Service Issues Guidance On Involuntary Change Of Accounting Methods

Rev. Proc. 2002-18

 SECTION 1. PURPOSE

.01 In General. This revenue procedure provides the procedures under § 446(b) of the Internal Revenue Code and § 1.446-1(b) of the Income Tax Regulations for changes in method of accounting imposed by the Internal Revenue Service (Service). This revenue procedure also provides the procedures that the Service will use for accounting method issues resolved by the Service on a nonaccounting-method-change basis.

.02 Voluntary Compliance. This revenue procedure provides terms and conditions for Service-imposed changes in method of accounting that are intended to encourage taxpayers to voluntarily request a change from an impermissible method of accounting prior to being contacted for examination. Under this approach, a taxpayer that is contacted for examination and required to change its method of accounting by the Service ("involuntary change") generally receives less favorable terms and conditions when the change results in a positive § 481(a) adjustment than the taxpayer would have received if it had filed an application to change its method of accounting ("voluntary change") before the taxpayer was contacted for examination. For example, an involuntary change generally is made with an earlier year of change and a shorter § 481(a) adjustment period for a positive adjustment, and a voluntary change generally is made with a current year of change and a longer § 481(a) adjustment period for a positive adjustment. See Rev. Proc. 97-27, 1997-1 C.B. 680, as modified by Rev. Proc. 2002-19, 2002-13 I.R.B., and Rev. Proc. 2002-9, 2002-3 I.R.B. 327, as modified by Ann. 2002-17, 2002-8 I.R.B. 561, and Rev. Proc. 2002-19, 2002-13 I.R.B., which provide the procedures for voluntary requests to change an accounting method.

.03 Procedures for Examination, Appeals, and Counsel for the Government for Resolving Accounting Method Issues. This revenue procedure sets forth procedures for Examination, Appeals, and counsel for the government to resolve accounting method issues. It does not alter Examination's authority to examine the returns of a taxpayer. It provides parameters for Examination to resolve accounting method issues, but does not limit or expand Examination's authority to resolve any issues under any applicable Delegation Order (e.g., Delegation Order No. 236, Application of Appeals Settlement to Coordinated Examination Program Taxpayers, and Delegation Order No. 247, Authority of Examination Case Managers to Accept Settlement Offers and Execute Closing Agreements on Industry Specialization Program and International Field Assistance Program Issues). This revenue procedure also does not alter or limit the authority of Appeals or counsel for the government to resolve or settle any issues.

SECTION 2. BACKGROUND

.01 Change in Method of Accounting Defined.

(1) Section 1.446-1(e)(2)(ii)(a) provides that a change in method of accounting includes a change in the overall plan of accounting for gross income or deductions, or a change in the treatment of any material item. A material item is any item that involves the proper time for the inclusion of the item in income or the taking of the item as a deduction. In determining whether a taxpayer's accounting practice for an item involves timing, generally the relevant question is whether the practice permanently changes the amount of the taxpayer's lifetime income. If the practice does not permanently affect the taxpayer's lifetime income, but does or could change the taxable year in which income is reported, it involves timing and is therefore a method of accounting. See Rev. Proc. 91-31, 1991-1 C.B. 566.

(2) Although a method of accounting may exist under this definition without a pattern of consistent treatment of an item, a method of accounting is not adopted in most instances without consistent treatment. The treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed tax returns (without regard to any change in status of the method as permissible or impermissible) represents consistent treatment of that item for purposes of § 1.446- 1(e)(2)(ii)(a). If a taxpayer treats an item properly in the first return that reflects the item, however, the taxpayer has adopted a method of accounting for that item. If a taxpayer has adopted a method of accounting under these rules, the taxpayer may not change the method by amending its prior income tax returns(s). See Rev. Rul. 90-38, 1990-1 C.B. 57. Rather, a taxpayer that wants to change its method of accounting must follow either the automatic method change procedures of Rev. Proc. 2002-9 (or its successor), if applicable, or the advance consent procedures of Rev. Proc. 97-27 (or its successor).

(3) Section 1.446-1(e)(2)(ii)(b) of the regulations provides examples of circumstances that do not constitute changes in method of accounting, including:

(a) correction of mathematical or posting errors, or errors in the computation of tax liability (such as errors in computation of the foreign tax credit, net operating loss, percentage depletion, or investment credit);

(b) adjustment of any item of income or deduction that does not involve the proper time for the inclusion of the item or the taking of a deduction; and

(c) a change in treatment resulting from a change in underlying facts.

.02 Method Changes Imposed by the Service.

(1) Section 446(b) and § 1.446-1(b)(1) provide that if a taxpayer does not regularly employ a method of accounting that clearly reflects its income, the computation of taxable income must be made in the manner that, in the opinion of the Commissioner, does clearly reflect income.

(2) The Commissioner has broad discretion in determining whether a taxpayer's method of accounting clearly reflects income, and the Commissioner's determination must be upheld unless it is clearly unlawful. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979); RCA Corp. v. United States, 664 F.2d 881 (2nd Cir. 1981), cert. denied, 457 U.S. 1133 (1982).

(3) The Commissioner has broad discretion in selecting a method of accounting that the Commissioner believes properly reflects the income of a taxpayer once the Commissioner has determined that the taxpayer's method of accounting does not clearly reflect income, and the Commissioner's selection may be challenged only upon showing an abuse of discretion by the Commissioner. See Wilkinson- Beane, Inc. v. Commissioner, 420 F.2d 352 (1st Cir. 1970); Standard Paving Co. v. Commissioner, 190 F.2d 330 (10th Cir.), cert. denied, 342 U.S. 860 (1951).

(4) The Commissioner has the discretion to change a taxpayer's method of accounting even though the Commissioner previously changed the taxpayer to the method if the Commissioner determines that the method of accounting does not clearly reflect the taxpayer's income. The Commissioner is not precluded from correcting mistakes of law in determining a taxpayer's tax liability, including the power to retroactively correct rulings or other determinations on which the taxpayer may have relied. See Dixon v. United States, 381 U.S. 68 (1965); Automobile Club of Michigan v. Commissioner, 353 U.S. 180 (1957); Massaglia v. Commissioner, 286 F.2d 258 (10th Cir. 1961).

(5) The Commissioner does not have discretion, however, to require a taxpayer to change from a method of accounting that clearly reflects income to a method that, in the Commissioner's view, more clearly reflects income. See Capitol Federal Savings & Loan v. Commissioner, 96 T.C. 204 (1991); W.P. Garth v. Commissioner, 56 T.C. 610 (1971), acq., 1975-1 C.B. 1.

(6) The Commissioner may change the accounting method of a taxpayer that is under examination, before an appeals office, or before a federal court, except as otherwise provided in published guidance. See, for example, section 9 of Rev. Proc. 97-27, which generally precludes the Service from changing a taxpayer's method of accounting for an item for prior taxable years if the taxpayer timely files a Form 3115, Application to Change a Method of Accounting, pursuant to Rev. Proc. 97-27 requesting to change its method of accounting for the item.

.03 No Right to Retroactive Method Change. Although the Commissioner is authorized to consent to a retroactive accounting method change, a taxpayer does not have a right to a retroactive change, regardless of whether the change is from a permissible or impermissible method. See generally, Rev. Rul. 90-38.

.04 Method Change With a § 481(a) Adjustment.

(1) Need for adjustment. Section 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding taxable year. When there is a change in method of accounting to which § 481(a) is applied, income for the taxable year preceding the year of change must be determined under the method of accounting that was then used, and income for the year of change and the following taxable years must be determined under the new method of accounting as if the new method had always been used.

Example. A taxpayer, although not permitted to use the cash receipts and disbursements method of accounting by § 448, uses the overall cash method and changes to an overall accrual method. The taxpayer has $120,000 of income earned but not yet received (accounts receivable) and $100,000 of expenses incurred but not yet paid (accounts payable) as of the end of the taxable year preceding the year of change. A positive § 481(a) adjustment of $20,000 ($120,000 accounts receivable less $100,000 accounts payable) is required as a result of the change.

(2) Adjustments attributable to pre-1954 years. Section 481(a)(2) and § 1.481-3 provide that if the adjustments required by § 481(a) are attributable to a change in method of accounting not initiated by the taxpayer, no portion of any adjustments which is attributable to pre-1954 taxable years is taken into account in computing taxable income.

(3) Adjustment period. Section 481(c) and §§ 1.446-1(e)(3)(i) and 1.481-4 provide that the adjustment required by § 481(a) may be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer. Generally, in the absence of such an agreement, the § 481(a) adjustment is taken into account in computing taxable income completely in the year of change. However, § 481(b) may limit the amount of tax attributable to a substantial § 481(a) adjustment that increases taxable income

.05 Method Change Using a Cut-off Method. The Commissioner may determine that certain changes in method of accounting will be made without a § 481(a) adjustment, using a "cut-off method." Under a cut-off method, only the items arising on or after the beginning of the year of change are accounted for under the new method of accounting. Any items arising before the year of change continue to be accounted for under the taxpayer's former method of accounting. Because no items are duplicated or omitted from income when a cut-off method is used to effect a change in accounting method, no § 481(a) adjustment is necessary.

.06 Previous Method Change Without Consent. The Commissioner may require a taxpayer that has changed a method of accounting without the Commissioner's consent to change back to its former method. The Commissioner may do so even when the taxpayer changed from an impermissible to a permissible method. The change back to the former method may be made in the taxable year the taxpayer changed without consent, or if that year is closed by the running of the period of limitations, in the earliest open year. See Commissioner v. O. Liquidating Corp., 292 F.2d 225 (3rd Cir.), cert. denied, 368 U.S. 898 (1961); Wright Contracting Co. v. Commissioner, 316 F.2d 249 (5^th Cir., 1963), cert. denied 375 U.S. 879 (1963), reh'g denied 375 U.S. 981 (1964), acq. 1966-2 C.B. 7; Daktronics, Inc. v. Commissioner, T.C. Memo. 1991-60; Handy Andy T.V. and Appliances, Inc. v. Commissioner, T.C. Memo. 1983- 713. For example, the Service may change a taxpayer back to its former impermissible method of accounting if the taxpayer changed to a permissible method of accounting without the Commissioner's consent and miscalculated the § 481(a) adjustment, even where the statute of limitations has expired for the year of change

.07 Penalties. Any otherwise applicable penalty for the failure of a taxpayer to change its method of accounting (for example, the accuracy-related penalty under § 6662 or the fraud penalty under § 6663) may be imposed if the Service imposes an accounting method change. See § 446(f). Additionally, the taxpayer's return preparer may also be subject to the preparer penalty under § 6694.

SECTION 3. DEFINITIONS

.01 Accounting Method Issue. The term "accounting method issue" means an issue regarding whether the taxpayer's accounting treatment of an item is proper, but only if changing the taxpayer's treatment of such item could constitute a change in method of accounting. See the definition of change in method of accounting in § 1.446-1(e)(2) and section 2.01 of this revenue procedure.

.02 Year of Change. The year of change is the taxable year for which a change in method of accounting is effective, that is, the first taxable year the new method is used, even if no affected items are taken into account for that year. The year of change is also the first taxable year for complying with all the terms and conditions accompanying the change.

.03 Section 481(a) Adjustment Period. The § 481(a) adjustment period is the applicable number of taxable years for taking into account the § 481(a) adjustment required as a result of the change in method of accounting. The year of change is the first taxable year in the adjustment period and the § 481(a) adjustment is taken into account ratably over the number of taxable years in the adjustment period.

.04 Taxpayer. The term "taxpayer" has the same meaning as the term "person" defined in § 7701(a)(1) (rather than the meaning of the term "taxpayer" defined in § 7701(a)(14)).

SECTION 4. SCOPE

Except as otherwise provided in published guidance, this revenue procedure applies to any accounting method change imposed by the Service, and to any accounting method issue resolved by the Service on a nonaccounting-method-change basis.

SECTION 5. EXAMINATION DISCRETION TO RESOLVE ACCOUNTING METHOD ISSUES

.01 In General. Using professional judgment in accordance with auditing standards, an examining agent will make findings of fact and apply Service position on issues of law to determine whether an issue is an accounting method issue (as defined by section 3.01 of this revenue procedure) and whether the taxpayer's method of accounting is permissible. See Policy Statement P-4-117. Except as otherwise provided in published guidance (for example, Delegation Order No. 236), the discretion of an examining agent to resolve an accounting method issue is set forth in sections 5.02 through 5.06 of this revenue procedure. See section 10.01 of this revenue procedure for an example of the application of section 5 of this revenue procedure.

.02 Requirement to Treat an Accounting Method Issue as a Method Change. An examining agent who determines that a taxpayer's method of accounting is impermissible, or that a taxpayer changed its method of accounting without obtaining the consent of the Commissioner, may propose an adjustment with respect to that method only by changing the taxpayer's method of accounting.

.03 Selection of New Method of Accounting. Except as provided in section 2.06 of this revenue procedure, an examining agent changing a taxpayer's method of accounting will select a new method of accounting by properly applying the law to the facts determined by the agent. The method selected must be a proper method of accounting and will not be a method contrived to reflect the hazards of litigation.

Example. A taxpayer held long-term zero coupon bonds during the taxable year under examination but did not include any original issue discount (OID) in income for that year. The examining agent determines that the taxpayer should have included OID in income for that year under § 1272. Accordingly, the examining agent will change the taxpayer's method of accounting to include the OID in income in accordance with § 1272 and the regulations thereunder. The examining agent will not impose a method of accounting that is designed to take into account litigation hazards (for example, a method that only requires the accrual of an arbitrary percentage of the OID that would otherwise accrue during the year under § 1272 and the regulations thereunder).

.04 Terms and Conditions of Change.

(1) Year of change. An examining agent changing a taxpayer's method of accounting will make the change in a year under examination. Ordinarily, the change will be made in the earliest taxable year under examination, or, if later, the first taxable year the method is considered to be impermissible. However, in appropriate circumstances, an examining agent may defer the year of change to a later taxable year. For example, an examining agent may defer the year of change if the examining agent determines that:

(a) the taxpayer's books and records do not contain sufficient information to compute a § 481(a) adjustment for the taxable year in which the change would otherwise be imposed and the adjustment cannot be reasonably estimated;

(b) the taxpayer's existing method of accounting does not have a material effect for the taxable year in which the change would otherwise be imposed; or

(c) there are taxable years for which the statute of limitations has expired following the taxable year in which the change would otherwise be imposed.

An examining agent will not defer the year of change in order to reflect the hazards of litigation. Moreover, an examining agent will not defer the year of change to later than the most recent year under examination on the date of the agreement finalizing the change.

(2) Section 481(a) adjustment. An examining agent changing a taxpayer's method of accounting ordinarily will impose a § 481(a) adjustment, subject to a computation of tax under § 481(b)(if applicable). However, an examining agent should use a cut- off method to make a change (other than a change within the LIFO inventory method as defined in section 3.09 of Revenue Procedure 97-27, 1997-1 C.B. 680, or a change in method of accounting for intercompany transactions, see § 1.1502-13) when a statute, regulation or administrative pronouncement of the Service effective for the year of change directs that the change be made using a cut-off method. See, e.g., § 174. In addition, an examining agent may use a cut-off method to make a change in appropriate circumstances. For example, the examining agent may use a cut-off method to make a change if the agent determines that the taxpayer's books and records do not contain sufficient information to compute a § 481(a) adjustment and the adjustment cannot be reasonably estimated. Finally, an examining agent will not make a change on a cut-off method in order to reflect the hazards of litigation.

(3) Spread of § 481(a) adjustment. The § 481(a) adjustment, whether positive or negative, will be taken into account entirely in the year of change.

SECTION 6. APPEALS AND COUNSEL FOR THE GOVERNMENT DISCRETION TO RESOLVE ACCOUNTING METHOD ISSUES

.01 Authority to Resolve Accounting Method Issues. An appeals officer or counsel for the government may resolve an accounting method issue (as defined by section 3.01 of this revenue procedure) when it is in the interest of the government to do so. See P-8-47.

.02 Types of Resolutions.

(1) In general. An appeals officer or counsel for the government may resolve an accounting method issue by using any of the means described in section 6 of this revenue procedure, or any other means deemed appropriate under the circumstances, to reflect the hazards of litigation. See sections 10.02 through 10.04 of this revenue procedure for examples of the application of section 6 of this revenue procedure.

(2) Accounting method changes.

(a) Treating an accounting method issue as a method change. An appeals officer or counsel for the government resolving an accounting method issue may treat the issue as a change in method of accounting.

(b) Selection of new method of accounting. Except as provided in section 2.06 of this revenue procedure, an appeals officer or counsel for the government changing a taxpayer's method of accounting will select a new method of accounting by properly applying the law to the facts. The appeals officer or counsel for the government will not put the taxpayer on an improper method of accounting in order to reflect the hazards of litigation.

(c) Terms and conditions of change. An appeals officer or counsel for the government changing a taxpayer's method of accounting may agree to terms and conditions that differ from those ordinarily applicable to an Examination-imposed accounting method change, including the following (or any combination thereof):

(i) Year of change. An appeals officer or counsel for the government may compromise the year of change (for example, by agreeing to a later year of change). However, an appeals officer or counsel for the government changing a taxpayer's method of accounting ordinarily will not defer the year of change to later than the most recent taxable year under examination on the date of the agreement finalizing the change, and, in no event, will defer the year of change to later than the taxable year that includes the date of the agreement finalizing the change;

(ii) Section 481(a) adjustment. An appeals officer or counsel for the government may make the change using a § 481(a) adjustment or a cut-off method. If a § 481(a) adjustment is used, the appeals officer or counsel for the government may compromise the amount of the § 481(a) adjustment (for example, by agreeing to a reduced § 481(a) adjustment). If the appeals officer or counsel for the government agrees to compromise the amount of the § 481(a) adjustment, the agreement must be in writing; and

(iii) Spread of the § 481(a) adjustment. An appeals officer or counsel for the government may compromise the § 481(a) adjustment period (for example, by agreeing to a longer § 481(a) adjustment period).

(3) Alternative-timing resolution. In lieu of changing a taxpayer's method of accounting, an appeals officer or counsel for the government may resolve an accounting method issue by agreeing to alternative timing for all or some of the items arising during, or prior to and during, the taxable years before Appeals or a federal court. The resolution of an accounting method issue on an alternative-timing basis for certain items will not affect the taxpayer's method of accounting for any items not covered by the resolution.

Example. The Service and the taxpayer agree that the taxpayer will capitalize the inventoriable costs incurred during 1999 that were deducted under the taxpayer's method of accounting. The taxpayer's inventoriable costs covered by the agreement must be capitalized and accounted for under the taxpayer's inventory method. The inventoriable costs that are not covered by the agreement (that is, those costs incurred in taxable years prior and subsequent to 1999) are not affected by the resolution and thus, consistent with the taxpayer's method of accounting, must continue to be deducted.

(4) Time-value of money resolution.

(a) In general. In lieu of changing a taxpayer's method of accounting, an appeals officer or counsel for the government may resolve an accounting method issue by agreeing that the taxpayer will pay the government a "specified amount" that approximates the time- value-of-money benefit the taxpayer has derived from using its method of accounting for the taxable years before appeals or a federal court (instead of the method of accounting determined by the appeals officer or counsel for the government to be the proper method of accounting), reduced by an appropriate factor to reflect the hazards of litigation. If the sum of the time-value-of-money benefit (detriment) computed with respect to each taxable year is negative, the specified amount will be zero and no refund will be made to the taxpayer. The specified amount is not interest under § 163(a), and may not be deducted or capitalized under any provision of the Code. In appropriate circumstances, however, the computation of the specified amount may be tax affected to reflect the approximate effect of a hypothetical tax deduction, as demonstrated in the sample computation. See section 6.02(4)(b)(ii)(B) of this revenue procedure. The specified amount will be treated as a miscellaneous payment as described in the Internal Revenue Manual.

(b) Computation of specified amount.

(i) In general. An appeals officer or counsel for the government may use any reasonable manner to compute the specified amount, including the sample computation described in section 6.02(4)(b)(ii) of this revenue procedure, or a computation that takes into account the taxpayer's actual tax rates and tax attributes.

(ii) Sample computation. Under the sample computation, the specified amount equals the sum of the time-value-of-money benefit (detriment) computed with respect to each taxable year before Appeals or a federal court. The time-value-of-money benefit (detriment) with respect to each taxable year before Appeals or a federal court equals the "hypothetical underpayment (overpayment)" (as defined in section 6.02(4)(b)(ii)(A) of this revenue procedure), multiplied by the "applicable time-value rate" (as defined in section 6.02(4)(b)(ii)(B) of this revenue procedure), compounded daily for the "applicable period" (as defined in section 6.02(4)(b)(ii)(C) of this revenue procedure).

(A) Hypothetical underpayment (overpayment). The hypothetical underpayment (overpayment) for each taxable year before Appeals or a federal court is equal to the net increase or decrease in taxable income (including the § 481(a) adjustment) that would have been reflected on the return for the taxable year if the Service had changed the taxpayer's method of accounting (in the earliest taxable year before Appeals or a federal court, or, if later, the first taxable year the method is considered impermissible), multiplied by the applicable tax rate for the taxable year of the underpayment (overpayment). For this purpose, only adjustments associated with the change are taken into account. The applicable tax rate is the highest rate of income tax applicable to the taxpayer (for example, the highest rate in effect under § 1 for individuals or § 11 for corporations).

(B) Applicable time-value rate. The applicable time-value rate generally equals an average of the quarterly underpayment rates in effect under § 6621(a) for the applicable period. However, for a taxpayer that would be entitled to a deduction under § 163(a) for the specified amount if the specified amount were treated as interest arising from the underpayment of tax, the applicable time- value rate is computed at a reduced rate equaling an average of the quarterly underpayment rates in effect under § 6621(a) for the applicable period, multiplied by the excess of 100% over the applicable tax rate for the taxable year of the underpayment (overpayment).

(C) Applicable period. The applicable period begins on the due date (without regard to extensions) of the return for the taxable year of the underpayment (overpayment) and ends on the date on which the specified amount is paid.

(D) Processing of specified amount. The Appeals Officer or government counsel resolving the issue should forward checks in payment of specified amounts to:

SECTION 7. PROCEDURES FOR A SERVICE-IMPOSED ACCOUNTING METHOD CHANGE.

.01 Requirement to Provide Notice to Taxpayer.

(1) In general. An examining agent, appeals officer, or counsel for the government changing a taxpayer's method of accounting will provide notice that an accounting method issue is being treated as an accounting method change. However, an appeals officer or counsel for the government resolving an accounting method issue as an accounting method change is not required to provide notice that the accounting method issue is being treated as an accounting method change if such notice has been provided by the examining agent. In addition, if the examining agent has provided notice that an accounting method issue is being treated as an accounting method change and an appeals officer or counsel for the government subsequently resolves such accounting method issue on a nonaccounting-method-change basis, the appeals officer or counsel for the government should provide notice that the accounting method issue has not been treated as an accounting method change.

(2) Form of notice. The notice must be in writing. If the taxpayer and the Service execute a closing agreement finalizing the change, the notice will be provided in the closing agreement. If the taxpayer and the Service do not execute a closing agreement, the notice ordinarily will be provided in the examiner's report or the Form 870AD (Offer of Waiver of Restriction on Assessment and Collection of Deficiency in Tax and of Acceptance of Overpayment). However, the Service may also provide the notice in a preliminary notice of deficiency, a statutory notice of deficiency, a notice of claim disallowance, a notice of final administrative adjustment, a pleading (for example, a petition, complaint, or answer) or amendment thereto, or in any other similar writing provided to the taxpayer.

(3) Content of notice. The notice must include:

(a) a statement that the accounting method issue is being treated as an accounting method change or a clearly labeled § 481(a) adjustment; and

(b) a description of the new method of accounting.

(4) Method not established without notice. The resolution of an accounting method issue will not establish a new method of accounting if the Service does not provide the notice required by section 7.01 of this revenue procedure. See section 9 of this revenue procedure for the procedures applicable if the Service does not provide this notice.

.02 Finalizing a Service-imposed Method Change.

(1) In general. To implement a Service-imposed change in method of accounting, the taxpayer and the Service should execute a closing agreement under § 7121 in which the taxpayer agrees to the change and the terms and conditions of the change. For purposes of this revenue procedure, in the case of accounting method issues before a federal court, the term "closing agreement" includes any other appropriate settlement agreement. If the taxpayer and the Service execute such a closing agreement, then the change is final as of the date of the agreement (unless otherwise provided by a federal court). In the absence of such an agreement, a Service-imposed accounting method change is final only upon the expiration of the period of limitations for filing a claim for refund under § 6511 for the year of change or the date of a final court order requiring the change.

(2) Content of closing agreement. A closing agreement finalizing a Service-imposed accounting method change must comply with the requirements of Rev. Proc. 68-16, 1968-1 C.B. 770, and should include the information outlined in the Model Closing Agreement for Settlement on an Accounting Method Basis attached as APPENDIX A of this revenue procedure. A settlement agreement finalizing a Service-imposed accounting method change with respect to an accounting method issue that is pending before a federal court must conform to the rules and procedures of the court and should include the information outlined in the Model Closing Agreement for Settlement on an Accounting Method Change Basis attached as APPENDIX A of this revenue procedure.

.03 Implementing a Service-imposed Method Change.

(1) Years before the Service. The Service should make the adjustments necessary to effect a Service-imposed accounting method change to the taxpayer's returns for the taxable years under examination, before Appeals, or before a federal court. These adjustments include the adjustments to taxable income necessary to reflect the new method (including the § 481(a) adjustment required as a result of the change), and any collateral adjustments to taxable income or tax liability resulting from the change.

(2) Succeeding years for which returns have been filed. If a Service-imposed accounting method change is finalized by a closing agreement, the Service may require that the taxpayer file amended returns to reflect the change for any affected succeeding taxable years for which a federal income tax return has been filed as of the date of the agreement. The amended returns must include the adjustments to taxable income and any collateral adjustments to taxable income or tax liability resulting from the change necessary to reflect the new method. The Service may require that the amended returns be filed prior to execution of the closing agreement finalizing the change. If the Service does not require the amended returns, the taxpayer should file such amended returns. If the Service does not require the amended returns and the taxpayer does not file the amended returns, the Service should make the adjustments necessary to reflect the change for affected succeeding taxable years if and when it examines the returns for those years. A taxpayer that files an amended return using the new method prior to the date a Service-imposed change becomes final must continue to use the new method on all subsequent returns, unless the taxpayer obtains the consent of the Commissioner to change from the new method or the Service changes the taxpayer from the new method on subsequent examination. See Rev. Rul. 90-38. A taxpayer eligible to file a "qualified amended return" under Rev. Proc. 94-69, 1994-2 C.B. 804, may satisfy any requirement to file an amended return by filing a "qualified amended return" in accordance with that revenue procedure.

(3) Future years. The taxpayer must use the new method of accounting on all returns filed after the date that a Service-imposed accounting method change becomes final (see section 7.02 of this revenue procedure), unless the taxpayer obtains the consent of the Commissioner to change from the new method or the Service changes the taxpayer from the new method on subsequent examination. A taxpayer that files a return using the new method prior to the date a Service-imposed change becomes final must continue to use the new method on all subsequent returns, unless the taxpayer obtains the consent of the Commissioner to change from the new method or the Service changes the taxpayer from the new method on subsequent examination. If the taxpayer does not use the new method on any return filed prior to the date a Service-imposed change becomes final, and does not file amended returns to reflect the change, the Service should make the adjustments necessary to reflect the change for the affected taxable years if and when it examines those returns.

.04 Effect of Final Service-imposed Method Change.

(1) New method established. A Service-imposed change that is final establishes a new method of accounting within the meaning of § 446(e) and § 1.446-1(e). As a result, the taxpayer is required to use the new method of accounting for the year of change and for all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change from the new method or the Service changes the taxpayer from the new method on subsequent examination.

(2) Subsequent examination. Except as provided in section 7.04(3) of this revenue procedure, the Service is not precluded from changing the taxpayer from the new method of accounting if the Service determines that the new method does not clearly reflect the taxpayer's income.

(3) Audit protection.

(a) In general. A taxpayer that executes a closing agreement finalizing a Service-imposed accounting method change will not be required to change or modify the new method for any taxable year for which a federal income tax return has been filed as of the date of the closing agreement, provided that:

(i) the taxpayer has complied with all the applicable provisions of the closing agreement;

(ii) there has been no taxpayer fraud, malfeasance, or misrepresentation of a material fact;

(iii) there has been no change in the material facts on which the closing agreement was based; and

(iv) there has been no change in the applicable law on which the closing agreement was based.

(b) Limitations. The Service may require the taxpayer to change or modify the new method in the earliest open taxable year if the taxpayer fails to comply with the applicable provisions of the agreement or upon a showing of the taxpayer's fraud, malfeasance, or misrepresentation of a material fact. The Service may require the taxpayer to change or modify the new method in the earliest open taxable year in which the material facts have changed. The Service also may require the taxpayer to change or modify the new method in the earliest open taxable year in which the applicable law has changed. For this purpose, a change in the applicable law includes: (i) the enactment of legislation; (ii) a decision of the United States Supreme Court; (iii) the issuance of temporary or final regulations; or (iv) the issuance of a revenue ruling, revenue procedure, notice, or other guidance published in the Internal Revenue Bulletin.

.05 Coordination with Examination. An appeals officer or counsel for the government changing a taxpayer's method of accounting will coordinate the resolution with Examination if the appeals officer or counsel for the government proposes to defer the year of change to any taxable year not before appeals or a federal court. Examination will advise the appeals officer or counsel for the government of any changes in material fact in any taxable year under examination.

.06 Deemed Cut-off Method. If the Service does not impose a § 481(a) adjustment but otherwise provides the notice required by section 7.01 of this revenue procedure, the Service-imposed change will be treated as being made using a cut-off method, unless the Service and the taxpayer specifically have agreed in writing to compromise the amount of the § 481(a) adjustment.

SECTION 8. PROCEDURES FOR RESOLVING ACCOUNTING METHOD ISSUES ON A NONACCOUNTING-METHOD-CHANGE BASIS

.01 Closing agreement required . To resolve an accounting method issue raised by the Service on a nonaccounting-method-change basis, the Service and the taxpayer will execute a closing agreement under § 7121. For purposes of this revenue procedure, in the case of accounting method issues before a federal court, the term "closing agreement" includes any other appropriate settlement agreement. If the accounting method issue is being resolved on an alternative-timing basis as described in section 6.02(3) of this revenue procedure, the taxpayer must agree to pay the government any taxes and interest due as a result of the resolution. If the accounting method issue is being resolved on a time-value-of-money basis as described in section 6.02(4) of this revenue procedure, the taxpayer must agree to pay the government the specified amount as a result of the resolution.

.02 Content of Closing Agreement. A closing agreement finalizing the resolution of an accounting method issue on a nonaccounting-method-change basis must comply with the requirements of Rev. Proc. 68-16, and should include the information outlined in the Model Closing Agreement for Settlement on a Nonaccounting-method- change Basis attached as APPENDIX B of this revenue procedure. A closing agreement resolving an accounting method issue that is pending before a federal court on a nonaccounting-method-basis must conform to the rules and procedures of the court and should include the information outlined in the Model Closing Agreement for Settlement on a Nonaccounting-method-change Basis attached as APPENDIX B of this revenue procedure.

.03 Implementing Resolution of an Accounting Method Issue on a Nonaccounting-method-change Basis.

(1) Resolution on an alternative-timing basis.

(a) Years before the Service. The Service should make the adjustments necessary to effect an alternative-timing resolution for the taxable years before appeals or before a federal court. These adjustments include the adjustments to taxable income necessary to reflect the resolution and any collateral adjustments to taxable income or tax liability resulting from the resolution.

(b) Succeeding years for which returns have been filed. The Service may require that the taxpayer file amended returns to reflect an alternative-timing resolution for any affected succeeding taxable years for which a federal income tax return has been filed as of the date of the closing agreement. The amended returns must include the adjustments to taxable income and any collateral adjustments to taxable income or tax liability resulting from the resolution necessary to reflect the resolution. The Service may require that the amended returns be filed prior to execution of the closing agreement finalizing the resolution. If the Service does not require the amended returns, the taxpayer should file such amended returns. If the Service does not require amended returns and the taxpayer does not file amended returns, the Service should make the adjustments necessary to reflect the resolution for affected succeeding taxable years if and when it examines the returns for those years. A taxpayer eligible to file a "qualified amended return" under Rev. Proc. 94-69 may satisfy any requirement to file an amended return by filing a "qualified amended return" in accordance with that revenue procedure.

(c) Future years. The taxpayer must reflect the alternative-timing resolution on the returns for any affected succeeding taxable years for which a return has not been filed as of the date of the closing agreement. The taxpayer must continue to file its returns on its current method of accounting for all items not covered by the closing agreement, unless the taxpayer obtains the consent of the Commissioner to change from its current method or the Service changes the taxpayer from its current method on subsequent examination.

(2) Resolution on a time-value-of-money basis. The taxpayer must pay the specified amount required by the time-value- of-money resolution. The Service will not change or otherwise propose adjustments to taxable income with respect to the taxpayer's method of accounting for the taxable years covered by a closing agreement. The taxpayer must continue to file its returns on its current method of accounting, unless the taxpayer obtains the consent of the Commissioner to change from its current method or the Service changes the taxpayer from its current method on subsequent examination.

.04 Effect of Resolving an Accounting Method Issue on a Nonaccounting-method-change Basis.

(1) No change in method. If the Service resolves an accounting method issue on a nonaccounting-method-change basis, the resolution does not constitute a change in method of accounting. If the accounting method issue is resolved on an alternative-timing basis, the taxpayer is required to use its current method of accounting for all items not covered by the closing agreement, unless the taxpayer obtains the consent of the Commissioner to change from its current method or the Service changes the taxpayer from its current method on subsequent examination. If the accounting method issue is resolved on a time-value-of-money basis, the taxpayer is required to continue to use its current method of accounting on all returns for taxable years subsequent to the years covered by the closing agreement, unless the taxpayer obtains the consent of the Commissioner to change from its current method or the Service changes the taxpayer from its current method on subsequent examination.

(2) Subsequent change.

(a) Resolution on an alternative-timing basis. If an accounting method issue is resolved on an alternative-timing basis, the Service is not precluded from changing the taxpayer's method of accounting in any open taxable year for any item not covered by the closing agreement.

(b) Resolution on a time-value-of-money basis. If an accounting method issue is resolved on a time-value-of-money basis, the Service is not precluded from changing the taxpayer's method of accounting in any open taxable year not covered by the closing agreement.

(3) Effect of subsequent change.

(a) Resolution on an alternative-timing basis. If an accounting method issue is resolved on an alternative-timing basis and the taxpayer's method of accounting subsequently is changed (voluntarily or involuntarily) in any open taxable year, the § 481(a) adjustment (if any) will be determined by reference to all items arising prior to the year of change, except those items covered by the closing agreement (that is, those items for which the closing agreement specifically provides the manner in which the items are to be accounted for).

(b) Resolution on a time-value-of-money basis. If an accounting method issue is resolved on a time-value-of-money basis and the taxpayer's method of accounting subsequently is changed (voluntarily or involuntarily) in any open taxable year not covered by the closing agreement, the § 481(a) adjustment (if any) will be determined by reference to all items arising prior to the year of change. If the Service subsequently changes the taxpayer's method of accounting and imposes a § 481(a) adjustment, the interest that is assessed on any underpayment, or the interest that is due on any overpayment, for the year of change will be treated as paid to the extent necessary to prevent duplicate payment of the time-value-of- money benefit relating to the § 481(a) adjustment.

SECTION 9. DEFAULT PROCEDURES

.01 In General. Section 9 of this revenue procedure applies to the resolution of any accounting method issue if the Service changes the taxpayer's method of accounting and fails to provide the notice required by section 7.01 of this revenue procedure, or if the Service resolves the accounting method issue on a nonaccounting-method-change basis and the Service and the taxpayer do not execute a closing agreement as required by section 8.01 of this revenue procedure. See section 10.05 of this revenue procedure for an example of the application of section 9 of this revenue procedure.

.02 Effect of Adjustments. For accounting method issues resolved under section 9 of this revenue procedure:

(1) No omission or duplication. The Service and the taxpayer are required to treat all items in a manner that prevents the duplication or omission of items of income or deduction;

(2) No change in method. The resolution does not constitute a change in method of accounting. The taxpayer is required to continue to use its current method of accounting for all items not affected by the adjustments made by the Service, unless the taxpayer obtains the consent of the Commissioner to change from its current method or the Service changes the taxpayer from its current method on subsequent examination;

(3) Subsequent change. The Service is not precluded from changing the taxpayer's method of accounting in any open taxable year; and

(4) Effect of subsequent change. If the taxpayer's method of accounting subsequently is changed (voluntarily or involuntarily) in any open taxable year, the § 481(a) adjustment (if any) will be determined by reference to all items arising prior to the year of change, including the items affected by the adjustment made by the Service.

SECTION 10. EXAMPLES.

The following examples illustrate how the provisions of this revenue procedure apply to the resolution of accounting method issues in various circumstances. These examples include explanations of the resolution of an accounting method issue previously resolved by Appeals on a nonaccounting-method-change basis in the event that Examination resolves such issue in a subsequent taxable year by changing the taxpayer's method of accounting. Note, however, that where the resolution of an accounting method issue is imposed by Appeals, an examining agent addressing such issue in a subsequent taxable year may resolve it consistently with the prior resolution by Appeals (see Delegation Order 236).

.01 Examination-imposed Change.

(1) Facts. A taxpayer that is a corporation deducted costs that the Service determines should have been capitalized to real property that was placed in service in 2000. The taxpayer incurred and deducted $1,000,000 of the costs in 1996, $2,000,000 in each of 1997 and 1998, and $5,000,000 in each of 1999 and 2000. The taxpayer is examined for the 1997 and 1998 taxable years (1997 is the earliest open year). The examining agent determines that the treatment of the costs is an accounting method issue, and that the taxpayer's deduction of the costs is an impermissible method of accounting. The examining agent therefore proposes an adjustment.

(2) Effect. Under section 5 of this revenue procedure, the examining agent is required to properly apply the law to the facts and change the taxpayer to the capitalization method of accounting for the costs. The examining agent imposes the change in 1997, the earliest open taxable year. The examining agent will provide the notice required by section 7.01 of this revenue procedure. The examining agent imposes a § 481(a) adjustment of $1,000,000 (representing the $1,000,000 of the costs deducted in 1996), the entire amount of which will be taken into account in computing taxable income in 1997. The examining agent also disallows the deductions of $2,000,000 in each of 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 is increased by $5,000,000 (representing the $1,000,000 § 481(a) adjustment and the disallowance of the $2,000,000 of deductions in each of 1997 and 1998). The method change (once final) is effective for 1997. Thus, the taxpayer is required to capitalize the costs in 1997 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

.02 Appeals Resolution of Accounting Method Issue as a Method Change With Compromise Terms and Conditions.

(1) Facts. The facts are the same as in section 10.01 of this revenue procedure, except that the issue of whether the costs should be capitalized is referred to Appeals. The appeals officer believes that hazards of litigation exist with respect to the Service's position. The appeals officer and the taxpayer agree to resolve the accounting method issue by changing the taxpayer's method of accounting for the costs, but with compromise terms and conditions to reflect the hazards of litigation.

(2) Effect. Under section 6.02(2) of this revenue procedure, when the appeals officer changes the taxpayer's method of accounting, the appeals officer is required to properly apply the law to the facts and change the taxpayer to the capitalization method of accounting for the costs. The appeals officer should provide the notice required by section 7.01 of this revenue procedure.

The appeals officer may make the change using the cut-off method. If the appeals officer makes the change in 1997 using the cut-off method, the appeals officer will disallow the deductions of $2,000,000 in each of 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 will be increased by $4,000,000 (representing the disallowance of the $2,000,000 of deductions in each of 1997 and 1998). The method change (once final) is effective for 1997. Thus, the taxpayer is required to capitalize the costs in 1997 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

Alternatively, the appeals officer may compromise the amount of the § 481(a) adjustment. If the appeals officer makes the change in 1997 and agrees to reduce the § 481(a) adjustment by 25%, the appeals officer will impose a § 481(a) adjustment of $750,000 (representing 75% of the amount of the costs deducted in 1996), the entire amount of which will be taken into account in computing taxable income in 1997. The appeals officer will disallow the deductions of $2,000,000 in each of 1997 and 1998. The taxpayer and the appeals officer agree in a closing agreement that basis in the property as of the beginning of 1998 will be increased by $4,750,000 (representing the reduced § 481(a) adjustment of $750,000 and the disallowance of the $2,000,000 of deductions in each of 1997 and 1998). The method change (once final) is effective for 1997. Thus, the taxpayer is required to capitalize the costs in 1997 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

As another alternative, the appeals officer may compromise the year of change and/or the § 481(a) adjustment period. For example, the appeals officer may agree to make the change in 1998 with a two-year § 481(a) adjustment period. The appeals officer will impose a § 481(a) adjustment of $3,000,000 (representing the $1,000,000 of costs deducted in 1996 and the $2,000,000 of costs deducted in 1997), one-half of which will be taken into account in computing taxable income in each of 1998 and 1999. The appeals officer will disallow the deduction of $2,000,000 in 1998. The taxpayer's basis in the property as of the beginning of 1998 will be increased by $5,000,000 (representing the $3,000,000 § 481(a) adjustment and the disallowance of the $2,000,000 of deductions in 1998). The method change (once final) is effective for 1998. Thus, the taxpayer is required to capitalize the costs in 1998 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

.03 Appeals Resolution of Accounting Method Issue on an Alternative-timing Basis.

(1) Facts. The facts are the same as in section 10.02 of this revenue procedure, except that the appeals officer and the taxpayer agree to resolve the issue on an alternative-timing basis as described in section 6.02(3) of this revenue procedure and they enter into a closing agreement as required by section 8.01 of this revenue procedure. The accounting method issue is resolved by providing in the closing agreement that the taxpayer will deduct 50% of the costs incurred in 1997 and 1998 and capitalize the other 50% of the costs incurred in those years.

(2) Effect. The appeals officer will disallow $1,000,000 of the deductions in each of 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 is increased by $2,000,000 (representing the disallowance of the $1,000,000 of deductions in each of 1997 and 1998). The taxpayer's current method of accounting for the costs is not changed. Thus, the taxpayer is required to continue to deduct the costs not covered by the agreement (that is, the costs incurred in 1996 and the costs incurred in 1999 and all subsequent taxable years), unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination. If the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $1,000,000 (including the amount of the costs deducted in 1996, which are not covered by the agreement, and excluding the amount of those costs deducted in 1997 and 1998 because the costs are covered by the agreement). The Service will also disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by an additional $6,000,000 (representing the $1,000,000 § 481(a) adjustment and the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

Alternatively, the accounting method issue may be resolved by providing in the closing agreement that the taxpayer will capitalize $1,000,000 of the costs incurred in each of 1997 and 1998 (and the agreement is silent as to the manner in which the other $1,000,000 of costs incurred in each of 1997 and 1998 are to be accounted for). The results for 1997 and 1998 will be the same as under the closing agreement in the original facts described in section 10.03(1) of this revenue procedure. That is, the appeals officer will disallow $1,000,000 of the deduction in each of 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 is increased by $2,000,000 (representing the disallowance of the $1,000,000 of deductions in each of 1997 and 1998). Because the taxpayer's current method of accounting for the costs is not changed, the taxpayer is required to continue to deduct the costs not covered by the closing agreement (that is, the costs incurred in 1996, the remaining $1,000,000 of costs incurred in each of 1997 and 1998, and the costs incurred in 1999 and all subsequent taxable years). However, if the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $3,000,000 (including the $1,000,000 of the costs deducted in 1996 and the remaining $2,000,000 of the costs deducted in 1997 and 1998, because those costs are not items covered by the closing agreement). The Service also will disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by an additional $8,000,000 (representing the $3,000,000 § 481(a) adjustment and the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

Assuming, in the alternative, that the accounting method issue is resolved by providing in the closing agreement that, for the costs incurred in 1996 through 1998, the taxpayer will deduct 50% of the costs and capitalize the other 50% of the costs, and will increase taxable income by $500,000 in 1997 (representing the disallowance of $500,000 of costs in 1996). The appeals officer will disallow $1,000,000 of the deductions in each of 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 is increased by $2,500,000 (representing the disallowance of the $500,000 of deductions in 1996 and the $1,000,000 of deductions in each of 1997 and 1998). The taxpayer's current method of accounting for the costs is not changed. Thus, the taxpayer is required to continue to deduct the costs not covered by the closing agreement (that is, the costs incurred in 1999 and all subsequent taxable years), unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination. If the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $0 (excluding the amount of the costs deducted in 1996 through 1998, because the manner in which those costs are to be accounted for is specifically covered by the closing agreement). The Service also will disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by an additional $5,000,000 (representing the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

.04 Appeals Resolution of Accounting Method Issue on Time- value-of-money Basis.

(1) Facts. The facts are the same as section 10.02 of this revenue procedure, except that the appeals officer and the taxpayer agree to settle the issue on a time-value-of-money basis as described in section 6.02(4) of this revenue procedure. The taxpayer files its return on a calendar year basis. The appeals officer and the taxpayer agree to compute the specified amount using the sample computation described in section 6.02(4)(b)(ii) of the revenue procedure. The appeals officer believes that an appropriate factor to reflect the hazards of litigation is 25%. The taxpayer pays the specified amount on May 15, 2000. The highest marginal tax rate applicable to the taxpayer for 1997 and 1998 is 35% and the quarterly large corporation underpayment rates in effect for January 1, 1998, through June 30, 2000, are: 11%, 10%, 10%, 10%, 9%, 10%, 10%, 10%, 10%, 11%. The specified amount under section 6.02(4) of this revenue procedure would be deductible under § 163(a) by the taxpayer if it were treated as interest expense arising from an underpayment of tax.

(2) Computation of specified amount. The hypothetical underpayment of tax for 1997 is $1,050,000, computed as follows: the net increase in taxable income of $3,000,000 (representing the § 481(a) adjustment of $1,000,000 and the disallowance of the deduction of $2,000,000 computed as if Examination had changed the taxpayer's method in 1997) multiplied by the applicable tax rate of 35%. The hypothetical underpayment of tax for 1998 is $700,000, computed as follows: the net increase in taxable income of $2,000,000 (representing the disallowance of the deduction of $2,000,000 computed as if Examination had changed the taxpayer's method in 1997) multiplied by the applicable tax rate of 35%.

The applicable time-value rate for 1997 is 6.565%, which is computed as follows: The applicable period for 1997 is March 15, 1998 (the due date of the return) to May 15, 2000 (the date the specified amount is paid). The underpayment rates in effect for the applicable period are 11%, 10%, 10%, 10%, 9%, 10%, 10%, 10%, 10%, and 11%. The average underpayment rate in effect for the applicable period is 10.1% [(11+10+10+10+9+10+10+10+10+11)/10]. The applicable after-tax time-value rate is 6.565%, computed by multiplying the average underpayment rate by one minus the applicable tax rate [10.1% * (1- .35)].

The applicable time-value rate for 1998 is 6.5%, which is computed as follows: The applicable period for 1998 is March 15, 1999 (the due date of the return) to May 15, 2000 (the date the specified amount is paid). The underpayment rates in effect for the applicable period are 9%, 10%, 10%, 10%, 10%, and 11%. The average underpayment rate in effect for the applicable period is 10.00% [(9+10+10+10+10+11)/6]. The applicable after-tax time-value rate is 6.5%, computed by multiplying the average underpayment rate by one minus the applicable tax rate [10.00% * (1-.35)].

The time-value-of-money benefit for each taxable year is computed by using the following formula:

The specified amount is the sum of the time-value-of-money benefit for 1997 and 1998 reduced by 25% to reflect the hazards of litigation. The specified amount is $161,763 computed as follows: ($160,519+$55,165)*(1-.25).

(3) Effect. The Service will not propose any adjustments to taxable income with respect to the taxpayer's method of accounting for the costs for 1997 and 1998. The taxpayer's basis in the property as of the beginning of 1998 is not changed. The taxpayer's current method of accounting for the costs is not changed. Thus, the taxpayer is required to continue to deduct the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination. If the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $5,000,000 (representing the $1,000,000 of the costs deducted in 1996 and the $2,000,000 of costs deducted in each of 1997 and 1998). The Service will also disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by $10,000,000 (representing the $5,000,000 § 481(a) adjustment and the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

The interest on the taxpayer's deficiency (which reflects the inclusion of the $5,000,000 § 481(a) adjustment in taxable income) for 1999 is $100,000. A portion of the $100,000 of interest will be treated as paid to the extent necessary to prevent duplicate payment of the time-value-of-money benefit relating to the § 481(a) adjustment. The interest on the deficiency for 1999 includes the time-value-of-money benefit attributable to the § 481(a) adjustment for the period March 15, 2000, through the date of payment of the deficiency. The taxpayer previously paid the Service the time- value-of-money benefit attributable to $3,000,000 of the § 481(a) adjustment for the period March 15, 1998, through May 15, 2000, and $2,000,000 of disallowed deduction for the period March 15, 1999, through May 15, 2000. The interest on the deficiency for 1999 attributable to the overlap period of March 15, 2000, through May 15, 2000, is $19,112, computed as follows:

.05 Default Procedures.

(1) Facts. The facts are the same as section 10.01 of this revenue procedure, except that the examining agent does not provide the notice required by section 7.01 of this revenue procedure. Specifically, the examining agent disallows the deductions of $2,000,000 in each of 1997 and 1998, but does not compute the § 481(a) adjustment of $1,000,000 or otherwise provide notice that the accounting method issue is being treated as an accounting method change.

(2) Effect. The taxpayer's basis in the property as of the beginning of 1998 is increased by $4,000,000 (representing the disallowance of the $2,000,000 of deductions in each of 1997 and 1998). The taxpayer's current method of accounting for the costs is not changed. Thus, the taxpayer is required to continue to deduct the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination. If the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $1,000,000 (representing the $1,000,000 of the costs deducted in 1996). The Service will also disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by an additional $6,000,000 (representing the $1,000,000 § 481(a) adjustment and the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

Assume that the examining agent disallows the deductions of $2,000,000 in each of 1997 and 1998 and computes the § 481(a) adjustment of $1,000,000, but does not label the § 481(a) adjustment or otherwise provide notice that the accounting method issue is being treated as an accounting method change. The taxpayer's basis in the property as of the beginning of 1998 is increased by $5,000,000 (representing the $1,000,000 adjustment and the disallowance of the $2,000,000 of deductions in each of 1997 and 1998). The taxpayer's current method of accounting for the costs is not changed. Thus, the taxpayer is required to continue to deduct the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination. If the Service changes the taxpayer's method in 1999, the Service will compute a § 481(a) adjustment of $0 (excluding the $1,000,000 of the costs deducted in 1998 and the $2,000,000 of the costs deducted in each of 1997 and 1998 because the costs were accounted for in the prior adjustments). The Service will also disallow the deduction of $5,000,000 in 1999. The taxpayer's basis in the property as of the beginning of 1999 will be increased by an additional $5,000,000 (representing the disallowance of the $5,000,000 deduction in 1999). The method change (once final) is effective for 1999. Thus, the taxpayer is required to capitalize the costs in 1999 and all subsequent taxable years, unless the taxpayer obtains the consent of the Commissioner to change the method or the Service changes the taxpayer from the method on subsequent examination.

SECTION 11. EFFECTIVE DATE

.01 In General. Except as provided in section 11.02 of this revenue procedure, this revenue procedure is effective for:

(1) examiner's reports issued on or after July 1, 2002; and

(2) Forms 870AD and agreements executed on or after July 1, 2002 (regardless of when the underlying examiner's report was issued).

.02 Transition Rule. The Service and the taxpayer may agree to apply this revenue procedure to agreements executed on or after March 14, 2002.

DRAFTING INFORMATION

The principal author of this revenue procedure is Grant Anderson of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Anderson on (202) 622-4970 (not a toll-free call).

Closing Agreement on Final Determination Covering Specific Matters

Under § 7121 of the Internal Revenue Code, [ Insert taxpayer's name, address, telephone number, and identifying number ] ("the taxpayer") and the Commissioner of Internal Revenue ("the Commissioner") make the following closing agreement: WHEREAS:

1. The accounting method issue covered by this agreement is the taxpayer's method of accounting for [ identify subject: for example: "credit sales" ];

2. The taxable year(s) covered by this closing agreement are [ insert taxable year(s) covered by the agreement ];

3. The taxpayer and the Commissioner relied on the following facts and representations in making this closing agreement: [ insert any relevant facts ];

4. Under the taxpayer's present method of accounting for [ identify subject: for example, "credit sales" ], the taxpayer [ describe in detail the method of accounting being changed: for example, "includes income from credit sales in gross income when payment is received" ];

5. [ If applicable, insert: ] The taxpayer has filed an amended return(s) for the taxable year(s) ended [ insert applicable affected succeeding taxable year(s) for which a federal income tax return has been filed as of the date of the closing agreement ] to reflect the change in method of accounting for [ insert subject: for example, "credit sales" ] described in this closing agreement;

6. [ If applicable, insert: ] A stipulated decision has been entered by the [ insert name of federal court ] with respect to the taxable year(s) ended [ insert date(s) ] that reflects taxable income for such year(s) computed using the new method of accounting for [ insert subject: for example, "credit sales" ].

NOW IT IS HEREBY DETERMINED AND AGREED for federal income tax purposes that:

1. The Service is changing the taxpayer's method of accounting for [ insert subject: for example, "credit sales" ] to the method of [ describe the method of accounting to which the taxpayer is being changed: for example, 'including income from credit sales in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy (an accrual method)" ];

2. The change in method of accounting for [ insert subject: for example, "credit sales" ] is to be effected for the taxable year ended [ insert date ] (the year of change);

3. [ Insert if applicable ] An adjustment to income is required under § 481(a) of the Internal Revenue Code in the amount of $ [ insert amount in numbers ] ([ insert amount in words ] dollars), [ if applicable, insert computed by taking into account the limitations under § 481(b),] as of the beginning of the year of change ([ insert date ]), for [ describe the adjustment: for example, "credit sales" ], which amount previously has not been included in the taxpayer's gross income. [ Alternatively, insert ]The change in method of accounting for [ insert subject: for example, "credit sales" ] is to made on a cut-off basis;

4. [ Insert if applicable ] The § 481(a) adjustment will be taken into account [ insert § 481(a) adjustment spread period: for example, "entirely in the year of change." ]

5. [ Insert if applicable ] The adjustment(s) to tax attributable to the adjustment(s) to taxable income resulting from the change in the method of accounting for [ insert subject: for example, "credit sales" ] (including the § 481(a) adjustment, current year adjustment(s), and any collateral adjustments to taxable income or tax liability resulting fom the change) for each taxable year covered by the closing agreement are as follows: [ insert the adjustments to each taxable year covered by the closing agreement in table form ], and;

6. The change in method of accounting for [ insert subject: for example, "credit sales" ] is a change in method of accounting within the meaning of Rev. Proc. 2002-18. As such, the provisions of section 446 of the Code, and the regulations thereunder, apply to the new method of accounting for [insert subject: for example, "credit sales."];

7. The Service is not precluded from changing the taxpayer's method of accounting for [ insert subject: for example, "credit sales" ] from the new method of accounting if the Service determines that the new method does not clearly reflect the taxpayer's income. However, under section 7.04(3) of Rev. Proc. 2002-18, the Service will not require the taxpayer to change its method of accounting for [ insert subject: for example, "credit sales" ] from the new method for [ insert taxable year(s) for which a federal income tax return has been filed as of the date of this closing agreement ], provided that:

(a) the taxpayer has complied with all the applicable provisions of this closing agreement;

(b) there has been no taxpayer fraud, malfeasance, or misrepresentation of a material fact;

(c) there has been no change in the material facts on which this closing agreement was based; and

(d) there has been no change in the applicable law on which this closing agreement was based;

8. [ Insert if applicable: ] The following additional conditions also apply: [ insert, for example, conditions with respect to waiving restrictions on assessment and collection, paying any tax, abating any overassessment, or refunding or crediting any tax overpayment ];

9. The taxpayer accepts this settlement and agrees to the applicable terms of Rev. Proc. 2002-18.

This agreement is final and conclusive except:

(1) The matter it relates to may be reopened in the event of fraud, malfeasance, or misrepresentation of a material fact;

(2) It is subject to the Internal Revenue Code sections that expressly provide that effect be given to their provisions (including any stated exception for § 7122) notwithstanding any law or rule of law; and

(3) If it relates to a tax period ending after the date of this agreement, it is subject to any law enacted after the agreement date, that applies to the tax period.

By signing, the parties certify that they have read and agreed to the terms of this document.

 Your signature _____________________________________ Date: __________________

If an attorney or agent signs the agreement for the taxpayer, the power of attorney (or a copy) authorizing that person to sign must be attached to the agreement.

If the taxpayer is a corporation, the agreement must be dated and signed with the name of the corporation, the signature and title of an authorized officer or officers, or the signature of an authorized attorney or agent. It is not necessary that a copy of an enabling corporate resolution be attached.

Use additional pages if necessary and identify them as part of this agreement.

Please see Rev. Proc. 68-16, 1968-1 C.B. 770, for a detailed description of practices and procedures applicable to most closing agreements.

Closing Agreement on Final Determination Covering Specific Matters

Under § 7121 of the Internal Revenue Code, [ Insert taxpayer's name, address, telephone number, and identifying number ] ("the taxpayer") and the Commissioner of Internal Revenue ("the Commissioner") make the following closing agreement: WHEREAS:

1. The accounting method issue covered by this closing agreement is [ identify subject: for example: "costs of acquiring nondepreciable asset X" ];

2. [ Insert if alternative-timing resolution ] The item(s) covered by this closing agreement are [ identify items subject to the closing agreement: for example, "the costs incurred in connection with the acquisition of nondepreciable asset X in 1997 and 1998"]. [Alternatively, insert if time-value-of-money resolution ] The taxable year(s) covered by this closing agreement are [ insert taxable year(s) covered by the agreement ];

3. The taxpayer and the Commissioner relied on the following facts and representations in making this closing agreement: [ insert any relevant facts ];

4. Under the taxpayer's present method of accounting for [ identify subject: for example, "costs of acquiring nondepreciable asset X" ], the taxpayer [ describe in detail the accounting method issue: for example, "deducts the costs as an ordinary and necessary business expense" ];

5. [ If applicable, insert: ] The taxpayer has filed an amended return(s) for the taxable year(s) ended [ insert applicable affected succeeding taxable years for which a federal income tax return has been filed as of the date of the closing agreement ] to reflect the alternative-timing resolution for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] described in this closing agreement;

6. [ If applicable, insert: ] A stipulated decision has been entered by the [ insert name of federal court ] with respect to the taxable years ended [ insert date(s) ] that reflects the nonaccounting-method-change resolution set forth in this agreement for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ].

NOW IT IS HEREBY DETERMINED AND AGREED for federal income tax purposes that:

1. The Service is not changing the taxpayer's method of accounting for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ].

2. The accounting method issue covered by this agreement ([ identify subject: for example: "costs of acquiring nondepreciable asset X" ]) is being resolved on [ insert basis for resolution: for example, "an alternative-timing basis" or "a time-value-of-money basis" ].

[ If alternative-timing resolution, insert the following paragraphs 3 - 9 as applicable ]

3. The items covered by the closing agreement are to be accounted for in the affected taxable years as follows: [ insert a description of the manner in which the items are to be accounted for, for example, "Fifty percent of the costs incurred in each of 1997 and 1998 ($1,000,000) will be deductible and the remaining fifty percent ($1,000,000) will be capitalized" ];

4. As a result of this treatment, [Insert a description of any collateral effects of thie alternative-timing treatment: for example, "the taxpayer's basis in asset X is increased by $2,000,000"];

5. Any items not specifically covered by this closing agreement are not affected by this agreement;

6. The adjustment(s) to tax attributable to the adjustment to taxable income resulting from the resolution of [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] by this agreement (including the current year adjustment and any collateral adjustments for each taxable year affected by this closing agreement) is [ insert taxable year(s)], $ [ insert amount in numbers ] ([ insert amount in words ] dollars);

7. The Service is not precluded from changing the taxpayer's method of accounting for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] upon subsequent examination for any open taxable year for items not covered by this agreement;

8. If the taxpayer's method of accounting for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] subsequently is changed (voluntarily or involuntarily) in any open taxable year, the adjustment under § 481(a) (if any) will be determined by reference to all items arising prior to the year of change except for those items specifically covered by this closing agreement; and

9. [ Insert if applicable: ] The following additional conditions also apply: [ insert, for example, conditions with respect to waiving restrictions on assessment and collection, paying any tax, abating any overassessment, or refunding or crediting any tax overpayment ];

[ Alternatively, if a time-value-of-money resolution, insert the following paragraphs 3 - 10 as applicable ]

3. The computation of the specified amount as provided in section 6.02(4)(b) of Rev. Proc. 2002-18 has been made as follows: [ insert computation ].

4. The specified amount is not interest under § 163(a) of the Code and may not be deducted or capitalized under any provision of the Code.

5. [ Insert if the computation of the specified amount takes into account the taxpayer's actual tax attributes ] The tax attributes that may affect the computation of the taxpayer's tax liability in subsequent taxable years [ insert "are" or "are not" ] adjusted to reflect their effect on the specified amount;

6. The Service is not precluded from changing the taxpayer's method of accounting for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] upon subsequent examination for any open taxable year not covered by the agreement;

8. If the taxpayer's method of accounting for [ insert subject: for example, "costs of acquiring nondepreciable asset X" ] subsequently is changed (voluntarily or involuntarily) in any open taxable year not covered by this agreement, the adjustment under § 481(a) (if any) will be determined by reference to all items arising prior to the year of change;

9. If the Service changes the taxpayer's method of accounting in an open taxable year not covered by this agreement and imposes a § 481(a) adjustment, the interest that is assessed on any underpayment, or the interest that is due on any overpayment, for the year of change will be treated as paid to the extent necessary to prevent duplicate payment of the time-value-of-money benefit relating to the § 481(a) adjustment;

10. [ Insert if applicable: ] The following additional conditions also apply: [ insert, for example, conditions with respect to waiving restrictions on assessment and collection, paying any tax, abating any overassessment, or refunding or crediting any tax overpayment ];

The taxpayer accepts this settlement and agrees to the applicable terms of Rev. Proc. 2002-18.

This agreement is final and conclusive except:

(1) The matter it relates to may be reopened in the event of fraud, malfeasance, or misrepresentation of a material fact;

(2) It is subject to the Internal Revenue Code sections that expressly provide that effect be given to their provisions (including any stated exception for § 7122) notwithstanding any law or rule of law; and

(3) If it relates to a tax period ending after the date of this agreement, it is subject to any law enacted after the agreement date, that applies to the tax period. By signing, the parties certify that they have read and agreed to the terms of this document.

 Your signature __________________________________  Date: __________________

The agreement may relate to one or more years.

If an attorney or agent signs the agreement for the taxpayer, the power of attorney (or a copy) authorizing that person to sign must be attached to the agreement.

If the taxpayer is a corporation, the agreement must be dated and signed with the name of the corporation, the signature and title of an authorized officer or officers, or the signature of an authorized attorney or agent. It is not necessary that a copy of an enabling corporate resolution be attached.

Use additional pages if necessary and identify them as part of this agreement.

Please see Rev. Proc. 68-16, 1968-1 C.B. 770, for a detailed description of practices and procedures applicable to most closing agreements.