[Federal Register Volume 72, Number 221 (Friday, November 16, 2007)]
[Proposed Rules]
[Pages 64545-64558]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-22411]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-151884-03]
RIN 1545-BD81


Update and Revision of Sections 1.381(c)(4)-1 and 1.381(c)(5)-1

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations that provide 
guidance under sections 381(c)(4) and (c)(5) of the Internal Revenue 
Code (Code) relating to the accounting method or combination of 
methods, including the inventory method, to use after certain corporate 
reorganizations and tax-free liquidations. These proposed regulations 
clarify and simplify the existing regulations under sections 381(c)(4) 
and (c)(5). The regulations affect corporations that acquire the assets 
of other corporations in transactions described in section 381(a).

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 14, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-151884-03), Room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
151884-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at http://www.regulations.gov/ (IRS REG-151884-03).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Cheryl Oseekey at (202) 622-4970; concerning submissions of comments 
and requests for a hearing, Kelly Banks at (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

Overview

    Section 381 of the Code was enacted in 1954 to provide statutory 
authority for determining the carryover of certain tax attributes, 
including accounting methods, in certain corporate reorganizations and 
tax-free liquidations. Regulations implementing section 381(c)(4) were 
issued on August 5, 1964 (29 FR 11263). On August 23, 1972, the IRS 
proposed to revise these regulations (37 FR 16947). On December 23, 
1998, the IRS withdrew the regulations that had been proposed in 1972 
(63 FR 71047). Regulations implementing section 381(c)(5) were issued 
on January 15, 1975 (40 FR 2684).
    Section 1.381(c)(4)-1 generally provides that after a section 
381(a) transaction, the accounting method or combination of methods 
used by the parties to the section 381(a) transaction prior to the 
transaction will continue. However, when the accounting methods used 
prior to the section 381(a) transaction cannot continue to be used 
after the transaction, Sec.  1.381(c)(4)-1 identifies the accounting 
method(s) to use after the transaction. Section 1.381(c)(5)-1 provides 
similar rules regarding inventory accounting methods.
    The IRS and the Treasury Department are aware that the current 
regulations are inconsistent in the treatment of adjustments for 
inventory methods and for other accounting methods, and that there is 
confusion regarding the appropriate procedure for making accounting 
method changes required by section 381. In a notice of proposed 
rulemaking (68 FR 25310) issued on May 12, 2003, regarding sections 
263A and 448, the IRS and the Treasury Department indicated that 
guidance regarding the accounting method(s) to be used after a section 
381(a) transaction was contemplated. This notice of proposed rulemaking 
provides that guidance.
    This notice of proposed rulemaking generally continues many of the 
provisions of the regulations originally issued in 1964 and 1975 
regarding the accounting method or combination of methods to be used by 
the corporation that acquires the assets of another corporation in a 
section 381(a) transaction. However, the following

[[Page 64546]]

changes to these regulations are proposed.

Consistency Between Sections 381(c)(4) and (c)(5)

    Under the current regulations, there are several inconsistencies 
between the rules that apply to accounting method changes made pursuant 
to section 381(c)(4) and those made under section 381(c)(5). The 
proposed regulations generally make the rules that apply to accounting 
method changes made pursuant to section 381(c)(4) consistent with the 
rules that apply to changes made under section 381(c)(5).

Determining the Method To Be Used After the Section 381(a) Transaction

    In general, the current regulations under both sections 381(c)(4) 
and (c)(5) provide that the accounting method to be used after a 
section 381(a) transaction by the party that survives the 
reorganization or liquidation (acquiring corporation) will depend on 
whether (1) The parties to the section 381(a) transaction used (or did 
not use) the same accounting method on the date of the section 381(a) 
transaction, and (2) The businesses of the parties to the section 
381(a) transaction are combined after the transaction by the party that 
survives the transaction. If different methods are used and the 
combined corporations are operated as a single trade or business after 
the section 381(a) transaction, then the principal and special method 
(including the inventory method) rules apply.
    The parties to the section 381(a) transaction determine the 
principal method by applying various tests under the regulations. The 
applicable test depends on whether the method under consideration is 
the overall accounting method, the method for a particular type of 
goods for which the Code or regulations provide a special method or 
methods, or an inventory method. The rules under the current 
regulations also address situations in which there is no principal 
method, or the principal method does not clearly reflect income. 
Currently, the regulations provide that if there is no principal method 
after applying the appropriate test or if that method is impermissible, 
the Commissioner shall select a suitable accounting method to use after 
the transaction.
    The IRS and the Treasury Department believe that the various tests 
in the regulations and the need for the Commissioner in some situations 
to select a suitable accounting method to be used after the transaction 
have caused confusion and have led to controversies between taxpayers 
and the IRS. In order to eliminate the confusion and uncertainty and 
provide simplicity and uniformity, the IRS and the Treasury Department 
propose to provide rules that are similar to the current regulations 
but have a default rule to determine the principal method.
    The proposed regulations generally provide under both sections 
381(c)(4) and (c)(5) that the accounting method to be used after a 
section 381(a) transaction by the acquiring corporation will depend on 
whether (1) The businesses of the parties to the section 381(a) 
transaction are combined after the transaction by the acquiring 
corporation, and (2) The method is permissible. As under the current 
regulations, if the trades or businesses of the parties to the section 
381(a) transaction are operated as separate trades or businesses after 
the section 381(a) transaction, an accounting method used by the 
parties prior to the section 381(a) transaction carries over and is 
used by the acquiring corporation provided the method is permissible 
(carryover method). If the trades or businesses of the parties to the 
section 381(a) transaction are not operated as separate trades or 
businesses after the section 381(a) transaction, then the acquiring 
corporation must determine and use the principal method.
    The proposed regulations provide a general rule that the principal 
method generally is the accounting method used by the acquiring 
corporation prior to the section 381(a) transaction. However, there are 
two exceptions. First, if the acquiring corporation does not have an 
accounting method for a particular item or type of goods, the principal 
method is the accounting method for the item or type of goods used by 
the distributor or transferor corporation prior to the section 381(a) 
transaction. Second, if the distributor or transferor corporation is 
larger than the acquiring corporation, the principal methods for the 
overall accounting method and for the accounting method for a 
particular item or type of goods are the methods used by the 
distributor or transferor corporation prior to the section 381(a) 
transaction. The principal method continues to be determined separately 
for the overall accounting method and for any special accounting 
methods, such as an accounting method used for a long-term contract.
    Under the proposed regulations, whether the distributor or 
transferor corporation is larger than the acquiring corporation is 
determined using the test in Sec.  1.381(c)(4)-1 of the current 
regulations for determining the overall principal method for methods 
other than inventory. Therefore, the parties to the section 381(a) 
transaction will compare their relative sizes in terms of total asset 
bases and gross receipts for both the overall accounting method and for 
special accounting methods. For inventory, whether the distributor or 
transferor corporation is larger than the acquiring corporation will be 
determined based on the value of the inventory using a test similar to 
the test in Sec.  1.381(c)(5)-1 of the current regulations. The 
principal method is the inventory method used by the party with the 
largest fair market value of a particular type of goods. The 
regulations provide a simplified election that allows the acquiring 
corporation to apply the principal method test by comparing the value 
of the entire inventories of the parties to the section 381(a) 
transaction rather than the value of each particular type of goods.
    Under the proposed regulations, if the carryover method or 
principal method is an impermissible method, the acquiring corporation 
generally must file a request to change to a permissible accounting 
method. However, if the carryover method is impermissible solely 
because only a single accounting method with respect to a particular 
item may be used by the acquiring corporation on the date of the 
section 381(a) transaction regardless of the number of separate and 
distinct trades or businesses operated on that date, the acquiring 
corporation must use the principal method as determined under Sec.  
1.381(c)(4)-1(c) of the proposed regulations.
    All parties to a section 381(a) transaction may request permission 
to change their accounting methods for the taxable year in which the 
transaction occurs or is expected to occur under section 446(e). 
However, the acquiring corporation need not secure the Commissioner's 
consent to continue a carryover method or use the principal method.
    Additionally, there is confusion under the current regulations as 
to whether an accounting method is established immediately upon use of 
a carryover method or principal method if the method is impermissible, 
and as to the appropriate remedy if an acquiring corporation discovers 
after the deadline for filing a request to change an accounting method 
for the year of the section 381(a) transaction that the carryover 
method or principal method is an impermissible method. The proposed 
regulations make it clear that every accounting method, whether it is a 
carryover method or a principal method, and whether the method is a 
permissible or impermissible method, is an established accounting 
method. Therefore, if an acquiring corporation

[[Page 64547]]

discovers after the deadline for filing a request to change an 
accounting method for the year of the section 381(a) transaction that 
it is using an impermissible method, the acquiring corporation must 
file for an accounting method change to a permissible accounting method 
for the taxable year following the section 381(a) transaction.

Determining Adjustments Arising From a Change in an Accounting Method 
Under Sections 381(c)(4) and (c)(5)

    Under the current regulations in Sec.  1.381(c)(4)-1, once a 
principal method is determined, any party to the section 381(a) 
transaction that is required to change its accounting method to the 
principal method must compute the adjustment necessary to reflect the 
change by determining the difference between its tax liability as 
reflected on its actual return computed using its old accounting 
method, and the tax liability reflected on a hypothetical federal 
income tax return using the new accounting method. This adjustment is 
computed as if, on the date of the section 381(a) transaction, each 
changing corporation initiates an accounting method change. If there is 
an increase or decrease in tax liability, the acquiring corporation 
takes into account the hypothetical increase or decrease in tax in the 
taxable year that includes the date of the section 381(a) transaction.
    The procedures are different for inventory under the current 
regulations in Sec.  1.381(c)(5)-1. In lieu of the acquiring 
corporation taking into account the hypothetical increase or decrease 
in tax in the taxable year that includes the date of the section 381(a) 
transaction, the acquiring corporation takes the increase or decrease 
in income attributable to the accounting method change directly into 
account.
    The IRS and the Treasury Department believe that the procedures for 
implementing changes to a principal method under the current 
regulations have been inconsistently applied and are another source of 
confusion. The proposed regulations modify Sec.  1.381(c)(4)-1 and 
generally apply the adjustment methodology used under section 446(e) 
and Sec.  1.381(c)(5)-1 of the current regulations. The proposed 
regulations generally make accounting method changes to a principal 
method and the resulting section 481(a) adjustment, if any, 
procedurally consistent with accounting method changes made pursuant to 
section 446(e). Accordingly, the acquiring corporation computes the 
section 481(a) adjustment necessary to reflect the accounting method 
change, if any, as if it had initiated an accounting method change for 
the trade or business required to implement the principal method. The 
acquiring corporation takes into account the appropriate amount of the 
section 481(a) adjustment, if any, computed as of the date of the 
section 381(a) transaction, from the accounting method change as an 
increase or decrease to its taxable income on the date of the section 
381(a) transaction.
    Furthermore, to simplify the procedures under section 381(a) for 
accounting method changes, the proposed regulations provide that the 
rules governing accounting method changes under section 446(e) apply to 
determine (1) Whether the section 381(a) accounting method change is 
implemented with a section 481(a) adjustment or on a cut-off basis, (2) 
The computation of the section 481(a) adjustment, and (3) The 
appropriate period of taxable years over which the adjustment is 
included in taxable income. These rules are contained in applicable 
administrative published procedures that govern voluntary accounting 
method changes under section 446(e). (See, for example, Rev. Proc. 
2002-9 (2002-1 CB 327) (see Sec.  601.601(d)(2)(ii)(b) of this 
chapter), as modified and clarified by Announcement 2002-17 (2002-1 CB 
561), modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696) (see 
Sec.  601.601(d)(2)(ii)(b) of this chapter), and amplified, clarified 
and modified by Rev. Proc. 2002-54 (2002-2 CB 432), and Rev. Proc. 97-
27 (1997-1 CB 680) (see Sec.  601.601(d)(2)(ii)(b) of this chapter), as 
modified and amplified by Rev. Proc. 2002-19, as amplified and 
clarified by Rev. Proc. 2002-54). For example, if the current 
administrative procedures allow a section 481(a) adjustment to be taken 
into account over a period of four years for a particular accounting 
method change, an acquiring corporation will take into account one-
fourth of the section 481(a) adjustment in the taxable year that 
includes the section 381(a) transaction, and one-fourth of the section 
481(a) adjustment in each of the subsequent three years.

Time and Manner of Requesting Permission To Change an Accounting Method 
Under Sec.  1.381(c)(4)-1 or Sec.  1.381(c)(5)-1

    Under the current regulations, if the acquiring corporation cannot 
use a principal method because it is impermissible, that is, it does 
not clearly reflect income or it conflicts with a closing agreement, or 
the acquiring corporation does not want to use the principal method 
even though it is permissible, there is confusion as to the manner in 
which a taxpayer requests the Commissioner's permission to use a 
different accounting method. Specifically, it is unclear whether an 
acquiring corporation may file a Form 3115, Application for Change in 
Accounting Method, to request the Commissioner's permission or whether 
the acquiring corporation must file a request for a private letter 
ruling. The proposed regulations make it clear that a taxpayer must 
request an accounting method change consistent with the manner in which 
accounting method changes are requested pursuant to section 446(e), 
that is, on a Form 3115.
    The regulations under section 446(e) currently allow taxpayers to 
request an accounting method change at any time during the taxable 
year. See Sec.  1.446-1(e)(3)(i). Under Sec. Sec.  1.381(c)(4)-1(d) and 
1.381(c)(5)-1(d) of the current regulations, the time for filing a 
request for an accounting method change is inconsistent with the 
section 446(e) regulations. Although the times for filing under these 
two regulations were consistent when the regulations were initially 
published, the section 446(e) regulations were subsequently amended 
without making conforming changes to Sec. Sec.  1.381(c)(4)-1(d) and 
1.381(c)(5)-1(d) of the current regulations. This inconsistency also 
has caused confusion. Rev. Proc. 2005-63 (2005-2 CB 491) (see Sec.  
601.601(d)(2)(ii)(b) of this chapter) was issued to address the 
problem. The revenue procedure extends the time to file a request to 
change an accounting method to the later of (1) The last day of the 
taxable year in which the distribution or transfer occurred, or (2) The 
earlier of (a) the day that is 180 days after the section 381(a) 
transaction date, or (b) the day on which the acquiring corporation 
files its tax return for the taxable year in which the distribution or 
transfer occurred.
    The proposed regulations generally incorporate the time provided in 
Rev. Proc. 2005-63 for requesting the Commissioner's consent to change 
an accounting method. The IRS and the Treasury Department intend by 
this revision generally to conform the due dates for requesting an 
accounting method change under sections 381(c)(4) and (c)(5) to the due 
dates for requesting other accounting method changes under section 
446(e), while providing sufficient time to request the Commissioner's 
consent if the section 381(a) transaction occurs at or near the end of 
a taxable year.

[[Page 64548]]

Changing Accounting Methods in the Taxable Year of the Section 381(a) 
Transaction

    The existing regulations under sections 381(c)(4) and (c)(5) 
require certain adjustments attributable to an accounting method change 
to be taken into account entirely in one taxable year. The adjustment 
required of the acquiring corporation under the existing section 
381(c)(4) regulations is to take into account the hypothetical tax 
increase due to the accounting method change rather than a section 
481(a) adjustment. The administrative procedures applicable to 
voluntary accounting method changes historically have required a 
section 481(a) adjustment to be taken into account over a period of 
taxable years. This discrepancy in when the adjustments are taken into 
account produced an incentive for taxpayers to request a voluntary 
accounting method change in the year in which the section 381(a) 
transaction occurred for changes that would result in a positive 
adjustment while making changes that would result in a negative 
adjustment under the rules in Sec.  1.381(c)(4)-1 or Sec.  1.381(c)(5)-
1 of the current regulations. The IRS generally declined to entertain 
requests for an accounting method change that otherwise would be 
effected pursuant to sections 381(c)(4) and (c)(5). More recently, 
however, the administrative procedures that apply to voluntary 
accounting method changes have provided for taking positive section 
481(a) adjustments into account over a period of taxable years while 
allowing negative section 481(a) adjustments to be taken into account 
in the year in which the method change is effected, which lessens the 
incentive to make an accounting method change under section 446(e) in 
lieu of section 381(a).
    Generally, the proposed regulations provide that the acquiring 
corporation will be permitted to request an accounting method change 
for the taxable year in which the section 381(a) transaction occurs. 
The proposed regulations also provide that the other parties to a 
section 381(a) transaction will be allowed to request accounting method 
changes for the taxable year that ends with the section 381(a) 
transaction. For trades or businesses that will not operate as separate 
trades or businesses after the section 381(a) transaction, an 
accounting method change will be granted only if the requested method 
is the method that will continue to be used after the section 381(a) 
transaction. For example, an acquiring corporation will be granted 
permission to change an accounting method only if the proposed method 
will be the principal method on the date of the section 381(a) 
transaction. The IRS generally will not grant an accounting method 
change to a distributor or transferor corporation for the taxable year 
that ends with the section 381(a) transaction if that method must 
change to a different method under the principal method rules of 
Sec. Sec.  1.381(c)(4)-1(c) and 1.381(c)(5)-1(c) of the proposed 
regulations. Similarly, the IRS generally will not grant an accounting 
method change to an acquiring corporation in the taxable year that 
includes the section 381(a) transaction if that method must change to a 
different method under the principal method rules of Sec. Sec.  
1.381(c)(4)-1(c) and 1.381(c)(5)-1(c) of the proposed regulations. If 
and when the proposed regulations are finalized, the IRS and the 
Treasury Department intend to make changes to the administrative 
procedures applicable to voluntary accounting methods to generally 
allow changes during the year of a section 381(a) transaction as 
previously described and will change relevant terms and conditions, as 
needed, particularly for taxpayers who are under exam or in appeals.

Audit Protection

    Changes to the principal method under Sec. Sec.  1.381(c)(4)-1 and 
1.381(c)(5)-1 of the current regulations are made without audit 
protection. The IRS and the Treasury Department believe that audit 
protection is not warranted when either the carryover method or 
principal method, as applicable, is used in the context of voluntary 
compliance under sections 381(c)(4) and (c)(5). Unlike accounting 
method changes under section 446(e) for which a taxpayer must disclose 
its use of an improper accounting method as part of the accounting 
method change process, changes to a principal method pursuant to 
Sec. Sec.  1.381(c)(4)-1 and 1.381(c)(5)-1 of the current regulations 
are made by the taxpayer on the tax return without disclosing the 
change on a Form 3115, Application for Change in Accounting Method.
    The IRS and the Treasury Department, however, believe that audit 
protection is warranted when an accounting method other than the 
carryover method or principal method is used in the context of 
voluntary compliance under sections 381(c)(4) and (c)(5). Under the 
proposed regulations, a taxpayer using an improper accounting method 
may request permission to change the method at any time before the end 
of its taxable year. Thus, if the acquiring corporation is using an 
improper accounting method or would be required to use an improper 
accounting method because of the application of Sec.  1.381(c)(4)-1 or 
Sec.  1.381(c)(5)-1 of the proposed regulations, it can request consent 
to change to a proper accounting method. That change will be accorded 
the usual audit protection procedures provided in guidance issued under 
section 446(e) for the requested change. Similarly, if another party to 
the section 381(a) transaction is using an improper accounting method, 
it may request consent to change to a proper accounting method at any 
time prior to the section 381(a) transaction. That change also will be 
accorded the usual audit protection procedures provided in guidance 
issued under section 446(e) for the requested change.

Proposed Effective/Applicability Date

    These regulations are proposed to apply to corporate 
reorganizations and tax-free liquidations described in section 381(a) 
that occur on or after the date these regulations are published as 
final regulations in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It is hereby 
certified that these regulations will not have a significant economic 
impact on a substantial number of small entities. Therefore, a 
regulatory flexibility analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required. Although there is a lack of 
available data regarding the extent to which small entities engage in 
the corporate reorganizations and tax-free liquidations described in 
section 381(a), this certification is based on the belief of the IRS 
and the Treasury Department that these transactions generally involve 
larger entities. Notwithstanding this certification that only large 
entities are affected, these proposed regulations will not have a 
significant economic impact on large or small taxpayers. These proposed 
regulations will reduce burden on taxpayers by clarifying existing 
rules and simplifying the procedures for requesting changes in 
accounting methods to methods other than the carryover or principal 
methods. Additionally, these proposed regulations make the 
implementation rules more consistent with the general rules for changes 
in accounting methods. Therefore, because these proposed regulations 
would generally clarify and simplify existing rules, these regulations 
will not have a significant economic impact on a substantial number of 
small entities. The IRS and

[[Page 64549]]

the Treasury Department specifically solicit comment from any party, 
particularly affected small entities, on the accuracy of this 
certification. Pursuant to section 7805(f) of the Code, this notice of 
proposed rulemaking will be submitted to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
business.

Comments and Requests for Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and 8 
copies) or electronic comments that are submitted timely to the IRS. 
The IRS and the Treasury Department want to provide clear, consistent, 
and administrable rules that will reduce the uncertainty and 
controversy in this area. Thus, the IRS and the Treasury Department 
request comments on the clarity of the proposed rules and how they can 
be made easier to understand. Topics on which comments are requested 
include: (1) In determining the relative sizes of the parties to a 
section 381(a) transaction, is it appropriate to calculate the gross 
receipts for a representative period by examining the gross receipts 
that are properly recognized under the acquiring corporation's and the 
distributor or transferor corporation's accounting method used for that 
period for federal income tax purposes, and (2) For a taxpayer using 
the last-in, first-out (LIFO) inventory method, should the principal 
method be applied at the level of each particular type of goods, or to 
pools of goods? All comments will be made available for public 
inspection and copying. A public hearing will be scheduled if requested 
in writing by any person that timely submits written comments. If a 
public hearing is scheduled, notice of the date, time, and place for 
the public hearing will be published in the Federal Register.

Drafting Information

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

List of Subjects in 26 CFR 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.381(c)(4)-1 also issued under 26 U.S.C. 381(c)(4). * * 
*
    Section 1.381(c)(5)-1 also issued under 26 U.S.C. 381(c)(5). * * 
*

    Par. 2. In Sec.  1.381(a)-1, paragraph (b)(1)(i) is revised and 
paragraph (e) is added to read as follows:


Sec.  1.381(a)-1  General rule relating to carryovers in certain 
corporate acquisitions.

* * * * *
    (b) * * *
    (1) * * * (i) The complete liquidation of a subsidiary corporation 
upon which no gain or loss is recognized in accordance with the 
provisions of section 332;
* * * * *
    (e) Effective/applicability date. The rules of paragraph (b)(1)(i) 
of this section apply to corporate reorganizations and tax-free 
liquidations described in section 381(a) that occur on or after the 
date of publication of the Treasury decision adopting these rules as 
final regulations in the Federal Register.
    Par. 3. Section1.381(c)(4)-1 is revised to read as follows:


Sec.  1.381(c)(4)-1  Accounting method.

    (a) Introduction--(1) Purpose. This section provides guidance 
regarding the accounting method or combination of methods (other than 
inventory and depreciation accounting methods) an acquiring corporation 
must use following a distribution or transfer to which sections 381(a) 
and (c)(4) apply and how to implement any associated accounting method 
changes. See Sec.  1.381(c)(5)-1 for guidance regarding the inventory 
accounting methods an acquiring corporation must use following a 
distribution or transfer to which sections 381(a) and (c)(5) apply. See 
Sec.  1.381(c)(6)-1 for guidance regarding the depreciation accounting 
methods an acquiring corporation must use following a distribution or 
transfer to which sections 381(a) and (c)(6) apply.
    (2) Carryover requirement--(i) In general. In a transaction to 
which section 381(a) applies, if an acquiring corporation operates the 
trades or businesses of the parties to the section 381(a) transaction 
as separate and distinct trades or businesses after the date of 
distribution or transfer, then the acquiring corporation generally must 
use the same accounting method(s) used by the distributor or transferor 
corporation(s) on the date of distribution or transfer for the acquired 
trade or business (carryover method). If an acquiring corporation does 
not operate the trades or businesses of the parties to the section 
381(a) transaction as separate and distinct trades or businesses after 
the date of distribution or transfer, then the acquiring corporation 
must use a principal method as determined under paragraph (c) of this 
section and must take into account any section 481(a) adjustment, if 
applicable, as required under paragraph (d)(1) of this section. The 
acquiring corporation need not secure the Commissioner's consent to 
continue or to use a permissible carryover method or principal method.
    (ii) Carryover method or principal method not permissible. In 
general, if a carryover method or principal method is an impermissible 
accounting method, the acquiring corporation must secure the 
Commissioner's consent to change to a different accounting method as 
provided in paragraph (d)(2) of this section. If, however, a carryover 
method is impermissible solely because only a single accounting method 
with respect to a particular item may be used by the acquiring 
corporation after the date of the section 381(a) transaction regardless 
of the number of separate and distinct trades or businesses operated on 
that date, the acquiring corporation must use a principal method as 
determined under paragraph (c) of this section.
    (iii) Voluntary change. All parties to a section 381(a) transaction 
may request permission under section 446(e) to change an accounting 
method for the taxable year in which the transaction occurs or is 
expected to occur. For trades or businesses that will not operate as 
separate trades or businesses after the section 381(a) transaction, an 
accounting method change will be granted only if the requested method 
is the method that the acquiring corporation must use after the date of 
the distribution or transfer in the taxable year that includes the 
section 381(a) transaction. The time and manner of obtaining the 
Commissioner's consent to change to a different accounting method is 
described in paragraph (d)(2) of this section.
    (iv) Examples. The following examples illustrate the rules of this 
paragraph (a):

    Example 1. Separate and distinct trades or businesses after the 
date of the distribution

[[Page 64550]]

or transfer--(i) Facts. X Corporation operates an employment agency 
that uses the overall cash receipts and disbursements accounting 
method. T Corporation operates an educational institution that uses 
an overall accrual method. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. X 
Corporation operates the employment agency and educational 
institution as separate and distinct trades or businesses after the 
date of the section 381(a) transaction.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will use the cash receipts and disbursements method for 
the employment agency and an accrual method for the educational 
institution. X Corporation need not secure the Commissioner's 
consent to continue either accounting method.
    Example 2. Carryover of special accounting  method--(i) Facts. X 
Corporation provides personal grooming consulting and T Corporation 
provides weight management consulting. Both X Corporation and T 
Corporation use an overall accrual method. X Corporation acquires 
all of the assets of T Corporation in a transaction to which section 
381(a) applies. X Corporation operates the personal grooming and 
weight management consulting businesses as separate and distinct 
trades or businesses after the date of the section 381(a) 
transaction. X Corporation has made an election to use the recurring 
item exception under Sec.  1.461-4(h). T Corporation has not.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will use an overall accrual method for both the personal 
grooming consulting business and the weight management consulting 
business. X Corporation must continue to use the recurring item 
exception under Sec.  1.461-4(h) for the personal grooming 
consulting business. X Corporation need not secure the 
Commissioner's consent to continue its overall accrual method and 
the recurring item exception under Sec.  1.461-4(h) for the personal 
grooming consulting business.
    Example 3. One accounting method allowed--(i) Facts. X 
Corporation is an engineering firm that uses the overall cash 
receipts and disbursements accounting method and has elected under 
section 171 to amortize bond premium with respect to its taxable 
bonds acquired at a premium. T Corporation is a manufacturer that 
uses an overall accrual accounting method and has not made a section 
171 election to amortize bond premium with respect to its taxable 
bonds acquired at a premium. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. X 
Corporation operates the engineering firm and manufacturing 
operations as separate and distinct trades or businesses after the 
date of the section 381(a) transaction.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will use the cash receipts and disbursements method for 
the engineering firm and an overall accrual method for the 
manufacturing operations. X Corporation may not continue separate 
accounting methods for amortizable bond premium, notwithstanding 
that it has two separate and distinct trades or businesses, because 
a taxpayer is permitted only one accounting method for amortizable 
bond premium. For both trades or businesses, X Corporation must use 
the principal method for bond premium as determined under paragraph 
(c) of this section. X Corporation will make the necessary changes 
to this principal method using the procedures described in paragraph 
(d)(1) of this section. Further, if the principal method is not to 
amortize bond premium, X Corporation may make an election to 
amortize bond premium to the extent permitted by section 171. See 
paragraph (e)(2) of this section.
    Example 4. Voluntary change--(i) Facts. The facts are the same 
as in Example 1 except that X Corporation wants to cease using an 
overall accrual method for the educational institution and change to 
the cash receipts and disbursements method.
    (ii) Conclusion. X Corporation must secure the Commissioner's 
consent to use the cash receipts and disbursements method for the 
educational institution by filing a Form 3115, Application for 
Change in Accounting Method, as described in paragraph (d)(2) of 
this section.

    (b) Definitions--(1) Accounting method has the same meaning as 
provided in section 446 and any applicable regulations.
    (2) Special accounting method is a method expressly permitted or 
required by the Code, Income Tax Regulations, or administrative 
guidance published in the Internal Revenue Bulletin that deviates from 
the normal application of the cash receipts and disbursements method or 
an accrual method. For example, the installment method under section 
453 and the mark-to-market method under section 475 are special 
accounting methods. See Sec.  1.446-1(c)(1)(iii).
    (3) Principal method is an accounting method that is determined 
under paragraph (c) of this section.
    (4) Adopting an accounting method has the same meaning as provided 
in Sec.  1.446-1(e)(1).
    (5) Changing an accounting method has the same meaning as provided 
in Sec.  1.446-1(e)(2).
    (6) Acquiring corporation has the same meaning as provided in Sec.  
1.381(a)-1(b)(2).
    (7) Distributor corporation means the corporation, foreign or 
domestic, that distributes its assets to another corporation described 
in section 332(b) in a distribution to which section 332 (relating to 
liquidations of subsidiaries) applies.
    (8) Transferor corporation means the corporation, foreign or 
domestic, that transfers its assets to another corporation in a 
transfer to which section 361 (relating to nonrecognition of gain or 
loss to corporations) applies, but only if--
    (i) The transfer is in connection with a reorganization described 
in section 368(a)(1)(A), (C), or (F), or
    (ii) The transfer is in connection with a reorganization described 
in section 368(a)(1)(D) or (G), provided the requirements of section 
354(b) are met.
    (9) Parties to the section 381(a) transaction means the acquiring 
corporation and the distributor or transferor corporation(s) that 
participate in a transaction to which section 381(a) applies.
    (10) Date of distribution or transfer has the same meaning as 
provided in section 381(b)(2) and Sec.  1.381(b)-(1)(b).
    (11) Separate and distinct trades or businesses has the same 
meaning as provided in Sec.  1.446-1(d).
    (12) Gross receipts means all the receipts in the appropriate 
period that must be recognized under the acquiring corporation's and 
the distributor or transferor corporation's accounting method actually 
used in that period (determined without regard to this section) for 
federal income tax purposes. For example, gross receipts includes 
income from investments, amounts received for services, rents, total 
sales (net of returns and allowances) and interest.
    (13) Audit protection means that the IRS will not require the 
corporation required to change its accounting method under this section 
to change its method for the same item for a taxable year prior to the 
taxable year of the section 381(a) transaction requiring the change in 
accounting method.
    (14) Section 481(a) adjustment means an adjustment that must be 
taken into account as required under section 481(a) to prevent amounts 
from being duplicated or omitted when the taxable income of a taxpayer 
is computed under an accounting method different from the method used 
to compute taxable income for the preceding taxable year.
    (15) Cut-off basis means an accounting method change made without a 
section 481(a) adjustment and under which only the items arising on or 
after the date the accounting method change is made are accounted for 
under the new accounting method.
    (16) Adjustment period means the number of taxable years for taking 
into account the section 481(a) adjustment required as a result of an 
accounting method change.
    (c) Principal method--(1) In general. The principal methods for the 
overall accounting method and for all accounting methods for particular 
items generally are the accounting methods used by the acquiring 
corporation immediately prior to the date of the section 381(a) 
transaction (acquiring

[[Page 64551]]

corporation's carryover method(s)). If, however, the acquiring 
corporation does not have an accounting method for a particular item or 
if the distributor or transferor corporation is larger, the principal 
methods are the methods used by the distributor or transferor 
corporation immediately prior to the date of the transaction 
(distributor or transferor corporation's carryover method). The 
distributor or transferor corporation is larger if the--
    (i) Adjusted bases of the distributor or transferor corporation's 
assets (determined under section 1011 and the regulations thereunder) 
exceed the adjusted bases of the acquiring corporation's assets 
immediately prior to the date of distribution or transfer, and
    (ii) The distributor or transferor corporation's gross receipts for 
a representative period (generally the most recent period of 12 
consecutive calendar months ending on the date of distribution or 
transfer) exceed the acquiring corporation's gross receipts for the 
same period.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. Principal method is the acquiring corporation's 
carryover method--(i) Facts. X Corporation and T Corporation operate 
employment agencies. X Corporation uses the overall cash receipts 
and disbursements accounting method while T Corporation uses an 
overall accrual method. X Corporation acquires the assets of T 
Corporation in a transaction to which section 381(a) applies. The 
adjusted bases of X Corporation's assets immediately prior to the 
transaction exceed the adjusted bases of T Corporation's assets and 
X Corporation's gross receipts for the representative period are 
more than T Corporation's gross receipts for the period. The 
employment agencies are not operated as separate and distinct trades 
or businesses after the date of the distribution or transfer.
    (ii) Conclusion. Because the adjusted bases of the assets and 
the gross receipts of X Corporation exceed the adjusted bases of the 
assets and the gross receipts of T Corporation, the accounting 
method used by X Corporation immediately prior to the date of the 
section 381(a) transaction is the principal method. After the 
section 381(a) transaction, X Corporation uses the cash receipts and 
disbursements method for the employment agency business operated by 
X Corporation prior to the section 381(a) transaction. X Corporation 
need not secure the Commissioner's consent to use this method. 
However, X Corporation must change the accounting method for the 
employment agency business acquired from T Corporation to the cash 
receipts and disbursements method and take into account the 
applicable section 481(a) adjustment as provided in paragraph (d)(1) 
of this section.
    Example 2. Principal method is the acquiring corporation's 
carryover method--(i) Facts. The facts are the same as in Example 1 
except that T Corporation's gross receipts for the representative 
period exceed X Corporation's gross receipts.
    (ii) Conclusion. Because the gross receipts of T Corporation 
exceed the gross receipts of X Corporation but the adjusted bases of 
the assets of T Corporation do not exceed the adjusted bases of the 
assets of X Corporation, the accounting method used by X Corporation 
immediately prior to the date of the section 381(a) transaction is 
the principal method. After the section 381(a) transaction, X 
Corporation will use the cash receipts and disbursements method for 
the employment agency business operated by X Corporation prior to 
the section 381(a) transaction. X Corporation need not secure the 
Commissioner's consent to use this method. However, X Corporation 
must change the accounting method for the employment agency business 
acquired from T Corporation to the cash receipts and disbursements 
method and take into account the applicable section 481(a) 
adjustment as provided in paragraph (d)(1) of this section.
    Example 3. Principal method is the distributor or transferor 
corporation's carryover method--(i) Facts. The facts are the same as 
in Example 1 except that the adjusted bases of T Corporation's 
assets immediately prior to the section 381(a) transaction exceed 
the adjusted bases of Corporation X's assets and T Corporation's 
gross receipts for the representative period are more than X 
Corporation's gross receipts for the period.
    (ii) Conclusion. Because the adjusted bases of the assets and 
the gross receipts of T Corporation exceed the adjusted bases of the 
assets and the gross receipts of X Corporation, the accounting 
method used by T Corporation immediately prior to the date of the 
section 381(a) transaction is the principal method. After the 
section 381(a) transaction, X Corporation uses an overall accrual 
method for the employment agency business operated by T Corporation 
prior to the section 381(a) transaction. X Corporation need not 
secure the Commissioner's consent to use this method. However, X 
Corporation must change the accounting method for the employment 
agency business operated by X Corporation prior to the section 
381(a) transaction to an overall accrual method and take into 
account the applicable section 481(a) adjustment as provided in 
paragraph (d)(1) of this section. If X Corporation chooses, it may 
request the Commissioner's consent to change to the cash receipts 
and disbursements method, if permissible, or some other permissible 
method as provided in paragraph (d)(2) of this section.
    Example 4. Impermissible method--(i) Facts. The facts are the 
same as in Example 1 except that X Corporation is prohibited under 
section 448 from using the cash receipts and disbursements method 
after the date of the section 381(a) transaction.
    (ii) Conclusion. Because X Corporation is not permitted under 
section 448 to use the cash receipts and disbursements method, X 
Corporation must request permission to change to a permissible 
method as provided in paragraph (d)(2) of this section.
    Example 5. Principal method is the acquiring corporation's 
carryover method with a special accounting method--(i) Facts. X 
Corporation and T Corporation publish magazines. X Corporation 
acquires the assets of T Corporation in a transaction to which 
section 381(a) applies. Both X Corporation and T Corporation use an 
overall accrual method. X Corporation has elected to defer income 
from its subscription sales under section 455. T Corporation has not 
elected to defer income from its subscription sales under section 
455 and instead has recognized the income from these sales in 
accordance with section 451. The adjusted bases of X Corporation's 
assets immediately prior to the section 381(a) transaction exceed 
the adjusted bases of T Corporation's assets and X Corporation's 
gross receipts for the representative period are more than T 
Corporation's gross receipts for the period. The publication 
businesses are not operated as separate and distinct trades or 
businesses after the date of the distribution or transfer.
    (ii) Conclusion. Because the adjusted bases of the assets and 
the gross receipts of X Corporation exceed the adjusted bases of the 
assets and the gross receipts of T Corporation, the accounting 
method used by X Corporation immediately prior to the date of the 
section 381(a) transaction is the principal method. After the 
section 381(a) transaction, X Corporation will continue to use its 
overall accrual method and the section 455 deferral method. X 
Corporation need not secure the Commissioner's consent to continue 
to use its overall accrual method and the section 455 deferral 
method. However, under paragraph (d)(1) of this section X 
Corporation must change its accounting method for the magazine 
business acquired from T Corporation to the section 455 deferral 
method using a cut-off basis.
    Example 6. Principal method is the acquiring corporation's 
carryover method with a special accounting method--(i) Facts. The 
facts are the same as in Example 5 except that T Corporation's gross 
receipts for the representative period exceed X Corporation's gross 
receipts for the period.
    (ii) Conclusion. Because the gross receipts of T Corporation 
exceed the gross receipts of X Corporation but the adjusted bases of 
the assets of T Corporation do not exceed the adjusted bases of the 
assets of X Corporation, the accounting method used by X Corporation 
immediately prior to the date of the section 381(a) transaction is 
the principal method. After the section 381(a) transaction, X 
Corporation continues to use an overall accrual method and the 
section 455 deferral method. X Corporation need not secure the 
Commissioner's consent to continue to use an overall accrual method 
and the section 455 deferral method. However, under paragraph (d)(1) 
of this section X Corporation must change its accounting method for 
the magazine business acquired from T Corporation to the section 455 
deferral method using a cut-off basis.

    (d) Procedures for changing accounting methods--(1) Change made to 
principal method--(i) Section 481(a) adjustment--(A) In general. The 
acquiring corporation does not need to secure the Commissioner's 
consent to use a principal method. To the extent

[[Page 64552]]

use of a principal method constitutes a change in an accounting method, 
the change in accounting method is treated as a change initiated by the 
acquiring corporation for purposes of section 481(a)(2). Any change to 
a principal method under paragraph (c)(1) of this section, whether the 
change relates to the trade or business of the acquiring corporation or 
the trade or business of the distributor or transferor corporation, 
must be reflected on the acquiring corporation's federal income tax 
return for the taxable year that includes the date of distribution or 
transfer. The amount of the section 481(a) adjustment and the 
adjustment period, if any, necessary to implement this accounting 
method change are determined under Sec.  1.446-1(e) and the applicable 
administrative procedures that govern voluntary changes in accounting 
methods under section 446(e). The appropriate section 481(a) adjustment 
as determined above is included in the taxable income of the acquiring 
corporation for the taxable year that includes the date of distribution 
or transfer and subsequent taxable year(s), as necessary. Thus, if the 
administrative procedures require that an accounting method change be 
implemented on a cut-off basis, the acquiring corporation must 
implement the change, on a cut-off basis as of the date of distribution 
or transfer, on its federal income tax return for the taxable year that 
includes the date of distribution or transfer. If the administrative 
procedures require a section 481(a) adjustment, the acquiring 
corporation must determine the section 481(a) adjustment and include 
the appropriate amount of the section 481(a) adjustment on its federal 
income tax return for the taxable year that includes the date of 
distribution or transfer and subsequent taxable year(s), as necessary. 
This adjustment is determined by the acquiring corporation as of the 
beginning of the day that is immediately after the day on which the 
section 381(a) transaction occurs.
    (B) Example. The following example illustrates the rules of this 
paragraph (d)(1)(i):

    Example. X Corporation uses the overall cash receipts and 
disbursements accounting method while T Corporation uses an overall 
accrual method. X Corporation acquires the assets of T Corporation 
in a transaction to which section 381(a) applies. X Corporation 
determines that under the rules of paragraph (c)(1) of this section, 
X Corporation must change the accounting method for the business 
acquired from T Corporation to the cash receipts and disbursements 
method. X Corporation will determine the section 481(a) adjustment 
pertaining to the change to the cash receipts and disbursements 
method by consolidating the adjustments (whether the amounts thereof 
represent increases or decreases in items of income or deductions) 
arising with respect to balances in the various accounts, such as 
accounts receivable, as of the beginning of the day that immediately 
follows the day on which X Corporation acquires the assets of T 
Corporation. This adjustment, or an appropriate part thereof, will 
be reflected on the federal income tax return filed by X Corporation 
for the taxable year that includes this section 381(a) transaction.

    (ii) Audit protection. Notwithstanding any other provision in any 
other regulation or administrative procedure, no audit protection is 
provided for any change in accounting method under paragraph (d)(1)(i) 
of this section.
    (iii) Other terms and conditions. Except as otherwise provided in 
this section, other terms and conditions provided in Sec.  1.446-1(e) 
and the applicable administrative procedures that govern voluntary 
accounting method changes under section 446(e) apply to a change in 
accounting method under this section. Thus, for example, if the 
administrative procedures that govern a particular accounting method 
change have a term and condition that provides for the acceleration of 
the section 481(a) adjustment period, this term and condition applies 
to changes made under this paragraph (d)(1). Similarly, if the 
administrative procedures provide as a term and condition that an 
identical accounting method change is barred for a period of years, 
this term and condition applies to changes made under this paragraph 
(d)(1) to bar future changes of that accounting method, if identical, 
for the same period, but not changes to the principal method under this 
section.
    (2) Change made to an accounting method other than the principal 
method or a carryover method. A party to a section 381(a) transaction 
that desires to change to an accounting method other than the principal 
method as determined under paragraph (c) of this section, or a 
carryover method within the meaning of paragraph (a)(2)(i) of this 
section, must follow the provisions of Sec.  1.446-(1)(e) that govern 
the accounting method change, except that for an accounting method 
change requiring advance consent--
    (i) Under the authority of Sec.  1.446-1(e)(3)(ii), the application 
for accounting method change (for example, Form 3115) must be filed 
with the IRS on or before the later of--
    (A) The due date for filing a Form 3115 as specified in Sec.  
1.446-1(e), for example, the last day of the taxable year in which the 
distribution or transfer occurred, or
    (B) The earlier of--
    (1) The day that is 180 days after the date of the distribution or 
transfer, or
    (2) The day on which the acquiring corporation files its federal 
income tax return for the taxable year in which the distribution or 
transfer occurred; and
    (3) An application on Form 3115 filed with the IRS should be 
labeled ``Filed under section 381(c)(4)'' at the top.
    (e) Rules and procedures--(1) No accounting method. If a party to a 
section 381(a) transaction is not using an accounting method, does not 
have an accounting method for a particular item, or came into existence 
as a result of the transaction, the party will not be treated as having 
an accounting method different from that used by the other parties to 
the section 381(a) transaction.
    (2) Elections and adoptions allowed. An acquiring corporation is 
not precluded by section 381(c)(4) or these regulations from making any 
election for the taxable year that includes the date of distribution or 
transfer that does not require the Commissioner's consent and that is 
otherwise permissible. Similarly, an acquiring corporation may adopt 
any accounting method in that year that is otherwise permissible.
    (3) Elections continue after section 381(a) transaction--(i) 
General rule. The acquiring corporation is not required to renew any 
election previously made by it or by a distributor or transferor 
corporation with respect to a carryover method or principal method if 
the acquiring corporation uses the method after a section 381(a) 
transaction. Furthermore, an election previously made by an acquiring 
corporation or by a distributor or transferor corporation with respect 
to a method that is in effect immediately prior to the date of 
distribution or transfer continues to the same extent as though the 
distribution or transfer had not occurred.
    (ii) Examples. The following examples illustrate the rules of this 
paragraph (e)(3):

    Example 1. Election continues. The acquiring corporation, X 
Corporation, has previously elected to treat animals purchased for 
dairy purposes as property used in its trade or business subject to 
depreciation after maturity while otherwise using the unit-
livestock-price method. X Corporation's accounting method continues 
after its merger with T Corporation in a transaction to which 
section 381(a) applies. X Corporation is not required to renew its 
election, and is bound by it, after the section 381(a) transaction.
    Example 2. Election continues. The acquiring corporation, X 
Corporation, has previously elected under section 171 to amortize 
bond premium with respect to taxable bonds. X Corporation's method 
for bond premium continues after T Corporation merges with X 
Corporation in a transaction to which section 381(a) applies. X

[[Page 64553]]

Corporation is not required to renew its election, and is bound by 
it, after the section 381(a) transaction.

    (4) Appropriate times for determining the method used and trade or 
business character--(i) Determining the accounting method. The 
accounting method existing at the time of a section 381(a) transaction 
is the method used immediately prior to the distribution or transfer by 
the parties to the transaction.
    (ii) Determining whether there are separate trades or businesses 
after a section 381(a) transaction. Whether an acquiring corporation 
will operate the trades or businesses of the parties to a section 
381(a) transaction as separate and distinct trades or businesses after 
the distribution or transfer will be determined as of the time of the 
transaction based upon the facts and circumstances. Intent to combine 
books and records of the trades or businesses may be demonstrated by 
contemporaneous records and documents or by other objective evidence 
that reflects the acquiring corporation's ultimate plan of operation, 
even though the actual combination of the books and records may extend 
beyond the end of the taxable year in which the section 381(a) 
transaction occurs.
    (5) Representative period for accumulating gross receipts. If a 
party to the section 381(a) transaction was not in existence for the 12 
consecutive months immediately prior to the date of distribution or 
transfer, then all parties to the section 381(a) transaction will 
compare their gross receipts for the period that the party was in 
existence. For example, if the acquiring corporation was formed in 
August and the section 381(a) transaction occurred in December of the 
same year, the gross receipts for those five months will be compared 
with the gross receipts of the other parties to the section 381(a) 
transaction for the same period.
    (6) Establishing an accounting method. Notwithstanding any other 
provision in any other regulation or administrative procedure, an 
accounting method used by the distributor or transferor corporation 
immediately prior to the date of distribution or transfer that 
continues to be used by the acquiring corporation in the taxable year 
that includes the date of distribution or transfer is an established 
method of accounting for purposes of section 446(e).
    (7) Other applicable provisions. Section 381(c)(4) and these 
regulations do not preempt any other section of the Code or regulations 
that is applicable to the acquiring corporation's circumstances. For 
example, income, deductions, credits, allowances, and exclusions may be 
allocated among the parties to a section 381(a) transaction and other 
taxpayers under sections 269 and 482, if appropriate. Similarly, 
transfers of contracts accounted for using a long-term contract 
accounting method are governed by the rules provided in Sec.  1.460-
4(k). Further, if other paragraphs of section 381(c) apply for purposes 
of determining accounting methods that carryover in a section 381(a) 
transaction, section 381(c)(4) and this Sec.  1.381(c)(4)-1 will not 
apply to the tax treatment of the items. For example, section 381(c)(4) 
and these regulations do not apply to inventories that an acquiring 
corporation obtains in a transaction to which section 381(a) applies. 
Instead, the rules of section 381(c)(5) and Sec.  1.381(c)(5)-1 govern 
the inventory method to be used by the acquiring corporation after the 
distribution or transfer. Similarly, if the acquiring corporation 
assumes an obligation of the distributor or transferor corporation that 
gives rise to a liability, within the meaning of Sec.  1.381(c)(16)-
1(a)(4), the deductibility of the item is determined under section 
381(c)(4) and these regulations only after the rules of section 
381(c)(16) and its regulations are applied.
    (8) Character of items of income and deduction. Items of income and 
deduction have the same character in the hands of the acquiring 
corporation as they would have had in the hands of the distributor or 
transferor corporation if no distribution or transfer had occurred.
    (9) Accounting method selected by project or job. If other sections 
of the Code or regulations permit an acquiring corporation to elect an 
accounting method on a project-by-project, job-by-job, or other similar 
basis, the method elected with respect to each project or job is the 
established method only for that project or job. For example, the 
election under section 460 to classify a ``hybrid contract,'' that is, 
a contract to perform both manufacturing and construction activities, 
as a long-term construction contract if at least 95 percent of the 
estimated total allocable contract costs are reasonably allocated to 
the construction activities is made on a contract-by-contract basis. 
Accordingly, the accounting method previously elected for a project or 
job generally continues after the section 381(a) transaction. However, 
if the trades or businesses of the parties to a section 381(a) 
transaction are not operated as separate and distinct trades or 
businesses after the date of distribution or transfer, and two or more 
of the parties to the section 381(a) transaction previously worked on 
the same project or job and used different accounting methods for the 
project or job immediately before the distribution or transfer, then 
the acquiring corporation must determine the method to use after the 
section 381(a) transaction as provided in paragraph (c) of this 
section.
    (10) Prohibited accounting methods. An acquiring corporation may 
not use the accounting method determined under paragraph (a)(2) of this 
section if the method fails to reflect clearly the acquiring 
corporation's income within the meaning of section 446(b). Thus, 
section 381(c)(4) and these regulations do not limit, restrict, or 
otherwise prevent the Commissioner from requiring the use of another 
accounting method.
    (f) Effective/applicability date. The rules of this section apply 
to corporate reorganizations and tax-free liquidations described in 
section 381(a) that occur on or after the date of publication of the 
Treasury decision adopting these rules as final regulations in the 
Federal Register.
    Par. 4. Section 1.381(c)(5)-1 is revised to read as follows:


Sec.  1.381(c)(5)-1  Inventory method.

    (a) Introduction--(1) Purpose. This section provides guidance 
regarding the inventory accounting method an acquiring corporation must 
use following a distribution or transfer to which sections 381(a) and 
(c)(5) apply and how to implement any associated accounting method 
changes. See Sec.  1.381(c)(4)-1 for guidance regarding the accounting 
method or combination of methods (other than inventory and depreciation 
accounting methods) an acquiring corporation must use following a 
distribution or transfer to which sections 381(a) and (c)(4) apply. See 
Sec.  1.381(c)(6)-1 for guidance regarding the depreciation accounting 
methods an acquiring corporation must use following a distribution or 
transfer to which sections 381(a) and (c)(6) apply.
    (2) Carryover requirement--(i) In general. In a transaction to 
which section 381(a) applies, if the acquiring corporation operates the 
trades or businesses of the parties to the section 381(a) transaction 
as separate and distinct trades or businesses after the date of the 
distribution or transfer, then the acquiring corporation generally must 
use the same accounting method(s) for inventory used by the distributor 
or transferor corporation(s) on the date of the section 381(a) 
transaction (carryover method). If the acquiring corporation does not 
operate the trades or

[[Page 64554]]

businesses of the parties to the section 381(a) transaction as separate 
and distinct trades or businesses after the date of distribution or 
transfer, then the acquiring corporation must use a principal method as 
determined under paragraph (c) of this section and must take into 
account any section 481(a) adjustment, if applicable, as required under 
paragraph (d)(1) of this section. The acquiring corporation need not 
secure the Commissioner's consent to continue or to use a permissible 
carryover method or principal method.
    (ii) Carryover method or principal method not permissible. In 
general, if a carryover method or principal method is an impermissible 
accounting method, the acquiring corporation must secure the 
Commissioner's consent to change to a different accounting method as 
provided in paragraph (d)(2) of this section. If, however, a carryover 
method is impermissible solely because only a single inventory method 
with respect to a particular type of goods may be used by the acquiring 
corporation after the date of the section 381(a) transaction regardless 
of the number of separate and distinct trades or businesses operated on 
that date, the acquiring corporation must use a principal method as 
determined under paragraph (c) of this section.
    (iii) Voluntary change. All parties to a section 381(a) transaction 
may request permission under section 446(e) to change an inventory 
accounting method for the taxable year in which the transaction occurs 
or is expected to occur. For trades or businesses that will not operate 
as separate trades or businesses after the section 381(a) transaction, 
an accounting method change will be granted only if the requested 
change is the method that the acquiring corporation must use after the 
date of the distribution or transfer in the taxable year that includes 
the section 381(a) transaction. The time and manner of obtaining the 
Commissioner's consent to change to a different inventory accounting 
method is described in paragraph (d)(2) of this section.

    (iv) Examples. The following examples illustrate the rules of this 
paragraph (a):

    Example 1. Separate and distinct trades or businesses after the 
date of the distribution or transfer--(i) Facts. X Corporation 
manufactures radios and television sets. X Corporation uses the 
first-in, first-out (FIFO) inventory method to identify its 
inventory goods, values the goods at cost, and capitalizes costs 
under section 263A. T Corporation manufactures washing machines and 
dryers. T Corporation uses the last-in, first-out (LIFO) inventory 
method to identify its inventory goods, values the goods at cost, 
and capitalizes costs under section 263A using methods other than 
those used by X Corporation. X Corporation acquires the inventory of 
T Corporation in a transaction to which section 381(a) applies. X 
Corporation operates the two manufacturing operations as separate 
and distinct trades or businesses after the date of the section 
381(a) transaction.
    (ii) Conclusion. After the section 381(a) transaction, for the 
business of manufacturing radios and television sets X Corporation 
will use the same FIFO inventory method to identify its inventory 
goods, value the goods at cost, and capitalize costs under section 
263A using the methods it had previously used. For the business of 
manufacturing washing machines and dryers X Corporation will use the 
same LIFO inventory method to identify its inventory goods, value 
the goods at cost, and capitalize costs under section 263A using the 
methods previously used by T Corporation. X Corporation need not 
secure the Commissioner's consent to continue the inventory methods.
    Example 2. Impermissible method--(i) Facts. X Corporation 
manufactures food and beverages. X Corporation uses the FIFO 
inventory method to identify its inventory goods, values the goods 
at cost, and capitalizes costs under section 263A. T Corporation 
sells sporting equipment. T Corporation uses the FIFO inventory 
method to identify its inventory goods, and values the goods at 
cost. T Corporation did not capitalize costs under section 263A 
because it met the small reseller exception under section 263A. X 
Corporation acquires the inventory of T Corporation in a transaction 
to which section 381(a) applies. X Corporation operates the food and 
beverage business and the sporting goods business as separate trades 
or businesses after the date of the section 381(a) transaction. 
After the section 381(a) transaction, X Corporation does not qualify 
for the small reseller exception under section 263A for its sporting 
equipment business.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will continue to identify its food and beverage 
inventory goods by using the FIFO inventory method, value the 
inventory at cost, and use its previously selected cost 
capitalization methods under section 263A as provided in paragraph 
(a)(2)(i) of this section. X Corporation will continue to identify 
its sporting equipment inventory goods by using the FIFO inventory 
method and value the inventory at cost in the same manner as T 
Corporation did prior to the section 381(a) transaction. X 
Corporation need not secure the Commissioner's consent to continue 
these inventory methods. Because X Corporation does not qualify for 
the small reseller exception under section 263A for its sporting 
equipment business, X Corporation must secure the Commissioner's 
consent to change to a permissible cost capitalization method under 
section 263A for the sporting equipment business. X Corporation must 
request this consent by filing a Form 3115, Application for Change 
in Accounting Method, using the procedures in paragraph (d)(2) of 
this section.
    Example 3. Voluntary change--(i) Facts. The facts are the same 
as in Example 1 except that X Corporation wants to cease valuing the 
radios and television sets at cost and change to the cost or market, 
whichever is lower, method.
    (ii) Conclusion. X Corporation must secure the Commissioner's 
consent to use the cost or market, whichever is lower, method and 
must do so by filing a Form 3115 as described in paragraph (d)(2) of 
this section.

    (b) Definitions--(1) Inventory method is a method used to account 
for merchandise on hand (including finished goods, work in process, and 
raw materials) at the beginning of a year for purposes of computing 
taxable income for that year. The term includes not only the method for 
identifying inventory, for example, the FIFO inventory method or the 
LIFO inventory method, but also all other methods necessary to account 
for merchandise.
    (2) Principal method is an accounting method that is determined 
under paragraph (c) of this section.
    (3) Adopting an accounting method has the same meaning as provided 
in Sec.  1.446-1(e)(1).
    (4) Changing an accounting method has the same meaning as provided 
in Sec.  1.446-1(e)(2).
    (5) Acquiring corporation has the same meaning as provided in Sec.  
1.381(a)-1(b)(2).
    (6) Distributor corporation means the corporation, foreign or 
domestic, that distributes its assets to another corporation described 
in section 332(b) in a distribution to which section 332 (relating to 
liquidations of subsidiaries) applies.
    (7) Transferor corporation means the corporation, foreign or 
domestic, that transfers its assets to another corporation in a 
transfer to which section 361 (relating to nonrecognition of gain or 
loss to corporations) applies, but only if--
    (i) The transfer is in connection with a reorganization described 
in section 368(a)(1)(A), (C), or (F), or
    (ii) The transfer is in connection with a reorganization described 
in section 368(a)(1)(D) or (G), provided the requirements of section 
354(b) are met.
    (8) Parties to the section 381(a) transaction means the acquiring 
corporation and the distributor or transferor corporation(s) involved 
in the transaction to which section 381(a) applies.
    (9) Date of distribution or transfer has the same meaning as 
provided in section 381(b)(2) and Sec.  1.381(b)-1(b).
    (10) Separate and distinct trades or businesses has the same 
meaning as provided in Sec.  1.446-1(d).
    (11) Audit protection means that the IRS will not require the 
corporation

[[Page 64555]]

required to change its accounting method under this section to change 
its method for the same item for a taxable year prior to the taxable 
year of the section 381(a) transaction requiring the change in 
accounting method.
    (12) Section 481(a) adjustment means an adjustment that must be 
taken into account as required under section 481(a) to prevent amounts 
from being duplicated or omitted when the taxable income of a taxpayer 
is computed under an accounting method different from the method used 
to compute taxable income for the preceding taxable year.
    (13) Cut-off basis means an accounting method change made without a 
section 481(a) adjustment and under which only the goods arising on or 
after the date the accounting method change is made are accounted for 
under the new accounting method.
    (14) Adjustment period means the number of taxable years for taking 
into account the section 481(a) adjustment required as a result of an 
accounting method change.
    (c) Principal method--(1) In general. The principal method for a 
particular type of goods generally is the method used by the acquiring 
corporation for that type of goods immediately prior to the date of the 
section 381(a) transaction (acquiring corporation's carryover method). 
If, however, the acquiring corporation does not have an inventory 
accounting method for a particular type of goods or if the distributor 
or transferor corporation holds more inventory of that type of goods, 
the principal method for that type of goods is the method used by the 
distributor or transferor corporation for that type of goods 
immediately prior to the date of the transaction (distributor or 
transferor corporation's carryover method). The distributor or 
transferor corporation holds more inventory if, for a particular type 
of goods, the fair market value of the goods held by the distributor or 
transferor corporation exceeds the fair market value of the goods held 
by the acquiring corporation immediately prior to the date of 
distribution or transfer. Alternatively, as a simplifying convention, 
the acquiring corporation may elect to apply the preceding sentence to 
the value of the entire inventories of the distributor or transferor 
corporation and the acquiring corporation rather than to each 
particular type of goods.
    (2) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1. Principal method is the acquiring corporation's 
carryover method--(i) Facts. X Corporation and T Corporation are 
manufacturers of tennis equipment. Both X Corporation and T 
Corporation value their inventories at cost but use different 
methods to capitalize costs under section 263A. X Corporation uses 
the simplified production method without the historic absorption 
ratio election provided in Sec.  1.263A-2(b)(3). T Corporation uses 
the simplified production method with the historic absorption ratio 
election provided in Sec.  1.263A-2(b)(4). Furthermore, X 
Corporation identifies its inventory using the FIFO inventory 
method, while T Corporation identifies its inventory using the LIFO 
inventory method.
    X Corporation acquires the inventory of T Corporation in a 
transaction to which section 381(a) applies. The manufacturing 
businesses are not operated as separate and distinct trades or 
businesses after the date of the distribution or transfer. 
Immediately prior to the acquisition, the fair market value of each 
particular type of goods in X Corporation's inventory exceeds the 
fair market value of each particular type of goods in T 
Corporation's inventory.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will continue to identify its inventory using the FIFO 
inventory method, value its inventory at cost, and use the 
simplified production method without the historic absorption ratio 
election because the FIFO inventory method is the principal method 
for identifying inventory, cost is the principal method for valuing 
inventories, and the simplified production method without the 
historic absorption ratio election is the principal method for 
allocating costs to ending inventory under section 263A. X 
Corporation need not secure the Commissioner's consent to use these 
methods. However, with respect to the inventory acquired from T 
Corporation, X Corporation will change the method of identifying 
inventory to the FIFO inventory method, use the simplified 
production method without the historic absorption ratio election, 
and take into account the applicable section 481(a) adjustment as 
provided in paragraph (d)(1) of this section. If X Corporation 
chooses, it may request the Commissioner's consent to change to 
another permissible method as provided in paragraph (d)(2) of this 
section.
    Example 2. Principal method is the distributor or transferor 
corporation's carryover method--(i) Facts. The facts are the same as 
in Example 1 except that the fair market value of each particular 
type of goods in T Corporation's inventory is in excess of the fair 
market value of each particular type of goods in X Corporation's 
inventory.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will identify its inventory using the LIFO inventory 
method used by T Corporation, value its inventories at cost, and use 
the simplified production method with the historic absorption ratio 
election, because the LIFO inventory method used by T Corporation is 
the principal method for identifying inventory, cost is the 
principal method for valuing inventories, and the simplified 
production method with the historic absorption ratio election is the 
principal method for allocating costs to ending inventory under 
section 263A. X Corporation need not secure the consent of the 
Commissioner to use these methods. However, with respect to the 
inventory manufactured by X Corporation prior to the section 381(a) 
transaction, X Corporation will change its methods as needed by 
using the procedures of paragraph (d)(1) of this section. 
Specifically, X Corporation will change its method of identifying 
inventory to the LIFO inventory method using a cut-off basis and 
change its cost capitalization method to the simplified production 
method with the historic absorption ratio election by taking into 
account the applicable section 481(a) adjustment. If X Corporation 
chooses, it may request the Commissioner's consent to change to 
another permissible method as provided in paragraph (d)(2) of this 
section.
    Example 3. Principal method is the acquiring corporation's 
carryover method--(i) Facts. The facts are the same as in Example 1 
except that the fair market values of the inventories of X 
Corporation and T Corporation are identical.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will continue to identify its inventory using the FIFO 
inventory method, value its inventory at cost, and use the 
simplified production method without the historic absorption ratio 
election because the FIFO inventory method is the principal method 
for identifying inventory, cost is the principal method for valuing 
inventories, and the simplified production method without the 
historic absorption ratio election is the principal method for 
allocating costs to ending inventory under section 263A. X 
Corporation need not secure the Commissioner's consent to use these 
methods. However, with respect to the inventory acquired from T 
Corporation, X Corporation will change the method of identifying 
inventory to the FIFO inventory method, use the simplified 
production method without the historic absorption ratio election, 
and take into account the applicable section 481(a) adjustment as 
provided in paragraph (d)(1) of this section. If X Corporation 
chooses, it may request the Commissioner's consent to change to 
another permissible method as provided in paragraph (d)(2) of this 
section.
    Example 4. Inventory convention elected--(i) Facts. X 
Corporation manufactures planes and T Corporation manufactures 
planes and pool tables. X Corporation identifies its inventory using 
the FIFO inventory method and values it at cost or market, whichever 
is lower, while T Corporation identifies its inventory using the 
LIFO inventory method and values it at cost. Both X Corporation and 
T Corporation use the same method to capitalize costs under section 
263A.
    X Corporation acquires the inventory of T Corporation in a 
transaction to which section 381(a) applies. The manufacturing 
businesses are not operated as separate and distinct trades or 
businesses after the date of the distribution or transfer. In lieu 
of determining the fair market value of each particular type of 
goods held on the date of distribution or transfer, X Corporation 
elects to value the entire inventories held by itself and T 
Corporation. Immediately prior to the acquisition, the fair market 
value of T Corporation's inventory exceeds the fair market value of 
X Corporation's inventory.
    (ii) Conclusion. After the section 381(a) transaction, X 
Corporation will identify its

[[Page 64556]]

inventory using the LIFO inventory method used by T Corporation and 
value this inventory at cost because the LIFO inventory method used 
by T Corporation is the principal method for identifying inventory 
and cost is the principal method for valuing inventories. X 
Corporation need not secure the consent of the Commissioner to use 
these methods. However, with respect to the inventory manufactured 
by X Corporation prior to the section 381(a) transaction, X 
Corporation will change the method of identifying inventory to the 
LIFO inventory method on a cut-off basis as provided in paragraph 
(d)(1) of this section. The method used prior to the section 381(a) 
transaction to capitalize costs under section 263A continues after 
the transaction. If X Corporation chooses, it may request the 
Commissioner's consent to change to another permissible method as 
provided in paragraph (d)(2) of this section.

    (d) Procedures for changing accounting methods--(1) Change made to 
principal method--(i) Section 481(a) adjustment--(A) In general. The 
acquiring corporation does not need to secure the Commissioner's 
consent to use a principal method. To the extent use of a principal 
method constitutes a change in an accounting method, the change in 
accounting method is treated as a change initiated by the acquiring 
corporation for purposes of section 481(a)(2). Any change to a 
principal method under paragraph (c) of this section, whether the 
change relates to the trade or business of the acquiring corporation or 
the trade or business of the distributor or transferor corporation, 
must be reflected on the acquiring corporation's federal income tax 
return for the taxable year that includes the date of distribution or 
transfer. The amount of the section 481(a) adjustment and the 
adjustment period, if any, necessary to implement this accounting 
method change are determined under Sec.  1.446-1(e) and the applicable 
administrative procedures that govern voluntary changes in accounting 
methods under section 446(e). The appropriate section 481(a) adjustment 
as determined above is included in the taxable income of the acquiring 
corporation for the taxable year that includes the date of distribution 
or transfer and subsequent taxable year(s), as necessary. Thus, if the 
administrative procedures require that an accounting method change be 
implemented on a cut-off basis, the acquiring corporation must 
implement the change, on a cut-off basis as of the date of distribution 
or transfer, on its federal income tax return for the taxable year that 
includes the date of distribution or transfer. If the administrative 
procedures require a section 481(a) adjustment, the acquiring 
corporation must determine the section 481(a) adjustment and include 
the appropriate amount of the section 481(a) adjustment on its federal 
income tax return for the taxable year that includes the section 381(a) 
transaction and subsequent taxable year(s), as necessary. This 
adjustment is determined by the acquiring corporation as of the 
beginning of the day that is immediately after the day on which the 
section 381(a) transaction occurs.
    (B) Example. The following example illustrates the rules of this 
paragraph (d)(1)(i):

    Example. X Corporation uses the FIFO inventory method while T 
Corporation uses the LIFO inventory method. X Corporation acquires 
the assets of T Corporation in a transaction to which section 381(a) 
applies on July 15th. X Corporation determines that under the rules 
of paragraph (c)(1) of this section, X Corporation must change the 
inventory method for the business acquired from T Corporation to the 
FIFO inventory method. X Corporation will determine the section 
481(a) adjustment pertaining to the change to the FIFO inventory 
method (whether the amounts thereof represent increases or decreases 
in income) as of the beginning of July 16th. This adjustment, or an 
appropriate part thereof, will be included in X Corporation's 
federal income tax return for the taxable year that includes July 
15th.

    (ii) Audit protection. Notwithstanding any other provision in any 
other regulation or administrative procedure, no audit protection is 
provided for any change in accounting method under paragraph (d)(1)(i) 
of this section.
    (iii) Other terms and conditions. Except as otherwise provided in 
this section, other terms and conditions provided in Sec.  1.446-1(e) 
and the applicable administrative procedures that govern voluntary 
changes in accounting methods under section 446(e) apply to a change in 
accounting method under this section. Thus, for example, if the 
administrative procedures that govern a particular accounting method 
change have a term and condition that provides for the acceleration of 
the section 481(a) adjustment period, this term and condition applies 
to changes made under this paragraph (d)(1). Similarly, if the 
administrative procedures provide as a term and condition that an 
identical accounting method change is barred for a period of years, 
this term and condition applies to changes made under this paragraph 
(d)(1) to bar future changes of that accounting method, if identical, 
for the same period, but not changes to the principal method under this 
section.
    (2) Change made to an accounting method other than the principal 
method or a carryover method. A party to a section 381(a) transaction 
that desires to change to an accounting method other than the principal 
method as determined under paragraph (c) of this section, or a 
carryover method within the meaning of paragraph (a)(2)(i) of this 
section, must follow the provisions of Sec.  1.446-(1)(e) that govern 
the accounting method change, except that for an accounting method 
change requiring advance consent--
    (i) Under the authority of Sec.  1.446-1(e)(3)(ii), the application 
for accounting method change (for example, Form 3115) must be filed 
with the IRS on or before the later of--
    (A) The due date for filing a Form 3115 as specified in Sec.  
1.446-1(e), for example, the last day of the taxable year in which the 
distribution or transfer occurred, or
    (B) The earlier of--
    (1) The day that is 180 days after the date of the distribution or 
transfer, or
    (2) The day on which the acquiring corporation files its federal 
income tax return for the taxable year in which the distribution or 
transfer occurred; and
    (ii) An application on Form 3115 filed with the IRS should be 
labeled ``Filed under section 381(c)(5)'' at the top.
    (e) Rules and procedures--(1) Inventory method selected for a 
particular type of goods. If other sections of the Code or Income Tax 
Regulations allow a taxpayer to elect an inventory method for a 
particular type of goods, the method elected with respect to those 
goods is the established inventory method only for those goods. For 
example, an election to use the LIFO inventory method to identify 
specified goods in inventory, such as certain products in finished 
goods, is the inventory method only for those products.
    (2) No accounting method. If a party to a section 381(a) 
transaction is not using an inventory method, does not have a 
particular type of goods immediately prior to the date of distribution 
or transfer, or came into existence as a result of the transaction, the 
party will not be treated as having an inventory accounting method 
different from that used by the other parties to the section 381(a) 
transaction.
    (3) Elections and adoptions allowed. An acquiring corporation is 
not precluded by section 381(c)(5) or these regulations from making any 
election for the taxable year that includes the date of distribution or 
transfer that does not require the Commissioner's consent and that is 
otherwise permissible. Similarly, an acquiring corporation may adopt 
any accounting method in that year that is otherwise permissible. For 
example, an acquiring corporation may elect to identify its inventory 
using the LIFO

[[Page 64557]]

inventory method in the year of the distribution or transfer.
    (4) Elections continue after section 381(a) transaction. The 
acquiring corporation is not required to renew any election previously 
made by it or by a distributor or transferor corporation with respect 
to a carryover method or principal method if the acquiring corporation 
uses the method after a section 381(a) transaction. Furthermore, an 
election previously made by an acquiring corporation or by a 
distributor or transferor corporation with respect to a method that is 
in effect immediately prior to the date of distribution or transfer 
continues to the same extent as though the distribution or transfer had 
not occurred. For example, when the acquiring corporation has elected 
to use the LIFO inventory method under section 472 prior to the date of 
the section 381(a) transaction and the method continues after the 
transaction, the acquiring corporation need not renew this inventory 
election and is bound by it after the date of the transaction.
    (5) Adopting the LIFO inventory method. A party to a section 381(a) 
transaction will be deemed to be using the LIFO inventory method with 
respect to a particular type of goods on the date of distribution or 
transfer if such party elects under section 472 to adopt that inventory 
method with respect to those goods for its taxable year within which 
the date of distribution or transfer occurs. See section 472 for the 
requirements to adopt the LIFO inventory method.
    (6) Inventory layers treatment--(i) Adjustments required after a 
section 381(a) transaction. An acquiring corporation that determines 
the principal method of taking an inventory after a section 381(a) 
transaction under paragraph (c) of this section may need to integrate 
inventories and make appropriate adjustments as provided in paragraphs 
(e)(6)(ii) and (iii) of this section.
    (ii) LIFO inventory method used after the section 381(a) 
transaction--(A) LIFO inventory method used by the distributor or 
transferor corporation--(1) Dollar-value method. If an acquiring 
corporation is required to use the LIFO dollar-value method of pricing 
inventories (dollar-value method) for a particular type of goods for 
its taxable year that includes the date of the section 381(a) 
transaction, and immediately prior to the distribution or transfer the 
distributor or transferor corporation used the specific goods method of 
pricing inventories for that particular type of goods, the inventory of 
the distributor or transferor corporation shall be placed on the 
dollar-value method as provided in Sec.  1.472-8(f), and then the 
inventory shall be integrated with the inventory of the acquiring 
corporation. If pools of each corporation are required to be combined, 
the pools shall be combined as provided in Sec.  1.472-8(g)(2). For 
purposes of combining pools, all base-year inventories or layers of 
increment that occur in taxable years including the same December 31 
shall be combined. A base-year inventory or layer of increment 
occurring in any short taxable year not including a December 31, or in 
the final taxable year of a distributor or transferor corporation, 
shall be merged with and considered a layer of increment of its 
immediately preceding taxable year.
    (2) Specific goods method. If an acquiring corporation is required 
to use the specific goods method of pricing inventories for a 
particular type of goods for its taxable year that includes the date of 
the section 381(a) transaction, and immediately prior to the 
distribution or transfer the distributor or transferor corporation used 
the LIFO inventory method for that particular type of goods, the 
inventory shall be treated by the acquiring corporation as having the 
acquisition dates and costs of the distributor or transferor 
corporation.
    (B) LIFO inventory method not used by the distributor or transferor 
corporation. If an acquiring corporation is required to use the LIFO 
inventory method for a particular type of goods for its taxable year 
that includes the date of the section 381(a) transaction, and 
immediately prior to the distribution or transfer the distributor or 
transferor corporation did not use the LIFO inventory method for that 
particular type of goods, the inventory shall be treated by the 
acquiring corporation as having been acquired at average unit cost in a 
single transaction on the date of the distribution or transfer. Thus, 
if an inventory of a particular type of goods is combined in an 
existing dollar-value pool, the goods shall be treated as if they were 
purchased by the acquiring corporation at the average unit cost on the 
date of the distribution or transfer with respect to such pool. 
Alternatively, if the goods are not combined in an existing pool, the 
goods will be treated as if they were purchased by the acquiring 
corporation at the average unit cost on the date of the distribution or 
transfer with respect to a new pool, with the base year being the year 
of the section 381(a) transaction. Adjustments resulting from a 
restoration to cost of any write-down to market value of the 
inventories of a distributor or transferor corporation shall be taken 
into account by the distributor or transferor corporation in its final 
taxable year ending on the date of the distribution or transfer. See 
section 472(d).
    (iii) FIFO inventory method used after the section 381(a) 
transaction--(A) FIFO inventory method used by the distributor or 
transferor corporation. If an acquiring corporation is required to use 
the FIFO inventory method for a particular type of goods for its 
taxable year that includes the date of the section 381(a) transaction, 
and immediately prior to the distribution or transfer the distributor 
or transferor corporation used the FIFO inventory method for that 
particular type of goods, the inventory of that type of goods shall be 
treated by the acquiring corporation as having the same acquisition 
dates and costs as the distributor or transferor corporation. However, 
if the acquiring corporation values its inventories at cost or market, 
whichever is lower, the acquiring corporation shall treat the 
inventories of the distributor or transferor corporation as having been 
acquired at cost or market, whichever is lower.
    (B) FIFO inventory method not used by the distributor or transferor 
corporation. If an acquiring corporation is required to use the FIFO 
inventory method for a particular type of goods for its taxable year 
that includes the date of the section 381(a) transaction, and 
immediately prior to the distribution or transfer the distributor or 
transferor corporation did not use the FIFO inventory method for that 
particular type of goods, the inventory of the distributor or 
transferor corporation shall be treated by the acquiring corporation as 
having the same acquisition dates and costs that the inventory would 
have had if the distributor or transferor corporation had been using 
the FIFO inventory method for its taxable year ending on the date of 
distribution or transfer. However, if the acquiring corporation values 
its inventories at cost or market, whichever is lower, the acquiring 
corporation shall treat the acquired inventories as having been 
acquired at cost or market, whichever is lower.
    (7) Appropriate times for determining the method used and trade or 
business character--(i) Determining the accounting method. The 
accounting method existing at the time of a section 381(a) transaction 
is the method used immediately prior to the date of distribution or 
transfer by the parties to the transaction.
    (ii) Determining whether there are separate trades or businesses 
after a section 381(a) transaction. Whether an acquiring corporation 
will operate the trades or businesses of the parties to a

[[Page 64558]]

section 381(a) transaction as separate and distinct trades or 
businesses after the distribution or transfer will be determined at the 
time of the transaction based upon the facts and circumstances. Intent 
to combine books and records of the trades or businesses may be 
demonstrated by contemporaneous records and documents or by other 
objective evidence that reflects the acquiring corporation's ultimate 
plan of operation, even though the actual combination of the books and 
records may extend beyond the end of the taxable year in which the 
section 381(a) transaction occurs.
    (8) Establishing an accounting method for taking an inventory. 
Notwithstanding any other provision in any other regulation or 
administrative procedure, an accounting method used by the distributor 
or transferor corporation immediately prior to the date of distribution 
or transfer that continues to be used by the acquiring corporation in 
the taxable year that includes the date of distribution or transfer is 
an established method of accounting for purposes of section 446(e).
    (9) Other applicable provisions. Section 381(c)(5) and these 
regulations do not preempt any other section of the Code or regulations 
that is applicable to the acquiring corporation's circumstances. 
Section 381(c)(5) and this Sec.  1.381(c)(5)-1 determine only the 
inventory method to be used after a section 381(a) transaction. 
Specifically, section 381(c)(5) and this Sec.  1.381(c)(5)-1 do not 
apply to assets other than inventory that an acquiring corporation 
obtains in a transaction to which section 381(a) applies.
    (10) Use of the cash receipts and disbursements method. If a party 
to a section 381(a) transaction uses the cash receipts and 
disbursements method within the meaning of section 446(c)(1) and Sec.  
1.446-1(c)(1)(i), or is not required to use inventory accounting 
methods for its goods, immediately prior to the date of distribution or 
transfer, section 381(c)(5) and Sec.  1.381(c)(5)-1 do not apply. 
Section 381(c)(4) and Sec.  1.381(c)(4)-1 must be applied to determine 
the accounting methods that continue after the transaction.
    (11) Character of items of income and deduction. Items of income 
and deduction have the same character in the hands of the acquiring 
corporation as they would have had in the hands of the distributor or 
transferor corporation if no distribution or transfer had occurred.
    (12) Prohibited methods. An acquiring corporation may not use the 
accounting method determined under paragraph (a)(2) of this section if 
the method fails to reflect clearly the acquiring corporation's income 
within the meaning of section 446(b). Thus, section 381(c)(5) and these 
regulations do not limit, restrict, or otherwise prevent the 
Commissioner from requiring the use of another accounting method.
    (f) Effective/applicability date. The rules of this section apply 
to corporate reorganizations and tax-free liquidations described in 
section 381(a) that occur on or after the date of publication of the 
Treasury decision adopting these rules as final regulations in the 
Federal Register.
    Par. 5. Section 1.446-1 is amended by:
    1. Revising the first sentence in paragraph (e)(3)(i) and adding a 
new second sentence.
    2. Revising the first sentence in paragraph (e)(4)(i).
    3. Adding paragraph (e)(4)(iii).
    The revisions and addition read as follows:


Sec.  1.446-1  General rule for methods of accounting.

* * * * *
    (e) * * *
    (3) * * * (i) Except as otherwise provided under the authority of 
paragraph (e)(3)(ii) of this section, to secure the Commissioner's 
consent to a taxpayer's change in method of accounting, the taxpayer 
generally must file an application on Form 3115 with the Commissioner 
during the taxable year in which the taxpayer desires to make the 
change in method of accounting. See Sec. Sec.  1.381(c)(4)-1(d)(2) and 
1.381(c)(5)-1(d)(2) for rules allowing additional time, in some 
circumstances, for the filing of an application on Form 3115 with 
respect to a transaction to which section 381(a) applies.
* * * * *
    (4) * * * (i) In general. Except as provided in paragraphs 
(e)(3)(iii), (e)(4)(ii) and (e)(4)(iii) of this section, paragraph (e) 
of this section applies on or after December 30, 2003.
* * * * *
    (iii) Effective/applicability date for paragraph (e)(3)(i). The 
rules of paragraph (e)(3)(i) of this section apply to corporate 
reorganizations and tax-free liquidations described in section 381(a) 
that occur on or after the date of publication of the Treasury decision 
adopting these rules as final regulations in the Federal Register.

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E7-22411 Filed 11-15-07; 8:45 am]
BILLING CODE 4830-01-P