The IRS often turns a deaf ear to taxpayers who miss a filing deadline due to some action or inaction by their CPA or tax preparer. This is the case for late filing tax penalties. But what about a late filed accounting method change? Is reliance on a CPA or tax preparer sufficient for a late accounting method change when the form isn’t submitted timely? The IRS’s recent PLR 201931002 provides the answer.
Facts & Procedural History
The taxpayer reported its income and expense on the cash method. Due to a business acquisition, the taxpayer wanted to change to the accrual method. This may have been due to an increase in the amount of its gross receipts, that it now had inventory, or there was a timing benefit to making the change.
The taxpayer hired a CPA to prepare its tax returns and to make the method change. The CPA mailed the Form 3115 requesting the change to the IRS. It did so timely. But the CPA was not able to timely file the taxpayer’s tax return due to a problem with his tax software. As a result, the Form 3115 was not filed with a timely return. This prevented the taxpayer from obtaining automatic consent from the IRS to change its method of accounting.
The question is whether relying on a CPA or tax preparer for a missed filing is a sufficient excuse for filing an accounting method change late?
Accounting Method Changes
Our income tax system requires taxpayers self-report items of income and expense. The manner in which these items are reported establishes an accounting method.
Once established, the taxpayer has to continue to report the item of income or expense in a consistent method. This rule prevents taxpayers from engaging in tax planning to make tax-motivated changes that are inconsistent with their tax position in a prior year.
Our tax laws allow taxpayers to make accounting method changes, but generally only by getting advance permission from the IRS to do so. This special reporting mechanism puts the IRS on notice of the method change, so that it can decide whether to examine the change.
There are some changes that, even if tax-motivated, are commonplace. The IRS has established procedures for requesting many of these common changes. Several of these changes are deemed to be automatically approved by the IRS if the taxpayer files the proper forms with the IRS. These forms can include the Form 3115, Application for Change in Accounting Method.
Common accounting method changes include changes for accrual to cash, capitalize to expense, cash to accrual (as in the ruling request that is the subject of this blog post), change to deferral method for advanced payments, depreciation, expense to capitalize, inventory valuation change, lifo change–including pooling, and long-term contracts.
The Section 481 Adjustment
With most accounting method changes, a Section 481 adjustment is required. This adjustment reflects a change to the prior year tax treatment to bring it in line with the current year tax treatment that one is changing to. The Section 481 adjustment is reported on the current year tax return for these prior year adjustments.
For example, a taxpayer that fails to claim all allowable depreciation deductions on a prior year return may be able to take the deductions in the current year by reporting a Section 481 adjustment in the current year. This would be a favorable Section 481 adjustment, as it produces a tax savings in the year of the change. Section 481 adjustments can also be negative in that they result in additional tax due.
Section 481 adjustments are allowable if the method change is properly reported to the IRS to obtain its approval. This approval is automatically granted by the IRS if the taxpayer fulfills all of the requirements for automatic approval under IRS guidance (the IRS has issued guidance providing for automatic approval for many different types of method changes; the guidance also describes some method changes that are not eligible for automatic approval). There are a number of requirements for automatic approval, but at a minimum, it includes filing the Form 3115 with a timely-filed tax return.
Filing the Form 3115 Late
The Form 3115 was filed late in the ruling request that is the subject of this blog post. Because the tax return was not filed timely, the Form 3115 that goes with the tax return was not timely.
Generally, for penalties associated with filing a tax return late, reliance on a CPA or tax preparer to make the filing is not accepted by the IRS as a legitimate reason for avoiding late filing penalties. The IRS is quick to cite the United States v. Boyle, 469 U.S. 241 (1985) line of cases for this (and taxpayers cite the court cases that sidestep Boyle).
In Boyle, the taxpayer relied on a tax attorney for filing an estate tax return. The tax attorney had all of the information needed to file the tax return, but failed to do so timely due to a problem with his calendaring system. The Court concluded that it was not reasonable for the taxpayer to rely on the tax attorney for the filing deadline (please note that reliance related to a filing deadline is different than reliance on tax advice, such as the propriety of an item reported on a tax return).
How does this compare to filing a late accounting method change? Is reliance on a tax preparer to make a filing sufficient? The ruling does not specifically address the issue, but, since the IRS approves the accounting method change in the ruling, it appears that relying on a tax preparer is sufficient in this context. So the standard is different for late-filed accounting method changes vs. late-filed tax returns.
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