Filing a Form 3115 to request an automatic change of accounting methods is something almost every CPA eventually has to do, but it’s also an rather unusual process that isn’t like a normal tax return filing. Not surprisingly, this is just the sort of thing where steps get missed by accident—resulting in the taxpayer failing to obtain the required permission to change its accounting method, a failure that can be both costly to the client and embarrassing to the CPA firm.
PLR 201935002 reminds us that the problem can be corrected—but also that the way to do so requires the formal process of requesting a private letter ruling and the user fee related to the application (currently set at $11,800 per Appendix A(3)(ii) of Revenue Procedure 2019-01).
In this case the taxpayer was asking for a change of accounting method that was available under the automatic change procedures found in Revenue Procedure 2018-31, changing its method for accounting for prepaid liabilities under Section 11.05 of that procedure.
When such a request for an automatic change of accounting method is filed, the taxpayer submits the original Form 3115 with the tax return for the year of change and, at the same time, mails a copy of the signed Form 3115 to the designated IRS office (in Covington, KY at the time this change was requested).
What happened is described in the ruling as follows:
Taxpayer engaged A, a certified public accounting firm, to prepare and file its federal tax return and Form 3115 for the taxable year ending Date2. Taxpayer, with the assistance of A, electronically filed its Form 1120, U.S. Corporation Income Tax Return (with original Form 3115 application attached), for the taxable year ended Date2. However, because of unusual circumstances and administrative oversight, the copy of the signed Form 3115 was not mailed to the IRS Covington, KY office.
Such a failure to follow the procedures results in the loss of the automatic permission to change accounting methods. Under IRC §446(e), a taxpayer must have the IRS’s permission to change its accounting method, so without that permission the taxpayer would have to continue to use its prior method—meaning the current year’s return is in error with additional tax due on the return since the taxpayer was barred from using the method the taxpayer actually used.
So now the taxpayer looks to get permission to make a late election under the relief provisions found in Reg. §301.9100-3. That rule provides:
(a) In general. Requests for extensions of time for regulatory elections that do not meet the requirements of § 301.9100-2 must be made under the rules of this section. Requests for relief subject to this section will be granted when the taxpayer provides the evidence (including affidavits described in paragraph (e) of this section) to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government.
One key limitation is that this only works for regulatory elections, which are elections where the date to make the election is set by the IRS and not by Congress writing a date into the IRC. But the automatic accounting change election is governed by dates set by the IRS, so it qualifies for this relief. In this case, the date is set by Reg. §1.263(a)-5(f).
The IRS also generally accepts that a mistake by the tax adviser will meet the good faith requirements. Example 2 found in Reg. §301.9100-3(f) specifically deals with a situation very close to the one faced by this taxpayer:
Example 2, Reg. §301.9100-3(f)
Reliance on Qualified Tax Professional
Taxpayer B hires a qualified tax professional to advise B on preparing B's 1997 income tax return. The professional was competent to render advice on the election and B provided the professional with all the relevant facts. The professional fails to advise B that a regulatory election is necessary in order for B to report income on B's 1997 return in a particular manner. Nevertheless, B reports this income in a manner that is consistent with having made the election. In 2000, during the examination of the 1997 return by the IRS, the examining agent discovers that the election has not been filed. B promptly files for relief in accordance with this section, including attaching an affidavit from B's professional stating that the professional failed to advise B that the election was necessary. Assume paragraphs (b)(3) (i) through (iii) of this section do not apply. Under paragraph (b)(1)(v) of this section, B is deemed to have acted reasonably and in good faith because B reasonably relied on a qualified tax professional and the tax professional failed to advise B to make the election.
The error was discovered after the return was filed. Once the error was discovered, the CPA notified the taxpayer and the process was started to request late election relief.
After the fee was paid and, likely, significant uncompensated time was devoted by the CPA firm to getting this request through the PLR process, the IRS granted the relief, holding:
Based upon our analysis of the facts and representations provided, Taxpayer acted reasonably and in good faith, and granting relief will not prejudice the interests of the Government due to unusual or compelling circumstances. Therefore, the requirements of §§ 301.9100-1 and 301.9100-3 have been met.
Taxpayer is granted an extension of 60 days from the date of this ruling to file a duplicate copy of a completed automatic Form 3115 with the IRS office in Covington, Kentucky as required.