Definition
A taxpayer that changes its method of accounting for an item of income or deduction generally needs IRS consent under section 446(e), requested on Form 3115. Examples include changing the treatment of capitalized costs, depreciation of a class of assets, or revenue timing. Automatic procedures cover changes on the IRS's published list, and other changes use a non-automatic request. Section 481(a) requires an adjustment for the cumulative difference between the old and new methods. A positive adjustment, which increases income, is generally spread over four years, and a negative adjustment is generally taken in the year of change.
Why it matters in an audit or review
A method change moves taxable income between years and changes temporary differences. Auditors find the Form 3115, recompute the adjustment, reflect the deferred tax effect, and distinguish a tax method change from a book change in accounting principle under ASC 250.
Example
Illustrative: a company adopts a new capitalization method and the 481(a) adjustment is a positive $200,000. Spread over four years, taxable income rises by $50,000 in each year. The deferred tax liability at 25% is $50,000 at the change date, reducing by $12,500 each year.
Common mistakes
- Confusing a method change with a correction of an error on an amended return.
- Using the wrong designated change number on Form 3115.
Sources
- Internal Revenue Code sections 446(e) and 481(a)
- IRS, Instructions for Form 3115: https://www.irs.gov/forms-pubs/about-form-3115
- Treas. Reg. 1.446-1(e)
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error