Washington Tax Alert August 14, 2006

The Service recently issued new instructions for Form 3115 (Application for Change in Accounting Method). There are now 103 changes in accounting method that can be made automatically. These automatic changes include changes that are listed in the Appendix to Rev. Proc. 2002-9, as well as automatic changes permitted under other guidance issued by the Service.

In an important technical advice memorandum published today ( see TAM 200631029), the National Office retroactively revoked a consent to a change in accounting method that had been granted to a national retailer of brand name merchandise. The retailer had requested permission to use the simplified resale method under the IRC § 263A regulations. The National Office approved the change. Subsequently, during an examination of the taxpayer’s tax return for the year of change, the examining agents took the position that the consent to use the new accounting method should be revoked because the taxpayer had failed to disclose all material information in its Form 3115. The National Office agreed with the examining agents and revoked its consent to use the new method of accounting. Taxpayers filing Forms 3115 have an obligation to provide all information necessary for the National Office to make a determination as to the taxpayer’s eligibility for a requested accounting method change. In particular, question 19 on the current Form 3115, which asks for “a full explanation of the legal basis supporting the proposed method” (italics added), should be answered completely.

The Form 3115 that was revoked in TAM 200631029 appears to have been prepared by one of the Big 4 accounting firms. Historically, some practitioners have completed Forms 3115 generally, not disclosed all relevant facts, and failed to articulate fully their legal rationale for the requested accounting method change. Forms 3115 completed in that manner, even if initially approved, are increasingly at risk of being challenged by the Service on examination.