Rev. Proc. 2005-9 Extends Automatic Accounting-Method Changes Relating to Intangibles Capitalization

In December 2004, the IRS released Rev. Proc. 2005-9, to provide exclusive administrative procedures to obtain automatic consent to change an accounting method for a taxpayer’s second year ending after Dec. 30, 2003, under Sec. 263(a) final regulations on the capitalization of amounts paid to acquire or create intangible assets.

Background

Sec. 263(a) regulations: In December 2003, the IRS and Treasury issued Sec. 263(a) final regulations for determining whether expenditures incurred to acquire or create intangible assets have to be capitalized, effective for amounts paid or incurred after Dec. 30, 2003 (TD 9107).

Under these rules, a taxpayer may automatically change its accounting method to comply with the regulations for its first tax year ending after Dec. 30, 2003, by following the procedures in Rev. Proc. 2002-9. The final regulations also waive the scope limitations of Rev. Proc. 2002-9 for such tax year. To implement the method change, taxpayers must calculate a Sec. 481(a) adjustment taking into account only those costs incurred in tax years ending after Jan. 23, 2002.

Rev. Proc. 2004-23: In March 2004, the IRS released Rev. Proc. 2004-23, which provided the exclusive administrative procedures to obtain automatic consent for a taxpayer’s first tax year ending after Dec. 30, 2003, to change to an accounting method provided in Regs. Sec. 1.263(a)-4 or -5, or 1.167(a)-3(b). In Rev. Proc. 2004-23, the IRS noted its intent to issue future guidance for accounting-method changes made for subsequent tax years, including automatic consent procedures for some or all accounting methods provided in the final regulations.

For method changes pending when the regulations were finalized, Rev. Proc. 2004-23 specified that the Service would not grant a request to change to an accounting method provided in the final regulations for a change year earlier than the final regulations’ effective date. For example, the procedure noted that the IRS had received numerous requests as to the application of the 12-month rule contained in Regs. Sec. 1.263(a)-4(f)(1), which is consistent with the holding in U.S. Freightways Corp., 270 F3d 1137 (7th Cir. 2001). As a result, affected taxpayers were notified in 2004, and given the opportunity to withdraw their requests and obtain a refund of the user fee. Any request not withdrawn was processed in accordance with the procedures under which it was filed (e.g., Rev. Proc. 97-27), on the basis that the IRS National Office was adverse to the request. Taxpayers who had made an unauthorized method change for a prior year were eligible to use Rev. Proc. 2004-23’s automatic consent procedures only if they amended prior Federal income tax returns to correct the unauthorized change.

In addition, Rev. Proc. 2004-23 also applied to taxpayers that, in conjunction with these changes, also sought to change their accounting method to use Regs. Sec. 1.461-4(d)(6)(ii)’s 3¹/2-month rule or the recurring-item exception in Regs. Sec. 1.461-5.

Finally, Rev. Proc. 2004-23 offered several procedural rules for filing Form 3115, Application for Change in Accounting Method, including:

1. Reiterating the waiver of the scope restrictions of Section 4.02 of Rev. Proc. 2002-9;

2. Using one Form 3115 for all changes under the regulations;

3. Clarifying the information to be submitted as part of the filing;

4. Requiring taxpayers to use the current version of Form 3115 (revised December 2003);

5. Providing a special filing address; and

6. Offering transition rules for certain taxpayers that had filed Form 3115 for their first effective tax year prior to the issuance of this guidance.

Rev. Proc. 2005-9

Rev. Proc. 2005-9 extends the automatic accounting-method change procedures of Rev. Proc. 2004-23 (i.e., for method changes made under Regs. Secs. 1.263(a)-4 and -5, and 1.167(a)-3(b)) by providing an automatic change for a taxpayer’s second year ending after Dec. 30, 2003. Rev. Proc. 2005-9 is generally consistent with Rev. Proc. 2004-23. Notably, the new procedure retains the provision allowing a taxpayer to elect the recurring-item exception or 3¹/2-month rule in conjunction with a capitalization change, and continues to allow those that made unauthorized changes in a prior year to use the automatic procedure as long as prior-year returns are amended.

However, Rev. Proc. 2005-9 contains some different rules from Rev. Proc. 2004-23; most importantly, except for the “five-year prior change scope limitation” (discussed below), Rev. Proc. 2005-9 does not waive the scope limitations in Rev. Proc. 2002-9, Section 4.02. Thus, if a taxpayer falls into one of the exclusions in Section 4.02, it is generally precluded from filing the method change, unless it meets one of the exceptions to the scope restrictions (e.g., if a taxpayer is under examination, it must either fall into one of the “window periods” set forth in Section 6 of Rev. Proc. 2002-9 or obtain Director consent to file the change).

This is a significant difference between the revenue procedures, because, under Rev. Proc. 2004-23, taxpayers could obtain automatic consent to change a method while receiving audit protection for prior years, even in cases in which they were under examination and the method at issue was under consideration by the examining agent.

When originally issued, Rev. Proc. 2005-9 provided that none of the scope limitations in Rev. Proc. 2002-9, Section 4.02, were waived. However, Rev. Proc. 2005-17 later modified Rev. Proc. 2005-9 to provide eligible taxpayers a waiver of the “five-year prior change scope limitation.” Section 4.02(6) of Rev. Proc. 2002-9 provides that if a taxpayer, within the last five tax years (including the year of change), has either (1) made a change in the same accounting method (with or without obtaining the IRS’s consent) or (2) applied to change the same accounting method without effectuating the change (whether, for example, the application to change was withdrawn, not perfected, not granted or denied), such taxpayer is barred from using the automatic-change procedure.

As noted in Rev. Proc. 2005-17, the IRS’s initial failure to waive this scope limitation resulted in certain taxpayers being ineligible to use Rev. Proc. 2005-9’s automatic provisions, because either the taxpayer withdrew a previous application to change or a previous application was denied. The IRS did not intend this result; thus, the waiver of the five-year prior-change scope limitation allows such a taxpayer to avail itself of the automatic-change provisions, provided that all other requirements of Rev. Proc. 2005-9 are met.

From Cathy Fitzpatrick, CPA, MST, Washington, DC