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Internal Revenue Code, § 481. Adjustments Required By Changes In Method Of Accounting

I.R.C. § 481(a) General Rule
In computing the taxpayer's taxable income for any taxable year (referred to in this section as the “year of the change”)—
I.R.C. § 481(a)(1)
if such computation is under a method of accounting different from the method under which the taxpayer's taxable income for the preceding taxable year was computed, then
I.R.C. § 481(a)(2)
there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted, except there shall not be taken into account any adjustment in respect of any taxable year to which this section does not apply unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer.
I.R.C. § 481(b) Limitation On Tax Where Adjustments Are Substantial
I.R.C. § 481(b)(1) Three Year Allocation
If—
I.R.C. § 481(b)(1)(A)
the method of accounting from which the change is made was used by the taxpayer in computing his taxable income for the 2 taxable years preceding the year of the change, and
I.R.C. § 481(b)(1)(B)
the increase in taxable income for the year of the change which results solely by reason of the adjustments required by subsection (a)(2) exceeds $3,000,
then the tax under this chapter attributable to such increase in taxable income shall not be greater than the aggregate increase in the taxes under this chapter (or under the corresponding provisions of prior revenue laws) which would result if one-third of such increase in taxable income were included in taxable income for the year of the change and one-third of such increase were included for each of the 2 preceding taxable years.
I.R.C. § 481(b)(2) Allocation Under New Method Of Accounting
If—
I.R.C. § 481(b)(2)(A)
the increase in taxable income for the year of the change which results solely by reason of the adjustments required by subsection (a)(2) exceeds $3,000, and
I.R.C. § 481(b)(2)(B)
the taxpayer establishes his taxable income (under the new method of accounting) for one or more taxable years consecutively preceding the taxable year of the change for which the taxpayer in computing taxable income used the method of accounting from which the change is made,
then the tax under this chapter attributable to such increase in taxable income shall not be greater than the net increase in the taxes under this chapter (or under the corresponding provisions of prior revenue laws) which would result if the adjustments required by subsection (a)(2) were allocated to the taxable year or years specified in subparagraph (B) to which they are properly allocable under the new method of accounting and the balance of the adjustments required by subsection (a)(2) was allocated to the taxable year of the change.
I.R.C. § 481(b)(3) Special Rules For Computations Under Paragraphs (1) And (2)
For purposes of this subsection—
I.R.C. § 481(b)(3)(A)
There shall be taken into account the increase or decrease in tax for any taxable year preceding the year of the change to which no adjustment is allocated under paragraph (1) or (2) but which is affected by a net operating loss (as defined in section 172) or by a capital loss carryback or carryover (as defined in section 1212), determined with reference to taxable years with respect to which adjustments under paragraph (1) or (2) are allocated.
I.R.C. § 481(b)(3)(B)
The increase or decrease in the tax for any taxable year for which an assessment of any deficiency, or a credit or refund of any overpayment, is prevented by any law or rule of law, shall be determined by reference to the tax previously determined (within the meaning of section 1314(a)) for such year.
I.R.C. § 481(c) Adjustments Under Regulations
In the case of any change described in subsection (a), the taxpayer may, in such manner and subject to such conditions as the Secretary may by regulations prescribe, take the adjustments required by subsection (a)(2) into account in computing the tax imposed by this chapter for the taxable year or years permitted under such regulations.
I.R.C. § 481(d) Adjustments Attributable To Conversion From S Corporation To C Corporation
I.R.C. § 481(d)(1) In General
In the case of an eligible terminated S corporation, any adjustment required by subsection (a)(2) which is attributable to such corporation's revocation described in paragraph (2)(A)(ii) shall be taken into account ratably during the 6-taxable year period beginning with the year of change.
I.R.C. § 481(d)(2) Eligible Terminated S Corporation
For purposes of this subsection, the term “eligible terminated S corporation” means any C corporation—
I.R.C. § 481(d)(2)(A)
which—
I.R.C. § 481(d)(2)(A)(i)
was an S corporation on the day before the date of the enactment of the Tax Cuts and Jobs Act, and
I.R.C. § 481(d)(2)(A)(ii)
during the 2-year period beginning on the date of such enactment makes a revocation of its election under section 1362(a), and
I.R.C. § 481(d)(2)(B)
the owners of the stock of which, determined on the date such revocation is made, are the same owners (and in identical proportions) as on the date of such enactment.
(Aug. 16, 1954, ch. 736, 68A Stat. 160; Sept. 2, 1958, Pub. L. 85-866, title I, Sec. 29(a), (b), 72 Stat. 1626-1628; Dec. 30, 1969, Pub. L. 91-172, title V, Sec. 512(f)(4), 83 Stat. 641; Oct. 4, 1976, Pub. L. 94-455, title XIX, Sec. 1901(a)(70), 1906(b)(13)(A), 90 Stat. 1776, 1834; Oct. 19, 1980, Pub. L. 96-471, Sec. 2(b)(3), 94 Stat. 2254; Pub. L. 105-34, title IX, X, Sec. 961(b)(2), 1004(b)(2)(C), 1042(b)(1), 1088(b)(2), Aug. 5, 1997, 111 Stat 788; Pub. L. 113-295, Div. A, title II, Sec. 221(a)(61), Dec. 19, 2014, 128 Stat. 4010; Pub. L. 115-97, title I, Sec. 13543(a), Dec. 22, 2017, 131 Stat. 2054.)
BACKGROUND NOTES
Amendments to Part
1964--Pub. L. 88-272, title II, 224(b), Feb. 26, 1964, 78 Stat. 79, added item 483.
AMENDMENTS
2017 - Subsec. (d). Pub. L. 115-97, Sec. 13543(a), added subsec. (d).
2014 - Subsec. (b)(3)(C). Pub. L. 113-295, Div. A, Sec. 221(a)(61), struck subpar. (C). Before being struck, it read as follows:
“(C) In applying section 7807(b)(1), the provisions of chapter 1 (other than subchapter E, relating to self-employment income) and chapter 2 of the Internal Revenue Code of 1939 shall be treated as the corresponding provisions of the Internal Revenue Code of 1939.”
1980 - Subsec. (d). Pub. L. 96-471 struck out subsec. (d) which provided that this section was not to apply to a change to which section 453 of this title, relating to change to installment method, applied.
1976 - Subsecs. (b)(1), (2). Pub. L. 94-455, Sec. 1901(a)(70)(B), struck out ‘, other than the amount of such adjustments to which paragraph (4) or (5) applies,’ after ‘required by subsection (a)(2)’.
Subsec. (b)(4), (5), (6). Pub. L. 94-455, Sec. 1901(a)(70)(A), struck out par. (4) which related to special rule for pre-1954 general adjustments, par. (5) which related to special rule for pre-1954 adjustments in case of certain decedents, and par. (6) which related to the application of the special rule for pre-1954 general adjustments.
Subsec. (c). Pub. L. 94-455, Sec. 1906(b)(13)(A), struck out ‘or his delegate’ after ‘Secretary’.
1969 - Subsec. (b)(3)(A). Pub. L. 91-172 substituted ‘loss carryback or carryover’ for ‘loss carryover’.
1958 - Subsec. (a)(2). Pub. L. 85-866, Sec. 29(a)(1), inserted ‘unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer’, after ‘does not apply’.
Subsec. (b)(1). Pub. L. 85-866, Sec. 29(b)(1)-(3), inserted ‘, other than the amount of such adjustments to which paragraph (4) or (5) applies,’ after ‘subsection (a)(2)’ and substituted ‘the aggregate increase in the taxes’ for ‘the aggregate of the taxes’ and ‘which would result if one-third of such increase in taxable income’ for ‘which would result if one-third of such increase’.
Subsec. (b)(2). Pub. L. 85-866, Sec. 29(b)(1), (4), inserted ‘other than the amount of such adjustments to which paragraph (4) or (5) applies,’ after ‘subsection (a)(2)’, wherever appearing and ‘(or under the corresponding provisions of prior revenue laws)’ after ‘the net increase in the taxes under this Chapter’.
Subsec. (b)(3)(A). Pub. L. 85-866, Sec. 29(b)(5), substituted ‘paragraph (1) or (2)’ for ‘paragraph (2)’, wherever appearing.
Subsec. (b)(4) to (6). Pub. L. 85-866, Sec. 29(a)(2), added pars. (4) to (6).
EFFECTIVE DATE OF 2017 AMENDMENT
Amendment by Pub. L. 115-97, Sec. 13543(a), effective on the date of enactment of this Act [Enacted: Dec. 22, 2017].
EFFECTIVE DATE OF 2014 AMENDMENT
Amendment by Pub. L. 113-295, Div. A, Sec. 221(a)(61), effective on the date of the enactment of this Act [Enacted: Dec. 19, 2014].
Section 221(b)(2) of Pub. L. 113-295, Div. A, provided the following Savings Provision:
“(2) SAVINGS PROVISION.—If—
“(A) any provision amended or repealed by the amendments made by this section applied to—
“(i) any transaction occurring before the date of the enactment of this Act [Enacted: Dec. 19, 2014],
“(ii) any property acquired before such date of enactment, or
“(iii) any item of income, loss, deduction, or credit taken into account before such date of enactment, and
“(B) the treatment of such transaction, property, or item under such provision would (without regard to the amendments or repeals made by this section) affect the liability for tax for periods ending after date of enactment, nothing in the amendments or repeals made by this section shall be construed to affect the treatment of such transaction, property, or item for purposes of determining liability for tax for periods ending after such date of enactment.”
EFFECTIVE DATE OF 1980 AMENDMENT
For effective date of amendment by Pub. L. 96-471, see section 6(a)(1) of Pub. L. 96-471, set out as an Effective Date note under section 453 of this title.
EFFECTIVE DATE OF 1976 AMENDMENT
Amendment by section 1901(a)(70) of Pub. L. 94-455 effective for taxable years beginning after Dec. 31, 1976, see section 1901(d) of Pub. L. 94-455, set out as a note under section 2 of this title.
EFFECTIVE DATE OF 1969 AMENDMENT
Amendment by Pub. L. 91-172 applicable with respect to net capital losses sustained in taxable years beginning after Dec. 31, 1969, see section 512(g) of Pub. L. 91-172, set out as a note under section 1212 of this title.
EFFECTIVE DATE OF 1958 AMENDMENT
Section 29(d) of Pub. L. 85-866, as amended by Pub. L. 99-514, Sec. 2, Oct. 22, 1986, 100 Stat. 2095, provided that:
‘(1) In general. - The amendments made by this section (amending this section and section 381 of this title) shall apply with respect to any change in a method of accounting where the year of the change (within the meaning of section 481 of the Internal Revenue Code of 1986 (formerly I.R.C. 1954)) is a taxable year beginning after December 31, 1953, and ending after August 16, 1954.
‘(2) Exception for certain agreements. - The amendments made by subsections (a), (b)(I), and (c) (amending this section and section 381 of this title) shall not apply if before the date of the enactment of this Act (Sept. 2, 1958) -
‘(A) the taxpayer applied for a change in the method of accounting in the manner provided by regulations prescribed by the Secretary of the Treasury or his delegate, and
‘(B) the taxpayer and the Secretary of the Treasury or his delegate agreed to the terms and conditions for making the change.’
COORDINATION WITH SECTION 481
Sec. 13221(d) of Pub. L. 115-97 provided:
“(1) IN GENERAL.
“In the case of any qualified change in method of accounting for the taxpayer's first taxable year beginning after December 31, 2017—
“(A) such change shall be treated as initiated by the taxpayer, and
“(B) such change shall be treated as made with the consent of the Secretary of the Treasury.
“(2) QUALIFIED CHANGE IN METHOD OF ACCOUNTING.
“For purposes of this subsection, the term “qualified change in method of accounting” means any change in method of accounting which—
“(A) is required by the amendments made by this section, or
“(B) was prohibited under the Internal Revenue Code of 1986 prior to such amendments and is permitted under such Code after such amendments.”
CERTAIN ADJUSTMENTS NOT TO APPLY
Sec. 403(s)(2) of Pub. L. 109-135 amended Pub. L. 108-357, Sec. 708 by redesignating 708(d) as 708(e) and adding (d), which provided that:
”(d) Certain Adjustments Not to Apply- Section 481 of the Internal Revenue Code of 1986 shall not apply with respect to any change in the method of accounting which is required by this section.”
CHANGE IN METHOD OF ACCOUNTING
Sec. 7003(c)(2) of Pub. L. 105-206 provided that:
“In the case of any taxpayer required by the amendments made by this section to change its method of accounting for its first taxable year ending after the date of the enactment of this Act--
“(A) such change shall be treated as initiated by the taxpayer,
“(B) such change shall be treated as made with the consent of the Secretary of the Treasury, and
“(C) the net amount of the adjustments required to be taken into account by the taxpayer under section 481 of the Internal Revenue Code of 1986 shall be taken into account ratably over the 4-taxable year period beginning with such first taxable year.”
CHANGE IN METHOD OF ACCOUNTING
Sec. 7001(b)(2) of Pub. L. 105-206 provided that:
“ In the case of any taxpayer required by the amendment made by subsection (a) to change its method of accounting for its first taxable year ending after the date of the enactment of this Act--
“(A) such change shall be treated as initiated by the taxpayer,
“(B) such change shall be treated as made with the consent of the Secretary of the Treasury, and
“(C) the net amount of the adjustments required to be taken into account by the taxpayer under section 481 of the Internal Revenue Code of 1986 shall be taken into account ratably over the 3-taxable year period beginning with such first taxable year.”
DETERMINATION OF ORIGINAL ISSUE DISCOUNT WHERE POOLED DEBT OBLIGATIONS SUBJECT TO ACCELERATION
In the case of any taxpayer required by this section [Pub. L. 105-34, Sec. 1004 amending section 481] to change its method of accounting for its first taxable year beginning after the date of the enactment of this Act--
(A) such change shall be treated as initiated by the taxpayer,
(B) such change shall be treated as made with the consent of the Secretary of the Treasury, and
(C) the net amount of the adjustments required to be taken into account by the taxpayer under section 481 of the Internal Revenue Code of 1986 shall be taken into account ratably over the 4-taxable year period beginning with such first taxable year.
TREATMENT OF EXCEPTION FROM INSTALLMENT SALES RULES FOR SALES OF PROPERTY BY A MANUFACTURER TO A DEALER
In the case of any taxpayer required by this section [Pub. L. 105-34, Sec. 1088, as amended by Pub. L. 105-206, Sec. 6010(q), amending section 481] to change its method of accounting for any taxable year--
(A) such change shall be treated as initiated by the taxpayer,
(B) such change shall be treated as made with the consent of the Secretary of the Treasury, and
(C) the net amount of the adjustments required to be taken into account by the taxpayer under section 481 of the Internal Revenue Code of 1986 shall be taken into account ratably over the 4-taxable year period beginning with the first taxable year beginning more than 1 year after the date of the enactment of this Act [Enacted: Aug. 5, 1997].
COORDINATION WITH SECTION 471
In the case of any taxpayer permitted by this section [Pub. L. 105-34, Sec. 961 amending section 471] to change its method of accounting to a permissible method for any taxable year--
(A) such changes shall be treated as initiated by the taxpayer,
(B) such changes shall be treated as made with the consent of the Secretary of the Treasury, and
(C) the period for taking into account the adjustments under section 481 by reason of such change shall be 4 years.
SECTION 501(m) ORGANIZATIONS
Pub. L. 105-34, Sec. 1042(b) provided that:
“In the case of an organization to which section 501(m) of the Internal Revenue Code of 1986 applies solely by reason of the amendment made by subsection (a)--
(1) no adjustment shall be made under section 481 (or any other provision) of such Code on account of a change in its method of accounting for its first taxable year beginning after December 31, 1997, and
(2) for purposes of determining gain or loss, the adjusted basis of any asset held on the 1st day of such taxable year shall be treated as equal to its fair market value as of such day.”
LIMITATION ON LOSS RECOGNITION AND ON DEDUCTION FOR RESERVE INCREASES
Pub. L. 104-188, Sec. 1612(c)(3), Aug. 20, 1996, 110 Stat. 1755, provided that:
“(3) Limitation on loss recognition and on deduction for reserve increases.--
(A) Limitation on loss recognition.--
(i) In general.--The aggregate loss recognized by reason of the application of section 481 of the Internal Revenue Code of 1986 with respect to section 817A(b) of such Code (as added by this section) for the first taxable year of the taxpayer beginning after December 31, 1995, shall not exceed the amount included in the taxpayer's gross income for such year by reason of the excess (if any) of--
(I) the amount of life insurance reserves as of the close of the prior taxable year, over
(II) the amount of such reserves as of the beginning of such first taxable year,
to the extent such excess is attributable to subsection (a) of such section 817A. Notwithstanding the preceding sentence, the adjusted basis of each segregated asset shall be determined as if all such losses were recognized.
(ii) Disallowed loss allowed over period.--The amount of the loss which is not allowed under clause (i) shall be allowed ratably over the period of 7 taxable years beginning with the taxpayer's first taxable year beginning after December 31, 1995.
(B) Limitation on deduction for increase in reserves.--
(i) In general.--The deduction allowed for the first taxable year of the taxpayer beginning after December 31, 1995, by reason of the application of section 481 of such Code with respect to section 817A(a) of such Code (as added by this section) shall not exceed the aggregate built-in gain recognized by reason of the application of such section 481 with respect to section 817A(b) of such Code (as added by this section) for such first taxable year.
(ii) Disallowed deduction allowed over period.--The amount of the deduction which is disallowed under clause (i) shall be allowed ratably over the period of 7 taxable years beginning with the taxpayer's first taxable year beginning after December 31, 1995.
(iii) Built-in gain.--For purposes of this subparagraph, the built-in gain on an asset is the amount equal to the excess of--
(I) the fair market value of the asset as of the beginning of the first taxable year of the taxpayer beginning after December 31, 1995, over
(II) the adjusted basis of such asset as of such time.”
CHANGES IN TREATMENT OF POLICYHOLDER DIVIDENDS BY QUALIFIED GROUP SELF-INSURERS' FUNDS
Pub. L. 101-239, title VII, Sec. 7816(m), Dec. 19, 1989, 103 Stat. 2421, provided that: ‘If, for the 1st taxable year beginning on or after January 1, 1987, a qualified group self-insurers’ fund changes its treatment of policyholder dividends to take into account such dividends no earlier than the date that the State regulatory authority determines the amount of the policyholder dividend that may be paid, then such change shall be treated as a change in a method of accounting and no adjustment under section 481(a) of the Internal Revenue Code of 1986 shall be made with respect to such change in method of accounting.'
TRANSITIONAL PROVISIONS FOR INCOME TAX TREATMENT OF DEALER RESERVE INCOME
Pub. L. 86-459, May 13, 1960, 74 Stat. 124, authorized any person who computed taxable income under the accrual method of accounting for his most recent taxable year ending on or before June 22, 1959, and who treated dealer reserve income for such taxable year as accruable for a subsequent taxable year, to elect before Sept. 1, 1960, to have section 481 of this title apply to the treatment for income tax purposes of dealer reserve income.
ELECTION TO RETURN TO FORMER METHOD OF ACCOUNTING
Section 29(e) of Pub. L. 85-866 authorized an election by certain taxpayers, who, for any taxable years beginning after Dec. 31, 1953, and ending after Aug. 16, 1954, and before Sept. 2, 1958, computed their taxable incomes using different accounting methods in succeeding taxable years, to return to their first method of accounting, where the election was made within six months after Sept. 2, 1958. Claims for refunds of overpayments of tax resulting from the election were to be filed within one year after the date of the election. Such an election was to be considered a consent to an assessment of a deficiency resulting from the election, where the assessment is made within one year after the date of the election.