United States

IRS updates automatic method change for terminated S corporations

TAX ALERT  | 

On Aug. 22, 2018, the IRS released Rev. Proc. 2018-44, which provides guidance for overall cash to accrual method changes by eligible terminated S corporations. Rev. Proc. 2018-44 modifies section 15.01(3) of Rev. Proc. 2018-31 to incorporate changes to section 481 made by the recent tax reform legislation (commonly referred to as the Tax Cuts and Jobs Act, or TCJA).

Background

Section 448 generally prohibits C corporations from using the overall cash method of accounting, subject to certain exceptions. An S corporation may be permitted to use the cash method in circumstances under which the Code would require the accrual method for a C corporation. Accordingly, termination of S corporation status by revocation may require a change in method of accounting, and may further create a short taxable year. Changing between the cash and accrual methods of accounting may require an adjustment under section 481(a). Section 15.01 of Rev. Proc. 2018‑31 contains the procedures for making an automatic method change from the overall cash to the accrual method.

TCJA added new section 481(d) to the Code, which requires eligible terminated S corporations to take into account ratably over six years any section 481(a) adjustment attributable to a corporation’s revocation of its S corporation election under section 1362. An eligible terminated S corporation includes any C corporation that (1) was an S corporation on Dec. 21, 2017; (2) revokes its S corporation election after Dec. 21, 2017, but before Dec. 22, 2019; and (3) has the same owners of stock in identical proportions on Dec. 22, 2017 and the revocation date.

Rev. Proc. 2018-44

Rev. Proc. 2018-44 requires an eligible terminated S corporation to take a positive or negative section 481(a) adjustment ratably over six years beginning with the year of change if the corporation:

  1. must change from the overall cash method to an overall accrual method as a result of a revocation of its S corporation election; and
  2. makes this method change for the first taxable year of the C corporation.

Alternatively, Rev. Proc. 2018-44 permits (but does not require) a taxpayer to take a positive or negative section 481(a) adjustment ratably over six years in the case of an eligible terminated S corporation:

  1. permitted to continue using the cash method after the revocation of its S corporation election; and
  2. that changes to an overall accrual method for the first taxable year of the C corporation.

Rev. Proc. 2018-44 specifically states that the Rev. Proc. does not cover other changes in method of accounting and resulting section 481(a) adjustments attributable to the revocation of an S corporation election.   

Takeaways

Taxpayers changing from an S corporation to a C corporation to take advantage of the lower corporate rates attributable to the TCJA should consider their methods of accounting and consult with their tax professionals to evaluate whether a change in overall method may be required or otherwise advantageous.

TCJA added section 481(d) and created the six-year adjustment period back in December, and taxpayers waited some nine months for guidance on how to implement the new rules in a method change. This illustrates how important it is for taxpayers to stay informed as TCJA-related guidance continues to roll out. Check RSM’s Tax Reform Resource Center for the latest analysis on this and other developments related to tax reform.

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