Helping Tax Clients Manage Change With IRS Form 3115
A professional tax preparer helps their clients keep up in a fast-moving, always changing business environment. Growing businesses must constantly refine their business model to keep up with competitive factors, regulatory changes and other factors. Often this involves changes in accounting methods.
That’s when you might need to file IRS Form 3115, Application for Change in Accounting Method. You would typically file this form when your client needs to adjust their overall accounting methods or the accounting treatment of any item to comply with IRS regulations or to correct past errors. The form helps ensure that the changes are made in a manner that is consistent with IRS guidelines, thereby avoiding potential penalties or issues during audits.
When to Use Form 3115
There are various situations in which you would file Form 3115, such as:
- Changing Depreciation Methods
- Correcting Missed Depreciation
- Adopting a New Revenue Recognition Method
Let’s look at a few hypothetical situations in which a business client would need to file Form 3115:
Switching Depreciation Methods for a Manufacturing Company:
- Scenario: A manufacturing company has been using the straight-line method to depreciate its machinery and equipment. The company decides to switch to the Modified Accelerated Cost Recovery System (MACRS) to take advantage of higher depreciation deductions in the earlier years of the assets' lives.
- Reason for Filing: The change in depreciation method requires IRS approval to ensure that the new method is applied correctly and consistently. Form 3115 is used to request this change and to calculate any necessary adjustments to taxable income.
Correcting Missed Depreciation for a Small Business:
- Scenario: A small business owner discovers that they have not been recording depreciation for their office building for the past five years. This oversight has resulted in inaccurate financial statements and tax returns.
- Reason for Filing: To correct this error, the business needs to file Form 3115 to request a change in accounting method. This form allows the business to catch up on missed depreciation and adjust its financial records accordingly, ensuring compliance with IRS regulations.
Adopting a New Revenue Recognition Method for a Consulting Firm:
- Scenario: A consulting firm has been using the cash method of accounting, where revenue is recognized when cash is received. The firm decides to switch to the accrual method, where revenue is recognized when it is earned, regardless of when payment is received.
- Reason for Filing: The change in revenue recognition method impacts the timing of income reporting and tax payments. Form 3115 is used to request approval for this change and to provide the IRS with detailed information about the new accounting method and its impact on the firm's financial statements.
In each of these situations, filing Form 3115 ensures that the accounting method changes are properly documented and approved by the IRS, helping to maintain accurate financial records and compliance with tax regulations.
Choosing an Accounting Method
The IRS has specific rules regarding the selection and modification of accounting methods.
- Consistency Requirement: Taxpayers must use a consistent accounting method to report income and expenses. The two most common methods are:
- Cash Method: Income is reported in the tax year it is received, and expenses are deducted in the tax year they are paid.
- Accrual Method: Income is reported in the tax year it is earned, regardless of when payment is received, and expenses are deducted in the tax year they are incurred.
- Initial Selection: When a taxpayer files their first tax return, they select their accounting method. This method must be used consistently in subsequent years unless a change is approved by the IRS.
Changing an Accounting Method
- IRS Approval: To change an accounting method, taxpayers must obtain IRS approval by filing Form 3115, Application for Change in Accounting Method.
- Automatic Consent: Some changes qualify for automatic consent, meaning they can be made without waiting for IRS approval. These changes are listed in the IRS's revenue procedures.
- Non-Automatic Consent: Other changes require advance consent from the IRS, which involves a more detailed review process.
Key Sections of Form 3115 Form 3115 consists of several critical sections:
- Part I: Information for Automatic Change Request: This section requires basic information about the taxpayer and the type of change being requested. It includes details such as the taxpayer's name, identification number, and the specific accounting method change being applied for.
- Part II: Information for All Requests: Here, the preparer must provide detailed information about the current and proposed accounting methods, including a description of the item being changed and the reason for the change. This section also asks for the year of change and any prior changes made to the same item.
- Part IV: Section 481(a) Adjustment: This section calculates the cumulative effect of the accounting method change on taxable income. The Section 481(a) adjustment ensures that the change does not result in double counting or omission of income or expenses. It requires a detailed calculation of the adjustment amount and how it will be spread over the tax years.
Filing the Form
Form 3115 should be filed as early as possible during the year of change to allow adequate time for IRS processing. It can be submitted to the IRS National Office by mail, secure electronic facsimile, or encrypted electronic mail. The form must be filed with the taxpayer's timely filed (including extensions) federal income tax return for the year of change. Additionally, a copy of the form should be sent to the IRS office where the taxpayer's return is filed.
Additional Forms
In some cases, additional forms may need to be filed along with Form 3115. For example, if the change involves depreciation, Form 4562, Depreciation and Amortization, might also be required. This form is used to report depreciation deductions and other information related to the use of business property. Other forms that might be needed include Form 1128, Application to Adopt, Change, or Retain a Tax Year, if the accounting method change affects the taxpayer's tax year.
Deadline for Filing
The deadline for filing Form 3115 is generally the last day of the tax year for which the change is requested. However, it is advisable to file it as early as possible to ensure timely processing. Filing early allows the IRS sufficient time to review the request and provide any necessary feedback or additional information requests before the tax return is due.
By understanding when and how to file Form 3115, you can ensure compliance with IRS regulations and help your clients make necessary accounting adjustments efficiently. This knowledge is essential for maintaining accurate financial records and avoiding potential issues with the IRS.
References
About Form 3115, Application for Change in Accounting Method
IRS Publication 538 Accounting Periods and Methods
