Retroactive accounting-method change relief denied

Plain-English summary

An accrual-method S corporation bought merchandise on credit from a related cash-method S corporation and deducted the purchases before the seller recognized corresponding income, a method the buyer determined did not comply with section 267. After the common owner's death and an ownership change, the buyer sought extra time to file Form 3115 for its 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 taxpayer'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 make a retroactive accounting-method change under section 267?
• Outcome: denied
• Key authorities: IRC §§ 267, 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: 201740016                                              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-117918-17
                                                               Date:
                                                               June 28, 2017


Legend

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

Re: Request for Extension of Time to File a Form 3115 to Change Taxpayer’s Method
of Accounting to Comply with § 267

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 method of
accounting to comply with § 267 of the Internal Revenue Code.

FACTS

         Taxpayer represents the facts are as follows:

      A was the founder and owner of both Taxpayer and B. Taxpayer is an S
corporation that uses an overall accrual method of accounting. B is an S corporation
PLR-117918-17                               2

that uses the overall cash receipts and disbursements method of accounting (the “cash
method”).
       B manufactures and sells C to Taxpayer. Taxpayer purchases this merchandise
on credit. Taxpayer claims a deduction with respect to the purchase of this
merchandise for federal income tax purposes upon the purchase from B. In contrast,
since B is a cash method taxpayer, B does not recognize any corresponding taxable
income for federal income tax purposes upon the sale of this merchandise to Taxpayer.

         Taxpayer has determined that its method of accounting for purchases from B is
impermissible because it is not in compliance with § 267. Accordingly, Taxpayer seeks
to file a Form 3115 to change its method of accounting to comply with § 267 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 and B that was the result of the recent death of A in D.
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)
(the “§ 481(a) adjustment”) that will arise when Taxpayer complies with § 267.

       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 method of accounting to comply with § 267
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 certain accounting methods. A
taxpayer complying with all the applicable provisions of this revenue procedure has
PLR-117918-17                                3

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
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 an
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).
PLR-117918-17                                4


       It is in the interest of sound tax administration to generally preclude taxpayers
from requesting, or otherwise making, a retroactive change in an adopted 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 must be decided on a case-by-case basis in light of all applicable facts
and circumstances. Id. at 390.

        Taxpayer seeks permission to file a Form 3115 to change its method of
accounting to comply with § 267 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 its late filing of the Form
3115.

       Here, Taxpayer is most likely able to file an automatic change Form 3115 for its
current taxable year to change its method of accounting to comply with § 267 or, if it
does not qualify for an automatic change, it can still file a nonautomatic Form 3115.
See section 13.01 (losses, expenses, and interest with respect to transactions between
related taxpayers) of Rev. Proc. 2017-30, 2017-18 I.R.B. 1130, 1184. 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 an 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 method of accounting to comply with § 267 for the earliest taxable year not
closed by the statute of limitations. Specifically, Taxpayer has failed to demonstrate
PLR-117918-17                                5

unusual and compelling circumstances and, accordingly, the Government’s interests are
deemed prejudiced.

       Also, at the same time Taxpayer filed this request for an extension of time to file
its Form 3115, Taxpayer: (1) filed a Form 3115 to change its accounting method to
comply with § 267 for its E taxable year; and (2) filed amended returns for the E and F
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 the E and F 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 amended 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