Rev. Proc. 82-19

SECTION 1. PURPOSE

.01 The purpose of this revenue procedure is to provide a procedure whereby taxpayers may expeditiously obtain consent to change their method of accounting for deducting bad debts from the specific charge-off method as provided in section 166(a) of the Internal Revenue Code to the reserve method as provided in section 166(c). Taxpayers complying with this revenue procedure will be deemed to have obtained the consent of the Commissioner of Internal Revenue to change to the reserve method for deducting bad debts.

.02 This revenue procedure supersedes Rev. Proc. 64-51, 1964-2 C.B. 1003, as amplified and modified by Rev. Proc. 70-15, 1970-1 C.B. 441, and Rev. Proc. 77-39, 1977-2 C.B. 573.

SEC. 2. BACKGROUND

.01 Section 446(e) of the Code and section 1.446-1(e) of the Income Tax Regulations provide that in order to change a method of accounting for federal income tax purposes, the taxpayer must obtain the consent of the Commissioner. Section 1.446-1(e)(3)(i) requires that in order to obtain the consent, an application, Form 3115, Application for Change in Accounting Method, must be made within 180 days after the beginning of the tax year in which the proposed change is requested to be made. Section 1.446-1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to a change in its method of accounting in accordance with section 446(e).

.02 Section 481(a) of the Code requires that those adjustments necessary to prevent amounts from being duplicated or omitted be taken into account when the taxpayer's taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding tax year. Section 481(c) and section 1.481-5 of the regulations provide that the adjustment required by section 481(a) may be taken into account in determining taxable income in the manner and subject to the conditions agreed to by the Commissioner and the taxpayer.

.03 Under Rev. Proc. 64-51, as amplified and modified by Rev. Proc. 70-15 and Rev. Proc. 77-39, a taxpayer could expeditiously change its method of accounting for bad debts from the specific charge-off method to the reserve method by filing an application on Form 3115 with the Commissioner within 180 days after the beginning of the tax year in which the change is to be effected (year of change). Under the above cited revenue procedure, unless a letter was received by the taxpayer from the Commissioner denying permission to change to the reserve method because the Form 3115 was not timely filed it could be assumed by the taxpayer that the change had been granted and the taxpayer was required to attach a copy of the Form 3115 to the income tax return filed for the tax year of change. Taxpayers had to comply with all the specific conditions of Rev. Proc. 64-51, as amplified and modified, for the change to be deemed to have been made with the consent of the Commissioner.

SEC. 3. CHANGES

.01 This revenue procedure contains several major changes and amplifications in the procedures for obtaining the Commissioner's consent to a change in method of accounting for bad debts from the specific charge-off method to the reserve method. These changes and amplifications are intended to facilitate the manner in which the change can be affected as well as to update Rev. Proc. 64-51 to include many of the basic requirements of Rev. Proc. 80-51, 1980-2 C.B. 818. Rev. Proc. 80-51 contains the general procedures for changing a method of accounting. This section highlights the major changes and amplifications for processing bad debt cases.

.02 Section 4.01 waives the 180 day rule of section 1.446-1(e)(3)(i) of the regulations and grants consent to taxpayers to change their method of accounting in accordance with the provisions of this revenue procedure by filing a current Form 3115 in the manner described in section 8 of this revenue procedure and by otherwise complying with the provisions of this revenue procedure.

.03 Section 4.02 provides that the initial reserve for bad debts (the adjustment under section 481 of the Code or the "section 481(a) adjustment") is computed as of the beginning of the year of change. Under Rev. Proc. 64-51 taxpayers were permitted to compute the initial reserve as of the end of the year of change.

.04 Section 4.04 provides how the appropriate period for taking into account the section 481(a) adjustment is determined. Under Rev. Proc. 64-51 the adjustment was always taken into account ratably over 10 years.

.05 Section 4.08 provides that taxpayers that change from the specific charge-off to the reserve method for bad debts must keep their books and records for the year of change and for later tax years on the reserve method. Taxpayers, other than those discussed in section 4.12, must use the reserve method for all reports to shareholders, financial statements and statements for credit purposes.

.06 Section 4.11 provides that to the extent the portion of the negative section 481(a) adjustment to be taken into account in the year of change creates or increases an existing net operating loss, that amount may not be carried back to earlier tax years but must be carried forward to later tax years.

.07 Section 8.01 sets forth procedures taxpayers are to follow to receive the Commissioner's consent under this revenue procedure. The current Form 3115 is to be filed in duplicate; the original is to be filed with the taxpayer's timely filed federal income tax return filed for the year of change and the copy is to be sent to the National Office anytime during the first 270 days of the year of change. Thus, taxpayers are required to notify the National Office of their intention to invoke the provisions of this revenue procedure prior to the filing of their federal income tax return for the year of change.

SEC. 4. APPLICATION

.01 In accordance with section 1.446-1(e)(3)(ii) of the regulations the 180 day rule is waived and under section 1.446-1(e)(2)(i) consent is hereby granted to taxpayers to change from the specific charge-off method of accounting to the reserve method of accounting for bad debts. Consent to change is granted for the tax year for which the taxpayer requests a change (year of change) by filing a current Form 3115 for the year of change in accordance with section 8 of this revenue procedure and by otherwise complying with the provisions of this revenue procedure.

.02 An adjustment computed as of the beginning of the year of change is required under section 481(a) of the Code and the regulations thereunder when the change in method of accounting is made under the provisions of this revenue procedure. The amount of the adjustment is the amount of a reasonable reserve for bad debts that the taxpayer would have had as of the end of the tax year immediately preceding the year of change and represents a decrease in income. The adjustment, which is negative, referred to as the "section 481(a) adjustment" shall be taken into account in computing taxable income and in computing earnings and profits (see Rev. Proc. 79-47, 1979-2 C.B. 528, as to earnings and profits) as provided in 4.04 below. The approved change shall be considered to be a voluntary change initiated by the taxpayer.

.03 The amount of the section 481(a) adjustment shall be an amount determined by dividing total net losses on bad debts (bad debt losses less bad debt recoveries) for the 5 tax years preceding the tax year of change (or the number of years in existence if less than 5 tax years) by the sum of the amount of outstanding trade receivables at the close of those tax years used above, and then multiplying the amount of outstanding trade receivables at the close of the tax year preceding the year of change by the resulting decimal amount. If the taxpayer is a member of an affiliated group and more than one member of the group is requesting to change to the reserve method of deducting bad debts, the section 481(a) adjustment must be computed and separately stated for each taxpayer.

.04 1 The appropriate period for taking into account the section 481(a) adjustment referred to in section 4.02 (adjustment period) is generally determined as follows:

(a) When the entire amount of the section 481(a) adjustment is attributable to the tax year immediately preceding the year of change (first preceding year), the total section 481(a) adjustment is to be taken into account in computing taxable income for the year of change. The amount attributable to the tax year immediately preceding the year of change is the difference in the amount of the adjustment determined under section 481(a) of the Code for the year of change and the amount of the adjustment that would have been required under section 481(a) if the same change in method of accounting had been made in the first preceding year.

(b) When (a) does not apply and 67 percent or more of the amount of the section 481(a) adjustment is attributable to the 1-tax year period, 2-tax year period, or 3-tax year period immediately preceding the year of change, the highest percent attributable to the 1, 2, or 3-tax year period is to be taken into account ratably over a 3-tax year period beginning with the year of change. Any remaining balance is to be taken into account ratably over an additional period equal to the remainder of the number of tax years the taxpayer has used the method of accounting that is being changed. However, the total adjustment period shall not exceed 10 tax years. This subparagraph, 4.04 1(b), only applies if the taxpayer has used the method being changed for more than 3 tax years. If the method of accounting being changed has been used for no more than 4 tax years, 75 percent shall be substituted for 67 percent. An amount attributable to the 1, 2, or 3-tax year period is the difference in the amount of the adjustment determined under section 481(a) of the Code for the year of change and the amount that would have been required under section 481(a) if the same change had been made at the beginning of the preceding 1, 2, or 3-tax year period.

(c) In all other situations in which (a) and (b) above do not apply, the total section 481(a) adjustment will be taken into account ratably over the number of tax years (not to exceed 10) the taxpayer has used the method of accounting that is being changed.

2 In applying section 4.04 1 if a taxpayer's books and records do not contain sufficient information to compute the section 481(a) adjustment attributable to the 1, 2, or 3-tax year period immediately preceding the year of change, the taxpayer may reasonably estimate the amounts and also attach and sign the following statement to the Form 3115:

Under penalty of perjury, I hereby certify that:

(a) the books and records of [name of the taxpayer] to not contain sufficient information to permit a computation of the section 481(a) adjustment attributable to the 1-tax year period, 2-tax year period, or 3-tax year period immediately preceding the year of change as required by section 4.041(b) of Rev. Proc. 82-19.

(b) Based on the information that is contained in such records, to the best of my information and belief, the entire amount of the section 481(a) adjustment for the year of change [indicate either "is" or "is not," as the case may be] attributable to the tax year immediately preceding the year of change, and 67 percent or more [or "75 percent," in applicable cases] or more of the section 481(a) adjustment for the year of change [indicate "is" or "is not," as the case may be] attributable to the 1-tax year period, 2-tax year period, or 3-tax year period immediately preceding the year of change.

.05 For an example of the application of the rules prescribed in section 4.04 1 with respect to the appropriate period for taking into account the section 481(a) adjustment see Example A in section 5.13 of Rev. Proc. 80-51.

.06 The amount of the bad debt deduction for the year of change and tax years thereafter will consist of the reasonable addition to the reserve for bad debts for each year as provided by section 166(c) of the Code plus any amount of the section 481(a) adjustment determined in accordance with section 4.03 above required to be taken into account during the adjustment period.

.07 Ceasing to engage in the trade or business.

(a) With respect to a corporation:

If a corporate taxpayer ceases to engage in the trade or business, to which the section 481(a) adjustment (sections 4.02 and 4.03) relates, at any time prior to the expiration of the adjustment period referred to in section 4.04, the taxpayer shall take into account in that year the balance of the adjustment not previously taken into account in computing taxable income. See Rev. Rul. 80-39, 1980-1 C.B. 112, which holds that if a division of a corporation, for which a change in method of accounting had been granted, ceases to operate the trade or business for which the change in method was granted, the remaining section 481(a) adjustment applicable to the business conducted by that division of the corporation must be taken into income in the year the corporation ceases to engage in that trade or business. For purposes of this condition, the taxpayer is not considered to have ceased the trade or business if the cessation is the result of a transaction to which section 381 of the Code applies, but in that case the acquiring corporation shall continue to be subject to this revenue procedure as though it were the acquired corporation.

(b) With respect to a partnership:

In the event a partnership terminates or ceases to engage in the trade or business (within the meaning of section 708 of the Code), to which the section 481(a) adjustment (sections 4.02 and 4.03) relates, at any time prior to the expiration of the adjustment period referred to in section 4.04, the balance of the section 481(a) adjustment not previously taken into account in computing ordinary income shall be taken into account in the year of cessation. A partnership ceasing to engage in the trade or business includes the incorporation of the trade or business in a transaction to which section 351 applies (see Rev. Rul. 77-264, 1977-2 C.B. 187).

(c) With respect to a sole proprietor:

If a sole proprietor ceases to engage in the trade or business, to which the section 481(a) adjustment (sections 4.02 and 4.03) relates, at any time prior to the expiration of the adjustment period referred to in section 4.04, the balance of the adjustment not previously taken into account in computing taxable income shall be taken into account in the year of cessation. A sole proprietor ceasing to engage in the trade or business includes the incorporation of such trade or business in a transaction to which section 351 of the Code applies (see Rev. Rul. 77-264). A sole proprietorship does not cease to engage in that trade or business when the individual taxpayer sells a partial interest in the proprietorship and continues to be actively engaged in the management of the business that is subsequently operated as a partnership. The section 481(a) adjustment remaining at the time the partnership is formed is taken into account by the partnership as though there had been no change in ownership (see Rev. Rul. 66-206, 1966-2 C.B. 206).

.08 A taxpayer that changes from the specific charge-off method to the reserve method for bad debts under this revenue procedure must keep its books and records for the year of change and for later tax years on the reserve method. Taxpayers, other than banks described in section 585 of the Code, small business investment companies and business development corporations described in section 586 and mutual savings banks and other similar institutions described in section 593, must use the reserve method for all reports to shareholders, financial statements and statements for credit purposes.

.09 A taxpayer must take the full amount of the section 481(a) adjustment into account in determining its additions to the reserve for future years, even though it may not yet have taken all of the section 481(a) adjustment into account as a deduction in the computation of its taxable income. Also, it must file the statement required by section 1.166-4(c) of the regulations with its return for the year of change and for subsequent tax years.

.10 In computing the reserve for bad debts, a taxpayer will not include notes receivable sold without recourse or to be sold in the immediate future without recourse. Worthless debts arising from unpaid wages, salaries, fees, rents and similar items of taxable income shall not be allowed as a deduction under section 166 of the Code unless the income that these items represent has been included in the return of income for the year in which the deduction as a bad debt is claimed or in a prior tax year.

.11 To the extent that the portion of the negative section 481(a) adjustment to be taken into account in the year of change creates or increases an existing net operating loss for that year, that amount may not be carried back to earlier tax years, but must be carried forward until absorbed over the appropriate number of tax years specified in section 172 of the Code.

.12(1) Commercial banks shall effect the change as provided in section 4 of this revenue procedure, and shall determine the amount of the reserve for bad debts at the end of the tax year preceding the year of change in accordance with the provisions of section 585 of the Code, in lieu of the manner indicated in paragraph 4.03 above.

(2) Small business investment companies and business development corporations described in section 586 of the Code shall affect the change as provided in section 4 of this revenue procedure. The amount of the reserve for bad debts as of the end of the tax year preceding the year of change shall be determined in accordance with the provisions of section 586, in lieu of the manner indicated in subsection 4.03 above.

(3) Mutual savings banks not having capital stock represented by shares, domestic building and loan associations, and cooperative banks without capital stock organized and operated for mutual purposes and without profit shall effect the change as provided in section 4 of this revenue procedure, but the amount of the reserve for bad debts at the end of the tax year preceding the year of change shall be determined in accordance with section 593 of the Code, in lieu of the manner indicated in section 4.03 above.

SECTION 5. TAXPAYERS NOT COVERED BY THIS REVENUE PROCEDURE

.01 This revenue procedure does not apply to a taxpayer that has employed the specific charge-off method for bad debts and the use of that method is pending as an issue in connection with the examination of the taxpayer's federal income tax return for any year prior to the year of change or is an issue before any federal court.

.02 This revenue procedure also does not apply to taxpayers whose trade receivables include items of unrealized income for federal income tax purposes, such as taxpayers that use the cash receipts and disbursements method of accounting. Notwithstanding the above, this revenue procedure will apply to taxpayers described in section 4.12, as well as other taxpayers engaged in the business of making loans. Taxpayers whose circumstances prevent them from using this revenue procedure in changing from the specific charge-off method to the reserve method of accounting for bad debts may, nevertheless, make requests for such a change by filing applications on Form 3115 under the provisions of section 1.446-1(e)(3) of the regulations with the Commissioner of Internal Revenue, Attention: T:C:C:1, 1111 Constitution Avenue, N.W., Washington DC, 20224, within the 180 day period prescribed by the regulations. These taxpayers must comply with Rev. Proc. 80-51.

SEC. 6. RECORDS

Taxpayers must maintain adequate records so that the Service may, upon examination, verify the data concerning the change in method of accounting.

SEC. 7. COMPLIANCE WITH CONDITIONS

Taxpayers making a change from the specific charge-off method to the reserve method of accounting for bad debts without complying with all the conditions of this revenue procedure will be deemed to have initiated the change without obtaining the consent of the Commissioner.

SEC. 8. MANNER OF EFFECTING THE CHANGE

.01 Taxpayers to which this revenue procedure applies must effect the change in their methods of accounting pursuant to the provisions set forth in this revenue procedure by filing a current Form 3115 in duplicate. The original shall be attached to the taxpayer's timely filed federal income tax return for the year of change. A copy of the current Form 3115 shall be filed with the National Office addressed to the Commissioner of Internal Revenue, Attention: T:C:C:1, 1111 Constitution Avenue, N.W., Washington, DC 20224, no later than 270 days after the beginning of the tax year of change. The Service will acknowledge the receipt of the copy of the Form 3115 by return mail. A copy of the acknowledgment is to be attached by the taxpayer to the taxpayer's federal income tax return for the year of change. In addition to providing all of the information required on the current Form 3115, the taxpayer must state that it proposes to take the section 481(a) adjustment into account over the appropriate period required by section 4.04. The National Office will sample the Forms 3115 to determine whether the requirements of this revenue procedure have been followed. Also, where it is found that the taxpayer does not qualify for the automatic change in method of accounting under this revenue procedure, the National Office or the district director will advise the taxpayer.

.02 In order to assist in the processing of these changes in methods of accounting and to insure proper handling, reference to this revenue procedure shall be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "FILED UNDER REV. PROC. 82-19."

.03 The signature of the individual or person preparing the application for the taxpayer must appear in the space at the bottom of page 1 on the Form 3115. An application made by an agent on behalf of a taxpayer must be accompanied by a power of attorney authorizing the agent to sign for the taxpayer. If the agent is also authorized to represent the taxpayer before the Service, receive the original or a copy of correspondence concerning the request, or perform any other act(s) regarding the application on behalf of the taxpayer, the power of attorney must reflect such authorization(s). If the taxpayer is a member of an affiliated group that has elected to file a consolidated federal income tax return, a Form 3115 submitted on behalf of the taxpayer must be signed by a duly authorized officer of the common parent. (See section 1.1502-77 of the regulations.)

SEC. 9. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 64-51, Rev. Proc. 70-15, and Rev. Proc. 77-39, are superseded.

SEC. 10. EFFECTIVE DATE

This revenue procedure shall be effective for applications, Forms 3115, filed for tax years ending after March 15, 1982, the date of its publication in the Internal Revenue Bulletin.

SEC. 11. INQUIRIES

Inquiries in regard to this revenue procedure should refer to its numbers and be addressed to the Commissioner of Internal Revenue, Attention: T:C:C:1, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.