New automatic method change procedures for small businesses

Small-business taxpayer exception

Taxpayers that meet the gross receipts test under IRC Section 448(c) satisfy the small-business exception and are exempt from numerous complex provisions of the code. A taxpayer meets the gross receipts test for any taxable year if its average annual gross receipts for the three-taxable-year period immediately preceding such taxable year, taking into account certain aggregation rules, does not exceed $25 million (indexed for inflation). Under Revenue Procedure 2021-45, this threshold was increased to $26 million for taxable years beginning in 2019, 2020, and 2021, and to $27 million for taxable years beginning in 2022.

The simplified tax accounting methods afforded to those taxpayers that meet the IRC Section 448(c) gross receipts test include:

• Small-business taxpayers that are not tax shelters may use the overall cash method of accounting (certain taxpayers are prohibited from using the overall cash method unless they meet the small-business taxpayer exception).
• In lieu of applying the rules under IRC Section 471(a), small-business taxpayers may account for inventories either as nonincidental materials and supplies (NIMS) or as conforming to their applicable financial statements (AFS) (or books and records if a taxpayer does not have an AFS).
• Small-business taxpayers may forgo applying the uniform capitalization rules under IRC Section 263A that generally require the capitalization of additional costs to property produced or acquired for resale.
• Small-business taxpayers may be exempt from the requirement to account for long-term contracts under the percentage-of-completion method under IRC Section 460.

Revenue Procedure 2022-9

Following are highlights of some of the changes included in Revenue Procedure 2022-9:

Updated automatic procedures

In addition to reflecting the changes made by the final regulations, Revenue Procedure 2022-9 includes the following notable revisions to the automatic accounting method change guidance in Revenue Procedure 2019-43:

• Taxpayers generally are prohibited from making an automatic change in accounting method for a particular item if the taxpayer made a change for that item within the prior five taxable years, including the year of change. However, Revenue Procedure 2022-9 provides that if a taxpayer wants to make a change in accounting method to apply the small-business provisions, prior changes made in the first taxable year that the taxpayer did not qualify as a small business generally are disregarded for purposes of the prior five-year change eligibility limitations.
• The prior five-year change eligibility limitation generally is waived for changes made by a small business to adopt the final regulations. This eligibility limitation also is waived for changes to the accrual method in the first year a taxpayer is required to use the accrual method under either IRC Sections 447 or 448.
• The guidance for a small business to change to the overall cash method is expanded to include 1) a change to account for exempt construction contracts under the cash method, and 2) changes to use an accrual method for purchases and sales of inventories and the cash method for computing all other items of income and expense.
• A small business changing to alternative accounting methods for inventories under IRC Section 471 may use streamlined method change procedures provided the change does not result in an IRC Section 481(a) adjustment. Under the streamlined method change procedures, the requirement to file a Form 3115, “Application for Change in Accounting Method,” is waived.
• A new method change is provided for changes within a small business’s existing alternative inventory method (for example, a taxpayer treating its inventory as NIMS and changing from using a specific identification method to a first in, first out method).
• A new method change is provided for taxpayers changing from a small-business inventory method to the general inventory rules under IRC Section 471(a).

Removal of Section 3.04 of Revenue Procedure 2018-40

Section 3.04 of Revenue Procedure 2018-40 provides that taxpayers making a change in accounting method under the small-business rules have the option of netting the remaining portion of an IRC Section 481(a) adjustment that resulted from a prior method change. Revenue Procedure 2022-9 removes this option.

Revocation of election under proposed Section 1.448-2(b)(2)(iii)(B)

Proposed Section 1.448-2(b)(2)(iii)(B) provides an election, irrevocable for the year in which it is made and all future years, to test an allocation of losses based on the prior taxable year rather than the current year for purposes of determining whether the taxpayer is a syndicate and, therefore, not eligible for the small-business exception under Section 448(c). The final regulations make the election an annual election, irrevocable only for the year the election is made. To allow taxpayers to take advantage of the final regulations, Revenue Procedure 2022-9 provides deemed consent to revoke a prior election under the proposed regulations by 1) making an election under the final regulations on a timely filed return, 2) including a statement with a timely filed return that the taxpayer is not making an election under the final regulations, or 3) filing a Form 3115 with a timely filed return.

Looking ahead

Revenue Procedure 2022-9 is effective for a Form 3115 filed on or after Dec. 16, 2021. Small-business taxpayers should consider whether they should file an accounting method change for their 2021 tax year to take advantage of the favorable tax provisions afforded under the final regulations.