[Federal Register Volume 67, Number 6 (Wednesday, January 9, 2002)]
[Rules and Regulations]
[Pages 1075-1095]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-184]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8976]
RIN 1545-AX20


Dollar-Value LIFO Regulations; Inventory Price Index Computation 
Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under section 472 of 
the Internal Revenue Code that relate to accounting for inventories 
under the last-in, first-out (LIFO) method. The final regulations 
provide guidance regarding methods of valuing dollar-value LIFO pools 
and affect persons who elect to use the dollar-value LIFO and inventory 
price index computation (IPIC) methods or who receive dollar-value LIFO 
inventories in certain nonrecognition transactions.

DATES: Effective Date: These regulations are effective on December 31, 
2001.
    Applicability Date: For dates of applicability, see Secs. 1.472-
8(e)(3)(v) and 1.472-8(h)(4).

FOR FURTHER INFORMATION CONTACT: Leo F. Nolan II at (202) 622-4970 (not 
a toll-free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information in this final rule have been 
reviewed and, pending receipt and evaluation of public comments, 
approved by the Office of Management and Budget (OMB) under 44 U.S.C. 
3507 and assigned control number 1545-1767. The collections of 
information in this regulation are in Sec. 1.472-8(e)(3)(iii)(B)(3) and 
(e)(3)(iv). To elect the IPIC method, a taxpayer must file Form 970, 
``Application to Use LIFO Inventory Method.'' This information is 
required to inform the Commissioner regarding the taxpayer's elections 
under the IPIC method. This information will be used to determine 
whether the taxpayer is properly accounting for its dollar-value pools 
under the IPIC method. The collections of information are required if 
the taxpayer wants to obtain the tax benefits of the LIFO method. The 
likely respondents are business or other for-profit institutions, and/
or small businesses or organizations.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    The reporting burden contained in Sec. 1.472-8(e)(3)(iii)(B)(3) and 
(e)(3)(iv) is reflected in the burden of Form 970.
    Comments on the collections of information should be sent to the 
Office of Management and Budget, Attn: Desk Officer for the Department 
of the Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S, Washington, DC 
20224.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 472 of the Internal Revenue Code (Code) permits a taxpayer 
to account for inventories using a last-in, first-out (LIFO) method of 
accounting. Section 472(f) directs the Secretary to prescribe 
regulations that permit the use of suitable published governmental 
price indexes for purposes of the LIFO method. The IRS and Treasury 
Department prescribed the inventory price index computation (IPIC) 
method in Sec. 1.472-8(e)(3) (TD 7814, 47 FR 11271, 1982-1 C.B. 84) 
(the current regulations), under the authority contained in sections 
472 and 7805. A taxpayer using the IPIC method must base its inventory 
price indexes on the consumer price indexes or producer price indexes 
published by the United States Bureau of Labor Statistics (BLS). The 
IPIC method was intended to simplify the use of the dollar-value LIFO 
method, so that the LIFO method could be used by more taxpayers and so 
that taxpayers already using the dollar-value LIFO method would have a 
simpler alternative method of computing an index for their dollar-value 
pool.
    On May 19, 2000, the IRS and Treasury Department published a notice 
of proposed rulemaking (REG-107644-98, 65 FR 31841, 2000-23 I.R.B. 
1229) (the proposed regulations) intended to simplify and clarify 
certain aspects of the IPIC method. In addition, the proposed 
regulations provided rules for computing the LIFO value of a dollar-
value pool when a taxpayer receives LIFO inventories in certain 
nonrecognition transactions. Comments responding to the notice were 
received,

[[Page 1076]]

and a public hearing was held on September 15, 2000.
    The IRS and Treasury Department received 16 comment letters 
concerning the proposed regulations. After considering the comments 
contained in these letters, the IRS and Treasury Department adopt the 
proposed regulations as revised by this Treasury decision. The comments 
and revisions are discussed below.

Explanation of Provisions and Summary of Comments

1. Overview

    Under the last-in, first-out (LIFO) method, inventory on hand at 
the end of the year is treated as consisting of ``layers,'' first of 
inventory on hand at the beginning of the year (in the order of 
acquisition), and then of any inventory acquired during the current 
year. Section 1.472-8 permits a taxpayer to use the dollar-value LIFO 
method, which accounts for all items in an inventory ``pool'' (dollar-
value pool) in terms of dollars of cost rather than in terms of 
quantities and prices of specific goods. Specifically, the taxpayer 
annually determines the existence of an increase (increment) or 
decrease (liquidation) in a dollar-value pool by comparing inventory 
quantities measured in terms of equivalent-value dollars (base-year 
cost). The current-year cost of beginning and ending inventory is 
converted into base-year cost using an inflation index, which is the 
ratio of the dollar-value pool's total current-year cost to its total 
base-year cost. By subtracting the base-year cost of the dollar-value 
pool at the beginning of the taxable year from the base-year cost of 
the dollar-value pool at the end of the taxable year, the taxpayer 
determines the amount of any resulting increment or liquidation. 
Finally, the taxpayer computes the LIFO value of an increment (layer) 
by multiplying that increment's base-year cost by an inflation index.
    The current regulations provide an alternative method for a 
taxpayer to determine an inflation index. Under the inventory price 
index computation (IPIC) method, the taxpayer computes an inventory 
price index (IPI) based on the consumer price indexes (CPI) or producer 
price indexes (PPI) published monthly by the United States Bureau of 
Labor Statistics (BLS) in the ``CPI Detailed Report'' and ``PPI 
Detailed Report,'' respectively. See also http://www.bls.gov.
    To facilitate a taxpayer's use of the IPIC method, the final 
regulations use new, more-descriptive terms for some IPIC method 
concepts. For example, pool index has been replaced with IPI, 
appropriate index has been replaced with category inflation index, and 
index category has been replaced with BLS index category. Within this 
preamble, the discussion of the current and proposed regulations uses 
both old and new terms, and the discussion of the final regulations 
generally uses the new terms.

2. Inventory Price Index--20 Percent Reduction

    The current regulations state that ``[a]n inventory price index 
computed [under the IPIC method] shall be a stated percentage of the 
percent change in the selected consumer or producer price index or 
indexes for a specific category or categories of goods.'' For this 
purpose, ``stated percentage'' means ``100 percent'' in the case of an 
eligible small business, as defined in section 474 (i.e., average 
annual gross receipts for the three preceding taxable years do not 
exceed $5,000,000), and ``80 percent'' in all other cases. The proposed 
regulations retained this 20 percent reduction for large taxpayers.
    Several commentators objected to the continuing requirement that 
large taxpayers reduce the IPI by 20 percent. Some of these 
commentators opined that the IPIC method is effectively a safe harbor 
method that significantly simplifies the LIFO computation and reduces 
IRS and taxpayer controversy; however, the 20 percent reduction is a 
major deterrent to its use by large taxpayers. Others argued that the 
CPI and PPI are representative of true inflation and, therefore, the 20 
percent reduction decreases the accuracy of the IPIC method. Other 
commentators recommended that the stated percentage not be decreased by 
20 percent until the taxpayer's gross receipts exceed $10,000,000. In 
their view, a taxpayer's gross receipts are likely to exceed $5,000,000 
by the time the taxpayer's business is profitable enough to benefit by 
changing to the LIFO method.
    The 20 percent reduction contained in the current regulations 
represents a balance between two competing tax policies--simplification 
and prevention of adverse selection. The IPIC method was developed 
originally to simplify the LIFO rules so that small businesses that 
could not compute an internal inflation index could use the LIFO 
method. Nonetheless, availability of the method was provided to all 
taxpayers because it was believed to be too difficult to define the 
class of taxpayers for which the LIFO rules were unduly burdensome and 
inappropriate to prevent large taxpayers from using the simplified 
method. Allowing all taxpayers to use the CPI or PPI regardless of the 
rate of inflation they actually experienced, however, provided an 
opportunity for adverse selection whereby a sophisticated taxpayer 
would adopt the IPIC method only when the inflation reflected in the 
CPI or PPI exceeded the taxpayer's internal rate of inflation. The 20 
percent reduction of the IPI was incorporated into the current 
regulations to reduce this potential for adverse selection.
    The IRS and Treasury Department now believe that the benefits of 
simplification (and reduced controversy) obtained from the IPIC method 
outweigh the need to prevent adverse selection. Consequently, the final 
regulations eliminate the requirement to reduce the IPI by 20 percent. 
All taxpayers electing to use the IPIC method may use 100 percent of 
the IPI to compute the LIFO value of a dollar-value pool.

3. Use of 10 Percent Categories and BLS Weights

    The current regulations provide rules for assigning the items in a 
dollar-value pool to the applicable categories listed in the ``CPI 
Detailed Report'' or the ``PPI Detailed Report'' for which the BLS 
publishes corresponding cumulative price indexes (BLS categories and 
BLS price indexes, respectively) for purposes of computing the IPI for 
a dollar-value pool. In very simple terms, taxpayers use a process of 
elimination to assign all the items in a dollar-value pool to BLS 
categories that include at least 10 percent of the total inventory 
value (10 percent BLS categories) and then use the corresponding BLS 
weights to compute a weighted-average appropriate index for the items 
assigned to those 10 percent BLS categories.
    The proposed regulations eliminate the requirements to use the 10 
percent BLS categories and BLS weights to compute an appropriate index 
because it was believed that these requirements did not provide the 
intended simplicity but rather added unnecessary complexity to the IPIC 
method. Instead, the proposed regulations require the taxpayer to 
assign items in a dollar-value pool to the most-detailed BLS categories 
listed in the ``CPI Detailed Report'' or the ``PPI Detailed Report,'' 
whichever is applicable, and to weight the BLS price indexes based on 
the relative current-year cost of the items assigned to those BLS 
categories.
    Several commentators objected to the elimination of the requirement 
to use the 10 percent BLS categories and BLS weights to compute an 
appropriate index. They suggested that this regime does in fact provide 
simplification for

[[Page 1077]]

some taxpayers and consequently should be retained as an option, 
particularly for retail grocers that would have to incur substantial 
administrative costs to have the items contained in their dollar-value 
pools assigned to numerous, most-detailed BLS categories. Other 
commentators supported the elimination of the requirement to use BLS 
weights, arguing that this will reduce both the complexity of the IPIC 
method and the potential for distortion caused by the use of the BLS 
weights. However, these commentators generally recommended retention of 
the 10 percent categories or, alternatively, modification of the 
proposed rule to permit a taxpayer to assign items in a dollar-value 
pool to less-detailed BLS categories (e.g., using 6-digit or 4-digit 
commodity codes in the PPI). Another commentator suggested lowering the 
testing threshold from 10 percent to 8 percent.
    The IRS and Treasury Department now understand that the requirement 
to use 10 percent BLS categories and BLS weights provides simplicity 
for some taxpayers but complexity for others. Accordingly, the final 
regulations retain the 10 percent BLS categories and BLS weights as an 
elective method (10 percent method) of determining the category 
inflation index of a 10 percent BLS category. The final regulations 
clarify, however, that to determine whether a BLS category may be 
selected under the 10 percent method, a taxpayer must compare the 
current-year cost of the items in that category to the total current-
year cost of the items in the dollar-value pool, not to the total 
current-year cost of the items in the taxpayer's entire inventory.

4. Weighted Harmonic Mean for Computing Inventory Price Index

    A pool index computed using the dollar-value LIFO method should 
reflect a weighted average of the inflation rates of the items 
contained in the ending inventory of the dollar-value pool. The current 
regulations state that the appropriate indexes are weighted according 
to the relative current-year costs of the items in each selected BLS 
category. However, the regulations do not state how a taxpayer computes 
a weighted average of the appropriate indexes using the amount of 
relative current-year costs in each selected BLS category. An example 
of IPIC weighting methodology is found in Rev. Proc. 84-57 (1984-2 C.B. 
496), which shows the computation of an IPI based on a weighted 
arithmetic mean of the appropriate indexes. (Weighted Arithmetic Mean = 
[Sum of (Weight x Appropriate Index)] / Sum of Weights). In addition, 
an example found in Rev. Proc. 98-49 (1998-2 C.B. 321) uses a weighted 
arithmetic mean to compute a weighted-average percent change for a 
selected BLS category.
    The proposed regulations provide that the pool index must be 
computed using a weighted harmonic mean, instead of a weighted 
arithmetic mean, based on the relative current-year costs in the 
dollar-value pool. (Weighted Harmonic Mean = Sum of Weights / Sum of 
(Weight / Appropriate Index)).
    Using a weighted arithmetic mean of the category inflation indexes 
of the BLS categories represented in a dollar-value pool is not a 
mathematically correct method of computing the IPI for the pool when 
the corresponding weights are the relative current-year costs at the 
end of the taxable year. If a taxpayer's dollar-value pool has the same 
quantity of two items with identical base-year costs, the IPI should 
reflect the inflation rates of the two items equally. However, a 
weighted arithmetic mean of the category inflation indexes will assign 
more weight to the inflation rate of the item that has the higher 
current-year cost. Thus, the mean will be skewed in favor of BLS 
categories that experience higher rates of inflation, and the IPI will 
be overstated. This result also will occur when the items in the 
dollar-value pool experience deflation because too much weight will be 
assigned to the BLS categories that experience less deflation.
    Several commentators objected to the mandatory use of the weighted 
harmonic mean when computing an IPI. Acknowledging that an IPI based on 
a weighted harmonic mean is mathematically correct, these commentators 
stated that the inaccuracy built into a weighted arithmetic mean is 
offset (in the case of larger taxpayers) by the 20 percent reduction of 
the ``stated percentage.'' Thus, they recommended that taxpayers be 
permitted to continue computing IPIs based on a weighted arithmetic 
mean rather than be required to incur additional administrative costs 
to begin computing IPIs based on a weighted harmonic mean.
    The IRS and Treasury Department did not adopt these suggestions 
because a weighted arithmetic mean based on relative current-year costs 
at the end of the period is not mathematically correct and the 
conversion from a weighted arithmetic mean to a weighted harmonic mean 
is not unduly burdensome. To assist taxpayers that need to change to a 
weighted harmonic mean, the final regulations include the formula for, 
and examples of, computing a weighted harmonic mean.
    On the other hand, the use of a weighted arithmetic mean is 
mathematically correct when computing a weighted-average category 
inflation index based on relative costs at the beginning of the taxable 
year. The published BLS weights applicable for a taxable year are 
essentially based on relative costs at the beginning of the period. 
Therefore, whenever it is necessary to compute the category inflation 
index of a 10 percent BLS category using BLS weights, taxpayers must 
compute a weighted arithmetic mean. When computing the IPI for a 
dollar-value pool, however, even taxpayers electing to use the 10 
percent method must use the weighted harmonic mean based on the 
current-year cost of the items assigned to each 10 percent BLS 
category.

5. Selecting an Appropriate Month

    The current regulations state that a taxpayer not using the retail 
method must select price indexes ``as of the month or months'' most 
appropriate to its method of determining current-year cost (appropriate 
month), or make a one-time binding election of an appropriate 
representative month (representative month). In the case of a retailer 
using the retail method, the appropriate month is the last month of the 
retailer's taxable year. The IRS has ruled that a month is a 
representative month if a nexus exists between the selected month, the 
taxpayer's method of determining current-year cost, and the taxpayer's 
historic experience of inventory purchases. Rev. Rul. 89-29 (1989-1 
C.B. 168). In practice, many taxpayers have been confused about the 
meaning of ``month or months most appropriate to the taxpayer's method 
of determining current-year cost.''
    The proposed regulations clarify that for each dollar-value pool, a 
taxpayer not using the retail method either must annually select an 
appropriate month or must make an election to use a representative 
month. The principles of Rev. Rul. 89-29, which have been incorporated 
into the final regulations, continue to apply for the purpose of 
determining whether a particular month is appropriate or 
representative.
    Several commentators stated that taxpayers should be permitted to 
use two IPIs for each taxable year (dual indexes), so that they will 
not be denied the right to use the earliest acquisitions method of 
determining current-year costs. These commentators suggest that a 
taxpayer whose accounting system determines the current-year cost of 
ending inventory using a first-in, first-out (FIFO) method (i.e., most 
recent purchases) could compute an IPI based on indexes selected from 
the CPI or PPI applicable to a month late in the taxable

[[Page 1078]]

year to deflate the current-year cost of items in ending inventory for 
the purpose of determining whether an increment or liquidation has 
occurred during the taxable year. If there is an increment, the 
taxpayer would compute a second IPI based on indexes selected from the 
CPI or PPI applicable to a month early in the taxable year to inflate 
the base-year cost of the increment to its LIFO value based on its 
``pricing election'' (i.e., earliest acquisitions).
    The IRS and Treasury Department did not adopt this suggestion for 
several reasons. First, the IPIC method and the earliest acquisitions 
method are not mutually exclusive. In fact, the current and proposed 
IPIC regulations clearly permit an electing taxpayer to use any method 
of determining current-year cost permitted under Sec. 1.472-
8(e)(2)(ii), including the earliest acquisitions method. A dual index 
IPIC method is not needed to ensure that an electing taxpayer will be 
able to use the earliest acquisitions method. However, the earliest 
acquisitions method is available under the IPIC method only to a 
taxpayer that actually computes the current-year cost of its ending 
inventory using the earliest acquisitions method because use of a dual 
index is inconsistent with the IPIC method's concept of an appropriate 
month. The appropriate month concept requires a taxpayer to select a 
month that correlates with its actual method of computing current-year 
cost and its experience with inventory purchases. As explained in Rev. 
Rul. 89-29, ``[t]he timing of the index (and the month selected) must 
relate to the timing of the determination of current-year cost, 
otherwise distortion would occur.'' The determination of an appropriate 
month is not a choice between equally acceptable methods of determining 
current-year cost, but depends on the taxpayer's actual method of 
determining current-year cost and actual purchases. Thus, a taxpayer 
using a calendar tax year may select January as the appropriate month 
only if items represented in the ending inventory were purchased in 
January and the taxpayer determines the current-year cost of the ending 
inventory based on the cost of those January purchases.
    Moreover, though a dual index IPIC method would eliminate the 
requirement to determine the actual earliest acquisitions cost of the 
items in a dollar-value pool, the method would not simplify a 
taxpayer's use of the dollar-value LIFO method. A dual index IPIC 
method will require an electing taxpayer to compute (and the IRS to 
examine) twice as many category inflation indexes because the taxpayer 
would need BLS price indexes that reflect its inflation experience 
under the most recent purchases method as well as under the earliest 
acquisitions method. Similarly, a dual index IPIC method would require 
a taxpayer to select twice as many appropriate or representative months 
for each taxable year. Not only does the requirement to select two 
appropriate months increase the complexity of the IPIC method, it also 
decreases the accuracy of the method as some accuracy is lost as a 
result of determining the appropriate month for the entire pool rather 
than for each inventory item or each BLS category.
    In summary, the IPIC method was intended to simplify the dollar-
value LIFO method, primarily so it could be used by taxpayers that were 
otherwise unable to use the method. The IPIC method was neither 
intended nor designed to serve as a surrogate for determining the 
earliest acquisitions cost of the items in a dollar-value pool. The 
prohibition on the use of dual indexes in connection with the IPIC 
method, however, does not necessarily mean that the use of dual indexes 
will be prohibited in the context of other LIFO methods.
    Several commentators objected to the rule that requires a taxpayer 
using both the retail method and LIFO method to use the last month of 
the taxable year as its appropriate month. In their view, a month in 
the middle of the year would be more representative because the retail 
method produces an average cost for a group of goods based on purchases 
for an entire year.
    The IRS and Treasury Department did not adopt this suggestion 
because they believe that the appropriate month for a taxpayer using 
the retail method is the last month of the taxable year. Section 1.471-
8 generally requires that a taxpayer adjust retail selling prices of 
the goods on hand at the end of the year to cost based on the ratio of 
goods available for sale at cost to goods available for sale at retail 
(the cost complement percentage). While this ratio may reflect an 
average cost complement percentage for the year, it is applied to 
retail selling prices of the goods on hand at the end of the taxable 
year rather than the average retail selling price of these goods during 
the year. Consequently, the approximate cost determined under the 
retail method is not necessarily equal to the average cost of the 
inventory.
    One commentator suggested that the final regulations should include 
factors for determining an appropriate month. Other commentators 
requested an example showing how to determine an appropriate month when 
a short taxable year follows the first taxable year that a taxpayer 
uses the IPIC method. In response to these comments, the final 
regulations incorporate the guidance on an appropriate representative 
month (including three of the examples) found in Rev. Rul. 89-29.

6. Calculation of a Category Inflation Index

    The proposed regulations generally provide that in the case of a 
taxpayer using the double-extension IPIC method, the inflation index 
for a selected BLS category is equal to the quotient of the BLS price 
index for the appropriate or representative month of the current 
taxable year and the month preceding the first day of the base year. In 
the case of a taxpayer using the link-chain IPIC method, the inflation 
index for a selected BLS category is equal to the BLS price index for 
the appropriate or representative month of the current taxable year 
divided by the appropriate or representative month used for the 
immediately preceding taxable year. However, if the first taxable year 
the taxpayer uses the IPIC method also is the first taxable year the 
taxpayer uses the dollar-value LIFO method, the inflation index is 
equal to the quotient of the published cumulative index for the 
appropriate or representative month for the current taxable year 
divided by the published cumulative index for the month immediately 
preceding the first day of the taxable year.
    Several commentators argued that the prescribed calculation for the 
first taxable year a taxpayer uses both the dollar-value LIFO and IPIC 
methods is likely to overstate or understate inflation if the taxpayer 
has opening inventories, unless the opening inventories were purchased 
during the last month of the preceding taxable year. To address this 
concern, the commentators suggested that a taxpayer be permitted to 
compare the BLS price index for the appropriate month of the first LIFO 
taxable year with the BLS price index for the appropriate month of the 
taxpayer's last non-LIFO taxable year. Another commentator suggested 
that the denominator in this formula should be the BLS price index that 
reflects prices during the last inventory turn of the immediately 
preceding taxable year.
    The IRS and Treasury Department agree with the commentators' 
concerns. In addition, the IRS and Treasury Department recognize that 
the same problem exists under the proposed regulations as a result of 
the requirement to use the month preceding the first day of the base 
year to compute

[[Page 1079]]

an appropriate index under the double-extension IPIC method. 
Accordingly, the final regulations generally provide that a category 
inflation index should be computed with reference to the BLS price 
indexes for an appropriate month of the year preceding its LIFO 
election (in the case of the double-extension IPIC method) or of the 
preceding year (in the case of the link-chain IPIC method). In 
addition, the final regulations incorporate the general guidance of 
Rev. Proc. 98-49 concerning the computation of a category inflation 
index when a selected BLS category is revised for the taxable year.

7. Scope of an IPIC Method Election

    The current regulations generally require a taxpayer using the IPIC 
method to use that method to account for all items accounted for using 
the LIFO method (LIFO inventory items). The current regulations also 
prohibit the use of the IPIC method by a taxpayer that is eligible to 
use BLS price indexes prepared for the purpose of valuing the LIFO 
inventory items of a specific industry. For example, a taxpayer 
eligible to use the BLS retail price indexes published in ``Department 
Store Inventory Price Indexes'' (DSIP indexes) may not use the IPIC 
method.
    The proposed regulations liberalize the eligibility restrictions 
applicable to the IPIC method in two respects. First, a taxpayer must 
use the IPIC method for all items accounted for under the dollar-value 
LIFO method, but not for all items accounted for under the LIFO method. 
Second, a taxpayer eligible to use DSIP indexes may elect to use the 
IPIC method for all its LIFO inventory items or for those LIFO 
inventory items that do not fall within any of the 23 major groups 
listed in ``Department Store Inventory Price Indexes.''
    Several commentators objected to the proposed general requirement 
that an electing taxpayer use the IPIC method for all its LIFO 
inventory items. In their view, section 446(d) permits a taxpayer to 
elect the IPIC method for each trade or business. The requirement to 
use the IPIC method for all LIFO inventory items, as originally 
promulgated, was designed to prevent adverse selection. The IRS and 
Treasury Department understand, however, that taxpayers often have 
valid business reasons for using the IPIC method in some businesses but 
not in others. For example, a taxpayer may have difficulty using the 
double-extension method in one of its trades or businesses but not in 
another. Accordingly, the final regulations permit a taxpayer to limit 
its IPIC election to one or more specific trades or businesses.

8. Selection of ``CPI Detailed Report'' or ``PPI Detailed Report''

    The current regulations state that a retailer may select price 
indexes from the ``CPI Detailed Report'' or the ``PPI Detailed 
Report,'' but if equally appropriate price indexes may be selected from 
either, a retailer using the retail method must select from the ``CPI 
Detailed Report,'' and a retailer not using the retail method must 
select from the ``PPI Detailed Report.''
    The proposed regulations eliminate the requirement that retailers 
determine whether the ``CPI Detailed Report'' and ``PPI Detailed 
Report'' contain equally appropriate price indexes. Instead, the 
proposed regulations require retailers using the retail method to 
select price indexes from the ``CPI Detailed Report'' and require all 
other taxpayers using the IPIC method to select price indexes from the 
``PPI Detailed Report.''
    Several commentators suggested that the IRS and Treasury Department 
permit all retailers using the IPIC method to select price indexes from 
either the ``CPI Detailed Report'' or the ``PPI Detailed Report.'' 
These commentators argue that many retailers selecting price indexes 
from the CPI do not use the retail method and would be forced to 
change. This change would be particularly burdensome because the 
categories listed in the ``PPI Detailed Report'' are far more detailed 
(and less correlated) than those listed in the ``CPI Detailed Report.'' 
In addition, these commentators argue that the proposed rule fails to 
recognize that the PPI does not necessarily reflect cost for retailers 
not using the retail method because the majority of retailers purchase 
their goods from wholesalers not producers. Finally, the commentators 
expressed concern that the proposed rule would preclude retailers that 
use the retail method at their stores and a cost method at their 
warehouses from using the price indexes listed in the ``CPI Detailed 
Report'' when retail price information is not ascertained or readily 
available for goods in warehouses.
    The IRS and Treasury Department generally agree with the 
commentators' concerns. Accordingly, the final regulations permit all 
retailers using the IPIC method to assign items in dollar-value pools 
to the BLS categories listed in either the ``CPI Detailed Report'' or 
the ``PPI Detailed Report,'' whichever is selected.

9. BLS Category for Work-in-Process

    The proposed regulations provide that manufacturers and processors 
must assign all work-in-process (WIP) items in a dollar-value pool to 
the most-detailed index categories that include the finished goods into 
which the WIP item will be manufactured or processed. For this purpose, 
finished good means any good that is in a salable state.
    Several commentators objected to the proposed requirement that a 
taxpayer compute a separate inflation index for a WIP item that is in a 
salable state but not regularly sold by the taxpayer.
    The IRS and Treasury Department agree with the commentators' 
objection to the extent that the taxpayer's WIP items are merely 
salable. Accordingly, the final regulations provide that a taxpayer is 
not required to compute a separate category inflation index for a 
salable WIP item, unless the taxpayer regularly sells that WIP item.

10. Relocation and Clarification of Special Pooling Rules

    The current regulations provide special, elective pooling rules for 
retailers, wholesalers, jobbers, and distributors that use the IPIC 
method. These taxpayers are permitted to establish a dollar-value pool 
for any group of goods included in one of the 11 general categories of 
consumer goods described in the ``CPI Detailed Report.'' In addition, 
Rev. Proc. 84-57 provides that inventory pools may be established for 
any group of goods included within one of the 15 general categories of 
producer goods described in Table 6 of the ``PPI Detailed Report.'' 
Finally, the regulations provide that dollar-value pools that comprise 
less than 5 percent of inventory value may be combined to form a single 
miscellaneous dollar-value pool. If the resulting miscellaneous dollar-
value pool itself comprises less than 5 percent of inventory value, 
that pool may be combined with the largest dollar-value pool.
    The proposed regulations retain the special, elective pooling rules 
for inventory items accounted for under the IPIC method contained in 
the current regulations and incorporate the special, elective pooling 
rules contained in Rev. Proc. 84-57.
    Several commentators asked whether taxpayers must apply the 5 
percent rules to a dollar-value pool annually and, if so, how they are 
to account for dollar-value pools that no longer satisfy the 5 percent 
threshold. One commentator suggested that the IRS and Treasury 
Department make these 5 percent rules optional, state whether these 
rules are methods of accounting, and require taxpayers to apply the 
principles of Sec. 1.472-8(g)(2) when changing dollar-value pools 
because of these 5 percent rules. Another commentator recommended that 
taxpayers be permitted to include inventories not

[[Page 1080]]

accounted for under the LIFO method in ``inventory value'' when 
determining whether the 5 percent rules apply.
    The IRS and Treasury Department believe that both of the 5 percent 
rules for dollar-value pools have been, and remain, optional. Under the 
current and proposed regulations, a taxpayer may, but is not required 
to, combine two or more specific dollar-value pools into a single 
miscellaneous dollar-value pool when the cost of each specific dollar-
value pool does not exceed 5 percent of the total cost of the 
taxpayer's LIFO inventory. In addition, a taxpayer may, but is not 
required to, combine the single miscellaneous dollar-value pool and the 
largest specific dollar-value pool when cost of the miscellaneous 
dollar-value pool does not exceed 5 percent of the total cost of the 
taxpayer's LIFO inventory. Furthermore, the IRS and Treasury Department 
believe that both of the 5 percent rules are methods of accounting 
within the broader IPIC pooling method, so a taxpayer may not change 
to, or cease using, either of the 5 percent rules without obtaining the 
Commissioner's prior consent. In addition, any change in pooling 
required by the taxpayer's proper use of the 5 percent rule(s) is a 
change in method of accounting. Thus, the final regulations require a 
taxpayer in these circumstances to combine and separate its dollar-
value pools in accordance with Sec. 1.472-8(g). Moreover, the final 
regulations require a taxpayer to determine whether to separate or 
combine the 5 percent pools every third taxable year based on current-
year data rather than on average data.

11. New Base Year for IPIC Method Changes

    The current regulations require a taxpayer that changes to the IPIC 
method from another dollar-value LIFO method to treat the year of 
change as the base year in determining the LIFO value of the dollar-
value pool(s) for the year of change and later taxable years. The 
taxpayer is required to restate the base-year cost of the existing 
increments in terms of new base-year cost, which also requires the 
restatement of the IPI of each of the layers. This procedure is 
referred to alternatively as updating the base year or establishing a 
new base year.
    One commentator suggested eliminating the reference to Sec. 1.472-
8(f)(2) in the case of a voluntary change from the specific goods LIFO 
method to the dollar-value LIFO method because taxpayers and tax 
practitioners have long questioned how to implement this change without 
updating the base year. The final regulations adopt this suggestion and 
require a taxpayer changing from the specific goods LIFO method to the 
IPIC method to establish a new base year. Although guidance addressing 
taxpayers changing from the specific goods LIFO method to a dollar-
value LIFO method other than the IPIC method is outside the scope of 
these regulations, the IRS and Treasury Department are considering 
whether to issue additional guidance to address the commentator's 
concerns regarding changes from the specific goods method to a dollar-
value LIFO method.
    The proposed regulations clarify that the base-year-updating 
procedure is mandatory for voluntary changes to the IPIC method. 
However, the proposed regulations authorized examining agents to 
require a change to the IPIC method in circumstances where the 
taxpayer's prior method does not clearly reflect income and to 
implement the change using a cutoff method in circumstances where the 
taxpayer's books and records lacked the information necessary to 
compute a section 481(a) adjustment. The latter provision was intended 
to provide examining agents with an alternative to LIFO termination in 
appropriate circumstances.
    One commentator objected to giving examining agents the authority 
to require a taxpayer using a LIFO method to change to the double-
extension IPIC method even when the taxpayer produces records that will 
allow the agent to calculate the effect of changing to a correct method 
other than the IPIC method. This commentator requested ``clear-cut'' 
published guidance on the types of records that taxpayers using a LIFO 
method must retain and the length of time that they must retain them. 
In addition, because of the administrative burden associated with 
record retention (particularly those records needed for LIFO methods 
not used by the taxpayer), this commentator requested that the IRS and 
Treasury Department create a shortcut procedure, similar to the three-
year transition rule under Sec. 1.263A-7(c)(2)(iv), to calculate the 
effect of changing the taxpayer's LIFO method. Finally, this 
commentator suggested that the IRS and Treasury Department, as a matter 
of fairness, permit a taxpayer to recompute each year's layer using the 
IPI for that year.
    Several commentators urged the IRS and Treasury Department to 
withdraw the involuntary change provisions entirely or, alternatively, 
to modify them to give examining agents discretion to impose a change 
to the double-extension IPIC method with or without establishing a new 
base year. One of these commentators also urged the IRS and Treasury 
Department to give these examining agents discretion to impose a change 
to either the double-extension IPIC method or the link-chain IPIC 
method.
    In response to these comments, the final regulations provide that 
an examining agent may change a taxpayer from a LIFO method that does 
not clearly reflect income to the IPIC method. If the agent decides to 
change the taxpayer to the IPIC method, and the taxpayer does not 
provide sufficient information from its books and records to compute an 
adjustment under section 481, the agent may implement the change using 
the simplified transition method. Under the simplified transition 
method, the agent makes certain assumptions regarding the composition 
of ending inventory in prior taxable years and recomputes the LIFO 
value of each dollar-value pool as of the beginning of the year of 
change using the IPIC method. The section 481(a) adjustment arising 
from the accounting method change is equal to the difference between 
that recomputed LIFO value and the LIFO value of the dollar-value pool 
determined under the taxpayer's former method. The IRS and Treasury 
Department are considering other simplified methods of computing a 
section 481(a) adjustment arising from a change from one LIFO method to 
another and may publish additional guidance in the future. The 
suggestion regarding the issuance of guidance on a taxpayer's record 
keeping requirement is beyond the scope of this project, but will be 
considered for possible future guidance.

12. Inventories Received in Certain Nonrecognition Transactions

    An election to use the dollar-value LIFO method for LIFO 
inventories received in a nonrecognition transaction to which section 
381 does not apply (non-section 381 transfer) may not continue the LIFO 
reserve of the transferor. If the mix of goods in the inventory changes 
significantly after the transfer, the mechanics of the dollar-value 
LIFO method may produce an artificial increment in the year the 
inventories are received that effectively eliminates the LIFO reserve 
established by the transferor. This artificial increment occurs because 
the base-year cost of new items are reconstructed to the transferee's 
base year (i.e., the year it elects LIFO) and not to the transferor's 
base year. When a transferee elects the LIFO and IPIC methods for LIFO 
inventories received in a non-section 381 transfer, the transferee will 
have an artificial increment in the year the inventories are received 
even without a significant change in the mix of goods

[[Page 1081]]

in its ending inventory. The IPIC method invariably produces an 
increment because the difference between the current-year cost and the 
carryover basis of the transferred inventories (i.e., the base-year 
cost) reflects more than one year's inflation and the IPI used to 
convert the current-year cost of the dollar-value pool at the end of 
the taxable year to base-year cost will reflect only one year's 
inflation.
    To prevent the recapture of a transferor's LIFO reserve in a non-
section 381 transfer, the proposed regulations require the transferee 
to update its base-year cost if a transferee uses the dollar-value LIFO 
method for inventories received in a non-section 381 transfer and the 
transferor accounted for those inventories using the dollar-value LIFO 
method as follows. First, the transferee's base year for the 
inventories received from the transferor is the year of transfer. 
Second, the transferee's base-year cost for the inventories received 
from the transferor is equal to the transferor's current-year cost for 
those inventories. Finally, if the transferee owned inventories prior 
to the transfer, the new base-year cost of those inventories will be 
equal to their current-year cost. The proposed regulations do not 
affect either the ability of a newly formed transferee to elect new 
accounting methods or the holdings of Rev. Rul. 70-564 (1970-2 C.B. 
109) and Rev. Rul. 70-565 (1970-2 C.B. 110). However, the proposed 
regulations do not apply to a non-section 381 transfer if its principal 
purpose is to avail the transferee of a method of accounting that is 
unavailable to the transferor (or is unavailable to the transferor 
without the Commissioner's consent).
    One commentator asserted that when a taxpayer described in Rev. 
Rul. 70-564 (i.e., no beginning LIFO inventories) applies the proposed 
rule to transferred inventories, the resulting IPI of the collapsed 
base-year layer will not equal 1. Because this result may cause some 
confusion, the commentator suggested including an example in the final 
regulations. The final regulations include an example demonstrating the 
computation of increments and liquidations after a new base year is 
established.
    Several commentators asserted that the proposed rule may result in 
the creation of an artificial increment or liquidation when a 
transferee and transferor use different methods of determining current-
year costs. Thus, the regulations should be changed to permit a 
transferee to establish (or reconstruct) the new base-year cost of the 
transferred inventories equal to the transferor's first-in, first-out 
cost for the year immediately preceding the year of transfer, or 
alternatively, if the final regulations continue to require the use of 
the transferor's current-year cost and current-year cost method, the 
regulations should be changed to provide that the period for measuring 
inflation for the base year is between the appropriate month for 
determining base-year cost and the appropriate month for determining 
current-year cost. In addition, one commentator suggested that the 
final regulations be changed to clarify that ``beginning inventory, if 
any'' refers only to inventory that the transferee actually owned 
before the nonrecognition transaction.
    The IRS and Treasury Department agree with these commentator's 
concerns. Accordingly, the final regulations permit the transferee to 
compute the base-year cost of transferred inventories using its 
current-year cost and its method of determining current-year cost. The 
final regulations also clarify the meaning of beginning inventory.
    Another commentator contended that the holding of Rev. Rul. 70-564 
is incorrect and, thus, the average cost rule of section 472(b)(3) 
should not be applied to inventories received by a transferee without 
an existing LIFO election in a non-section 381 transfer. In addition, 
this commentator noted that the holding of Rev. Rul. 70-564 is 
inconsistent with Sec. 1.1502-13 (concerning intercompany 
transactions), which generally provides that an intercompany 
transaction may not change the timing of the recognition of income or 
deductions. This commentator suggested that the holding of Rev. Rul. 
70-565, which provides for a carryover of a transferor's LIFO layer 
history in a section 351 transfer to a transferee with an existing LIFO 
election, should be applied in all non-section 381 transfers.
    The IRS and Treasury Department believe this comment is outside the 
scope of these final regulations. However, in response to this comment, 
the IRS and Treasury Department are reconsidering whether to continue 
to require different results upon the transfer of LIFO inventories in a 
non-section 381 transfer (as currently required by Rev. Rul. 70-564 and 
Rev. Rul. 70-565 ) depending upon whether the transferee has an 
existing LIFO election.

13. Effective Date of Final Regulations

    The proposed regulations provide that proposed Secs. 1.472-8(b)(4), 
(c)(2), and (e)(3) will apply to taxable years beginning on or after 
the date they are published in the Federal Register as final 
regulations. In addition, the proposed regulations provide that 
proposed Sec. 1.472-8(h) will apply to transfers occurring on or after 
the date it is published in the Federal Register as a final regulation.
    One commentator suggested that taxpayers be permitted, but not 
required, to apply Secs. 1.472-8(b)(4), (c)(2), and (e)(3) for taxable 
years ending on or after the date the regulations are published in the 
Federal Register as final regulations. This commentator also suggested 
that taxpayers be permitted to apply Sec. 1.472-8(h) to transfers 
occurring during the taxable year ending on or after the date the 
regulations are published in the Federal Register as final regulations. 
In addition, several commentators suggested that the transition period 
for an automatic change in method of accounting to comply with 
Secs. 1.472-8(b)(4), (c)(2), and (e)(3) be extended to include the 
second taxable year ending on or after the date the regulations are 
published in the Federal Register as final regulations.
    The IRS and Treasury Department agree with these suggestions. 
However, in order to ensure that taxpayers may implement these changes 
for taxable years ending December 31, 2001, as requested by the 
commentators, the final regulations are effective for taxable years 
ending on or after December 31, 2001.

Effect on Other Documents

    Rev. Proc. 84-57, Rev. Rul. 89-29, and Rev. Proc. 98-49 are 
obsolete on January 9, 2002.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 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. Pursuant to 
section 7805(f) of the Code, the proposed regulations preceding this 
Treasury decision was submitted to the Chief Counsel for Advocacy of 
the Small Business Administration for comment on their impact on small 
business. It is hereby certified that the collections of information in 
this Treasury decision will not have a significant economic impact on a 
substantial number of small entities. First, only taxpayers that adopt, 
or change to, the IPIC method will be affected by the collections of 
information. Second, relatively few small entities are expected to 
adopt, or change to, the IPIC method. Third, the

[[Page 1082]]

burden of the collections of information is not significant. Therefore, 
a Regulatory Flexibility Analysis under the Regulatory Flexibility Act 
(5 U.S.C. chapter 6) is not required.

Drafting Information

    The principal author of these regulations is Leo F. Nolan II of the 
Office of Associate Chief Counsel (Income Tax and Accounting). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Sec. 1.472-8 also issued under 26 U.S.C. 472. * * *


    Par. 2. Section 1.472-8 is amended as follows:
    1. Paragraph (b)(4) is added.
    2. The text of paragraph (c) following the paragraph heading is 
redesignated as paragraph (c)(1) and a paragraph heading for newly 
designated (c)(1) is added.
    3. Paragraph (c)(2) is added.
    4. Paragraph (e)(3) and (h) are revised.
    5. The undesignated paragraph following paragraph (h) is removed.
    The revisions and additions read as follows:


Sec. 1.472-8  Dollar-value method of pricing LIFO inventories.

* * * * *
    (b) * * *
    (4) IPIC method pools. A manufacturer or processor that elects to 
use the inventory price index computation method described in paragraph 
(e)(3) of this section (IPIC method) for a trade or business may elect 
to establish dollar-value pools for those items accounted for using the 
IPIC method based on the 2-digit commodity codes (i.e., major commodity 
groups) in Table 6 (Producer price indexes and percent changes for 
commodity groupings and individual items, not seasonally adjusted) of 
the ``PPI Detailed Report'' published monthly by the United States 
Bureau of Labor Statistics (available from New Orders, Superintendent 
of Documents, PO Box 371954, Pittsburgh, PA 15250-7954). A taxpayer 
electing to establish dollar-value pools under this paragraph (b)(4) 
may combine IPIC pools that comprise less than 5 percent of the total 
current-year cost of all dollar-value pools to form a single 
miscellaneous IPIC pool. A taxpayer electing to establish dollar-value 
pools under this paragraph (b)(4) may combine a miscellaneous IPIC pool 
that comprises less than 5 percent of the total current-year cost of 
all dollar-value pools with the largest IPIC pool. Each of these 5 
percent rules is a method of accounting. A taxpayer may not change to, 
or cease using, either 5 percent rule without obtaining the 
Commissioner's prior consent. Whether a specific IPIC pool or the 
miscellaneous IPIC pool satisfies the applicable 5 percent rule must be 
determined in the year of adoption or year of change (whichever is 
applicable) and redetermined every third taxable year. Any change in 
pooling required or permitted as a result of a 5 percent rule is a 
change in method of accounting. A taxpayer must secure the consent of 
the Commissioner pursuant to Sec. 1.446-1(e) before combining or 
separating pools and must combine or separate its IPIC pools in 
accordance with paragraph (g)(2) of this section.
    (c) * * * (1) In general. * * *
    (2) IPIC method pools. A retailer that elects to use the inventory 
price index computation method described in paragraph (e)(3) of this 
section (IPIC method) for a trade or business may elect to establish 
dollar-value pools for those items accounted for using the IPIC method 
based on either the general expenditure categories (i.e., major groups) 
in Table 3 (Consumer Price Index for all Urban Consumers (CPI-U): U.S. 
city average, detailed expenditure categories) of the ``CPI Detailed 
Report'' or the 2-digit commodity codes (i.e., major commodity groups) 
in Table 6 (Producer price indexes and percent changes for commodity 
groupings and individual items, not seasonally adjusted) of the ``PPI 
Detailed Report.'' A wholesaler, jobber, or distributor that elects to 
use the IPIC method for a trade or business may elect to establish 
dollar-value pools for any group of goods accounted for using the IPIC 
method and included within one of the 2-digit commodity codes (i.e., 
major commodity groups) in Table 6 (Producer price indexes and percent 
changes for commodity groupings and individual items, not seasonally 
adjusted) of the ``PPI Detailed Report.'' The ``CPI Detailed Report'' 
and the ``PPI Detailed Report'' are published monthly by the United 
States Bureau of Labor Statistics (BLS) (available from New Orders, 
Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 15250-
7954). A taxpayer electing to establish dollar-value pools under this 
paragraph (c)(2) may combine IPIC pools that comprise less than 5 
percent of the total current-year cost of all dollar-value pools to 
form a single miscellaneous IPIC pool. A taxpayer electing to establish 
pools under this paragraph (c)(2) may combine a miscellaneous IPIC pool 
that comprises less than 5 percent of the total current-year cost of 
all dollar-value pools with the largest IPIC pool. Each of these 5 
percent rules is a method of accounting. Thus, a taxpayer may not 
change to, or cease using, either 5 percent rule without obtaining the 
Commissioner's prior consent. Whether a specific IPIC pool or the 
miscellaneous IPIC pool satisfies the applicable 5 percent rule must be 
determined in the year of adoption or year of change (whichever is 
applicable) and redetermined every third taxable year. Any change in 
pooling required or permitted under a 5 percent rule is a change in 
method of accounting. A taxpayer must secure the consent of the 
Commissioner pursuant to section 1.446-1(e) before combining or 
separating pools and must combine or separate its IPIC pools in 
accordance with paragraph (g)(2) of this section.
* * * * *
    (e) * * *
    (3) Inventory price index computation (IPIC) method--(i) In 
general. The inventory price index computation method provided by this 
paragraph (e)(3) (IPIC method) is an elective method of determining the 
LIFO value of a dollar-value pool using consumer or producer price 
indexes published by the United States Bureau of Labor Statistics 
(BLS). A taxpayer using the IPIC method must compute a separate 
inventory price index (IPI) for each dollar-value pool. This IPI is 
used to convert the total current-year cost of the items in a dollar-
value pool to base-year cost in order to determine whether there is an 
increment or liquidation in terms of base-year cost and, if there is an 
increment, to determine the LIFO inventory value of the current year's 
layer of increment (layer). Using one IPI to compute the base-year cost 
of a dollar-value pool for the current taxable year and using a 
different IPI to compute the LIFO inventory value of

[[Page 1083]]

the current taxable year's layer is not permitted under the IPIC 
method. The IPIC method will be accepted by the Commissioner as an 
appropriate method of computing an index, and the use of that index to 
compute the LIFO value of a dollar-value pool will be accepted as 
accurate, reliable, and suitable. The appropriateness of a taxpayer's 
computation of an IPI, which includes all the steps described in 
paragraph (e)(3)(iii) of this section, will be determined in connection 
with an examination of the taxpayer's federal income tax return. A 
taxpayer using the IPIC method may elect to establish dollar-value 
pools according to the special rules in paragraphs (b)(4) and (c)(2) of 
this section or the general rules in paragraphs (b) and (c) of this 
section. Taxpayers eligible to use the IPIC method are described in 
paragraph (e)(3)(ii) of this section. The manner in which an IPI is 
computed is described in paragraph (e)(3)(iii) of this section. Rules 
relating to the adoption of, or change to, the IPIC method are in 
paragraph (e)(3)(iv) of this section.
    (ii) Eligibility. Any taxpayer electing to use the dollar-value 
LIFO method may elect to use the IPIC method. Except as provided in 
this paragraph (e)(3)(ii) or in other published guidance, a taxpayer 
that elects to use the IPIC method for a specific trade or business 
must use that method to account for all items of dollar-value LIFO 
inventory. A taxpayer that uses the retail price indexes computed by 
the BLS and published in ``Department Store Inventory Price Indexes'' 
(available from the BLS by calling (202) 606-6325 and entering document 
code 2415) may elect to use the IPIC method for items that do not fall 
within any of the major groups listed in ``Department Store Inventory 
Price Indexes.''
    (iii) Computation of an inventory price index--(A) In general. The 
computation of an IPI for a dollar-value pool requires the following 
four steps, which are described in more detail in this paragraph 
(e)(3)(iii): First, selection of a BLS table and an appropriate month; 
second, assignment of items in a dollar-value pool to BLS categories 
(selected BLS categories); third, computation of category inflation 
indexes for selected BLS categories; and fourth, computation of the 
IPI. A taxpayer may compute the IPI for each dollar-value pool using 
either the double-extension method (double-extension IPIC method) or 
the link-chain method (link-chain IPIC method), without regard to 
whether the use of a double-extension method is impractical or 
unsuitable. The use of either the double-extension IPIC method or the 
link-chain IPIC method is a method of accounting, and the adopted 
method must be applied consistently to all dollar-value pools within a 
trade or business accounted for under the IPIC method. A taxpayer that 
wants to change from the double-extension IPIC method to the link-chain 
IPIC method, or vice versa, must secure the consent of the Commissioner 
under Sec. 1.446-1(e). This change must be made with a new base year as 
described in paragraph (e)(3)(iv)(B)(1).
    (B) Selection of BLS table and appropriate month--(1) In general. 
Under the IPIC method, an IPI is computed using the consumer or 
producer price indexes for certain categories (BLS price indexes and 
BLS categories, respectively) listed in the selected BLS table of the 
``CPI Detailed Report'' or the ``PPI Detailed Report'' for the 
appropriate month.
    (2) BLS table selection. Manufacturers, processors, wholesalers, 
jobbers, and distributors must select BLS price indexes from Table 6 
(Producer price indexes and percent changes for commodity groupings and 
individual items, not seasonally adjusted) of the ``PPI Detailed 
Report'', unless the taxpayer can demonstrate that selecting BLS price 
indexes from another table of the ``PPI Detailed Report'' is more 
appropriate. Retailers may select BLS price indexes from either Table 3 
(Consumer Price Index for all Urban Consumers (CPI-U): U.S. city 
average, detailed expenditure categories) of the ``CPI Detailed 
Report'' or from Table 6 (or another more appropriate table) of the 
``PPI Detailed Report.'' The selection of a BLS table is a method of 
accounting and must be used for the taxable year of adoption and all 
subsequent years, unless the taxpayer obtains the Commissioner's 
consent under Sec. 1.446-1(e) to change its table selection. A taxpayer 
that changes its BLS table must establish a new base year in the year 
of change as described in paragraph (e)(3)(iv)(B) of this section.
    (3) Appropriate month. In the case of a retailer using the retail 
method, the appropriate month is the last month of the retailer's 
taxable year. In the case of all other taxpayers, the appropriate month 
is the month most consistent with the method used to determine the 
current-year cost of the dollar-value pool under paragraph (e)(2)(ii) 
of this section and the taxpayer's history of inventory production or 
purchases during the taxable year. A taxpayer not using the retail 
method may annually select an appropriate month for each dollar-value 
pool or make an election on Form 970, ``Application to Use LIFO 
Inventory Method,'' to use a representative appropriate month 
(representative month). An election to use a representative month is a 
method of accounting and the month elected must be used for the taxable 
year of the election and all subsequent taxable years, unless the 
taxpayer obtains the Commissioner's consent under Sec. 1.446-1(e) to 
change or revoke its election.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (e)(3)(iii)(B)(3):

    Example 1. Determining an appropriate month.  A wholesaler of 
seasonal goods timely files a Form 970, ``Application to Use LIFO 
Inventory Method,'' for the taxable year ending December 31, 2001. 
The taxpayer indicates elections to use the dollar-value LIFO 
method, to determine the current-year cost using the earliest 
acquisitions method in accordance with paragraph (e)(2)(ii)(b) of 
this section, and to use the IPIC method under paragraph (e)(3) of 
this section. Although the taxpayer purchases inventory items 
regularly throughout the year, the items purchased vary according to 
the seasons. The seasonal items on hand at December 31, 2001, are 
purchased between October and December. Thus, based on the 
taxpayer's use of the earliest acquisitions method of determining 
current-year cost and its experience with inventory purchases, the 
appropriate month for the items represented in the ending inventory 
at December 31, 2001, is October.
    Example 2. Electing a representative month. A retailer not using 
the retail method timely files a Form 970, ``Application to Use LIFO 
Inventory Method,'' for the taxable year ending December 31, 2001. 
The taxpayer indicates elections to use the dollar-value LIFO 
method, the most recent purchases method of determining current-year 
cost under paragraph (e)(2)(ii)(a) of this section, the IPIC method 
under paragraph (e)(3) of this section, and December as its 
representative month under paragraph (e)(3)(iii)(B)(3) of this 
section. The items in the taxpayer's ending inventory are purchased 
fairly uniformly throughout the year, with the first purchases 
normally occurring in January and the last purchases normally 
occurring in December. The taxpayer's election to use December as 
its representative month is permissible because the taxpayer elected 
to use the most recent purchases method and the taxpayer's last 
purchases of the taxable year normally occur during December, the 
last month of the taxpayer's taxable year.
    Example 3. Changing representative month.  The facts are the 
same as in Example 2, except the taxpayer files a Form 3115, 
``Application for Change in Accounting Method,'' requesting 
permission to change to the earliest acquisitions method of 
determining current-year cost in accordance with paragraph 
(e)(2)(ii)(b) of this section and to change its representative month 
from December to January beginning with the taxable year ending 
December 31, 2003. If the Commissioner consents to the taxpayer's 
request to change to the earliest acquisitions method, December will 
no longer be a permissible representative month for this

[[Page 1084]]

taxpayer because of the absence of a nexus between the earliest 
acquisitions method, the month of December (the last month of the 
taxpayer's taxable year), and the taxpayer's experience with 
inventory purchases during the year. Thus, the Commissioner will 
permit the taxpayer to change its representative month to January, 
the first month of the taxpayer's taxable year.
    Example 4. Changing representative month.  The facts are the 
same as in Example 2. In 2002, the taxpayer changes its annual 
accounting period to a taxable year ending June 30, which requires 
the taxpayer to file a return for the short taxable year beginning 
January 1, 2002, and ending June 30, 2002. As a result, December is 
no longer a permissible representative month because of the absence 
of a nexus between the most recent purchases method, the month of 
December, and the taxpayer's experience with inventory purchases 
during the year. The taxpayer should file a Form 3115 requesting 
permission to change its representative month from December to June 
beginning with the short taxable year ending June 30, 2002. Because 
the taxpayer's last purchases of the taxable year now will occur in 
June, the Commissioner will consent to the taxpayer's request to 
change its representative month to June.
    Example 5. Changing representative month. The facts are the same 
as in Example 2, except that the taxpayer elects to use January as 
its representative month. The taxpayer timely files a Form 3115 
requesting permission to change its representative month from 
January to December beginning with the taxable year ending December 
31, 2003. January is not a permissible representative month because 
of the absence of a nexus between the most recent purchases method, 
the taxpayer's history of inventory purchases, and the month of 
January, the first month in the taxpayer's taxable year. Because 
December is a permissible representative month, the Commissioner 
will permit the taxpayer to change its representative month to 
December.

    (C) Assignment of inventory items to BLS categories--(1) In 
general. Except as provided in paragraph (e)(3)(iii)(C)(2) of this 
section, a taxpayer must assign each item in a dollar-value pool to the 
most-detailed BLS category of the selected BLS table that contains that 
item. For example, in Table 6 of the ``PPI Detailed Report'' for a 
given month, the commodity codes for the various BLS categories run 
from 2 to 8 digits, with the least-detailed BLS categories having a 2-
digit code and the most-detailed BLS categories usually (but not 
always) having an 8-digit code. For purposes of assigning items to the 
most-detailed BLS category, manufacturers and processors must assign 
each raw material item to the most-detailed PPI category that includes 
that raw material and must assign each finished good item to the most-
detailed PPI category that includes that finished good. In addition, 
manufacturers and processors must assign each work-in-process (WIP) 
item to the most-detailed PPI category that includes the finished good 
into which the item will be manufactured or processed. For this 
purpose, finished good means a salable item that the taxpayer regularly 
sells. For example, a gasoline-engine manufacturer that also 
manufactures the pistons used in those engines and regularly sells some 
of the pistons (e.g., to retailers of replacement parts) must assign 
both finished pistons that have not been affixed to an engine block and 
piston WIP items to the most-detailed PPI category that includes 
pistons. Finished pistons that have been affixed to an engine block 
must be assigned to the most-detailed PPI category that includes 
gasoline engines. In contrast, if sales of these pistons occur 
infrequently, the taxpayer must assign both finished pistons and piston 
WIP items to the most-detailed PPI category that includes gasoline 
engines.
    (2) 10 percent method. Instead of assigning each item in a dollar-
value pool to the most-detailed BLS categories, as described in 
paragraph (e)(3)(iii)(C)(1) of this section, a taxpayer may elect to 
use the 10 percent method described in this paragraph 
(e)(3)(iii)(C)(2). Under the 10 percent method, items are assigned to 
BLS categories using a three-step procedure. First, when the current-
year cost of a specific item is 10 percent or more of the total 
current-year cost of the dollar-value pool, the taxpayer must assign 
that item to the most-detailed BLS category that includes that item (10 
percent BLS category). Any other item that is includible in that 10 
percent BLS category (other than an item that qualifies for its own 10 
percent BLS category under the preceding sentence) must be assigned to 
that 10 percent BLS category. Second, if one or more items have not 
been assigned to BLS categories in the first step, the taxpayer must 
investigate successively less-detailed BLS categories and assign the 
unassigned item(s) to the first BLS category that contains unassigned 
items whose current-year cost, in the aggregate, is 10 percent or more 
of the total current-year cost of the dollar-value pool (also, 10 
percent BLS categories). This step must be repeated until all the items 
in the dollar-value pool have been included in an appropriate 10 
percent BLS category, the current-year cost of the unassigned items, in 
the aggregate, is less than 10 percent of the total current-year cost 
of the dollar-value pool, or the taxpayer determines that a single BLS 
category is not appropriate for the aggregate of the unassigned items. 
Third, if items in a dollar-value pool have not been assigned to a 10 
percent BLS category because the current-year cost of those items, in 
the aggregate, is less than 10 percent of the total current-year cost 
of the dollar-value pool, the taxpayer must assign those items to the 
most-detailed BLS category that includes all those items (also, a 10 
percent category). On the other hand, if items in a dollar-value pool 
have not been assigned to a 10 percent BLS category because the 
taxpayer determines that a single BLS category is not appropriate for 
the aggregate of those items, the taxpayer must assign each of those 
items to a single miscellaneous BLS category created by the taxpayer 
(also, a 10 percent category). In no event may a taxpayer assign items 
in a dollar-value pool to a BLS category that is less detailed than 
either the major groups of consumer goods described in Table 3 of the 
monthly ``CPI Detailed Report'' or the major commodity groups of 
producer goods described in Table 6 of the monthly ``PPI Detailed 
Report.'' Principles similar to those described in paragraph 
(e)(3)(iii)(C)(1) apply for purposes of assigning raw material, work-
in-process, and finished good items to the most-detailed BLS category 
under the 10 percent method.
    (3) Change in method of accounting. The 10 percent method of 
assigning items in a dollar-value pool to BLS categories is a method of 
accounting. In addition, a taxpayer's selection of a BLS category for a 
specific item is a method of accounting. However, the assignment of 
items to different BLS categories solely as a result of the application 
of the 10 percent method is a change in underlying facts and not a 
change in method of accounting. Likewise, the selection of a new BLS 
category for a specific item as a result of a revision to a BLS table 
is a change in underlying facts and not a change in method of 
accounting. A taxpayer that wants to change its method of selecting BLS 
categories (i.e., to or from the 10-percent method) or of selecting a 
BLS category for a specific item must secure the Commissioner's consent 
in accordance with Sec. 1.446-1(e). A taxpayer that voluntarily changes 
its method of selecting BLS categories or of selecting a BLS category 
for a specific item must establish a new base year in the year of 
change as described in paragraph (e)(3)(iv)(B) of this section.
    (D) Computation of a category inflation index--(1) In general. As 
described in more detail in this paragraph (e)(3)(iii)(D), a category 
inflation index reflects the inflation that occurs in the BLS price 
indexes for a selected BLS category (or, if applicable,

[[Page 1085]]

10 percent BLS category) during the relevant measurement period.
    (2) BLS price indexes. The BLS price indexes are the cumulative 
indexes published in the selected BLS table for the appropriate month. 
A taxpayer may elect to use either preliminary or final BLS price 
indexes for the appropriate month, provided that the selected BLS price 
indexes are used consistently. However, a taxpayer that elects to use 
final BLS price indexes for the appropriate month must use preliminary 
BLS price indexes for any taxable year for which the taxpayer files its 
original federal income tax return before the BLS publishes final BLS 
price indexes for the appropriate month. If a BLS price index for a 
most-detailed or 10 percent BLS category is not otherwise available for 
the appropriate or representative month (but not because the BLS 
categories in the BLS table have been revised), the taxpayer must use 
the BLS price index for the next most-detailed BLS category that 
includes the specific item(s) in the most-detailed or 10 percent BLS 
category. If a BLS price index is not otherwise available for the 
appropriate or representative month because the BLS categories in the 
BLS table have been revised, the rules of paragraph (e)(3)(iii)(D)(4) 
of this section apply.
    (3) Category inflation index. (i) In general. Except as provided in 
paragraph (e)(3)(iii)(D)(4) of this section (concerning compound 
category inflation indexes) or (e)(3)(iii)(D)(5) of this section 
(concerning category inflation indexes for certain 10 percent BLS 
categories), a category inflation index for a selected BLS category 
(or, if applicable, 10 percent BLS category) is computed under the 
rules of this paragraph (e)(3)(iii)(D)(3).
    (ii) Double-extension IPIC method. In the case of a taxpayer using 
the double-extension IPIC method, the category inflation index for a 
BLS category is the quotient of the BLS price index for the appropriate 
or representative month of the current year divided by the BLS price 
index for the appropriate month of the taxable year preceding the base 
year (base month). However, if the taxpayer did not have an opening 
inventory in the year that its election to use the dollar-value LIFO 
method and double-extension IPIC method became effective, the category 
inflation index for a BLS category is the quotient of the BLS price 
index for the appropriate or representative month of the current year 
divided by the BLS price index for the month immediately preceding the 
month of the taxpayer's first inventory production or purchase.
    (iii) Link-chain IPIC method. In the case of a taxpayer using the 
link-chain IPIC method, the category inflation index for a BLS category 
is the quotient of the BLS price index for the appropriate or 
representative month of the current year divided by the BLS price index 
for the appropriate month used for the immediately preceding taxable 
year. However, if the taxpayer did not have an opening inventory in the 
year that its election to use the dollar-value LIFO method and link-
chain IPIC method became effective, the category inflation index for a 
BLS category for the year of election is the quotient of the BLS price 
index for the appropriate or representative month of the current year 
divided by the BLS price index for the month immediately preceding the 
month of the taxpayer's first inventory production or purchase.
    (iv) Special rules concerning representative months. A taxpayer 
electing to use a representative month under paragraph 
(e)(3)(iii)(B)(3) of this section must use an appropriate month, rather 
than the representative month, to determine category inflation indexes 
in the circumstances described in this paragraph (e)(3)(iii)(D)(3)(iv) 
and in other similar circumstances. For example, in the case of a short 
taxable year, the category inflation index should reflect the inflation 
that occurs from the base month (in the case of the double-extension 
IPIC method), or the appropriate or representative month used for the 
preceding taxable year (in the case of the link-chain IPIC method), and 
the appropriate month for the short taxable year. Similarly, if a 
taxpayer using the link-chain IPIC method is granted consent to change 
both its method of determining the current-year cost of a dollar-value 
pool and its representative month, the category inflation index for the 
year of change should reflect the inflation that occurs between the old 
representative month used for the preceding taxable year and the new 
representative month used for the year of change.
    (4) Compound category inflation index for revised BLS categories or 
price indexes--(i) In general. Periodically, the BLS revises a BLS 
table to add one or more new BLS categories, eliminate one or more 
previously reported BLS categories, or reset the base-year BLS price 
index of one or more BLS categories. If the BLS has revised the 
applicable BLS table for a taxable year, a taxpayer must compute the 
category inflation index for each BLS category for which the taxpayer 
cannot compute a category inflation index in accordance with paragraph 
(e)(3)(iii)(D)(3) of this section (affected BLS category) using a 
reasonable method, provided the method is used consistently for all 
affected BLS categories within a particular taxable year. For example, 
if the BLS revised the CPI by adding new BLS categories as of January 
2001 and eliminating some previously reported BLS categories as of 
December 2000, January 2002 would be the first month for which it would 
be possible to compute a category inflation index for a 12-month period 
using the BLS price indexes for any affected category. The compound 
category inflation index described in paragraph (e)(3)(iii)(D)(4)(ii) 
of this section is a reasonable method of computing the category 
inflation index for an affected BLS category.
    (ii) Computation of compound category inflation index. When the 
applicable BLS table is revised as described in paragraph 
(e)(3)(iii)(D)(4)(i) of this section, a taxpayer may use the procedure 
described in this paragraph (e)(3)(iii)(D)(4)(ii) to compute a compound 
category inflation index for each affected BLS category represented in 
the taxpayer's ending inventory. For this purpose, a compound category 
inflation index is the product of the category inflation index for the 
``first portion'' multiplied by the corresponding category inflation 
index for the ``second portion.'' The category inflation index for the 
first portion must reflect the inflation that occurs between the end of 
the base month (in the case of the double-extension IPIC method), or 
the preceding year's appropriate or representative month (in the case 
of the link-chain IPIC method), and the end of the last month covered 
by the unrevised BLS table based on the old BLS category. The 
corresponding category inflation index for the second portion must 
reflect the inflation that occurs between the beginning of the first 
month covered by the revised BLS table based on the new BLS category 
and the end of the current year's appropriate or representative month. 
First, using the revised BLS table for the current-year's appropriate 
or representative month, the taxpayer assigns items in the dollar-value 
pool using its method of assigning items to BLS categories as described 
in paragraph (e)(3)(iii)(C) of this section. Second, for each affected 
BLS category represented in the ending inventory, the taxpayer computes 
the category inflation index for the second portion using this formula: 
[A/B], where A equals the BLS price index for the current year's 
appropriate or representative month and B equals the BLS price index 
for the last month covered by the unrevised BLS table (as

[[Page 1086]]

published for the first month of the revised BLS table). Third, using 
the unrevised BLS table for the base month (in the case of the double 
extension IPIC method) or the preceding year's appropriate or 
representative month (in the case of the link-chain IPIC method), the 
taxpayer assigns each of the items in the dollar-value pool using its 
method of assigning items to BLS categories. Fourth, for each affected 
BLS category represented in the ending inventory, the taxpayer computes 
the category inflation index for the first portion using this formula: 
[C/D], where C equals the BLS price index for the last month covered by 
the unrevised BLS table (as published for the last month of the 
unrevised BLS table) and D equals the BLS price index for the base 
month (in the case of the double-extension IPIC method) or the 
preceding year's appropriate or representative month (in the case of 
the link-chain IPIC method). Fifth, for each affected BLS category 
represented in the ending inventory, the taxpayer computes the compound 
category inflation index using this formula: [X*Y], where X equals the 
category inflation index for the second portion, and Y equals the 
corresponding category inflation index for the first portion. For the 
purpose of computing the compound category inflation index for each 
affected BLS category, the corresponding category inflation index for 
the first portion is the category inflation index for the unrevised BLS 
category that includes the specific inventory item(s) included in the 
revised BLS category. If items included in a single revised BLS 
category had been included in separate BLS categories before the 
revision of the BLS table, the corresponding category inflation index 
for the first portion is the weighted harmonic mean of the category 
inflation indexes for these unrevised BLS categories. See paragraph 
(e)(3)(iii)(E)(1) of this section for a formula of the weighted 
harmonic mean. When computing this weighted-average category inflation 
index, a taxpayer must use the current-year costs (or in the case of a 
retailer using the retail method, the retail selling prices) in ending 
inventory as the weights.
    (iii) New base year. A taxpayer may establish a new base year in 
the year following the taxable year for which the taxpayer computed a 
compound category inflation index under this paragraph 
(e)(3)(iii)(D)(4) for one or more affected BLS categories in a dollar-
value pool. See paragraph (e)(3)(iv)(B) of this section for the 
procedures and computations incident to establishing a new base year.
    (iv) Examples. The following examples illustrate the rules of this 
paragraph (e)(3)(iii)(D)(4):

    Example 1. BLS categories eliminated. (i) A retailer, whose 
taxable year ends January 31, elected to account for its inventories 
using the dollar-value LIFO method and double-extension IPIC method 
(based on the CPI), beginning with the taxable year ending January 
31, 1997. The taxpayer does not use the retail method, but elected 
to use January as its representative month. On January 31, 1999, the 
taxpayer's only dollar-value pool contains only two items--lemons 
and peaches. The total current-year cost of these items is as 
follows: lemons, $40, and peaches, $30.
    (ii) The CPI was revised in October of 1998 to eliminate the 
``Citrus fruits'' subcategory of ``Other fresh fruits.'' In 
addition, the base-year BLS price index for ``Other fresh fruits'' 
was reset to 100.00 as of October 1, 1998. In relevant part, the 
January 1999 CPI permits the assignment of both lemons and peaches 
to ``Other fresh fruits.'' The January 1999 BLS price indexes for 
``Citrus fruits'' and ``Other fresh fruits'' are 96.6 and 105.6, 
respectively. In relevant part, the September 1998 CPI permits the 
assignment of lemons to ``Citrus fruits'' and peaches to ``Other 
fresh fruits.'' The September 1998 BLS price indexes for ``Citrus 
fruits'' and ``Other fresh fruits'' are 194.9 and 294.9, 
respectively, and the January 1997 BLS price indexes for ``Citrus 
fruits'' and ``Other fresh fruits'' are 190.2 and 290.2, 
respectively.
    (iii) Because the BLS eliminated the category, ``Citrus 
fruits,'' as of October 1998, it did not publish a BLS price index 
for that category in the January 1999 CPI. Thus, the taxpayer cannot 
compute a category inflation index for ``Citrus fruits'' under the 
normal procedures, but may compute a compound category inflation 
index for that affected BLS category using the procedures described 
in paragraph (e)(3)(iii)(D)(4)(ii) of this section.
    (iv) The taxpayer computes a compound category inflation index 
for the two BLS categories that formerly included lemons and 
peaches. The taxpayer first assigns lemons and peaches to ``Other 
fresh fruits,'' the most-detailed index in the January 1999 CPI, and 
then computes the category inflation index for the second portion as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Jan. 1999 index/Sept.
              Item                          1999 category                  1998 index (as           Category
                                                                      published in Oct. 1998)   inflation index
----------------------------------------------------------------------------------------------------------------
Lemons and Peaches.............  Other fresh fruits.................              105.6/100.0             1.0560
----------------------------------------------------------------------------------------------------------------

    (v) The taxpayer assigns the lemons and peaches to the most-
detailed BLS categories in the January 1998 CPI as follows: lemons 
to ``Citrus fruits'' and peaches to ``Other fresh fruits.'' Then, 
the taxpayer computes the category inflation index for the first 
portion as follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Sept. 1998 index (as
             Item                          1998 category                published in Sept.    Category inflation
                                                                         1998)/Jan. 1997             index
----------------------------------------------------------------------------------------------------------------
Lemons........................  Citrus fruits......................              194.9/190.2             1.0247
Peaches.......................  Other fresh Fruits.................              294.9/290.2             1.0162
----------------------------------------------------------------------------------------------------------------

    (vi) Because lemons and peaches, which are included together in 
the revised ``Other fresh fruits'' category, had been included in 
separate BLS categories before the BLS table was revised, the 
taxpayer must compute a single corresponding category inflation 
index for the affected BLS categories for the first portion. This 
corresponding category inflation index is the weighted harmonic mean 
of the separate corresponding category inflation indexes for the 
first portion using the cost of the items in ending inventory as the 
weights. The taxpayer computes the corresponding category inflation 
index for ``Other fresh fruits'' for the first portion as follows:

[[Page 1087]]



----------------------------------------------------------------------------------------------------------------
                                                               (I)  Weight     (II)  Category   (III)  Quotient:
                           Item                              (cost of item)    inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
Lemons....................................................            $40.00            1.0247            $39.04
Peaches...................................................             30.00            1.0162             29.52
                                                           -----------------------------------------------------
    Total.................................................             70.00  ................             68.56
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                (V)  Sum of (weight/     (VI)  Weighted harmonic
                    (IV)  Sum of weights                         category inflation        mean of other fresh
                                                                       index)               fruits: (IV)/(V)
----------------------------------------------------------------------------------------------------------------
$70.00......................................................                   $68.56                    1.0210
----------------------------------------------------------------------------------------------------------------

    (vii) Finally, the taxpayer computes the compound category 
inflation index for Other fresh fruits as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                (III)  Compound
                                                           (I)  Category      (II)  Category        category
                          Item                            inflation index    inflation index    inflation index:
                                                          (second portion)   (first portion)        (I)*(II)
----------------------------------------------------------------------------------------------------------------
Other fresh fruits.....................................            1.0560             1.0210             1.0782
----------------------------------------------------------------------------------------------------------------

    (viii) The taxpayer may establish a new base year for the 
taxable year ending January 31, 2000.
    Example 2. BLS categories separated. (i) The facts are the same 
as in Example 1, except prior to October 1998, both lemons and 
peaches were assigned to ``Other fresh fruits'' and in the October 
1998 CPI, the BLS created a new category, ``Citrus fruits,'' for 
citrus fruits, such as lemons. Moreover, the BLS reset the base-year 
BLS price index for ``Other fresh fruits'' to 100.0 as of October 1, 
1998. As a result of these changes, the taxpayer may no longer 
assign lemons to ``Other fresh fruits.''
    (ii) Because ``Citrus fruits'' is new as of October 1998, the 
BLS did not publish a BLS price index for this BLS category in the 
January 1999 CPI. Thus, because the taxpayer cannot compute a 
category inflation index for ``Citrus fruits'' under the normal 
procedures, the taxpayer may compute a compound category inflation 
index for the affected BLS category using the procedures described 
in paragraph (e)(3)(iii)(D)(4)(ii) of this section.
    (iii) Based on the January 1999 CPI, the taxpayer assigns lemons 
to ``Citrus fruits'' and peaches to ``Other fresh fruits.'' Then, 
the taxpayer computes a compound category inflation index for each 
of the two BLS categories. The computation of the category inflation 
index for the second portion is as follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Jan. 1999 index/Sept.
              Item                          1999 category                  1998 index (as           Category
                                                                      published in Oct. 1998)   inflation index
----------------------------------------------------------------------------------------------------------------
Lemons.........................  Citrus fruits......................                 96.6/100             0.9660
Peaches........................  Other fresh fruits.................                105.6/100             1.0560
----------------------------------------------------------------------------------------------------------------

    (iv) Then, the taxpayer computes the category inflation index 
for the first portion as follows:

----------------------------------------------------------------------------------------------------------------
                                                                      Sept. 1998 index (as
             Item                          1998 category            published in Sept. 1998)/ Category inflation
                                                                            Jan. 1997                index
----------------------------------------------------------------------------------------------------------------
Lemons & Peaches..............  Other fresh fruits................              294.9/290.2              1.0162
----------------------------------------------------------------------------------------------------------------

    (v) Finally, the taxpayer computes the compound category 
inflation index for ``Citrus fruits'' and ``Other fresh fruits'':

----------------------------------------------------------------------------------------------------------------
                                                                                                 (III)  Compound
                                                              (I)  Category    (II)  Category       category
                           Item                              inflation index   inflation index  inflation index:
                                                            (second portion)   (first portion)      (I)*(II)
----------------------------------------------------------------------------------------------------------------
Citrus fruits.............................................            0.9660            1.0162            0.9816
Other fresh fruits........................................            1.0560            1.0162            1.0731
----------------------------------------------------------------------------------------------------------------


[[Page 1088]]

    (vi) The taxpayer may establish a new base year for the taxable 
year ending January 31, 2000.

    (5) 10 percent method. (i) Applicability. A taxpayer that elects to 
use the 10 percent method described in paragraph (e)(3)(iii)(C)(2) of 
this section must compute a category inflation index for a less-
detailed 10 percent BLS category as provided in this paragraph 
(e)(3)(iii)(D)(5). A less-detailed 10 percent category is a BLS 
category that--
    (A) subsumes two or more BLS categories;
    (B) Does not have a single assigned item whose current-year cost is 
10 percent or more of the current-year cost of all the items in the 
dollar-value pool;
    (C) Has at least one item in at least one of the subsumed BLS 
categories; and
    (D) Has at least one subsumed BLS category that either does not 
have any assigned items or is a separate 10 percent BLS category.
    (ii) Determination of category inflation index. If the rules of 
this paragraph (e)(3)(iii)(D)(5) apply, the category inflation index 
for the less-detailed 10 percent BLS category is equal to the weighted 
arithmetic mean of the category inflation index (or, compound category 
inflation index, if applicable) for each of the subsumed BLS categories 
that have been assigned at least one item from the taxpayer's dollar-
value pool (excluding any item that is properly assigned to a separate 
10 percent BLS category). [Weighted Arithmetic Mean = Sum of (Weight x 
Category Inflation Index)]/Sum of Weights]. The appropriate weight for 
each of the most-detailed BLS categories referenced in the preceding 
sentence is the corresponding BLS weight. Currently, in January of each 
year, the BLS publishes the BLS weights determined for December of the 
preceding year. In the case of a taxpayer using the double-extension 
IPIC method, the BLS weights for December of the taxable year preceding 
the base year are to be used for all taxable years. In the case of a 
taxpayer using the link-chain IPIC method, the BLS weights for December 
of a given calendar year are to be used for taxable years that end 
during the 12-month period that begins on July 1 of the following 
calendar year. However, if the BLS weights are not published for all of 
the most-detailed BLS categories referenced above, the taxpayer may use 
the current-year cost (or in the case of a retailer using the retail 
method, the retail selling prices) of all items assigned to a specific 
most-detailed BLS category as the appropriate weight for that category, 
but must compute a weighted harmonic mean. See paragraph 
(e)(3)(iii)(E)(1) of this section for a formula of the weighted 
harmonic mean.
    (E) Computation of Inventory Price Index (IPI)--(1) Double-
extension IPIC method. Under the double-extension IPIC method, the IPI 
for a dollar-value pool is the weighted harmonic mean of the category 
inflation indexes (or, if applicable, compound category inflation 
indexes) determined under paragraph (e)(3)(iii)(D) of this section for 
each selected BLS category (or, if applicable 10 percent BLS category) 
represented in the taxpayer's dollar-value pool at the end of the 
taxable year. The formula for computing the weighted harmonic mean of 
the category inflation indexes is: [Sum of Weights/Sum of (Weight/
Category Inflation Index)]. The weights to be used when computing this 
weighted harmonic mean are the current-year costs (or, in the case of a 
retailer using the retail method, the retail selling prices) in each 
selected BLS category represented in the dollar-value pool at the end 
of the taxable year.
    (2) Link-chain IPIC method. Under the link-chain IPIC method, the 
IPI for a dollar-value pool is the product of the weighted harmonic 
mean of the category inflation indexes (or, if applicable, the compound 
category inflation indexes) determined under paragraph (e)(3)(iii)(D) 
of this section for each selected BLS category (or, if applicable, 10 
percent BLS category) represented in the taxpayer's dollar-value pool 
at the end of the taxable year multiplied by the IPI for the 
immediately preceding taxable year. The formula for computing the 
weighted harmonic mean of the category inflation indexes is: [Sum of 
Weights/Sum of (Weight/Category Inflation Index)]. The weights to be 
used when computing this weighted harmonic mean are the current-year 
costs (or, in the case of a retailer using the retail method, the 
retail selling prices) in each selected BLS category represented in the 
dollar-value pool at the end of the taxable year.
    (3) Examples. The following examples illustrate the rules of this 
paragraph (e)(3)(iii)(E):

    Example 1. Double-extension method. (i) Introduction. R is a 
retail furniture merchant that does not use the retail method. For 
the taxable year ending December 31, 2000, R used the first-in, 
first-out method of identifying inventory and valued its inventory 
at cost. The total cost of R's inventory on December 31, 2000, was 
$850,000. R elected to use the dollar-value LIFO and double-
extension IPIC methods for its taxable year ending December 31, 
2001. R does not elect to use the 10 percent method described in 
paragraph (e)(3)(iii)(C)(2) of this section. R determines the 
current-year cost of the items using the actual cost of the most 
recently purchased goods. R elected to pool its inventory based on 
the major groups in Table 6 of the monthly ``PPI Detailed Report'' 
in accordance with the special IPIC pooling rules of paragraph 
(b)(4) of this section. All items in R's inventories fall within the 
2-digit commodity code in Table 6 of the monthly ``PPI Detailed 
Report'' for ``furniture and household durables.'' Therefore, R will 
maintain a single dollar-value pool.
    (ii) Select a BLS table and appropriate month for 2001. R 
determines that the appropriate month for 2001 is October. R also 
determines that the appropriate month for 2000 would have been 
December if R had used the IPIC method for that year.
    (iii) Assign inventory items to BLS categories for 2001. For 
2001, R assigns all items in the dollar-value pool to the most-
detailed BLS categories listed in Table 6 of the October 2001 ``PPI 
Detailed Report'' that contain those items. The BLS categories and 
the current-year cost of the items assigned to them are summarized 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                  Current-year
              Commodity code                                     Category                             cost
----------------------------------------------------------------------------------------------------------------
12120101.................................  Living Room Table..................................       $111,924.00
12120211.................................  Dining Room Table..................................        159,578.00
12120216.................................  Dining Room Chairs.................................         98,639.00
12130101.................................  Upholstered Sofas..................................        332,488.00
12130111.................................  Upholstered Chairs.................................        218,751.00
                                                                                               -----------------
    Total................................  ...................................................        921,380.00
----------------------------------------------------------------------------------------------------------------

    (iv) Compute category inflation indexes for 2001. Because R 
elected to use the double-extension IPIC method and did not elect 
the 10 percent method, the category inflation indexes are computed 
in accordance with paragraph (e)(3)(iii)(D)(3)(ii) of this section 
(BLS price indexes for October 2001 divided by BLS price indexes for 
December 2000). R computes the category inflation indexes for 2001 
as follows:

[[Page 1089]]



----------------------------------------------------------------------------------------------------------------
                                                                                                 (III)  Category
                         Category                            (I)  Oct. 2001    (II)  Dec. 2000  inflation index:
                                                                  index             index           (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Table.........................................             172.4             169.2          1.018913
Dining Room Tab1e.........................................             171.9             168.1          1.022606
Dining Room Chairs........................................             172.8             169.7          1.018268
Upholstered Sofas.........................................             142.2             140.9          1.009226
Upholstered Chairs........................................             134.1             132.5          1.012075
----------------------------------------------------------------------------------------------------------------

    (v) Compute IPI for 2001. R must compute the IPI for 2001, which 
is the weighted harmonic mean of the category inflation indexes for 
2001. The formula for the weighted harmonic mean provided in 
paragraph (e)(3)(iii)(E)(1) of this section is [Sum of Weights/Sum 
of (Weight/Category Inflation Index)]. The IPI for 2001 is computed 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                               (II)  Category   (III)  Quotient:
                         Category                              (I)  Weight     inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Table.........................................       $111,924.00          1.018913       $109,846.47
Dining Room Table.........................................        159,578.00          1.022606        156,050.33
Dining Room Chairs........................................         98,639.00          1.018268         96,869.39
Upholstered Sofas.........................................        332,488.00          1.009226        329,448.51
Upholstered Chairs........................................        218,751.00          1.012075        216,141.10
                                                           -----------------------------------------------------
    Total.................................................       $921,380.00  ................       $908,355.80
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                     (V)  Sum of (weight/
                       (IV)  Sum of weights                           category inflation   (VI)  Inventory price
                                                                            index)            index: (IV)/(V)
----------------------------------------------------------------------------------------------------------------
$921,380.00.......................................................           $908,355.80             1.01433821
----------------------------------------------------------------------------------------------------------------

    (vi) Determine the LIFO value of the dollar-value pool for 2001. 
For 2001, R determines the total base-year cost of its ending 
inventory by dividing the total current-year cost of the items in 
the dollar-value pool by the IPI for 2001. The total base-year cost 
of R's ending inventory is $908,355.80 ($921,380/1.01433821). 
Comparing the base-year cost of the ending inventory to the base-
year cost of the beginning inventory, R determines that the base-
year cost of the 2001 increment is $58,355.80 ($908,355.80--
$850,000.00). R multiplies the base-year cost of the 2001 increment 
by the IPI for 2001 and determines that the LIFO value of the 2001 
layer is $59,192.52 ($58,355.80 * 1.01433821). Thus, the LIFO value 
of R's total inventory at the end of 2001 is $909,192.52 
($850,000.00 (opening inventory) + $59,192.52 (2001 layer)).
    (vii) Select a BLS table and appropriate month for 2002. For 
2002.0, R must compute a new IPI under the double-extension IPIC 
method to determine the LIFO value of its dollar-value pool. R 
determines that the appropriate month for 2002 is November.
    (viii) Assign inventory items to BLS categories for 2002. For 
2002, R assigns all items in the dollar-value pool to the most-
detailed BLS categories listed in Table 6 of the November 2002 ``PPI 
Detailed Report'' that contain those items. The BLS categories and 
the current-year cost of the items assigned to them are summarized 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                  Current-year
              Commodity code                                     Category                             cost
----------------------------------------------------------------------------------------------------------------
12120103.................................  Living Room Desks..................................       $125,008.00
12120211.................................  Dining Room Table..................................        136,216.00
12120216.................................  Dining Room Chairs.................................        113,569.00
12130101.................................  Upholstered Sofas..................................        343,900.00
12130111.................................  Upholstered Chairs.................................        233,050.00
                                                                                               -----------------
    Total................................  ...................................................       $951,743.00
----------------------------------------------------------------------------------------------------------------

    (ix) Compute category inflation indexes for 2002. Because R uses 
the double-extension IPIC method and did not elect the 10 percent 
method, the category inflation indexes are computed in accordance 
with paragraph (e)(3)(iii)(D)(3)(ii) of this section (BLS price 
indexes for November 2002 divided by BLS price indexes for December 
2000). R computes the category inflation indexes for 2002 as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                 (III)  Category
                         Category                            (I)  Nov. 2002    (II)  Dec. 2000   inflation index
                                                                  index             index           (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Desks.........................................             172.6             160.3          1.076731
Dining Room Table.........................................             174.8             168.1          1.039857
Dining Room Chairs........................................             177.0             169.7          1.043017
Upholstered Sofas.........................................             144.9             140.9          1.028389
Upholstered Chairs........................................             136.6             132.5          1.030943
----------------------------------------------------------------------------------------------------------------


[[Page 1090]]

    (x) Compute IPI for 2002. R must compute the IPI for 2002, which 
is the weighted harmonic mean [Sum of Weights/Sum of (Weight/
Category Inflation Index)] of the category inflation indexes for 
2002. The IPI for 2002 is computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                (II) Category    (III) Quotient:
                         Category                              (I) Weight      inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Desks.........................................       $125,008.00          1.076731       $116,099.56
Dining Room Table.........................................        136,216.00          1.039857        130,994.93
Dining Room Chairs........................................        113,569.00          1.043017        108,885.09
Upholstered Sofas.........................................        343,900.00          1.028389        334,406.53
Upholstered Chairs........................................        233,050.00          1.030943        226,055.17
                                                           -----------------------------------------------------
    Total.................................................        951,743.00  ................        916,441.28
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                         (V) Category       (VI) Inventory price
                        (IV) Sum of weights                            inflation index        index: (IV)/(V)
----------------------------------------------------------------------------------------------------------------
$951,743.00.......................................................           $916,441.28             1.03852044
----------------------------------------------------------------------------------------------------------------

    (xi) Determine the LIFO value of the pool for 2002. For 2002, R 
determines the total base-year cost of its ending inventory by 
dividing the total current-year cost of the items in the dollar-
value pool by the IPI for 2002. The total base-year cost of the 
ending inventory is $916,441.28 ($951,743.00/1.03852044). Comparing 
the base-year cost of the ending inventory to the base-year cost of 
the beginning inventory, R determines that the base-year cost of the 
2002 increment is $8,085.48 ($916,441.28-$908,355.80). R multiplies 
the base-year cost of the 2002 increment by the IPI for 2002 and 
determines that the LIFO value of the 2002 layer is $8,396.94 
($8,085.48 * 1.03852044). Thus, the LIFO value of R's total 
inventory at the end of 2002 is $917,589.46 ($850,000.00 (opening 
inventory) + $59,192.52 (2001 layer) + $8,396.94 (2002 layer)).
    Example 2. Link-chain method. (i) Introduction. The facts are 
the same as Example 1, except that R uses the link-chain IPIC 
method. The double-extension IPIC method and the link-chain IPIC 
method yield the same results for the first taxable year in which 
the dollar-value LIFO and IPIC methods are used. Therefore, this 
example illustrates only how R will compute the IPI for, and 
determine the LIFO value of, its dollar-value pool for 2002.
    (ii) Select a BLS table and appropriate month for 2002. R 
determines that the appropriate month for 2002 is November.
    (iii) Assign inventory items to BLS categories for 2002. For 
2002, R assigns all items in the dollar-value pool to the most-
detailed BLS categories listed in Table 6 of the November 2002 ``PPI 
Detailed Report'' that contain those items. The BLS categories and 
the current-year cost of the items assigned to them are summarized 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                  Current-year
              Commodity code                                     Category                             cost
----------------------------------------------------------------------------------------------------------------
12120103.................................  Living Room Desks..................................       $125,008.00
12120211.................................  Dining Room Table..................................        136,216.00
12120216.................................  Dining Room Chairs.................................        113,569.00
12130101.................................  Upholstered Sofas..................................        343,900.00
12130111.................................  Upholstered Chairs.................................        233,050.00
                                                                                               -----------------
    Total................................  ...................................................        951,743.00
----------------------------------------------------------------------------------------------------------------

    (iv) Compute category inflation indexes for 2002. Because R uses 
the link-chain IPIC method and did not elect the 10 percent method, 
the category inflation indexes are computed in accordance with 
paragraph (e)(3)(iii)(D)(3)(iii) of this section (BLS price indexes 
for November 2002 divided by BLS price indexes for October 2001). R 
computes the category inflation indexes for 2002 as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                 (III) Category
                         Category                             (I) Nov. 2002    (II) Oct. 2001   inflation index:
                                                                  index             index           (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Desks.........................................             172.6             162.0          1.065432
Dining Room Table.........................................             174.8             171.9          1.016870
Dining Room Chairs........................................             177.0             172.8          1.024306
Upholstered Sofas.........................................             144.9             142.2          1.018987
Upholstered Chairs........................................             136.6             134.1          1.018643
----------------------------------------------------------------------------------------------------------------

    (v) Compute IPI for 2002. As provided in paragraph 
(e)(3)(iii)(E)(2) of this section, R must compute the IPI for 2002 
by multiplying the weighted harmonic mean of the category inflation 
indexes for 2002 by the IPI for 2001. The IPI for 2002 is computed 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                (II) Category    (III) Quotient:
                         Category                              (I) Weight      inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
Living Room Desks.........................................       $125,008.00          1.065432       $117,330.81
Dining Room Table.........................................        136,216.00          1.016870        133,956.16

[[Page 1091]]

 
Dining Room Chairs........................................        113,569.00          1.024306        110,874.09
Upholstered Sofas.........................................        343,900.00          1.018987        337,492.04
                                                           ------------------                  -----------------
Upholstered Chairs........................................        233,050.00          1.018643        228,784.77
    Total.................................................        951,743.00  ................        928,437.87
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                      (VI) Weighted
                              (V) Sum of (weight/    harmonic mean of     (VII) Inventory      (VIII) Inventory
     (IV) Sum of weights       category inflation   category inflation    price index for      price index for
                                     index)         indexes for 2002:           2001           2002: (VI)*(VII)
                                                         (IV)/(V)
----------------------------------------------------------------------------------------------------------------
$951,743.00.................         $928,437.87           1.02510144           1.01433821           1.03979956
----------------------------------------------------------------------------------------------------------------

    (vi) Determine the LIFO value of the pool for 2002. R determines 
the total base-year cost of its ending inventory by dividing the 
total current-year cost of the items in the dollar-value pool by the 
IPI for 2002. The total base-year cost of the ending inventory is 
$915,313.91 ($951,743.00 / 1.03979956). Comparing the base-year cost 
of the ending inventory to the base-year cost of the beginning 
inventory, R determines that the base-year cost of the 2002 layer is 
$6,958.11 ($915,313.91-$908,355.80). R multiplies the base-year cost 
of the 2002 layer by the IPI for 2002 and determines that the LIFO 
value of the 2002 layer is $7,235.04 ($6,958.11 * 1.03979956). Thus, 
the LIFO value of R's total inventory at the end of 2002 is 
$916,427.56 ($850,000.00 (opening inventory) + $59,192.52 (2001 
layer) + $7,235.04 (2002 layer)).

    (iv) Adoption or change of method--(A) Adoption or change to IPIC 
method. The use of an inventory price index computed under the IPIC 
method is a method of accounting. A taxpayer permitted to adopt the 
dollar-value LIFO method without first securing the Commissioner's 
consent also may adopt the IPIC method without first securing the 
Commissioner's consent. The IPIC method may be adopted and used, 
however, only if the taxpayer provides the following information on a 
Form 970, ``Application to Use LIFO Inventory Method,'' or in another 
manner as may be acceptable to the Commissioner: A complete list of 
dollar-value pools (including a description of the items in each 
dollar-value pool); the BLS table (i.e., CPI or PPI) selected for each 
dollar-value pool; the representative month, if applicable, elected for 
each dollar-value pool; the BLS categories to which the items in each 
dollar-value pool will be assigned; the method of assigning items to 
BLS categories (e.g., the 10 percent method) for each dollar-value 
pool; and the method of computing the IPI (i.e., double-extension IPIC 
method or link-chain IPIC method) for each dollar-value pool. In the 
case of a taxpayer permitted to adopt the IPIC method without 
requesting the Commissioner's consent, the Form 970 must be attached to 
the taxpayer's income tax return for the taxable year of adoption. In 
all other cases, a taxpayer may change to the IPIC method only after 
securing the Commissioner's consent as provided in Sec. 1.446-1(e). In 
these latter cases, the Form 970 containing the information described 
in this paragraph (e)(3)(iv)(A) must be attached to a Form 3115, 
``Application for Change in Accounting Method,'' filed as required by 
Sec. 1.446-1(e). A taxpayer that simultaneously changes to the dollar-
value LIFO and IPIC methods from another LIFO method must apply the 
rules of paragraph (f)(2) of this section before applying the rules of 
paragraph (e)(3)(iv)(B)(1) of this section. To satisfy the requirements 
of Sec. 1.472-2(h), taxpayers must maintain adequate books and records, 
including those concerning the use of the IPIC method and necessary 
computations. Notwithstanding the rules in paragraph (e)(1) of this 
section, a taxpayer that adopts, or changes to, the link-chain IPIC 
method is not required to demonstrate that the use of any other method 
of determining the LIFO value of a dollar-value pool is impractical.
    (B) New base year--(1) Voluntary change--(i) In general. In the 
case of a taxpayer using a non-IPIC method to determine the LIFO value 
of inventory, the layers previously determined under that method, if 
any, and the LIFO values of those layers are retained if the taxpayer 
voluntarily changes to the IPIC method. Instead of using the earliest 
taxable year for which the taxpayer adopted the LIFO method for any 
items in the dollar-value pool, the year of change is used as the new 
base year for the purpose of determining the amount of increments and 
liquidations, if any, for the year of change and subsequent taxable 
years. The base-year cost of the layers in a dollar-value pool at the 
beginning of the year of change must be restated in terms of new base-
year cost using the year of change as the new base year and, if 
applicable, the indexes for the previously determined layers must be 
recomputed accordingly. The recomputed indexes will be used to 
determine the LIFO value of subsequent liquidations. For purposes of 
computing an IPI under paragraph (e)(3)(iii)(E) of this section, the 
IPI for the immediately preceding year is 1.00. The new total base-year 
cost of the items in a dollar-value pool for the purpose of determining 
future increments and liquidations is equal to the total current-year 
cost of the items in the dollar-value pool (determined using the 
taxpayer's method of determining the total current-year cost of the 
items in the dollar-value pool under paragraph (e)(2)(ii) of this 
section). A taxpayer must allocate this new total base-year cost to 
each layer based on the ratio of the old base-year cost of the layer to 
the old total base-year cost of the dollar-value pool.
    (ii) Example. The following example illustrates the rules of this 
paragraph (e)(3)(iv)(B)(1):

    Example. (i) In 1990, X elected to use a dollar-value LIFO 
method (other than the IPIC method) for its single dollar-value 
pool. X is granted permission to change to the link-chain IPIC 
method, beginning with the taxable year ending December 31, 2001. X 
will continue using a single dollar-value pool. X's beginning 
inventory as of January 1, 2001, computed using its former inventory 
method, is as follows:

[[Page 1092]]



----------------------------------------------------------------------------------------------------------------
                                                                                                   (III)  LIFO
                           Layer                             (I)  Base-year    (II)  Inflation    value: (I) *
                                                                  cost              index             (II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $135,000              1.00          $135,000
1991 layer................................................            20,000              1.43            28,600
1994 layer................................................            60,000              1.55            93,000
1995 layer................................................            13,000              1.59            20,670
1997 layer................................................             2,000              1.61             3,220
                                                           ------------------                  -----------------
    Total.................................................           230,000                             280,490
----------------------------------------------------------------------------------------------------------------

    (ii) Under X's method of determining the current-year cost of 
items in a dollar-value pool, the current-year cost of the beginning 
inventory is $391,000. Thus, X's new base-year cost as of January 1, 
2001, is $391,000. X allocates this new base-year cost to each layer 
based on the ratio of old base-year cost of the layer to the total 
old base-year cost of the dollar-value pool. To recompute the 
inflation indexes for each of its layers, X divides the LIFO value 
of each layer by the new base-year cost attributable to the layer. 
The new base-year cost, recomputed inflation indexes, and LIFO value 
of X's layers as of January 1, 2001, are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                   (III)  LIFO
                           Layer                             (I)  Base-year    (II)  Inflation    value: (I) *
                                                                  cost              index             (II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $229,500          0.588235          $135,000
1991 layer................................................            34,000          0.841176            28,600
1994 layer................................................           102,000          0.911765            93,000
1995 layer................................................            22,100          0.935294            20,670
1997 layer................................................             3,400          0.947059             3,220
                                                           ------------------                  -----------------
    Total.................................................           391,000                             280,490
----------------------------------------------------------------------------------------------------------------

    (iii) In 2001, the current-year cost of X's ending inventory is 
$430,139. The weighted harmonic mean of the category inflation 
indexes applicable to X's ending inventory is 1.075347, and in 
accordance with paragraph (e)(3)(iv)(B)(1)(i) of this section, the 
inflation index for the immediately preceding taxable year is 1.00. 
Thus, X's IPI for 2001 is 1.075347 (1.00 * 1.075347). The total 
base-year cost of X's ending inventory is $400,000 ($430,139/
1.075347). The base-year cost, IPI, and LIFO value of X's layers as 
of December 31, 2001, are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                   (III)  LIFO
                           Layer                             (I)  Base-year    (II)  Inventory    value: (I) *
                                                                  cost           price index          (II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $229,500          0.588235          $135,000
1991 layer................................................            34,000          0.841176            28,600
1994 layer................................................           102,000          0.911765            93,000
1995 layer................................................            22,100          0.935294            20,670
1997 layer................................................             3,400          0.947059             3,220
2001 layer................................................             9,000          1.075347             9,678
                                                           ------------------                  -----------------
    Total.................................................           400,000                             290,168
----------------------------------------------------------------------------------------------------------------

    (iv) In 2002, the current-year cost of X's ending inventory is 
$418,000. The weighted harmonic mean of the category inflation 
indexes applicable to X's ending inventory is 1.02292562, and the 
IPI for the immediately preceding year is 1.075347. Thus, X's IPI 
for 2001 is 1.10 (1.075347 * 1.02292562). The total base-year cost 
of X's ending inventory is $380,000 ($418,000/1.10), which results 
in a liquidation of $20,000 ($400,000-$380,000) in terms of base-
year cost. This liquidation eliminates the 2001 layer ($9,000 base-
year cost), the 1997 layer ($3,400 base-year cost), and part of the 
1995 layer ($7,600 base-year cost). The base-year cost, indexes, and 
LIFO value of X's layers as of December 31, 2002, are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                   (III)  LIFO
                           Layer                             (I)  Base-year    (II)  Inventory    value: (I) *
                                                                  cost           price index          (II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $229,500          0.588235          $135,000
1991 layer................................................            34,000          0.841176            28,600
1994 layer................................................           102,000          0.911765            93,000
1995 layer................................................            14,500          0.935294            13,562
                                                           ------------------                  -----------------
    Total.................................................           380,000                             270,162
----------------------------------------------------------------------------------------------------------------

    (2) Involuntary change--(i) In general. If a taxpayer uses a non-
IPIC method to compute the LIFO value of a dollar-value pool, and if 
the Commissioner determines that the taxpayer's method does not clearly 
reflect income, the Commissioner may require the taxpayer to change to 
the IPIC method. If the Commissioner requires a taxpayer to

[[Page 1093]]

change to the IPIC method, and the taxpayer does not provide sufficient 
information from its books and records to compute an adjustment under 
section 481, the Commissioner may implement the change using the 
simplified transition method described in paragraph 
(e)(3)(iv)(B)(2)(ii) of this section.
    (ii) Simplified Transition Method. Under the simplified transition 
method, the Commissioner will recompute the LIFO value of each dollar-
value pool as of the beginning of the year of change using the double-
extension IPIC method or the link-chain IPIC method. The adjustment 
under section 481 is equal to the difference between the recomputed 
LIFO value and the LIFO value of the pool determined under the 
taxpayer's former method. The Commissioner will compute an IPI using 
the double-extension IPIC method or link-chain IPIC method for each 
taxable year in which the LIFO method was used by the taxpayer based on 
the assumptions that the ending inventory of the pool in each taxable 
year was comprised of items that fall into the same BLS categories as 
the items in the ending inventory of the year of change and that the 
relative weights of those BLS categories in all prior years were the 
same as the relative weights of those BLS categories in the ending 
inventory of the year of change. The base-year cost of the items in a 
dollar-value pool at the end of a taxable year will be determined by 
dividing the IPI computed for the taxable year into the current-year 
cost of the items in that pool determined in accordance with paragraph 
(e)(2)(ii) of this section. If the comparison of the base-year cost of 
the beginning and ending inventory produces a current-year increment, 
the base-year cost of that increment will be multiplied by the IPI 
computed for that taxable year to determine the LIFO value of that 
layer.
    (iii) Example. The following example illustrates the rules of this 
paragraph (e)(3)(iv)(B)(2)(ii).
    Example. (i) Z began using a dollar-value LIFO method other than 
the IPIC method in the taxable year ending December 31, 1998, and 
maintains a single dollar-value pool. Z's beginning inventory as of 
January 1, 2000, computed using its method of accounting, was as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                             (I)  Base-year    (II)  Inflation     (III)  LIFO
                           Layer                                  cost              index       value:  (I)*(II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $105,000              1.00          $105,000
1998 layer................................................             3,000              1.40             4,200
                                                           ------------------                  -----------------
    Total.................................................           108,000  ................           109,200
----------------------------------------------------------------------------------------------------------------

    (ii) Upon examining Z's federal income tax return for the 
taxable year ending December 31, 2000, the examining agent 
determines that Z's dollar-value LIFO method does not clearly 
reflect income. The examining agent chooses to change Z to the 
double-extension IPIC method for 2000 and implements the change 
using the simplified transition method as follows. First, the 
inventory in Z's dollar-value pool at the end of 2000 is assigned to 
the most-detailed categories in the CPI or PPI, whichever is 
appropriate. Assume that 80 percent of the current-year cost of Z's 
inventory as of December 31, 2000, is assigned to Category 1, 10 
percent is assigned to Category 2, and 10 percent is assigned to 
Category 3. Assume further that the current-year cost of the 
inventory in Z's dollar-value pool at the end of 1998 and 1999 was 
$133,000 and $145,000, respectively.
    (iii) The category inflation indexes for 1998 computed under the 
double-extension IPIC method are 1.17 for Category 1, 1.26 for 
Category 2, and 1.19 for Category 3. The weights to be used in 
computing the IPI for 1998 are $106,400 ($133,000 * 80 percent) for 
Category 1, $13,300 ($133,000 * 10 percent) for Category 2, and 
$13,300 ($133,000 * 10 percent) for Category 3. The IPI for 1998 is 
computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                               (II)  Category   (III)  Quotient:
                         Category                              (I)  Weight     inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
1.........................................................          $106,400              1.17            90,940
2.........................................................            13,300              1.26            10,556
3.........................................................            13,300              1.19            11,176
                                                           ------------------                  -----------------
    Total.................................................           133,000  ................           112,672
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                     (V)  Sum of (weight/
                       (IV)  Sum of weights                           category inflation    (VI) Inventory price
                                                                            index)            index: (IV)/(V)
----------------------------------------------------------------------------------------------------------------
 $133,000.........................................................              $112,672               1.180417
----------------------------------------------------------------------------------------------------------------

    (iv) The base-year cost of the inventory in Z's pool at the end 
of 1998 is $112,672 ($133,000/1.180417), and the base-year cost of 
the 1998 increment is $7,672 ($112,672-$105,000). The LIFO value of 
the 1998 layer is $9,056 ($7,672  x  1.180417).
    (v) The category inflation indexes for 1999 computed under the 
double-extension IPIC method were 1.21 for Category 1, 1.29 for 
Category 2 and 1.23 for Category 3. The weights to be used in 
computing the IPI for 1999 are $116,000 ($145,000  x  80 percent) 
for Category 1, $14,500 ($145,000  x  10 percent) for Category 2, 
and $14,500 ($145,000  x  10 percent) for Category 3. The IPI for 
1999 is computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                               (II)  Category   (III)  Quotient:
                         Category                              (I)  Weight     inflation index      (I)/(II)
----------------------------------------------------------------------------------------------------------------
1.........................................................          $116,000              1.21           $95,868
2.........................................................            14,500              1.29            11,240

[[Page 1094]]

 
3.........................................................            14,500              1.23            11,789
                                                           ------------------                  -----------------
    Total.................................................           145,000  ................           118,897
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                     (V)  Sum of (weight/
                       (IV)  Sum of weights                           category inflation    (VI) Inventory price
                                                                            index)            index: (IV)/(V)
----------------------------------------------------------------------------------------------------------------
$145,000..........................................................              $118,897               1.219543
----------------------------------------------------------------------------------------------------------------

    (vi) The base-year cost of the inventory in Z's pool at the end 
of 1999 is $118,897 ($145,000/1.219543), and the base-year cost of 
the 1999 layer is $6,225 ($118,897-$112,672). The LIFO value of the 
1999 layer is $7,592 ($6,225  x  1.219543).
    (vii) The LIFO value of Z's dollar-value pool at the end of 1999 
computed under the double-extension IPIC method is as follows:

----------------------------------------------------------------------------------------------------------------
                                                              (I) Base-year    (II)  Inventory     (III) LIFO
                           Layer                                  cost           price index     value: (I)*(II)
----------------------------------------------------------------------------------------------------------------
Base layer................................................          $105,000          1.000000          $105,000
1998 layer................................................             7,672          1.180417             9,056
1999 layer................................................             6,225          1.219542             7,592
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½
    Total.................................................           118,897  ................           121,648
----------------------------------------------------------------------------------------------------------------

    (viii) The section 481(a) adjustment is equal to the difference 
between the LIFO value of the inventory at the beginning of 2000 
computed under Z's former method of accounting and recomputed by the 
examining agent under the double-extension IPIC method, or $12,448 
($121,648--$109,200).
    (ix) Finally, the examining agent will recompute Z's taxable 
income for 2000 and succeeding taxable years using the double-
extension IPIC method.

    (v) Effective date--(A) In general. The rules of this paragraph 
(e)(3) and paragraphs (b)(4) and (c)(2) of this section are applicable 
for taxable years ending on or after December 31, 2001.
    (B) Change in method of accounting. Any change in a taxpayer's 
method of accounting necessary to comply with this paragraph (e)(3) or 
with paragraphs (b)(4) or (c)(2) of this section is a change in method 
of accounting to which the provisions of section 446 and the 
regulations thereunder apply. For the first or second taxable year 
ending on or after December 31, 2001, a taxpayer is granted the consent 
of the Commissioner to change its method of accounting to a method 
required or permitted by this paragraph (e)(3) and paragraphs (b)(4) 
and (c)(2) of this section. A taxpayer that wants to change its method 
of accounting under this paragraph (e)(3)(v) must follow the automatic 
consent procedures in Rev. Proc. 2002-9 (2002-3 I.R.B. xxx) (see 
Sec. 601.601(d)(2) of this chapter). However, the scope limitations in 
section 4.02 of Rev. Proc. 2002-9 do not apply, and the five-year 
limitation on the readoption of the LIFO method under section 10.01(2) 
of the Appendix is waived. In addition, if the taxpayer's method of 
accounting for its LIFO inventories is an issue under consideration at 
the time the application is filed with the national office, the audit 
protection of section 7 of Rev. Proc. 2002-9 does not apply. If a 
taxpayer changing its method of accounting under this paragraph 
(e)(3)(v)(B) is under examination, before an appeals office, or before 
a federal court with respect to any income tax issue, the taxpayer must 
provide a copy of the application to the examining agent(s), appeals 
officer or counsel for the government, as appropriate, at the same time 
it files the application with the national office. Any change under 
this paragraph (e)(3)(v)(B) must be made using a cut-off method and new 
base year as required by paragraph (e)(3)(iv)(B)(1) of this section. 
Because a change under this paragraph (e)(3)(v)(B) is made using a cut-
off method, a section 481(a) adjustment is not permitted. However, a 
taxpayer changing its method of accounting under this paragraph 
(e)(3)(v)(B) must comply with the requirements of section 10.06(3) of 
the APPENDIX of Rev. Proc. 2002-9 (concerning bargain purchases).
* * * * *
    (h) LIFO inventories received in certain nonrecognition 
transactions--(1) In general. Except as provided in paragraph (h)(3) of 
this section, if inventory items accounted for under the LIFO method 
are received in a transaction described in paragraph (h)(2) of this 
section, then, for the purpose of determining future increments and 
liquidations, the transferee must use the year of transfer as the base 
year and must use its current-year cost (computed under the 
transferee's method of accounting) of those items as their new base-
year cost. If the transferee had opening inventories in the year of 
transfer, then, for the purpose of determining future increments and 
liquidations, the transferee must use its current-year cost (computed 
under the transferee's method of accounting) of those inventories as 
their new base-year cost. For this purpose, ``opening inventory'' 
refers to all items owned by the transferee before the transfer for 
which the transferee uses, or elects to use, the LIFO method. The total 
new base-year cost of the transferee's inventory as of the beginning of 
the year of transfer is equal to the new base-year cost of the 
inventory received from the transferor and the new base-year cost of 
the transferee's opening inventory. The index (or, the cumulative index 
in the case of the link-chain method) for the year immediately 
preceding the year of transfer is 1.00. The base-year cost of any 
layers in the dollar-value pool, as determined after the transfer, must 
be recomputed accordingly. See paragraph (e)(3)(iv)(B)(1) of this 
section for an example of this computation.
    (2) Transactions to which this paragraph (h) applies. The rules in 
this

[[Page 1095]]

paragraph (h) apply to a transaction in which--
    (i) The transferee determines its basis in the inventories, in 
whole or in part, by reference to the basis of the inventories in the 
hands of the transferor;
    (ii) The transferor used the dollar-value LIFO method to account 
for the transferred inventories;
    (iii) The transferee uses the dollar-value LIFO method to account 
for the inventories in the year of the transfer; and
    (iv) The transaction is not described in section 381(a).
    (3) Anti-avoidance rule. The rules in this paragraph (h) do not 
apply to a transaction entered into with the principal purpose to avail 
the transferee of a method of accounting that would be unavailable to 
the transferor (or would be unavailable to the transferor without 
securing consent from the Commissioner). In determining the principal 
purpose of a transfer, consideration will be given to all of the facts 
and circumstances. However, a transfer is deemed made with the 
principal purpose to avail the transferee of a method of accounting 
that would be unavailable to the transferor without securing consent 
from the Commissioner if the transferor acquired inventory in a bargain 
purchase within the five taxable years preceding the year of the 
transfer and used a dollar-value LIFO method to account for that 
inventory that did not treat the bargain purchase inventory and 
physically identical inventory acquired at market prices as separate 
items. Inventory is deemed acquired in a bargain purchase if the actual 
cost of the inventory (or, if appropriate, the allocated cost of the 
inventory) was less than or equal to 50 percent of the replacement cost 
of physically identical inventory. Inventory is not considered acquired 
in a bargain purchase if the actual cost of the inventory (or, if 
appropriate, the allocated cost of the inventory) was greater than or 
equal to 75 percent of the replacement cost of physically identical 
inventory.
    (4) Effective date. The rules of this paragraph (h) are applicable 
for transfers that occur during a taxable year ending on or after 
December 31, 2001.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


    Par. 4. In Sec. 602.101, in the table in paragraph (b), the entry 
for 1.472-8 is revised to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                                Current
                                                                  OMB
     CFR part or section where identified and described         control
                                                                  No.
------------------------------------------------------------------------
 
                  *        *        *        *        *
1.472-8.....................................................   1545-0028
                                                               1545-0042
                                                               1545-1767
 
                  *        *        *        *        *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 21, 2001.
Mark Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 02-184 Filed 1-8-02; 8:45 am]
BILLING CODE 4830-01-P