Rev. Proc. 99-28: Changing Bad Debt Accounting Methods

Changing an accounting method is governed by Internal Revenue Service (IRS) directives. For many changes, taxpayers can gain automatic consent by following procedures in guidance that the IRS updates periodically. These procedures provide a standardized path for taxpayers to align their accounting practices with tax regulations without needing to request a private letter ruling. For bad debts, this often involves moving to a method that properly reflects when a debt becomes worthless. The automatic consent framework is designed to streamline this transition for both the taxpayer and the IRS, establishing clear requirements and outcomes.

Scope and Applicability of the Procedure

The IRS issues specific guidance for certain industries. For example, automatic change procedures for bad debt accounting have been tailored for regulated financial companies and members of regulated financial groups, allowing them to change to a permissible charge-off method.

However, this path is not available to all taxpayers. Certain banks changing from the Section 585 reserve method are excluded and must use non-automatic change procedures, which require a more extensive application and a user fee. Eligibility to use an automatic change procedure is also restricted if the taxpayer is under an IRS examination for the accounting method in question.

Required Documentation and Information

Changing an accounting method for bad debts requires filing IRS Form 3115, Application for Change in Accounting Method. This form serves as the foundation of the filing, detailing the taxpayer’s current accounting practice, the proposed new method, and the legal basis for the change. The taxpayer must describe the present method as improper and outline the proposed method that complies with tax regulations.

For certain automatic changes, such as for regulated financial companies, the change is made on a “cut-off basis.” This means the new accounting method applies to transactions from the beginning of the year of change forward. A Section 481(a) adjustment, which calculates the cumulative financial impact of the change, is neither permitted nor required.

The Filing Process

After completing Form 3115, the taxpayer must follow a dual-filing procedure to notify the IRS of the change. The primary step is to attach the original, signed Form 3115 to the taxpayer’s timely filed federal income tax return for the year the change is implemented, including any valid extensions.

In conjunction with the tax return filing, a separate, signed copy of the same Form 3115 must be submitted to the IRS. For automatic changes, this duplicate copy should be sent to the address listed in the official Form 3115 instructions. The deadline for submitting this copy is no 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.

Terms and Conditions of Consent

A benefit of using this procedure is receiving audit protection. When a taxpayer properly files Form 3115 to change from an improper method, the IRS will not require the taxpayer to change its method for the same item for a tax year prior to the year of change. There is no user fee required by the IRS for a Form 3115 filed under automatic change procedures.