By George G. Jones and Mark A. Luscombe

In early May, several pronouncements were issued by the Internal Revenue Service in connection with changes in accounting periods.

The guidance reflects the continuing effort by the IRS to identify areas in which requests to adopt, change or retain accounting periods can be allowed automatically or otherwise expedited, freeing up government resources for other matters. In general, the guidance should be very helpful to taxpayers and tax practitioners who are looking to switch accounting periods to a more logical (or tax efficient) timeframe.

Notices 2001-34 and 2001-35 had pointed to the direction that the IRS was hoping to go with respect to changes in accounting periods. Rev. Proc. 2002-38 now has finalized the guidance in Notice 2001-35 with respect to automatic approval procedures for accounting periods for partnerships, S corporations, electing S corporations and professional service corporations.

Rev. Proc. 2002-39 has finalized the guidance in Notice 2001-34 with respect to requests for changes in accounting periods. Rev. Proc. 2002-37, issued at the same time, provides automatic approval procedures with respect to corporations. Announcement 2002-53 provides a summary of the tax service’s thinking in finalizing its guidance and consideration of comments received in response to the notices.

Rev. Proc. 2002-37

Rev. Proc. 2002-37 specifies the procedures that certain corporations are required to follow to be considered to have automatic approval for a change in their annual accounting period. A corporation complying with the new procedures will be deemed to have established a sufficient business purpose and to have obtained IRS approval for the change.

The revenue procedure states that it is the exclusive procedure to be used by corporations within its scope and then specifies in detail the types of corporations covered or excluded. The final guidance provides more flexibility for changing to or from a 52- to 53-week tax year and for changes to, or retention of, a natural business year by a corporation that satisfies the 25 percent gross receipts test.

The final guidance shortens from six years to 48 months, the required time between a requested change, and a prior accounting period change and adds to the list of changes that will not be considered prior changes for purposes of the new 48-month rule.

The revenue procedure also adds to the list of corporations outside of the scope of the procedure in the areas of interests in a pass-through entity, controlled foreign corporations, foreign personal

holding companies and corporations with a required tax year.

Guidance is also added with respect to exceptions to the record keeping/bookkeeping conformity rule and the prevention of the carryback of capital losses generated in the short period resulting from the accounting period change.

Rev. Proc. 2002-37 is effective for all changes in annual accounting periods for which the first effective year ends on or after May 10, 2002, although procedures are provided for corporations to elect earlier application of the guidance.

Rev. Proc. 2002-38

Revenue Procedure 2002-38 provides the exclusive procedures for certain partnerships, S corporations, electing S corporations and personal service corporations, to obtain automatic approval to adopt, change or retain an annual accounting period.

Consistent with the changes for corporations promulgated in Rev. Proc. 2002-37, this procedure also provides more flexibility in changing to or from a 52- to 53-week tax year, changes to a required or natural business year satisfying the 25 percent gross receipts test, the new 48-month period between the requested change and the prior accounting period change and the restrictions on the carryback of capital losses from the short period. This guidance also includes changes to a year corresponding to the ownership.

The guidance specifies that, under certain circumstances, a partnership can retain its current tax year for one year, even though a minor percentage change in ownership would have otherwise required a change in the tax year. Also, a professional service corporation may automatically change its tax year even if it makes an S corporation election for the tax year immediately following the short period. Restrictions are imposed on using the guidance to change an annual accounting period while under examination.

The guidance also permits S corporations and electing S corporations to disregard the ownership interests of certain tax-exempt entities when determining their tax year.

Except in specified circumstances, the entities that are subject to Rev. Proc. 2002-38 will be required to compute their income and keep their books and records (including financial statements) on the basis of the requested tax year. The guidance also extends the due date for filing a Form 1128 to the due date of the taxpayer’s federal income tax return (including extensions) for the first effective year, and provides audit protection for accounting period changes made within the scope of the procedure.

Like Rev. Proc. 2002-37, Rev. Proc. 2002-38 is effective for adoptions, changes or retentions of annual accounting periods for which the first effective year ends on or after May 10, 2002. It also provides for similar elections of retroactive application.

Rev. Proc. 2002-39

In contrast to the automatic procedures for corporations and pass-through entities that are covered in Rev. Procs. 2002-37 and 2002-38, Rev. Proc. 2002-39 provides guidance to all taxpayers when obtaining IRS approval to adopt, change or retain an annual accounting period and for establishing a business purpose for the change.

The business purpose requirement is a facts-and-circumstances test, although a business purpose is deemed satisfied for an accounting period that corresponds to the taxpayer’s required tax year, ownership tax year or natural business year (with the natural business year again based on the 25 percent gross receipts test).

Safe harbors are provided in connection with annual business cycles and seasonal businesses. The revenue procedure states that the safe harbors are designed to require reliance on a facts-and-circumstances test only in rare situations. Excepted from the scope of this general guidance are, on one side of the equation, requests for automatic approval, and, on the other, requests in which the taxpayer is under examination or where the accounting period is already an issue in a proceeding.

On the former exception, the IRS advised taxpayers to check the rules for automatic approval before filing a request with the IRS for a change. Some taxpayers, nevertheless, may wish the comfort of being rejected for approval under Rev. Proc. 2002-39 because they qualify for automatic approval before changing their year-end strategies and other tax planning to reflect their new tax year period.

The effective date for Rev. Proc. 2002-39 is generally for applications filed on or after May 10, 2002. Again, a taxpayer may request retroactive application of the procedure to a request pending on May 10, 2002.


The finalized guidance on changes of accounting periods is, on the whole, taxpayer friendly and should be well received by the tax practitioner community. The automatic approval procedures and safe harbors for requesting changes should provide much greater certainty to taxpayers and free IRS resources to address other matters.

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