A marketing company currently uses the accrual method of accounting and recognizes revenue under the completed contract method. The company wants to change to the percentage-of-completion method and, to do so, submitted Form 3115 (Application for Change in Accounting Method), citing Section 460 of the Internal Revenue Code as the basis. However, the IRS returned the form, stating that the company is not a contractor and cannot cite Section 460.

The company raises two core questions: First, since it is not changing from the accrual method to the cash method, is it still required to file Form 3115? Second, if it is indeed required, which section of the Code should it cite as a professional services company? The company's annual sales exceed $25 million.

Background Analysis

Under U.S. tax law, changes in accounting methods generally require IRS consent, typically obtained by filing Form 3115. However, not all changes in accounting methods require filing this form; some changes may fall within automatic change or no-consent categories. The company's change from the completed contract method to the percentage-of-completion method is a change in revenue recognition method, generally considered a change in accounting method, so it likely requires filing Form 3115 unless a specific exception applies.

Regarding the Code citation, Section 460 specifically applies to long-term construction contracts and is primarily aimed at contractors. A marketing company is not a contractor, so citing that section is inappropriate. For professional services companies, revenue recognition methods may be governed by other provisions, such as Section 451 (general principles of revenue recognition) or Section 446 (general rules for accounting methods). However, the specific section to cite depends on the nature of the change and industry practice.

Key Issues Summary

  • Is filing Form 3115 required? If the change is a change in accounting method and does not fall within automatic change or exception categories, it is generally required. It is recommended to consult a tax professional to confirm whether automatic change procedures (such as Rev. Proc. 2015-13) apply.
  • Which section should be cited? Since Section 460 does not apply, consider citing Section 446 (general rules for accounting methods) or Section 451 (timing of income recognition). However, the specific citation should be based on the substance of the change and IRS guidance.
  • Impact of annual sales: Annual sales exceeding $25 million may affect whether cash method limitations apply, but since this involves a method change under the accrual method, this factor may not be directly relevant.

Recommended Next Steps

Given that the IRS has returned the form, it is recommended that the company reassess the appropriateness of the change and consult a tax attorney or CPA to determine the correct Code citation and application procedure. Additionally, consider reviewing IRS revenue procedures (such as Rev. Proc. 2015-13) regarding automatic consent provisions for accounting method changes to see if they apply.

Note: This information provides general information only and does not constitute tax legal advice. For specific issues, please consult a qualified professional.