IRS Rev. Proc. Addresses Accounting Method Changes for an Eligible Terminated S Corp

(Parker Tax Publishing August 2018)

The IRS issued guidance which requires an eligible terminated S corporation that is required to change from the overall cash method of accounting to an overall accrual method of accounting as a result of revoking its S corporation election, and that makes this change for the C corporation's first tax year after such revocation, to take into account the resulting positive or negative adjustment required by Code Sec. 481(a)(2) ratably during the six-year period beginning with the year of change. The guidance also provides that an eligible terminated S corporation that is permitted to continue to use the cash method after the revocation of its S corporation election and that changes to an overall accrual method for the C corporation's first tax year after such revocation, may take into account the resulting positive or negative adjustment required by Code Sec. 481(a)(2) ratably during the six-year period beginning with the year of change. Rev. Proc. 2018-44.

The Tax Cuts and Jobs Act of 2017 enacted new Code Sec. 481(d). Code Sec. 481(d)(1) requires an eligible terminated S corporation to take into account ratably during the six-year period beginning with the year of change any adjustment required by Code Sec. 481(a)(2) that is attributable to the corporation's revocation of its S corporation election. An eligible terminated S corporation is any C corporation (1) which (i) was an S corporation on December 21, 2017, and (ii) during the two-year period beginning on December 22, 2017, revokes its election under Code Sec. 1362(a), and (2) the owners of the stock of which, determined on the date such revocation is made, are the same owners (and in identical proportions) as on December 22.

Code Sec. 1362(e)(1) provides that generally in the case of an S termination year, the portion of such year ending before the first day for which the termination is effective is treated as a short tax year for which the corporation is an S corporation, and the portion of such year beginning on such first day is treated as a short tax year for which the corporation is a C corporation. Generally, an S termination year is any tax year of a corporation in which the termination of its S election takes effect (other than on the first day thereof).

Code Sec. 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method of accounting used to compute taxable income for the preceding taxable year. Generally, except as otherwise provided, a taxpayer must secure IRS consent before changing a method of accounting. In Rev. Proc. 2015-13, the IRS provides procedures by which a taxpayer obtains automatic IRS consent to change a method of accounting. Rev. Proc. 2015-13, as modified, 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 as contained in Rev. Proc. 2018-31. Section 15.01 of Rev. Proc. 2018-31 provides automatic changes for certain taxpayers that want to change their overall method of accounting from the cash method to an accrual method, including taxpayers required to make this change by Code Sec. 448.

The IRS has now issued Rev. Proc. 2018-44, which provides that an eligible terminated S corporation required to change from the cash method to an accrual method as a result of a revocation of its S corporation election, and that makes this accounting method change under Section 15.01 of Rev. Proc. 2018-31 for the first tax year that it is a C corporation, must take the resulting positive or negative adjustment required by Code Sec. 481(a)(2) into account ratably during the six-year period beginning with the year of change. Rev. Proc. 2018-44 also allows an eligible terminated S corporation that is permitted to continue to use the cash method after the revocation of its S corporation election and that changes to an accrual method under Section 15.01 of Rev. Proc. 2018-31 for the first tax year that it is a C corporation, to take the resulting positive or negative adjustment required by Code Sec. 481(a)(2) into account ratably during the six-year period beginning with the year of change.

Observation: In addition to the change to an accrual method described in Section 15.01 of Rev. Proc. 2018-31, an eligible terminated S corporation may have other accounting method changes that result in adjustments required by Code Sec. 481(a) that are attributable to such corporation's revocation of its S corporation election as described in Code Sec. 481(d)(2). However, the IRS makes clear that such changes are not within the scope of Rev. Proc. 2018-44.

For a discussion of Code Sec. 481 adjustments required by a change in method of accounting, see Parker Tax ¶241,595.

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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