Change in Accounting Method

You can generally choose any permitted accounting method when you file your first tax return. You do not need IRS approval to choose the initial method. You must, however, use the method consistently from year to year and it must clearly show your income. See Accounting Methods, earlier.

A change in your accounting method includes a change not only in your overall system of accounting but also in the treatment of any material item. A material item is one that affects the proper time for inclusion of income or allowance of a deduction. Although an accounting method can exist without treating an item consistently, an accounting method is not established for that item, in most cases, unless the item is treated consistently.

IRS Approval

Once you have set up your accounting method and filed your first return, you must get IRS approval to change the method. If your current method clearly shows your income, the IRS will weigh the need for consistency in reporting against the need for change.

If you do not request IRS approval to change an accounting method, the absence of IRS approval will not be accepted as a defense to any penalty.

Approval required. The following changes are examples of types of changes that require IRS approval.

1. A change from the cash method to an accrual method or vice versa.
2. A change in the method or basis used to value inventory.
3. A change in the method of figuring depreciation (except certain permitted changes to the straight-line method for property placed in service before 1981, as explained in Publication 534, Depreciating Property Placed in Service Before 1987).

Approval not required. The following are not changes in accounting methods and do not require IRS approval.

1. Correction of a math or posting error.
2. Correction of an error in figuring tax liability (such as an error in figuring a credit).
3. An adjustment of any item of income or deduction that does not involve the proper time for including it in income or deducting it.
4. An adjustment in the useful life of a depreciable asset.

Filing Form 3115

In general, you must file a current Form 3115 to request a change in either an overall accounting method or the accounting treatment of any item. Attach any required user fee. No user fee is required for an automatic change (discussed later).

You must file Form 3115 during the tax year for which the change is requested. You should file as early in the year as possible to give the IRS enough time to respond to the form before the original due date of the return for the year of change. If you do not file a Form 3115 during the year of change, an extension to file the form will be granted only in unusual and compelling circumstances.

The IRS normally acknowledges receipt of a completed Form 3115 within 30 days after the applicant's filing date. See the form instructions if you do not receive an acknowledgment. The IRS does not acknowledge receipt of Form 3115 for automatic change procedures.

Conference. If you think the IRS may give an unfavorable response to your request to change your accounting method, you can request a conference when you file Form 3115. The National Office will arrange one before the IRS formally replies to your Form 3115. If you do not specifically request a conference, the IRS presumes you do not want one.

More than one business. You can use different methods of accounting for separate and distinct businesses. However, if you request a change in accounting method for one of the businesses, the IRS will consider whether the change creates or shifts profits or losses between the businesses and whether the proposed method clearly reflects your income. You must identify each business by name and method of accounting.

Incomplete Form 3115. If your application is not properly completed according to the instructions for a current Form 3115, you will be notified and given 21 days from the date of the notification letter to furnish the necessary information. If you do not submit the required information within the reply period, the IRS will not process your Form 3115. However, the IRS can grant up to an additional 15 days to furnish the information. Your written request for the 15-day extension must be submitted within the 21-day period.

Taxpayers under examination. If the IRS has contacted you to schedule an examination of any of your returns, you can request approval to change your accounting method under section 6 of Revenue Procedure 97-27 (or any successor) if that method of accounting is not an issue under consideration. You can request to make the change only under the following circumstances.

1. During the first 90 days of any tax year if you have been under examination for at least 12 months.
2. During the 120-day period following the date an examination ends, regardless of whether a subsequent examination has begun.
3. With the permission of the IRS director for your area.

Revenue Procedure 97-27 is in Cumulative Bulletin 1997-2.

Automatic Change Procedures

These are procedures under which certain taxpayers can presume to have IRS approval to change their method of accounting. The approval is granted for the tax year for which the taxpayer requests a change (year of change), if the taxpayer complies with the provisions of the automatic change procedures. No user fee is required for an application filed under an automatic change procedure. Generally, you must use Form 3115 to request an automatic change. See the form instructions and Revenue Procedure 99-49, as modified, (or any successor), for more information. Revenue Procedure 99-49 is in Cumulative Bulletin 1999-2.