Accountant's Adoption of New Paperless Tax System Justified Client's Form 3115 Filing Extension

(Parker Tax Publishing February 2017)

The IRS granted an extension of time for a taxpayer to file Form 3115 where the taxpayer missed the filing deadline as a result of the adoption by the taxpayer's accounting firm of a new paperless tax system that caused the firm to overlook certain procedures necessary to timely file the Form 3115. The IRS concluded that the facts constituted "unusual and compelling circumstances" for granting an extension of time. PLR 201702021.

Background

In PLR 201702021, the taxpayer, a construction contractor who was not sophisticated in tax matters, hired an accounting firm (the Firm) to provide tax preparation services. The taxpayer operated his business as an S corporation. Initially, the business capitalized its prepaid insurance expenses and periodically adjusted the deductions as the asset expired. Subsequently, the taxpayer discussed with the Firm the possibility of changing the method of accounting so the business could deduct those expenses in the year they were paid if they met the 12-month rule under Reg. Sec. 1.263(a)-4(f). The change would qualify as an automatic change of accounting method under Rev. Proc. 2015-14 and Rev. Proc. 2015-13.

Observation: A change that qualifies as an automatic change in accounting method does not require payment of a user fee and can be submitted up to the extended filing date of the tax return for the year of change. The latter point enables preparers to correct an accounting method deficiency that is identified during the return preparation process. Otherwise, the Form 3115 must be submitted under nonautomatic consent procedures for the next tax year.

The Firm had adopted a paperless system for filing and storing tax forms and records. The taxpayer's Form 3115, Application for Change in Accounting Method, was prepared and saved in the Firm's electronic files. However, a box was not checked on the internal processing control sheet, which would have alerted the preparer that a Form 3115 should be attached to the return. Therefore, the form was inadvertently omitted from taxpayer's Form 1120S, and the requisite copy was not filed with the IRS as required by Rev. Proc. 2015-13. However, the taxpayer's Form 1120S was prepared and filed consistent with the accounting method change, referenced the (missing) Form 3115, and included the necessary Code Sec. 481(a) adjustment.

For reasons unrelated to this omission, the taxpayer subsequently hired another accounting firm (New Firm). The omission of the Form 3115 was discovered when a member of the New Firm asked the taxpayer for a copy of it. The taxpayer asked the Firm for a copy of the form. At that point, the Firm prepared a private letter ruling requesting an extension of time to file the Form 3115.

Analysis

Reg. Sec. 301.9100-1(c) authorizes the IRS to grant a reasonable extension of time to make certain regulatory elections under the rules in Reg. Secs. 301.9100-2 and 301.9100-3. Reg. Sec. 301.9100-1(b) defines a "regulatory election" in part as an election whose due date is prescribed by a revenue procedure. According to Reg. Sec. 301.9100-3(a), requests for relief under Reg. Sec. 301.9100-3 will be granted when the taxpayer acted reasonably and in good faith, and granting relief would not prejudice the interests of the government. The interests of the government would be prejudiced if granting relief would result in the taxpayer having a lower total tax liability for all tax years affected by the election.

Reg. Sec. 301.9100-3(c)(2) provides special rules for accounting method regulatory elections. Under that regulation, the interests of the government are prejudiced, except in unusual or compelling circumstances, if the accounting method change (1) is subject to the advance consent procedures for method changes; (2) requires a Code Sec. 481(a) adjustment; (3) involves a change from an impermissible method of accounting that is under consideration by an IRS examiner, appeals officer, or federal court; or (4) provides a more favorable method of accounting if the election is made by a certain date or tax year.

Similarly, according to Rev. Proc. 2015-13: "Except in unusual and compelling circumstances, a taxpayer is not eligible for an extension of time to file a Form 3115, and is not eligible to make a late election under section 7.03(3)(d) of Rev. Proc. 2015-13 under [Reg. Secs.] 301.9100-1 and 301.9100-3."

Fortunately for the taxpayer, the IRS found the facts of PLR 201702021 to be unusual and compelling. The IRS noted that the taxpayer engaged the Firm believing its experience with complex tax matters would allow the taxpayer to properly change its method of accounting for prepaid insurance expenses. The taxpayer provided the necessary information to the Firm, which prepared the Form 3115 and Form 1120S as if the change in method had been properly made (i.e., the Form 1120S referenced the Form 3115 and included the necessary Code Sec. 481(a) adjustment).

The IRS concluded that the failure to properly file the Form 3115 was inadvertent and beyond the taxpayer's control. Upon discovery of the error, the Firm promptly requested relief and the relief was requested before the IRS discovered the error. The IRS found that the taxpayer was not using hindsight in requesting relief, and no facts had changed since the original filing deadline. Finally, the IRS observed, the taxpayer would not have a lower total tax liability for all affected tax years if the request for relief was granted. Therefore, the IRS granted an extension of 60 days from the date of the ruling to file the Form 3115.

For discussion of requesting a change in accounting method, including filing Form 3115, 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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