4.11.6. Changes in Accounting Methods

(1) Neither the Code nor the regulations specifically define the term "method of accounting." In general, an accounting method is a set of rules used to determine when and how a taxpayer takes income and expenses into account for federal income tax purposes.

(1) The following Internal Revenue Code and regulation sections govern changes in accounting methods:

• IRC 446 - General Rule for Methods of Accounting

• IRC 481 - Adjustments Required by Changes in Method of Accounting

• Treas. Regs. 26 CFR 1.446-1et seq, 26 CFR 1.481-1 and 26 CFR 1.481-2

• Rev. Rul. 90-38, 1990-18 I.R.B. 7 - 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.

• Rev. Proc. 97-27, 1997-21 I.R.B. 10 - This advance consent (voluntary change) revenue procedure provides the general procedures under Treas. Reg. 1.446-1(c) for obtaining the consent of the Commissioner of Internal Revenue to change a method of accounting for federal income tax purposes. Rev. Proc. 97-27 was modified by Rev. Proc. 2002-19, Rev. Proc. 2007-67 and Rev. Proc. 2009-39, and superseded by Rev. Proc. 2015-13.

• Rev. Proc. 2002-18, 2002-13 I.R.B. 678 - This revenue procedure provides the procedures under IRC 446(b) and Treas. Reg. 1.446-1(b) for Service-imposed (involuntary) changes in accounting methods. This revenue procedure also provides the procedures that the Service (other than examiners) may use for accounting method issues resolved on a non-accounting method change basis. This revenue procedure is effective for examiner's reports issued on or after July 1, 2002.

• Rev. Proc. 2002-19, 2002-13 I.R.B. 696 - This revenue procedure modified Rev. Proc. 97-27 and Rev. Proc. 2002-9 to provide procedures for obtaining consent for a change in accounting method. This procedure introduced a method change without audit protection for an "issue pending" for a tax year under examination and shortened the spread period for a taxpayer-favorable (negative) IRC 481(a) adjustment.

• Rev. Proc. 2007-67, 2007-48 I.R.B. 1072 - This revenue procedure allowed taxpayers, under certain conditions, to request to revise the year of change for a Form 3115, Application for Change in Accounting Method, that is pending with the National Office. It also modified the period for taking into account a net positive IRC 481(a) adjustment when the Commissioner approves the taxpayer's request to revise the year of change.

• Rev. Proc. 2008-52, 2008-36 I.R.B. 587 - This revenue procedure superseded Rev. Proc. 2002-9 to provide procedures for obtaining automatic consent for specifically identified change in accounting methods.

• Rev. Proc. 2009-39, 2009-38 I.R.B. 371 - This revenue procedure modified Rev. Proc. 97-27 and Rev. Proc. 2008-52, and was modified by Rev. Proc. 2011-14, to provide procedures for obtaining consent for a change in accounting method.

• Rev. Proc. 2011-14, 2011-4 I.R.B. 330 - This automatic consent (voluntary change) revenue procedure provided the procedures by which a taxpayer could obtain automatic consent to change the methods of accounting described in the Appendix. Pronouncements issued subsequent to the publication of Rev. Proc. 2011-14 that refer to this revenue procedure have modified its Appendix to include other methods of accounting. Rev. Proc. 2011-14 was superseded by Rev. Proc. 2015-13 and the list of automatic method changes included separately in Rev. Proc. 2015-14.

• Rev. Proc. 2015-13, 2015-5 I.R.B. 419 - This revenue procedure updates and revises the procedures by which a taxpayer may obtain non-automatic consent and automatic consent to change a method of accounting. It modified the procedures for taxpayers under examination by replacing the consent of director and issue pending provisions with broad eligibility rules. In conjunction, it modified the IRC 481(a) adjustment period and audit protections.

• Rev. Proc. 2015-14, 2015-5 I.R.B. 450 - This revenue procedure provides the first separate list of automatic method changes. Pronouncements issued subsequent to its publication have modified it to include additional automatic method changes.

• Rev. Proc. 2016-29, 2016-21 I.R.B. 880 - This revenue procedure updates and modifies the list of automatic method changes in Rev. Proc. 2015-14. Pronouncements issued subsequent to its publication have modified it to include additional automatic method changes.

• Rev. Proc. 2017-30, 2017-17 I.R.B 1131 - This revenue procedure updates and modifies the list of automatic method changes in Rev. Proc. 2016-29. Pronouncements issued subsequent to its publication have modified it to include additional automatic method changes.

• Rev. Proc. 2018-31, 2018-22 I.R.B. 637 - This revenue procedure updates and modifies the list of automatic method changes in Rev. Proc. 2017-30. Pronouncements issued subsequent to its publication have modified it to include additional automatic method changes.

• Rev. Proc. 2019-43, 2019-48 I.R.B. 1107 - This revenue procedure updates and modifies the list of automatic method changes in Rev. Proc. 2018-31. Pronouncements issued subsequent to its publication have modified it to include additional automatic method changes.

(1) For responsibilities of LB&I teams, in general, see IRM 4.46.1.1.3, Roles and Responsibilities.

(1) The following are related resources:

• IRS Virtual Library - Methods of Accounting and Timing Shelf

• IRM 4.2.3 - Examination Techniques

• Publication 538 (Rev. 01/2019) - Accounting Periods and Methods

(1) A change in method of accounting generally requires an adjustment under IRC 481(a) to prevent duplication or omission of income or deductions when the taxpayer computes its taxable income 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 IRC 481(a) is applied, income for the taxable years preceding the year of change must be determined under the method of accounting that was then employed, and the new method of accounting determines the income for the year of change and the subsequent taxable years as if the new method had always been used.

(1) A change in accounting method requires the computation of an IRC 481(a) adjustment as of the beginning of the taxable year for which the method is being changed (year of change). Simply stated, the adjustment represents the cumulative difference (without regard to the statute of limitations) between the present and proposed methods. The IRC 481(a) adjustment may increase income (positive adjustment) or decrease income (negative adjustment). In addition to the following example, see Exhibit 4.11.6-1 for a more detailed example of computing an adjustment under IRC 481(a).

(1) A net positive IRC 481(a) adjustment increases income and is often referred to as a "government-favorable" adjustment. A net negative IRC 481(a) adjustment decreases income and may be referred to as a "taxpayer-favorable" adjustment. When a taxpayer uses the voluntary method change procedures or a regulation provision, it generally takes a net negative IRC 481(a) adjustment into account in the year of change. A taxpayer generally takes a net positive IRC 481(a) adjustment into account over four years (year of change and next three taxable years). See also IRM 4.11.6.6.4.1. When a taxpayer under examination requests consent for a voluntary change under Rev. Proc. 2015-13 or successors, it takes a net positive IRC 481(a) adjustment into account over two years, unless one of the following exceptions applies. See Rev. Proc. 2015-13, § 7.03(3)(b):

• Change filed in the three-month window (Rev. Proc. 2015-13, § 8.02(1)(a)),

• Change filed in a 120-day window (Rev. Proc. 2015-13, § 8.02(1)(b)),

• Present method not before the director (Rev. Proc. 2015-13, § 8.02(1)(c)),

• New member of a consolidated group in Compliance Assurance Process (CAP) (Rev. Proc. 2015-13, § 8.02(1)(d)).

(1) When the Service imposes a method change (involuntary method change) and the entire amount of the adjustment is taken into account in the year of change, it is mandatory to apply IRC 481(b) when the net positive IRC 481(a) adjustment is in excess of $3,000. For the taxable year of change, IRC 481(b) provides a limitation on the tax attributable to the adjustments required under IRC 481(a) and 26 CFR 1.481-1 The tax limitation is only applicable to tax under Chapter 1 of the Internal Revenue Code. The following special rules apply for flow through entities under 26 CFR 1.481-2(c)(5).

1. S corporation - When the service changes an S corporation’s method of accounting, it makes the adjustments required by IRC 481(a) on the S corporation’s return. However, the limitations on tax under IRC 481(b) apply to the individual shareholders. IRC 481(b) applies to a shareholder whose taxable income is increased by more than $3,000 as a result of an IRC 481(a) adjustment to the corporation's ordinary income.

2. Partnerships - When the service changes a partnership's method of accounting, it makes the adjustments required by IRC 481(a) on the partnership’s return. However, the limitations on tax under IRC 481(b) apply to the individual partners. IRC 481(b) applies to a partner whose taxable income is increased by more than $3,000 as a result of an IRC 481(a) adjustment to the partnership's ordinary income.

(2) The increase to income tax attributable to the IRC 481(a) adjustment is generally limited to the lesser of:

1. Tax attributable to the IRC 481(a) adjustment taken into account entirely in the year of change; or

2. Tax attributable to the IRC 481(a) adjustment taken into account under a hypothetical three-year ratable spreadback (year of change and the two (2) preceding tax years) if the taxpayer used the prior method in the two (2) taxable years preceding the year of change.

(3) If the taxpayer establishes the taxable income (under the new method) for one or more taxable years consecutively preceding the year of change, the tax amount resulting from 4.11.6.5.4(2) above is further limited to the tax attributable to a specific allocation of the IRC 481(a) amount to those consecutive source years.

(4) If IRC 481(b) limits the tax, the Service treats the difference between regularly computed tax and limited tax as a tax credit in the Revenue Agent Report (RAR) for the year of change.

(5) See Exhibit 4.11.6-2 for an example of the tax computation required under IRC 481(b)(1).

(1) The Commissioner may determine that certain changes in method of accounting will be made without an IRC 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 (or other operative date) are taken into account under the new method of accounting. Any items arising before the year of change (or other operative date) continue to be taken into account under the taxpayer's former method of accounting. The cut-off method does not duplicate or omit any amounts from income; therefore, an IRC 481(a) adjustment is not necessary or required. The cut-off method may be available in a taxpayer-initiated method change (e.g., a change in the tax treatment of IRC 174 costs), but an examiner should make a method of accounting change using a cut-off method generally only where specifically allowed or required by statute, regulation or by the Commissioner in published guidance for the year of change.

(1) Normally, a taxpayer uses the general automatic or non-automatic consent procedures (Rev. Proc. 2015-13 or successors) to request consent to change its method of accounting. However, in some instances, a statute, regulation or IRS publication may establish unique procedures, terms and conditions for obtaining consent to change a method of accounting. For example see IRC 174, IRC 263A, IRC 448 , and IRC 460 and the related treasury regulations. Thus, it is important that the examiner determine the authority used to support the change in method of accounting.

(1) Rev. Proc. 2015-13 contains procedures for obtaining non-automatic and automatic consent to change a method of accounting. In general, these procedures apply to all accounting method changes initiated by a taxpayer, except those accounting method changes made under special procedures established by statutes, regulations or IRS publications.

(2) Rev. Proc. 2015-13 is effective for Forms 3115 filed on or after January 16, 2015 for a year of change ending on or after May 31, 2014. Transition rules provide additional time to file Forms 3115 for non-automatic and automatic method changes under the prior provisions of Rev. Proc. 97-27 and Rev. Proc. 2011-14, respectively.

1. For non-automatic method changes, the transition period is applicable for tax years ending on or after November 30, 2014, and on or before January 31, 2015 until March 2, 2015.

2. For automatic method changes, the transition period (modified by Rev. Proc. 2015-33) is applicable for tax years ending on or after May 31, 2014 and beginning before January 1, 2015 until the due date of the taxpayer’s timely filed (including extensions) tax return for the requested year of change.

(3) The IRC 481(a) adjustment period is one taxable year for a net negative adjustment and, in general, is four taxable years for a net positive adjustment for an accounting method change. If the taxpayer is under examination, the IRC 481(a) adjustment period is two taxable years unless the taxpayer meets one of the exceptions. See Rev. Proc. 2015-13, § 7.03(3)(b).

(1) A taxpayer who timely files for an accounting method change generally receives audit protection, which means that the Service will not require the taxpayer to change its method of accounting for the same item for a taxable year prior to the year of change. For example, a taxpayer has been using an impermissible method of accounting for advance payments for several years. In 2015, the taxpayer files an application under Rev. Proc. 2015-13 to change to a proper method of accounting for such payments. If the change has audit protection, the Service would not be able to propose an adjustment for the impermissible method of accounting for the advance payments in an examination of an earlier year. See Rev. Proc. 2015-13, § 8.01.

(2) There is no audit protection for years prior to the requested year of change in the following circumstances:

1. Form 3115 filed while under examination
   See IRM 4.11.6.6.3.1.

2. Change request lacking audit protection
   See IRM 4.11.6.6.3.2.

3. Change not made or made improperly
   See IRM 4.11.6.6.3.3.

4. Change in a sub-method of accounting
   See IRM 4.11.6.6.3.4(1).

5. CFC or 10/50 corporation
   See IRM 4.11.6.6.3.4(2).

6. Criminal investigation
   See IRM 4.11.6.6.3.4(3)

7. Issue under consideration.
   See IRM 4.11.6.6.3.4(4)

8. Prior year initiated change.
   See IRM 4.11.6.6.3.4(5)

(1) A taxpayer must implement any change in method of accounting requested under Rev. Proc. 2015-13 (or successors) pursuant to the terms and conditions of the revenue procedure in addition to either:

1. The automatic change provisions of Rev. Proc. 2019-43 (or successors) for the specific method change, or

2. A Consent Agreement issued by National Office of Chief Counsel (non-automatic change).

(2) IRC 481(a) adjustment period - The applicable number of taxable years that the taxpayer takes the 481(a) adjustment into account. See IRM 4.11.6.6.4.1.

(3) Changes within the LIFO method of accounting - In general, a taxpayer must implement a change within the LIFO inventory method of accounting on a cut-off basis. A change from one LIFO inventory method or sub method to another LIFO inventory method or sub method is a change within the LIFO inventory method of accounting.

(4) NOL carryback limitation for taxpayer subject to criminal investigation - A taxpayer subject to criminal investigation may not carry any portion of any net operating loss attributable to a negative IRC 481(a) adjustment back to a taxable year prior to the year of change that is the subject of any pending or future criminal investigation. See Rev. Proc. 2015-13, § 7.05.

(5) Maintenance of adequate records - The taxpayer must maintain accounting records for the year of change and subsequent taxable years to support the method of accounting for which it received consent.

(6) Additional terms and conditions apply in the following circumstances:

1. A change in method of accounting made on behalf of a CFC or a 10/50 corporation. See Rev. Proc. 2015-13, § 7.07.

2. A change in method of accounting of a domestic corporation, domestic partnership, or U.S. person that affects the amount of foreign source taxable income. See Rev. Proc. 2015-13, § 7.08.

3. A foreign partnership makes a change in method of accounting. See Rev. Proc. 2015-13, § 7.09.

(1) Issue under consideration is a relevant concept when a taxpayer, who is under examination, wishes to file for a voluntary method change under one of the following three exceptions found in Rev. Proc. 2015-13, § 8.02: three-month window, 120-day window, or new member of a consolidated group in the Compliance Assurance Process (CAP).

(2) In general, a taxpayer under examination who files for a method change is subject to limited terms and conditions and does not receive audit protection unless an exception applies. See IRM 4.11.6.6.3 and IRM 4.11.6.6.4. A taxpayer may not file under any of the three exceptions, above, if the item that is the subject of the method change request, is an issue under consideration.

(3) A taxpayer’s method of accounting for an item is an issue under consideration for the taxable years under examination if the examining agent(s) provides the taxpayer with written notification (for example, by examination plan, information document request (IDR), notification of proposed adjustment (NOPA) or income tax examination changes) specifically citing the treatment of the item as an issue under consideration. See Rev. Proc. 2015-13, § 3.08 for examples of an issue under consideration.

(4) If the Service does not propose an adjustment for an item that is an issue under consideration, the item continues to be an issue under consideration only if the issue is placed in suspense.

(5) An issue placed in suspense is included within the definition of an issue under consideration. An issue is placed in suspense, if by the date the examination ends, the Service provides the taxpayer with written notification that the IRS intends to examine the issue during the examination of the subsequent taxable year(s).

(6) Examiners may refer questions of whether a method of accounting is an issue under consideration to the National Office of Chief Counsel as a request for technical advice under the provisions of Rev. Proc. 2021-2 (or successors).

(1) Responsibilities for changes filed for a subsequent year - If a taxpayer under examination files a Form 3115, it must provide a copy of the Form 3115 to the examiner no later than the date the taxpayer timely files the Form 3115 (original or duplicate copy, whichever is earlier, in the case of an automatic change).

(2) When an examiner receives a copy of a Form 3115 from a taxpayer, the examiner should determine whether the taxpayer has audit protection for prior years. See IRM 4.11.6.6.3.

1. If the taxpayer has audit protection, the examiner cannot require the taxpayer to change its method of accounting for the same item for taxable years prior to the year of change.
   

2. If the taxpayer does not have audit protection, the examiner should consider changing the taxpayer’s method of accounting in the earliest year under examination.

(3) After the review of the Form 3115, the examiner may have questions or concerns with the request (e.g., Automatic change v. Non-Automatic change, Changing to an impermissible method).

1. The examiner should advise the taxpayer of the concern(s) and document the fact that the taxpayer was so advised.

2. The examiner should document the concerns in the historical file, or file an information report, so the concerns are considered upon examination of the method change in the year of change.

3. If the request was made pursuant to a non-automatic consent procedure, the examiner may contact the National Office of Chief Counsel attorney assigned to the request to discuss the concerns. Contact the Methods of Accounting and Timing Practice Network to coordinate with the assigned National Office of Chief Counsel attorney.

(4) Responsibilities for changes filed for a year under examination – An examiner should consider the following as potential areas of inquiry when examining a tax return in which a taxpayer has implemented a voluntary change in accounting method.

(5) Non-automatic method change:

• Was the ruling letter granting consent to the change followed?

• Is the method the taxpayer implemented consistent with the facts presented and the representations made in the consent agreement?

• Is the IRC 481(a) adjustment correct?

  Note: Exam may correct the IRC 481(a) adjustment without a Technical Advice Memorandum (TAM).

  Note: Exam may take into account the entire amount necessary to correct an IRC 481(a) adjustment in the earliest year of the IRC 481(a) adjustment period under examination. See Rev. Proc. 2015-13 , § 12.02(2).

• Exam may perfect the method change as an examination adjustment when deemed appropriate.

• A TAM is required to revoke or modify the ruling letter.

(6) Automatic method change:

• Did the taxpayer fully comply with the provisions in the voluntary method change procedure (Rev. Proc. 2015-13 or successors)?

• Is the method the taxpayer implemented consistent with the automatic method change provisions described in Rev. Proc. 2019-43 (or successors) for the designated change number?

  Note: If the method change is invalid, exam may raise an unauthorized method change issue.

• Is the IRC 481(a) adjustment correct?

  Note: Exam may correct the IRC 481(a) adjustment without a TAM.

  Note: Exam may take into account the entire amount necessary to correct an IRC 481(a) adjustment in the earliest year of the IRC 481(a) adjustment period under examination. See Rev. Proc. 2015-13, § 12.02(2).

• Exam may perfect the method change as an examination adjustment when deemed appropriate.

• A TAM is necessary if the taxpayer made the method change in compliance with the applicable procedures but the examiner wants to revoke or modify the method change.

(7) If Exam determines the taxpayer’s change in method of accounting does not comply with all applicable provisions, Rev. Proc. 2015-13, § 12.02 provides that the examiner may:

1. Make any adjustments (including the amount of any IRC 481(a) adjustment) to bring the change in method of accounting into compliance with all the applicable provisions,

2. Deny the change in method of accounting and place the taxpayer on a proper method of accounting, or

3. Deny the change in method of accounting and require the taxpayer to continue to use the prior method of accounting.

(1) Revenue Procedure 2002-18 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 4-24 and Delegation Order 4-25). This revenue procedure also does not alter or limit the authority of Appeals or Counsel for the government to resolve or settle any issues.

(1) Examiners face potential accounting method change issues in three situations:

1. The examiner determines that the taxpayer’s accounting method does not clearly reflect income or is improper - IRC 446(b) issue.

2. The taxpayer changed its method of accounting without obtaining the consent of the Commissioner - IRC 446(e) issue.

3. The taxpayer filed an amended return or claim (formal or informal) which constitutes a retroactive change in accounting method. - IRC 446(e) issue. See Rev. Rul. 90-38 .

(1) IRC 446(b) and 26 CFR 1.446-1(b)(1) provide that if a taxpayer does not regularly employ a method of accounting that clearly reflects income, the computation of taxable income must be made in the manner that, in the opinion of the Commissioner, does clearly reflect income. 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. Once the Commissioner has determined that a taxpayer's method of accounting does not clearly reflect income, the Commissioner has broad discretion in selecting a method of accounting, which properly reflects income. The taxpayer may challenge the selection only upon showing an abuse of discretion by the Commissioner. The Commissioner does not have discretion 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.

(2) Accordingly, the first determination that the examiner must make is whether the taxpayer’s adopted accounting method for an item is permissible. The examiner must first make a concerted effort to understand the taxpayer’s accounting method for the item(s) in question. This determination may entail having the taxpayer walk the examiner through transactions, journal entries, or other books and records. Generally, the examiner should verify examples of journal entries shown by the taxpayer based upon hypothetical data with actual transactional data including actual journal entries that are contained in the books and records. After the examiner acquires an understanding of the taxpayer's transactions and accounting method for items, the examiner needs to ascertain permissible accounting treatment(s) based upon the Service’s position.

(3) Generally, there are established Service positions as to what are proper methods of accounting for items. However, if the examiner is unable to ascertain the Service’s position or if there is no official Service position and the examiner believes there is an accounting method issue, the examiner may consider seeking advice (formal or informal) from local field counsel, the National Office of Chief Counsel subject matter experts, or the Methods of Accounting and Timing Practice Network.

(4) If the taxpayer’s accounting method for item(s) is impermissible, the examiner may propose an adjustment with respect to that method only by changing the taxpayer's method of accounting pursuant to Rev. Proc. 2002-18, in order to place the taxpayer on a proper method of accounting for such item(s).

(1) IRC 446(e) provides that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. 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 Service may change the taxpayer back to its former method in the taxable year the taxpayer changed without consent, or if the statute of limitations is closed for that year, in the earliest open year. 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, even where the statute of limitations has expired for the year of change. See Rev. Proc. 2002-18, § 2.06.

(2) While the examiner may allow an unauthorized method change, such action should only be an exception. The examiner, using professional judgment, should consider the following factors when applying the exception:

1. Benefit to taxpayer/Cost to government – The examiner should quantify the time-value-of-money benefit the taxpayer will receive by allowing the taxpayer's non-compliance with the consent requirements. Specifically, the examiner should determine the impact (including restricted interest computations) of not moving the year of change from the earliest year under examination to the current year. The supposition that the method change the taxpayer made without consent may have been granted if the taxpayer had complied with the consent requirements should not be a consideration.

2. Jurisdiction of oversight – The examiner should determine the proper procedure the taxpayer should have followed to implement the change, and what the taxpayer circumvented by making the unauthorized change. For example, if the taxpayer should have followed the non-automatic change provisions under Rev. Proc. 2015-13, the taxpayer would have paid a fee (e.g., $8,600) and received a ruling letter with terms and conditions specified by National Office of Chief Counsel. In addition, the taxpayer did not put the Service on notice that it made the method change, nor make representations regarding that change, by filing a Form 3115.

3. Utilization of resources – The examiner should analyze the impact on the examination for expending the time and resources required for the necessary compliance oversight of the unauthorized method change as opposed to other potential areas of examination.

4. Fairness to all – The examiner should consider the disparity that results if the taxpayer's unauthorized change in method of accounting is allowed while the similarly situated taxpayer not under examination must file a Form 3115 and make the change in a later year. In addition, the examiner should consider any negative impact on compliance that may result from the examiner's action. (Refer to Policy Statement 1-236 in IRM 1.2.1.2.36)

(3) The examiner should fully explain in the work papers the rationale for proposing or not proposing the unauthorized method change issue. If a change in method of accounting issue is not proposed, the examiner should confirm and document that the taxpayer treated all items in a manner that prevents the duplication or omission of items of income or deduction. If the unauthorized method change duplicates or omits income or deductions, the examiner should make adjustments to correct these items. The examiner should contact the Methods of Accounting and Timing Practice Network for assistance in addressing these arguments if necessary.

(1) Error correction or retroactive accounting method change? Often, during the conduct of an examination, the examining agent will encounter a claim (formal or informal) requesting an adjustment. The examiner should carefully review such claim to determine whether the claim constitutes:

1. The correction of an item that does not involve "timing"

2. A request for a retroactive change in method of accounting for a year under examination

(1) 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 and whether the taxpayer's method of accounting is permissible. The term "accounting method issue" means an issue addressing 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 26 CFR 1.446-1(e)(2) and Rev. Proc. 2002-18, § 2.01 and § 3.01.

(2) 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. Failure to recognize and properly treat an accounting method issue as a change in method of accounting can result in a permanent overstatement or understatement of a taxpayer's lifetime taxable income. See Rev. Proc. 2002-18, § 5.02

(3) 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. See Rev. Proc. 2002-18, § 5.03

(4) An examining agent changing a taxpayer's method of accounting will make the change in a year under examination. Ordinarily, the examiner will make the change in the earliest taxable year under examination, or, if later, the first taxable year the Service considers the method impermissible. However, in appropriate circumstances, an examining agent may defer the year of change to a later taxable year. See Rev. Proc. 2002-18 § 5.04(1). Deferring the year of change to reflect the hazards of litigation to a year later than the earliest year under examination is not appropriate.

(5) An examining agent changing a taxpayer's method of accounting ordinarily will impose an IRC 481(a) adjustment, subject to a computation of tax under IRC 481(b) (if applicable). See Exhibit 4.11.6-1 and Exhibit 4.11.6-2. 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 Rev. Proc. 2015-13 § 7.04, or a change in method of accounting for intercompany transactions (See 26 CFR 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., IRC 174. In addition, an examining agent may use a cut-off method to make a change in appropriate circumstances. See Rev. Proc. 2002-18 § 5.04(2). It is not appropriate for exam to impose a change in accounting method using a cut-off method to reflect the hazards of litigation.

(6) The IRC 481(a) adjustment, whether positive or negative, will be taken into account entirely in the year of change. See Rev. Proc. 2002-18, § 5.04(3).

(1) An examining agent changing a taxpayer's method of accounting will provide written notice that the Service is treating an accounting method issue as an accounting method change. Resolution of an accounting method issue without notice will not establish a new method of accounting. Written notice is a statement in the RAR that the Service is proposing a method change pursuant to IRC 446 and IRC 481. To implement a Service-imposed change in accounting method, Rev. Proc. 2002-18 provides that the taxpayer and the Service should execute a closing agreement under IRC 7121 in which the taxpayer agrees to the change and the terms and conditions of the change. A model closing agreement is included in the revenue procedure. A closing agreement is not mandatory and in actual practice, it is the exception and not the norm.

(2) The written notice must include:

1. A statement that the accounting method issue is being treated as an accounting method change or a clearly labeled IRC 481(a) adjustment

2. A description of the new method of accounting

(3) If the taxpayer and the Service execute a closing agreement, 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 IRC 6511 for the year of change or the date of a final court order requiring the change.

(4) 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 required IRC 481(a) adjustment), and any collateral adjustments to taxable income or tax liability resulting from the change.

(5) 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.