What Is Revenue Procedure 96-57 for Method Changes?
Learn how Revenue Procedure 96-57 provides a streamlined path for taxpayers required to change from the cash to the accrual method of accounting.
The IRS offers a streamlined process providing automatic consent for certain taxpayers to change their accounting method. This applies to those required to switch from a cash to an accrual basis under Internal Revenue Code (IRC) Section 448.
Eligibility for Automatic Consent
The primary candidates are taxpayers mandated by this rule to discontinue the cash method. This rule prohibits C corporations, partnerships with a C corporation as a partner, and tax shelters from using it. An exception exists for entities whose average annual gross receipts for the three preceding tax years do not exceed $31 million for tax years beginning in 2025. To qualify, the taxpayer must not be under an IRS examination for any prior year where the cash method was improperly used.
Certain conditions render a taxpayer ineligible for this automatic change. A taxpayer cannot use this procedure if they have changed their overall accounting method at any point within the preceding five taxable years. The procedure is also unavailable if the taxpayer is before an appeals office or a federal court regarding an income tax issue and the accounting method is a placed issue.
Calculating the Required Adjustment
Before filing, a taxpayer must compute a transitional adjustment under Internal Revenue Code Section 481(a). This adjustment prevents the duplication or omission of income or expense items resulting from the switch from the cash to the accrual method. It represents the cumulative difference in income between the two methods as if the accrual method had been used in all prior years, calculated as of the first day of the year of the change.
The calculation begins by identifying all items of income and expense that would be treated differently under the accrual method. Items that increase the adjustment, thereby increasing taxable income, include accounts receivable and inventory on hand. Conversely, items that decrease the adjustment, and thus taxable income, include accounts payable and other accrued liabilities. The net sum of these positive and negative adjustments constitutes the final adjustment amount.
All outstanding receivables and payables must be tallied as of the beginning of the tax year of the change. The value of inventory must also be determined, as this is an asset under the accrual method but is expensed as purchased under the cash method.
Filing for the Accounting Method Change
The taxpayer must complete and file Form 3115, Application for Change in Accounting Method. This form formally requests the change and reports the computed adjustment amount, citing the requirement for the change.
The filing process involves a dual-filing requirement. The original Form 3115 must be attached to the taxpayer’s timely filed federal income tax return for the year of the change. A copy of the same Form 3115 must be filed with the IRS National Office. No user fee is required when filing under these automatic change procedures. This dual submission notifies both the return processing center and the National Office of the change.
The net adjustment is taken into account over a four-year period, beginning with the year of the change. If the adjustment is positive, one-fourth of the amount is added to taxable income each year for four years. If the adjustment is negative, the full amount is deducted in the year of the change. This spread-out period for positive adjustments mitigates the immediate tax burden that could result from recognizing multiple years of deferred income all at once.