[Federal Register Volume 62, Number 150 (Tuesday, August 5, 1997)]
[Rules and Regulations]
[Pages 42051-42062]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-20530]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8728]
RIN 1545-AQ94
Procedure for Changing a Method of Accounting Under Section 263A
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: This document contains final regulations relating to the
requirements for changing a method of accounting for costs subject to
section 263A. The regulations provide guidance regarding changes in
method of accounting for costs incurred in producing property and
acquiring property for resale. The regulations affect taxpayers
changing their method of accounting for costs subject to section 263A.
DATES: These regulations are effective August 5, 1997.
FOR FURTHER INFORMATION CONTACT: Cheryl Lynn Oseekey, (202) 622-4970
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On March 30, 1987 and August 7, 1987, temporary regulations under
section 263A were published in the Federal Register (TD 8131, 52 FR
10052 and TD 8148, 52 FR 29375), and cross-referenced to notices of
proposed rulemaking published in the Federal Register on the same date
(52 FR 10118 and 52 FR 29391). The temporary regulations contain rules
for taxpayers changing their method of accounting to comply with the
capitalization rules of section 263A. A public hearing on these
temporary and proposed regulations was held on December 7, 1987.
On August 9, 1993, final regulations under section 263A were
published in the Federal Register (TD 8482, 58 FR 42198). These final
regulations did not address the accounting method provisions in the
1987 temporary regulations, which continued in effect. On August 5,
1994, final and temporary regulations were published in the Federal
Register (TD 8559, 59 FR 39958). These final regulations address ``pick
and pack costs'' and other expenses. The August 5, 1994 temporary
regulations renumbered the accounting method provisions in the 1987
temporary regulations from Sec. 1.263A-1T(e) to Sec. 1.263A-7T.
This document adopts, with modifications, Sec. 1.263A-7T as final
regulations.
Explanation of Provisions
In 1987, the IRS and the Treasury Department issued temporary
regulations that provide guidance to taxpayers changing their method of
accounting to comply with the capitalization rules of section 263A. The
regulations provide automatic consent for taxpayers required to change
their method of accounting for the first taxable year section 263A was
effective.
Subsequent to promulgation of the 1987 temporary regulations, the
IRS and the Treasury Department issued various revenue procedures that
set forth rules and procedures applicable to certain changes in method
of accounting for costs subject to section 263A for which taxpayers can
obtain automatic consent. These revenue procedures provide automatic
consent to change the method of accounting in years other than the
first taxable year section 263A was effective. Where automatic consent
is not available by revenue procedure, taxpayers can obtain the
Commissioner's consent to change a method of accounting for costs
subject to section 263A under Rev. Proc. 97-27 (1997-21 I.R.B. 10).
Rev. Proc. 97-27 and the automatic change revenue procedures
describe how a change in method of accounting may be effected, but they
do not describe how inventory and other property on hand at the
beginning of the year of change should be revalued. These final
regulations provide guidance regarding how taxpayers must revalue
property in connection with a change in method of accounting for costs
subject to section 263A. The revaluation rules for inventory are
substantially similar to the revaluation rules contained in the 1987
temporary
[[Page 42052]]
regulations. Section 1.263A-7(c) provides guidance regarding how items
or costs included in beginning inventory in the year of change must be
revalued. Section 1.263A-7(d) provides guidance regarding how non-
inventory property on hand at the beginning of the year of change must
be revalued.
The regulations also provide certain rules that apply to changes in
method of accounting for costs subject to section 263A, in addition to
the rules and procedures that apply under the applicable revenue
procedures. See, Sec. 1.263A-7(b).
In addition, the regulations clarify whether certain changes are
changes in method of accounting under section 263A and therefore are
within the scope of the regulations. For example, a change from one
permissible capitalization method, such as the simplified resale method
in former Sec. 1.263A-1T(d)(4), to another permissible capitalization
method, such as the simplified resale method in Sec. 1.263A-3(d), is a
change in method of accounting under section 263A and is therefore
within the scope of the regulations. See Sec. 1.263A-7(a)(5).
The final regulations delete certain provisions of Sec. 1.263A-7T
that were primarily applicable to accounting method changes made in
1987. For example, the final regulations do not incorporate provisions
such as Sec. 1.263A-7T(e)(2), which provide automatic consent to make
the change in method of accounting for the first taxable year section
263A was effective, and Sec. 1.263A-7T(e)(7) (iii), (iv) and (v) and
Sec. 1.263A-7T(e)(8), which provide special rules for adjusting the
revaluation factor for costs attributable to different methods of
accounting for depreciation (including cost recovery) and differences
in the percentage of fixed indirect production costs that were expensed
by taxpayers using the practical capacity concept.
Certain Administrative Guidance
The final regulations incorporate the provisions of Notice 88-23
(1988-1 C.B. 490) (ordering rules for accounting method changes), and
sections IV(A) (guidance regarding deferred intercompany exchanges) and
IV(B) (permission to elect a new base year for taxpayers using the
last-in, first-out (LIFO) inventory method) of Notice 88-86 (1988-2
C.B. 401). These notices or portions thereof are withdrawn for taxable
years to which this Treasury decision applies.
Effect on Other Documents
The following publications are obsolete as of August 5, 1997:
Notice 88-23 (1988-1 C.B. 490). Notice 88-86 (1988-2 C.B. 401),
sections IV(A) and IV(B).
Public Comments
The IRS and the Treasury Department received a number of comments
in response to the 1987 temporary and proposed regulations. Most of the
comments received in response to the temporary regulations issued in
March 1987 were considered in connection with the temporary regulations
issued in August 1987. In general, those comments are not discussed
again here.
Revaluing Beginning Inventory--the 3-Year Average Method
A. Extending Availability of the Method
Under the temporary regulations, taxpayers using the dollar-value
LIFO inventory method were permitted to use a 3-year average method for
revaluing their beginning inventory in the year they changed their
method of accounting to comply with section 263A. Several commentators
suggested that taxpayers other than those on the dollar-value LIFO
inventory method should also be permitted to use this 3-year average
method for revaluing beginning inventory in the year of change.
Specifically, commentators suggested that the 3-year average method be
made available to taxpayers using the specific goods LIFO inventory
method. Another suggestion was that taxpayers using the first-in,
first-out (FIFO) inventory method should be permitted to use the 3-year
average method even though those taxpayers may have sufficient
information to revalue their inventory under the facts and
circumstances method.
The final regulations do not adopt these suggestions. The House and
Senate Reports to the Tax Reform Act of 1986 indicate Congress intended
that taxpayers generally revalue their inventory in the year of change
using the facts and circumstances method. Because Congress realized
that dollar-value LIFO taxpayers may not have the data needed to use
the facts and circumstances method, it suggested two other revaluation
methods that could be used in conjunction with, or in lieu of, the
facts and circumstances method. The 3-year average method was one of
those other methods. H.R. Rep. No. 426, 99th Cong., 1st Sess. 633-637
(1985), 1986-3 (Vol. 2) C.B. 633-637 and S. Rep. No. 313, 99th Cong.,
2nd Sess. 147-152 (1986), 1986-3 (Vol. 3) C.B. 147-152. The IRS and the
Treasury Department believe that limiting the 3-year average method to
dollar-value LIFO taxpayers is more consistent with legislative history
which expresses Congress' concern that dollar-value LIFO taxpayers may
have particular problems in revaluing inventory. H.R. Rep. No. 426,
633, 1986-3 (Vol. 2) C.B. 633 and S. Rep. No. 313, 147, 1986-3 (Vol.3)
C.B. 147.
B. Altering the Mechanics of the Method
One commentator suggested that taxpayers be permitted to revalue
items or costs included in beginning inventory in the year of change by
using data from the year of change instead of data from the prior three
years, and calculate a section 481(a) adjustment accordingly. This
commentator further suggested that three years after the year of
change, the taxpayer would recompute the section 481(a) adjustment
using data from the three new years to test its original adjustment
under section 481(a). If the new adjustment were larger than the
original adjustment by a substantial amount, the taxpayer would be
required to amend its federal income tax returns. The final regulations
do not adopt this suggestion. Requiring taxpayers to compute two
adjustments under section 481(a) would unnecessarily complicate
application of the 3-year average method.
Another commentator suggested that some taxpayers be permitted to
revalue items or costs included in beginning inventory in the year of
change by using data from the immediately preceding year rather than
the prior three years. This proposal to use only the prior year's data
would be limited to taxpayers that can show they have not had a
significant change in costs over the preceding three years. This
suggested modification to the 3-year average method was not adopted.
The suggested modification would not substantially simplify the process
of revaluing beginning inventory because taxpayers would be required to
determine whether their costs significantly changed during the
preceding three-year period.
C. Limiting Costs Subject to Revaluation
One commentator suggested that LIFO layers should be revalued only
if the items of inventory comprising those layers are still in
existence in the year of change. This suggestion was not adopted.
However, the final regulations continue the rule in the temporary
regulations that taxpayers may adjust the revaluation factor (under
either the 3-year average method or the weighted average method) to the
extent they can show that additional section 263A costs included in the
calculation of the revaluation factor were not incurred in
[[Page 42053]]
the prior years in which the LIFO layers were accumulated.
D. New Base Year
Under the 3-year average method, taxpayers generally are required
to establish a new base year. Several commentators commented that
requiring link-chain LIFO taxpayers to establish a new base year is
costly and pointless and suggested that these taxpayers be excluded
from the general requirement that all dollar-value LIFO taxpayers
establish a new base year. The IRS and the Treasury Department did not
adopt this suggestion. If a new base year is not established, the
current-year index, determined under the taxpayer's new method of
accounting, would be multiplied by the prior-year cumulative index,
determined under the taxpayer's former method of accounting, and could
distort the taxpayer's LIFO inventory valuation. This distortion is
eliminated when the taxpayer establishes a new base year and
establishes a new index. Accordingly, the final regulations provide
that all dollar-value LIFO taxpayers (whether using double extension or
link-chain) should generally establish a new base year when they use
the 3-year average method to revalue their inventories under section
263A.
Commentators also suggested that taxpayers using the 3-year average
method and either the simplified production method or the simplified
resale method be allowed, but not required, to establish a new base
year. Section IV(B) of Notice 88-86 permits these taxpayers to choose
whether to establish a new base year. This rule is incorporated into
the final regulations.
One commentator noted that the example in the 1987 temporary
regulations illustrating the 3-year average method did not use the
current year revaluation factor in computing the updated base year cost
of inventory. The example has been revised to use the current year
revaluation factor.
Revaluing Beginning Inventory--Facts and Circumstances Method
One commentator suggested that specific rules or guidelines be
adopted to clarify what is a reasonable estimate or procedure for
revaluing beginning inventory in connection with a change in method of
accounting. This suggestion was not adopted. What is a reasonable
estimate or procedure must be decided on a case-by-case basis in light
of all applicable facts and circumstances. The final regulations
continue the provision in the temporary regulations that permissible
estimates and procedures include using information from a more recent
period to estimate the amount and nature of inventory costs applicable
to earlier periods, and using information with respect to comparable
items of inventory to estimate the costs associated with other items of
inventory.
New Base Year When the 3-Year Average Method Is Not Used
Several commentators suggested that dollar-value LIFO taxpayers not
using the 3-year average method to revalue beginning inventory be
permitted to update their base year if they so choose. Section IV (B)
of Notice 88-86 permits these taxpayers to establish a new base year.
The final regulations adopt this rule.
Scope of Accounting Method Change
Several commentators suggested that the regulations should allow
taxpayers to change from the specific goods LIFO inventory method to
the dollar-value LIFO inventory method in connection with changing
their method of accounting for costs under section 263A without
obtaining the Commissioner's consent. Generally, taxpayers must secure
the Commissioner's consent before effecting a change in method of
accounting under section 446(e) unless this requirement is specifically
waived. The IRS and the Treasury Department do not believe an exception
from this general rule is warranted for changes from the specific goods
LIFO inventory method to the dollar-value LIFO inventory method except
to the extent permitted by Sec. 1.472-8(f)(1).
Several commentators also suggested that taxpayers that change
their method of accounting for costs subject to section 263A be
permitted to make additional changes in their methods of accounting in
future tax years under section 263A without obtaining additional
consents from the Commissioner. The IRS and the Treasury Department
have issued various revenue procedures that provide automatic consent
procedures for taxpayers to change their method of accounting for costs
under section 263A.
One commentator suggested that the regulations provide that when
making the change from the full absorption rules of Sec. 1.471-11 to
the uniform capitalization rules of section 263A, taxpayers may cease
taking into account any costs not treated as inventoriable under
section 263A that may have been erroneously inventoried under prior
law. The temporary regulations issued in August 1987 and the final
regulations permit this result. In revaluing beginning inventory to
include additional section 263A costs, taxpayers may cease capitalizing
costs that had been capitalized but are not required to be capitalized
under section 263A.
Audit Protection
Several commentators noted that taxpayers should be guaranteed
audit protection for costs or items that are part of a change in method
of accounting under section 263A. The IRS' long-standing administrative
position is that if a taxpayer files an application to change its
method of accounting in accordance with the applicable administrative
guidance, for example, Rev. Proc. 97-27, an examining agent may not
later propose that the taxpayer change its method of accounting for the
same item for a taxable year prior to the year of change.
Ordering Rules
One commentator suggested that overall accounting method changes
(for example, the cash receipts and disbursements method to an accrual
method) should be implemented prior to any change in method of
accounting for costs under section 263A. The temporary regulations
generally provide that a change in method of accounting for costs under
section 263A is deemed to occur prior to any other change in method of
accounting effected during the year of change. The final regulations
continue that general rule with four modifications. Taxpayers that are
discontinuing the LIFO inventory method may make that change prior to a
change in method of accounting under section 263A. Additionally,
taxpayers that are changing from the specific goods LIFO inventory
method to the dollar-value LIFO inventory method may make that change
prior to a change in method of accounting under section 263A. Also,
taxpayers that are changing their overall method of accounting from the
cash method to an accrual method must make the change to an accrual
method prior to a change in method of accounting under section 263A.
Finally, taxpayers that are changing their method of accounting for
depreciation when any portion of the depreciation is subject to section
263A must make the method change for depreciation prior to a change in
method of accounting under section 263A.
Cost Allocation Method
Several commentators suggested that the regulations be clarified to
provide that a taxpayer must use the same cost allocation method to
restate its beginning inventory and to value its ongoing inventory. The
final regulations clarify this point. Inventory on hand at
[[Page 42054]]
the beginning of the year of change is revalued as if the taxpayer's
new method had applied to all prior periods. The same cost allocation
method must be used both retroactively (for purposes of restating
beginning inventory) and prospectively (for purposes of the current
year and all subsequent years, unless the taxpayer seeks specific
consent from the Commissioner to change this method of accounting).
Intercompany Items
One commentator suggested that taxpayers be given automatic consent
to discontinue filing consolidated federal income tax returns so that
they could avoid the need to revalue the amount of intercompany items
resulting from the sale or exchange of inventory property in
intercompany transactions. The regulations do not adopt this
suggestion. Generally, taxpayers must secure the Commissioner's consent
before discontinuing the filing of consolidated tax returns. The IRS
and the Treasury Department do not think an exception from this general
rule is warranted in this situation.
Effective Date
These regulations are effective for taxable years beginning on or
after August 5, 1997.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, these
regulations were submitted to the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal author of these regulations is Cheryl Lynn Oseekey,
Office of Assistant Chief Counsel (Income Tax and Accounting). However,
other personnel from the IRS and the Treasury Department participated
in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.263A-0 is amended by revising the introductory
text and adding entries for Sec. 1.263A-7 to read as follows:
Sec. 1.263A-0 Outline of regulations under section 263A.
This section lists the paragraphs in Secs. 1.263A-1 through 1.263A-
3 and Sec. 1.263A-7 through 1.263A-15.
* * * * *
Sec. 1.263A-7 Changing a method of accounting under section 263A.
(a) Introduction.
(1) Purpose.
(2) Taxpayers that adopt a method of accounting under section 263A.
(3) Taxpayers that change a method of accounting under section
263A.
(4) Effective date.
(5) Definition of change in method of accounting.
(b) Rules applicable to a change in method of accounting.
(1) General rules.
(2) Special rules.
(i) Ordering rules when multiple changes in method of accounting
occur in the year of change.
(A) In general.
(B) Exceptions to the general ordering rule.
(1) Change from the LIFO inventory method.
(2) Change from the specific goods LIFO inventory method.
(3) Change in overall method of accounting.
(4) Change in method of accounting for depreciation.
(ii) Adjustment required by section 481(a).
(iii) Base year.
(A) Need for a new base year.
(1) Facts and circumstances revaluation method used.
(2) 3-year average method used.
(i) Simplified method not used.
(ii) Simplified method used.
(B) Computing a new base year.
(c) Inventory
(1) Need for adjustments.
(2) Revaluing beginning inventory.
(i) In general.
(ii) Methods to revalue inventory.
(iii) Facts and circumstances revaluation method.
(A) In general.
(B) Exception.
(C) Estimates and procedures allowed.
(D) Use by dollar-value LIFO taxpayers.
(E) Examples.
(iv) Weighted average method.
(A) In general.
(B) Weighted average method for FIFO taxpayers.
(1) In general.
(2) Example.
(C) Weighted average method for specific goods LIFO taxpayers.
(1) In general.
(2) Example.
(D) Adjustments to inventory costs from prior years.
(v) 3-year average method.
(A) In general.
(B) Consecutive year requirement.
(C) Example.
(D) Short taxable years.
(E) Adjustments to inventory costs from prior years.
(1) General rule.
(2) Examples of costs eligible for restatement adjustment
procedure.
(F) Restatement adjustment procedure.
(1) In general.
(2) Examples of restatement adjustment procedure.
(3) Intercompany items.
(i) Revaluing intercompany transactions.
(ii) Example.
(iii) Availability of revaluation methods.
(4) Anti-abuse rule.
(i) In general.
(ii) Deemed avoidance of this section.
(A) Scope.
(B) General rule.
(iii) Election to use transferor's LIFO layers.
(iv) Tax avoidance intent not required.
(v) Related corporation.
(d) Non-inventory property.
(1) Need for adjustments.
(2) Revaluing property.
Sec. 1.263A-1 [Amended]
Par. 3. Section 1.263A-1 is amended by removing ``1.263A-7T(e)
generally'' from the last sentence in paragraph (a)(2)(i) and replacing
it with ``1.263A-7''.
Par. 4. Section 1.263A-7 is added to read as follows:
Sec. 1.263A-7 Changing a method of accounting under section 263A.
(a) Introduction--(1) Purpose. These regulations provide guidance
to taxpayers changing their methods of accounting for costs subject to
section 263A. The principal purpose of these
[[Page 42055]]
regulations is to provide guidance regarding how taxpayers are to
revalue property on hand at the beginning of the taxable year in which
they change their method of accounting for costs subject to section
263A. Paragraph (c) of this section provides guidance regarding how
items or costs included in beginning inventory in the year of change
must be revalued. Paragraph (d) of this section provides guidance
regarding how non-inventory property should be revalued in the year of
change.
(2) Taxpayers that adopt a method of accounting under section 263A.
Taxpayers may adopt a method of accounting for costs subject to section
263A in the first taxable year in which they engage in resale or
production activities. For purposes of this section, the adoption of a
method of accounting has the same meaning as provided in Sec. 1.446-
1(e)(1). Taxpayers are not subject to the provisions of these
regulations to the extent they adopt, as opposed to change, a method of
accounting.
(3) Taxpayers that change a method of accounting under section
263A. Taxpayers changing their method of accounting for costs subject
to section 263A are subject to the revaluation and other provisions of
this section. Taxpayers subject to these regulations include, but are
not limited to--
(i) Resellers of personal property whose average annual gross
receipts for the immediately preceding 3-year period (or lesser period
if the taxpayer was not in existence for the three preceding taxable
years) exceed $10,000,000 where the taxpayer was not subject to section
263A in the prior taxable year;
(ii) Resellers of real or personal property that are using a method
that fails to comply with section 263A and desire to change to a method
of accounting that complies with section 263A;
(iii) Producers of real or tangible personal property that are
using a method that fails to comply with section 263A and desire to
change to a method of accounting that complies with section 263A; and
(iv) Resellers and producers that desire to change from one
permissible method of accounting for costs subject to section 263A to
another permissible method.
(4) Effective date. The provisions of this section are effective
for taxable years beginning on or after August 5, 1997. For taxable
years beginning before August 5, 1997, the rules of Sec. 1.263A-7T
contained in the 26 CFR part 1 edition revised as of April 1, 1997, as
modified by other administrative guidance, will apply.
(5) Definition of change in method of accounting. For purposes of
this section, a change in method of accounting has the same meaning as
provided in Sec. 1.446-1(e)(2)(ii). Changes in method of accounting for
costs subject to section 263A include changes to methods required or
permitted by section 263A and the regulations thereunder. Changes in
method of accounting may be described in the preceding sentence
irrespective of whether the taxpayer's previous method of accounting
resulted in the capitalization of more (or fewer) costs than the costs
required to be capitalized under section 263A and the regulations
thereunder, and irrespective of whether the taxpayer's previous method
of accounting was a permissible method under the law in effect when the
method was being used. However, changes in method of accounting for
costs subject to section 263A do not include changes relating to
factors other than those described therein. For example, a change in
method of accounting for costs subject to section 263A does not include
a change from one inventory identification method to another inventory
identification method, such as a change from the last-in, first-out
(LIFO) method to the first-in, first-out (FIFO) method, or vice versa,
or a change from one inventory valuation method to another inventory
valuation method under section 471, such as a change from valuing
inventory at cost to valuing the inventory at cost or market, whichever
is lower, or vice versa. In addition, a change in method of accounting
for costs subject to section 263A does not include a change within the
LIFO inventory method, such as a change from the double extension
method to the link-chain method, or a change in the method used for
determining the number of pools. Further, a change from the modified
resale method set forth in Notice 89-67 (1989-1 C.B. 723), see
Sec. 601.601(d)(2) of this chapter, to the simplified resale method set
forth in Sec. 1.263A-3(d) is not a change in method of accounting
within the meaning of Sec. 1.446-1(e)(2)(ii) and is therefore not
subject to the provisions of this section. However, a change from the
simplified resale method set forth in former Sec. 1.263A-1T(d)(4) to
the simplified resale method set forth in Sec. 1.263A-3(d) is a change
in method of accounting within the meaning of Sec. 1.446-1(e)(2)(ii)
and is subject to the provisions of this section.
(b) Rules applicable to a change in method of accounting--
(1) General rules. All changes in method of accounting for costs
subject to section 263A are subject to the rules and procedures
provided by the Code, regulations, and administrative procedures
applicable to such changes. The Internal Revenue Service has issued
specific revenue procedures that govern certain accounting method
changes for costs subject to section 263A. Where a specific revenue
procedure is not applicable, changes in method of accounting for costs
subject to section 263A are subject to the same rules and procedures
that govern other accounting method changes. See Rev. Proc. 97-27
(1997-21 I.R.B. 10) and Sec. 601.601(d)(2) of this chapter.
(2) Special rules--(i) Ordering rules when multiple changes in
method of accounting occur in the year of change.
(A) In general. A change in method of accounting for costs subject
to section 263A is generally deemed to occur (including the computation
of the adjustment under section 481(a)) before any other change in
method of accounting is deemed to occur for that same taxable year.
(B) Exceptions to the general ordering rule--(1) Change from the
LIFO inventory method. In the case of a taxpayer that is discontinuing
its use of the LIFO inventory method in the same taxable year it is
changing its method of accounting for costs subject to section 263A,
the change from the LIFO method may be made before the change in method
of accounting (and the computation of the corresponding adjustment
under section 481 (a)) under section 263A is made.
(2) Change from the specific goods LIFO inventory method. In the
case of a taxpayer that is changing from the specific goods LIFO
inventory method to the dollar-value LIFO inventory method in the same
taxable year it is changing its method of accounting for costs subject
to section 263A, the change from the specific goods LIFO inventory
method may be made before the change in method of accounting under
section 263A is made.
(3) Change in overall method of accounting. In the case of a
taxpayer that is changing its overall method of accounting from the
cash receipts and disbursements method to an accrual method in the same
taxable year it is changing its method of accounting for costs subject
to section 263A, the taxpayer must change to an accrual method for
capitalizable costs (see Sec. 1.263A-1(c)(2)(ii)) before the change in
method of accounting (and the computation of the corresponding
adjustment under section 481(a)) under section 263A is made.
(4) Change in method of accounting for depreciation. In the case of
a
[[Page 42056]]
taxpayer that is changing its method of accounting for depreciation in
the same taxable year it is changing its method of accounting for costs
subject to section 263A and any portion of the depreciation is subject
to section 263A, the change in method of accounting for depreciation
must be made before the change in method of accounting (and the
computation of the corresponding adjustment under section 481(a)) under
section 263A is made.
(ii) Adjustment required by section 481(a). In the case of any
taxpayer required or permitted to change its method of accounting for
any taxable year under section 263A and the regulations thereunder, the
change will be treated as initiated by the taxpayer for purposes of the
adjustment required by section 481(a). The adjustment required by
section 481(a) is to be taken into account in computing taxable income
over a period not to exceed 4 taxable years.
(iii) Base year--(A) Need for a new base year. Certain dollar-value
LIFO taxpayers (whether using double extension or link-chain) must
establish a new base year when they revalue their inventories under
section 263A.
(1) Facts and circumstances revaluation method used. A dollar-value
LIFO taxpayer that uses the facts and circumstances revaluation method
is permitted, but not required, to establish a new base year.
(2) 3-year average method used--(i) Simplified method not used. A
dollar-value LIFO taxpayer using the 3-year average method but not the
simplified production method or the simplified resale method to revalue
its inventory is required to establish a new base year.
(ii) Simplified method used. A dollar-value LIFO taxpayer using the
3-year average method and either the simplified production method or
the simplified resale method to revalue its inventory is permitted, but
not required, to establish a new base year.
(B) Computing a new base year. For purposes of determining future
indexes, the year of change becomes the new base year (that is, the
index at the beginning of the year of change generally must be 1.00)
and all costs are restated in new base year costs for purposes of
extending such costs in future years. However, when a new base year is
established, costs associated with old layers retain their separate
identity within the base year, with such layers being restated in terms
of the new base year index. For example, for purposes of determining
whether a particular layer has been invaded, each layer must retain its
separate identity. Thus, if a decrement in an inventory pool occurs,
layers accumulated in more recent years must be viewed as invaded
first, in order of priority.
(c) Inventory--(1) Need for adjustments. When a taxpayer changes
its method of accounting for costs subject to section 263A, the
taxpayer generally must, in computing its taxable income for the year
of change, take into account the adjustments required by section
481(a). The adjustments required by section 481(a) relate to
revaluations of inventory property, whether the taxpayer produces the
inventory or acquires it for resale. See paragraph (d) of this section
in regard to the adjustments required by section 481(a) that relate to
non-inventory property.
(2) Revaluing beginning inventory--(i) In general. If a taxpayer
changes its method of accounting for costs subject to section 263A, the
taxpayer must revalue the items or costs included in its beginning
inventory in the year of change as if the new method (that is, the
method to which the taxpayer is changing) had been in effect during all
prior years. In revaluing inventory costs under this procedure, all of
the capitalization provisions of section 263A and the regulations
thereunder apply to all inventory costs accumulated in prior years. The
necessity to revalue beginning inventory as if these capitalization
rules had been in effect for all prior years includes, for example, the
revaluation of costs or layers incurred in taxable years preceding the
transition period to the full absorption method of inventory costing as
described in Sec. 1.471-11(e), regardless of whether a taxpayer
employed a cut-off method under those regulations. The difference
between the inventory as originally valued using the former method
(that is, the method from which the taxpayer is changing) and the
inventory as revalued using the new method is equal to the amount of
the adjustment required under section 481(a).
(ii) Methods to revalue inventory. There are three methods
available to revalue inventory. The first method, the facts and
circumstances revaluation method, may be used by all taxpayers. Under
this method, a taxpayer determines the direct and indirect costs that
must be assigned to each item of inventory based on all the facts and
circumstances. This method is described in paragraph (c)(2)(iii) of
this section. The second method, the weighted average method, is
available only in certain situations to taxpayers using the FIFO
inventory method or the specific goods LIFO inventory method. This
method is described in paragraph (c)(2)(iv) of this section. The third
method, the 3-year average method, is available to all taxpayers using
the dollar-value LIFO inventory method of accounting. This method is
described in paragraph (c)(2)(v) of this section. The weighted average
method and the 3-year average method revalue inventory through
processes of estimation and extrapolation, rather than based on the
facts and circumstances of a particular year's data. All three methods
are available regardless of whether the taxpayer elects to use a
simplified method to capitalize costs under section 263A.
(iii) Facts and circumstances revaluation method--(A) In general.
Under the facts and circumstances revaluation method, a taxpayer
generally is required to revalue inventories by applying the
capitalization rules of section 263A and the regulations thereunder to
the production and resale activities of the taxpayer, with the same
degree of specificity as required of inventory manufacturers under the
law immediately prior to the effective date of the Tax Reform Act of
1986 (Pub. L. 99-514, 100 Stat. 2085, 1986-3 C.B. (Vol. 1)). Thus, for
example, with respect to any prior year that is relevant in determining
the total amount of the revalued balance as of the beginning of the
year of change, the taxpayer must analyze the production and resale
data for that particular year and apply the rules and principles of
section 263A and the regulations thereunder to determine the
appropriate revalued inventory costs. However, under the facts and
circumstances revaluation method, a taxpayer may utilize reasonable
estimates and procedures in valuing inventory costs if--
(1) The taxpayer lacks, and is not able to reconstruct from its
books and records, actual financial and accounting data which is
required to apply the capitalization rules of section 263A and the
regulations thereunder to the relevant facts and circumstances
surrounding a particular item of inventory or cost; and
(2) The total amounts of costs for which reasonable estimates and
procedures are employed are not significant in comparison to the total
restated value (including costs previously capitalized under the
taxpayer's former method) of the items or costs for the period in
question.
(B) Exception. A taxpayer that is not able to comply with the
requirement of paragraph (c)(2)(iii)(A)(2) of this section because of
the existence of a significant amount of costs that would require the
use of estimates and procedures must
[[Page 42057]]
revalue its inventories under the procedures provided in paragraph
(c)(2)(iv) or (v) of this section.
(C) Estimates and procedures allowed. The estimates and procedures
of this paragraph (c)(2)(iii) include--
(1) The use of available information from more recent years to
estimate the amount and nature of inventory costs applicable to earlier
years; and
(2) The use of available information with respect to comparable
items of inventory produced or acquired during the same year in order
to estimate the costs associated with other items of inventory.
(D) Use by dollar-value LIFO taxpayers. Generally, a dollar-value
LIFO taxpayer must recompute its LIFO inventory for each taxable year
that the LIFO inventory method was used.
(E) Examples. The provisions of this paragraph (c)(2)(iii) are
illustrated by the following three examples. The principles set forth
in these examples are applicable both to production and resale
activities and the year of change in all three examples is 1997. The
examples read as follows:
Example 1. Taxpayer X lacks information for the years 1993 and
earlier, regarding the amount of costs incurred in transporting
finished goods from X's factory to X's warehouse and in storing
those goods at the warehouse until their sale to customers. X
determines that, for 1994 and subsequent years, these transportation
and storage costs constitute 4 percent of the total costs of
comparable goods under X's method of accounting for such years.
Under this paragraph (c)(2)(iii), X may assume that transportation
and storage costs for the years 1993 and earlier constitute 4
percent of the total costs of such goods.
Example 2. Assume the same facts as in Example 1, except that
for the year 1993 and earlier, X used a different method of
accounting for inventory costs whereunder significantly fewer costs
were capitalized than amounts capitalized in later years. Thus, the
application of transportation and storage based on a percentage of
costs for 1994 and later years would not constitute a reasonable
estimate for use in earlier years. X may use the information from
1994 and later years, if appropriate adjustments are made to reflect
the differences in inventory costs for the applicable years,
including, for example--
(i) Increasing the percentage of costs that are intended to
represent transportation and storage costs to reflect the aggregate
differences in capitalized amounts under the two methods of
accounting; or
(ii) Taking the absolute dollar amount of transportation and
storage costs for comparable goods in inventory and applying that
amount (adjusted for changes in general price levels, where
appropriate) to goods associated with 1993 and prior periods.
Example 3. Taxpayer Z lacks information for certain years with
respect to factory administrative costs, subject to capitalization
under section 263A and the regulations thereunder, incurred in the
production of inventory in factory A. Z does have sufficient
information to determine factory administrative costs with respect
to production of inventory in factory B, wherein inventory items
were produced during the same years as factory A. Z may use the
information from factory B to determine the appropriate amount of
factory administrative costs to capitalize as inventory costs for
comparable items produced in factory A during the same years.
(iv) Weighted average method--(A) In general. A taxpayer using the
FIFO method or the specific goods LIFO method of accounting for
inventories may use the weighted average method as provided in this
paragraph (c)(2)(iv) to estimate the change in the amount of costs that
must be allocated to inventories for prior years. The weighted average
method under this paragraph (c)(2)(iv) is only available to a taxpayer
that lacks sufficient data to revalue its inventory costs under the
facts and circumstances revaluation method provided for in paragraph
(c)(2)(iii) of this section. Moreover, a taxpayer that qualifies for
the use of the weighted average method under this paragraph (c)(2)(iv)
must utilize such method only with respect to items or costs for which
it lacks sufficient information to revalue under the facts and
circumstances revaluation method. Particular items or costs must be
revalued under the facts and circumstances revaluation method if
sufficient information exists to make such a revaluation. If a taxpayer
lacks sufficient information to otherwise apply the weighted average
method under this paragraph (c)(2)(iv) (for example, the taxpayer is
unable to revalue the costs of any of its items in inventory due to a
lack of information), then the taxpayer must use reasonable estimates
and procedures, as described in the facts and circumstances revaluation
method, to whatever extent is necessary to allow the taxpayer to apply
the weighted average method.
(B) Weighted average method for FIFO taxpayers--(1) In general.
This paragraph (c)(2)(iv)(B) sets forth the mechanics of the weighted
average method as applicable to FIFO taxpayers. Under the weighted
average method, an item in ending inventory for which sufficient data
is not available for revaluation under section 263A and the regulations
thereunder must be revalued by using the weighted average percentage
increase or decrease with respect to such item for the earliest
subsequent taxable year for which sufficient data is available. With
respect to an item for which no subsequent data exists, such item must
be revalued by using the weighted average percentage increase or
decrease with respect to all reasonably comparable items in the
taxpayer's inventory for the same year or the earliest subsequent
taxable year for which sufficient data is available.
(2) Example. The provisions of this paragraph (c)(2)(iv)(B) are
illustrated by the following example. The principles set forth in this
example are applicable both to production and resale activities and the
year of change in the example is 1997. The example reads as follows:
Example. Taxpayer A manufactures bolts and uses the FIFO method
to identify inventories. Under A's former method, A did not
capitalize all of the costs required to be capitalized under section
263A. A maintains inventories of bolts, two types of which it no
longer produces. Bolt A was last produced in 1994. The revaluation
of the costs of Bolt A under this section for bolts produced in 1994
results in a 20 percent increase of the costs of Bolt A. A portion
of the inventory of Bolt A, however, is attributable to 1993. A does
not have sufficient data for revaluation of the 1993 cost for Bolt
A. With respect to Bolt A, A may apply the 20 percent increase
determined for 1994 to the 1993 production as an acceptable
estimate. Bolt B was last produced in 1992 and no data exists that
would allow revaluation of the inventory cost of Bolt B. The
inventories of all other bolts for which information is available
are attributable to 1994 and 1995. Revaluation of the costs of these
other bolts using available data results in an average increase in
inventory costs of 15 percent for 1994 production. With respect to
Bolt B, the overall 15 percent increase for A's inventory for 1994
may be used in revaluing the cost of Bolt B.
(C) Weighted average method for specific goods LIFO taxpayers--(1)
In general. This paragraph (c)(2)(iv)(C) sets forth the mechanics of
the weighted average method as applicable to LIFO taxpayers using the
specific goods method of valuing inventories. Under the weighted
average method, the inventory layers with respect to an item for which
data is available are revalued under this section and the increase or
decrease in amount for each layer is expressed as a percentage of
change from the cost in the layer as originally valued. A weighted
average of the percentage of change for all layers for each type of
good is computed and applied to all earlier layers for each type of
good that lack sufficient data to allow for revaluation. In the case of
earlier layers for which sufficient data exists, such layers are to be
revalued using actual data. In cases where sufficient data is not
available to make a weighted average estimate with respect to a
particular item of inventory, a weighted average increase or decrease
is to be determined using all other inventory items revalued by the
taxpayer in the
[[Page 42058]]
same specific goods grouping. This percentage increase or decrease is
then used to revalue the cost of the item for which data is lacking. If
the taxpayer lacks sufficient data to revalue any of the inventory
items contained in a specific goods grouping, then the weighted average
increase or decrease of substantially similar items (as determined by
principles similar to the rules applicable to dollar-value LIFO
taxpayers in Sec. 1.472-8(b)(3)) must be applied in the revaluation of
the items in such grouping. If insufficient data exists with respect to
all the items in a specific goods grouping and to all items that are
substantially similar (or such items do not exist), then the weighted
average for all revalued items in the taxpayer's inventory must be
applied in revaluing items for which data is lacking.
(2) Example. The provisions of this paragraph (c)(2)(iv)(C) are
illustrated by the following example. The principles set forth in this
example are applicable both to production and resale activities and the
year of change in the example is 1997. The example reads as follows:
Example. (i) Taxpayer M is a manufacturer that produces two
different parts. Under M's former method, M did not capitalize all
of the costs required to be capitalized under section 263A. Work-in-
process inventory is recorded in terms of equivalent units of
finished goods. M's records show the following at the end of 1996
under the specific goods LIFO inventory method:
----------------------------------------------------------------------------------------------------------------
Carrying
LIFO Product and layer Number Cost values
----------------------------------------------------------------------------------------------------------------
Product #1:
1993........................................................ 150 $5.00 $750
1994........................................................ 100 6.00 600
1995........................................................ 100 6.50 650
1996........................................................ 50 7.00 350
-----------------------------------------------
$2,350
Product #2:
1993........................................................ 200 $4.00 $800
1994........................................................ 200 4.50 900
1995........................................................ 100 5.00 500
1996........................................................ 100 6.00 600
-----------------------------------------------
2,800
===============================================
Total carrying value of Products #1 and #2 under M's
former method.......................................... .............. .............. 5,150
----------------------------------------------------------------------------------------------------------------
(ii) M has sufficient data to revalue the unit costs of Product
#1 using its new method for 1994, 1995 and 1996. These costs are:
$7.00 in 1994, $7.75 in 1995, and $9.00 in 1996. This data for
Product #1 results in a weighted average percentage change of 20.31
percent
((100 x ($7.00-$6.00))+(100 x ($7.75-$6.50))+(50 x ($9.00-$7.00))
divided by (100 x $6.00) + (100 x $6.50) + (50 x $7.00)]. M has
sufficient data to revalue the unit costs of Product #2 only in 1995
and 1996. These costs are: $6.00 in 1995 and $7.00 in 1996. This
data for Product #2 results in a weighted average percentage change
of 18.18 percent [(100 x ($6.00-$5.00))+(100 x ($7.00-$6.00))
divided by (100 x $5.00)+(100 x $6.00)].
(iii) M can estimate its revalued costs for Product #1 for 1993
by applying the weighted average increase computed for Product #1
(20.31 percent) to the unit costs originally carried on M's records
for 1993 under M's former method. The estimated revalued unit cost
of Product #1 would be $6.02 ($5.00 x 1.2031). M estimates its
revalued costs for Product #2 for 1993 and 1994 in a similar
fashion. M applies the weighted average increase determined for
Product #2 (18.18 percent) to the unit costs of $4.00 and $4.50 for
1993 and 1994 respectively. The revalued unit costs of Product #2
are $4.73 for 1993 ($4.00 x 1.1818) and $5.32 for 1994
($4.50 x 1.1818).
(iv) M's inventory would be revalued as follows:
----------------------------------------------------------------------------------------------------------------
Carrying
LIFO product and layer Number Cost values
----------------------------------------------------------------------------------------------------------------
Product #1:
1993........................................................ 150 $6.02 $903
1994........................................................ 100 7.00 700
1995........................................................ 100 7.75 775
1996........................................................ 50 9.00 450
-----------------------------------------------
$2,828
Product #2:
1993........................................................ 200 4.73 946
1994........................................................ 200 5.32 1,064
1995........................................................ 100 6.00 600
1996........................................................ 100 7.00 700
-----------------------------------------------
3,310
Total value of Products #1 and #2 as revalued under M's
new method............................................. .............. .............. 6,138
===============
Total amount of adjustment required under section 481(a)
[$6,138-$5,150]........................................ .............. .............. 988
----------------------------------------------------------------------------------------------------------------
(D) Adjustments to inventory costs from prior years. For special
rules applicable when a revaluation using the weighted average method
includes costs not incurred in prior years, see paragraph (c)(2)(v)(E)
of this section.
(v) 3-year average method--(A) In general. A taxpayer using the
dollar-value LIFO method of accounting for inventories may revalue all
existing LIFO layers of a trade or business based on the 3-year average
method as
[[Page 42059]]
provided in this paragraph (c)(2)(v). The 3-year average method is
based on the average percentage change (the 3-year revaluation factor)
in the current costs of inventory for each LIFO pool based on the three
most recent taxable years for which the taxpayer has sufficient
information (typically, the three most recent taxable years of such
trade or business). The 3-year revaluation factor is applied to all
layers for each pool in beginning inventory in the year of change. The
3-year average method is available to any dollar-value taxpayer that
complies with the requirements of this paragraph (c)(2)(v) regardless
of whether such taxpayer lacks sufficient data to revalue its inventory
costs under the facts and circumstances revaluation method prescribed
in paragraph (c)(2)(iii) of this section. The 3-year average method
must be applied with respect to all inventory in a taxpayer's trade or
business. A taxpayer is not permitted to apply the method for the
revaluation of some, but not all, inventory costs on the basis of
pools, business units, or other measures of inventory amounts that do
not constitute a separate trade or business. Generally, a taxpayer
revaluing its inventory using the 3-year average method must establish
a new base year. See, paragraph (b)(2)(iii)(A)(2)(i) of this section.
However, a dollar-value LIFO taxpayer using the 3-year average method
and either the simplified production method or the simplified resale
method to revalue its inventory is permitted, but not required, to
establish a new base year. See, paragraph (b)(2)(iii)(A)(2)(ii) of this
section. If a taxpayer lacks sufficient information to otherwise apply
the 3-year average method under this paragraph (c)(2)(v) (for example,
the taxpayer is unable to revalue the costs of any of its LIFO pools
for three years due to a lack of information), then the taxpayer must
use reasonable estimates and procedures, as described in the facts and
circumstances revaluation method under paragraph (c)(2)(iii) of this
section, to whatever extent is necessary to allow the taxpayer to apply
the 3-year average method.
(B) Consecutive year requirement. Under the 3-year average method,
if sufficient data is available to calculate the revaluation factor for
more than three years, the taxpayer may use data from such additional
years in determining the average percentage increase or decrease only
if the additional years are consecutive to and prior to the year of
change. The requirement under the preceding sentence to use consecutive
years is applicable under this method regardless of whether any
inventory costs in beginning inventory as of the year of change are
viewed as incurred in, or attributable to, those consecutive years
under the LIFO inventory method. Thus, the requirement to use data from
consecutive years may result in using information from a year in which
no LIFO increment occurred. For example, if a taxpayer is changing its
method of accounting in 1997 and has sufficient data to revalue its
inventory for the years 1991 through 1996, the taxpayer may calculate
the revaluation factor using all six years. If, however, the taxpayer
has sufficient data to revalue its inventory for the years 1990 through
1992, and 1994 through 1996, only the three years consecutive to the
year of change, that is, 1994 through 1996, may be used in determining
the revaluation factor. Similarly, for example, a taxpayer with LIFO
increments in 1995, 1993, and 1992 may not calculate the revaluation
factor based on the data from those years alone, but instead must use
the data from consecutive years for which the taxpayer has information.
(C) Example. The provisions of this paragraph (c)(2)(v) are
illustrated by the following example. The principles set forth in this
example are applicable both to production and resale activities and the
year of change in the example is 1997. The example reads as follows:
Example. (i) Taxpayer G, a calendar year taxpayer, is a reseller
that is required to change its method of accounting under section
263A. G will not use either the simplified production method or the
simplified resale method. G adopted the dollar-value LIFO inventory
method in 1991, using a single pool and the double extension method.
G's beginning LIFO inventory as of January 1, 1997, computed using
its former method, for the year of change is as follows:
----------------------------------------------------------------------------------------------------------------
Base year LIFO carrying
costs Index value
----------------------------------------------------------------------------------------------------------------
Base layer $14,000 1.00 $14,000
1991 layer...................................................... 4,000 1.20 4,800
1992 layer...................................................... 5,000 1.30 6,500
1993 layer...................................................... 2,000 1.35 2,700
1994 layer...................................................... 0 1.40 0
1995 layer...................................................... 4,000 1.50 6,000
1996 layer...................................................... 5,000 1.60 8,000
-----------------------------------------------
Total....................................................... 34,000 .............. 42,000
----------------------------------------------------------------------------------------------------------------
(ii) G is able to recompute total inventoriable costs incurred
under its new method for the three preceding taxable years as
follows:
----------------------------------------------------------------------------------------------------------------
Current cost
as recorded Current cost Percentage
(former as adjusted change
method) (new method)
----------------------------------------------------------------------------------------------------------------
1994............................................................ $35,000 $45,150 .29
1995............................................................ 43,500 54,375 .25
1996............................................................ 54,400 70,720 .30
-----------------------------------------------
Total....................................................... 132,900 170,245 .28
----------------------------------------------------------------------------------------------------------------
(iii) Applying the average revaluation factor of .28 to each
layer, G's inventory is restated as follows:
----------------------------------------------------------------------------------------------------------------
Restated base Restated LIFO
year costs Index carrying value
----------------------------------------------------------------------------------------------------------------
Base layer...................................................... $17,920 1.00 $17,920
[[Page 42060]]
1991 layer...................................................... 5,120 1.20 6,144
1992 layer...................................................... 6,400 1.30 8,320
1993 layer...................................................... 2,560 1.35 3,456
1994 layer...................................................... 0 1.40 0
1995 layer...................................................... 5,120 1.50 7,680
1996 layer...................................................... 6,400 1.60 10,240
-----------------------------------------------
Total....................................................... 43,520 .............. 53,760
----------------------------------------------------------------------------------------------------------------
(iv) The adjustment required by section 481(a) is $11,760. This
amount may be computed by multiplying the average percentage of .28
by the LIFO carrying value of G's inventory valued using its former
method ($42,000). Alternatively, the adjustment required by section
481(a) may be computed by the difference between--
(A) The revalued costs of the taxpayer's inventory under its new
method ($53,760), and
(B) The costs of the taxpayer's inventory using its former
method ($42,000).
(v) In addition, the inventory as of the first day of the year
of change (January 1, 1997) becomes the new base year cost for
purposes of determining the LIFO index in future years. See,
paragraphs (b)(2)(iii)(A)(2)(i) and (b)(2)(iii)(B) of this section.
This requires that layers in years prior to the base year be
restated in terms of the new base year index. The current year cost
of G's inventory, as adjusted, is $70,720. Such cost must be
apportioned to each layer in proportion to the restated base year
cost of that layer to total restated base year costs ($43,520), as
follows:
----------------------------------------------------------------------------------------------------------------
Restated base Restated LIFO
year costs Restated index carrying value
----------------------------------------------------------------------------------------------------------------
Old base layer.................................................. $29,120 .615 $17,920
1991 layer...................................................... 8,320 .738 6,144
1992 layer...................................................... 10,400 .80 8,320
1993 layer...................................................... 4,160 .831 3,456
1994 layer...................................................... 0 .............. 0
1995 layer...................................................... 8,320 .923 7,680
1996 layer...................................................... 10,400 .985 10,240
-----------------------------------------------
Total................................................... 70,720 .............. 53,760
----------------------------------------------------------------------------------------------------------------
(D) Short taxable years. A short taxable year is treated as a full
12 months.
(E) Adjustments to inventory costs from prior years--(1) General
rule--(i) The use of the revaluation factor, based on current costs, to
estimate the revaluation of prior inventory layers under the 3-year
average method, as described in paragraph (c)(2)(v) of this section,
may result in an allocation of costs that include amounts attributable
to costs not incurred during the year in which the layer arose. To the
extent a taxpayer can demonstrate that costs that contributed to the
determination of the revaluation factor could not have affected a prior
year, the revaluation factor as applied to that year may be adjusted
under the restatement adjustment procedure, as described in paragraph
(c)(2)(v)(F) of this section. The determination that a cost could not
have affected a prior year must be made by a taxpayer only upon showing
that the type of cost incurred during the years used to calculate the
revaluation factor (revaluation years) was not present during such
prior year. An item of cost will not be eligible for the restatement
adjustment procedure simply because the cost varies in amount from year
to year or the same type of cost is described or referred to by a
different name from year to year. Thus, the restatement adjustment
procedure allowed under paragraph (c)(2)(v)(F) of this section is not
available in a prior year with respect to a particular cost if the same
type of cost was incurred both in the revaluation years and in such
prior year, although the amount of such cost and the name or
description thereof may vary.
(ii) The provisions of this paragraph (c)(2)(v)(E) are also
applicable to taxpayers using the weighted average method in revaluing
inventories under paragraph (c)(2)(iv) of this section. Thus, to the
extent a taxpayer can demonstrate that costs that contributed to the
determination of the restatement of a particular year or item could not
have affected a prior year or item, the taxpayer may adjust the
revaluation of that prior year or item accordingly under the weighted
average method. All the requirements and definitions, however,
applicable to the restatement adjustment procedure under this paragraph
(c)(2)(v)(E) fully apply to a taxpayer using the weighted average
method to revalue inventories.
(2) Examples of costs eligible for restatement adjustment
procedure. The provisions of this paragraph (c)(2)(v)(E) are
illustrated by the following four examples. The principles set forth in
these examples are applicable both to production and resale activities
and the year of change in the four examples is 1997. The examples read
as follows:
Example 1. Taxpayer A is a reseller that introduced a defined
benefit pension plan in 1994, and made the plan available to
personnel whose labor costs were (directly or indirectly) properly
allocable to resale activities. A determines the revaluation factor
based on data available for the years 1994 through 1996, for which
the pension plan was in existence. Based on these facts, the costs
of the pension plan in the revaluation years are eligible for the
restatement adjustment procedure for years prior to 1994.
Example 2. Assume the same facts as in Example 1, except that a
defined contribution plan was available, during prior years, to
personnel whose labor costs were properly allocable to resale
activities. The defined contribution plan was terminated before the
introduction of the defined benefit plan in 1994. Based on these
facts, the costs of the defined benefit pension plan in the
revaluation years are not eligible for the restatement adjustment
procedure with respect to years for which the defined contribution
plan existed.
Example 3. Taxpayer C is a manufacturer that established a
security department in 1995 to patrol and safeguard its production
and warehouse areas used in C's trade or business. Prior to 1995, C
had not been required to utilize security personnel in its trade or
business; C established the security department in 1995 in response
to increasing vandalism and theft at its plant locations. Based on
these facts, the costs of the security
[[Page 42061]]
department are eligible for the restatement adjustment procedure for
years prior to 1995.
Example 4. Taxpayer D is a reseller that established a payroll
department in 1995 to process the company's weekly payroll. In the
years 1991 through 1994, D engaged the services of an outside vendor
to process the company's payroll. Prior to 1991, D's payroll
processing was done by D's accounting department, which was
responsible for payroll processing as well as for other accounting
functions. Based on these facts, the costs of the payroll department
are not eligible for the restatement adjustment procedure. D was
incurring the same type of costs in earlier years as D was incurring
in the payroll department in 1995 and subsequent years, although
these costs were designated by a different name or description.
(F) Restatement adjustment procedure--(1) In general--(i) This
paragraph (c)(2)(v)(F) provides a restatement adjustment procedure
whereunder a taxpayer may adjust the restatement of inventory costs in
prior taxable years in order to produce a different restated value than
the value that would otherwise occur through application of the
revaluation factor to such prior taxable years.
(ii) Under the restatement adjustment procedure as applied to a
particular prior year, a taxpayer must determine the particular items
of cost that are eligible for the restatement adjustment with respect
to such prior year. The taxpayer must then recompute, using reasonable
estimates and procedures, the total inventoriable costs that would have
been incurred for each revaluation year under the taxpayer's former
method and the taxpayer's new method by making appropriate adjustments
in the data for such revaluation year to reflect the particular costs
eligible for adjustment.
(iii) The taxpayer must then compute the total percentage change
with respect to each revaluation year, using the revised estimates of
total inventoriable costs for such year as described in paragraph
(c)(2)(v)(F)(1)(ii) of this section. The percentage change must be
determined by calculating the ratio of the revised total of the
inventoriable costs for such revaluation year under the taxpayer's new
method to the revised total of the inventoriable costs for such
revaluation year under the taxpayer's former method.
(iv) An average of the resulting percentage change for all
revaluation years is then calculated, and the resulting average is
applied to the prior year in issue.
(2) Examples of restatement adjustment procedure. The provisions of
this paragraph (c)(2)(v)(F) are illustrated by the following two
examples. The principles set forth in these examples are applicable
both to production and resale activities and the year of change in the
two examples is 1997. The examples read as follows:
Example 1. Taxpayer A is a reseller that is eligible to make a
restatement adjustment by reason of the costs of a defined benefit
pension plan that was introduced in 1994, during the revaluation
period. The revaluation factor, before adjustment of data to reflect
the pension costs, is as provided in the example in paragraph
(c)(2)(v)(C) of this section. Thus, for example, with respect to the
year 1994, the total inventoriable costs under A's former method is
$35,000, the total inventoriable costs under A's new method is
$45,150, and the percentage change is .29. Under the method of
accounting used by A during 1994 (the former method), none of the
pension costs were included as inventoriable costs. Thus, under the
restatement adjustment procedure, the total inventoriable cost under
A's former method would remain at $35,000 if the pension plan had
not been in existence. Similarly, A determines that the total
inventoriable costs for 1994 under A's new method, if the pension
plan had not been in existence, would have been $42,000. The
restatement adjustment for 1994 determined under this paragraph
(c)(2)(v)(F) would then be equal to .20 ([$42,000-$35,000]/$35,000).
A would make similar calculations with respect to 1995 and 1996. The
average of such amounts for each of the three years in the
revaluation period would then be determined as in the example in
paragraph (c)(2)(v)(C) of this section. Such average would be used
to revalue cost layers for years for which the pension plan was not
in existence. Such revalued layers would then be viewed as restated
in compliance with the requirements of this paragraph. With respect
to cost layers incurred during years for which the pension plan was
in existence, no adjustment of the revaluation factor would occur.
Example 2. Assume the same facts as in Example 1, except that a
portion of the pension costs were included as inventoriable costs
under the method used by A during 1994 (the former method). Under
the restatement adjustment procedure, A determines that the total
inventoriable costs for 1994 under the former method, if the pension
plan had not been in existence, would have been $34,000. Similarly,
A determines that the total inventoriable costs for 1994 under A's
new method, if the pension plan had not been in existence, would
have been $42,000. The restatement adjustment for 1994 determined
under this paragraph (c)(2)(v)(F) would then be equal to .24
([$42,000-$34,000]/$34,000). A would make similar calculations with
respect to 1995 and 1996. The average of such amounts for each of
the three years in the revaluation period would then be determined
as in the example in paragraph (c)(2)(v)(C) of this section. Such
average would be used to revalue cost layers for years for which the
pension plan was not in existence.
(3) Intercompany items--(i) Revaluing intercompany transactions.
Pursuant to any change in method of accounting for costs subject to
section 263A, taxpayers are required to revalue the amount of any
intercompany item resulting from the sale or exchange of inventory
property in an intercompany transaction to an amount equal to the
intercompany item that would have resulted, had the cost of goods sold
for that inventory property been determined under the taxpayer's new
method. The requirement of the preceding sentence applies with respect
to both inventory produced by a taxpayer and inventory acquired by the
taxpayer for resale. In addition, the requirements of this paragraph
(c)(3) apply only to any intercompany item of the taxpayer as of the
beginning of the year of change in method of accounting. See
Sec. 1.1502-13(b)(2)(ii). A taxpayer must revalue the amount of any
intercompany item only if the inventory property sold in the
intercompany transaction is held as inventory by a buying member as of
the date the taxpayer changes its method of accounting under section
263A. Corresponding changes to the adjustment required under section
481(a) must be made with respect to any adjustment of the intercompany
item required under this paragraph (c)(3). Moreover, the requirements
of this paragraph (c)(3) apply regardless of whether the taxpayer has
any items in beginning inventory as of the year of change in method of
accounting. See Sec. 1.1502-13 for the definition of intercompany
transaction.
(ii) Example. The provisions of this paragraph (c)(3) are
illustrated by the following example. The principles set forth in this
example are applicable both to production and resale activities and the
year of change in the example is 1997. The example reads as follows:
Example. (i) Assume that S, a member of a consolidated group
filing its federal income tax return on a calendar year,
manufactures and sells inventory property to B, a member of the same
consolidated group, in 1996. The sale between S and B is an
intercompany transaction as defined under Sec. 1.1502-13(b)(1). The
gain from the intercompany transaction is an intercompany item to S
under Sec. 1.1502-13(b)(2). As of the beginning of the year of
change in method of accounting (January 1, 1997), the inventory
property is still held by B based on the particular inventory method
of accounting used by B for federal income tax purposes (for
example, the LIFO or FIFO inventory method). The property was sold
by S to B in 1996 for $150; the cost of goods sold with respect to
the property under the method in effect at the time the inventory
was produced was $100, resulting in an intercompany item of $50 to S
under Sec. 1.1502-13. As of January 1, 1997, S still has an
intercompany item of $50.
(ii) S is required to revalue the amount of its intercompany
item to an amount equal to what the intercompany item would have
[[Page 42062]]
been had the cost of goods sold for that inventory property been
determined under S's new method. Assume that the cost of the
inventory under this method would have been $110, had the method
applied to S's manufacture of the property in 1996. Thus, S is
required to revalue the amount of its intercompany item to $40 (that
is, $150 less $110), necessitating a negative adjustment to the
intercompany item of $10. Moreover, S is required to increase its
adjustment under section 481(a) by $10 in order to prevent the
omission of such amount by virtue of the decrease in the
intercompany item.
(iii) Availability of revaluation methods. In revaluing the amount
of any intercompany item resulting from the sale or exchange of
inventory property in an intercompany transaction to an amount equal to
the intercompany item that would have resulted had the cost of goods
sold for that inventory property been determined under the taxpayer's
new method, a taxpayer may use the other methods and procedures
otherwise properly available to that particular taxpayer in revaluing
inventory under section 263A and the regulations thereunder, including,
if appropriate, the various simplified methods provided in section 263A
and the regulations thereunder and the various procedures described in
this paragraph (c).
(4) Anti-abuse rule--(i) In general. Section 263A(i)(1) provides
that the Secretary shall prescribe such regulations as may be necessary
or appropriate to carry out the purposes of section 263A, including
regulations to prevent the use of related parties, pass-thru entities,
or intermediaries to avoid the application of section 263A and the
regulations thereunder. One way in which the application of section
263A and the regulations thereunder would be otherwise avoided is
through the use of entities described in the preceding sentence in such
a manner as to effectively avoid the necessity to restate beginning
inventory balances under the change in method of accounting required or
permitted under section 263A and the regulations thereunder.
(ii) Deemed avoidance of this section--(A) Scope. For purposes of
this paragraph (c), the avoidance of the application of section 263A
and the regulations thereunder will be deemed to occur if a taxpayer
using the LIFO method of accounting for inventories, transfers
inventory property to a related corporation in a transaction described
in section 351, and such transfer occurs:
(1) On or before the beginning of the transferor's taxable year
beginning in 1987; and
(2) After September 18, 1986.
(B) General rule. Any transaction described in paragraph
(c)(4)(ii)(A) of this section will be treated in the following manner:
(1) Notwithstanding any provision to the contrary (for example,
section 381), the transferee corporation is required to revalue the
inventories acquired from the transferor under the provisions of this
paragraph (c) relating to the change in method of accounting and the
adjustment required by section 481(a), as if the inventories had never
been transferred and were still in the hands of the transferor; and
(2) Absent an election as described in paragraph (c)(4)(iii) of
this section, the transferee must account for the inventories acquired
from the transferor by treating such inventories as if they were
contained in the transferee's LIFO layer(s).
(iii) Election to use transferor's LIFO layers. If a transferee
described in paragraph (c)(4)(ii) of this section so elects, the
transferee may account for the inventories acquired from the transferor
by allocating such inventories to LIFO layers corresponding to the
layers to which such properties were properly allocated by the
transferor, prior to their transfer. The transferee must account for
such inventories for all subsequent periods with reference to such
layers to which the LIFO costs were allocated. Any such election is to
be made on a statement attached to the timely filed federal income tax
return of the transferee for the first taxable year for which section
263A and the regulations thereunder applies to the transferee.
(iv) Tax avoidance intent not required. The provisions of paragraph
(c)(4)(ii) of this section will apply to any transaction described
therein, without regard to whether such transaction was consummated
with an intention to avoid federal income taxes.
(v) Related corporation. For purposes of this paragraph (c)(4), a
taxpayer is related to a corporation if--
(A) the relationship between such persons is described in section
267(b)(1), or
(B) such persons are engaged in trades or businesses under common
control (within the meaning of paragraphs (a) and (b) of section 52).
(d) Non-inventory property--(1) Need for adjustments. A taxpayer
that changes its method of accounting for costs subject to section 263A
with respect to non-inventory property must revalue the non-inventory
property on hand at the beginning of the year of change as set forth in
paragraph (d)(2) of this section, and compute an adjustment under
section 481(a). The adjustment under section 481(a) will equal the
difference between the adjusted basis of the property as revalued using
the taxpayer's new method and the adjusted basis of the property as
originally valued using the taxpayer's former method.
(2) Revaluing property. A taxpayer must revalue its non-inventory
property as of the beginning of the year of change in method of
accounting. The facts and circumstances revaluation method of paragraph
(c)(2)(iii) of this section must be used to revalue this property. In
revaluing non-inventory property, however, the only additional section
263A costs that must be taken into account are those additional section
263A costs incurred after the later of December 31, 1986, or the date
the taxpayer first becomes subject to section 263A, in taxable years
ending after that date. See Sec. 1.263A-1(d)(3) for the definition of
additional section 263A costs.
Sec. 1.263A-7T [Removed]
Par. 5. Section 1.263A-7T is removed.
Sec. 1.263A-15 [Amended]
Par. 6. Section 1.263A-15 is amended by removing ``1.263A-7T (e)
generally'' from the last sentence in paragraph (a)(1) and replacing it
with ``1.263A-7''.
Dated: July 28, 1997.
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-20530 Filed 8-4-97; 8:45 am]
BILLING CODE 4830-01-U