Automatic accounting method changes is a term used to describe certain alterations in the approach used by taxpayers to determine the timing of income or deduction items when filing business income tax returns in the United States. Automatic accounting method changes can be differentiated from all other forms of accounting method changes as they do not require Internal Revenue Service approval before the taxpayer may make the change on his income tax return.
The IRS requires business income taxpayers to submit notification of all changes in the taxpayer’s method of accounting.
This notification must be made on IRS Form 3115, "Application for Change in Accounting Method." The taxpayer must determine whether the change qualifies as an automatic consent change, meaning the taxpayer may make the change on her future income tax reporting without awaiting IRS approval of the change. If not, the taxpayer must wait for a formal IRS response to the application prior to completing future income tax returns based upon the change in the method of accounting.
Method of Accounting
A method of accounting is an approach used by the taxpayer in determining the timing of items of income or deduction. A very basic method of accounting involves the cash or accrual basis of reporting. Taxpayers reporting on the cash basis of accounting will report income when actually received and report deductions when actually paid. Taxpayers reporting on the accrual basis of accounting, however, will report income when earned and report deductions when incurred. Any switch from one method of accounting to the other would be a change in accounting method.
Taxpayers will generally change accounting methods for one of two reasons. First, the taxpayer may determine he has been using an improper method of accounting. An improper method of accounting is a method that it is not consistent with the Internal Revenue Code and has been consistently applied by the taxpayer for more than one tax period. (A method not consistently applied does not result in a change of the method of accounting. Instead, the taxpayer must file an amended return.) Second, a taxpayer will change accounting methods if he feels the new method of accounting has a beneficial tax result, such as accelerating items of deduction and deferring items of income.
List of Changes
The IRS publishes a list of all changes that qualify for automatic changes of accounting method, rather than requiring IRS approval. This list is expansive and covers a broad range of accounting methods. These methods may include changing from a improper method to a specific proper method or changing from one specific proper method to a second specific proper method. For example, it is an automatic accounting method change if a taxpayer moves from a proper method of capitalizing research and development costs to inventory to a proper method of expensing these costs when occurred. As a second example, it is also an automatic accounting method change if a taxpayer using an improper method to reserve bad debts switches to a proper method of reserving for bad debts.
Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.