Automatic Changes Provided for TCJA Small Business Accounting Methods

August 3, 2018 Ed Zollars, CPA

The IRS has now issued guidance on how businesses may obtain automatic consent to change accounting methods to use the new “small business” methods contained in the Tax Cuts and Jobs Act in Revenue Procedure 2018-40.

The accounting methods in question are each available to taxpayers with average annual gross receipts of $25 million or less for the prior three years. The affected changes, as described by the Revenue Procedure are:

Section 13102 of “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97 (the “Act”), amended § 448 of the Internal Revenue Code (Code) to expand the number of small business taxpayers eligible to use the cash receipts and disbursements method of accounting (cash method).

Section 13102 of the Act also amended the Code to exempt small business taxpayers from

the requirements to capitalize costs, including for certain home construction contracts, under § 263A,

to account for certain long-term contracts under § 460, and

to account for inventories under § 471.

Since IRC §446(e) requires taxpayers to obtain the IRS’s consent to change its method of accounting for any material item, the procedure provides new automatic changes of accounting methods that will enable a taxpayer to make these changes by filing the Form 3115 at the time the tax return for the year of change is filed.

Taxpayers making these changes will use the automatic change procedures found in Revenue Procedure 2015-13 and Revenue Procedure 2018-31 as modified this procedure.

Small Businesses Changing to the Overall Cash Method

The change to the cash method is found at Section 2.02(1), adding new section 15.18 to Revenue Procedure 2018-31.

The description of the change added reads:

(1) Description of change. This change applies to a small business taxpayer, as defined in section 15.18(5)(a) of this revenue procedure, that wants to change its overall method of accounting from an overall accrual method of accounting to the overall cash method of accounting for a trade or business, and is otherwise not prohibited from using the overall cash method or required to use another overall method of accounting. A small business taxpayer may be required to use a method of accounting (other than the cash method) for one or more items of income or expense under certain provisions of the Code or regulations, including, for example §§ 475 and 1272.

This automatic change is available for tax years beginning after December 31, 2017.

Certain taxpayers are barred from using this procedure:

A bank changing to the overall cash/hybrid method. The bank may be able to change to the cash/hybrid method under section 15.12 of Revenue Procedure 2018-31.
Farmers changing to the overall cash method. The farmers should look to section 15.13 of Revenue Procedure 2018-31.

The rule barring a taxpayer from making a change in overall method of accounting within five years of a prior change of overall method does not apply for this change, so long as the change is requested in the first, second or third tax year beginning after December 31, 2017.

Example

ABC Distributing, Inc., a C corporation, was required to change its method of accounting to the overall accrual method for 2017 as its income exceed the prior $5,000,000 average gross receipt limit. For 2018 the average of the prior three years’ revenue is well less than $25 million.

Despite having changed its overall method in the prior year, under this Revenue Procedure ABC could change its method back to the overall cash method in 2018. Assuming it meets the revenue test, the same exception would allow ABC to change its overall method in 2019 and 2020 as well. However, beginning in 2021 the five-year test would again apply—thus ABC could not make this automatic change in 2021.

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The taxpayer filing for this change of method only must complete the following portions of the Form 3115.

(a) The identification section of page 1 (above Part I);

(b) The signature section at the bottom of page 1;

(d) Part II, all lines except line 16;

(e) Part IV, all lines except line 25; and

(f) Schedule A, Part I, all lines except lines 3, 4, and 5.

The procedure provides that the taxpayer makes the change of methods for no longer following IRC §263A and not keeping inventories on the same Form 3115.

The designated change number (DCN) for this change is 233.

Section 263A Exemption

New Section 12.16 is added to Revenue Procedure 2018-31 to allow for the following changes for a qualifying small taxpayer:

This change applies to a small business taxpayer, as defined in section 15.18(5)(a) of this revenue procedure, that capitalizes costs under § 263A and wants to change to a method of accounting that no longer capitalizes costs under § 263A, including to self-constructed assets, pursuant to § 263A(i).

The change is effective for taxable years beginning after December 31, 2017.

This change is not available to a taxpayer that choses to no longer capitalize costs under IRC §263A for home construction contracts, as that matter is covered under the small contractor change.

The rule barring a taxpayer from making a change in the same item within five years of a prior change in that item does not apply for this change, so long as the change is requested in the first, second or third tax year beginning after December 31, 2017. Thus, a retailer that exceeded the $10,000,000 gross revenue test first for 2017 (and thus began using §263A methods) can change its method back to not using that method in 2018, 2019 or 2020.

A taxpayer asking for this change fills in the following portions of Form 3115:

(a) The identification section of page 1 (above Part I);

(b) The signature section at the bottom of page 1;

(d) Part II, all lines except line 16; and

(e) Part IV, all lines except line 25.

As was noted earlier, this change can be made on the same Form 3115 as a request to change to the overall cash method and to cease recording inventories.

The DCN for this change is 234.

Exception from Accounting for Inventories

This change of method is described as follows in the Revenue Procedure:

This change applies to a small business taxpayer, as defined in section 15.18(5)(a) of this revenue procedure, that wants to change its § 471 method of accounting for inventory items to one of the following:

(a) treating inventory as non-incidental materials and supplies under § 1.162- 3; or

(b) conforming to the taxpayer’s method of accounting reflected in its applicable financial statements, as defined in § 451(b)(3), with respect to the taxable year, or if the taxpayer does not have an applicable financial statement for the taxable year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures.

The second option is the interesting one—that option is not one provided for by TCJA, but rather was added by the IRS.

But is important to note that using it comes with a caveat. The Revenue Procedure warns:

(5) No ruling on method of accounting used. The consent granted under section 9 of Rev. Proc. 2015-13 for a change made under section 22.19(1)(b) of this revenue procedure is not a determination by the Commissioner that the proposed inventory method of accounting is permissible, and does not create any presumption that the proposed method is a permissible method of accounting under a provision of the Code. The director will ascertain whether the proposed method is permissible under the Code.

As with the earlier two changes, this automatic change applies to tax years beginning after December 31, 2017.

The taxpayer fills in the following portions of Form 3115 when asking for this change:

(a) The identification section of page 1 (above Part I);

(b) The signature section at the bottom of page 1;

(d) Part II, all lines except line 16; and

(e) Part IV, all lines except line 25

Once again, this change can be filed on the same Form 3115 as a request to be exempted from IRC §263A and to use the overall cash method of accounting.

The DCN for this change is 235.

Small Contractor Exemption from IRC §460

Section 19.01 is added to Revenue Procedure 2018-31. This change is described as follows:

This change applies to a taxpayer that, beginning in the year of change, qualifies as a small business taxpayer, as defined in section 15.18(5)(a) of this revenue procedure, and (a) wants to change its method of accounting for exempt long-term construction contracts described in § 460(e)(1)(B) from the percentage-of-completion method of accounting described in § 1.460-4(b) to an exempt contract method of accounting described in § 1.460-4(c), or (b) chooses to stop capitalizing costs under § 263A for home construction contracts defined in § 460(e)(1)(A).

The change applies to long term contracts entered into after December 31, 2017 in tax years beginning after December 31, 2017.

The Revenue Procedure reminds taxpayers that this change only applies to exempt contracts. If the taxpayer has exempt and non-exempt contracts (a contract expected to take more than 2 years to complete from the beginning of work on the job), the percentage of completion method will still have to be used on the non-exempt contracts.

(3) Inapplicability. A taxpayer can use a method of accounting for its exempt long-term contracts that is different from the method used for contracts that are not exempt. Thus, a taxpayer must use the percentage-of-completion method of accounting for nonresidential long-term construction contracts entered into in the first taxable year that the taxpayer fails the § 448(c) gross receipts test, but must continue to use its exempt contract method of accounting for its existing exempt long-term construction contracts. Similarly, in the taxable year that a taxpayer first meets the § 448(c) gross receipts test, the taxpayer can use a permissible exempt contract method of accounting for long-term construction contracts it expects to complete within two years. Rev. Rul. 92-28, 1992-1 C.B. 153. Accordingly, only a taxpayer who previously adopted the percentage-of-completion method of accounting for exempt long-term construction contracts and wants to change to another permissible exempt contract method of accounting is required to request consent to change under this section 19.01. Similarly, a taxpayer that meets the § 448(c) gross receipts test and enters into a home construction contract that it expects to complete within two years requires consent to change its method of accounting to not capitalize costs under § 263A only if the taxpayer has previously applied § 263A to home construction contracts exempt from the capitalization requirement under § 460(e)(1).

This change also must be made on the cut-off method. No §481(a) adjustment is computed. Rather, the taxpayer completes its contract open on the first day of the year of change using the percentage of completion method and begins using the new method only with contracts entered into once the year begins.

The taxpayer making this change fills in the following portions of Form 3115:

(a) The identification section of page 1 (above Part I);

(b) The signature section at the bottom of page 1;

(d) Part II, all lines except line 16;

(e) Part IV, line 25; and

(e) Schedule D, Part I.

This change, unlike the others in this Revenue Procedure, does not have a clause allowing it to requested on a Form 3115 with any other change request.

The DCN is 236.

Other Changes

The Revenue Procedure makes changes to existing automatic changes that are rendered irrelevant by the new changes.

Existing 481(a) Adjustment

A taxpayer may be in the middle of the period for recognizing a Section 481(a) adjustment creating when changing to a method prior to 2018 that is now being reversed due to the law change.

In that case the IRS provides a choice for the taxpayer as outlined below:

If a taxpayer is taking into account a § 481(a) adjustment resulting from a prior, but related, change in method of accounting at the time it changes its method of accounting described in section 3 of this revenue procedure, the taxpayer may account for the prior § 481(a) adjustment separately from the § 481(a) adjustment required by a change in method of accounting described in section 3 of this revenue procedure. For example, a taxpayer that changed from the cash method to an overall accrual method in a prior year and was required to take the relevant § 481(a) adjustment into account over four years could continue to take into account any remaining adjustment over the appropriate number of years even if the taxpayer changes to the cash method in the current year under section 3 of this revenue procedure. However, the taxpayer may also choose to combine or net the remaining portion of the prior § 481(a) adjustment with the § 481(a) adjustment required by the change in method of accounting made under section 3 of this revenue procedure. Any taxpayer choosing to combine or net the § 481(a) adjustments indicates this choice in the statement required on Line 26 on the Form 3115, Application for Change in Accounting Method, (Rev. December 2015) required to be filed to make the change(s) in method of accounting under section 3 of this revenue procedure.

Non-Automatic Change Request Already Filed with the IRS

Some taxpayers may have filed a non-automatic change request for these changes out of concern that the IRS might not have provided for an automatic change or some other reason. The transition rules allow a taxpayer to withdraw such a request.