IRS Issues Accounting Method Change Procedure to Comply With Final Sec. 451 Regs

(Parker Tax Publishing August 2021)

The IRS issued a procedure under Code Sec. 446 and Reg. Sec. 1.446-1(e) for taxpayers to obtain automatic consent to change methods of accounting in order to comply with final regulations under Reg. Sec. 1.451-3, relating to the timing of income inclusion, Reg. Sec. 1.451-8, relating to the tax treatment of certain advance payments, and Reg. Sec. 1.1275-2(l), relating to the original issue discount rule for certain income items, and to change methods of accounting for certain inventory costs if made in connection with a change to comply with Reg. Sec. 1.451-3 and/or Reg. Sec. 1.451-8. The procedure also allows a taxpayer to obtain consent to change its method of accounting to comply with Reg. Sec. 1.451-3 and/or Reg. Sec. 1.451-8, as applicable, by providing rules relating to cost offset method changes. Rev. Proc. 2021-34.

Background

In 2017, the Tax Cuts and Jobs Act amended Code Sec. 451(b) to provide that, for a taxpayer using an accrual method of accounting, the all events test for any item of gross income, or portion thereof, is met no later than when that item, or portion thereof, is taken into account as revenue in an applicable financial statement (AFS) (AFS income inclusion rule). Code Sec. 451(b) also overturned the historical federal income tax treatment of credit card late fees, credit card cash advance fees, and interchange fees by subjecting the fees to the AFS income inclusion rule instead of the original issue discount (OID) timing rules. In addition, Code Sec. 451(c) was amended to provide that an accrual method taxpayer may use the deferral method of accounting provided in Code Sec. 451(c) for advance payments.

In 2019, the IRS published proposed regulations under Reg. Sec. 1.451-3 (REG-104870-18), Reg. Sec. 1.451-8 (REG-104554-18), and Reg. Sec. 1.1275-2(l) (REG-104870-18). Prop. Reg. Sec. 1.451-3 provided rules relating to the tax year of inclusion in gross income under Code Sec. 451(b). Prop. Reg. Sec. 1.451-8 provided rules relating to the use of the deferral method for advance payments under Code Sec. 451(c). Prop. Reg. Sec. 1.1275-2(l) provides rules clarifying that an item of income that is subject to the timing rules in Prop. Reg. Sec. 1.451-3, such as specified credit card fees, is not taken into account in determining the OID on a debt instrument. Concurrent with the issuance of the proposed regulations, the IRS issued Rev. Proc. 2019-37 to provide procedures for a taxpayer to obtain automatic consent to make an accounting method change to comply with Code Sec. 451(b), Prop. Reg. Sec. 1.451-3, Prop. Reg. Sec. 1.451-8, and Prop. Reg. Sec. 1.1275-2(l), as applicable.

In December of 2020, the IRS issued final regulations under Reg. Sec. 1.451-3, Reg. Sec. 1.451-8, and Reg. Sec. 1.1275- 2(l) in T.D. 9941. The regulations are generally applicable for tax years beginning on or after January 1, 2021, with the exception of the rules in Reg. Sec. 1.451-3(j) and Reg. Sec. 1.1275-2(l)(1) for specified fees that are not specified credit card fees, as defined in Reg. Sec. 1.451-3(j)(2), which apply for tax years beginning on or after January 6, 2022. However, a taxpayer and its related parties, within the meaning of Code Sec. 267(b) and Code Sec. 707(b), may choose to apply both the rules in Reg. Sec. 1.451-3 and, to the extent relevant, the rules in Reg. Sec. 1.451-8 for a tax year beginning after December 31, 2017, and before January 1, 2021, provided the rules are applied in their entirety and in a consistent manner for such tax year and all subsequent years. In addition, for specified credit card fees, a taxpayer and its related parties may apply both the rules in Reg. Sec. 1.451-3 and Reg. Sec. 1.1275-2(l) that apply to specified credit card fees for a tax year beginning after December 31, 2018, and before January 1, 2021, provided that the rules are applied in their entirety and in a consistent manner for such tax year and all subsequent tax years. Alternatively, a taxpayer may rely on Prop. Reg. Sec. 1.451-3, Prop. Reg. Sec. 1.451-8, and/or Prop. Reg. Sec. 1.1275-2(l), as applicable, for tax years beginning after December 31, 2017 (or December 31, 2018, in the case of specified credit card fees) and before January 1, 2021. For a specified fee that is not a specified credit card fee, a taxpayer may neither choose to apply the final regulations to, nor rely on the proposed regulations for, a tax year beginning before January 6, 2022.

Observation: The final regulations obsoleted Rev. Procs. 2004-33, 2004-34, 2005-47, 2011-18, 2013-29, and Notice 2018-35 for tax years beginning on or after January 1, 2021. A taxpayer that relied on the now-obsoleted guidance must determine whether a change in method of accounting occurs once it ceases to use the obsoleted guidance. A change to comply with the final regulations under Reg. Sec. 1.451-3, Reg. Sec. 1.451-8, and/or Reg. Sec. 1.1275-2(l), as applicable, is a change in method of accounting to which the provisions of Code Sec. 446 and Code Sec. 481 and the accompanying regulations apply. Except as otherwise provided by the Code or the regulations, Code Sec. 446(e) and Reg. Sec. 1.446-1(e)(2) require a taxpayer to secure the consent of the IRS before changing a method of accounting for federal income tax purposes. Reg. Sec. 1.446-1(e)(3)(ii) authorizes the IRS to prescribe administrative procedures that provide the terms and conditions necessary for a taxpayer to obtain consent to a change in method of accounting.

Rev. Proc. 2015-13 provides the general procedures by which a taxpayer may obtain automatic consent to a change in method of accounting described in the List of Automatic Changes. Rev. Proc. 2019-43 provides the current List of Automatic Changes to which the automatic change procedures in Rev. Proc. 2015-13 apply. Rev. Proc. 2015-13 also sets forth the application procedures for timely filing a change in method of accounting under the automatic change procedures and provides that a taxpayer may not request, or otherwise make, a retroactive change in method of accounting on an amended federal income tax return, unless specifically authorized by the IRS or by statute. A taxpayer that chooses to early apply the final regulations under Reg. Sec. 1.451-3, Reg. Sec. 1.451-8, and/or Reg. Sec. 1.1275-2(l), as applicable, to a tax year beginning before January 1, 2021, must follow the rules for changes in method of accounting under Code Sec. 446, the accompanying regulations, and the applicable procedural guidance. Accordingly, such taxpayer cannot change its method(s) of accounting to early apply the final regulations under Reg. Sec. 1.451-3, Reg. Sec. 1.451-8, and/or Reg. Sec. 1.1275-2(l), as applicable, on an amended federal income tax return.

Rev. Proc. 2021-34

On August 12, the IRS issued Rev. Proc. 2021-34. The procedure modifies the current List of Automatic Changes in Rev. Proc. 2019-43. Rev. Proc. 2021-34 provides procedures for a taxpayer to obtain the automatic consent of the IRS to change its methods of accounting to comply with Reg. Sec. 1.451-3, Reg. Sec. 1.451-8, and/or Reg. Sec. 1.1275-2(l), as applicable, including special terms and conditions for certain changes to comply with such regulations. In addition, Section 4 of Rev. Proc. 2021-34 modifies Rev. Proc. 2015-13 to provide procedures for a taxpayer to obtain the consent of the IRS to change its method of accounting to comply with Reg. Sec. 1.451-3 and/or Reg. Sec. 1.451-8, as applicable. Rev. Proc. 2021-34 is generally applicable for a Form 3115, Application for Change in Accounting Method, filed on or after August 12, 2021.

For a discussion of the inclusion of tax income no later than its inclusion in an applicable financial statement, see Parker Tax ¶241,715. For a discussion of the tax treatment of advance payments, see Parker Tax ¶241,720. For a discussion of changes in method of accounting, see Parker Tax ¶241,590.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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