February 28, 2002
The Honorable Mark A. Weinberger
Department of the Treasury
Room 1334 MT
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220
The Honorable Charles O. Rossotti
Internal Revenue Service
Room 3000 IR.
1111 Constitution Avenue, N.W.
Washington, D.C. 20224
Re: Notice 2001-76, 2001-52 I.R.B. 613
These comments are submitted by the American Institute of Certified Public Accountants (AICPA) in response to Notice 2001-76, 2001-52 I.R.B. 613 (Notice), containing proposed new rules regarding the availability of the cash method of accounting. They were prepared by the Tax Accounting Technical Resource Panel (TRP) and approved by the Tax Executive Committee.
We commend the Treasury and IRS for taking a significant step toward simplifying our tax system for small business. By making the cash method generally available to taxpayers with less than $10M in gross receipts (other than those subject to section 448, farming businesses, or businesses in ineligible NAICS codes), the Notice promises to ease the compliance burden on many thousands of small business taxpayers who would otherwise be precluded from using the cash method because of the inventory requirement of section 471. The Notice also eliminates uncertainty for many small businesses where the law is not clear as to whether they are required to use the accrual method. By providing a safe harbor, the Notice will eliminate a substantial degree of uncertainty. We also commend the Treasury and IRS for clarifying that the relief provided by the Notice is effective for calendar year 2001 in Notice 2002–1 4, 2002–8 I.R.B. 1.
We offer the following suggestions that might improve readers' comprehension of the Notice.
The attached flow chart may be useful to taxpayers' understanding, particularly those unfamiliar with the Notice's formal language.
Examples 2 and 3 might be supplemented to address a taxpayer whose situation shifts from Example 2 to Example 3, i.e., its principal business activity shifts from an eligible one to an ineligible one. The Examples do not make clear whether the testing for a principal business activity is done on a one-year or longer basis period. If the testing is done annually, the ineligible principal business activity must presumably change to the accrual method. Where the mix of an eligible and an ineligible business is close to the 50-50 mark, the taxpayer might conceivably be required to change accounting methods on a virtually annual basis—a prospect that would undermine the substantial simplification brought about by the Notice. Accordingly, we suggest that the testing be done on a period longer than one year.
The term "principal business activity" is not defined in Section 4 of the Notice. Examples 2 and 3 also imply that the determination of principal business activity is based on gross receipts. If gross receipts is the only way to determine a taxpayer's principal business activity, this should be stated in the body of the forthcoming revenue procedure, as should whether the principal business determination is made on a year-by-year basis or over a three-year period.
Where provision of services is linked to the provision of property, it may be difficult to separate the gross receipts for property versus services. Existing case law might be read to suggest that, as long as merchandise is involved, there are no services. For example, in Surtronics, Inc. v. Comm'r., T.C. Memo. 1985–277, the court held that the taxpayer was selling merchandise, rather than providing electroplating services. Does Notice 2001-76 change this result to allow such a taxpayer to categorize itself as having a principal business activity of selling services with the provision of property incident to those services? Or, would such a business be viewed as receiving all its receipts from the sale of merchandise?
The Examples all refer to "Taxpayer" without noting the taxpayer's type of entity. Because the safe harbor provision does not apply to taxpayers subject to section 448, the Examples should state that the taxpayer is not a C corporation, partnership with a C corporation partner, or a tax shelter. Thus, Example 1 could be modified to include: (1) an S corporation; (2) a C corporation with average annual gross receipts of $5 million or less; (3) a C corporation with average annual gross receipts of $1 million or less; and (4) a C corporation with average annual gross receipts exceeding $5 million.
In addition, we offer the following substantive comments:
Section 4.01 of the Notice states that no inference should be drawn regarding the availability of the cash method to taxpayers not eligible for relief under the terms of the Notice. To avoid possible misunderstandings, we think it would be advisable to include this statement in the introduction to the final revenue procedure.
We are familiar with the 2001 Priority Guidance plan item relating to the inventory requirement in reg. section 1.471–1 ("inventories…are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor"). A Tax Accounting TRP Task Force is currently addressing the issue of defining "merchandise." The Task Force is focusing on the development of safe harbors that would reduce the uncertainty resulting from inconsistent case law. One possible safe harbor might be a de minimis rule which would relieve a taxpayer from the inventory requirement without regard to the Notice's $10M threshold (e.g., an exemption that would be linked to the relative proportion of merchandise sales to service income). Because we consider the need for guidance under reg. section 1.471–1 to be critical, we hope that publication of the final revenue procedure will not deter Treasury from completing this item on the business plan.
We appreciate this opportunity to comment on Notice 2001– 76.If you have any questions regarding these comments, please do not hesitate to contact either: Annette Nellen, member of the Tax Executive Committee at (408) 924– 3508; or George White, AICPA technical manager, at (202) 434– 9268.
Pamela J. Pecarich
Tax Executive Committee