TruPoint Accounting & Tax Today

It cannot be put off any longer! We have known about the new repairs regulations involving Form 3115. We have had proposed and then temporary guidance that we could choose to follow or not follow. Now the guidance is finalized and complete. Tax years beginning on or after Jan. 1, 2014, must comply with the guidance.

So What is Form 3115, Tangible Property Regulations (TPR) and What Does it mean to Business Owners like myself?

What Are the Fees Associated to Filing?

The $7,000 user fee applies to a taxpayer seeking non-automatic consent for an accounting method change. The 3115’s required to comply with the TPR’s generally receive automatic consent without a user fee, BUT after 2014 there will be cases where an automatic method change may not be available because of “scope limitations.” Through 2014, the IRS has waived all normal scope limitations to accommodate compliance with the TPR’s. For example, one scope limitation allows for only one accounting method change every five years. In another case, scope limitations limit certain taxpayers with Section 263A (self-constructed assets) method changes to non-automatic consent. Through 2014, all taxpayers will be given automatic consent in spite of these limitations. After 2014, these scope limitations will again be applicable, and changing method of accounting may require a $7,000 fee.

What Are The Risks of Not Filing Form 3115?

Permanent loss of deductions, penalties, and risk of an IRS audit exists for those who do not file a Form 3115. Under the “use it or lose it” rules of depreciation, any improperly capitalized (and depreciated) assets or repairs could be permanently lost as a deduction. Reg 1.1016-3 became final with these TPR’s allowing the IRS to now enforce this “allowed or allowable” rule. Conversely, claiming too much depreciation that is not allowable could subject one to 20% understatement penalties. Through 2014, the IRS is also allowing one to dispose of the replaced portion of an improved asset in a late partial disposition. Such late partial disposition allows one to write-off the old replaced component, resulting in a permanent tax saving by eliminating “dual depreciation” and recapture on the disposed component.These late partial asset dispositions will not be available after 2014.

Risk of audit is also substantial if a Form 3115 is not filed with your 2012, 2013, or 2014 tax return. Upon audit, the IRS has broad discretion on what method of accounting best reflects income, which would likely not be in favor of the taxpayer. Per an examiner’s discretion, the agent could move, defer, or deny a deduction if no 3115 was filed. In this case, the laws and regulations support the IRS either way, because the final regulations require one thing (new rules) but allow another (old or impermissible rules) if not properly implemented.

Example: Writing off routine maintenance under the new rules without ever filing a 3115 to adopt the new rules could allow an auditor to mandate capitalization of those repairs. Or an auditor could claim your capitalized repairs should have been written off and deny the depreciation deduction taken, and if such expenditure was more than 3 years old, that deduction would be permanently lost. In theory, it is possible a taxpayer’s previous accounting method may have been compliant with the final TPR’s by mere happenstance; however, the reality is the final TPR’s are so extensive that such a possibility is nearly remote. For instance, previously capitalizing an expenditure that should have been a repair (in light of the new regs) makes it necessary to change accounting methods.

Are there any advantages?

Long-standing tax rules require that taxpayers receive permission from the Internal Revenue Service (IRS) before changing their accounting methods. But new rules released by the IRS in Rev. Proc. 97-27 (May 1997) and Rev. Proc. 97-37 (August 1997) make obtaining permission for such changes more predictable and straightforward. These taxpayer-friendly procedures also relax previous restrictions on the timing of requests and provide automatic consent for certain changes.

Taxpayer Advantages
The IRS can force taxpayers to change from inappropriate methods of accounting to methods it deems more appropriate. However, taxpayers cannot make accounting changes willingly without first requesting and receiving IRS permission. Taxpayers who make unauthorized changes risk an IRS adjustment (often to the most unfavorable of the methods employed) and penalties. However, by asking permission to change their procedures, taxpayers can select the accounting methods most favorable to them, gaining protection from an inappropriate or overly aggressive historical method. If taxpayers request to change from a method before the IRS tells them to, they can get IRS audit protection for prior open years and can make the change prospectively, usually with a spread-period for the cumulative catch-up adjustment.

Assume, for example, that a taxpayer has been using the cash accounting method and determines that the accrual method would reflect income more clearly. Perhaps the taxpayer has determined that because of existing inventories, the accrual method should have been used anyway. If so, the taxpayer is potentially at risk of IRS adjustment, forcing a change in accounting method on examination in the earliest year for which the statute of limitations is open, consequently owing tax, interest, and potential penalties.

New Provisions
Formerly, a taxpayer could not change to the more-appropriate method without outlining the prior and proposed methods in form 3115, filed with the IRS national office within 180 days of the year of change, paying a user fee to get the IRS to process the request, and spreading the adjustment according to complex IRS rules. New rules streamline the request process; taxpayers can file such requests at any time during the year of change, and in certain cases, avoid paying the IRS user fee.

Some of the major changes in Rev. Proc. 97-27 include:

• The Section 481(a) adjustment period for bringing the cumulative impact of a change into income/deduction is now four years for both positive and negative adjustments. The new rules terminate the category A, category B, and designated category B distinctions, eliminating most spread-period questions.
• The former requirement that taxpayers must file a request to change an accounting method on or before the 180th day of the tax year of change has been eliminated; taxpayers now can file at any time during the year for which the change is effective.
• The 90-day window period after IRS contact for examination has been eliminated.
• The 30-day window for taxpayers under continuous examination has been expanded to 90 days. Additionally, the number of consecutive months that a taxpayer is required to be under examination has been reduced by the IRS from 18 to 12 months.
• The 90-day post-affiliation window has been eliminated. Rev. Proc. 97-27 provides a detailed definition of when a taxpayer is under examination for purposes of Rev. Proc. 97-27.
• The consent requirement for taxpayers before an appeals office or a federal court has been replaced with a notification requirement.
• If an item of partnership or S corporation income/deduction is an issue under consideration at the partner or shareholder level, the partnership or S corporation is considered under examination for purposes of requesting a change in accounting method.

Rev. Proc. 97-27, generally effective for forms 3115 filed on or after May 15, 1997, also clarifies the definitions of “under examination” and “issue under consideration” for purposes of determining whether a taxpayer is eligible for a window period. Generally, “under examination” begins on the date a taxpayer is contacted by the IRS to schedule any type of examination.

Several of the terms and conditions relating to the section 481(a) adjustment also have been eliminated, such as the rules that 90 percent was attributable to the first preceding year and to acceleration for reduction in inventory value.

Automatic Consent 
Rev. Proc. 97-37, effective August 18, 1997, provides new automatic-consent procedures for several specific accounting methods. If a taxpayer’s proposed change method is enumerated in the Rev. Proc. 97-37 appendix list, the taxpayer is not required to pay an IRS user fee to process the change request, and the change is automatic, assuming the taxpayer complies with procedure protocol.

Under earlier rules, taxpayers had to actually receive IRS permission before they could make an accounting method change. However, changes listed in Rev. Proc. 97-37 appendix are automatic; no overt IRS permission is required.

If the IRS requests additional information, taxpayers have 21 days to respond. For listed changes, taxpayers should file a copy of their completed form 3115 with their timely filed (including extensions) original income tax return and file a separate copy of form 3115 with the IRS national office no later than when the original tax return is filed. The filing must include a statement that the taxpayer agrees to all of the terms and conditions of Rev. Proc. 97-37. This revenue procedure provides audit protection with respect to an item, but only if it is filed before an IRS examination begins. Accordingly, if audit protection is desired, form 3115 should be filed with the IRS national office at the earliest possible date instead of the later tax return due date.

So how many hours will this take to complete?

Reference Work Cited Links

https://www.linkedin.com/pulse/20141003225401-313328628-faq-implementing-tangible-property-regulations-tpr-s

http://www.ccim.com/cire-magazine/articles/taxpayer-friendly-procedures-ease-accounting-method-changes