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The IRS has issued proposed regulations that would clarify and simplify current regulations regarding the accounting method or combination of methods to be used after corporate reorganizations and tax-free liquidations under Code Sec. 381 The proposed regulations would apply when issued as final regulations.
Background
The current regulations under Code Sec. 381(c)(4) and (c)(5)
provide that the accounting method to be used after a Code Sec. 381(a) transaction depends on whether the parties to the transaction used or did not use the same accounting method on the date of the transaction and whether the businesses of the parties are combined by the party that survives the transaction. If different methods are used by the parties and the combined corporations are operated as a single trade or business after the transaction, then the principal and special method (including the inventory method) rules apply. The parties to the transaction determine the principal method by applying various tests under the regulations. The applicable test depends on whether the method being considered is: (1) the overall accounting method, (2) the method for a particular type of goods for which the tax code or regulations provide a special method or methods or (3) an inventory method.
Proposed Regulations
The proposed regulations provide that, under both Code Sec. 381(c)(4) and (c)(5), the accounting method to be used after a Code Sec. 381(a) transaction by the acquiring corporation will depend on: (1) whether the businesses of the parties to the transaction are combined by the acquiring corporation after the transaction and (2) whether the method is permissible. As under current regulations, if the trades or businesses of the parties to the transaction are operated as separate trades or businesses after the transaction, an accounting method used by the parties prior to the transaction carries over and is used by the acquiring corporation if such method is permissible (carryover method). If the trades or businesses are not operated as separate trades or businesses, then the principal method must be determined and used.
There are two exceptions to the general rule that the principal method is the accounting method used by the acquiring corporation prior to the transaction. First, if the acquiring corporation does not have an accounting method for a particular item or type of goods, the principal method is the accounting method for the item or type of goods used by the distributor or transferror corporation before the transaction. Second, if the distributor or transferror corporation is larger than the acquiring corporation, the principal methods for the overall accounting method and for the accounting method for a particular item or type of goods are the methods used by the distributor or transferror corporation before the transaction. The principal method continues to be determined separately for the overall accounting method and for any special accounting methods, such as an accounting method used for a long-term contract.
Under the proposed regulations, whether the distributor or transferror corporation is larger than the acquiring corporation is determined using the test in Reg. §1.381(c)(4)-1, which compares their relative sizes in terms of total asset bases and gross receipts for both the overall accounting method and for special accounting methods. For inventory, it would be determined based on the value of the inventory using a test similar to the test in Reg. §1.381(c)(5)-1 of the current regulations. The principal method is the inventory method used by the party with the largest fair market value of a particular type of goods. The regulations provide a simplified election that allows the acquiring corporation to apply the principal method test by comparing the value of the entire inventories of the parties to the transaction rather than the value of each particular type of goods.
Under the proposed regulations, if the carryover method or principal method is an impermissible method, the acquiring corporation generally must file a request to change to a permissible accounting method. However, if the carryover method is impermissible solely because only a single accounting method with respect to a particular item may be used by the acquiring corporation on the date of the transaction regardless of the number of separate and distinct trades or businesses operated on that date, the acquiring corporation must use the principal method as determined under Proposed Reg. §1.381(c)(4)-1(c).
Accounting Method Change Request
Under the current regulations, if the acquiring corporation cannot use a principal method because it is impermissible, it is unclear whether an acquiring corporation may file a Form 3115, Application for Change in Accounting Method, to request permission or whether the acquiring corporation must file a request for a private letter ruling. The proposed regulations make it clear that a taxpayer must request an accounting method change consistent with the manner in which accounting method changes are requested pursuant to Code Sec. 446(e), that is, on a Form 3115. The form must be filed by the later of: (1) the last day of the tax year in which the distribution or transfer occurred, or (2) the earlier of: (a) the day that is 180 days after the transaction date, or (b) the day on which the acquiring corporation files its tax return for the tax year in which the distribution or transfer occurred.
Audit Protection
Audit protection is generally not warranted when either the carryover method or principal method, as applicable, is used in the context of voluntary compliance under Code Sec. 381(c)(4) and (c)(5). However, audit protection is warranted when an accounting method other than the carryover method or principal method is used in the context of voluntary compliance under Code Sec. 381(c)(4) and (c)(5). Under the proposed regulations, a taxpayer using an improper accounting method may request permission to change the method at any time before the end of its tax year. Thus, if the acquiring corporation is using an improper accounting method or would be required to use an improper accounting method because of the application of Proposed Reg. §§1.381(c)(4)-1 or (c)(5)-1, it can request consent to change to a proper accounting method. That change will be accorded the usual audit protection procedures provided in guidance issued under Code Sec. 446(e) for the requested change. Similarly, if another party to the Code Sec. 381(a) transaction is using an improper accounting method, it may request consent to change to a proper accounting method at any time prior to the Code Sec. 381(a)
transaction.
Proposed Regulations, NPRM REG-151884-03, 2007FED ¶49,776
Revision of Annual Information Return/Reports Final Rule
Notice of Adoption of Revisions to Annual Return/Report Forms
Other References:
Code Sec. 381
CCH Reference - 2007FED ¶17,003C
CCH Reference - 2007FED ¶17,009C
CCH Reference -2007FED ¶17,011C
Code Sec. 446
CCH Reference - 2007FED ¶20,608F
Tax Research Consultant
CCH Reference - TRC REORG: 33,158