Taxpayer Allowed to Revoke Election Out of Installment Reporting Where Accountant Made Error in Computing Taxable Income

Mistakes happen, but in this case the IRS allowed a tax advisers a “get of jail (not quite) free” card with regard to giving bad advice to a client due to an error in computing the taxpayer’s taxable income when preparing a return.  In PLR 201503005 the IRS granted the taxpayer the right to revoke an election out of the installment basis of accounting.

The taxpayer had sold an asset in the year in question, receiving 30% down and the remainder to be paid over time.  The accountant when preparing the taxpayer’s return for the year in question determined, based on the taxable income he computed, that the use of the installment method would not benefit the taxpayers in the year in question.

Based on this calculation, the accountant prepared the return in question reporting the entire gain.  The accountant would later admit in an affidavit submitted with the ruling request that he was solely responsible for the election and that the taxpayer were not made aware (and they stated they weren’t aware) that the return elected out of the installment method.

When preparing the next year’s tax return, the accountant became aware of the error on the prior year’s return.  When the accountant properly computed the taxable income for that prior year, it was clear that the taxpayers would have benefitted from electing the installment method on that return.

As the ruling notes:

Section 453(d)(1) and section 15A.453-1(d)(1) provide that a taxpayer may elect out of the installment method in the manner prescribed by the regulations. Section 15A.453-1(d)(3) provides that a taxpayer who reports an amount realized equal to the selling price including the full face amount of an installment obligation on a timely filed tax return for the taxable year in which the installment sale occurs is considered to have elected out of the installment method.

Except as otherwise provided in the regulations, section 453(d)(2) requires a taxpayer who desires to elect out of the installment method to do so on or before the due date (including extensions) of the taxpayer's federal income tax return for the taxable year of the sale. Section 15A.453-1(d)(4) provides that an election under section 453(d)(1) is generally irrevocable. An election may be revoked only with the consent of the Internal Revenue Service. Section 15A.453-1(d)(4) provides that revocation of an election out of the installment method is retroactive and will not be permitted when one of its purposes is the avoidance of federal income taxes.

Since “avoidance” in “IRS-speak” translates into a reduction of taxes, that appears to present a problem, especially coupled with the caveat that the election out is generally irrevocable.

But in this case the IRS decided the facts were such that they were willing to grant the revocation of the election.  The ruling concluded:

In the instant case, Taxpayers' accountant erroneous computation when preparing Taxpayers' Year 1 federal return lead the accountant to elect out of the installment method under § 453. Taxpayers were not aware of the accountant's action. When the accountant realized his erroneous computation, he and Taxpayers filed a request for consent to revoke the election out of the installment method. The information submitted indicates that Taxpayers' desire to revoke the election is due to the accountant's oversight rather than hindsight by Taxpayers or a purpose of avoiding federal income taxes.

Thus the IRS allowed the taxpayers to go back and take advantage of the installment method on the return for the year of sale.

The good news for the accountant was that the client was able to avoid being stuck with taxes that otherwise would either have been due years later or, perhaps, in a lesser amount.  Had that not been the case, the accountant may have found him/herself looking at a damage claim from the client.

While the accountant did not get off without any negative effects (it seems likely the accountant had to shepherd this request through the IRS without any compensation and also may likely had ended up footing the bill for the user fee), it was still a far preferable result to the alternative.