Of all of the questions that I’ve received this tax season, one of the most popular is also one of the most unexpected: What do you do about Form 3115?
Federal Form 3115, Application for Change in Accounting Method (downloads as a pdf), is the form used to request a change in either an overall method of accounting or the accounting treatment of a particular item. As a rule, Form 3115 is most typically filed by businesses, though it may also apply to individual taxpayers, estates and other taxpayers on occasion. Sounds kind of obscure, right?
Not so fast.
Under the Tax Code, you’re required to get permission from IRS before changing your method of accounting. That’s made clear at section 446(e):
Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary.
You can obtain “automatic consent” as follows:
- Complete Form 3115 and attach it to a timely filed return; and
- Complete Form 3115 and file with the IRS National Office (unless the Appendix of Rev. Proc. 2011-14 or other published guidance requires you to file the copy with the IRS office in Ogden, UT, instead of the IRS National Office).
If you can’t or don’t obtain automatic consent, you can make an advance consent request. If the request is approved, you’ll receive a letter ruling; that means, unlike automatic consent, a user fee is required. While a form 3115 is considered accepted as filed, IRS normally sends an acknowledgment of receipt within 60 days after receiving form 3115 filed requesting an advance consent request. That means that automatic consent is almost always better.
Under the old rules, most taxpayers only filed the form when a significant change happened – like a change from, say, accrual to cash basis. This didn’t happen terribly often.
For 2015, however, your definition of accounting method may be very different from the IRS’ definition. Remember that Code section I cited above? It specifically states that Form 3115 is required for a change in the method of accounting for computing taxable income. That means that it may apply to changes in the way you record and report certain kinds of tax breaks, like depreciation, expensing and basis – almost certainly applicable to most businesses which own real and/or tangible property (especially landlords). And the rules don’t just apply to changes you make voluntarily: it may also include changes made as a result of updated IRS rules like those that apply to expenses for repairs and maintenance and improvements.
Put another way, you may be required to notify the IRS that you’re changing your accounting methods to comply with their own rule changes. Totally logical, right?
It feels like that you shouldn’t have to jump through more hoops after complying with updated IRS rules in the first place. As a result, some professionals are taking the position that those changes don’t apply to Form 3115.
Others don’t agree.
So do you file the form or not? The tax community is split on the issue. Since there’s no user fee – and virtually no risk – I tend to agree with those who suggest that businesses owning real and/or tangible property err on the side of caution and file Form 3115 to obtain automatic consent.
Filing the form has some benefits beyond peace of mind.
First, you can avoid the potential loss of deductions and tax breaks. If you don’t have any changes in your depreciation or other accounting methods approved via Form 3115, the IRS could, in theory, later disallow those changes. That means that any related tax deductions would also be disallowed.
It also potentially affords you some audit protection for previous years. Filing Form 3115 is your way of telling the IRS that you previously complied with IRS regulations. In return, IRS agrees not to impose penalties and interest on any underpayments of tax as the result of inconsistent deductions.
Finally, if it turns out that you do owe the IRS money because of your previous accounting methods, filing Form 3115 allows you four years to pay any tax due. Without Form 3115, you’d have to pay any tax due in one year.
There is a downside (of course). Form 3115 is not for the faint of heart: it’s not unrealistic that you may have to file more than one form 3115 or that the forms must be sent to different IRS centers. It’s wise to consult with a tax professional to assist you with preparing the form – as well as reviewing the books to see if you need to make any adjustments. That could add a few bucks (or more properly, a few hundred, depending on the size any type of your business) to the cost of your return.
This issue is extraordinarily complex: there has been a lot of discussion about the new IRS rules and how they affect reporting on Form 3115 – especially as they apply to depreciation. I don’t profess to have all the answers. It’s the first year that taxpayers have to grapple with many of these changes and IRS hasn’t had to deal with confused taxpayers over this issue just yet. I wouldn’t be surprised to see some additional guidance as 2015 progresses.
My advice is to be proactive – but not to panic. Check with your tax professional if you have specific questions.
I’ll keep you posted as more information becomes available.
For more on the repair regs, check out these articles from Forbes contributor Peter J. Reilly:
- Repair Regs – A Hellish Tax Season and Refunds of Biblical Magnitude
- Building Repair Deductions – Thirty Percent Of What?
