Rev Proc 2018-31: Automatic Accounting Method Changes

The Internal Revenue Service (IRS) offers a streamlined process for taxpayers to change accounting methods. The primary guidance is a master list of automatic changes, updated periodically in a Revenue Procedure, that grants automatic consent for any change included. This eliminates the need to file a formal request and wait for an approval letter.

This process removes the uncertainty and delays of the traditional method, which requires a user fee and a formal ruling from the IRS national office. Automatic consent allows for an extended filing timeframe and immediate implementation of the new method. This helps taxpayers efficiently adopt accounting methods that may better reflect their income or expenses.

Key Automatic Accounting Method Changes

The list of automatic changes covers many situations. Each change is assigned a designated automatic accounting method change (DCN) number, which is required for the filing process. Common changes include:

• Depreciation and Amortization: DCN #7 allows a taxpayer to change from an impermissible method of depreciation for property placed in service in prior years to a permissible one. This could include correcting the recovery period, the depreciation method, or the convention for an asset.
• Capital Expenditures vs. Repairs: DCN #184 allows a business to change its treatment of repair and maintenance costs to align with tangible property regulations. This involves capitalizing amounts paid for improvements while deducting routine maintenance expenses.
• Inventory Methods: A business may change its method of identifying and valuing inventory, such as to the LIFO or FIFO method. DCN #12.16 allows certain small business taxpayers to change their method to no longer capitalize costs under Section 263A, simplifying inventory accounting.
• Revenue and Expense Recognition: A business might need to change how it accounts for advance payments received from customers to comply with Treasury Regulations. A change to properly accrue expenses in the correct period can also be made automatically.

Understanding the Section 481(a) Adjustment

When changing an accounting method, an adjustment under Internal Revenue Code Section 481(a) is required. This adjustment prevents the duplication or omission of income or deductions by capturing the cumulative difference between the old and new accounting methods. This ensures a clean transition without distorting taxable income in the year of change.

The adjustment is calculated as of the first day of the tax year in which the change occurs. The process involves determining what the balance of an affected account, like inventory, would have been on that date if the new method had always been in use. This hypothetical balance is then compared to the actual balance under the old method.

A positive Section 481(a) adjustment increases taxable income and is generally spread forward over four tax years, beginning with the year of the change. For example, if a change results in a $100,000 positive adjustment, the taxpayer would recognize an additional $25,000 of income in each of the next four years.

In contrast, a negative Section 481(a) adjustment decreases taxable income and is generally taken in full in the year of the change. For instance, if a change results in a $40,000 negative adjustment, the taxpayer would deduct the entire $40,000 on their tax return for that year.

Required Information for Form 3115

To initiate an automatic accounting method change, a taxpayer must file Form 3115, Application for Change in Accounting Method. Proper completion of this form is necessary for the change to be considered valid under the automatic consent procedures.

The form requires basic taxpayer identification information, such as name and address. It also requires the designated automatic accounting method change (DCN) number from the current list, which corresponds to the specific change being made.

A detailed description of both the present and proposed methods of accounting is also required. The form also requires the calculated Section 481(a) adjustment amount, whether it is positive or negative, and the applicable period over which it will be recognized.

For certain changes, the applicable revenue procedure may require additional statements or attachments to be included with Form 3115. These specific requirements are detailed within the description of each automatic change.

The Filing Process

Once Form 3115 is completed, the taxpayer must follow a specific process known as the “duplicate filing requirement.” This process ensures that both the taxpayer’s tax return and the IRS have a record of the change. Failure to follow this procedure can invalidate the request.

The first step is to attach the original, signed Form 3115 to the taxpayer’s timely filed federal income tax return for the year of the change. This includes filing by the due date of the return, including any extensions.

The second step involves sending a signed copy of the same Form 3115 to the Internal Revenue Service in Ogden, UT 84201, or faxing it to (844) 249-8134. This copy cannot be filed any earlier than the first day of the year of change and no later than the date the original form is filed with the tax return.

After properly filing both copies of Form 3115, the process is complete. Because the consent is automatic for the changes listed in the revenue procedure, the IRS does not send an acknowledgment or an approval letter.