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Washington Tax Alert November 11, 2015 (accounting method changes in connection with acquisitions)

Washington Tax Alert from Don Barnes, dbarnes@washingtontaxlaw.com

November 11, 2015

The current accounting method change procedure, Rev. Proc. 2015-13, contains a new provision that may be useful to taxpayers making certain acquisitions of corporate stock or assets, or acquisitions of partnership interests. This new provision was not in the prior administrative procedures.

In course of investigating a potential acquisition of corporate stock or assets or an interest in a partnership, the acquiring taxpayer may discover that the target company has been using an improper accounting method which, if subsequently corrected or discovered on examination by the IRS, would result in an unfavorable IRC § 481 adjustment. The target company will have an unfavorable or positive IRC § 481 adjustment if it has been using an accounting method that understates income or overstates deductions for tax purposes.

Prior to Rev. Proc. 2015-13, if an acquiring taxpayer determined that the target company has been using an improper accounting method that would result in an unfavorable IRC § 481 adjustment if corrected, the acquiring taxpayer would obtain an adjustment to the purchase price, or an indemnity from the selling parties to protect against the potential tax liability associated with the improper accounting method.

Under Rev. Proc. 2015-13, the target company can change its improper accounting methods, either under the automatic consent provisions or with the National Office's advance consent, and elect to take the entire positive IRC § 481 adjustment into account in the year of change if the target company is the subject of an "eligible" acquisition transaction during the year of change or in the subsequent taxable year on or before the extended due date for filing the target company's Federal income tax return for the year of change. Rev. Proc. 2015-13, § 7.03(3)(d)(i). If the target company makes this election, the target company will bear the entire tax liability associated with its improper accounting methods.

In order to make the new election permitted by Rev. Proc. 2015-13, § 7.03(3)(d)(i), the target company must be the subject of an eligible acquisition. An eligible acquisition includes the following:

  • Acquisition of stock in a C corporation which results in the acquiring taxpayer owning at least 50.1% of the corporation's stock.
  • Acquisition of any amount of stock in an S corporation as long as the acquisition does not cause the S corporation to cease to exist for Federal income tax purposes.
  • Acquisition of an interest in a partnership that does not result in a constructive termination of the partnership under IRC § 708(b)(1)(B), such as an acquisition of less than a 50% interest in partnership capital and profits.
  • Acquisition of stock in a corporation that results in the target corporation leaving an affiliated group filing a consolidated tax return.
  • Acquisition of stock in a corporation that results in the target corporation becoming a member of an affiliated group filing a consolidated tax return.
  • Acquisition of the assets of a corporation in a reorganization transaction described in IRC §§ 368(a)(1)(A), (C), (D), (F) or (G), or in a corporate liquidation under IRC § 332.

Because an accounting method change may not be made in the final year of the trade or business to which the change in accounting method relates (except if the final year of the trade or business results from an IRC § 381(a) transaction), the target company generally will be required to file Forms 3115 for the taxable year preceding the year in which the eligible acquisition takes place if the target company ceases to engage in its trade or business in the year of the eligible acquisition.

Law Offices of Donald A. Barnes, PLLC
818 Connecticut Avenue, N.W.
Suite 1200
Washington, DC 20006
Telephone: (202) 728-4407
Cell: (202) 360-0275
E-Mail: dbarnes@washingtontaxlaw.com
Website: www.washingtontaxlaw.com