What Is Rev Proc 2021-28 for Accounting Method Changes?

Rules for small businesses simplifying their inventory accounting are rooted in Internal Revenue Code (IRC) Section 471. Introduced by the Tax Cuts and Jobs Act (TCJA), this exemption allows qualifying small businesses to use simplified inventory methods. The IRS provides the procedural rules for these changes through revenue procedures. These guidelines grant automatic IRS consent for eligible businesses, reducing the administrative process.

Determining Eligibility

Eligibility for simplified inventory methods hinges on qualifying as a “small business taxpayer” by meeting the gross receipts test under IRC Section 448. To pass this test, a business must have average annual gross receipts for the three prior taxable years that do not exceed an inflation-adjusted threshold, which is $31 million for 2025.

The calculation requires totaling the gross receipts for the three-year period and dividing by three. Gross receipts are broadly defined to include total sales, net of returns and allowances, and all amounts received for services. This also includes income from investments, such as interest, dividends, rents, and royalties.

Under the aggregation rule, if a business is part of a group of companies under common control, the gross receipts of all members must be combined when applying the test. This prevents businesses from splitting into smaller entities to meet the threshold. A failure to properly aggregate receipts can lead to an incorrect determination of eligibility.

Certain businesses are prohibited from using these simplified methods, even if they meet the gross receipts test. Tax shelters are not eligible for this relief, so a business must first confirm it is not classified as one before determining its eligibility.

Permissible Inventory Accounting Methods

Once a business confirms its eligibility, it can choose from several simplified inventory methods. A primary benefit is an exemption from the uniform capitalization (UNICAP) rules of IRC Section 263A. The exemption allows small businesses to avoid complex UNICAP calculations, simplifying their record-keeping and potentially accelerating expense deductions.

One common method is to treat inventory as non-incidental materials and supplies (NIMS). Under this treatment, the cost of inventory items is deducted in the year they are first used or consumed in the business’s operations, rather than the year they are purchased. For example, a manufacturer would deduct the cost of raw materials as they are incorporated into production.

Another option is to conform the tax accounting method for inventory to the method used in the taxpayer’s Applicable Financial Statement (AFS). An AFS is a certified, audited financial statement filed with a government agency or used for credit purposes. This allows a business to use the same inventory method for tax and financial reporting, promoting consistency.

If a taxpayer does not have an AFS, it can use the inventory method reflected in its non-AFS books and records. This method must be one the business consistently uses for its internal management and reporting. This provides flexibility for businesses without formal audited financials but that maintain reliable internal records.

Choosing one of these methods is not a permanent election, as a business can change methods if its circumstances change. For instance, a taxpayer using the NIMS method could later change its identification procedure, such as moving from specific identification to a first-in, first-out (FIFO) method. These changes are also often covered under automatic consent procedures.

Required Information for Form 3115

To execute the change, a taxpayer must file Form 3115, Application for Change in Accounting Method. The form requires specific information about the taxpayer, the old method of accounting, the new method being adopted, and the justification for the change. The form also requires a Designated Change Number (DCN) to identify the specific automatic change being made.

For these small business inventory changes, several DCNs are relevant. For example, a change to treat inventory as NIMS or to conform to an AFS or books and records method falls under DCN 239. A change within one of these methods, such as altering the valuation procedure, is made under DCN 240. If a business becomes ineligible and must change back to a traditional inventory method, it would use DCN 241.

A key part of completing Form 3115 is the calculation of the net Section 481 adjustment. This adjustment represents the cumulative financial impact of the accounting method change, preventing the duplication or omission of income or deductions. The calculation involves determining what the inventory balance would have been under the new method at the end of the prior year and comparing it to the actual inventory balance under the old method.

The resulting adjustment can be either positive or negative. A positive adjustment, which increases taxable income, is recognized over a period of four years, starting with the year of the change. A negative adjustment, which decreases taxable income, is taken in full in the year of the change.

How to File for the Accounting Method Change

The filing process for an automatic accounting method change is streamlined. The completed Form 3115 must be attached to the taxpayer’s timely filed federal income tax return for the year of the change. This includes filing by the extended due date if a valid extension is in place.

In some cases, a duplicate copy of Form 3115 must also be filed with an IRS address in Ogden, Utah. This duplicate must be filed no later than the date the original form is filed with the tax return. Taxpayers should consult the latest Form 3115 instructions to confirm if this step is necessary, as it has been waived for many automatic changes.

Because these are automatic changes, the taxpayer does not need to wait for IRS approval before implementing the new method. Consent is granted automatically, provided the form is completed correctly and filed according to procedural rules. No user fee is required for an automatic change.

Implementing the new method means the taxpayer will begin using it for all inventory-related transactions from the first day of that year. The taxpayer must also properly account for the adjustment on the tax return for the year of change and, if it is a positive adjustment, in the subsequent three years.