal Revenue Code of 1986 
relating to the requirements for changes in a taxpayer's method of 
accounting. The proposed amendments conform existing regulations to the 
IRS's long-standing administrative procedures and practices for 
changing a taxpayer's method of accounting. The proposed amendments 
would affect taxpayers subject to sections 446(e) and 481.

DATES: Written comments must be received by February 27, 1995. Requests 
to appear and outlines of oral comments to be presented at the public 
hearing scheduled for March 10, 1995, at 10 a.m. must be received by 
February 17, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R:(IA-42-93), Room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
D.C. 20044. In the alternative, submissions may be hand delivered 
between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R(IA-42-93), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
N.W., Washington, D.C. The public hearing scheduled for March 10, 1995, 
will be held in the IRS Auditorium, 7th floor, 1111 Constitution 
Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Rosemary 
DeLeone, 202-622-4930; concerning submissions and the hearing, 
Christina Vasquez, 202-622-6803. These are not toll-free numbers.

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) to clarify rules under sections 446(e) and 
481 regarding changes in method of accounting.

Explanation of Provisions

    Section 446(e) states that, except as otherwise expressly provided, 
a taxpayer must secure the Commissioner's consent prior to computing 
its taxable income under a new method of accounting. Section 446(e) was 
enacted as part of the Internal Revenue Code of 1954, Pub. L. 591, 68A 
Stat. 1, to codify then-existing regulations that authorized the 
Commissioner to impose terms and conditions on voluntary changes in 
method of accounting (i.e., changes initiated by the taxpayer).
    Section 481 was also enacted as part of the Internal Revenue Code 
of 1954, Pub. L. 591, 68A Stat. 1. Section 481(a) generally provides 
that in computing a taxpayer's taxable income for the year of a change 
in method of accounting, there shall be taken into account those 
adjustments which are determined to be necessary, solely by reason of 
the change, in order to prevent amounts from being duplicated or 
omitted. Under section 481(c), however, a section 481(a) adjustment may 
be taken into account in such manner and subject to such conditions as 
prescribed by the Commissioner.
    As originally enacted, section 481 provided that the portion of the 
adjustment attributable to pre-1954 Code years was excluded from the 
required adjustment, regardless of whether the change was voluntary or 
involuntary. This exclusion enabled taxpayers to change from one 
permissible method to another permissible method or from an 
impermissible method to a permissible method without accounting for any 
duplication or omission of amounts that were attributable to pre-1954 
Code years. When it became apparent that this provision was being 
abused, Congress amended section 481 in the Technical Amendments Act of 
1958, Pub. L. 85-866, 72 Stat. 1606, Title 1, to provide that the 
section 481(a) adjustment would include amounts attributable to pre-
1954 Code years if the change was voluntary, but would exclude such 
amounts if the change was required by the Commissioner.
    Under the authority of sections 446(e) and 481(c), the IRS's long-
standing administrative practice has been to provide specific 
adjustment periods under section 481(a) for voluntary changes in method 
of accounting. These adjustment periods are intended to achieve an 
appropriate balance between the goals of mitigating distortions of 
income that would otherwise occur by taking the section 481(a) 
adjustment into account entirely in the year of change and providing 
appropriate incentives for voluntary compliance. See, for example, Rev. 
Proc. 92-20, 1992-1 C.B. 685; Rev. Proc. 84-74, 1984-2 C.B. 736; Rev. 
Proc. 80-51, 1980-2 C.B. 818; and Rev. Proc. 70-27, 1970-2 C.B. 509, 
clarified, Rev. Proc. 75-18, 1975-1 C.B. 687. With respect to 
involuntary changes in method of accounting, the IRS's long-standing 
administrative practice generally has been to require that the section 
481(a) adjustments be taken into account in computing taxable income 
entirely in the year of change.
    In order to conform existing regulations with the IRS's long-
standing administrative practice regarding section 481(a) adjustments, 
certain amendments are provided in this notice of proposed rulemaking. 
Section 1.481-1(c) is amended to clarify that, generally, any section 
481(a) adjustments attributable to a voluntary or involuntary change in 
method of accounting are taken into account in the taxable year of the 
change, regardless of whether the adjustments increase or decrease 
taxable income. However, sections 1.446-1(e)(3) and 1.481-5 are also 
amended to clarify the Commissioner's authority to prescribe terms and 
conditions for effecting a change in method of accounting, including 
the taxable year or years in which any adjustment that is necessary to 
prevent amounts from being duplicated or omitted is taken into account. 
The terms and conditions that may be prescribed by the Commissioner may 
include terms and conditions that require the change in method of 
accounting to be effected on a cut-off basis.
    Finally, because the Tax Reform Act of 1986, Pub. L. 99-514, 100 
Stat. 2085, redesignated the Internal Revenue Code of 1954 as the 
Internal Revenue Code of 1986, certain references to the Internal 
Revenue Code of 1954 contained in Secs. 1.481-1, 1.481-2, 1.481-3, and 
1.481-5 are revised to reflect the redesignation. In addition, 
Secs. 1.481-1, 1.481-2, 1.481-3, 1.481-4, 1.481-5, and 1.481-6 are 
revised to remove certain obsolete provisions.

Effective Date

    These regulations are proposed to be effective for Consent 
Agreements signed on or after December 27, 1994.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It has also been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations and, therefore, a Regulatory Flexibility 
Analysis is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, these regulations will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on their 
impact on small businesses.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight copies) that are submitted timely to the IRS. All comments 
will be available for public inspection and copying.
    A public hearing has been scheduled for Friday, March 10, 1995, at 
10 a.m., in the IRS Auditorium, 7th floor, 1111 Constitution Avenue, 
N.W., Washington, DC. Because of access restrictions, visitors will not 
be admitted beyond the Internal Revenue Building lobby more than 15 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by February 27, 1995 and submit an outline (a 
signed original and eight copies) of the topics to be discussed and the 
time to be devoted to each topic by February 17, 1995. A period of 10 
minutes will be allotted to each person for making comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Rosemary DeLeone, 
Office of the Assistant Chief Counsel (Income Tax and Accounting), 
Internal Revenue Service. However, personnel from other offices of the 
IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
revising the entry for section 1.446-1 and by adding the following 
citations:

    Authority: 26 U.S.C. 7805. * * *

    Section 1.446-1 also issued under 26 U.S.C. 446 and 461(h). * * *
    Section 1.481-1 also issued under 26 U.S.C. 481.
    Section 1.481-2 also issued under 26 U.S.C. 481.
    Section 1.481-3 also issued under 26 U.S.C. 481.
    Section 1.481-4 also issued under 26 U.S.C. 481.
    Section 1.481-5 also issued under 26 U.S.C. 481.

    Par. 2. Section 1.446-1 is amended as follows:

    1. Paragraph (e)(3) is revised to read as follows:


Sec. 1.446-1  General rule for methods of accounting.

* * * * *
    (e) * * *
    (3)(i) Except as otherwise provided under the authority of 
paragraph (e)(3)(ii) of this section, to secure the Commissioner's 
consent to a taxpayer's change in method of accounting the taxpayer 
must file an application on Form 3115 with the Commissioner within 180 
days after the beginning of the taxable year in which the taxpayer 
desires to make the change in method of accounting. To the extent 
applicable, the taxpayer must furnish all information requested on the 
Form 3115. This information includes all classes of items that would be 
treated differently under the new method of accounting, any amounts 
that would be duplicated or omitted as a result of the proposed change, 
and the taxpayer's computation of any adjustments necessary to prevent 
such duplications or omissions. The Commissioner may require such other 
information as may be necessary to determine whether the proposed 
change will be permitted. Permission to change a taxpayer's method of 
accounting will not be granted unless the taxpayer agrees to the 
Commissioner's prescribed terms and conditions for effecting the 
change, including the taxable year or years in which any adjustment 
necessary to prevent amounts from being duplicated or omitted is to be 
taken into account. See section 481 and the regulations thereunder, 
relating to certain adjustments resulting from accounting method 
changes and section 472 and the regulations thereunder, relating to 
adjustments for changes to and from the last-in, first-out inventory 
method.
    (ii) Notwithstanding the provisions of paragraph (e)(3)(i) of this 
section, the Commissioner may prescribe administrative procedures under 
which taxpayers will be permitted to change their method of accounting. 
The administrative procedures shall prescribe those terms and 
conditions necessary to obtain the Commissioner's consent to effect the 
change and to prevent amounts from being duplicated or omitted. The 
terms and conditions that may be prescribed by the Commissioner may 
include terms and conditions that require the change in method of 
accounting to be effected on a cut-off basis or by an adjustment under 
section 481(a) to be taken into account in the taxable year or years 
prescribed by the Commissioner.
    (iii) This paragraph (e)(3) is effective for Consent Agreements 
signed on or after February 27, 1995. For Consent Agreements signed 
before December 27, 1994, see Sec. 1.446-1(e)(3) as contained in the 26 
CFR Part 1 edition revised as of April 1, 1994.
    Par. 3. Section 1.481-1 is amended as follows:
    1. Paragraph (a)(2) is amended by adding the phrase ``(hereinafter 
referred to as ``pre-1954 years'')'' to the end of the sentence.
    2. The third sentence of paragraph (c)(1) is amended by removing 
``pre-1954 Code years'' and replacing it with ``pre 1954 years''.
    3. Paragraphs (c)(2), (3), and (4) are revised.
    4. Paragraph (c)(6) is removed.
    5. Paragraph (c)(7) is removed.
    6. Paragraph (d) is revised.
    7. Paragraph (e) is removed.
    8. The revised paragraphs read as follows:


Sec. 1.481-1  Adjustments in general.

* * * * *
    (c) * * *
    (2) If a change in method of accounting is voluntary (i.e., 
initiated by the taxpayer), the entire amount of the adjustments 
required by section 481(a) is generally taken into account in computing 
taxable income in the taxable year of the change, regardless of whether 
the adjustments increase or decrease taxable income. See, however, 
Sec. 1.446-1(e)(3) and 1.481-4 which provide that the Commissioner may 
prescribe the taxable year or years in which the adjustments are taken 
into account.
    (3) If the change in method of accounting is involuntary (i.e., not 
initiated by the taxpayer), then only the amount of the adjustments 
required by section 481(a) that is attributable to taxable years 
beginning after December 31, 1953, and ending after August 16, 1954, 
(hereinafter referred to as ``post-1953 years'') is taken into account. 
This amount is generally taken into account in computing taxable income 
in the taxable year of the change, regardless of whether the 
adjustments increase or decrease-taxable income. See, however, 
Secs. 1.446-1(e)(3) and 1.481-4 which provide that the Commissioner may 
prescribe the taxable year or years in which the adjustments are taken 
into account. See also Sec. 1.481-3 for rules relating to adjustments 
attributable to pre-1954 years.
    (4) For any adjustments attributable to post-1953 years that are 
taken into account entirely in the year of change and that increase 
taxable income by more than $3,000, the limitations on tax provided in 
sections 481(b)(1) or (2) apply. See Sec. 1.481-2 for rules relating to 
the limitations on tax provided by sections 481(b) (1) and (2).
* * * * *
    (d) Any adjustments required under section 481(a) that are taken 
into account during a taxable year must be properly taken into account 
for purposes of computing gross income, adjusted gross income, or 
taxable income in determining the amount of any item of gain, loss, 
deduction, or credit that depends on gross income, adjusted gross 
income, or taxable income.
    Par. 4. Section 1.481-2 is amended as follows:
    1. The first and second sentences of paragraph (a) are revised.
    2. The first sentence of paragraph (b) introductory text is 
revised.
    3. The first sentence of paragraph (c)(1) is revised.
    4. The first sentence of paragraph (c)(2) is amended by removing 
``subparagraph (1) of this paragraph'' and replacing it with 
``paragraph (c)(1) of this section''.
    5. Paragraph (c)(3) introductory text is amended by removing 
``subparagraph (1) of this paragraph'' and replacing it with 
``paragraph (c)(1) of this section''.
    6. Paragraph (c)(4) is revised.
    7. Paragraph (c)(6) is amended by removing ``Internal Revenue Code 
of 1954'' and replacing it with ``Internal Revenue Code of 1986''.
    8. The second sentence of paragraph (d) is amended by removing 
``Internal Revenue Code of 1954'' and replacing it with ``Internal 
Revenue Code of 1986''.
    9. Example (1) of paragraph (d) is amended by removing ``pre-1954 
Code years'' and replacing it with ``pre-1954 years'' every place that 
it appears.
    10. The revised paragraphs read as follows:


Sec. 1.481-2  Limitation on tax.

    (a) Three-year allocation. Section 481(b)(1) provides a limitation 
on the tax under chapter 1 of the Internal Revenue Code for the taxable 
year of change that is attributable to the adjustments required under 
section 481(a) and Sec. 1.481-1 if the entire amount of the adjustments 
is taken into account in the year of change. If such adjustments 
increase the taxpayer's taxable income for the taxable year of the 
change by more than $3,000, then the tax for such taxable year that is 
attributable to the adjustments shall not exceed the lesser of the tax 
attributable to taking such adjustments into account in computing 
taxable income for the taxable year of the change under section 481(a) 
and Sec. 1.481-1, or the aggregate of the increases in tax that would 
result if the adjustments were included ratably in the taxable year of 
the change and the two preceding taxable years. * * *
    (b) Allocation under new method of accounting. Section 481(b)(2) 
provides a second alternative limitation on the tax for the taxable 
year of change under chapter 1 of the Internal Revenue Code that is 
attributable to the adjustments required under section 481(a) and 
Sec. 1.481-1 where such adjustments increase taxable income for the 
taxable year of change by more than $3,000. * * *
    (c) Rules for computation of tax. (1) The first step in determining 
whether either of the limitations described in sections 481(b)(1) or 
(2) applies is to compute the increase in tax for the taxable year of 
the change that is attributable to the increase in taxable income for 
such year resulting solely from the adjustments required under section 
481(a) and Sec. 1.481-1.
* * * * *
    (4) The tax for the taxable year of the change shall be the tax for 
such year, computed without taking any of the adjustments referred to 
in paragraph (c)(1) of this section into account, increased by the 
smallest of the following amounts:
    (i) The amount of tax for the taxable year of the change 
attributable solely to taking into account the entire amount of the 
adjustments required by section 481(a) and Sec. 1.481-1;
    (ii) The sum of the increases in tax liability for the
    (ii) The sum of the increases in tax liability for the taxable year 
of the change and the two immediately preceding taxable years that 
would have resulted solely from taking into account one-third of the 
amount of such adjustments required for each of such years as though 
such amounts had been properly attributable to such years (computed in 
accordance with paragraph (c)(2) of this section); or
    (iii) The net increase in tax attributable to allocating such 
adjustments under the new method of accounting (computed in accordance 
with paragraph (c)(3) of this section).
* * * * *
    Par. 5. Section 1.481-3 is amended as follows:
    1. Remove ``pre-1954 Code years'' and replace it with ``pre-1954 
years'' from the section heading and every place it appears in the 
section.
    2. Remove the last sentence of the section which reads ``See 
section 481(b)(4)(A).''.
    Par. 6. Section 1.481-4 is removed.
    Par. 7. Section 1.481-5 is redesignated as Sec. 1.481-4 and is 
revised to read as follows:


Sec. 1.481-4  Adjustments taken into account with consent.

    (a) In addition to the terms and conditions prescribed by the 
Commissioner under Sec. 1.446-1(e)(3) for effecting a change in method 
of accounting, including the taxable year or years in which the amount 
of the adjustments required by section 481(a) is to be taken into 
account, or the methods of allocation described in section 481(b), a 
taxpayer may request approval of an alternative method of allocating 
the amount of the adjustments under section 481. See section 481(c). 
Requests for approval of an alternative method of allocation shall set 
forth in detail the facts and circumstances upon which the taxpayer 
bases its request. Permission will be granted only if the taxpayer and 
the Commissioner agree to the terms and conditions under which the 
allocation is to be effected. See Sec. 1.446-1(e) for the rules 
regarding how to secure the Commissioner's consent to a change in 
method of accounting.
    (b) An agreement to the terms and conditions of a change in method 
of accounting under Sec. 1.446-1(e)(3), including the taxable year or 
years prescribed by the Commissioner under that section (or an 
alternative method described in paragraph (a) of this section) for 
taking the amount of the adjustments under section 481(a) into account, 
shall be in writing and shall be signed by the Commissioner and the 
taxpayer. It shall set forth the items to be adjusted, the amount of 
the adjustments, the taxable year or years for which the adjustments 
are to be taken into account, and the amount of the adjustments 
allocable to each year. The agreement shall be binding on the parties 
except upon a showing of fraud, malfeasance, or misrepresentation of 
material fact.
    Par. 7. A new section 1.481-5 is added to read as follows:


Sec. 1.481-5  Effective dates.

    Sections 1.481-1, 1.481-2, 1.481-3, and 1.481-4 are effective for 
Consent Agreements signed on or after December 27, 1994. For Consent 
Agreements signed before December 27, 1994, see Secs. 1.481-1, 1.481-2, 
1.481-3, and 1.481-4 as contained in the 26 CFR Part 1 edition revised 
as of April 1, 1994.
    Par. 8. Section 1.481-6 is removed.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-31531 Filed 12-27-94; 8:45 am]
BILLING CODE 4830-01-P