IRS Revenue Procedure
92-74
IRS Revenue Procedure 92-74
26 CFR 601.204: Changes in accounting periods and in
methods of accounting.
(Also Part I, Sections 446, 471, 481; 1.446-1,
1.471-1, 1.481-5.)
SECTION 1. PURPOSE
This revenue procedure provides the exclusive
procedures by which certain
taxpayers required to use inventories in order to
clearly reflect income may
obtain expeditious consent to change their method of
accounting to either (1) an
overall accrualmethod, or (2) an accrual method in
conjunction with a request
to change to a special method (e.g., long-tecontract
accounting Taxpayers
complying with this revnue procedure will be deed to
havobtained the
consent of theommissioner of Internalevenue tochange
to an accrual method.
This revenue procedure modifies and supersedes Rev.
Proc. 85-36, 1985-2 C.B.
434.
SEC. 2. BACKGROUND
.01 Section 471 of the Internal Revenue Code requires
the use of inventories
when in the opinion of the Commissioner it is
necessary in order to clearly
determine income. Section 1.471-1 of the Income Tax
Regulations provides that
in order to clearly determine income, inventories at
the beginning and end of
each taxable year are necessary in every case in which
the production, purchase,
or sale of merchandise is an income-producing factor.
.02 Section 1.446-1(c)(2)(i) of the regulations
provides that taxpayers must
use the accrual method of accounting with regard to
purchases and sales
when they are required to use inventories in order to
clearly reflect income.
.03 Section 446(e) of the Code and section 1.446-1(e)
of the regulations
state that, except as otherwise provided, a taxpayer
must obtain the consent of
the Commissioner to change a method of accounting for
federal income tax
purposes.
.04 Section 1.446-1(e)(3)(i) of the regulations
requires that in order to
obtain this consent a Form 3115, Application for
Change in Accounting Method,
generally must be filed within 180 days after the
beginning of the taxable year
in which the proposed change is to be made.
.05 Section 1.446-1(e)(3)(ii) of the regulations
authorizes the Commissioner
to prescribe administrative procedures setting forth
the limitations, terms, and
conditions deemed necessary to permit a taxpayer to
obtain consent to change its
method of accounting in accordance with section 446(e)
of the Code.
.06 Section 481(a) of the Code requires that those
adjustments necessary to
prevent amounts from being duplicated or omitted must
be taken into account when
the taxpayer's taxable income is computed under a
method of accounting [*3]
different from the method used to compute taxable
income for the preceding
taxable year.
.07 Section 481(c) of the Code and section 1.481-5 of
the regulations provide
that the adjustments required by section 481(a) must
be taken into account in
determining taxable income in the manner and subject
to the conditions agreed to
by the Commissioner and the taxpayer.
.08 Section 3.06 of Rev. Proc. 92-20, 1992-12 I.R.B.
10, defines a Category A
method of accounting ("Category A method")
as a method of accounting the
taxpayer is specifically not permitted to use under
the Code, the regulations,
or a decision of the Supreme Court of the United
States. A Category A method is
also a method of accounting that differs from a method
the taxpayer is
specifically required to use under the Code, the
regulations, or a decision of
the Supreme Court of the United States. The use of a
method of accounting other
than the accrual method for the purchase and sale of
merchandise when
inventories are required in order to clearly determine
income constitutes the
use of a Category A method.
SEC. 3. SIGNIFICANT CHANGES
.01 Section 4.01 provides that this revenue procedure
may be used by (1)
taxpayers [*4] that employ a hybrid method and desire
to change to an overall
accrual method, and (2) taxpayers that desire to
change to an accrual method in
conjunction with a request to change to a special
method. Thus, section 3.02(5)
of Rev. Proc. 85-36, which precluded taxpayers that
desired to change to an
accrual method in conjunction with a special method
from using Rev. Proc. 85-36,
has been deleted.
.02 Section 3.02(4) of Rev. Proc. 85-36, which
precluded manufacturers and
producers required to use the full absorption method
of inventory costing from
using Rev. Proc. 85-36, has been deleted. These
taxpayers are now subject to
the provisions of section 263A of the Code. See new
section 4.02(5) of this
revenue procedure.
.03 Section 4.02 prohibits the use of this revenue
procedure by financial
institutions described in section 581 or 591 of the
Code; taxpayers required to
use a long-term contract method in accordance with
section 460 but that are not
in compliance with that section's requirements;
taxpayers required to change
their method of accounting from the cash method by the
provisions of section
448; taxpayers desiring to change from any other
Category A method as part of
the [*5] change to an accrual method; or a corporation
that engages in a
transaction to which section 381(a) applies within the
proposed taxable year of
change (as determined without regard to any potential
closing of the year under
section 381(b)(1)).
.04 Section 4.02(13) provides that this revenue
procedure does not apply to
taxpayers that have, within the last 6 taxable years
prior to the year of
change, applied to change their method of accounting
under the provisions of
this revenue procedure or Rev. Proc. 85-36, without
effecting the change.
.05 Section 5.04 provides a de minimis rule under
which a taxpayer may elect
to take a net positive section 481(a) adjustment into
account in the year of
change if the adjustment is less than $ 25,000.
.06 Sections 5.05(3), 5.05(4), and 5.06(1) provide
special procedures under
which the net section 481(a) adjustment is or is not
taken into account on an
accelerated basis. These provisions generally conform
to similar provisions
found in section 8.03 of Rev. Proc. 92-20.
.07 Section 5.07 provides that taxpayers using this
revenue procedure and
desiring to adopt the recurring item exception
(provided in section 461(h)(3) of
the Code) as [*6] part of the change to an accrual
method in the year of
change may do so, but only under the provisions of
this revenue procedure.
SEC. 4. SCOPE
.01 Except as provided in section 4.02 below, this
revenue procedure applies
to taxpayers (including organizations that are tax
exempt pursuant to section
501(a) of the Code) that (1) either desire to change
their method of accounting
to an overall accrual method or desire to change to an
accrual method in
conjunction with a request to change to a special
method, (2) are required to
use inventories in order to clearly determine income,
and (3) either employ the
cash method as their overall method of accounting or
employ a hybrid method
under which certain items of income or expense are
reported on the cash method
and other items of income or expense are reported on
an accrual method (and/or
other methods).
.02 This revenue procedure does not apply to the
following taxpayers:
(1) Financial institutions described in section 581 or
591 of the Code;
(2) Farmers;
(3) Cooperative organizations described in section
501(c)(12), 521, or 1381
of the Code;
(4) Taxpayers that are not required to use an
inventory method of accounting
in order [*7] to clearly determine income. See Rev.
Proc. 92-75, 1992-38
I.R.B., dated September 21, 1992;
(5) Taxpayers that are subject to the uniform
capitalization rules under
section 263A of the Code for the year of change,
unless the taxpayer fulfills
the administrative requirements to change to a method
of accounting that
complies with section 263A and uses that method for
the year of change (see
section 5.06(3));
(6) Taxpayers that are required to use a long-term
contract method in
accordance with section 460 of the Code and that are
not in compliance with that
section and related administrative guidance;
(7) Taxpayers that are required to change from the
cash method pursuant to
section 448 of the Code;
(8) Except as otherwise provided in section 5.06(3),
taxpayers that include
as a part of the change to an accrual method a change
from a Category A method;
(9) A corporation that engages in a transaction to
which section 381(a) of
the Code applies within the proposed taxable year of
change (as determined
without regard to any potential closing of the year
under section 381(b)(1));
(10) Taxpayers that are "under examination"
as defined in section 3.02 of
Rev. Proc. 92-20 at the [*8] time for filing the Form
3115 with their timely
filed federal income tax return or with the National
Office;
(11) Taxpayers that at the time for filing the Form
3115 are:
(a) before an appeals office of the Service with
respect to an examination of
their federal income tax return(s) for any year,
unless the taxpayer has
obtained an agreement from the appeals officer that
there is no objection to the
proposed change in method of accounting and attaches
the agreement to the Form
3115, or
(b) before any federal court with respect to an income
tax issue arising in
any taxable year, unless the taxpayer has obtained an
agreement from counsel for
the government that there is no objection to the
proposed change in method of
accounting and attaches the agreement to the Form
3115;
(12) Taxpayers that are the subject of a criminal
investigation or proceeding
concerning (a) directly or indirectly, any issue
relating to the taxpayer's
federal tax liability for any year, or (b) the
possibility of false or
fraudulent statements made by the taxpayer with
respect to any issue relating to
its federal tax liability for any year; or
(13) Taxpayers that have, within the last 6 taxable
years prior [*9] to
the year of change, applied to change their method of
accounting under the
provisions of this revenue procedure or Rev. Proc.
85-36 without effecting the
change.
.03 Taxpayers to which this revenue procedure does not
apply, and that desire
to change their method of accounting to an overall
accrual method or to an
accrual method in conjunction with a request to change
to a special method, must
file an application (Form 3115) with the Commissioner
in accordance with the
requirements of section 1.446-1(e)(3)(i) of the
regulations and Rev. Proc.
92-20, or other applicable Code, regulations, or
administrative provisions
pertaining to the change.
SEC. 5. APPLICATION
.01 Consent. In accordance with section
1.446-1(e)(3)(ii) of the regulations,
with respect to a change to an overall accrual method
or to an accrual method in
conjunction with a request to change to a special
method, the requirement to
file an application on Form 3115 within the 180-day
period is waived, and under
section 1.446-1(e)(2)(i), the consent of the
Commissioner is hereby granted to
any taxpayer within the scope of this revenue
procedure to change its method of
accounting to an overall accrual method [*10] or to an
accrual method in
conjunction with a request to change to a special
method. This consent is
granted for the taxable year for which a taxpayer
requests a change (year of
change) by filing a current Form 3115 in the manner
described in section 7 of
this revenue procedure for a change to an overall
accrual method, or in section
8 of this revenue procedure for a change to an accrual
method in conjunction
with a request to change to a special method, and by
otherwise complying with
the provisions of this revenue procedure. See section
6 regarding compliance
with the provisions of this revenue procedure. In
changing to an overall
accrual method or an accrual method in conjunction
with a special method, the
taxpayer must place all items of income and expense on
a proper accrual method
(other than items covered by the special method).
.02 Net section 481(a) adjustment. Section 481(a) of
the Code prescribes the
rules to be followed in computing taxable income in
cases in which the taxable
income of a taxpayer is computed under a method of
accounting different from the
method used to compute the taxable income for the
preceding taxable year. An
adjustment is required to prevent [*11] items from
being duplicated or
omitted by reason of a change in method of accounting.
The adjustment, referred
to as the "net section 481(a) adjustment,"
is the net amount of the adjustment
required by section 481(a). The net section 481(a)
adjustment takes into
account inventories, accounts receivable, accounts
payable, and any other item
determined necessary in order to prevent items from
being duplicated or omitted.
However, the net section 481(a) adjustment does not
include any amounts required
to be capitalized pursuant to section 263A as of the
beginning of the year of
change. (See section 5.06 for additional guidance.)
Any income accrued but not
received should not include items that were worthless
or partially worthless
(within the meaning of section 166(a)) as of the last
day of the year preceding
the year of change. In addition, the net section
481(a) adjustment should not
contain amountshat are unallowabler amounts tat are
subject to restrictions
or limitations by the Code (e.g., charitable
contributions under section
170(b)). The net section 481(a) adjustment must be
taken into account in
computing taxable income in the manner provided in
section 5.03 [*12] below.
The approved change shall be considered to be a change
in method of accounting
initiated by the taxpayer, and therefore the net
section 481(a) adjustment is
not restricted to amounts after 1953. An example of
the computation of the net
section 481(a) adjustment is as follows:
EXAMPLE 1
As of December 31, 1991, A, a calendar year taxpayer
that is not subject to
section 263A of the Code and employs the overall cash
method, has the following
items of unreported income, undeducted expenses, and
deducted inventoriable
costs:
Income, the right to which is
fixed and the amount of
which is determinable, but
that has not yet been received $ 120,000
Inventory that was previously
deducted $ 100,000
Expenses, the liability for which
is fixed, the amount of which
is determinable, and with respect
to which economic performance
has occurred, but
that have not yet been paid $ 40,000
Taxpayer A changes to an overall accrual method for
calendar year 1992.
Taxpayer A computes the net section 481(a) adjustment
in the following manner:
Income that was not included in
gross income under A's old
method and that will never be
included in gross income under
A's new method (accounts
receivable at December 31,
1991) $ 120,000
Inventory at December 31,
1991, which was deducted under
A's old method and will
also be deducted under A's
new method $100,000
$ 220,000
Less:
Expenses that were not deducted
under A's old method
and that will never be deducted
under A's new method (accounts
payable at December
31, 1991) $ 40,000
Net section 481(a) adjustment
(increase in income) $ 180,000
.03 Section 481(a) adjustment period.
(1) The appropriate period (the "section 481(a)
adjustment period") for
taking the net section 481(a) adjustment (referred to
in section 5.02) into
account in computing taxable income is generally
determined as follows:
(a) If either the net section 481(a) adjustment is
negative or 90 percent or
more of the net section 481(a) adjustment is
attributable to the taxable year
immediately preceding the year of change, the taxpayer
must take the entire net
section 481(a) adjustment into account in computing
taxable income for the year
of change. The amount attributable to the taxable year
immediately preceding
the year of change is the difference between the
amount of the net section
481(a) adjustment for the year of change and the
amount of the net section
481(a) adjustment that would have been required if the
same change in method of
accounting had been made in the preceding year.
(b) When subparagraph (a) of this section 5.03(1) does
not apply, the
taxpayer, in computing taxable income, must take the
net section 481(a)
adjustment into account ratably over the number of
taxable years (not to exceed
3) that the taxpayer has used the method [*14] of
accounting that is being
changed.
(2) In applying section 5.03(1), if a taxpayer's books
and records do not
contain sufficient information to compute the net
section 481(a) adjustment
attributable to the taxable year immediately preceding
the year of change, the
taxpayer may reasonably estimate this amount, attach
to the Form 3115 the
computations upon which the estimate is based, and
attach the following signed
statement to the Form 3115:
Under penalties of perjury, I hereby certify that:
(a) the books and records of [name of the taxpayer] do
not contain sufficient
information to permit a computation of the net section
481(a) adjustment
attributable to the taxable year immediately preceding
the year of change, and
(b) based on the information that is contained in such
records, to the best
of my knowledge and belief, 90 percent or more of the
net section 481(a)
adjustment [indicate either "is" or "is
not," as the case may be] attributable
to the taxable year immediately preceding the year of
change.
(3) For examples of the application of the rules
prescribed in this section
5.03 with respect to the section 481(a) adjustment
period, see section 8.01 of
Rev. Proc. 92-20.
.04 Section 481(a) adjustment period de minimis rule.
If the entire net
positive section 481(a) adjustment is less than $
25,000, the taxpayer may elect
to use a one-year section 481(a) adjustment period in
lieu of the adjustment
period otherwise provided by this revenue procedure.
The taxpayer must
affirmatively state on an attachment to the Form 3115
that it desires to elect
this section 5.04 de minimis rule.
.05 Accounts receivable.
(1) The net section 481(a) adjustment must not include
any account receivable
that was worthless or partially worthless as of the
last day of the year
preceding the year of change. See section 1.166-3 of
the regulations.
(2) If, during the section 481(a) adjustment period
(see section 5.03), any
portion of the accounts receivable included in the net
section 481(a) adjustment
becomes worthless or partially worthless, such
portion, not previously included
in gross income, must be included in income in the
taxable year it becomes
worthless. This condition only applies when the net
section 481(a) adjustment
is positive. This condition is illustrated by the
following example:
EXAMPLE 2
A, the taxpayer in example 1 in section 5.02, has
determined that
the net section 481(a) adjustment is to be taken into
account ratably over three
taxable years in computing taxable income.
In 1993, $ 30,000 of the $ 120,000 accounts receivable
were determined to be
worthless. In 1993, A will not have included in gross
income $ 120,000 of the
net section 481(a) adjustment ($ 180,000 less $ 60,000
included in gross income
in 1992). In 1993, A must include in gross income the
remaining portion of the
accounts receivable determined to be worthless but not
previously included in
gross income of $ 20,000 ($ 30,000 less the $ 10,000
portion included in gross
income in 1992) plus one-half of the remaining balance
of the net section 481(a)
adjustment, $ 50,000. A total of $ 70,000 will be
included in gross income in
1993.
Net section 481(a) adjustment $ 180,000
Net section 481(a) adjustment taken
into account:
1992 $ 60,000
1993: Worthless accounts
receivable $ 20,000
1/2 of remaining net
section 481(a) adjustment
(($ 120,000 -
$ 20,000) / 2) 50,000
70,000
1994 50,000
$ 180,000
(3) If, on the last day of any taxable year of the
section 481(a)
adjustment period (see section 5.03), the accounts
receivable to which the net
section 481(a) adjustment relates are reduced by more
than 33 1/3 percent of the
accounts receivable balance at the beginning of the
first taxable year of the
section 481(a) adjustment period and are so reduced by
at least such percentage
at the end of the following taxable year (temporary
fluctuations are not
controlling; permanent reductions are controlling),
the remaining balance of the
net section 481(a) adjustment must be taken into
account in determining taxable
income in the year succeeding the year of the
reduction. This condition applies
only when the net section 481(a) adjustment is
positive. If the accounts
receivable balance does not remain reduced for one
year, the reduction is not
considered permanent, and the provisions of this
paragraph do not apply.
(4) The Commissioner may waive the application of
section 5.05(3) upon a
showing that the reduction is attributable to a
strike, involuntary conversion,
or involuntary interruption of the availability of
goods. The taxpayer must
request the waiver no later than 90 days after the end
of the taxable [*18]
year in which section 5.05(3) would otherwise apply.
For specific procedures to
be followed for requesting the waiver, see section
8.03(1) of Rev. Proc. 92-20.
.06 Inventory.
(1) If, on the last day of any taxable year of the
section 481(a) adjustment
period (see section 5.03), the value of the taxpayer's
inventory to which the
net section 481(a) adjustment relates is reduced by
more than 33 1/3 percent of
the inventory value at the beginning ofe first taxale
year of e section
481(a) adjustment period and is so reduced by at least
such percentage at the
end of the following taxable year (temporary
fluctuations are not controlling;
permanent reductions are controlling), the remaining
balance of the net section
481(a) adjustment must be taken into account in
determining taxable income in
the year succeeding the year of the reduction. This
condition applies only when
the net section 481(a) adjustment is positive. If the
value of the inventory
does not remain reduced for one year, the reduction is
not considered permanent
and the provisions of this paragraph do not apply. In
applying this section
5.06(1), the 33 1/3-percent rule applies only to the
specific category [*19]
of inventory to which the net section 481(a)
adjustment relates. For an
illustration of the computations required by the above
rule, see the example in
section 8.03(1) of Rev. Proc. 92-20.
(2) The Commissioner may waive the application of
section 5.06(1) upon a
showing that the reduction is attributable to a
strike, involuntary conversion,
or involuntary interruption of the availability of
goods. The taxpayer must
request the waiver no later than 90 days after the end
of the taxable year in
which section 5.06(1) would otherwise apply. For the
specific procedures to be
followed for requesting the waiver, see section
8.03(1) of Rev. Proc. 92-20.
(3) If the taxpayer is subject to the uniform
capitalization rules provided
by section 263A of the Code and has not complied with
those rules:
(a) the taxpayer must timely submit an application
(Form 3115) under the
applicable administrative procedures to comply with
section 263A of the Code;
(b) the change in method required by section 263A must
occur, and the related
net section 481(a) adjustment applicable to that
change must be computed, prior
to the change in method of accounting granted in this
revenue procedure (see
section [*20] 1.263A-1T(e)(11)(v) of the temporary
regulations); and
(c) the net section 481(a) adjustment attributable to
the change to an
accrual method therefore must not include the
adjustment necessary to value the
taxpayer's inventory in accordance with section 263A.
.07 Recurring item exception. As part of the change to
an overall accrual
method or to an accrual method in conjunction with a
request to change to a
special method, a taxpayer may adopt the recurring
item exception for the year
of change if the taxpayer is eligible and follows the
procedures of section
1.461-5(d) of the regulations. If the taxpayer is
eligible and wishes to adopt
this method as specified in section 461(h)(3) of the
Code, the amount of the net
section 481(a) adjustment must be modified to account
for the amount of the
additional deduction.
EXAMPLE 3
As of December 31, 1991, B, a calendar year taxpayer
that uses the overall
cash method, is eligible to adopt the recurring item
exception method specified
in section 461(h)(3) of the Code, and adopts this
method for the year of change.
B has the following items of unreported income and
undeducted expenses:
Income, the right to which is
fixed and the amount of
which is determinable, but
that has not yet been received $ 50,000
Expenses, the liability for which
is fixed, the amount of which
is determinable, and with respect
to which economic performance
has occurred, but
that have not yet been paid $ 15,000
Expenses, the liability for which
is fixed, the amount of which
is determinable, and with respect
to which the recurring
item exception method is
adopted $ 5,000
Taxpayer B changes to an overall accrual method for
calendar year 1992.
Taxpayer B computes the net section 481(a) adjustment
in the following manner:
Income that was not included in
gross income under B's old
method and that will never be
included in gross income under
B's new method (accounts
receivable at December 31,
1991) $ 50,000
Less:
Expenses that were not deducted
under B's old method and
that will never be deducted
under B's new method (accounts
payable at December
31, 1991) $ 15,000
Expenses with respect to which
the recurring item exception
method is adopted (previously
incurred) $ 5,000
Net section 481(a) adjustment
(increase in income) $ 30,000
.08 Ceasinto engage in the trade or business. If a
taxpayer that is taking
a net section 481(a) adjustment into account pursuant
to section 5.03 ceases to
engage in the trade or business to which the net
section 481(a) adjustment
relates, or if the taxpayer operating the trade or
business ceases to exist, any
balance of the net section 481(a) adjustment not
previously taken into account
must be taken into account in computing taxable income
in the taxable
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