Corporation Income Tax
Change from cash to accrual accounting method; Adjustments
Accounting Periods and Methods
October 8, 1991
Re: §58.1-1821 Application; Corporation Income Tax
This will reply to your letter of February 22, 1991, in which you seek a correction of corporation income tax for*************** ("the Taxpayer").
In 1987, the taxpayer changed its method of accounting for federal tax purposes from the cash to the accrual method. As a consequence of this change, certain income and expense accounts were required to be accrued as of the first of the year. In accordance with Internal Revenue Code (IRC) §481(a), these adjustments were prorated over a four-year period. The income adjustment on the 1987-1989 federal tax returns included prepaid state income taxes paid in 1986 and deducted on the 1986 federal income tax return. On its 1987-1989 Virginia income tax returns, the taxpayer claimed a subtraction for the portion of the §481(a) adjustment which represented prepaid state income taxes; the subtraction was disallowed by the auditor.
Under IRC §481, a taxpayer is permitted to include in its income the cumulative effect of a change in accounting methods over a four-year period. Included in the taxpayer's total adjustment were prepaid state income taxes which had been previously deducted under the cash method for federal income tax purposes. Because the taxpayer received a tax benefit from the deduction of state income taxes under the cash method of accounting, the taxpayer was required to include a portion of the deduction in federal taxable income over the four-year period to reflect the accrual of income taxes and the tax benefit received in 1986.
At the state level, there was no similar tax benefit. The state income taxes deducted on the 1986 federal return were added back in computing Virginia taxable income, as required under Va. Code §58.1-402 B.4. Because these taxes were not deducted on the 1986 Virginia return, and no prior benefit was derived, the prepaid taxes should not be included in the §481 income adjustment for state purposes.
Va. Code §58.1-440 E. allows adjustments which are determined to be necessary solely by reason of a change in accounting methods to prevent a duplication of adjustment amounts required under federal law. Such an adjustment is warranted in this situation.
Accordingly, the assessment will be abated.
W. H. Forst