A consistent mistake on a tax return for more than two years may require an accounting method change to correct. The IRS has procedures for making these elections, which generally require a timely filed tax return. But what if you miss the filing deadline–are you out of luck? Private Letter Ruling (“PLR”) 201850013 provides the answer.
Facts & Procedural History
The taxpayer realized that its subsidiary had adopted an impermissible method of accounting for prepaid insurance premium costs. The subsidiary should have taken a deduction for the expenses sooner rather than later.
The taxpayers return preparer prepared the tax return and Form 3115 to report the method change prior to the filing deadline, but was not able to eFile the return timely.
The IRS eventually received the return and Form 3115 and determined that the method change was late and not allowable. The taxpayer then submitted its PLR request to the IRS to obtain a ruling that it could make the method change late.
Accounting Method Changes
An accounting method is how items of income and expense are tallied up and reported on a tax return. It dictates when an item of income or expense is counted.
Disputes related to accounting methods present timing issues. The dispute is whether the item of income or expense has to be reported in one year or another year.
Taxpayers may inadvertently or intentionally report deductions sooner and income later, by adopting an impermissible accounting method. In other cases they may have missed favorable items, such as tax deductions in earlier years, mistakenly believing that they were to be deducted in later years.
If a taxpayer uses the incorrect method for more than one tax period, the taxpayer generally has to request permission from the IRS to correct the issue. This is done by filing for a ruling request, which can be expensive. In other cases identified by the IRS, a Form 3115 can be filed with the IRS to make the change. The later are referred to as automatic method changes.
The IRS has issued a number of tax rulings and guidance about when and how to make automatic method changes. These rules have changed considerably over time–particularly in 2014 when the tangible property regulations were made final.
Filing the Form 3115
The current automatic accounting method change rules generally require taxpayers to file the Form 3115 with an original and timely-filed tax return. They also require a second copy of the Form 3115 be filed separately with a specific IRS office.
This brings us back to PLR 201850013. The taxpayer’s return preparer had advised the client that the tax return, which would have included the Form 3115, would be timely filed. The return preparer filed the separate Form 3115 with the IRS timely. The return preparer also timely filed the state income tax returns, most of which probably factored in the item reported on the IRS’s Form 3115. But the tax return preparer filed the tax return with the Form 3115 a day late.
9100 Relief for Late Filed Returns
Is the taxpayer out of luck? The tax return preparer advised the taxpayer that it might qualify for 9100 relief. Requesting 9100 relief allows the taxpayer to obtain a ruling authorizing them to make late tax elections.
The IRS considers several factors in deciding whether to grant 9100 relief. These factors ask whether the taxpayer acted in good faith by:
- requesting relief before the failure to make the regulatory election is discovered by the Service;
- failing to make the election because of intervening events beyond the taxpayer’s control;
- failing to make the election because, after exercising reasonable diligence (taking into account the taxpayer’s experience and the complexity of the return at issue), the taxpayer was unaware of the necessity for the election;reasonably relying on the written advice of the Service; or
- reasonably relying on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make, the election.
Another requirement is that the interests of the government are not prejudiced by granting 9100 relief. The government’s interest is deemed to be prejudiced if relief would result in the taxpayer having a lower tax liability for all tax years affected by the election.
It’s this last requirement that confuses many taxpayers. This last requirement is looking to whether the taxpayer is trying to gain an advantage by using hindsight in making an election that will lower their taxes. This may result if the taxpayer is in a lower tax bracket or has other tax attributes (such as loss carryovers, etc.) in an earlier or later year–which can be used to the taxpayers advantage by making an election. This does not necessarily look to whether the taxpayer gets a tax benefit sooner rather than later, although the IRS can factor in time value of money principles.
In this PLR, the IRS grants the taxpayer relief. It did this given that the tax return preparer admitted fault, the filing deadline was missed due to the tax return preparer, the filing was a few days late, and there was no evidence that the taxpayer’s overall tax would be reduced by the fling.
Late Filed Applications
To change the facts slightly, what if the tax return preparer had timely filed the tax return but failed to make the accounting method change? What then? Rev. Proc. 2015-13 and Reg 301.9100-2 come into play. They generally authorize the taxpayer to file an amended return within six months of the original unextended due date to report the accounting method change. This helps taxpayers who timely filed their tax returns, but who failed to include accounting method changes.