Preface: Form 3115 is required when changing accounting methods to comply with IRS regulations. Changes can be either automatic or advanced consent required. Starting with the 2014 tax year IRS regulation adjusted the requirements for Form 3115 filings.

 

Changes in Accounting Method – 3115

Is your tax accountant suggesting a Form 3115 Change In Accounting Method to be filed for your business? Is it as complex as they quote? Here’s what you need to know.

Form 3115 is filed when changing an overall method of accounting or changing the accounting treatment of any item. Form 3115 is most commonly filed for changes in a basis of accounting, e.g. from cash to accrual accounting, or to long-term contracts, depreciation or amortization changes, a change in 263A costs or inventory methods, or say warranty expenses. A Form 3115 filing is as complex as a small business tax return. Two options are available for filing a Form 3115 for a change in accounting method(s). The first option is an automatic change request; the second is option an advanced consent request.

When applicable, an automatic change requests is the simplest filing of a Form 3115. An automatic request requires no user fee on behalf of the applying business. An automatic change request must be filed with an original timely filed federal tax return, including the extension date of the filing. Automatic change requests are not permitted when the business is under certain circumstances, say a tax audit, or in its final tax year as a trade or business, or the applicant made the change in method of accounting for the same item within the last five years.

Automatic accounting method changes include changes in depreciation or amortization from an impermissible method to a permissible method. Let’s say the prior accountant applied wrong depreciation periods for assets, e.g. depreciated equipment at 10 years instead of 7 years, the Form 3115 can be filed to change the period to 7 years, and accelerate depreciation expense, and thereby reducing IRS audit scrutiny. Automatic changes also include changes in depreciation from a permissible method to another permissible method, or accounting for material and supplies, to name only a few of the approximately 180 automatic accounting method changes the IRS now permits.

Now the advanced consent requests must be filed during the tax year the change is requested, unless otherwise stated in the guidelines. If you can file an automatic change request, then you are not permitted to file an advanced consent request. If the advanced consent request is filed and approved you’ll receive an IRS letter ruling. The letter ruling requires a fee; that fee can reach several thousand dollars, payable to IRS in some instances.

In 2014, the IRS adjusted its opinion on what is a change in accounting methods. Previously, Form 3115’s were only filed for major accounting change methods, i.e. say from cash to accrual accounting for a burgeoning business when realizing income on accounts receivables. Now Form 3115 is required if you are changing any accounting method to comply with IRS rules. Small businesses are permitted to make certain accounting changes under the tangible property regulation without filing a Form 3115, but businesses with assets in excess of $10m, or $10m of average revenues were required to file the Form 3115 for 2014 tax years. Tax practitioners have differing opinions on when a Form 3115 is now required for a small business; but typically you should file the Form 3115 when necessary. One advantage of filing Form 3115 is if you owe money on the change in accounting method, the IRS allows a four year span to pay the additional tax.

Summary: a Form 3115 is as complex as a small business tax return, and the cost to comply with IRS regulations requires tax expertise and leads to additional tax filing costs.