IRC Section 460 Long-term Method of
Accounting, Partnership 10 million Trip Wire
Is a
Partnership Required to file Form 3115, Application for Change
in Accounting Method, and does 4 year Section 481(a) spread
apply?
I. Fact
Pattern:
The company is a LLC taxed as a
partnership; sales are comprised solely of commercial contracts
(no residential jobs.)
This year, 201X, in accordance with
Section 460(e)(1)(B)(ii), the taxpayer must change their method
of accounting for long-term contracts to PCM as they solidly
tripped over the three year average $10 million gross receipts
test in 201X-1.
Their cash basis deferral at Dec
31, 201X-1 was $X million. They would like to
continue with cash basis for non-long-term contracts. The X
million is the difference between taxable income and book, where
book is full accrual PCM.
Composition of $X million Deferral.The taxpayer's X
million deferral is on the cash basis method of accounting for
all contracts, long-term and completed. This is a very important
distinction because the bulk of the X million is NOT from
long-term contracts, rather they are from completed contracts
where revenue was deferred and expenses accelerated.Thus, only an accrual
election would capture those items.In fact, only $XXX,000
of the $X million was attributable to a long-term contract.Completed jobs are
determined by the measurement of work in the ground, not with
regard to method of accounting.Thus, a job 95% complete in the ground, was not subject
to Alternative Minimum Tax (AMT). [under Reg. Sec.
1.460-1(c)(3), a contract is completed at the earlier of when
95% of the costs have been incurred, or when the subject matter
of the contract is finally completed and accepted.] Keep in mind
that prior to 201X, PCM was only applied for AMT income, so the
"in the ground" method of accounting has not been used for
regular tax purposes.
As a result, on an accrual PCM basis
WITH full accrual method, as of Dec 31, 201X-1, $X.X million of
the $X.0 million would have gone into 201X-1 and only XXXk would
have been deferred to 201X.
The taxpayer's overall accounting
method is cash basis.However, for AMT purposes where PCM was require, the
Simplified Cost-to-Cost Method was elected (i.e. only direct
costs used in PCM computations.) Also for AMT computation
purposes, the cash basis method was used in the computation of
AMT income on a PCM basis.
II.
Conclusion Summary
Based upon the forgoing the following
conclusions were reached:
Per Chief counsel's office, no Form
3115 is required and the "cut-off" method (i.e. no Section
481(a) adjustment is permitted) is applied when adopting
mandatory Section 460 PCM from an exempt-contract method.
The adoption of Section 460 PCM
strictly applies only to long-term contracts and the accrual
method must be used on those long-term contracts. HOWEVER, the
taxpayer may remain on simplified cost to cost method as long as
it does not elect the 10% method(i.e. no PCM income until 10% of costs are incurred.) In
application to 12/31/201X-1, this mean that PCM would have ONLY
applied XXXk of the X.0 million deferral. Thus, even if we were
to take the position documented below that Section 481(a)
adjustment applies, the 4 year spread would ONLY apply to the
XXXk, NOT the remaining X.X million.
The taxpayer could apply to change its
over all method from cash to accrual. That is known to be an
automatic election and would apply at 12/31/201X-1 to X.X
million of the deferral. Further, it would be Section 481(a)
qualified.However,
the taxpayer would loose its ability to defer on completed jobs
at the end of each year, beginning with the year ending Dec 31,
201X.
As for subsidiary transaction,
decision to wait until after 201X's audit opinion is issued.
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