Rev. Rul. 84-27
1984-1 C.B. 126, 1984-8 I.R.B. 4.
Internal Revenue Service
Revenue Ruling
ACCOUNTING METHODS; CHANGE; LONG-TERM CONTRACTS
Published: February 21, 1984
SECTION 446. - -GENERAL RULE FOR METHODS OF ACCOUNTING, 26 CFR 1.446-1: General rule for methods of accounting
(Also Sections 451, 481; 1.451-3, 1.481-5.)
Accounting methods; change; long-term contracts. A taxpayer who uses the completed contract method of accounting, and wishes to change from reporting income when each contract is substantially completed to reporting income when each contract is finally completed in order to comply with the regulations, must apply for the Commissioner's consent to a change in method of accounting.
ISSUE
Is a change in reporting income under the completed contract method of accounting from reporting income when each long-term contract is substantially completed to reporting income when each contract is finally completed a change in method of accounting?
FACTS
The taxpayer, a domestic corporation, elected the completed contract method of accounting under section 1.451-3(d) of the Income Tax Regulations to report its gross income for federal income tax purposes. It had been the consistent practice of the taxpayer for several years to report gross income when each contract was substantially completed but not finally completed and accepted. In 1981, the taxpayer began reporting income from each contract when it was finally completed and accepted by the customer. This was done without applying for a change in method of accounting on Form 3115, Application for Change in Accounting Method, with the Internal Revenue Service. This change resulted in reporting income in a different taxable year than under the method used in the preceding taxable year.
LAW AND ANALYSIS
Section 1.446-1(e)(2)(i) of the regulations provides that, except as otherwise expressly provided in the Internal Revenue Code and regulations thereunder, a taxpayer must secure the Commissioner's consent before changing its method of accounting. Consent is required even if the taxpayer's current method is improper.
Section 1.446-1(e)(2)(ii)(a) of the regulations provides that a change in the method of accounting includes a change in the treatment of any material item in an overall plan of accounting. A material item is any item that involves the proper time for the inclusion of the item in income or the taking of a deduction. Section 1.446-1(e)(2)(ii)(b) provides that a change in accounting method does not include correction of mathematical or posting errors.
Section 1.446-1(e)(3)(i) of the regulations provides that the taxpayer, in order to secure the Commissioner's consent to change a method of accounting, must file an application on Form 3115, with the Commissioner of Internal Revenue, Attn: CC:C:C:1, Washington, D.C. 20224, within 180 days after the beginning of the taxable year in which it is desired to make the change.
Section 1.451-3(b)(2) of the regulations provides that a long-term contract will not be considered "completed" until final completion and acceptance have occurred.
Section 1.451-3(d)(1) of the regulations provides that under the completed contract method of accounting, gross income derived from long-term contracts must be reported by including the gross contract price of each contract in gross income for the taxable year in which the contract is completed.
Section 481(a) of the Code requires that those adjustments necessary to prevent amounts from being duplicated or omitted be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding taxable year. Section 481(c) and section 1.481-5 of the regulations provide that the adjustments required by section 481(a) may be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer.
In H. F. Campbell Company v. Commissioner, 53 T.C. 439 (1969), as supplemented by, 54 T.C. 1021 (1970), aff'd, 443 F.2d 965 (6th Cir.1971), the taxpayer elected to use the completed contract method of accounting. The taxpayer reported income from each contract when the following criteria were met (1) physical completion, (2) customer acceptance, (3) recordation of all costs, and (4) computation of the final bill. Following an examination by the Service, the taxpayer changed to a method of reporting income under the completed contract method by using only the first two criteria. This change was made without the Commissioner's permission and was not dictated by the Service. The Tax Court held that this was a change in method of accounting since the taxable income shown in Campbell's income tax return for 1962 was computed under a method of accounting different from the method
under which the taxpayer's taxable income for the preceding taxable year was computed.
Under the regulations a change in method of accounting includes adjustments to any item of income or deduction that involves the proper time for the inclusion of the item in income or the taking of a deduction. In this case, prior to 1981 the taxpayer reported income from each long-term contract in a year preceding the year in which each contract was finally completed and accepted. The change in 1981 to reporting of income from each long-term contract in the year each contract was finally completed and accepted under section 1.451-3(b)(2) of the regulations resulted in the shifting of income or loss from one taxable year to another. This change is similar to the change in H. F. Campbell, which was held to be a change in method of accounting.
HOLDING
A change in reporting income under the completed contract method of accounting from when each contract is substantially completed to the reporting of income when each contract is finally completed to comply with section 1.451- 3(b)(2) of the regulations is a change in method of accounting and is subject to the provisions of sections 446 and 481 of the Code and regulations thereunder.
This ruling is identified as a designated ruling pursuant to section 5.12(2) of the Rev. Proc. 80-51, 1980-2 C.B. 818.
Rev. Rul. 84-27, 1984-1 C.B. 126, 1984-8 I.R.B. 4.