IRS updates accounting method change for some terminated S corporations

Tax Hot Topics newsletterThe IRS has issued Rev. Proc. 2018-44, which updates the automatic method change to convert from a cash method to an accrual method of accounting for a C corporation’s first taxable year after it revokes its S corporation election. The update was required to implement a statute change made by P.L. 115-97, commonly referred to as the Tax Cuts and Jobs Act (TCJA) and only applies to eligible S corporations that terminate during the two-year period beginning on Dec. 22, 2017. This procedure modifies the current comprehensive list of automatic method changes found in Rev. Proc. 2018-31. For more details, read our Tax Flash.

The TCJA added Section 481(d) to provide a special rule for newly converted C corporations required to change from an overall cash method of accounting to an overall accrual method because of the revocation of an S corporation election under Section 1362(a). The Section 481(a) adjustment period for changes made pursuant to Section 15.01 of Rev. Proc. 2018-31 by eligible terminated S corporations is modified to a six-year spread period for all Section 481(a) adjustments, regardless of whether they are positive or negative adjustments, beginning with the year of change. This is in lieu of the standard four-year period for positive adjustments and one-year period for negative adjustments provided in Section 7.03(1) of Rev. Proc. 2015-13. Additionally, C corporations eligible to continue to use the cash method after the revocation that voluntarily file a change to the overall accrual method may opt to use the six-year adjustment period. This six-year Section 481(a) adjustment period does not apply to any other method changes that may be attributable to the revocation of the S election. 

In order to be eligible to apply these procedures, an S corporation must: (1) be an S corporation on Dec. 21, 2017, (2) revoke its S election after Dec. 21, 2017, but before Dec. 22, 2019, and (3) have the same owners of stock in identical proportions on Dec. 22, 2017, and the revocation date.

The guidance does not address what happens if the S corporation has a qualified subchapter S subsidiary (Qsub). When the S corporation revokes its S election, the Qsub election also terminates. Under Section 1361(b)(3)(C) the S corporation is effectively treated as contributing all of the Qsub’s assets and liabilities to a new corporation in a Section 351 transaction. Because a new corporation generally adopts methods of accounting on a prospective basis (other than depreciation and amortization), no method change would be required or allowed for the receivables and payables of the Qsub that are dropped into the new corporation.

It is unclear whether Congress intended the six-year Section 481(a) adjustment to apply to new methods of a terminated Qsub that becomes a C corporation as a result of the parent S corporation’s revocation of its S election. Thus, taxpayers should give careful consideration to this issue when determining whether to revoke the S election of a cash-basis S corporation that owns one or more Qsubs through which it operates its trade or business. In some instances, certain self-help measures may be available to ameliorate the issue.

Sharon Kay
Partner, Accounting Methods
Washington National Tax Office
T +1 202 861 4140

Bryan Keith
Managing Director
Washington National Tax Office
T  +1 202 861 4116

Caleb Cordonnier
Washington National Tax Office
T +1 202 521 1555

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