[Federal Register Volume 60, Number 151 (Monday, August 7, 1995)]
[Rules and Regulations]
[Pages 40077-40079]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-19283]



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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[TD 8608]
RIN 1545-AS93


Adjustments Required by Changes in Method of Accounting

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
requirements for changes in method of accounting. These regulations 
clarify the Commissioner's authority to prescribe terms and conditions 
for effecting a change in method of accounting. The regulations affect 
taxpayers changing a method of accounting for federal income tax 
purposes.

DATES: These regulations are effective August 4, 1995. For dates of 
applicability see Secs. 1.446-1(e)(3)(iii) and 1.481-5.

FOR FURTHER INFORMATION CONTACT: Cheryl Oseekey, (202) 622-4970 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On December 28, 1994, the IRS published a notice of proposed 
rulemaking in the Federal Register (59 FR 66825), relating to the 
requirements for changes in method of accounting. That document 
proposed clarifying amendments to the regulations under sections 446 
and 481. No public hearing was requested or held.
    Two comments responding to this notice were received. After 
consideration of the comments, the amendments proposed by IA-42-93 are 
adopted with minor editorial revisions by this Treasury decision.

Summary of Comments

    The notice of proposed rulemaking proposes to conform the existing 
regulations under sections 446(e) and 481(c) to long-standing IRS 
administrative practices regarding the use of adjustment periods under 
section 481(a) and the use of a cut-off method. Under the general rule 
of the proposed regulations, any section 481(a) adjustment attributable 
to a voluntary or an involuntary change in method of accounting is 
taken into account in the taxable year of change, whether the 
adjustment increases or decreases taxable income. However, the 
regulations also propose to amend Secs. 1.446-1(e)(3) and 1.481-5 to 
clarify the Commissioner's authority to prescribe the terms and 
conditions for effecting a change in method of accounting. Under the 
regulations, the terms and conditions that may be prescribed by the 
Commissioner include the taxable year or years in which a section 
481(a) adjustment is taken into account and the use of a cut-off method 
to effect a change in method of accounting.
    Two comments were received in response to the notice. The comments 
questioned IRS authority to require the use of a cut-off method, and 
whether to require it is sound administrative practice. After 
considering the comments, the IRS and the Treasury Department continue 
to believe that the IRS has the authority under section 446(e) to 
impose a cut-off method, and that it is consistent with section 481(a). 
Furthermore, the IRS and the Treasury Department believe that requiring 
a change in method of accounting on a cut-off basis in appropriate 
circumstances is administratively sound. For example, the application 
of a cut-off method to effect a change within the last-in, first-out 
(LIFO) inventory method is justified on the basis of simplicity because 
it eliminates the need to revalue LIFO increments.
    The amendments proposed by IA-42-93 are adopted by this Treasury 
decision.

Special Analyses

    It has been determined that this Treasury decision 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, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements. 

[[Page 40078]]


Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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 in numerical order to read as follows:

    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 by revising paragraph (e)(3) 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 will be 
treated differently under the new method of accounting, any amounts 
that will 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 December 27, 1994. 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, 1995).
    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 paragraph.
    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. Paragraphs (c) (6) and (7) are removed.
    5. Paragraph (d) is revised.
    6. Paragraph (e) is removed.
    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, 
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.
    (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 
section 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 

[[Page 40079]]
years'' and replacing it with ``pre-1954 years'' in each place that it 
appears.
    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 section 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 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).
* * * * *


Sec. 1.481-3  [Amended]

    Par. 5. Section 1.481-3 is amended as follows:
    1. The language ``pre-1954 Code years'' is removed and the language 
``pre-1954 years'' is added in its place in the section heading and the 
first, second and third sentences of the section.
    2. Remove the last sentence of the section.


Sec. 1.481-4  [Removed]

    Par. 6. Section 1.481-4 is removed.


Sec. 1.481-5  [Redesignated as Sec. 1.481-4]

    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. 8. 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, 1.481-4, and 1.481-5 (as contained in the 26 CFR part 1 
edition revised as of April 1, 1995).


Sec. 1.481-6  [Removed]

    Par. 9. Section 1.481-6 is removed.

Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: July 26, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-19283 Filed 8-4-95; 8:45 am]
BILLING CODE 4830-01-U