a-02-37.pdf

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Part IV -- Items of General Interest

# Changes in Method of Accounting

# Announcement 2002-37

## PURPOSE

In 1998, the Service published Notice 98-31, 1998-1 C.B. 1165, which
proposed procedures for changes in method of accounting imposed by the
Service under § 446(b) of the Internal Revenue Code and § 1.446-1(b) of the
Income Tax Regulations ("involuntary changes"), and for accounting method
issues resolved by the Service on a nonaccounting-method-change basis.
Notice 98-31 also requested comments from the public in connection with these
proposed procedures. The final involuntary change procedures appear
concurrently in this Bulletin as Rev. Proc. 2002-18. The purpose of this
announcement is to discuss some of the most significant and prevalent issues
raised in the comments to Notice 98-31, and the manner in which those issues
are addressed in the final guidance.

Along with Rev. Proc. 2002-18, this Bulletin contains Rev. Proc. 2002-19,
which modifies the procedures contained in Rev. Proc. 97-27 and Rev. Proc.
2002-9 for taxpayers within the scope of those revenue procedures to obtain
advance consent of the Commissioner, or automatic consent, respectively, to
change a method of accounting ("voluntary changes"). Together, these three

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revenue procedures are intended to provide a more efficient use of Service and
taxpayer resources with respect to accounting method issues and facilitate
greater uniformity in the Service's resolution of accounting method issues.
CHANGES TO NOTICE 98-31

The Service received a number of comments in connection with Notice
98-31, which were considered carefully in revising and finalizing the proposed
procedures in Rev. Proc. 2002-18. The following discussion describes some of
the most significant comments and the manner in which the final guidance
addresses them.

Commentators expressed concern that use of the term "timing issue" to
describe the scope of the proposed procedures, and in particular an examining
agent's discretion, inappropriately expanded the scope of the procedures to
issues that affect timing but that should not be treated as changes in method of
accounting, such as where the issue is an isolated occurrence or results from a
change in underlying facts. The Service and Treasury Department did not intend
to alter the definition of a change in method of accounting or to expand the
scope of the proposed revenue procedure beyond issues concerning changes in
method of accounting. To address the commentators' concerns, the final
revenue procedure uses the term "accounting method issue" rather than "timing
issue," clarifies the definition of an accounting method issue, and changes the
reference for the definition of a change in method of accounting to § 1.446-
1(e)(2).

Commentators expressed concern that the procedures set forth in Notice

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98-31 would deprive examining agents of the authority to exercise discretion and
professional judgment in resolving accounting method issues. Specifically, the
commentators believed that the procedures would limit the existing authority of
an examining agent to make findings of fact and to apply the law to those facts in
determining whether an issue is an accounting method issue and whether the
taxpayer's method of accounting is permissible. Rev. Proc. 2002-18 makes clear
that these procedures do not limit or expand an examining agent's authority
under existing delegation orders. Under Rev. Proc. 2002-18, an examining
agent's ability to exercise professional judgment in accordance with existing
auditing standards to make findings of fact, and to apply the law to the facts as
found by the agent is preserved. Rev. Proc. 2002-18 also clarifies that although
accounting method changes ordinarily will be implemented in the earliest open
year under examination, and with a § 481(a) adjustment, there may be
instances in which it is appropriate for an examining agent to consider deferring
the year of change to a later year under examination, or to impose the change
on a cut-off basis.

Similarly, some commentators believed that the procedures set forth in
Notice 98-31 would limit the existing authority of Appeals and counsel for the
government to resolve accounting method issues. Rev. Proc. 2002-18 clarifies
that an appeals officer or counsel for the government may resolve an accounting
method issue as an accounting method change (with or without compromise
terms and conditions), using one of the nonaccounting-method change
procedures provided in Rev. Proc. 2002-18, or using any other means deemed

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appropriate under the circumstances, consistent with existing delegation orders.

The background section of the proposed revenue procedure provides that
the Service ordinarily will not initiate an accounting method change if the change
will place the taxpayer in a position more favorable than if the taxpayer had not
been contacted for examination (taxpayer-favorable change). Some
commentators thought that this statement was out of place in a document
intended to provide the procedures for how the Service will resolve accounting
issues that are raised on examination. The Service and Treasury Department
agree that this statement does not belong in the background of the involuntary
method change revenue procedure and thus have deleted it from Rev. Proc.
2002-18.

Consistent with Rev. Proc. 97-27 and Rev. Proc. 2002-9, the background
section of the proposed revenue procedure provides that a change in the
characterization of an item may constitute a change in method of accounting if
the change has the effect of shifting income from one period to another. Some
commentators objected to the inclusion of this statement, questioning whether a
change in characterization of an item is properly considered a change in method
of accounting and, in any event, whether such a rule belongs in the revenue
procedures. Consistent with the purpose of these documents to provide
procedural, rather than substantive, rules governing changes in method of
accounting, the Service and the Treasury Department have not included section
2.01(3) of Notice 98-31 in Rev. Proc. 2002-18. Further, similar paragraphs have
been removed from Rev. Proc. 97-27 and Rev. Proc. 2002-9 by Rev. Proc. 2002-

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19\. The Service and Treasury Department are considering issuing separate
guidance to address the issue of characterization in the context of a guidance
project regarding the definition of a change in method of accounting.

The Service and Treasury Department were considering including
guidance regarding the effect of closed years following the year of change
(closed intervening years) in the final revenue procedure. In response to a
specific request to opine as to the effect of closed intervening years,
commentators suggested that substantive guidance addressing this issue should
not be set forth in the final revenue procedure. Upon further consideration, the
Service and Treasury Department agree that the resolution of this legal issue
should not be set forth in Rev. Proc. 2002-18 and are considering issuing
separate guidance to address this issue.

Finally, some commentators objected to the fact that, under Notice 98-31,
the specified amount payable in the case of accounting method issues resolved
by Appeals or counsel for the government on a time-value-of-money (TVM) basis
is not treated as interest under § 163, and is not deductible under any provision
of the Code. The commentators argued that this limitation was effectively
punitive, and made the TVM alternative less attractive. In fact, as the sample
computation contained in Notice 98-31 illustrates, the computation of the
specified amount should be based on a tax-effected tax rate for taxpayers that
would otherwise be entitled to a deduction if the specified amount were treated
as interest under the Code. The use of a tax-effected rate effectively allows a
deduction for the specified amount. A sentence is included in the final revenue

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procedure to clarify the use of tax-effected rates.

The Service and Treasury Department recognize that the TVM resolution
has not been widely tested in practice, and that as the Service and taxpayers
gain experience with this alternative, issues may arise that will require further
clarifying guidance. The Service and Treasury Department anticipate that the
TVM resolution will be most attractive in situations where it would be
unnecessary to perform the complex interest credit calculation upon a
subsequent change in method, such as when the resolution includes all years
preceding a point at which a statutorily prescribed method becomes effective, a
safe harbor method becomes available and is elected, or the issue of the proper
method is otherwise resolved.

## RELATED GUIDANCE

In addition to the proposed revenue procedure, Notice 98-31 outlined
other guidance that the Service intended to publish as part of a comprehensive,
and interrelated, set of procedures for resolving accounting method issues raised
on audit. First, Notice 98-31 announced that the Service intended to publish
guidance making the Coordinated Examination Program (CEP) early referral
process provided in Rev. Proc. 96-9, 1996-1 C.B. 575, available to non-CEP
taxpayers for the resolution of accounting method issues. This guidance has
been published as Rev. Proc. 99-28, 1999-2 C.B. 109. By expanding the early
referral procedures to include all taxpayers with respect to accounting method
issues, the Service intends to provide a mechanism for expediting the resolution
of those issues, which otherwise might be delayed pending the resolution of

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other (non-accounting-method) issues raised in the course of the audit.

Second, the Service announced that it intended to publish guidance that
would permit taxpayers under examination who otherwise cannot request a
voluntary change in method of accounting under the advance consent revenue
procedure (Rev. Proc. 97-27) or the automatic consent revenue procedure (Rev.
Proc. 2002-9) to do so prospectively without audit protection. That guidance is
contained in Rev. Proc. 2002-19. The modification is intended to provide a
means for taxpayers under examination with an accounting method issue
pending, as well as taxpayers before an area appeals office or a federal court
with an accounting method issue under consideration, to change their method of
accounting on a going forward basis while the issue is in the process of being
resolved for prior taxable years. This new procedure set forth in Rev. Proc.
2002-19 does not limit or extend the existing authority of an examining agent,
appeals officer, or counsel for the government to resolve accounting method
issues raised on examination.

Also in connection with finalizing Notice 98-31 and the related guidance,
the Service and Treasury Department have reconsidered the appropriateness of
a 4-year § 481(a) adjustment period for voluntary accounting method changes
that result in a negative adjustment. The Service and Treasury Department have
concluded that the objectives of prompt voluntary compliance are enhanced by
reducing the § 481(a) adjustment period for such changes from 4 years to 1 year.
This new 1-year § 481(a) adjustment period, reflected in Rev. Proc. 2002-19, is
effective for taxable years ending on or after December 31, 2001.

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Third, Notice 98-31 provided that the Service intended to publish a model
closing agreement for Service-initiated accounting method changes in order to
provide greater uniformity in the Service's resolution of accounting method
issues. Appendices A and B of Rev. Proc. 2002-18 provide model closing
agreements for use in finalizing accounting method changes imposed by the
Service, and for finalizing accounting method issues resolved by the Service on
a nonaccounting-method-change basis, respectively. Closing agreements are
encouraged, but not required, in the case of accounting method issues resolved
as accounting method changes. Closing agreements are required for accounting
method issues resolved on a nonaccounting-method-change basis. In response
to comments, the Service is considering whether it would be appropriate to
change the existing delegation orders to authorize approval of closing
agreements for accounting method change issues at lower levels.

Fourth, Notice 98-31 referred to certain other anticipated guidance
projects (i.e., guidance that would delegate limited discretionary authority to
Examination to resolve certain accounting method issues, and guidance to
expand the accelerated issue resolution procedures of Rev. Proc. 94-67, 1994-2
C.B. 800, to non-CEP taxpayers to allow these taxpayers and the Service to
resolve accounting method issues for taxable years beyond the years under
examination, before appeals, or before a federal court). The Service is
interested in receiving comments from taxpayers and practitioners on the extent
to which there is a need for this guidance.

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