IRS issues Section 451 accounting method change procedures

In detail

Accounting method changes to comply with the Section 451 final regulations

The final regulations generally are effective for tax years beginning on or after January 1, 2021, but allow taxpayers to adopt the final regulations for earlier tax years.

Observation: Taxpayers should consider whether to implement the final regulations on their 2020 federal income tax returns, particularly if implementation could increase taxable income in 2020 and mitigate a possible increase in the corporate tax rate in a later tax year or if a method change is needed to secure audit protection for an impermissible method.

Changes covered by the automatic procedures

Rev. Proc. 2021-34 amends Rev. Proc. 2019-43 to allow taxpayers with an AFS to use the automatic procedures to change to certain accounting methods, including:

• A method allowed under the proposed regulations under Sections 451(b) and 1275 for tax years beginning before January 1, 2021,
• A method allowed under the proposed regulations under Section 451(c) for tax years beginning before January 1, 2021,
• The AFS inclusion rule, or the alternative AFS inclusion rule to recognize revenue to which a taxpayer does not have an enforceable right to payment no later than when recognized in an AFS, under the Section 451(b) final regulations,
• Applying or not applying the cost offset method for sales of goods under Section 451(b) or Section 451(c) and changing the cost offset method consistent with changes to a permissible underlying inventory method,
• For allocating transaction price,
• To address mismatched tax and financial accounting years under the Section 451(b) or Section 451(c) regulations,
• The Section 451(c) full inclusion method or deferral method for advance payments,
• The specified good Section 451(c) method under which specified goods otherwise excepted from Section 451(c) may be accounted for under either the full inclusion or deferral method, and
• For allocating advance payments to multiple performance obligations under a contract.

Rev. Proc. 2021-34 also allows taxpayers without an AFS to change to methods authorized under the Section 451(c) regulations, including the full inclusion, deferral, and cost offset methods, and to allocate advance payments to multiple performance obligations.

Rev. Proc. 2021-34 provides that it does not apply to changes to a special method of accounting (which may be covered by other provisions in Rev. Proc. 2019-43), to methods of accounting for specified fees other than specified credit card fees, to a change to a Section 451(b) method for payments for specified goods, or to methods that do not comply with the final regulations. 

Changes to general method change procedures

Rev. Proc. 2021-34 modifies Rev. Proc. 2015-13 to require that a taxpayer makes a change to its cost offset method to conform to a permissible inventory method and a ‘cost-offset related inventory method change’ concurrently. A ‘cost-offset related inventory method change’ is a change in accounting method for inventory or a liability that could affect a taxpayer’s cost of goods in progress offset under the cost offset method.

Method changes relating to specified fees

Rev. Proc. 2013-26 describes the proportional method of accounting for OID on a pool of credit card receivables. Under the final regulations, OID no longer includes a specified fee, such as a specified credit card fee, that is subject to the timing rules of Section 451(b). Rev. Proc. 2021-35 amends Rev. Proc. 2013-26 to conform to these rules.

Rev. Proc. 2021-34 modifies Rev. Proc. 2019-43 for method changes related to specified fees, including providing procedures for a taxpayer using the proportional method of accounting to change its method of accounting for specified credit card fees to remove specified credit card fees from its pools of credit card receivables.

Conforming changes to automatic method change procedures

Rev. Proc. 2021-34 makes certain other changes to the automatic method change procedures to conform to the new rules, including:

• Temporarily waiving the limitation on using the automatic method change procedures for the same item more than once in five years for certain inventory changes made in connection with changes to comply with Section 451,
• Modifying the change in overall method of accounting from the cash method to an accrual method for taxpayers with an AFS,
• Removing automatic changes for credit card late fees and credit card advance fees,
• Sunsetting automatic changes relating to advance payments under Rev. Proc. 2004-34 for tax years beginning after 2020,
• Removing an automatic change to the Section 451(b) proposed regulations, and
• Modifying provisions for method changes relating to the new financial accounting standards for revenue recognition under ASC 606.

Administrative provisions

Procedure for making change

Rev. Proc. 2021-34 allows taxpayers to make the automatic method changes on an abbreviated Form 3115.

Under a streamlined procedure, taxpayers generally may change certain methods of accounting (for example, the Section 451(b) AFS or alternative AFS inclusion rule, or the Section 451(c) full inclusion or deferral rule for advance payments) without filing a Form 3115 for the first tax year beginning before January 1, 2021, or for the first tax year beginning on or after January 1, 2021, that the taxpayer applies the Section 451(b) or Section 451(c) final regulations. The streamlined procedures do not apply if the taxpayer is making a concurrent change relating to the cost offset method.

The taxpayer must meet the gross receipts test for a small taxpayer under Section 448(c) and may not be a tax shelter. Each change made under the streamlined procedures must have a zero Section 481(a) adjustment. A taxpayer making a change under the streamlined procedures does not receive audit protection for the change.

Observation: Taxpayers eligible to change their methods without filing a Form 3115 under the streamlined procedures should consider whether the benefits of audit protection outweigh the inconvenience of filing a Form 3115. However, a taxpayer that changed its method of accounting to comply with the Section 451 amendments under earlier guidance and received audit protection should retain that protection. Thus, for example, a taxpayer that changed its method of accounting to comply with the proposed regulations for a tax year beginning in 2020 and received audit protection will continue to have audit protection for tax years before 2020. A taxpayer that then uses the streamlined procedures to change its method of accounting for its tax year beginning in 2021 will lack audit protection only for the 2020 and 2021 tax years. Nonetheless, the lack of audit protection may not be significant if the Section 481(a) adjustment is zero, which is required to use the streamlined procedures.

Under certain conditions, a taxpayer may change a cost offset method to conform to a permissible inventory method on an amended federal income tax return if it received consent to change a corresponding cost-offset related inventory method for the same tax year of change under the nonautomatic procedures.

Section 481(a) adjustments

Rev. Proc. 2021-34 includes a number of special rules for Section 481(a) adjustments. For example, taxpayers must provide a single Section 481(a) adjustment for certain concurrent method changes, such as changing to the AFS inclusion rule or alternative AFS inclusion rule concurrent with a change to or from the Section 451(b) cost offset method.

A taxpayer must use the same negative or positive Section 481(a) spread period for a change to a cost offset method to conform to a permissible inventory method as is required for a concurrent cost-offset related inventory method change. Thus, the taxpayer must spread a negative Section 481(a) adjustment for the cost offset method change over four tax years if the cost-offset related inventory method change results in a positive Section 481(a) adjustment that must be spread over four tax years.

Taxpayers may use either a Section 481(a) adjustment or a cut-off for a change to a method under the proposed regulations under Sections 451(b) and 1275 if the taxpayer adopts ASC 606 in the same tax year, or for a change to a method under the proposed regulations under Section 451(c), subject to certain exceptions and conditions.

Rev. Proc. 2021-34 reiterates that the Section 481(a) adjustment period is six tax years for a change in method of accounting for income from a specified credit card fee to a method that is required by the regulations.

Other terms and conditions

Rev. Proc. 2021-34 waives (1) the limitation on using the automatic method change procedures if a taxpayer has made or requested a change for the same item in the last five tax years and (2) the denial of audit protection for an item under examination, for the following method changes:

• To comply with the Section 451(b) or Section 451(c) proposed regulations, for a taxpayer’s first, second, or third tax year beginning after 2017 and before 2021,
• For the taxpayer’s first tax year beginning before January 1, 2021, or for the first tax year beginning on or after January 1, 2021, that the taxpayer applies the Section 451(b) or Section 451(c) final regulations, and
• For specified credit cards fees,
  • For a change to the Section 451(b) proposed regulations for a taxpayer’s first or second tax year beginning after 2018 and before 2021, and
  • For a taxpayer’s first tax year beginning before January 1, 2021, or for the first tax year beginning on or after January 1, 2021, that the taxpayer complies with the Section 451(b) final regulations.

The five-year limitation also is waived for a change to a cost offset method to conform to a permissible inventory method. However, no audit protection is provided for this change if the corresponding cost-offset related inventory method is under examination, unless the taxpayer ultimately receives audit protection for the cost-offset related inventory method.

Observation: Rev. Proc. 2021-34 does not provide a comprehensive waiver of the five-year limitation for all method changes associated with the final regulations or for multiple tax years, as the IRS has done for taxpayers implementing other final regulations. The one-year waiver essentially permits a taxpayer simply to adopt the final regulations in 2021 although the taxpayer previously changed its method of accounting for items covered by the Section 451 regulations, for example to a reasonable interpretation of the Section 451 amendments before issuance of regulations or to the rules under the proposed regulations. The taxpayer would not be able to use the automatic procedures to change its method of accounting for the same item again in 2022, when tax rates may be higher.