May 13, 2024

Government updates procedures to change R&D, income recognition, and inventory methods in new Rev. Proc. 2024-23

Anna Hargett, Kristen Martin, Ellen McElroy, Michael Resnick

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Eversheds Sutherland (US) LLP

On April 30, 2024, the Internal Revenue Service (IRS) released Rev. Proc. 2024-23, List of Automatic Changes, which provides the list of tax accounting method changes a taxpayer may file under the IRS’s automatic procedures, updating the prior list of automatic changes provided in Rev. Proc. 2023-24. Automatic accounting method changes may be filed with a taxpayer’s federal income tax return for the year of change, and as such, this new revenue procedure clarifies the availability of accounting method changes that taxpayers may implement on a 2023 federal income tax return.

This guidance (in conjunction with Rev. Proc. 2015-13) sets forth the specific procedures, including terms and conditions, for each automatic change. In addition to general maintenance, including striking now-obsolete terms and conditions that were included in the predecessor list of automatic changes, Rev. Proc. 2024-23 modifies the new automatic changes provided in Rev. Proc. 2024-9 with regard to the treatment of section 174 expenditures, removes changes to certain uniform capitalization methods under section 263A from eligibility for automatic consent, and clarifies the scope and application of automatic method changes under section 451.

Background

Under section 446(e), a taxpayer must obtain IRS consent prior to changing a tax method of accounting, whether the change concerns an overall plan of accounting for income or deductions (e.g., cash to accrual) or the change in treatment of a material item used in such overall plan (e.g., depreciation). IRS review of the proposed accounting method change aims to ensure a taxpayer’s chosen method is proper and clearly reflects income. To facilitate this approval process, the IRS determines certain accounting method changes that are eligible for automatic consent, and publishes its list of automatic changes in a periodically-updated revenue procedure. Rev. Proc. 2024-23 is the most recent update to this list of automatic changes, making twenty-one significant modifications to its predecessor, Rev. Proc. 2023-24.

Pursuant to Rev. Proc. 2015-13, which provides the general procedures for both automatic and non-automatic method changes, a taxpayer applies for automatic consent by including an original Form 3115, Application for Change in Accounting Method, with its federal income tax return for the year of the change and filing a duplicate copy of the Form 3115 with the IRS in Ogden, Utah. IRS consent is then deemed granted provided that the taxpayer has complied with all applicable consent procedures provided in Rev. Proc. 2015-13, as well as all applicable terms and conditions for the particular automatic change described in Rev. Proc. 2024-23 (or successor revenue procedure).

Transition rules and general housekeeping

Revenue Procedure 2024-23 is effective for all Forms 3115 filed on or after April 30, 2024, for a year of change ending on or after September 30, 2023. With regard to method changes that qualify for automatic consent under both Rev. Proc. 2024-23 and Rev. Proc. 2023-24, a transition rule is available for taxpayers that have already filed the requisite duplicate copy under Rev. Proc. 2023-24 with the IRS in Ogden, Utah, but have not yet filed the corresponding original Form 3115 with a timely filed federal income tax return. The transition rule offers flexibility, permitting taxpayers either to perfect previously filed documents pursuant to Rev. Proc. 2023-24 or to file a new Form 3115 pursuant to the provisions of Rev. Proc. 2024-23. Transition rules are also available for taxpayers that have filed 2023 non-automatic method change requests that now qualify for automatic procedures under Rev. Proc. 2024-23 and for taxpayers that have filed 2023 automatic method change requests under Rev. Proc. 2023-24 that no longer qualify for automatic procedures.

Eversheds Sutherland Observation: The majority of the twenty-one listed significant changes in Rev. Proc. 2024-23 reflect deletions of provisions that are now obsolete (e.g., limited-time waivers of the five-year previous change rule to promote compliance with new provisions). That said, a careful review of the new revenue procedure is merited by companies planning to file method changes with their 2023 federal income tax returns, as some of the touted “significant changes” are just that, and may impact a company’s ability to make certain changes for the 2023 year. We discuss these more significant changes in detail below.

Section 174

The updated guidance incorporates new automatic changes for taxpayers seeking to comply with section 174, including reliance on certain provisions of Notice 2023-63 as modified by Notice 2024-12. These updates largely follow the automatic change procedures provided in Rev. Proc. 2024-9, with two notable changes. The government revised section 7.01 of the revenue procedure to eliminate designated change number (DCN) 270, permitting all automatic changes to comply with section 174, including reliance on certain provisions of Notice 2023-63 as modified by Notice 2024-12, to be filed under DCN 265.

Eversheds Sutherland Observation: The elimination of DCN 270 should ameliorate taxpayer concerns under prior procedural guidance regarding identifying the proper DCN for changes in method of accounting under section 174. Publicly, the government had indicated there was no intent behind the use of two separate DCNs other than for reporting purposes and data collection.

More significantly, the revenue procedure also waives the final year of the trade or business eligibility requirement for automatic changes to comply with section 174, and extends the five year prior change waiver to include changes made in a taxpayer’s first or second year beginning after December 31, 2021. In order to receive audit protection in conjunction with a DCN 265, a taxpayer must have already filed an accounting method change to comply with section 174, as modified by the Tax Cuts and Jobs Act. A taxpayer that did not file a method change to comply with section 174 for the first taxable year beginning after December 31, 2021, does not receive audit protection. Section 7.01(9) provides that the consent granted for DCN 265 is not a determination, nor does it create any presumption, that the new method of accounting is permissible.

Eversheds Sutherland Observation: Because the government has not yet issued definitive guidance under section 174, it seems unduly harsh to restrict audit protection and to provide no presumption of permissibility with regard to a method of accounting in this revenue procedure. Considering the lingering uncertainty with respect to application of section 174, practitioners and taxpayers alike hoped the revenue procedure would be more permissive. Instead, the revenue procedure suggests taxpayers that did not file an earlier method change while awaiting definitive guidance may be subject to future examination activity with respect to section 174 methods.

Section 263A

Modifications to the automatic changes related to uniform capitalization under section 263A limit flexibility with respect to inventory methods. Specifically, the new list of automatic changes removes automatic consent eligibility for taxpayers making a change to or from the direct reallocation method or the step allocation method. It also removes automatic consent for a change to or from applying the 90/10 de minimis rule for taxpayers using a direct reallocation or step allocation method.

Eversheds Sutherland Observation: While not entirely unexpected, the result is reduced flexibility and more burdensome compliance for taxpayers. This result seems odd in light of the Congressional intent, as indicated in the legislative history to section 263A, to adopt a “liberal approach” and “provide a large measure of flexibility to taxpayers in allocating indirect costs” for purposes of section 263A.¹ Companies considering inventory method changes should exercise caution and ensure they properly abide by the non-automatic method change procedures. Because these changes are no longer permitted under automatic procedures, taxpayers that planned to file a Form 3115 for such change(s) with their 2023 returns this fall missed an opportunity to make the change for the 2023 tax year. Non-automatic changes for the 2023 year must have been filed by December 31, 2023.

Section 451

Automatic changes available under section 16.08 of Rev. Proc. 2024-23 to comply with section 451(b) or (c) now explicitly exclude a taxpayer seeking to comply with the all events test under Treas. Reg. section 1.451-1(a). The revision makes clear that a change to comply generally with the all events test, separate and apart from the AFS Income Inclusion Rule under Treas. Reg. section 1.451-3, is not available using automatic consent procedures. Additionally, Rev. Proc. 2024-23 provides that cost-offset related inventory method changes under section 451 must be implemented before any concurrent cost offset changes.

Eversheds Sutherland Observation: At the recent ABA Tax Section May Meeting, Heather Harman, Tax Policy Advisor, US Department of the Treasury, suggested the flip in ordering of the cost-offset related inventory changes was intended to help ease the administrative burden of taxpayers changing to comply with section 451 by simplifying the computations required under section 481(a).

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₁_{S. Rep. No. 99-313, 99th Cong., 2d Sess. 144 (1986).}

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.