Section 446(e) requires a taxpayer to obtain IRS consent prior to changing its accounting method. A change in method of accounting may include either a change in an overall plan of accounting for gross income or deductions (i.e., a change from the cash method of accounting to an accrual method) or a change in the treatment of any material item used in such overall plan (e.g., a change in the taxpayer’s depreciation method). IRS consent is required because such a change affects when items or income and expense are recognized. Also, IRS review of the proposed accounting method change ensures that the taxpayer’s chosen method is proper and that it clearly reflects income.

To facilitate this approval process, the IRS grants automatic consent for certain accounting method changes. Regularly, the IRS identifies the specific accounting method changes eligible for automatic consent. A taxpayer applies for an automatic consent by including an original Form 3115 (Application for Change in Accounting Method) with the taxpayer’s federal income tax return for the year of the change; a duplicate copy is also required to be filed with IRS in Ogden, UT. IRS consent is granted provided the taxpayer complies with all the applicable provisions of the consent procedures.

On January 31, 2022, the IRS released the latest update to the list of accounting method changes that are available automatically, Rev. Proc. 2022-14. This guidance also sets forth the specific procedures, including terms and conditions, for each automatic change. Although the list of automatic method changes is generally updated annually, due to the impact of the COVID-19 pandemic, this update took the government several years to get across the finish line. The new guidance highlights 22 significant modifications, reflecting substantive guidance that has been published to address TCJA provisions, ramifications from the CARES Act, and recently released final regulations. In addition to cleaning up its predecessor, Rev. Proc. 2019-43, and striking terms and conditions for certain accounting method changes that are now obsolete, Rev. Proc. 2022-14 provides a number of modifications for taxpayers seeking to file automatic accounting method changes to comply with Section 451(b) and (c), as well as changes involving depreciation and UNICAP. This alert provides an overview of the more significant changes made in Rev. Proc. 2022-14 to the list of automatic accounting method changes.

General transition rule

Certain taxpayers have already filed the requisite copies of the Form 3115 for the 2021 tax year even though an original Form 3115 has not yet been filed because the taxpayer has not filed its 2021 federal income tax return. As part of the new procedural requirements for automatic accounting method changes, Rev. Proc. 2022-14 offers flexibility to such taxpayers allowing them to either perfect previously filed documents (filed pursuant to Rev. Proc. 2019-43) or file a new Form 3115 pursuant to the provisions of Rev. Proc. 2022-14. If the previous filing remains unchanged, the taxpayer may file the original Form 3115 with a 2021 Federal income tax return following the procedures of Rev. Proc. 2019-43. Alternatively, these taxpayers are permitted to file a new Form 3115 following the terms and conditions set forth in Rev. Proc. 2022-14. Under the latter approach, a taxpayer will be able to file under the new terms and conditions of Rev. Proc. 2022-14, but will be required to file a new duplicate copy, alerting the IRS of the decision to file the accounting method change under the new guidance.

Income recognition clarifications

As a result of the TCJA enactment of Sections 451(b) and (c), many taxpayers are now required to change the time when income is recognized. Following the publication of final regulations under Section 451(b) and (c), the IRS released Rev. Proc. 2021-34, which provides accounting method change guidance for taxpayers seeking to comply with these final regulations. However, taxpayers and practitioners noted that a number of issues had not been addressed and for this reason, Rev. Proc. 2022-14 provides both clarifying and modifying guidance for such accounting method changes. In this regard Rev. Proc. 2022-14 is more beneficial in certain respects and more restrictive in others.

For example, the government clarified that the five-year limitation provided in Section 5.01(1)(f) of Rev. Proc. 2015-13 does not apply to certain changes in methods of accounting involving Sections 451(b) and (c). Section 5.01(1)(f) provides that a taxpayer is able to make a change in method of accounting under the automatic change procedures only if the taxpayer has not made or requested a change for the same item during any of the five taxable years ending with the year of change. However, the government recognizes that certain taxpayers have already filed accounting method changes to comply with section 451 and these taxpayers may file a second accounting method change in accordance with the final regulations under section 451, which would otherwise be prohibited by the five-year limitation. Rev. Proc. 2022-14 specifies that the five year limitation is inapplicable to changes to the AFS income inclusion method (a change to recognize income no later than the taxpayer’s book method rather than per the all events test pre-TCJA); the Alternative AFS revenue method; a method to comply with the transaction price allocation rules in final Treas. Reg. §1.451-3(d); or, methods to address mismatched reportable accounting periods. It is important to note that the exclusion from the five-year rule is limited to accounting method changes for which the requisite Section 481(a) adjustment is zero. The same benefit is afforded to advance payment changes to the Full Inclusion Method, Deferral Method, Specific Goods Section 451(c) Method provided under the final regulations as well. The government did not extend this waiver of the five-year limitation to any of the automatic changes involving cost offsets, although such omission may be without consequence as it would be highly unlikely that changing to any of the cost offset methods provided in the final regulations would result in a zero Section 481(a) adjustment.

Although the revenue procedure excluded certain changes from the limitations of the five-year rule, it is much less generous in how the five-year rule should be applied in other instances. Specifically, an example regarding cost-offset inventory method changes was added to Section 16.10(5)(f) of Rev. Proc. 2022-14. This addition will likely frustrate taxpayers seeking to change to a cost offset method subsequent to a previously-filed change to comply with the final Section 451 regulations generally. Most taxpayers and practitioners view the cost offset methods as optional sub-methods and that taxpayers shouldn’t otherwise be precluded by the five-year limitation from changing to the cost offset method subsequent to an initial Section 451 method change. That is, because it is a sub-method, a subsequent change is not a change involving the same item. However, this example indicates otherwise. As such, this strict application of the five-year limitation means that any taxpayer, which has already made an accounting method change to comply with Section 451(b) or (c), is prohibited from making a subsequent cost offset accounting method change.

Additionally, Rev. Proc. 2022-14 confirmed that a taxpayer seeking to change to the Full Inclusion Method under proposed Treas. Reg. §1.451-8(a) is not permitted to make the change on a cut-off basis (that is, without any Section 481(a) adjustment). Although the proposed regulations permitted flexibility regarding the Section 481(a) adjustment, Rev. Proc. 2022-14 makes clear that such flexibility is no longer available.

Depreciation updates

In addition to removing a number of terms and conditions related to certain depreciation method changes that are now obsolete, Rev. Proc. 2022-14 provides a number of clarifications to existing changes. For example, Rev. Proc. 2022-14 clarified the waiver of the five-year limitation for certain late elections or revocations of elections under Sections 168(k)(5), (7) and (10) applies for a taxpayer’s first, second, or third taxable year succeeding the taxpayer’s taxable year beginning in 2016 or 2017 and ending on or after September 28, 2017. In earlier guidance, the specific timing of the five-year limitation waiver was unclear, and in response to taxpayer comments and concerns, the IRS and Treasury provided this clarification.

Additionally, the timing, scope and form of certain method changes involving 1-year property were clarified. One-year property is generally bonus-eligible property that has been in service for only one year. To the extent a taxpayer has 1-year property and seeks to change from an impermissible depreciation method to a permissible method (i.e., failing to claim bonus depreciation and seeking to claiming bonus depreciation), the change can be made with an amended return or AAR, as long as it is filed prior to the date the taxpayer files its return for the tax year immediately following the 1-year property’s placed-in-service year. Rev. Proc. 2022-14 also provides that if 1-year property is within scope of Rev. Proc. 2020-50, the procedural guidance issued to assist taxpayers in complying with the final regulations issued under 168(k), the taxpayer may file an amended return or AAR in accordance with the requirements of Rev. Proc. 2020-50. Similarly, taxpayers had requested a waiver of the five-year limitation for certain elections under Sections 168(k)(5), (7) and (10) involving 1-year property, which Rev. Proc. 2022-14 addressed.

In one of the more favorable modifications to the depreciation method changes, Rev. Proc. 2022-14 also clarified the level of detail required for Section 481(a) adjustments resulting from depreciation method changes made by CFCs when calculating their global intangible low-taxed income (GILTI) liabilities. Specifically, if any Section 481(a) adjustment (or component of a Section 481(a) adjustment) filed under Section 6.22 shares the same characteristics as any other Section 481(a) adjustment (or component) from a change under the same section, then only a single Section 481(a) adjustment is required. To the extent, any Section 481(a) adjustments do not share the same characteristics, then separate Section 481(a) adjustments are required. A seemingly minor tweak, this modification will reduce the administrative burden otherwise required for CFCs seeking to file depreciation method changes by allowing taxpayers to group the Section 481(a) adjustments accompanying the change by characteristic, as opposed to not being allowed to group them at all.

Other notable modifications

In addition to the several revisions to income recognition and depreciation method changes, Rev. Proc. 2022-14 also made a number of other modifications worth noting. For example, an automatic change in method of accounting was added for accrual method taxpayers to take into account certain employee commission liabilities. Previously, an automatic change in method of accounting was allowed only for accounting method changes involving liabilities for self-insured employee medical benefits, bonuses and vacation, sick & severance pay. Taxpayers had requested an automatic change for employee commission liabilities, and will appreciate that the government listened to their comments and provided an automatic change for the common expense that many taxpayers experience.

Rev. Proc. 2022-14 also provides that Sections 7.01 and 9.01, which provide automatic accounting method changes for Section 174 costs and computer software costs under Rev. Proc. 2000-50, do not apply to any amounts paid or incurred in any tax year for which amended Section 174 per TCJA is effective. While the change reflects, as is the case with others previously referenced, the removal of other obsolete provisions, the limited language provided is a clear indication by the government that the treatment of such expenses moving forward will be addressed in separate guidance. With the transition from immediate expensing of research costs to amortization imminent, taxpayers and practitioners alike are hopeful guidance will be released soon to assist in the implementation of the new Section 174.

Clarity was also provided with respect to certain Section 263A method changes. Most significantly, Rev. Proc. 2022-14 provides that the automatic accounting method changes included a change in method of accounting by a taxpayer electing to use the historic absorption ratio with one of the simplified methods to change to a different method for calculating additional Section 263A costs, i.e., to a different simplified method or a facts-and-circumstances method. This clarification applies to both changes available under Sections 12.01 and 12.02 of Rev. Proc. 2022-14. In light of recent judicial activity, the interest capitalization rules were also clarified to indicate that the automatic method change provision does not apply for taxpayers seeking to change from capitalizing to not capitalizing, or from not capitalizing to capitalizing interest for improvements under the associated property rules.

Lastly, the automatic accounting method change related to a change in basis of computing reserves under Section 807(f) for life insurance companies was modified. Rev. Proc. 2022-14 reduced the amount of information required to be furnished with a taxpayer’s return or on a Form 3115, due to the removal of the regulatory requirement by the final regulations under Section 807 released November 2, 2020. Additionally, Rev. Proc. 2022-14 clarified the manner in which a nonlife insurance company implements a change in basis of computing life insurance reserve. The revenue procedure also makes clear the netting required of Section 481(a) adjustments is at the same level of each item referred to in Section 807(c). Finally, it was clarified that a taxpayer that was an insurance company for the year of change does not accelerate a Section 481(a) adjustment merely because it changes from a life insurance company to a nonlife insurance company, or vice versa. All revisions made to the Section 807(f) method change rules should provide welcome clarity to the industry.

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