Final Regs Provide Rules for Limitation on Use of Cash Method of Accounting

 [4830-01-u]

 ACTION: Final and temporary regulations.

 SUMMARY: This document contains final regulations under section 448 of the Internal Revenue Code of 1986 (the Code) relating to the limitation on the use of the cash receipts and disbursements method of accounting (cash method). The final regulations provide procedures for requesting the Commissioner's approval of an accounting method change required by section 448 and provide guidance concerning the adjustment to taxable income under section 481(a) required by the method change. Changes to the applicable law were made by the Tax Reform Act of 1986.

 DATES: The regulations are effective December 27, 1993.

 For dates of applicability of these regulations, see section 1.448-1(i) of the regulations.

 FOR FURTHER INFORMATION CONTACT: Michael L. Gompertz, 202-622-4910, not a toll-free call.

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act (44 U.S.C. 3504(h)) under control number 1545-0152. This collection of information consists solely of the required filing of Form 3115, Application for Change in Accounting Method. The estimated average annual burden per respondent is 58 hours.

 This estimate is an approximation of the average time expected to be necessary for a collection of information. It is based on such information as is available to the Internal Revenue Service. Individual respondents may require more or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer PC:FP, Washington, D.C. 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503.

 On June 16, 1987, the Internal Revenue Service published in the Federal Register (52 FR 22764) section 1.448-1T of the temporary Income Tax Regulations as T.D. 8143 in response to the enactment of section 448 of the Code by section 801(a) of the Tax Reform Act of 1986 (Pub. L. No. 99-514, 100 Stat. 2345). A notice of proposed rulemaking by cross-reference to the temporary regulations was published in the Federal Register (52 FR 22795) on June 16, 1987 (the 1987 regulations). Several comments on the 1987 regulations were received concerning section 1.448-1T(g), relating to the treatment of an accounting method change required by section 448 and the timing rules for the section 481(a) adjustment, section 1.448-1T(h), relating to the procedures for making a change from the cash method required by section 448, and section 1.448-1T(i), relating to the effective date of section 448. However, a public hearing on section 1.448-1T(g), (h), and (i) was neither requested nor held.

 On January 7, 1991, amendments to paragraphs (g) and (h) of section 1.448-1T were published in the Federal Register (56 FR 484) as T.D. 8329 (the 1991 regulations). A corresponding notice of proposed rulemaking was also published in the Federal Register (56 FR 508) of January 7, 1991. No comments were received on the 1991 regulations, and a public hearing was not requested.

 Under section 7805(e), the 1991 regulations expire within three years after their issuance. To provide continuing guidance concerning accounting method changes required by section 448, this document adopts, with modifications, section 1.448-1T(g), (h), and (i) as final regulations.

EXPLANATION OF PROVISIONS AND DISCUSSION OF PUBLIC COMMENTS

 Section 448 of the Code generally prohibits the use of the cash method by C corporations, partnerships with a C corporation partner, and tax shelters. In general, section 448 is effective for taxable years beginning after December 31, 1986.

 Paragraphs (g) and (h) of section 1.448-1 of the regulations provide procedures for making a change from the cash method required by section 448 and provide guidance concerning the adjustment to taxable income required by section 481(a). The procedures a taxpayer must follow differ depending on whether the change from the cash method is timely or untimely and whether the change is to an overall accrual method or to a method other than an overall accrual method (a special or hybrid method).

TIMELY CHANGE FROM THE CASH METHOD

 A timely change to an overall accrual method is accomplished by attaching a current Form 3115 to a timely filed income tax return (including extensions) for the first taxable year in which the taxpayer is subject to section 448. The taxpayer must type or legibly print at the top of page 1 of Form 3115: "Automatic Change to Accrual Method--Section 448." In addition, the taxpayer must attach a statement to Form 3115 setting forth the period over which the section 481(a) adjustment will be taken into account and the basis for that conclusion. A taxpayer that follows these procedures has the Commissioner's consent to the change in method of accounting.

 A timely change to a special or hybrid method is generally accomplished by submitting Form 3115 to the appropriate office of the Internal Revenue Service by the due date prescribed in the applicable administrative procedure. (Under Rev. Proc. 92-20, 1992-1 C.B. 685, which is the current applicable administrative procedure, Form 3115 generally must be filed with the National Office of the Internal Revenue Service within 180 days after the beginning of the year of change.) However, under a special rule, Form 3115 may be submitted to the National Office on or before 30 days after the close of the first taxable year in which the taxpayer is subject to section 448 if the events or circumstances precluding continued use of the cash method occur after the 180th day of the taxable year. See section 1.448-1T(h)(3)(i) and (4)(ii). The taxpayer must type or legibly print at the top of page 1 of Form 3115: "Change to a Special Method of Accounting -- Section 448."

 A commentator recommended that the deadline for submitting Form 3115 under this special rule be changed from 30 days after year end to 90 days after year end. The Internal Revenue Service and the Treasury Department believe that an extension of the filing deadline is not warranted because section 1.448-1T(h)(4)(ii) already provides a deadline for filing Form 3115 later than the generally applicable deadline established by section 1.446-1(e)(3)(i), under which Form 3115 must be submitted within 180 days after the beginning of the taxable year. Also, a taxpayer that has missed the 30-day deadline is eligible to request relief under section 301.9100-1 of the Regulations on Procedure and Administration. Thus, there is no need to extend the deadline.

 In general, a taxpayer that makes a timely change from the cash method generally takes the section 481(a) adjustment into account ratably (beginning with the year of the change) over the shorter of (a) four taxable years or (b) the number of taxable years the taxpayer used the cash method. A hospital that makes a timely change generally takes the section 481(a) adjustment into account ratably (beginning with the year of the change) over 10 years. The final regulations define hospital in a manner essentially identical to the definition in the temporary regulations. However, a slight change in the language of the regulations was required because the name of the organization that accredits hospitals has been changed from the Joint Commission of Accreditation of Hospitals (JCAH) to the Joint Commission on Accreditation of Healthcare Organizations (JCAHO).

 A commentator suggested that all taxpayers, not only cooperatives described in section 1381(a), should have the option of taking into account a positive section 481(a) adjustment entirely in the year of the change from the cash method. However, this suggestion is not consistent with the legislative history of section 448, which indicates that the rules of Rev. Proc. 84-74, 1984-2 C.B. 736, are generally used to determine the timing of a section 481(a) adjustment. See H.R. Conf. Rep. 841, 99th Cong., 2d Sess. II-288, 289 (1986). Rev. Proc. 84-74 (which was subsequently superseded by Rev. Proc. 92-20) did not generally permit taxpayers to elect to take a positive section 481(a) adjustment into account entirely in the year of change. Accordingly, this comment has not been adopted. However, the final regulations permit taxpayers to elect to use a shorter adjustment period than would otherwise be allowed if the entire net section 481(a) adjustment (whether positive or negative) is a de minimis amount as determined under the applicable administrative procedure issued under section 1.446-1(e)(3)(ii) for obtaining the Commissioner's consent to a change in accounting method (currently, Rev. Proc. 92-20). See section 8.01(1) of Rev. Proc. 92-20 allowing taxpayers to elect a one-year adjustment period if the adjustment is de minimis (less than $25,000).

 The temporary regulations require a taxpayer which ceases to engage in the trade or business to which the section 481(a) adjustment relates before the end of the maximum four-year adjustment period (or, in the case of a hospital, the 10-year adjustment period) to take into account the balance of that section 481(a) adjustment in the year of cessation. However, the acceleration of the section 481(a) adjustment required by the cessation of trade or business rule does not apply if the taxpayer is acquired in a section 381 transaction, and the acquiring corporation continues to engage in the trade or business to which the section 481(a) adjustment relates.

 The final regulations clarify that a taxpayer that terminates its existence ceases to engage in the trade or business. The final regulations also replace the rule concerning cessation of trade or business in a section 381 transaction with the rules concerning cessation of the trade or business set forth in the applicable administrative procedure issued under section 1.446-1(e)(3)(ii) for obtaining the Commissioner's consent to a change in accounting method (currently, Rev. Proc. 92-20). See section 8.03(2) of Rev. Proc. 92-20.

UNTIMELY CHANGE FROM THE CASH METHOD

 The final regulations provide that a taxpayer making an untimely change from the cash method must satisfy the general method change requirements of section 1.446-1(e)(3) (including any applicable administrative procedure that is prescribed under the authority of section 1.446-1(e)(3)(ii) after January 7, 1991, specifically for purposes of complying with section 448). Absent the publication of an administrative procedure that is prescribed under section 1.446-1(e)(3) specifically addressing compliance with section 448, a taxpayer making an untimely change must request a change under section 1.446-1(e)(3) subject to any terms and conditions (including the year of change) as may be imposed by the Commissioner. The final regulations delete the provisions in the 1991 regulations that a taxpayer making an untimely change from the cash method by filing Form 3115 after January 7, 1991, is generally subject to terms and conditions (including the year of change) designed to place the taxpayer in a position no more favorable than a taxpayer that timely complied with section 448. Under the final regulations, unless an administrative procedure is published specifically concerning method changes under section 448, a taxpayer subject to section 448 which makes an untimely method change under section 448 will, in general, be subject to the terms and conditions (including the year of change) applicable to a Category A method of accounting as set forth in Rev. Proc. 92-20 (or any successor revenue procedure).

EFFECTIVE DATE RULES OF SECTION 448

 A comment letter on the 1987 regulations suggested that section 1.448-1T(i), relating to the effective date of section 448, be modified to reflect the provisions of section 801(d)(3) of the Tax Reform Act of 1986. This suggestion has been adopted through the addition of paragraph (i)(3) to section 1.448-1 of the regulations.

 The final regulations also provide a transitional rule for section 1.448-1(g), relating to the treatment of an accounting method change required by section 448 and the timing rules for the section 481(a) adjustment, and section 1.448-1(h), relating to the procedures for making a change from the cash method required by section 448. Under this transitional rule, section 1.448-1(g) and (h) will not be adversely applied with respect to transactions entered into by the taxpayer before December 27, 1993 to the extent the provisions of section 1.448-1(g) and (h) were not reflected in section 1.448-1T (g) and (h).

SPECIAL ANALYSES

 It has been determined that these regulations are not a significant regulatory action as defined in Executive Order 12866. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking published in the Federal Register on January 7, 1991 (56 FR 508) was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on the impact of the notice on small business.

DRAFTING INFORMATION

 The principal author of these regulations is James A. Orefice, formerly of the Office of Assistant Chief Counsel (Income Tax and Accounting), Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR Part 1

 Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

 Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for Part 1 continues to read in part:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Section 1.448-1 is added, and paragraphs (a) through (f) thereof are reserved.

Par. 3. Paragraphs (g), (h), and (i) of section 1.448-1T are redesignated as paragraphs (g), (h), and (i) of section 1.448-1 and are amended as follows:

1. Paragraph (g)(2)(ii)(B)(1) is amended by removing the language "Joint Commission of Accreditation of Hospitals" and adding in its place the language "Joint Commission on Accreditation of Healthcare Organizations or its predecessor" and by removing the language "JCAH" wherever it appears in that paragraph and adding in its place the language "JCAHO".

2. Paragraph (g)(2)(iii) is amended by removing the language "section 1.466-1(e)(3)" from the second sentence and adding in its place the language "section 1.446-1(e)(3)" and by removing the last sentence in that paragraph.

3. Paragraph (g)(3)(i) is amended by removing the language "(g)(3)(ii)" from the last sentence and adding in its place the language "(g)(2)(ii)".

4. Paragraph (g)(3)(iii) is revised.

5. Paragraph (g)(3)(iv) is added.

6. Paragraph (g)(5) is amended by removing the language "488" wherever it appears in the first and second sentences and adding in its place the language "448" and by removing the language "chosing" in the last sentence and adding in its place the language "choosing".

7. Paragraph (h)(4)(ii) is redesignated as paragraph (h)(3)(ii).

8. Paragraph (h)(4) is amended by removing the last sentence.

9. Paragraph (i)(1) and the third sentence of paragraph (i)(2)(i) are revised.

10. Paragraphs (i)(3) and (i)(4) are added.

11. The reserved, revised, and added provisions read as follows:

SECTION 1.448-1 LIMITATION ON THE USE OF THE CASH RECEIPTS AND DISBURSEMENTS METHOD OF ACCOUNTING.

(a) through (f). [Reserved]

(g) * * *

(3) * * *

(iii) CESSATION OF TRADE OR BUSINESS. If the taxpayer ceases to engage in the trade or business to which the section 481(a) adjustment relates, or if the taxpayer operating the trade or business terminates existence, and such cessation or termination occurs prior to the expiration of the adjustment period described in paragraph (g)(2)(i) or (ii) of this section, the taxpayer must take into account, in the taxable year of such cessation or termination, the balance of the adjustment not previously taken into account in computing taxable income. For purposes of this paragraph (g)(3)(iii), the determination as to whether a taxpayer has ceased to engage in the trade or business to which the section 481(a) adjustment relates, or has terminated its existence, is to be made under the principles of section 1.446-1(e)(3)(ii) and its underlying administrative procedures.

(iv) DE MINIMIS RULE FOR A TAXPAYER OTHER THAN A COOPERATIVE. Notwithstanding paragraph (g)(2)(i) and (ii) of this section, a taxpayer other than a cooperative (within the meaning of section 1381(a)) that is required to change from the cash method by this section may elect to use, in lieu of the adjustment period described in paragraph (g)(2)(i) and (ii) of this section, the adjustment period for de minimis section 481(a) adjustments provided in the applicable administrative procedure issued under section 1.446-1(e)(3)(ii) for obtaining the Commissioner's consent to a change in accounting method. A taxpayer may make an election under this paragraph (g)(3)(iv) only if --

(A) The taxpayer's entire net section 481(a) adjustment (whether positive or negative) is a de minimis amount as determined under the applicable administrative procedure issued under section 1.446-1(e)(3)(ii) for obtaining the Commissioner's consent to a change in accounting method,

(B) The taxpayer complies with the provisions of paragraph (h)(2) or (3) of this section for its first section 448 year,

(C) The return for such year is due (determined with regard to extensions) after December 27, 1993, and

(D) The taxpayer complies with any applicable instructions to Form 3115 that specify the manner of electing the adjustment period for de minimis section 481(a) adjustments.

* * * * *

(i) EFFECTIVE DATE -- (1) IN GENERAL. Except as provided in paragraph (i)(2), (3), and (4) of this section, this section applies to any taxable year beginning after December 31, 1986.

(2) ELECTION OUT OF SECTION 448 -- (i) IN GENERAL. * * * For rules relating to the making of such election, see section 301.9100- 7T (temporary regulations relating to elections under the Tax Reform Act of 1986). * * *

* * * * *

(3) CERTAIN CONTRACTS ENTERED INTO BEFORE SEPTEMBER 25, 1985. This section does not apply to a contract for the acquisition or transfer of real property or a contract for services related to the acquisition or development of real property if --

(i) The contract was entered into before September 25, 1985; and

(ii) The sole element of the contract which was not performed as of September 25, 1985, was payment for such property or services.

(4) TRANSITIONAL RULE FOR PARAGRAPHS (g) AND (h) OF THIS SECTION. To the extent the provisions of paragraphs (g) and (h) of this section were not reflected in paragraphs (g) and (h) of section 1.448-1T (as set forth in 26 CFR Part 1 as revised on April 1, 1993), paragraphs (g) and (h) of this section will not be adversely applied to a taxpayer with respect to transactions entered into before December 27, 1993.

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 4. The authority citation for Part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 5. Section 602.101(c) is amended by adding an entry to the table to read as follows: "section 1.448-1(g), (h), and (i) . . . . . . . . 1545-0152."

Par. 6. Section 602.101(c) is further amended by removing all entries in the table for section 1.448-1T.