Rev. Proc. 77-26

Section 1. Purpose.

The purpose of this Revenue Procedure is to supersede Rev. Proc. 66-6, 1966-1 C.B. 615. That Revenue Procedure describes the procedure generally 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 of 1954 in the short taxable 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 taxable 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 Commissioner or the change must be authorized under the regulations.

Under the provisions of section 1.442-1(c) of the regulations, corporations, other than electing small business corporations (as defined in section 1371(b) of the Code), a DISC (as defined in section 992(a)(1)), a controlled foreign corporation (as defined in section 957), or a foreign corporation that meets the stock ownership requirements of a foreign personal holding company (as defined in section 552), are permitted to change their accounting period without the prior approval of the Commissioner if certain conditions are met. One of these conditions is that the short period required to effect the change of annual accounting period is not a taxable year in which the corporation has a net operating loss as defined in section 172.

When taxpayers are unable to meet these conditions, prior approval of the Commissioner of Internal Revenue is required to effect a change of annual accounting period, and generally the 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 taxable year includes a slack period of operations reflecting a loss that would produce a net operating loss carryback to a prior taxable year. Thus, if a taxpayer whose seasonal period of operations extends from May through October changes from a calendar year to a fiscal year ending April 30th, the short period ending April 30th 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.

The Service will ordinarily approve a request for a change in accounting period under the following circumstances, provided the taxpayer otherwise qualifies for such change:

(i) The change results in a short period of 9 months or longer and the net operating loss for the full 12-month period beginning with the first day of the short period equals or exceeds the net operating loss for the short period, or

(ii) The net operating loss for the short period cannot be carried back to prior taxable years, or

(iii) The net operating loss for the short period is not substantial in amount. For such purposes, a net operating loss is considered not substantial if it does not exceed $10,000.

In other cases involving a net operating loss in the short period the Commissioner may, under the authority of section 1.442-1(b)(1) of the regulations, approve a request for change in accounting period if the taxpayer agrees, in lieu of a net operating loss carryback, to deduct the amount of the net operating loss ratably over the 10-year period following the short period.

Sec. 4. Effect on Other Documents.

Rev. Proc. 66-6 is superseded.