IRS EXPLAINS PROCEDURES FOR APPROVING A REQUEST FOR ACCOUNTING PERIOD CHANGE WHEN THERE IS A NET OPERATING LOSS IN RESULTING SHORT TAX YEAR

Rev. Proc. 85-16

SECTION 1. PURPOSE.

The purpose of this revenue procedure is to supersede Rev. Proc. 77-26, 1977-2 C.B. 536. That revenue procedure describes the procedure followed by the Internal Revenue Service in approving a request for a change in annual accounting period for which a substantial business purpose exists, even though the taxpayer sustains a net operating loss as defined in section 172 of the Internal Revenue Code in the short tax year resulting from the change.

SEC. 2. BACKGROUND.

Section 442 of the Code provides that if a taxpayer changes its annual accounting period, the new accounting period shall become the taxpayer's tax year only if the change is approved by the Secretary.

Section 1.442-1(a)(1) of the Income Tax Regulations provides that if a taxpayer wishes to change its annual accounting period, it must obtain prior approval from the Commission or the change must be authorized under the regulations.

Rev. Proc. 84-34, 1984-1 C.B. 508, provides a procedure whereby certain corporations may expeditiously obtain approval of a change of their accounting period even though the short period required to effect the change of annual accounting period is a tax year in which the corporation has a net operating loss as defined in section 172 of the Code. In other cases, most taxpayers must obtain prior approval from the Commissioner of Internal Revenue to effect a change of annual accounting period. Generally, a change will be approved when the taxpayer establishes a substantial business purpose for making the change. In determining whether a substantial business purpose has been established, consideration will be given to all the facts and circumstances, including the tax consequences resulting from the change.

A change in accounting period may result in tax benefits not otherwise available to the taxpayer. This might happen, for example, in the case of a change in accounting period when the short tax year includes a slack period of operations reflecting a loss that would produce a net operating loss carryback to a prior tax year. Thus, if a taxpayer whose seasonal period of operations extends from May through October change from a calendar year to a fiscal year ending April 30, the short period ending April 30 would terminate just before the opening of the new season, and such short period would reflect expenses but little or no income. Because the income of the short period is distorted in relation to the annual income of the taxpayer, approval for the change will not be granted unless the distortion, if substantial, is eliminated by appropriate adjustments.

SEC. 3. PROCEDURE.

If the Service approves a request for a change in annual accounting period when the short period required to effect the change of annual accounting period is a tax year in which the taxpayer has a net operating loss, the net operating loss must be deducted ratably over a 6-year period beginning with the first tax year after the short period unless the taxpayer meets one of the following exceptions:

(i) If the net operating loss resulting from the short period is $10,000 or less, the net operating loss can be carried back or carried over in accordance with section 172(b) of the Code; or

(ii) If the net operating loss resulting from a short period of 9 months or longer is greater than $10,000 and is less than the net operating loss for a full 12-month period beginning with the first day of the short period, the net operating loss can be carried back or carried over in accordance with section 172(b) of the Code.

SEC. 4. EFFECT ON OTHER DOCUMENTS.

Rev. Proc. 77-26 is superseded.