Every snow removal and ice management contractor and business can choose among different methods of accounting for recognizing revenue, and depreciating assets. While no IRS permission is needed when an accounting method is first adopted, approval is needed for subsequent changes.
Fortunately, the IRS will now automatically consent when a small business taxpayer asks to change accounting methods as they are required to do. In fact, the snow removal professional can reach out to the IRS in advance to request permission to change accounting methods. Failure to make the request, even with so-called “automatic” changes can, however, result in penalties.
The term "method of accounting" includes (a) an overall plan of accounting, such as that used for gross income and deductions, and (b) the treatment of any “material item” that involves the proper timing for inclusion in income or claiming the item as a deduction, or both.
Once a snow removal business has begun using a particular method for treating income, expenses, deductions or transactions in a manner that properly reflects income, it is considered to have “adopted” that method of accounting. It is not necessary to treat the item consistently in two or more consecutive returns in order to have “adopted” a method of accounting.
In general, the IRS allows the snow removal operation use either the accrual accounting method or the cash accounting method to track and report financial data. Many businesses also have the option of using a combination of both accounting systems. While there is a great deal of flexibility, there is one catch: the snow removal business must continue to use whatever method was first chosen – unless approval for a change in the method used is requested from the IRS.
The Tax Cuts and Jobs Act (TCJA) enacted in December 2017, expanded the number of small business taxpayers eligible to use the cash method of accounting and exempted many of these small businesses from accounting rules for cost capitalization and long-term contracts. The definition for small businesses now includes most incorporated businesses and partnerships with average annual gross earnings of $25 million or less during the last three years.
The tax laws require every snow and ice removal business to get the permission of the IRS to change a “method of accounting.” In other words, permission is needed whenever the way something is reported on the operation’s tax return is changed. It can be as simple as changing to a newly permitted method of accounting, the timing of income or expense, but not the total amount over time.
IRS permission is required before changing the way things are accounted for – even accounting method changes demanded by an IRS auditor or necessary to comply with new tax laws. And those requests to change accounting methods all require certain adjustments to avoid distorting the snow removal operation’s income and/or deductions.CHANGING FOR SAVINGS
The IRS doesn’t want anyone willy-nilly changing anything that might affect their annual tax bill. After all, changing the “method of accounting” can affect that tax bill. According to our tax laws, the Internal Revenue Code, a change occurs when the method to be used by a taxpayer for an item when computing taxable income is different than the operation’s “established” accounting method.
The IRS’s latest guidelines for changing the way a business accounts for things outlines the steps required for obtaining the advance (non-automatic) consent of the IRS Commissioner to change the snow removal operation’s method of accounting. Those guidelines also outline the procedure for obtaining a so-called “automatic” consent.
AUTOMATIC OR NOT SO AUTOMATIC
In order to obtain the IRS's consent to change a method of accounting, the snow and ice removal business must usually file a Form 3115, Application for Change in Accounting Method, during the taxable year for which the change is proposed. As mentioned, the IRS automatically approves many of the changes requested on Form 3115, but other changes require advance consent.
Obviously, the IRS doesn’t require filing Form 3115 to fix a math error, adjust income or expenses for reasons not involved in the timing of the adjustment or to make certain adjustments to the useful life used for depreciation or amortization. And, no fee is required except when advance consent is requested.
Under a recent IRS Revenue Procedure, taxpayers will be given automatic approval from the IRS to change their method of accounting for a number of listed changes. Instead of amending an earlier-filed tax return, the snow removal business can now simply attach Form 3115 to a timely-filed federal income tax return for the year in which the change applies, as well as sending a copy to the IRS national office.
The IRS’s newly issued Revenue Procedure outlines the procedures every snow removal and ice management business should use when changing their method of accounting – whether to obtain non-automatic consent or automatic consent to change certain methods of accounting for federal income tax purposes. Included within these automatic method changes is a change from an impermissible method of depreciation under which the taxpayer did not claim the depreciation allowable, to a permissible method.
Since the new revenue procedure contains the steps that must be followed in order to make non-automatic changes in methods of accounting, which are changes that require the IRS’s consent, as well as the procedures for applying for automatic changes in accounting methods, which do not require the IRS’s consent.
Obviously, the IRS doesn’t want changes made that might distort the operation’s tax bill. Fortunately, since the IRS doesn’t have the time to consider every accounting method change, it publishes a long list of acceptable “automatic” method changes each year.
ADJUSTMENTS FOR CHANGE
The “adjustment" required whenever accounting methods are changed involves computing the amount necessary to prevent amounts from being duplicated or omitted when the snow removal operation computes its taxable income for the year of change and thereafter using a different accounting method. Of course, the IRS may decide that certain changes in methods of accounting can be made without an adjustment.
The cumulative negative effect (taxpayer favorable) of the change in the taxpayer's method of accounting must be reported as an adjustment, which can be deducted immediately in the taxable year of change. A positive adjustment (unfavorable to the taxpayer) can be amortized and written-off over a period of four consecutive years (beginning with the first year in which the change was applicable).
When there is a change in the method of accounting, taxable income for the tax year before the year of change must be determined under the method of accounting that was then employed. Taxable income for the year of change and the following taxable years must also be determined using the method of accounting for which consent is granted as if that method of accounting had always been used.
When a change in method of accounting is made without an adjustment (for example, on a cut-off basis), generally only those items arising on or after the beginning of the year of change, or other operative date, must be accounted for using the method of accounting for which consent has been granted. Any items arising before the year of change, or other operative date, must continue to be accounted for using the snow removal operation’s previous method of accounting.
The tax rules clearly state that if a taxpayer does not regularly employ a method of accounting that clearly reflects its income the IRS may change the method of accounting to one that, in their opinion, does clearly reflect income.
It is no secret that accounting method changes are frequently required as the result of an IRS audit or examination. In situations where the snow or ice management business is compelled to change its method of accounting, especially a change that results in a positive adjustment The accounting method change will ordinarily be made in the earliest taxable year under examination with a one-year adjustment period.
CATCHING UP FOR SAVINGS
Unfortunately, even automatic changes aren’t free. Digging through old records to determine the catch-up deduction can be time-consuming. However, if a snow removal business has significant depreciable property, it’s probably worth the effort to investigate the advantages – and potential pitfalls – involved in changing accounting methods.
It should be kept in mind that the IRS won’t offer automatic approval for a change in accounting methods if the business is under examination. What’s more, there is no such thing as a “retroactive” change in a method of accounting. Unless specifically authorized by the Commissioner or by law, no one may request, or otherwise make, a retroactive change in method of accounting.
However, with many Forms 3115 filed for non-automatic changes requiring additional information, the IRS recommends filing a Form 3115 as early as possible during the year of change. Naturally, the assistance of a qualified professional will make things go smoother as well as possibly unearthing other areas that might benefit the snow removal and ice management business should ab accounting method be changed.