Retroactive cash-to-accrual method relief denied

Plain-English summary

A manufacturing S corporation using the cash method concluded that its business activities required an accrual method. After its founder's death and an ownership change, it sought extra time to file Form 3115 for the earliest open tax year so that previous owners would bear at least some of the positive section 481(a) adjustment. The IRS denied relief because the requested change required advance consent and a section 481(a) adjustment, so the government's interests were deemed prejudiced unless unusual and compelling circumstances existed. Wanting to shift the unfavorable adjustment to previous owners did not meet that standard. The IRS also treated the company's already-filed Form 3115 as a nullity, called its amended returns an unauthorized retroactive method change, and directed it to withdraw those returns and restore its original filings.

Ruling snapshot

• Question: May the taxpayer file Form 3115 late for its earliest open year to change retroactively from the cash method to an accrual method?
• Outcome: denied
• Key authorities: IRC §§ 446(e), 481(a); Treas. Reg. §§ 1.446-1(e)(3)(i), 301.9100-1, 301.9100-3

Full text (IRS public release)

Internal Revenue Service                                     Department of the Treasury
                                                             Washington, DC 20224

Number: 201740005                                            Third Party Communication: None
Release Date: 10/6/2017                                      Date of Communication: Not Applicable
Index Number: 9100.10-00
                                                             Person To Contact:
-------------------------------                              ------------------------, ID No. ------------------
-------------------------------------                        ----------------------------------------------------
--------------------                                         Telephone Number:
----------------------------                                 ----------------------
                                                             Refer Reply To:
                                                             CC:ITA:7
                                                             PLR-105089-17
                                                             Date:
                                                             June 28, 2017


Legend

Taxpayer                                = -------------------------------------
                                          --------------------------
A                                       = ------------------------
B                                       = ----------------------------
C                                       = -------
D                                       = -------
E                                       = -------

Re: Request for Extension of Time to File a Form 3115 to Change the Overall Method
of Accounting from the Cash Method to an Accrual Method

Dear ----------------:

       This letter ruling responds to a letter dated February 6, 2017, and subsequent
correspondence submitted by Taxpayer. Taxpayer is requesting an extension of time
pursuant to §§ 301.9100-1 and 301.9100-3 of the Procedure and Administration
Regulations to file a Form 3115, Application for Change in Accounting Method, for the
earliest taxable year not closed by the statute of limitations to change its overall method
of accounting from the cash receipts and disbursements method of accounting (the
“cash method”) to an accrual method.

FACTS

         Taxpayer represents the facts are as follows:

       Taxpayer is an S corporation that uses the overall cash receipts and
disbursements method of accounting (the “cash method)”. Taxpayer manufactures and
PLR-105089-17                               2

sells A. Taxpayer has determined that it should be using an overall accrual method of
accounting based on its business activities.

       Taxpayer seeks to file a Form 3115 to effect its proposed change to an accrual
method in the earliest open taxable year. In Taxpayer’s view, effecting the accounting
method change in the earliest open taxable year is the correct approach because of the
recent change in ownership of Taxpayer that was the result of the recent death of B in
C. B was the founder and owner of Taxpayer. Specifically, Taxpayer argues that
allowing it to change its accounting method in the earliest open taxable year is
appropriate as it will result in the previous owner(s) of Taxpayer recognizing at least
some, if not all, of the positive adjustment under § 481(a) of the Internal Revenue Code
(the “§ 481(a) adjustment”) that will arise from Taxpayer’s change from the cash
method.

       We held the conference of right on April 24, 2017. Taxpayer submitted post-
conference material on its proposed method change in a letter dated May 19, 2017. On
June 8, 2017, we advised Taxpayer’s authorized representative that we were adverse to
the requested extension of time to file a Form 3115 for the earliest open taxable year.
On June 19, 2017, Taxpayer’s authorized representative advised us that Taxpayer
would like an adverse ruling.

RULING REQUESTED

        Taxpayer requests an extension of time pursuant to §§ 301.9100-1 and
301.9100-3 to file a Form 3115 to change its overall method of accounting from the
cash method to an accrual method for the earliest taxable year not closed by the statute
of limitations.

LAW AND ANALYSIS

      Section 1.446-1(e)(3)(i) of the Income Tax Regulations provides that to secure
the Commissioner's consent to a taxpayer's change in method of accounting the
taxpayer generally must file an application on Form 3115, "Application for Change in
Accounting Method," with the Commissioner during the taxable year in which the
taxpayer desires to make the change in method of accounting.

      Currently, Rev. Proc. 2015-13, 2015-5 I.R.B. 419, provides the procedures by
which a taxpayer may obtain consent to change accounting methods. A taxpayer
complying with all the applicable provisions of this revenue procedure has obtained the
consent of the Commissioner to change its accounting method under § 446(e) and the
Regulations thereunder.

       Section 2.03(1) of Rev. Proc. 2015-13 provides that, unless specifically
authorized by the Commissioner or by statute, a taxpayer may not change an
PLR-105089-17                                3

established method of accounting by amending its prior federal income tax return(s).
See Rev. Rul. 90-38, 1990-1 C.B. 57.

       Section 2.05 of Rev. Proc. 2015-13 provides that, unless specifically authorized
by the Commissioner or by statute, a taxpayer may not request, or otherwise make, a
retroactive change in method of accounting. See generally Rev. Rul. 90-38.

       Section 6.03(4)(b) of Proc. 2015-13 provides that, except in unusual and
compelling circumstances or as provided in section 6.03(4)(a) of Rev. Proc. 2015-13
(the 6-month automatic extension for filing a Form 3115), a taxpayer is not eligible for
an extension of time to file a Form 3115.

       However, § 301.9100-1(c) provides that the Commissioner has discretion to
grant a reasonable extension of time under the rules set forth in §§ 301.9100-2 and
301.9100-3 to make certain regulatory elections.

       Sections 301.9100-1 through 301.9100-3 provide the standards the
Commissioner will use to determine whether to grant an extension of time to make an
election. Section 301.9100-2 provides automatic extensions of time for making certain
elections. Section 301.9100-3 provides extensions of time for making elections that do
not meet the requirements of § 301.9100-2.

       Section 301.9100-3(a) provides that requests for an extension of time subject to
§ 301.9100-3 will be granted when the taxpayer provides evidence to establish to the
satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith
and that the granting of the extension will not prejudice the interests of the Government.

        Section 301.9100-3(c)(2) imposes special rules for accounting method regulatory
elections such as the one in question. Section 301.9100-3(c)(2)(i) provides that the
interests of the Government are deemed to be prejudiced except in unusual and
compelling circumstances if the accounting method regulatory election for which the
extension of time is requested is subject to the procedure described in § 1.446-1(e)(3)(i)
(requiring the advance written consent of the Commissioner). Section 301.9100-
3(c)(2)(ii) provides that the interests of the Government are deemed to be prejudiced
except in unusual and compelling circumstances if the accounting method regulatory
election for which the extension of time is requested requires a § 481(a) adjustment (or
would require such an adjustment if the taxpayer changed to the method of accounting
for which the extension is requested in a taxable year subsequent to the year in which
the election should have been made).

       It is in the interest of sound tax administration to generally preclude taxpayers
from requesting, or otherwise making, a retroactive change in a method of accounting,
whether the change is from a permissible or impermissible method. T.D. 8742, 1998-1
C.B. 388, 389 (February 2, 1998). What are unusual and compelling circumstances
PLR-105089-17                                4

must be decided on a case-by-case basis in light of all applicable facts and
circumstances. Id. at 390.

        Taxpayer now seeks permission to file a Form 3115 to change to an overall
accrual method of accounting in the earliest taxable year not closed by the statute of
limitations. Taxpayer’s Form 3115 is subject to the procedure described in § 1.446-
1(e)(3)(i) and requires a § 481(a) adjustment. Thus, barring unusual and compelling
circumstances, Taxpayer is not entitled to an extension of time under § 301.9100-3
because the Government's interests are deemed prejudiced by a late filing of
Taxpayer’s Form 3115.

       Here, Taxpayer is most likely able to file an automatic change Form 3115 for its
current taxable year to change to an overall accrual method, or, if it does not qualify for
an automatic change, to file a nonautomatic change Form 3115. See section 15.01
(change in overall method from the cash method to an accrual method) of Rev. Proc.
2017-30, 2017-18 I.R.B. 1130, 1185. However, Taxpayer is not seeking to file its Form
3115 for the current taxable year. Instead, Taxpayer is attempting to file its Form 3115
to obtain a retroactive change in method of accounting. This retroactive change has not
been specifically authorized by the Commissioner or by statute. See section 2.05 of
Rev. Proc. 2015-13. In the Government’s view, it is in not in the interest of sound tax
administration to permit taxpayers from requesting, or otherwise making, a retroactive
change in a method of accounting, whether the change is from a permissible or
impermissible method. See T.D. 8742, 1998-1 C.B. at 389. Further, in the instant case,
because (1) the accounting method regulatory election for which the extension of time is
requested is subject to the procedure described in § 1.446-1(e)(3)(i) and (2) the
proposed change in accounting method requires a § 481(a) adjustment, the
Government's interests are deemed prejudiced by the late filing of Taxpayer’s Form
3115 unless Taxpayer demonstrates unusual and compelling circumstances. The
desire of Taxpayer’s current owner to shift the onus of an unfavorable § 481(a)
adjustment to Taxpayer’s previous owner(s) does not demonstrate unusual and
compelling circumstances.

CONCLUSION

        Based on the facts and representations submitted, we conclude that Taxpayer
has not satisfied the requirements for granting an extension of time to file a Form 3115
to change its overall method of accounting from the cash method to an accrual method
for the earliest taxable year not closed by the statute of limitations. Specifically,
Taxpayer has failed to demonstrate unusual and compelling circumstances and,
accordingly, the Government’s interests are deemed prejudiced.

      At the same time Taxpayer filed this request for an extension of time to file a
Form 3115 for the earliest open taxable year, Taxpayer also: (1) filed a Form 3115 to
change to an overall accrual method for its D taxable year; and (2) filed amended
PLR-105089-17                               5

returns for both the D and E taxable years to implement this change. The Internal
Revenue Service will not consider the filed Form 3115 as it does not satisfy the
requirements of § 1.446-1(e)(3)(i) and Rev. Proc. 2015-13 and it is a nullity. Moreover,
Taxpayer’s filing of amended returns for its D and E taxable years constitutes an
unauthorized retroactive change in method of accounting. See Rev. Rul. 90-38 (a
taxpayer may not, without the Commissioner's consent, retroactively change from an
erroneous to a permissible method of accounting by filing amended returns, even if the
period for amending the return for the first year in which the erroneous method was
used has not expired); and sections 2.03(1) and 2.05 of Rev. Proc. 2015-13, 2015-5
I.R.B. at 424-425. Taxpayer must withdraw these returns and return to its original tax
filings.

      The ruling contained in this letter ruling is based upon facts and representations
submitted by Taxpayer with accompanying penalty of perjury statements executed by
appropriate parties.

      This letter ruling is directed only to Taxpayer, who requested it. Section
6110(k)(3) provides that it may not be used or cited as precedent.

      In accordance with the power of attorney, we are sending a copy of this letter to
Taxpayer’s authorized representatives. We are also sending a copy of this letter to the
appropriate operating division director.


                                                Sincerely,

                                                Cheryl Oseekey

                                                CHERYL OSEEKEY
                                                Senior Counsel, Branch 6
                                                Office of Associate Chief Counsel
                                                (Income Tax and Accounting)
Enclosures (2):
      copy of this letter
      copy for section 6110 purposes