[Federal Register Volume 85, Number 151 (Wednesday, August 5, 2020)]
[Proposed Rules]
[Pages 47508-47534]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16364]



[[Page 47507]]

Vol. 85

Wednesday,

No. 151

August 5, 2020

Part III





 Department of the Treasury





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 Internal Revenue Service





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26 CFR Part 1





Small Business Taxpayer Exceptions Under Sections 263A, 448, 460 and 
471; Proposed Rule

  Federal Register / Vol. 85, No. 151 / Wednesday, August 5, 2020 / 
Proposed Rules  

[[Page 47508]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-132766-18]
RIN 1545-BP53


Small Business Taxpayer Exceptions Under Sections 263A, 448, 460 
and 471

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations to implement 
legislative changes to sections 263A, 448, 460, and 471 of the Internal 
Revenue Code (Code) that simplify the application of those tax 
accounting provisions for certain businesses having average annual 
gross receipts that do not exceed $25,000,000, adjusted for inflation. 
This document also contains proposed regulations regarding certain 
special accounting rules for long-term contracts under section 460 to 
implement legislative changes applicable to corporate taxpayers. The 
proposed regulations generally affect taxpayers with average annual 
gross receipts of not more than $25 million (adjusted for inflation). 
Additionally, this document contains a request for comments regarding 
the application of section 460 (or other special methods of accounting) 
to a contract with income that is accounted for in part under section 
460 (or other special method) and in part under section 451.

DATES: Written or electronic comments or a request for a public hearing 
must be received by September 14, 2020.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-132766-
18) by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The IRS expects to have limited personnel available to 
process public comments that are submitted on paper through mail. Until 
further notice, any comments submitted on paper will be considered to 
the extent practicable. The Department of the Treasury (Treasury 
Department) and the IRS will publish for public availability any 
comment submitted electronically, and to the extent practicable on 
paper, to its public docket.
    Send paper submissions to: CC:PA:LPD:PR (REG-132766-18), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT: Concerning proposed Sec. Sec.  1.460-1 
through 1.460-6, Innessa Glazman, (202) 317-7006; concerning all other 
proposed regulations in this document, Anna Gleysteen, (202) 317-7007; 
concerning submission of comments and/or requests for a public hearing, 
Regina Johnson, (202) 317-5177 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) to implement statutory amendments to 
sections 263A, 448, 460, and 471 of the Code made by section 13102 of 
Public Law 115-97 (131 Stat. 2054), commonly referred to as the Tax 
Cuts and Jobs Act (TCJA). These statutory amendments generally simplify 
the application of the method of accounting rules under those 
provisions to certain businesses (other than tax shelters) with average 
annual gross receipts that do not exceed $25,000,000, adjusted for 
inflation.
    This document also contains proposed amendments to the existing 
regulations under section 460 regarding the special accounting rules 
for long-term contracts to implement amendments to the Code applicable 
to corporate taxpayers made by TCJA sections 12001 (repealing the 
corporate alternative minimum tax imposed by section 55) and 14401 
(adding the base erosion anti-abuse tax imposed by new section 59A).
    On August 20, 2018, the Treasury Department and the IRS issued 
Revenue Procedure 2018-40 (2018-34 I.R.B. 320), which provided 
administrative procedures for a taxpayer (other than a tax shelter 
under section 448(d)(3)) meeting the requirements of section 448(c) to 
obtain consent to change the taxpayer's method of accounting to a 
method of accounting permitted by section 263A, 448, 460, or 471, as 
amended by the TCJA under the automatic change procedures of Revenue 
Procedure 2015-13 (2015-5 I.R.B. 419), as clarified and modified by 
Revenue Procedure 2015-33 (2015-24 I.R.B. 1067), as modified by Revenue 
Procedure 2016-1 (2016-1 I.R.B. 1), and Revenue Procedure 2017-59 
(2017-48 I.R.B. 543). The revenue procedure also invited comments for 
future guidance regarding the implementation of the TCJA modifications 
to sections 263A, 448, 460, and 471. Two comments were received in 
response to Revenue Procedure 2018-40 and are discussed in the 
Explanation of Provisions.
    Finally, part 5 of the Explanation of Provisions requests comments 
regarding the effects of section 451(b) on the application of section 
460, 467, or another special method of accounting, within the meaning 
of section 451(b)(2). On September 9, 2019, the Treasury Department and 
the IRS published proposed regulations under section 451(b) (REG-
104870-18) in the Federal Register (84 FR 47191) in which comments were 
requested on the allocation of the transaction price for contracts that 
include items of income subject to section 451 and items of income that 
are attributable to long-term contract activities subject to section 
460. One comment was received in response to this request, but was 
outside the scope of the rulemaking as it was received after the 
expiration of the comment period for REG-104870-18. As discussed in 
part 5 of the Explanation of Provisions, the Treasury Department and 
the IRS have considered that comment in requesting additional comments 
regarding the application of sections 451(b)(2) and 451(b)(4) to a 
contract with income that is accounted for in part under section 451 
and in part under section 460, 467, or another special method of 
accounting.

Explanation of Provisions

    These proposed regulations provide guidance under sections 263A, 
448, 460, and 471 to implement the TCJA's amendments to those 
provisions. These proposed regulations also modify Sec. Sec.  
1.381(c)(5)-1 and 1.446-1 to reflect these statutory amendments.

1. Section 263A Small Business Taxpayer Exemption

    The uniform capitalization (UNICAP) rules of section 263A provide 
that, in general, the direct costs and the properly allocable share of 
the indirect costs of real or tangible personal property produced, or 
real or personal property described in section 1221(a)(1) acquired for 
resale, cannot be deducted but must either be capitalized into the 
basis of the property or included in inventory costs, as applicable. 
Certain property is exempted from the capitalization requirements of 
section 263A. For example, section 263(A)(c)(4) provides an exemption 
to the capitalization requirements of section 263A for any property 
produced by a taxpayer pursuant to a long-term contract.

[[Page 47509]]

    In addition, certain taxpayers are exempt from the capitalization 
requirements. Prior to the enactment of the TCJA, section 263A(b)(2)(B) 
and Sec.  1.263A-3(b)(1) provided that resellers with average annual 
gross receipts of $10,000,000 or less were not subject to the 
capitalization requirements (Section 263A small business reseller 
exemption). Section 13102(b) of the TCJA replaced the Section 263A 
small reseller exemption with a new general exemption from section 263A 
under new section 263A(i) for small business taxpayers (Section 263A 
small business taxpayer exemption). The Section 263A small business 
taxpayer exemption applies to any taxpayer (other than a tax shelter 
under section 448(a)(3)), meeting the gross receipts test of section 
448(c), as amended by section 13102(a) of the TCJA and explained in 
greater detail in part 2 of this Explanation of Provisions (Section 
448(c) gross receipts test).
    The proposed regulations remove the now obsolete Section 263A small 
reseller exemption provided in existing Sec.  1.263A-3(a)(2)(ii) and 
(b). These proposed regulations also modify existing Sec. Sec.  1.263A-
1, 1.263A-2, 1.263A-3, 1.263A-4, 1.263A-7, and 1.263A-8 to incorporate 
the Section 263A small business taxpayer exemption.
A. Application of Section 448(c) Gross Receipts Test to Taxpayers That 
Are Not Corporations or Partnerships
    For purposes of the Section 263A small business taxpayer exemption, 
section 263A(i)(2) provides that the Section 448(c) gross receipts test 
is applied in the same manner as if each trade or business of the 
taxpayer were a corporation or partnership. Proposed Sec.  1.263A-
1(j)(2)(ii) provides that in the case of a taxpayer other than a 
corporation or partnership, the Section 448(c) gross receipts test is 
applied by taking into account the amount of gross receipts derived 
from all trades or businesses of that taxpayer. Under the proposed 
regulations, amounts not related to a trade or business of that 
taxpayer, such as inherently personal amounts of an individual 
taxpayer, are generally excluded from gross receipts. Such excluded 
amounts include, in the case of an individual, items such as Social 
Security benefits, personal injury awards and settlements, disability 
benefits, and wages received as an employee that are reported on Form 
W-2. The exclusion for wages does not extend to guaranteed payments, 
which are not generally equivalent to salaries and wages. See Revenue 
Ruling 69-184 (1969-1 CB 45). These proposed regulations implementing 
the Section 263A small business taxpayer exemption are consistent with 
the proposed regulations implementing the Section 460 small business 
taxpayer exemption and Section 471 small business taxpayer exemption 
discussed later in this Explanation of Provisions, which incorporate 
statutory language similar to that in section 263A(i).
    A commenter responding to Revenue Procedure 2018-40 requested 
clarification on the application of the Section 448(c) gross receipts 
test to individuals, noting that it was unclear whether the individual 
owner is required to include the owner's share of gross receipts from 
pass-through entities in the individual's gross receipts. The commenter 
noted that including such amounts in the individual's gross receipts 
would be distortive to the individual's other trades or business 
reported on Schedules C, Profit or Loss From Business, Schedule E, 
Supplemental Income and Loss, and Schedule F, Profit or Loss From 
Farming, of the Form 1040, U.S. Individual Income Tax Return.
    The Treasury Department and the IRS note that section 263A(i) 
refers to section 448(c), and section 448(c)(2) expressly requires the 
aggregation rules of sections 52(a) or (b) and 414(m) or (o) to apply. 
Thus, the aggregation rules under section 52(a) or (b) or section 
414(m) or (o) will always apply in connection with applying section 
263A(i)(2). Under section 52, an individual taxpayer with two or more 
trades or businesses reported on the individual's Schedule C or 
Schedule E of the individual's Form 1040 is required to aggregate the 
gross receipts of those trades or businesses. Proposed Sec.  1.263A-
1(j)(2)(ii) is consistent with these rules. Additionally, under section 
263A(i)(2), each trade or business of the taxpayer is treated as if it 
were a corporation or partnership, and it is well-established under 
Sec.  1.448-1T(f) that a corporation or partnership includes in its 
gross receipts all receipts that are properly recognized under that 
corporation's or partnership's accounting method in that taxable year, 
regardless of the source of the receipts. Since corporations and 
partnerships do not have inherently personal items, the exclusion of 
such items from the individual's trade or business gross receipts is 
not inconsistent with Sec.  1.448-1T(f)(2)(iv).
    Consistent with section 263A(i), proposed Sec.  1.263A-1(j)(2)(iii) 
provides that when determining whether a taxpayer qualifies for the 
Section 263A small business taxpayer exemption, each partner in a 
partnership includes a share of partnership gross receipts in 
proportion to such partner's distributive share of items of gross 
income that were taken into account by the partnership under section 
703; similarly, each shareholder in an S corporation includes a pro 
rata share of the S corporation's gross receipts taken into account by 
the S corporation under section 1363(b).
B. Removal of Small Reseller Exception
    Prior to the TCJA, the Section 263A small reseller exception in 
section 263A(b)(2)(B) exempted from section 263A resellers with gross 
receipts of $10 million or less (small reseller gross receipts test). 
The TCJA removed the Section 263A small reseller exception provided in 
section 263A(b)(2)(B).
    Consistent with the TCJA, these proposed regulations remove 
existing Sec.  1.263A-3(a)(2)(ii) and modify existing Sec.  1.263A-3(b) 
by removing the small reseller gross receipts test. The Treasury 
Department and the IRS expect that most taxpayers who previously 
satisfied the small reseller gross receipts test will meet the Section 
448(c) gross receipts test due to the increased dollar threshold in 
section 448(c), and therefore would be eligible to apply the small 
business taxpayer exemption under section 263A(i).
    The definition of gross receipts used for the small reseller gross 
receipts test under existing Sec.  1.263A-3(b) is applied for purposes 
of other simplifying conventions under the existing section 263A 
regulations. Since the TCJA removed the small reseller gross receipts 
test and added the Section 263A small business taxpayer exemption that 
refers to section 448(c), these proposed regulations update those 
simplifying conventions by cross referencing to the definition of gross 
receipts set forth in the proposed regulations under section 448 where 
applicable.
    Specifically, proposed Sec.  1.263A-3(a)(5) modifies the definition 
of gross receipts that is used to determine whether a reseller has de 
minimis production activities and proposed Sec.  1.263A-
1(d)(3)(ii)(B)(1) modifies the definition of gross receipts used to 
permit certain taxpayers to use the simplified production method under 
Sec.  1.263A-2(b) by cross referencing to the definition of ``gross 
receipts'' for purposes of the Section 448(c) gross receipts test.
C. Changes to the Uniform Interest Capitalization Rules
    Prior to the TCJA, section 263A(f)(1) required the capitalization 
of interest if the taxpayer produced certain types of property 
(designated property). The Section 263A small business taxpayer

[[Page 47510]]

exception applies for all purposes of section 263A, including the 
requirement to capitalize interest under section 263A(f). Accordingly, 
these proposed regulations modify Sec.  1.263A-7 and Sec.  1.263A-8 to 
add new paragraphs to implement the Section 263A(i) small business 
taxpayer exemption for purposes of the requirement to capitalize 
interest.
    Additionally, existing Sec.  1.263A-9 contains an election that 
permits taxpayers whose average annual gross receipts do not exceed $10 
million to use the highest applicable Federal rate as a substitute for 
the weighted average interest rate when tracing debt. Again, the 
Section 263A small business taxpayer exception applies for all purposes 
of section 263A, including the election for small business taxpayers 
who choose to capitalize interest under section 263A(f). Therefore, 
these proposed regulations modify Sec.  1.263A-9 to remove the $10 
million gross receipts test in the definition of eligible taxpayer and 
replace it with the Section 448(c) gross receipts test. The Treasury 
Department and the IRS have determined that the use of a single gross 
receipts test under the section 263A (other than the pre-existing 
higher $50 million threshold for testing eligibility to apply the 
simplified production method) simplifies application of the UNICAP 
rules for taxpayers.
D. Changes to Sec.  1.263A-4 for Farming Trades or Businesses
    Prior to the TCJA, section 263A(d)(3) permitted certain taxpayers 
to elect not to have the rules of section 263A apply to certain plants 
produced in a farming business conducted by the taxpayer. An electing 
taxpayer and any related person, as defined in Sec.  1.263A-
4(d)(4)(iii), are required to apply the alternative depreciation 
system, as defined in section 168(g)(2), to property used in the 
taxpayer's and any related persons' farming business and placed in 
service in the taxable years in which the election was in effect.
    The Treasury Department and the IRS are aware that taxpayers that 
made an election under section 263A(d)(3) may also qualify for the 
Section 263A small business taxpayer exemption, and may prefer to apply 
that exemption rather than the election under section 263A(d)(3). 
Proposed Sec.  1.263A-4(d)(5) permits a taxpayer to revoke its section 
263A(d)(3) election for any taxable year in which the taxpayer is 
eligible for and wants to apply the Section 263A small business 
taxpayer exemption by following applicable administrative guidance, 
such as Revenue Procedure 2020-13 (2020-11 IRB 515). In addition, some 
taxpayers may be eligible to apply the election under section 
263A(d)(3) in a taxable year in which they cease to qualify for the 
Section 263A small business taxpayer exemption. Therefore, proposed 
Sec.  1.263A-4(d)(6) permits such a taxpayer to change its method of 
accounting from the exemption under section 263A(i) by making a section 
263A(d)(3) election in the same taxable year by following applicable 
administrative guidance, such as Revenue Procedure 2020-13.
    Proposed Sec.  1.263A-4(d)(3)(i) is modified to remove the 
requirement that the election under section 263A(d)(3) by a partnership 
or S corporation be made by the partner, shareholder or member. The 
Treasury Department and the IRS believe that the inclusion of this 
requirement was a drafting error, as sections 703(b) and 1363(c) 
require the election to be made at the entity level.
    The TCJA added new section 263A(d)(2)(C), which provides a special 
temporary rule for citrus plants lost by reason of casualty. The 
provision, which expires in 2027, provides that section 263A does not 
apply to replanting costs paid or incurred by a taxpayer other than the 
owner if certain conditions are met. Proposed Sec.  1.263A-4(e)(5) is 
added to incorporate this special temporary rule.
E. Costing Rules for Self-Constructed Assets
    One commenter stated that the costing rules for self-constructed 
property used in a taxpayer's trade or business prior to the enactment 
of section 263A, which would apply to small business taxpayers choosing 
to apply the Section 263A small business taxpayer exemption, are not 
clear. The commenter asked for clarification of what costs a small 
business taxpayer is required to capitalize to its depreciable property 
if the taxpayer has chosen to apply the Section 263A small business 
taxpayer exemption. The Treasury Department and the IRS request further 
comments on specific clarifications needed regarding the costing rules 
that existed prior to the enactment of the UNICAP rules under section 
263A.

2. Changes to the Regulations Under Section 448

    Section 448(a) generally prohibits C corporations, partnerships 
with a C corporation as a partner, and tax shelters from using the cash 
receipts and disbursements method of accounting (cash method). However, 
section 448(b)(3) provides that section 448(a) does not apply to C 
corporations and partnerships with a C corporation as a partner that 
meet the Section 448(c) gross receipts test. Prior to the TCJA's 
enactment, a taxpayer met the gross receipts test of section 448(c) if, 
for all taxable years preceding the current taxable year, the average 
annual gross receipts of the taxpayer (or any predecessor) for any 3-
taxable-year period did not exceed $5 million. If a taxpayer had not 
been in existence for the entire 3-taxable-year period, then the gross 
receipt test was applied on the basis of the period during which the 
taxpayer or trade or business was in existence. For a taxable year less 
than 12 months, the gross receipts of that short taxable year were 
annualized (short taxable year rule). Additionally, this gross receipts 
test also required the aggregation of gross receipts for all persons 
treated as a single employer under section 52(a) or (b) or section 
414(m) or (o) (aggregation rule).
    Section 13102(a) of the TCJA amended the Section 448(c) gross 
receipts test to permit a taxpayer (other than a tax shelter) to meet 
the test if the taxpayer's average annual gross receipts for the 3-
taxable-year period ending with the year preceding the current taxable 
year does not exceed $25 million and indexed the $25 million threshold 
for inflation (Section 448 small business taxpayer exemption). Other 
rules in section 448(c), such as the short taxable year rule and the 
aggregation rule, were not altered by section 13102(a) of the TCJA.
A. General Rules of Section 448(c) and Section 448(c) Gross Receipts 
Test
    These proposed regulations modify existing Sec.  1.448-1 to clarify 
that it applies to taxable years beginning before January 1, 2018 for 
purposes of applying the restrictions on the use of the cash method by 
C corporations and partnerships with C corporation partners. Proposed 
Sec.  1.448-2 provides rules applicable for taxable years beginning 
after December 31, 2017. These rules are generally similar to the 
existing regulations under Sec.  1.448-1 and Sec.  1.448-1T of the 
Temporary Income Tax Regulations, including the short taxable year rule 
and the aggregation rule. However, for taxable years beginning after 
December 31, 2017, the proposed regulations update the rules to reflect 
the post-TCJA Section 448(c) gross receipts test. These proposed 
regulations also clarify that the gross receipts of a C corporation 
partner are included in the gross receipts of a partnership if the 
aggregation rules apply to the C corporation partner and the 
partnership.
    The Treasury Department and the IRS publish an annual revenue 
procedure for inflation-adjusted amounts and

[[Page 47511]]

intend to include the inflation-adjusted section 448(c) dollar 
threshold in that revenue procedure. See, for example, Revenue 
Procedure 2019-44 (2019-47 IRB 1093).
B. Tax Shelters Defined in Section 448(d)(3)
    Under section 448(a)(3), a tax shelter is prohibited from using the 
cash method. Section 448(d)(3) cross references section 461(i)(3) to 
define the term ``tax shelter.'' Section 461(i)(3)(B), in turn, 
includes a cross reference to the definition of ``syndicate'' in 
section 1256(e)(3)(B), which defines a syndicate as a partnership or 
other entity (other than a C corporation) if more than 35 percent of 
the losses of that entity during the taxable year are allocable to 
limited partners or limited entrepreneurs. Section 1.448-1T(b)(3) 
narrowed this definition by providing that a taxpayer is a syndicate 
only if more than 35 percent of its losses are allocated to limited 
partners or limited entrepreneurs. Consequently, a partnership or other 
entity (other than a C corporation) may be considered a syndicate only 
for a taxable year in which it has losses. These proposed regulations 
adopt the same definition of syndicate provided in Sec.  1.448-1T.
    One commenter expressed concern that the definition of syndicate is 
difficult to administer because many small business taxpayers may 
fluctuate between taxable income and loss between taxable years, thus 
their status as tax shelters may change each tax year. The commenter 
suggested that the Treasury Department and the IRS exercise regulatory 
authority under section 1256(e)(3)(C)(v) to provide that all the 
interests held in entities that meet the definition of a syndicate but 
otherwise meet the Section 448(c) gross receipts test be deemed as held 
by individuals who actively participate in the management of the 
entity, so long as the entities do not qualify to make an election as 
an electing real property business or electing farm business under 
section 163(j)(7)(B) or (C), respectively. The Treasury Department and 
the IRS decline to adopt this recommendation. The recommendation would 
allow a taxpayer that meets the Section 448(c) gross receipts test to 
completely bypass the ``syndicate'' portion of the tax shelter 
definition under section 448(d)(3). Neither the statutory language of 
section 448 nor the legislative history of the TCJA support limiting 
the application of the existing definition of tax shelter in section 
448(d)(3) in this manner.
    The Treasury Department and the IRS are aware of practical concerns 
regarding the determination of tax shelter status for the taxable year. 
For example, a taxpayer may determine computationally that it is a 
syndicate under section 1256 after the close of the taxable year while 
preparing its Federal income tax return for the taxable year. However, 
a taxpayer that is a tax shelter is not permitted to use the cash 
method for that taxable year, but may no longer be able to timely file 
a Form 3115, Application for Change in Accounting Method, to change 
from the cash method to an appropriate method, such as an accrual 
method of accounting (accrual method) for that taxable year, or it may 
otherwise have time constraints in filing its Federal income tax return 
by the due date of the return (without extensions) for such taxable 
year. While these procedural constraints also existed prior to the 
TCJA, the TCJA's modifications to several other sections of the Code to 
reference the section 448(d)(3) definition of tax shelter made the tax 
shelter status determination under section 448(c)(3) applicable to more 
taxpayers than prior to the TCJA, increasing the number of taxpayers 
affected by these procedural constraints.
    In light of the increased relevance of the definition of tax 
shelter under section 448(d)(3) after enactment of the TCJA, proposed 
Sec.  1.448-2(b)(2)(iii)(B) permits a taxpayer to elect to use the 
allocated taxable income or loss of the immediately preceding taxable 
year to determine whether the taxpayer is a syndicate for purposes of 
section 448(d)(3) for the current taxable year. A taxpayer that makes 
this election will know at the beginning of the taxable year whether it 
is a tax shelter for the current taxable year, alleviating concerns 
about the difficulties in timely determining whether it is a tax 
shelter under section 448(d)(3) and filing changes in method of 
accounting, if necessary. A taxpayer that makes this election must 
apply the rule to all subsequent taxable years, and for all purposes 
for which status as a tax shelter under section 448(d)(3) is relevant, 
unless the Commissioner permits a revocation of the election.
    Another commenter suggested a rule to provide relief to taxpayers 
that report negative taxable income in a taxable year solely because of 
a negative section 481(a) adjustment arising from an accounting method 
change and are consequently within the definition of tax shelter under 
section 448(d)(3), but that would otherwise meet the Section 448(c) 
gross receipts test. The suggested rule would deem such taxpayers to 
not be tax shelters for purposes of section 448(d)(3). The Treasury 
Department and the IRS decline to adopt this suggestion. No exception 
was provided in the TCJA to limit the application of the definition of 
tax shelter in section 448(d)(3) for taxpayers making an overall method 
change.
    The Treasury Department and the IRS continue to study the 
definition of tax shelter under section 448(d)(3) and request comments 
on whether additional relief is necessary.
C. Procedures for Taxpayers Required To Change From the Cash Method
    Prior to its amendment by the TCJA, a taxpayer met the gross 
receipts test of section 448(c) if its average annual gross receipts 
did not exceed $5 million for all prior 3-taxable-year periods. Once a 
taxpayer's average annual gross receipts had exceeded $5 million (first 
section 448 year), a taxpayer was prohibited under section 448 from 
using the cash method for all subsequent taxable years.
    The TCJA removed the requirement under section 448(c) that all 
prior taxable years of a taxpayer must satisfy the Section 448(c) gross 
receipts test for the taxpayer to qualify for the cash method for 
taxable years beginning after December 31, 2017. Thus, section 448 no 
longer permanently prevents a C corporation or a partnership with a C 
corporation partner from using the cash method for a year subsequent to 
a taxable year in which its gross receipts first exceed the dollar 
threshold for the Section 448(c) gross receipts test. Accordingly, the 
proposed regulations do not require taxpayers to meet the gross 
receipts test for all prior taxable years in order to satisfy the 
Section 448(c) gross receipts test.
    The term ``first section 448 year'' used in existing Sec.  1.448-1 
no longer reflects the statutory language of section 448 and these 
proposed regulations remove this term for taxable years beginning after 
December 31, 2017. Proposed Sec.  1.448-2(g)(1) uses the term 
``mandatory section 448 year'' to describe the first taxable year that 
a taxpayer is prevented by section 448 from using the cash method, or a 
subsequent taxable year in which the taxpayer is again prevented by 
section 448 from using the cash method after previously making a change 
in method of accounting that complied with section 448.
    Proposed Sec.  1.448-2(g)(3) requires a taxpayer that meets the 
Section 448(c) gross receipts test in the current taxable year to 
obtain the written consent of the Commissioner before changing to the 
cash method if the taxpayer had previously changed its overall method 
from the cash method during any of the five taxable years ending with 
the current taxable year. A taxpayer that

[[Page 47512]]

makes multiple changes in its overall method of accounting within a 
short period of time may not be treating items of income and expense 
consistently from year to year, and a change back to the cash method 
within the five year period may not clearly reflect income, as required 
by Sec.  1.446-1(a)(2), even if section 448 otherwise does not prohibit 
the use of the cash method.
    The proposed regulations also do not contain specific procedures to 
make a method change from the cash method to a permissible method. The 
Treasury Department and the IRS have determined that providing a single 
procedure in administrative guidance, such as Revenue Procedure 2015-13 
(or successor) and Revenue Procedure 2019-43 (2019-48 IRB 1107) (or 
successor) will reduce confusion for taxpayers to make voluntary 
changes in method of accounting to comply with section 448. 
Consequently, the proposed regulations provide that a taxpayer in a 
mandatory section 448 year must follow the applicable administrative 
procedures to change from the cash method to a permissible method.

3. Changes to the Regulations Under Section 460

    Section 460(a) provides that income from a long-term contract must 
be determined using the percentage-of-completion method (PCM). A long-
term contract is defined in section 460(f) as generally any contract 
for the manufacture, building, installation, or construction of 
property if such contract is not completed within the taxable year in 
which such contract is entered into. Subject to special rules in 
section 460(b)(3), section 460(b)(1)(A) generally provides that the 
percentage of completion of a long-term contract is determined by 
comparing costs allocated to the contract under section 460(c) and 
incurred before the close of the taxable year with the estimated total 
contract costs. Section 460(b)(1)(B) generally provides that a taxpayer 
is required to pay or is entitled to receive interest determined under 
the look-back rules of section 460(b)(2) on the amount of any tax 
liability under chapter 1 of the Code that was deferred or accelerated 
as a result of overestimating or underestimating total allocable 
contract costs or contract price with respect to income from long-term 
contracts reported under the PCM. Section 56(a)(3) generally provides 
that for alternative minimum tax (AMT) purposes, the taxable income 
from a long-term contract (other than a home construction contract 
defined in section 460(e)(5)(A)) is determined under the PCM (as 
modified by section 460(b)).
    Section 460(e)(1)(A) provides an exemption from the requirement to 
use the PCM for home construction contracts. Prior to the TCJA, section 
460(e)(1)(B) provided a separate exemption from the PCM for a long-term 
construction contract of a taxpayer who estimated that the contract 
would be completed within the 2-year period from the commencement of 
the contract (two-year rule), and whose average annual gross receipts 
for the 3-taxable-year period ending with the year preceding the year 
the contract was entered into did not exceed $10 million (Section 
460(e) gross receipts test). The flush language of section 460(e)(1) 
provides that a home construction contract with respect to which the 
two-year rule and Section 460(e) gross receipts test are not met will 
be subject to section 263A, notwithstanding the general exemption under 
section 263A(c)(4) for property produced pursuant to a long-term 
contract (large homebuilder rule). Additionally, for AMT purposes, 
section 56(a)(3) provides in the case of contract described in section 
460(e)(1), other than a home construction contract, the percentage of 
the contract completed is determined under section 460(b)(1) by using 
the simplified procedures for allocation of costs prescribed under 
section 460(b)(3).
    Section 13102(d) of the TCJA amended section 460(e)(1)(B) by 
removing the Section 460(e) gross receipts test and replacing it with 
the Section 448(c) gross receipts test, as amended by section 13102(a) 
of the TCJA, for the taxable year in which the contract is entered 
into. Thus, section 460(e)(1)(B), as modified by TCJA, provides a small 
contractor exemption for long-term construction contracts of a taxpayer 
other than a tax shelter that estimates that the contract will be 
completed within two years of the commencement of the contract and 
meets the Section 448(c) gross receipts test (Section 460 small 
contractor exemption). The Section 460 small contractor exemption. does 
not apply to home construction contracts, which remain exempt from 
required use of PCM under section 460(e)(1)(A).
A. Application of the Section 448(c) Gross Receipts Test and Rules 
Applicable to Taxpayers Other Than a Corporation or Partnership
    Proposed Sec.  1.460-3(b) modifies the rules relating to the small 
contractor exemption by incorporating the requirement in section 
460(e)(1)(B)(ii) that an eligible taxpayer must meet the Section 448(c) 
gross receipts test for the taxable year in which the contract is 
entered into.
    Section 460(e)(2), which has statutory language identical to that 
in section 263A(i)(2), provides that for a taxpayer that is not a 
corporation or partnership, the Section 448(c) gross receipts test is 
applied in the same manner as if each trade or business of the taxpayer 
were a corporation or a partnership. Proposed Sec.  1.460-
3(b)(3)(ii)(A) through (D) provide guidance under section 460(e)(2) 
consistent with the rules in proposed Sec.  1.263A-1(j)(2).
B. Home Construction Contract Rules
    The large homebuilder rule under section 460(e)(1) exempts home 
construction contracts from PCM but requires capitalization of costs 
under the UNICAP rules under section 263A. Consistent with section 
460(e)(1), proposed Sec.  1.460-5(d)(3) provides that a taxpayer must 
capitalize the costs of home construction contracts under section 263A 
and the regulations under section 263A, unless the taxpayer estimates, 
when entering into the contract, that it will be completed within two 
years of the contract commencement date and the taxpayer satisfies the 
Section 448(c) gross receipts test for the taxable year in which the 
contract is entered into.
C. Clarification of Method of Accounting Rules
    Section 460(e)(2)(B) provides that any change in method of 
accounting made pursuant to section 460(e)(1)(B)(ii) is treated as 
initiated by the taxpayer and made with the consent of the Secretary of 
the Treasury or his delegate (Secretary). The change is made on a cut-
off basis for all similarly classified contracts entered into on or 
after the year of change.
    Revenue Ruling 92-28 (92-1 CB 153) held that within the same trade 
or business, a taxpayer may use different methods of accounting for 
contracts exempt under section 460(e)(1) and contracts subject to 
mandatory use of PCM under section 460(a). Accordingly, a taxpayer with 
both exempt contracts and nonexempt contracts within the same trade or 
business may use a method of accounting other than PCM for all exempt 
contracts, even though the taxpayer would be required to use PCM for 
the nonexempt contracts.
    A commenter requested clarification on the interaction of Revenue 
Ruling 92-28 with section 460(e)(2)(B). The commenter asked for 
clarification because Revenue Ruling 92-28 describes situations in 
which a taxpayer is not required to obtain consent to a change in 
method of accounting because

[[Page 47513]]

it is either adopting a method of accounting for a new item (Situation 
1: PCM for nonexempt long-term contracts) or returning to the use of a 
previously adopted method (Situation 2: completed contract method for 
contracts exempt because taxpayer's average annual gross receipts have 
fallen below the threshold for the small contractor exemption).
    The Treasury Department and the IRS have determined that the 
holding in Revenue Ruling 92-28 remains correct, and that section 
460(e)(2)(B) does not apply to Situations 1 and 2 in Revenue Ruling 92-
28. In reconciling the statutory language of section 460(e)(2)(B) with 
section 446, the Treasury Department and the IRS interpret section 
460(e)(2)(B) as applying to situations in which a taxpayer has been 
using PCM for exempt contracts and would like to change to a different 
exempt contract method. Accordingly, proposed Sec.  1.460-1(f)(3) 
incorporates the holding of Revenue Ruling 92-28 and provides that a 
taxpayer may adopt any permissible method of accounting for each 
classification of contract (that is, exempt and nonexempt).
D. Look-Back Rules
    Section 460(b) provides that, upon the completion of any long-term 
contract, the look-back method is applied to amounts reported under the 
contract using PCM, whether for regular income tax purposes or for AMT 
purposes. Under the look-back method, taxpayers are required to pay 
interest if the taxpayer's Federal income tax liability is deferred as 
a result of underestimating the total contract price or overestimating 
total contract costs. Alternatively, a taxpayer is entitled to receive 
interest if the taxpayer's Federal income tax liability has been 
accelerated as a result of overestimating the total contract price or 
underestimating total contract costs. Any interest to be paid is based 
on a comparison of the difference between the Federal income tax 
liability actually reported by the taxpayer compared to the Federal 
income tax liability that would have been reported if the taxpayer had 
used actual contract prices and costs instead of estimated contract 
prices and costs in computing income under PCM.
i. Look-Back Rules and AMT
    Section 12001 of the TCJA amended section 55(a) so that the AMT is 
no longer imposed on corporations for taxable years beginning after 
December 31, 2017. Consistent with section 12001 of the TCJA, proposed 
Sec.  1.460-6(c) reflects the changes to section 55(a) by providing 
that in applying the look-back method, alternative minimum taxable 
income is redetermined only for taxable years in which the AMT is 
applicable. Similarly, the recomputed tax liability for prior contract 
years includes the AMT only for the taxable years in which the AMT is 
applicable. Consequently, for taxable years beginning after December 
31, 2017, for purposes of the look-back method, a corporation will not 
redetermine alternative minimum taxable income or recompute AMT 
liability. However, a corporation that has a contract that spans a 
period beginning before the TCJA (taxable years beginning before 
January 1, 2018) and ending after the TCJA (taxable years beginning 
after December 31, 2017), would be required to redetermine alternative 
minimum taxable income and recompute AMT for those taxable years 
beginning before January 1, 2018.
ii. De Minimis Exception to Look-Back Rules
    Section 460(b)(3) provides an exception to the requirement to apply 
the look-back method. Under the exception, the look-back method need 
not be applied if the contract price does not exceed the lesser of 
$1,000,000 or one percent of the taxpayer's average annual gross 
receipts for the prior 3-taxable-year period ending with the year 
preceding the taxable year in which the contract is completed, and the 
contract is completed within two years of the commencement of the 
contract. Proposed Sec.  1.460-3(b)(3) provides that, for purposes of 
this de minimis exception, gross receipts are determined in accordance 
with the regulations under section 448(c).
iii. Look-Back Rules and the BEAT
    Proposed Sec.  1.460-6 is also updated to reflect the enactment of 
the base erosion anti-abuse tax (BEAT) imposed by section 59A. For any 
taxable year, the BEAT is a tax on each applicable taxpayer (see Sec.  
1.59A-2) equal to the base erosion minimum tax amount (BEMTA) for that 
year. Generally, the taxpayer's BEMTA equals the excess of (1) the 
applicable tax rate for the taxable year (BEAT rate) multiplied by the 
taxpayer's modified taxable income under Sec.  1.59A-3(b) for the 
taxable year over (2) the taxpayer's adjusted regular Federal income 
tax liability for that year.
    Proposed Sec.  1.460-6 applies the look-back method to re-determine 
the taxpayer's modified taxable income under Sec.  1.59-3(b) and the 
taxpayer's BEMTA for the taxable year. Specifically, the taxpayer must 
determine its modified taxable income and BEMTA for each year prior to 
the filing year that is affected by contracts completed or adjusted in 
the filing year as if the actual total contract price and costs had 
been used in applying the percentage of completion method.
    The Treasury Department and the IRS have proposed this rule because 
the income from long-term contracts determined using the PCM may be 
overestimated or underestimated, which may change the taxpayer's 
modified taxable income or BETMA, or whether or not a taxpayer is an 
applicable taxpayer in a particular taxable year. Clarifying in the 
regulations under section 460 that the look-back method must take into 
account any application of the BEAT makes clear that section 460 
provides taxpayers will pay or receive interest (whichever is the case) 
if their Federal income tax liability, including any BEAT liability, is 
deferred, eliminated, understated, or overstated as a result of the 
taxpayer's estimation of the total contract price or total contract 
costs.

4. Section 471 Small Business Taxpayer Exemption

    Section 471(a) requires inventories to be taken by a taxpayer when, 
in the opinion of the Secretary, taking an inventory is necessary to 
determine the income of the taxpayer. Section 1.471-1 requires the 
taking of an inventory at the beginning and end of each taxable year in 
which the production, purchase, or sale of merchandise is an income-
producing factor. Additionally, when an inventory is required to be 
taken, Sec.  1.446-1(c)(1)(iv) and (c)(2) require that an accrual 
method be used for purchases and sales.
    Section 13102(c) of the TCJA added new section 471(c) to remove the 
statutory requirement to take an inventory when the production, 
purchase, or sale of merchandise is an income-producing factor for a 
taxpayer (other than a tax shelter) meeting the Section 448(c) gross 
receipts test (Section 471 small business taxpayer exemption). The 
Section 471 small business taxpayer exemption provides that the 
requirements of section 471(a) do not apply to a taxpayer for that 
taxable year, and the taxpayer's method of accounting for inventory for 
such taxable year shall not be treated as failing to clearly reflect 
income if the taxpayer either: (1) Treats the taxpayer's inventory as 
non-incidental materials and supplies, or (2) conforms the taxpayer's 
inventory method to the taxpayer's method of accounting for inventory 
reflected in an applicable financial statement as defined in section 
451(b)(3) (AFS), or if the taxpayer does

[[Page 47514]]

not have an AFS, in the taxpayer's books and records prepared in 
accordance with the taxpayer's accounting procedures.
    Section 471(c)(3) provides that in the case of a taxpayer that is 
not a corporation or partnership, the Section 448(c) gross receipts 
test is determined in the same manner as if each trade or business of 
such taxpayer were a corporation or partnership.
    A taxpayer's method of accounting for inventory may not clearly 
reflect income if a taxpayer meets the Section 448(c) gross receipts 
test but does not take an inventory, and also does not either treat its 
inventory as non-incidental materials and supplies or in conformity 
with its AFS, or its books and records if it does not have an AFS. In 
such instances, the general rules under section 446 for analyzing 
whether a method of accounting clearly reflects income are applicable.
    These proposed regulations modify existing Sec.  1.471-1 by adding 
proposed Sec.  1.471-1(b) to implement the Section 471 small business 
taxpayer exemption under section 471(c). Proposed Sec.  1.471-1(b) 
provides guidance on the application of the Section 448(c) gross 
receipts test to taxpayers other than a corporation or partnership, the 
treatment of inventory as non-incidental materials and supplies, and 
the conforming of inventory to an AFS or the taxpayer's books and 
records.
A. Application of the Section 448(c) Gross Receipts Test to Taxpayers 
Other Than a Corporation or Partnership
    These proposed regulations provide guidance under section 
471(c)(3), which has statutory language identical to section 
263A(i)(2), consistent with the rules in proposed Sec.  1.263A-1(j)(2). 
See part 1.A of this Explanation of Provisions for discussion of the 
application of the Section 448(c) gross receipts test to individuals 
and other taxpayers that are not a corporation or partnership.
B. Treatment of Inventory as Non-Incidental Materials and Supplies
    Section 471(c)(1)(B)(i) provides that a taxpayer, other than a tax 
shelter, that meets the Section 448(c) gross receipts test can treat 
its inventory as non-incidental materials and supplies.
    Prior to the TCJA, the Treasury Department and the IRS provided 
administrative relief for certain taxpayers from the requirements of 
section 471(a) with regard to purchases and sales of inventory. Under 
Revenue Procedure 2001-10 (2001-2 IRB 272), a taxpayer with average 
annual gross receipts that did not exceed $1 million was exempted from 
the requirements to use an accrual method under section 446 and to 
account for inventories under section 471. Similarly, under Revenue 
Procedure 2002-28 (2002-28 IRB 815), a ``qualifying small business 
taxpayer,'' as defined in section 4.01 of Revenue Procedure 2002-28, 
was also exempted from the requirements to use an accrual method under 
section 446 and to account for inventories under section 471. To 
qualify, a taxpayer must have had average annual gross receipts that 
did not exceed $10 million in certain industries, or reasonably 
determined that its principal business activity was the provision of 
services, or reasonably determined its principal business activity was 
the fabrication or modification of customized tangible personal 
property.
    Under both revenue procedures, a taxpayer was permitted to account 
for its inventory in the same manner as non-incidental materials and 
supplies under Sec.  1.162-3. Under Sec.  1.162-3, materials and 
supplies that are not incidental are deductible only in the year in 
which they are actually consumed and used in the taxpayer's business. 
For purposes of these revenue procedures, inventoriable items treated 
as non-incidental materials and supplies were treated as consumed and 
used in the taxable year the taxpayer provided the items to a customer. 
Thus, the costs of such inventoriable items were recovered by a cash 
basis taxpayer only in that year, or in the year in which the taxpayer 
actually paid for the goods, whichever was later. See section 4.02 of 
Revenue Procedure 2001-10 and section 4.05 of Revenue Procedure 2002-
28.
    Section 471(c)(1)(B)(i) generally codified the treatment of 
inventory using the non-incidental materials and supplies method of 
accounting described in Revenue Procedure 2001-10 and Revenue Procedure 
2002-28, with certain exceptions. Accordingly, proposed Sec.  1.471-
1(b)(4) provides rules similar to the provisions of these revenue 
procedures, including that the items continue to be inventory property. 
The proposed regulations refer to inventory treated as non-incidental 
materials and supplies as ``section 471(c) materials and supplies.''
i. Definition of the Term ``Used and Consumed''
    As explained previously and as noted in the Conference Report to 
the TCJA, an exception to the requirement to take an inventory was 
provided under Revenue Procedure 2001-10 and Revenue Procedure 2002-28. 
H.R. Rep. No. 115-466, at 378 fn. 638 and 639 (2017). Under that 
exception, a taxpayer was able to account for inventory as materials 
and supplies that are not incidental. The cost of non-incidental 
materials and supplies is deductible in the taxable year in which the 
materials and supplies are first used or consumed in the taxpayer's 
operations. Id. at 378 fn. 640. As discussed in part 4.B of this 
Explanation of Provisions, the administrative guidance as in existence 
prior to the TCJA provided that inventory treated as non-incidental 
materials and supplies under Sec.  1.162-3 remained inventory property, 
the cost of which was recovered by a cash basis taxpayer when the items 
were provided to a customer, or when the taxpayer paid for the items, 
whichever was later. The Conference Report describes the TCJA as 
generally permitting the costs of non-incidental materials and supplies 
to be recovered in the taxable year that is ``consistent with present 
law.'' Id. at 380 fn. 657. The Treasury Department and IRS interpret 
section 471(c)(1)(B)(i) as generally codifying the administrative 
guidance existing at the time of enactment (that is, Revenue Procedure 
2001-10 and Revenue Procedure 2002-28). Accordingly, proposed Sec.  
1.471-1(b)(4)(i) provides that section 471(c) materials and supplies 
are used or consumed in the taxable year in which the taxpayer provides 
the item to a customer and the cost of such item is recovered in that 
year or the taxable year in which the taxpayer pays for or incurs (in 
the case of an accrual method taxpayer) such cost, whichever is later.
    One commenter requested that raw materials used in the production 
of finished goods be deemed ``used or consumed'' when the raw material 
is used during production instead of when the finished product is 
provided to a customer. Under this approach, a producer would be able 
to recover production costs earlier than allowed under the 
administrative guidance of Revenue Procedure 2001-10 and Revenue 
Procedure 2002-28. Further, under this approach, a producer would be 
permitted to recover costs earlier than a reseller. The Treasury 
Department and the IRS decline to adopt this suggestion. As discussed 
previously, the Treasury Department and the IRS interpret section 
471(c)(1)(B)(i) and its legislative history generally as codifying the 
rules provided in the administrative guidance existing at the time the 
Act was enacted. Accordingly, proposed Sec.  1.471-1(b)(4) provides 
that section 471(c) materials and supplies are ``used and consumed'' in 
the taxable year the taxpayer provides the goods to a customer, and 
that the

[[Page 47515]]

cost of goods is recovered in that year or the taxable year in which 
such cost is paid or incurred (in accordance with the taxpayer's method 
of accounting), whichever is later.
ii. De Minimis Safe Harbor Under Sec.  1.263(a)-1(f)
    Section 1.263(a)-1(f) provides a regulatory de minimis safe harbor 
election through which an electing taxpayer may choose not to treat as 
a material or supply under Sec.  1.162-3(a) any amount paid in the 
taxable year for tangible property if the amount paid meets certain 
requirements, and instead to deduct the de minimis amount in accordance 
with its AFS, or books and records, if the taxpayer has no AFS. Section 
1.263(a)-1(f)(2)(i) provides that the de minimis safe harbor election 
does not apply to amounts paid for property that is or is intended to 
be included in inventory property.
    Two commenters asked for clarification on whether a taxpayer using 
the non-incidental materials and supplies method under section 
471(c)(1)(B)(i) may use the de minimis safe harbor election of Sec.  
1.263(a)-1(f). As discussed in part 4.B of this Explanation of 
Provisions, the Treasury Department and the IRS continue to interpret 
inventory treated as non-incidental materials and supplies as remaining 
characterized as inventory property. Consequently, proposed Sec.  
1.471-1(b)(4)(i) provides that inventory treated as section 471(c) non-
incidental materials and supplies is not eligible for the de minimis 
safe harbor election under Sec.  1.263(a)-1(f). Extending the 
regulatory election under Sec.  1.263(a)-1(f) to encompass section 
471(c) materials and supplies is outside the intended scope of the 
election and runs counter to section 471(c), which indicates section 
471(c) materials and supplies are inventory property.
iii. Identification and Valuation of Section 471(c) Materials and 
Supplies
    One commenter asked for guidance on how a taxpayer determines the 
cost basis of inventory items that are treated as non-incidental 
materials and supplies. Proposed Sec.  1.471-1(b)(4)(ii) provides 
guidance on how a taxpayer may identify and value section 471(c) 
materials and supplies. These identification and valuation methods 
would apply whether the taxpayer used the cash method or an accrual 
method.
    Consistent with Revenue Procedure 2002-28, and the legislative 
history to section 471(c), proposed Sec.  1.471-1(b)(4)(ii) permits 
taxpayers to determine the amount of their section 471(c) materials and 
supplies by using either a specific identification method, a first-in, 
first-out (FIFO) method, or an average cost method, provided that the 
method is used consistently. Taxpayers may not identify their inventory 
using a last-in, first-out (LIFO) method or value section 471(c) 
materials and supplies using a lower-of-cost-or-market (LCM) method. 
The Treasury Department and the IRS are aware that the purpose of the 
section 471(c) materials and supplies method is to provide 
simplification. Accounting methods using LIFO and LCM require 
sophisticated computations and are allowed under the more complex 
inventory rules of sections 471(a) and 472. Accordingly, these proposed 
regulations do not permit a taxpayer using the section 471(c) materials 
and supplies method to use either a LIFO method or the LCM method.
iv. Direct Labor and Overhead Costs for Section 471(c) Materials and 
Supplies
    Commenters asked for clarification as to the treatment of direct 
labor and overhead costs for section 471(c) materials and supplies. 
Revenue Procedure 2001-10 and Revenue Procedure 2002-28 did not 
directly address whether direct labor and overhead costs for inventory 
treated as non-incidental materials and supplies were immediately 
deductible. The commenters argue that if inventories are treated as 
non-incidental materials and supplies, then all of the direct labor and 
overhead costs incurred in producing the goods are deductible when 
incurred. One commenter noted that prior to the enactment of section 
263A, the costing rules for inventoriable goods produced by a taxpayer 
were governed by the full absorption method under Sec.  1.471-11, and 
Sec.  1.471-3, in the case of a reseller of inventory.
    The Treasury Department and the IRS have determined that under the 
section 471(c) materials and supplies method, the items retain their 
character as inventory property. Because the property remains 
characterized as inventory property, the costing rules in Sec.  1.471-
11 and Sec.  1.471-3 are the applicable rules to determine which costs 
are to be included under the section 471(c) materials and supplies 
method. However, the Treasury Department and the IRS are aware that the 
purpose of section 471(c)(1)(A)(i) is to provide simplification for 
taxpayers. Accordingly, these proposed regulations provide that a 
taxpayer using the section 471(c) materials and supplies method is 
required to include only direct costs paid to produce or acquire the 
inventory treated as section 471(c) materials and supplies. These 
direct costs are not immediately deductible but are recovered in 
accordance with proposed Sec.  1.471-1(b)(4). Consistent with existing 
law, these proposed regulations provide that a taxpayer is not 
permitted to recover a cost that it otherwise would be neither 
permitted to recover nor deduct for Federal income tax purposes solely 
by reason of it being included in the costs of section 471(c) materials 
and supplies.
C. Treatment of Inventory for an AFS Taxpayer
    A taxpayer, other than a tax shelter, that meets the Section 448(c) 
gross receipts test need not take an inventory under section 471(a) and 
may choose to treat its inventory as the inventory is reflected in the 
taxpayer's AFS, or if the taxpayer does not have an AFS, as the 
inventory is treated in the taxpayer's books and records prepared in 
accordance with the taxpayer's accounting procedures. These proposed 
regulations provide guidance on the definition of AFS, the types and 
amounts of costs reflected in an AFS that can be recovered under 
section 471(c), and when such costs may be taken into account. The 
proposed regulations use the term ``AFS section 471(c) method'' to 
describe the permissible section 471(c)(1)(B)(ii) method for a taxpayer 
with an AFS (AFS taxpayer).
i. Definition of AFS
    Section 471(c)(2) defines an AFS by cross-reference to section 
451(b)(3). Consistent with the statute, proposed Sec.  1.471-
1(b)(5)(ii) defines the term AFS in accordance with section 451(b)(3), 
and incorporates the definition provided in proposed Sec.  1.451-
3(c)(1). The rules relating to additional AFS issues provided in Sec.  
1.451-3(h) also apply to the AFS section 471(c) method. The proposed 
regulations also provide that a taxpayer has an AFS for the taxable 
year if all of the taxpayer's taxable year is covered by an AFS.
    If a taxpayer's AFS is prepared on the basis of a financial 
accounting year that differs from the taxpayer's taxable year, proposed 
Sec.  1.471-1(b)(5)(ii) provides that a taxpayer determines its 
inventory for the mismatched reportable period by using a method of 
accounting described in proposed Sec.  1.451-3(h)(4). The Treasury 
Department and the IRS propose to require a taxpayer with an AFS that 
uses the AFS section 471(c) method to consistently apply the same 
mismatched reportable period method provided in proposed Sec.  1.451-
3(h)(4) for purposes of its AFS section 471(c) method of accounting 
that is used for section 451. The Treasury Department

[[Page 47516]]

and the IRS request comments on the consistency requirement and other 
issues related to the application of proposed Sec.  1.451-3(h) to the 
AFS section 471(c) method.
ii. Types and Amounts of Costs Reflected in an AFS
    Proposed Sec.  1.471-1(b)(5) provides rules relating to the AFS 
section 471(c) method, including a description of the costs included in 
this method. The proposed regulations provide that an AFS taxpayer, 
other than a tax shelter, that meets the Section 448(c) gross receipts 
test may use the AFS section 471(c) method to account for its inventory 
costs for that taxable year. The proposed regulations also clarify that 
a taxpayer using the AFS section 471(c) method is maintaining 
inventory, but generally recovers the costs of inventory in accordance 
with its AFS inventory method and not by using an inventory method 
specified under section 471(a) and the regulations under section 471.
    Under the AFS section 471(c) method, the term ``inventory costs'' 
means the costs that a taxpayer capitalizes to property produced or 
property acquired for resale in its AFS. However, these proposed 
regulations clarify that the amount of an inventory cost in a 
taxpayer's AFS may not properly reflect the amount recoverable under 
the taxpayer's AFS section 471(c) method. These proposed regulations 
provide that a taxpayer is not permitted to recover a cost that it 
otherwise would be neither permitted to recover nor deduct for Federal 
income tax purposes solely by reason of it being an inventory cost in 
the taxpayer's AFS inventory method. In addition, these proposed 
regulations provide that a taxpayer may not capitalize a cost to 
inventory any earlier than the taxable year in which the amount is paid 
or incurred under the taxpayer's overall method of accounting for 
Federal income tax purposes (for example, if applicable, section 461(h) 
is met) or not permitted to be capitalized by another Code provision 
(for example, section 263(a)). As a result, a taxpayer may be required 
to reconcile any differences between its AFS and Federal income tax 
return treatment (book-tax adjustments) for all or a portion of a cost 
that was included in the taxpayer's AFS inventory method under the AFS 
section 471(c) method.
    The Treasury Department and the IRS are aware that some taxpayers 
may interpret section 471(c)(1)(B)(ii) as permitting a taxpayer to 
capitalize a cost to inventory for Federal income tax purposes when 
that cost is included in the taxpayer's AFS inventory method 
irrespective of: (1) Whether the amount is deductible or otherwise 
recoverable for Federal income tax purposes; or (2) when the amount is 
capitalizable under the taxpayer's overall method of accounting used 
for Federal income tax purposes. The Treasury Department and the IRS do 
not agree with this interpretation because section 471 is a timing 
provision. Section 471 is in subchapter E of chapter 1, Accounting 
Periods and Methods of Accounting. It is not in subchapter B of chapter 
1, Computation of Taxable Income. A method of accounting determines 
when an item of income or expense is recognized, not whether it is 
deductible or recoverable through cost of goods sold or basis.
    Accordingly, the Treasury Department and the IRS view section 
471(c)(1)(B)(ii) as an exemption from taking an inventory under section 
471(a) for certain taxpayers that meet the Section 448(c) gross 
receipts test and not as an exemption from the application of Code 
provisions other than section 471(a). While Congress provided an 
exemption from the general inventory timing rules of section 471(a), 
Congress did not exempt these taxpayers from applying other Code 
provisions that determine the deductibility or recoverability of costs, 
or the timing of when costs are considered paid or incurred. For 
example, Congress did not modify or alter section 461 regarding when a 
liability is taken into account, or any of the provisions that disallow 
a deduction, in whole or in part, such as any disallowance under 
section 274, to exempt these taxpayers. Accordingly, these proposed 
regulations require an AFS taxpayer that uses the AFS section 471(c) 
method to make book-tax adjustments for costs capitalized in its AFS 
that are not deductible or otherwise recoverable, in whole or in part, 
for Federal income tax purposes or that are taken into account in a 
taxable year different than the year capitalized under the AFS as a 
result of another Code provision.
D. Treatment of Inventory by Taxpayers Without an AFS
    Under section 471(c)(1)(B)(ii), a taxpayer, other than a tax 
shelter, that does not have an AFS and that meets the Section 448(c) 
gross receipts test is not required to take an inventory under section 
471(a), and may choose to treat its inventory as reflected in the 
taxpayer's books and records prepared in accordance with the taxpayer's 
accounting procedures (non-AFS section 471(c) method). These proposed 
regulations permit a taxpayer without an AFS (non-AFS taxpayer) to 
follow its method of accounting for inventory used in its books and 
records that properly reflect its business activities for non-Federal 
income tax purposes. The proposed regulations clarify that a non-AFS 
taxpayer using the non-AFS section 471(c) method has inventory, but 
recovers the costs of inventory through its book method, rather than 
through an inventory method under section 471(a) and the regulations 
under section 471.
    Two comments received requested a definition of ``books and records 
of the taxpayer prepared in accordance with the taxpayer's accounting 
procedures.'' The Treasury Department and the IRS decline to define 
books and records in these proposed regulations. It is well-established 
under existing law that the books and records of a taxpayer comprise 
the totality of the taxpayer's documents and electronically-stored 
data. See, for example, United States v. Euge, 444 U.S. 707 (1980). See 
also Digby v. Comm'r, 103 T.C. 441 (1994), and Sec.  1.6001-1(a). A 
commenter specifically asked for clarification on whether books and 
records of the taxpayer include the accountant's workpapers (whether 
recorded on paper, electronically or on other media). The Treasury 
Department and the IRS note that under existing law, these workpapers 
are generally considered part of the books and records of the taxpayer. 
United States v. Arthur Young & Co., 465 U.S. 805 (1984).
    The Treasury and the IRS interpret section 471(c)(1)(B)(ii) as a 
simplification of the inventory accounting rules in section 471(a) for 
certain small business taxpayers. Proposed Sec.  1.471-1(b)(6)(i) 
provides that under the non-AFS section 471(c) method, a taxpayer 
recovers the costs of inventory in accordance with the method used in 
its books and records and not by using an inventory method specified 
under section 471(a) and regulations under 471. A books and records 
method that determines ending inventory and cost of goods sold that 
properly reflects the taxpayer's business activities for non-Federal 
income tax purposes is to be used under the taxpayer's non-AFS section 
471(a) method. For example, a taxpayer that performs a physical count 
that is used in determining inventory in the taxpayer's books and 
records must use that count for purposes of the non-AFS section 471 
method.
    Consistent with the rules applicable to AFS taxpayers, proposed 
Sec.  1.471-1(b)(6)(ii) clarifies that a non-AFS taxpayer is not 
permitted to recover a cost that it otherwise would not be permitted to 
recover or deduct for

[[Page 47517]]

Federal income tax purposes solely by reason of it being an inventory 
cost in the taxpayer's non-AFS inventory method. These proposed 
regulations provide that a taxpayer may not capitalize a cost to 
inventory any earlier than the taxable year in which the amount is paid 
or incurred under the taxpayer's overall method of accounting for 
Federal income tax purposes (for example, if applicable, section 461(h) 
is met) or not permitted to be capitalized by another Code provision 
(for example, section 263(a)). See section 4.C.ii of this Explanation 
of Provisions.

5. Section 451 Allocation of Transaction Price

    As noted in the Background section of this preamble, section 
13221(a) of the TCJA added a new section 451(b) to the Code effective 
for taxable years beginning after December 31, 2017. This provision 
provides that, for an accrual method taxpayer with an AFS, the all 
events test with respect to any item of gross income (or portion 
thereof) is not treated as met any later than when the item (or portion 
thereof) is included in revenue for financial accounting purposes on an 
AFS. Section 451(b)(1)(A) sets forth the general AFS Income Inclusion 
Rule, providing that, for an accrual method taxpayer with an AFS, the 
all events test with respect to an item of gross income, or portion 
thereof, is met no later than when the item, or portion thereof, is 
included as revenue in an AFS (AFS Income Inclusion Rule). However, 
section 451(b)(2) provides that the AFS Income Inclusion Rule does not 
apply with respect to any item of gross income the recognition of which 
is determined using a special method of accounting, ``other than any 
provision of part V of subchapter P (except as provided in clause (ii) 
of paragraph (1)(B)).'' In addition, section 451(b)(4) provides that 
for purposes of section 451(b), in the case of a contract which 
contains multiple performance obligations, the allocation of the 
transaction price to each performance obligation is equal to the amount 
allocated to each performance obligation for purposes of including such 
item in revenue in the taxpayer's AFS. Additionally, section 
451(c)(4)(D), which provides rules for allocating payments to each 
performance obligation for purposes of applying the advance payment 
rules under section 451(c), provides that for purposes of section 
451(c), ``rules similar to section 451(b)(4) shall apply.''
    The preamble to the proposed regulations under section 451(b) 
contained in REG-104870-18 (84 FR 47191) requested comments on the 
allocation of transaction price for contracts that include both income 
subject to section 451 and income subject to a special method of 
accounting provision (specifically section 460). One commenter 
suggested that the allocation provisions under section 460 and the 
regulations thereunder, and not section 451(b)(4), should control the 
amount of gross income from a long-term contract that is accounted for 
under section 460. The commenter notes that using this approach is 
appropriate in light of section 451(b)(2), which reflects Congress's 
intent to not disturb the treatment of amounts for which a taxpayer 
uses a special method of accounting. The preamble to the proposed 
regulations under section 451(c) contained in REG-104554-18 (84 FR 
47175) also included a similar request for comments for advance payment 
purposes; however, no comments were received in response to this 
request.
    In light of the comment in the preceding paragraph and the 
questions received from taxpayers and practitioners regarding this 
issue in the context of other special methods of accounting (for 
example, section 467), the Treasury Department and the IRS are 
considering a rule that addresses the application of sections 451(b)(2) 
and (4) to contracts with income that is accounted for in part under 
section 451 and in part under a special method of accounting provision. 
The Treasury Department and the IRS are also considering a similar rule 
that addresses the application of section 451(c)(4)(D) to certain 
payments received under such contracts. The Treasury Department and the 
IRS have determined that these rules would benefit from further notice 
and public comment.
    The Treasury Department and the IRS are considering a rule 
providing that if an accrual method taxpayer with an AFS has a contract 
with a customer that includes one or more items of gross income subject 
to a special method of accounting (as defined in proposed Sec.  1.451-
3(c)(5)) and one or more items of gross income subject to section 451, 
the allocation rules under section 451(b)(4) do not apply to determine 
the amount of each item of gross income that is accounted for under the 
special method of accounting provision. Accordingly, the transaction 
price allocation rules in section 451(b)(4) and proposed Sec.  1.451-
3(g)(1) (as contained in REG-104870-18) would apply to only the portion 
of the gross transaction price that is not accounted for under the 
special method of accounting provision (that is, the residual amount) 
and only to the extent the contract contains more than one performance 
obligation that is subject to section 451. To the extent such a 
contract contains more than one performance obligation that is subject 
to section 451, the residual amount would be allocated to each section 
451 performance obligation in proportion to the amount allocated to 
each such performance obligation for purposes of including such item in 
revenue in the taxpayer's AFS. The Treasury Department and the IRS 
request comments on this rule (section 451(b) special method allocation 
rule), including (i) whether taxpayers should be permitted to use the 
allocation rules under section 451(b)(4) to determine the amount of an 
item of gross income that is accounted for under a special method of 
accounting, (ii) whether a specific allocation standard should be 
provided for determining the amount of an item of gross income that is 
accounted for under a special method of accounting in situations where 
an allocation standard is not provided under the applicable special 
method of accounting rules, and (iii) whether alternative allocation 
options may be appropriate for allocating the residual amount to 
multiple performance obligations that are within the scope of section 
451.
    The Treasury Department and the IRS are also considering a similar 
allocation rule for purposes of applying the advance payment rules 
under section 451(c). Specifically, the Treasury Department and the IRS 
are considering a rule providing that if an accrual method taxpayer 
with an AFS receives a payment that is attributable to one or more 
items of gross income that are described in proposed Sec.  1.451-
8(b)(1)(i)(C) and one or more items of gross income that are subject to 
a special method of accounting (as defined in proposed Sec.  1.451-
3(c)(5)), then the taxpayer must determine the portion of the payment 
allocable to the item(s) of gross income that are described in proposed 
Sec.  1.451-8(b)(1)(i)(C) by using an objective criteria standard 
(consistent with objective criteria standard under section 5.02(4) of 
Revenue Procedure 2004-34 (2004-22 IRB 991)). Under this rule a 
taxpayer that allocates the payment to each item of gross income in 
proportion to the total amount of each such item of gross income (as 
determined under the section 451(b) special method allocation rule that 
is described in the preceding paragraph), will be deemed to have meet 
the objective criteria standard. The Treasury Department and the IRS 
request comments on this rule, including whether alternative payment 
allocation

[[Page 47518]]

approaches may be more appropriate (for example, an approach that 
permits the taxpayer to follow its AFS allocation).

Proposed Applicability Date

    These regulations are proposed to be applicable for taxable years 
beginning on or after the date the Treasury Decision adopting these 
proposed regulations as final is published in the Federal Register. For 
taxable years beginning before the date the Treasury Decision adopting 
these regulations as final is published in the Federal Register, see 
Sec. Sec.  1.448-1, 1.448-2, 1.263A-0, 1.263A-1, 1.263A-2, 1.263A-3, 
1.263A-4, 1.263A-7, 1.263A-8, 1.263A-9, 1.263A-15, 1.381-1, 1.446-1, 
1.460-0, 1.460-1, 1.460-3, 1.460-4, 1.460-5, 1.460-6, and 1.471-1 as 
contained in 26 CFR part 1, April 1, 2019.
    However, for taxable years beginning after December 31, 2017, and 
before the date the Treasury Decision adopting these regulations as 
final regulations is published in the Federal Register, a taxpayer may 
rely on these proposed regulations, provided that the taxpayer follows 
all the applicable rules contained in the proposed regulations for each 
Code provision that the taxpayer chooses to apply. For example, a 
taxpayer using an accrual method with inventory subject to the 
capitalization rules of section 263A, may rely on proposed Sec.  1.448-
2 to determine whether it must continue its use of its accrual method 
and proposed Sec.  1.263A-1 to determine its cost capitalizing rules, 
but may maintain its current inventory method rather than follow the 
proposed regulations under section 471.

Statement of Availability of IRS Documents

    The IRS notices, revenue rulings, and revenue procedures cited in 
this preamble are published in the Internal Revenue Bulletin (or 
Cumulative Bulletin) and are available from the Superintendent of 
Documents, U.S. Government Publishing Office, Washington, DC 20402, or 
by visiting the IRS website at http://www.irs.gov.

Special Analysis

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations.

I. Paperwork Reduction Act

    Proposed Sec.  1.448-2(b)(2)(iii)(B) imposes a collection of 
information for an election to use prior year's allocated taxable 
income or loss to determine whether a partnership or other entity 
(other than a C corporation) is a ``syndicate'' for purposes of section 
448(d)(3) for the current tax year. The election is made by attaching a 
statement to the taxpayer's original Federal income tax return for the 
current tax year. The election is binding for all subsequent taxable 
years, and can only be revoked with the consent of the Commissioner. 
The collection of information is voluntary for purposes of obtaining a 
benefit under the proposed regulations. The likely respondents are 
businesses or other for-profit institutions, and small businesses or 
organizations.
    Estimated total annual reporting burden: 199,289 hours.
    Estimated average annual burden hours per respondent: 1 hour.
    Estimated number of respondents: 199,289.
    Estimated annual frequency of responses: Once.
    Other than the election statement, these proposed regulations do 
not impose any additional information collection requirements in the 
form of reporting, recordkeeping requirements or third-party disclosure 
statements. However, because the exemptions in sections 263A, 448, 460 
and 471 are methods of accounting under the statute, taxpayers are 
required to request the consent of the Commissioner for a change in 
method of accounting under section 446(e) to implement the statutory 
exemptions. The IRS expects that these taxpayers will request this 
consent by filing Form 3115, Application for Change in Accounting 
Method. Taxpayers may request these changes using reduced filing 
requirements by completing only certain parts of Form 3115. See Revenue 
Procedure 2018-40 (2018-34 I.R.B. 320). Revenue Procedure 2018-40 
provides procedures for a taxpayer to make a change in method of 
accounting using the automatic change procedures of Revenue Procedure 
2015-13 (2015-5 IRB 419) in order to use the exemptions provided in 
sections 263A, 460 and/or 471.
    For purposes of the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(c)) (PRA), the reporting burden associated with the collection of 
information for the election statement and Form 3115 will be reflected 
in the PRA submission associated with the income tax returns under the 
OMB control number 1545-0074 (in the case of individual filers of Form 
3115) and 1545-0123 (in the case of business filers of Form 3115).
    In 2018, the IRS released and invited comment on a draft of Form 
3115 in order to give members of the public the opportunity to benefit 
from certain specific provisions made to the Code. The IRS received no 
comments on the forms during the comment period. Consequently the IRS 
made the forms available in January 2019 for use by the public. The IRS 
notes that Form 3115 applies to changes of accounting methods generally 
and is therefore broader than sections 263A, 448, 460 and 471.
    As discussed above, the reporting burdens associated with the 
proposed regulations are included in the aggregated burden estimates 
for OMB control numbers 1545-0074 (in the case of individual filers of 
Form 3115), 1545-0123 (in the case of business filers of Form 3115 
subject to Revenue Procedure 2019-43 and business filers that make the 
election under proposed Sec.  1.448-2(b)(2)(iii)(B)). The overall 
burden estimates associated with the OMB control numbers below are 
aggregate amounts related to the entire package of forms associated 
with the applicable OMB control number and will include, but not 
isolate, the estimated burden of the tax forms that will be created or 
revised as a result of the information collections in these proposed 
regulations. These numbers are therefore not specific to the burden 
imposed by these proposed regulations. The burdens have been reported 
for other income tax regulations that rely on the same information 
collections and the Treasury Department and the IRS urge readers to 
recognize that these numbers are duplicates and to guard against 
overcounting the burdens imposed by tax provisions prior to the Act. No 
burden estimates specific to the forms affected by the proposed 
regulations are currently available. For the OMB control numbers 
discussed in the preceding paragraphs, the Treasury Department and the 
IRS estimate PRA burdens on a taxpayer-type basis rather than a 
provision-specific basis. Those estimates capture both changes made by 
the Act and those that arise out of discretionary authority exercised 
in the proposed regulations (when final) and other regulations that 
affect the compliance burden for that form.
    The Treasury Department and IRS request comment on all aspects of 
information collection burdens related to the proposed regulations, 
including estimates for how much time it would take to comply with the 
paperwork

[[Page 47519]]

burdens described above for each relevant form and ways for the IRS to 
minimize paperwork burden. In addition, when available, drafts of IRS 
forms are posted for comment at https://appsirs.gov/app/picklist/lit/draftTaxForms.htm. IRS forms are available at https://www.irs.gov/forms-instructions. Forms will not be finalized until after they have 
been approved by OMB under the PRA.

II. Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes 
certain requirements with respect to federal rules that are subject to 
the notice and comment requirements of section 553(b) of the 
Administrative Procedure Act (5 U.S.C. 551 et seq.) and that are likely 
to have a significant economic impact on a substantial number of small 
entities. Unless an agency determines that a proposal is not likely to 
have a significant economic impact on a substantial number of small 
entities, section 603 of the RFA requires the agency to present an 
initial regulatory flexibility analysis (IRFA) of the proposed rules. 
The Treasury Department and the IRS have not determined whether the 
proposed rules, when finalized, will likely have a significant economic 
impact on a substantial number of small entities. The determination of 
whether the voluntary exemptions under sections 263A, 448, 460, and 471 
will have a significant economic impact requires further study. 
However, because there is a possibility of significant economic impact 
on a substantial number of small entities, an IRFA is provided in these 
proposed regulations. The Treasury Department and the IRS invite 
comments on both the number of entities affected and the economic 
impact on small entities.
    Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking has been submitted to the Chief Counsel of Advocacy of the 
Small Business Administration for comment on its impact on small 
business.
1. Need for and Objectives of the Rule
    As discussed earlier in the preamble, these proposed regulations 
largely implement voluntary exemptions that relieve small business 
taxpayers from otherwise applicable restrictions and requirements under 
sections 263A, 448, 460, and 471.
    Section 448 provides a general restriction for C corporations and 
partnerships with C corporation partners from using the cash method of 
accounting, and sections 263A, 460 and 471 impose specific rules on 
uniform capitalization of direct and indirect production costs, the 
percentage of completion method for long-term contracts, and accounting 
for inventory costs, respectively. Section 13102 of TCJA provided new 
statutory exemptions from certain of these rules and expanded the scope 
of existing statutory exemptions from certain of these rules to reduce 
compliance burdens for small taxpayers. The proposed regulations 
clarify the exemption qualification requirements and provide guidance 
with respect to the applicable methods of accounting should a taxpayer 
choose to apply one or more exemptions.
    The objective of the proposed regulations is to provide clarity and 
certainty for small business taxpayers implementing the exemptions. 
Under the Code, small business taxpayers were able to implement these 
provisions for taxable years beginning after December 31, 2017 (or, in 
the case of section 460, for contracts entered into after December 31, 
2017) even in the absence of these proposed regulations. Thus, the 
Treasury Department and the IRS expect that, at the time these proposed 
regulations are published, many small business taxpayers may have 
already implemented some aspects of the proposed regulations.
2. Affected Small Entities
    The voluntary exemptions under sections 263A, 448, 460 and 471 
generally apply to taxpayers that meet the $25 million (adjusted for 
inflation) gross receipts test in section 448(c) and are otherwise 
subject to general rules under sections 263A, 448, 460, or 471.
A. Section 263A
    The Treasury Department and the IRS expect that the addition of 
section 263A(i) will expand the number of small business taxpayers 
exempted from the requirement to capitalize costs, including interest, 
under section 263A. Under section 263A(i), taxpayers (other than tax 
shelters) that meet the $25 million (adjusted for inflation) gross 
receipts test in section 448(c) can choose to deduct certain costs that 
are otherwise required to be capitalized to the basis of property. 
Section 263A applies to taxpayers that are producers, resellers, and 
taxpayers with self-constructed assets. The Treasury Department and the 
IRS estimate that there are between 38,100 and 38,900 respondents with 
gross receipts of not more than $25 million (adjusted for inflation) 
that are eligible to change their method of accounting to no longer 
capitalize costs under section 263A. These estimates come from 
information collected on: Form 1125-A, Cost of Goods Sold, and attached 
to Form 1120, U.S. Corporation Income Tax Return, Form 1065, U.S. 
Return of Partnership Income or Form 1120-S, U.S. Income Tax Return for 
an S Corporation, on which the taxpayer also indicated it had 
additional section 263A costs. The Treasury Department and the IRS do 
not have readily available data to measure the prevalence of entities 
with self-constructed assets. In addition, these data also do not 
include other business entities, such as a business reported on 
Schedule C, Profit or Loss Form Business, of an individual's Form 1040, 
U.S. Individual Income Tax Return.
    Under section 263A, as modified by the TCJA, small business 
entities that qualified for Section 263A small reseller exception will 
no longer be able to use this exception. The Treasury Department and 
the IRS estimate that nearly all taxpayers that qualified for the small 
reseller exception will qualify for the small business taxpayer 
exemption under section 263A(i) since the small reseller exception 
utilized a $10 million gross receipts test. The Treasury Department and 
the IRS estimate that there are between 38,100 and 38,900 respondents 
with gross receipts of not more than $25 million that are eligible for 
the exemption under section 263A(i). These estimates come from 
information collected on: Form 1125-A, Cost of Goods Sold, and attached 
to Form 1120, U.S. Corporation Income Tax Return, Form 1065, U.S. 
Return of Partnership Income or Form 1120-S, U.S. Income Tax Return for 
an S Corporation on which the taxpayer also indicated it had additional 
section 263A costs. These data provide an upper bound for the number of 
taxpayers affected by the repeal of the small reseller exception and 
enactment of section 263A(i) because the data includes taxpayers that 
were not previously eligible for the small reseller exception, such as 
producers and taxpayers with gross receipts of more than $10 million.
    The proposed regulations modify the $50 million gross receipts test 
in Sec.  1.263A-1(d)(3)(ii)(B)(1) by using the section 448 gross 
receipts test. The $50 million gross receipts amount is used by 
taxpayers to determine whether they are eligible to treat negative 
adjustments as additional section 263A costs for purposes of the 
simplified production method (SPM) under section 263A. The Treasury 
Department and the IRS do not have readily available data to measure 
the prevalence of entities using the SPM.
    Proposed Sec.  1.263A-9 modifies the current regulation to increase 
the

[[Page 47520]]

eligibility threshold to $25 million for the election permitting 
taxpayers to use the highest applicable Federal rate as a substitute 
for the weighted average interest rate when tracing debt for purposes 
of capitalizing interest under section 263A(f). The Treasury Department 
and the IRS estimate that there are between 38,100 and 38,900 
respondents with gross receipts of not more than $25 million that are 
eligible to make this election. These estimates come from information 
collected on: Form 1125-A, Cost of Goods Sold, attached to Form 1120, 
U.S. Corporation Income Tax Return, Form 1065, U.S. Return of 
Partnership Income or Form 1120-S, U.S. Income Tax Return for an S 
Corporation, on which the taxpayer also indicated it had additional 
section 263A costs. The Treasury Department and the IRS expect that 
many taxpayers eligible to make the election for purposes of section 
263A(f) will instead elect the small business exemption under section 
263A(i). Additionally, taxpayers who chose to apply section 263A even 
though they qualify for the small business exemption under 263A(i) may 
not have interest expense required to be capitalized under section 
263A(f). As a result, although these data do not include taxpayers with 
self-constructed assets that are eligible for the election, the 
Treasury Department and the IRS estimate that this data provides an 
upper bound for the number of eligible taxpayers.
B. Section 448
    The Treasury Department and the IRS expect that the changes to 
section 448(c) by the TCJA will expand the number of taxpayers 
permitted to use the cash method. Section 448(a) provides that C 
corporations, partnerships with C corporations as partners, and tax 
shelters are not permitted to use the cash method of accounting; 
however section 448(c), as amended by the TCJA, provides that C 
corporations or partnerships with C corporations as partners, other 
than tax shelters, are not restricted from using the cash method if 
their average annual gross receipts are $25 million (adjusted for 
inflation) or less. Prior to the amendments made by the TCJA, the 
applicable gross receipts threshold was $5 million. Section 448 does 
not apply to S corporations, partnerships without a C corporation 
partner, or any other business entities (including sole proprietorships 
reported on an individual's Form 1040). The Treasury Department and the 
IRS estimate that there are between 587,000 and 595,000 respondents 
with gross receipts of not more than $5 million presently using an 
accrual method, and between 70,000 and 73,000 respondents with gross 
receipts of more than $5 million but not more than $25 million that are 
permitted to use to the cash method. These estimates come information 
collected on Form 1120, U.S. Corporation Income Tax Return, Form 1065, 
U.S. Return of Partnership Income and Form 1120-S, U.S. Income Tax 
Return for an S Corporation.
    Under the proposed regulations, taxpayers that would meet the gross 
receipts test of section 448(c) and seem to be eligible to use the cash 
method but for the definition of ``syndicate'' under section 448(d)(3), 
may elect to use the allocated taxable income or loss of the 
immediately preceding taxable year to determine whether the taxpayer is 
a ``syndicate'' for purposes of section 448(d)(3) for the current 
taxable year. The Treasury Department and IRS estimate that 199,289 
respondents may potentially make this election. This estimate comes 
from information collected on the Form 1065, U.S. Return of Partnership 
Income and Form 1120-S, U.S. Income Tax Return for an S Corporation, 
and the Form 1125-A, Cost of Goods Sold, attached to the Forms 1065 and 
1120-S . The Treasury Department and the IRS estimate that these data 
provide an upper bound for the number of eligible taxpayers because not 
all taxpayers eligible to make the election will choose to do so.
C. Section 460
    The Treasury Department and the IRS expect that the modification of 
section 460(e)(1)(B) by the TCJA will expand the number of taxpayers 
exempted from the requirement to apply the percentage-of-completion 
method to long-term construction contracts. Under section 460(e)(1)(B), 
as modified by the TCJA, taxpayers (other than a tax shelters) that 
meet the $25 million (adjusted for inflation) gross receipts test in 
section 448(c) are not required to use PCM to account for income from a 
long-term construction contract expected to be completed in two years. 
Prior to the modification of section 460(e)(1)(B) by the TCJA, a 
separate $10 million dollar gross receipts test applied. The Treasury 
Department and the IRS estimate that there are between 15,400 and 
18,000 respondents with gross receipts of between $10 million and $25 
million who are eligible to change their method of accounting to apply 
the modified exemption. This estimate comes from information collected 
on the Form 1120, U.S. Corporation Income Tax Return, Form 1065, U.S. 
Return of Partnership Income and Form 1120-S, U.S. Income Tax Return 
for an S Corporation in which the taxpayer indicated its principal 
business activity was construction (NAICS codes beginning with 23). 
These data available do not distinguish between long-term contracts and 
other contracts, and also do not include other business entities that 
do not file Form 1120, U.S. Corporation Income Tax Return, Form 1065, 
U.S. Return of Partnership Income, and Form 1120-S, U.S. Income Tax 
Return for an S Corporation, such as a business reported on Schedule C, 
Profit or Loss from Business, of an individual's Form 1040, U.S. 
Individual Income Tax Return.
D. Section 471
    The Treasury Department and the IRS expect that the addition of 
section 471(c) will expand the number of taxpayers exempted from the 
requirement to take inventories under section 471(a). Under section 
471(c), taxpayers (other than tax shelters) that meet the $25 million 
(adjusted for inflation) gross receipts test in section 448(c) can 
choose to apply certain simplified inventory methods rather than those 
otherwise required by section 471(a). The Treasury Department and the 
IRS estimate that there are between 3,200,000 and 3,400,000 respondents 
with gross receipts of not more than $25 million that are exempted from 
the requirement to take inventories, and will treat their inventory 
either as non-incidental materials and supplies, or conform their 
inventory method to the method reflected in their AFS, or if they do 
not have an AFS, in their books and records. This estimate comes from 
data collected on the Form 1125-A, Cost of Goods Sold. Within that set 
of taxpayers, the Treasury Department and the IRS estimate that there 
are between 10,500 and 11,300 respondents that may choose to conform 
their method of accounting for inventories to their method for 
inventory reflected in their AFS. This estimate comes from IRS-
collected data on taxpayers that filed the Form 1125-A, Cost of Goods 
Sold, in addition to a Schedule M3, Net Income (Loss) Reconciliation 
for Corporations With Total Assets of $10 Million or More, that 
indicated they had an AFS. These data provide a lower bound because 
they do not include other business entities, such as a business 
reported on Schedule C, Profit or Loss from Business, of an 
individual's Form 1040, U.S. Individual Income Tax Return, that are not 
required to file the Form 1125-A, Cost of Goods Sold.
3. Impact of the Rule
    As discussed earlier in the preamble, section 448 provides a 
general restriction for C corporations,

[[Page 47521]]

partnerships with C corporation partners, and tax shelters from using 
the cash method of accounting, and sections 263A, 460 and 471 impose 
specific rules on uniform capitalization of direct and indirect 
production costs, the percentage of completion method for long-term 
contracts, and accounting for inventory costs, respectively. Section 
13102 of TCJA provided new statutory exemptions and expanded the scope 
of existing statutory exemptions from these rules to reduce compliance 
burdens for small taxpayers (e.g., reducing the burdens associated with 
applying complex accrual rules under section 451 and 461, maintaining 
inventories, identifying and tracking costs that are allocable to 
property produced or acquired for resale, identifying and tracking 
costs that are allocable to long-term contracts, applying the look-back 
method under section 460, etc.). For example, a small business taxpayer 
with average gross receipts of $20 million may pay an accountant an 
annual fee to perform a 25 hour analysis to determine the section 263A 
costs that are capitalized to inventory produced during the year. If 
this taxpayer chooses to apply the exemption under section 263A and 
these proposed regulations, it will no longer need to pay an accountant 
for the annual section 263A analysis.
    The proposed regulations implementing these exemptions are 
completely voluntary because small business taxpayers may continue 
using an accrual method of accounting, and applying sections 263A, 460 
and 471 if they so choose. Thus, the exemptions increase the 
flexibility small business taxpayers have regarding their accounting 
methods relative to other businesses. The proposed regulations provide 
clarity and certainty for small business taxpayers implementing the 
exemptions.
4. Projected Reporting, Recordkeeping, and Other Compliance 
Requirements
    The Treasury Department and the IRS have not performed an analysis 
with respect to the projected reporting, recordkeeping, and other 
compliance requirements associated with the statutory exemptions under 
sections 263A, 448, 460, and 471 and the proposed regulations 
implementing these exemptions. However, the Treasury Department and the 
IRS anticipate that the statutory exemptions and the proposed 
regulations implementing these exemptions will reduce the reporting, 
recordkeeping, and other compliance requirements of affected taxpayers 
relative to the requirements that exist under the general rules in 
sections 263A, 448, 460, and 471.
5. Alternatives Considered
    As described in more detail earlier in the preamble, the Treasury 
Department and the IRS considered a number of alternatives under the 
proposed regulations. For example, in providing rules related to 
inventory exemption in Section 471(c)(1)(B)(i), which permits the 
taxpayer to treat its inventory as non-incidental materials and 
supplies, the Treasury Department and the IRS considered whether 
inventoriable costs should be recovered by (i) using an approach 
similar to the approach set forth under Revenue Procedure 2001-10 
(2001-2 IRB 272) and Revenue Procedure 2002-28 (2002-28 IRB 815), which 
provided that inventory treated as non-incidental materials and 
supplies was ``used and consumed,'' and thus recovered through costs of 
goods sold by a cash basis taxpayer, when the inventory items were 
provided to a customer, or when the taxpayer paid for the items, 
whichever was later, or (ii) using an alternative approach that treated 
inventory as ``used and consumed'' and thus recovered through costs of 
goods sold by the taxpayer, in a taxable year prior to the year in 
which the inventory item is provided to the customer (e.g., in the 
taxable year in which an inventory item is acquired or produced). The 
alternative approach described in (ii) would produce a savings equal 
the amount of the cost recovery multiplied by an applicable discount 
rate (determined based on the number of years the cost of goods sold 
recovery would be accelerated under this alternative). The Treasury 
Department and the IRS interpret section 471(c)(1)(B)(i) and its 
legislative history generally as codifying the rules provided in the 
administrative guidance existing at the time TCJA was enacted. Based on 
this interpretation, the Treasury Department and the IRS have 
determined that section 471(c) materials and supplies are ``used and 
consumed'' in the taxable year the taxpayer provides the goods to a 
customer, and are recovered through costs of goods sold in that year or 
the taxable year in which the cost of the goods is paid or incurred (in 
accordance with the taxpayer's method of accounting), whichever is 
later. The Treasury Department and the IRS do not believe this approach 
creates or imposes undue burdens on taxpayers.
6. Duplicate, Overlapping, or Relevant Federal Rules
    The proposed rules would not conflict with any relevant federal 
rules. As discussed above, the proposed regulations merely implement 
voluntary exemptions that relieve small business taxpayers from 
otherwise applicable restrictions and requirements under sections 263A, 
448, 460, and 471.

III. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive Order. This final rule does not have 
federalism implications and does not impose substantial, direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive Order.
Comments and Requests for a Public Hearing
    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ADDRESSES heading. 
The Treasury Department and the IRS request comments on all aspects of 
the proposed regulations. Any electronic comments submitted, and to the 
extent practicable any paper comments submitted, will be made available 
at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits electronic or written comments. Requests for 
a public hearing are also encouraged to be made electronically. If a 
public hearing is scheduled, notice of the date and time for the public 
hearing will be published in the Federal Register. Announcement 2020-4, 
2020-17 I.R.B. 667 (April 20, 2020), provides that until further 
notice, public hearings conducted by the IRS will be held 
telephonically. Any telephonic hearing will be made accessible to 
people with disabilities.
Drafting Information
    The principal author of these proposed regulations is Anna 
Gleysteen, IRS Office of the Associate Chief Counsel (Income Tax and 
Accounting). However, other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 47522]]

Proposed Amendments to the Regulations
    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.263A-0 is amended by:
0
1. Revising the entry in the table of contents for Sec.  1.263A-
1(b)(1).
0
2. Redesignating the entries in the table of contents for Sec.  1.263A-
1(j), (k), and (l) as the entries for Sec.  1.263A-1(k), (l), and (m).
0
3. Adding a new entry in the table of contents for Sec.  1.263A-1(j).
0
4. Revising the newly designated entries for Sec.  1.263A-1(k), (l), 
and (m).
0
5. Revising the entries in the table of contents for Sec.  1.263A-
3(a)(2)(ii).
0
6. Adding entries for Sec.  1.263A-3(a)(5) and revising the entry for 
Sec.  1.263A-3(b).
0
7. Redesignating the entries in the table of contents for Sec.  1.263A-
4(a)(3) and (4) as the entries for Sec.  1.263A-4(a)(4) and (5).
0
8. Adding in the table of contents a new entry for Sec.  1.263A-
4(a)(3).
0
9. Revising the entry in the table of contents for Sec.  1.263A-4(d) 
introductory text.
0
10. Redesignating the entry in the table of contents for Sec.  1.263A-
4(d)(5) as the entry for Sec.  1.263A-4(d)(7).
0
11. Adding in the table of contents a new entry for Sec.  1.263A-
4(d)(5).
0
12. Adding an entry in the table of contents for Sec.  1.263A-4(d)(6).
0
13. Adding an entry in the table of contents for Sec.  1.263A-4(e)(5).
0
14. Revising the entry in the table of contents for Sec.  1.263A-4(f) 
introductory text.
0
15. Adding an entry in the table of contents for Sec.  1.263A-4(g).
0
16. Revising the entry in the table of contents for Sec.  1.263A-
7(a)(4).
    The revisions and additions read as follows:


Sec.  1.263A-0  Outline of regulations under section 263A.

* * * * *
Sec.  1.263A-1 Uniform Capitalization of Costs.

* * * * *
    (b) * * *
    (1) Small business taxpayers.
* * * * *
    (j) Exemption for certain small business taxpayers.
    (1) In general.
    (2) Application of the section 448(c) gross receipts test.
    (i) In general.
    (ii) Gross receipts of individuals, etc.
    (iii) Partners and S corporation shareholders.
    (iv) Examples.
    (A) Example 1
    (B) Example 2
    (3) Change in method of accounting.
    (i) In general.
    (ii) Prior section 263A method change.
    (k) Special rules
    (1) Costs provided by a related person.
    (i) In general
    (ii) Exceptions
    (2) Optional capitalization of period costs.
    (i) In general.
    (ii) Period costs eligible for capitalization.
    (3) Trade or business application
    (4) Transfers with a principal purpose of tax avoidance. [Reserved]
    (l) Change in method of accounting.
    (1) In general.
    (2) Scope limitations.
    (3) Audit protection.
    (4) Section 481(a) adjustment.
    (5) Time for requesting change.
    (m) Effective/applicability date.

Sec.  1.263A-3 Rules Relating to Property Acquired for Resale.

    (a) * * *
    (2) * * *
    (ii) Exemption for small business taxpayers.
* * * * *
    (5) De minimis production activities.
    (i) In general.
    (ii) Definition of gross receipts to determine de minimis 
production activities.
    (iii) Example.
    (b) [Reserved].
* * * * *
Sec.  1.263A-4 Rules for Property Produced in a Farming Business.

    (a) * * *
    (3) Exemption for certain small business taxpayers.
* * * * *
    (d) Election not to have section 263A apply under section 
263A(d)(3).
* * * * *
    (5) Revocation of section 263A(d)(3) election in order to apply 
exemption under section 263A(i).
    (6) Change from applying exemption under section 263A(i) to making 
a section 263A(d)(3) election.
* * * * *
    (e) * * *
    (5) Special temporary rule for citrus plants lost by reason of 
casualty.
    (f) Change in method of accounting.
* * * * *
    (g) Effective date.
    (1) In general.
    (2) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97).

Sec.  1.263A-7 Changing a method of accounting under section 263A.

    (a) * * *
    (4) Applicability dates.
    (i) In general.
    (ii) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97).
* * * * *
0
Par. 3. Section 1.263A-1 is amended by:
0
1. Revising the paragraph (a)(2) subject heading.
0
2. In paragraph (a)(2)(i), revising the second sentence and adding a 
new third sentence.
0
3. Revising paragraph (b)(1).
0
4. In the second sentence of paragraph (d)(3)(ii)(B)(1), the language 
``Sec.  1.263A-3(b)'' is removed and the language ``Sec.  1.263A-1(j)'' 
is added in its place.
0
5. Redesignating paragraphs (j) through (l) as paragraphs (k) through 
(m).
0
6. Adding a new paragraph (j).
    The revisions and addition read as follows:


Sec.  1.263A-1   Uniform capitalization of costs.

    (a) * * *
    (2) Applicability dates. (i) * * * In the case of property that is 
inventory in the hands of the taxpayer, however, these sections are 
applicable for taxable years beginning after December 31, 1993. The 
small business taxpayer exception described in paragraph (b)(1) of this 
section and set forth in paragraph (j) of this section is applicable 
for taxable years beginning after December 31, 2017. * * *
* * * * *
    (b) * * *
    (1) Small business taxpayers. For taxable years beginning after 
December 31, 2017, see section 263A(i) and paragraph (j) of this 
section for an exemption for certain small business taxpayers from the 
requirements of section 263A.
* * * * *
    (j) Exemption for certain small business taxpayers--(1) In general. 
A taxpayer, other than a tax shelter prohibited from using the cash 
receipts and disbursements method of accounting under section 
448(a)(3), that meets the gross receipts test under section 448(c) and 
Sec.  1.448-2(c) (section 448(c) gross receipts test) for any taxable 
year (small business taxpayer) is not required to capitalize costs 
under section 263A to any real or tangible personal property produced, 
and any real or personal property described in section 1221(a)(1) 
acquired for resale, during that taxable year.

[[Page 47523]]

    (2) Application of the section 448(c) gross receipts test--(i) In 
general. In the case of any taxpayer that is not a corporation or a 
partnership, and except as provided in paragraphs (j)(2)(ii) and (iii) 
of this section, the section 448(c) gross receipts test is applied in 
the same manner as if each trade or business of the taxpayer were a 
corporation or partnership.
    (ii) Gross receipts of individuals, etc. Except when the 
aggregation rules of section 448(c)(2) apply, the gross receipts of a 
taxpayer other than a corporation or partnership are the amount derived 
from all trades or businesses of such taxpayer. Amounts not related to 
a trade or business are excluded from the gross receipts of the 
taxpayer. For example, an individual taxpayer's gross receipts do not 
include inherently personal amounts, such as personal injury awards or 
settlements with respect to an injury of the individual taxpayer, 
disability benefits, Social Security benefits received by the taxpayer 
during the taxable year, and wages received as an employee that are 
reported on Form W-2.
    (iii) Partners and S corporation shareholders. Except when the 
aggregation rules of section 448(c)(2) apply, each partner in a 
partnership includes a share of the partnership's gross receipts in 
proportion to such partner's distributive share (as determined under 
section 704) of items of gross income that were taken into account by 
the partnership under section 703. Similarly, a shareholder of an S 
corporation includes such shareholder's pro rata share of S corporation 
gross receipts taken into account by the S corporation under section 
1363(b).
    (iv) Examples. The operation of this paragraph (j) is illustrated 
by the following examples:
    (A) Example 1. Taxpayer A is an individual who operates two 
separate and distinct trades or business that are reported on Schedule 
C, Profit or Loss from Business, of A's Federal income tax return. For 
2020, one trade or business has annual average gross receipts of $5 
million, and the other trade or business has average annual gross 
receipts of $35 million. Under paragraph (j)(2)(ii) of this section, 
for 2020, neither of A's trades or businesses meets the gross receipts 
test of paragraph (j)(2) of this section ($5 million + $35 million = 
$40 million, which is greater than the inflation-adjusted gross 
receipts test amount for 2020, which is $26 million).
    (B) Example 2. Taxpayer B is an individual who operates three 
separate and distinct trades or business that are reported on Schedule 
C of B's Federal income tax return. For 2020, Business X is a retail 
store with average annual gross receipts of $15 million, Business Y is 
a dance studio with average annual gross receipts of $6 million, and 
Business Z is a car repair shop with average annual gross receipts of 
$12 million. Under paragraph (j)(2)(ii) of this section, B's gross 
receipts are the combined amount derived from all three of B's trades 
or businesses. Therefore, for 2020, X, Y and Z do not meet the gross 
receipts test of paragraph (j)(2)(i) of this section ($15 million + $6 
million + $12 million = $33 million, which is greater than the 
inflation-adjusted gross receipts test amount for 2020, which is $26 
million).
    (3) Change in method of accounting--(i) In general. A change from 
applying the small business taxpayer exemption under paragraph (j) of 
this section to not applying the exemption under this paragraph (j), or 
vice versa, is a change in method of accounting under section 446(e) 
and Sec.  1.446-1(e). A taxpayer obtains the consent of the 
Commissioner to change its method of accounting to comply with 
paragraph (j) of this section by following the applicable 
administrative procedures to obtain the consent of the Commissioner to 
change a method of accounting under section 446(e) as published in the 
Internal Revenue Bulletin (See Revenue Procedure 2015-13, 2015-5 IRB 
419 (or successor) (see also Sec.  601.601(d)(2) of this chapter)). If 
an item of income or expense is not treated consistently from year to 
year, that treatment may not clearly reflect income, notwithstanding 
the application of this section. For rules relating to the clear 
reflection of income and the pattern of consistent treatment of an 
item, see section 446 and Sec.  1.446-1.
    (ii) Prior section 263A method change. A taxpayer that otherwise 
meets the requirements of paragraph (j) of this section, and that had 
previously changed its method of accounting to capitalize costs under 
section 263A because it no longer met the section 448(c) gross receipts 
test, may not change its method of accounting under section 263A to 
apply the exemption under paragraph (j) of this section without the 
consent of the Commissioner. Taxpayers must follow the administrative 
procedures to obtain the consent of the Commissioner to change a method 
of accounting under section 446(e) as published in the Internal Revenue 
Bulletin (See Revenue Procedure 2015-13, 2015-5 IRB 419 (or successor) 
(see also Sec.  601.601(d)(2) of this chapter)). For rules relating to 
the clear reflection of income and the pattern of consistent treatment 
of an item, see section 446 and Sec.  1.446-1.
* * * * *
0
Par. 4. Section 1.263A-2 is amended by:
0
1. Adding a sentence at the end of paragraph (a) introductory text.
0
2. Revising paragraph (a)(1)(ii)(C).
0
3. Revising the paragraph (g) subject heading.
0
4. Adding paragraph (g)(4).
    The additions and revisions read as follows:


Sec.  1.263A-2   Rules relating to property produced by the taxpayer.

    (a) * * * For taxable years beginning after December 31, 2017, see 
Sec.  1.263A-1(j) for an exception in the case of a small business 
taxpayer that meets the gross receipts test of section 448(c) and Sec.  
1.448-2(c).
    (1) * * *
    (ii) * * *
    (C) Home construction contracts. Section 460(e)(1) provides that 
section 263A applies to a home construction contract unless that 
contract will be completed within two years of the contract 
commencement date and, for contracts entered into after December 31, 
2017, in taxable years ending after December 31, 2017, the taxpayer 
meets the gross receipts test of section 448(c) and Sec.  1.448-2(c) 
for the taxable year in which such contract is entered into.
* * * * *
    (g) Applicability dates.* * *
    (4) The rules set forth in the last sentence of the introductory 
text of paragraph (a) of this section and in paragraph (a)(1)(ii)(C) of 
this section apply for taxable years beginning on or after [date the 
Treasury Decision adopting these proposed regulations as final is 
published in the Federal Register].
0
Par. 5. Section 1.263A-3 is amended:
0
1. In paragraph (a)(1), by revising the second sentence.
0
2. By revising paragraphs (a)(2)(ii) and (iii).
0
4. In paragraph (a)(3), by removing the language ``small reseller'' and 
adding in its place the language ``small business taxpayer''.
0
5. In paragraph (a)(4)(ii), by removing the language ``(within the 
meaning of paragraph (a)(2)(iii) of this section)'' and adding in its 
place the language ``(within the meaning of paragraph (a)(5) of this 
section)''.
0
6. By adding paragraph (a)(5).
0
7. By removing and reserving paragraph (b).
0
8. By revising paragraph (f).
    The revisions and additions read as follows:

[[Page 47524]]

Sec.  1.263A-3  Rules relating to property acquired for resale.

    (a) * * *
    (1) * * * However, for taxable years beginning after December 31, 
2017, a small business taxpayer, as defined in Sec.  1.263A-1(j), is 
not required to apply section 263A in that taxable year. * * *
    (2) * * *
    (ii) Exemption for certain small business taxpayers. For taxable 
years beginning after December 31, 2017, see Sec.  1.263A-1(j) for an 
exception in the case of a small business taxpayer that meets the gross 
receipts test of section 448(c) and Sec.  1.448-2(c).
    (iii) De minimis production activities. See paragraph (a)(5) of 
this section for rules relating to an exception for resellers with de 
minimis production activities.
* * * * *
    (5) De minimis production activities--(i) In general. In 
determining whether a taxpayer's production activities are de minimis, 
all facts and circumstances must be considered. For example, the 
taxpayer must consider the volume of the production activities in its 
trade or business. Production activities are presumed de minimis if--
    (A) The gross receipts from the sale of the property produced by 
the reseller are less than 10 percent of the total gross receipts of 
the trade or business; and
    (B) The labor costs allocable to the trade or business's production 
activities are less than 10 percent of the reseller's total labor costs 
allocable to its trade or business.
    (ii) Definition of gross receipts to determine de minimis 
production activities. Gross receipts has the same definition as for 
purposes of the gross receipts test under Sec.  1.448-2(c), except that 
gross receipts are measured at the trade-or-business level rather than 
at the single-employer level.
    (iii) Example: Reseller with de minimis production activities. 
Taxpayer N is in the retail grocery business. In 2019, N's average 
annual gross receipts for the three previous taxable years are greater 
than the gross receipts test of section 448(c). Thus, N is not exempt 
from the requirement to capitalize costs under section 263A. N's 
grocery stores typically contain bakeries where customers may purchase 
baked goods produced by N. N produces no other goods in its retail 
grocery business. N's gross receipts from its bakeries are 5 percent of 
the entire grocery business. N's labor costs from its bakeries are 3 
percent of its total labor costs allocable to the entire grocery 
business. Because both ratios are less than 10 percent, N's production 
activities are de minimis. Further, because N's production activities 
are incident to its resale activities, N may use the simplified resale 
method, as provided in paragraph (a)(4)(ii) of this section.
* * * * *
    (f) Applicability dates. (1) Paragraphs (d)(3)(i)(C)(3), 
(d)(3)(i)(D)(3), and (d)(3)(i)(E)(3) of this section apply for taxable 
years ending on or after January 13, 2014.
    (2) The rules set forth in the second sentence of paragraph (a)(1) 
of this section, paragraphs (a)(2)(ii) and (iii) of this section, the 
third sentence of paragraph (a)(3) of this section, and paragraphs 
(a)(4)(ii) and (a)(5) of this section apply for taxable years beginning 
on or after [date the Treasury Decision adopting these proposed 
regulations as final is published in the Federal Register].
0
Par. 6. Section 1.263A-4 is amended:
0
1. In paragraph (a)(1), by revising the last sentence.
0
2. In paragraph (a)(2)(ii)(A)(1), by removing the language ``section 
464(c)'' and adding in its place the language with ``section 461(k)''.
0
3. By redesignating paragraphs (a)(3) and (4) as paragraphs (a)(4) and 
(5) respectively.
0
4. By adding new paragraph (a)(3).
0
5. By revising the paragraph (d) subject heading.
0
6. In paragraph (d)(1), by revising the last sentence and adding a new 
last sentence.
0
7. In paragraph (d)(3)(i), by removing the last sentence.
0
8. By revising paragraph (d)(3)(ii).
0
9. By redesignating paragraph (d)(5) as paragraph (d)(7).
0
10. By adding new paragraph (d)(5)
0
11. By adding paragraphs (d)(6) and (e)(5).
0
12. By redesignating paragraph (f) as paragraph (g).
0
13. By adding new paragraph (f).
0
15. By revising the subject headings for newly redesignated paragraphs 
(g) and (g)(1), and revising newly designated paragraph (g)(2).
    The revisions and additions read as follows:


Sec.  1.263A-4   Rules for property produced in a farming business.

    (a) * * *
    (1) * * * Except as provided in paragraphs (a)(2), (a)(3), and (e) 
of this section, taxpayers must capitalize the costs of producing all 
plants and animals unless the election described in paragraph (d) of 
this section is made.
* * * * *
    (3) Exemption for certain small business taxpayers. For taxable 
years beginning after December 31, 2017, see Sec.  1.263A-1(j) for an 
exception in the case of a small business taxpayer that meets the gross 
receipts test of section 448(c) and Sec.  1.448-2(c).
* * * * *
    (d) Election not to have section 263A apply under section 
263A(d)(3)--(1) * * * Except as provided in paragraph (d)(5) and (6) of 
this section, the election is a method of accounting under section 446. 
An election made under section 263A(d)(3) and this paragraph (d) is 
revocable only with the consent of the Commissioner.
* * * * *
    (3) * * *
    (ii) Nonautomatic election. Except as provided in paragraphs (d)(5) 
and (6) of this section, a taxpayer that does not make the election 
under this paragraph (d) as provided in paragraph (d)(3)(i) of this 
section must obtain the consent of the Commissioner to make the 
election by filing a Form 3115, Application for Change in Method of 
Accounting, in accordance with Sec.  1.446-1(e)(3).
* * * * *
    (5) Revocation of section 263A(d)(3) election in order to apply 
exemption under section 263A(i). A taxpayer that elected under section 
263A(d)(3) and paragraph (d)(3) of this section not to have section 
263A apply to any plant produced in a farming business that wants to 
revoke its section 263A(d)(3) election, and in the same taxable year, 
apply the small business taxpayer exemption under section 263A(i) and 
Sec.  1.263A-1(j) may revoke the election in accordance with the 
applicable administrative guidance as published in the Internal Revenue 
Bulletin (see Sec.  601.601(d)(2)(ii)(b) of this chapter). A revocation 
of the taxpayer's section 263A(d)(3) election under this paragraph 
(d)(5) is not a change in method of accounting under sections 446 and 
481 and Sec. Sec.  1.446-1 and 1.481-1 through 1.481-5.
    (6) Change from applying exemption under section 263A(i) to making 
a section 263A(d)(3) election. A taxpayer whose method of accounting is 
to not capitalize costs under section 263A based on the exemption under 
section 263A(i), that becomes ineligible to use the exemption under 
section 263A(i), and is eligible and wants to elect under section 
263A(d)(3) for this same taxable year to not capitalize costs under 
section 263A for any plant produced in the taxpayer's farming business, 
must make the election in accordance with the applicable administrative 
guidance as published in the Internal Revenue Bulletin (see Sec.  
601.601(d)(2)(ii)(b) of this chapter). An election under section 
263A(d)(3) made in accordance with

[[Page 47525]]

this paragraph (d)(6) is not a change in method of accounting under 
sections 446 and 481 and Sec. Sec.  1.446-1 and 1.481-1 through 1.481-
5.
* * * * *
    (e) * * *
    (5) Special temporary rule for citrus plants lost by reason of 
casualty. Section 263A(d)(2)(A) provides that if plants bearing an 
edible crop for human consumption were lost or damaged while in the 
hands of the taxpayer by reason of freezing temperatures, disease, 
drought, pests, or casualty, section 263A does not apply to any costs 
of the taxpayer of replanting plants bearing the same type of crop 
(whether on the same parcel of land on which such lost or damaged 
plants were located or any other parcel of land of the same acreage in 
the United States). The rules of this paragraph (e)(5) apply to certain 
costs that are paid or incurred after December 22, 2017, and on or 
before December 22, 2027, to replant citrus plants after the loss or 
damage of citrus plants. Notwithstanding paragraph (e)(2) of this 
section, in the case of replanting citrus plants after the loss or 
damage of citrus plants by reason of freezing temperatures, disease, 
drought, pests, or casualty, section 263A does not apply to replanting 
costs paid or incurred by a taxpayer other than the owner described in 
section 263A(d)(2)(A) if--
    (i) The owner described in section 263A(d)(2)(A) has an equity 
interest of not less than 50 percent in the replanted citrus plants at 
all times during the taxable year in which such amounts were paid or 
incurred and the taxpayer holds any part of the remaining equity 
interest; or
    (ii) The taxpayer acquired the entirety of the equity interest in 
the land of that owner described in section 263A(d)(2)(A) and on which 
land the lost or damaged citrus plants were located at the time of such 
loss or damage, and the replanting is on such land.
    (f) Change in method of accounting. Except as provided in 
paragraphs (d)(5) and (6) of this section, any change in a taxpayer's 
method of accounting necessary to comply with this section is a change 
in method of accounting to which the provisions of sections 446 and 481 
and Sec.  1.446-1 through 1.446-7 and Sec.  1.481-1 through Sec.  
1.481-3 apply.
    (g) Applicability dates--(1) In general.* * *
    (2) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97). 
Paragraphs (a)(3), (d)(5), (d)(6), and (e)(5) of this section apply for 
taxable years ending on or after [date the Treasury Decision adopting 
these proposed regulations as final is published in the Federal 
Register]. Except as otherwise provided in this paragraph (g), for 
taxable years beginning before [date the Treasury Decision adopting 
these regulations as final is published in the Federal Register], see 
Sec.  1.263A-4 as contained in 26 CFR part 1, revised April 1, 2019.
0
Par. 7. Sec.  1.263A-7 is amended:
0
1. By revising paragraph (a)(3)(i).
0
2. By redesignating paragraph (a)(4) as paragraph (a)(4)(i).
0
3. By adding a paragraph (a)(4) subject heading.
0
4. By revising the newly designated paragraph (a)(4)(i) subject 
heading.
0
5. By adding paragraph (a)(4)(ii).
0
6. In paragraph (b)(1), by removing the language ``Rev. Proc. 97-27 
(1997-21 I.R.B.10)'' and adding in its place the language ``Revenue 
Procedure 2015-13 (2015-5 IRB 419)''.
0
7. In paragraph (b)(2)(ii), by removing the language ``Rev. Proc. 2002-
9 (2002-1 C.B. 327) and Rev. Proc. 97-27 (1991-1 C.B. 680)'' and adding 
the language ``applicable administrative procedures'' in its place.
    The revisions and additions read as follows:


Sec.  1.263A-7  Changing a method of accounting under section 263A.

    (a) * * *
    (3) * * *
    (i) For taxable years beginning after December 31, 2017, resellers 
of real or personal property or producers of real or tangible personal 
property whose average annual gross receipts for the immediately 
preceding 3-taxable-year period (or lesser period if the taxpayer was 
not in existence for the three preceding taxable years, annualized as 
required) exceed the gross receipts test of section 448(c) and the 
accompanying regulations where the taxpayer was not subject to section 
263A in the prior taxable year;
* * * * *
    (4) Applicability dates--(i) In general.* * *
    (ii) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97). 
Paragraph (a)(3)(i) of this section applies to taxable years ending on 
or after [date the Treasury Decision adopting these proposed 
regulations as final is published in the Federal Register]. Except as 
otherwise provided in this paragraph (a)(4), for taxable years 
beginning before [date the Treasury Decision adopting these regulations 
as final is published in the Federal Register], see Sec.  1.263A-
7(a)(3)(i) as contained in 26 CFR part 1, revised April 1, 2019.
* * * * *
0
Par. 8. Section 1.263A-8 is amended by adding a sentence to the end of 
paragraph (a)(1) to read as follows:


Sec.  1.263A-8   Requirement to capitalize interest.

    (a) * * *
    (1) * * * However, a taxpayer, other than a tax shelter prohibited 
from using the cash receipts and disbursements method of accounting 
under section 448(a)(3), that meets the gross receipts test of section 
448(c) for the taxable year is not required to capitalize costs, 
including interest, under section 263A. See Sec.  1.263A-1(j).
* * * * *
0
Par. 9. Section 1.263A-9 is amended by adding a sentence at the end of 
paragraph (e)(2) to read as follows:


Sec.  1.263A-9  The avoided cost method.

* * * * *
    (e) * * *
    (2) * * * A taxpayer is an eligible taxpayer for a taxable year for 
purposes of this paragraph (e) if the taxpayer is a small business 
taxpayer, as defined in Sec.  1.263A-1(j).
* * * * *
0
Par. 10. Section 1.263A-15 is amended by adding paragraph (a)(4) to 
read as follows:


Sec.  1.263A-15  Effective dates, transitional rules, and anti-abuse 
rule.

    (a) * * *
    (4) The last sentence of each of Sec.  1.263A-8(a)(1) and Sec.  
1.263A-9(e)(2) apply to taxable years beginning on or after [date the 
Treasury decision adopting these proposed regulations as final is 
published in the Federal Register]. Except as otherwise provided in 
this paragraph (a)(4), for taxable years beginning before [date the 
Treasury decision adopting these regulations as final is published in 
the Federal Register], see Sec.  1.263A-8(a)(1) and Sec.  1.263A-
9(e)(2) as contained in 26 CFR part 1, revised April 1, 2019.
* * * * *


Sec.  1.381(c)(5)-1  [Amended]

0
Par. 11. Section 1.381(c)(5)-1 is amended:
0
1. In paragraph (a)(6), by designating Examples 1 and 2 as paragraphs 
(a)(6)(i) and (ii), respectively.
0
2. In newly-designated paragraphs (a)(6)(i) and (ii), by redesignating 
the paragraphs in the first column as the paragraphs in the second 
column:

------------------------------------------------------------------------
              Old paragraphs                       New paragraphs
------------------------------------------------------------------------
(a)(6)(i)(i) and (ii).....................  (a)(6)(i)(A) and (B).
(a)(6)(ii)(i) and (ii)....................  (a)(6)(ii)(A) and (B).
------------------------------------------------------------------------


[[Page 47526]]

0
3. In newly designated paragraphs (a)(6)(ii)(A) and (B), by removing 
the language ``small reseller'' and adding in its place the language 
``small business taxpayer'' everywhere it appears.
0
Par. 12. Sec.  1.446-1 is amended:
0
1. In paragraph (a)(4)(i), by revising the first sentence.
0
2. By revising paragraph (c)(2)(i).
0
3. By adding paragraph (c)(3).
    The revisions and addition read as follows:


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

    (a) * * *
    (4) * * *
    (i) Except in the case of a taxpayer qualifying as a small business 
taxpayer for the taxable year under section 471(c), in all cases in 
which the production, purchase or sale of merchandise of any kind is an 
income-producing factor, merchandise on hand (including finished goods, 
work in progress, raw materials, and supplies) at the beginning and end 
of the year shall be taken into account in computing the taxable income 
of the year. * * *
* * * * *
    (c) * * *
    (2) * * *
    (i) In any case in which it is necessary to use an inventory, the 
accrual method of accounting must be used with regard to purchases and 
sales unless:
    (A) The taxpayer qualifies as a small business taxpayer for the 
taxable year under section 471(c), or
    (B) Otherwise authorized under paragraph (c)(2)(ii) of this 
section.
* * * * *
    (3) Applicability date. The first sentence of paragraph (a)(4)(i) 
of this section and paragraph (c)(2)(i) of this section apply to 
taxable years beginning on or after [date the Treasury Decision 
adopting these proposed regulations as final is published in the 
Federal Register]. For taxable years beginning before [date the 
Treasury Decision adopting these regulations as final is published in 
the Federal Register], see Sec.  1.446-1(c) as contained in 26 CFR part 
1, revised April 1, 2019.
* * * * *
0
Par. 13. Section1.448-1 is amended by adding new first and second 
sentences to paragraphs (g)(1) and (h)(1) to read as follows:


Sec.  1.448-1   Limitation on the use of the cash receipts and 
disbursements method of accounting.

* * * * *
    (g) * * *
    (1) * * * The rules provided in paragraph (g) of this section apply 
to taxable years beginning before January 1, 2018. See Sec.  1.448-2 
for rules relating to taxable years beginning after December 31, 2017. 
* * *
* * * * *
    (h) * * *
    (1) * * * The rules provided in paragraph (h) of this section apply 
to taxable years beginning before January 1, 2018. See Sec.  1.448-2 
for rules relating to taxable years beginning after December 31, 2017. 
* * *
* * * * *


Sec.  1.448-2  [Redesignated as Sec.  1.448-3]

0
Par. 14. Section 1.448-2 is redesignated as Sec.  1.448-3.
0
Par. 15. A new Sec.  1.448-2 is added to read as follows:


Sec.  1.448-2   Limitation on the use of the cash receipts and 
disbursements method of accounting for taxable years beginning after 
December 31, 2017.

    (a) Limitation on method of accounting--(1) In general. The rules 
of this section relate to the limitation on the use of the cash 
receipts and disbursements method of accounting (cash method) by 
certain taxpayers applicable for taxable years beginning after December 
31, 2017. For rules applicable to taxable years beginning before 
January 1, 2018, see Sec. Sec.  1.448-1 and 1.448-1T.
    (2) Limitation rule. Except as otherwise provided in this section, 
the computation of taxable income using the cash method is prohibited 
in the case of a:
    (i) C corporation;
    (ii) Partnership with a C corporation as a partner, or a 
partnership that had a C corporation as a partner at any time during 
the partnership's taxable year beginning after December 31, 1986; or
    (iii) Tax shelter.
    (3) Treatment of combination methods--(i) In general. For purposes 
of this section, the use of a method of accounting that records some, 
but not all, items on the cash method is considered the use of the cash 
method. Thus, a C corporation that uses a combination of accounting 
methods including the use of the cash method is subject to this 
section.
    (ii) Example. The following example illustrates the operation of 
this paragraph (a)(3). In 2020, A is a C corporation with average 
annual gross receipts for the prior three taxable years of greater than 
$30 million, is not a tax shelter under section 448(a)(3) and does not 
qualify as a qualified personal service corporation, as defined in 
paragraph (e) of this section. For the last 20 years, A used an accrual 
method for items of income and expenses related to purchases and sales 
of inventory, and the cash method for items related to its provision of 
services. A is using a combination of accounting methods that include 
the cash method. Thus, A is subject to section 448. A is prohibited 
from using the cash method for any item for 2020 and is required to 
change to a permissible method.
    (b) Definitions. For purposes of this section--
    (1) C corporation--(i) In general. The term C corporation means any 
corporation that is not an S corporation (as defined in section 
1361(a)(1)). For example, a regulated investment company (as defined in 
section 851) or a real estate investment trust (as defined in section 
856) is a C corporation for purposes of this section. In addition, a 
trust subject to tax under section 511(b) is treated, for purposes of 
this section, as a C corporation, but only with respect to the portion 
of its activities that constitute an unrelated trade or business. 
Similarly, for purposes of this section, a corporation that is exempt 
from Federal income taxes under section 501(a) is treated as a C 
corporation only with respect to the portion of its activities that 
constitute an unrelated trade or business. Moreover, for purposes of 
determining whether a partnership has a C corporation as a partner, any 
partnership described in paragraph (a)(2)(ii) of this section is 
treated as a C corporation. Thus, if partnership ABC has a partner that 
is a partnership with a C corporation, then, for purposes of this 
section, partnership ABC is treated as a partnership with a C 
corporation partner.
    (ii) [Reserved]
    (2) Tax shelter--(i) In general. The term tax shelter means any--
    (A) Enterprise, other than a C corporation, if at any time 
(including taxable years beginning before January 1, 1987) interests in 
such enterprise have been offered for sale in any offering required to 
be registered with any Federal or state agency having the authority to 
regulate the offering of securities for sale;
    (B) Syndicate, within the meaning of paragraph (b)(2)(iii) of this 
section, or
    (C) Tax shelter, within the meaning of section 6662(d)(2)(C).
    (ii) Requirement of registration. For purposes of paragraph 
(b)(2)(i)(A) of this section, an offering is required to be registered 
with a Federal or state agency if, under the applicable Federal or 
state law, failure to register the offering would result in a violation 
of the applicable Federal or state law; this rule applies regardless of 
whether the offering is in fact registered. In addition, an offering is 
required to be registered with a Federal or state agency if, under

[[Page 47527]]

the applicable Federal or state law, failure to file a notice of 
exemption from registration would result in a violation of the 
applicable Federal or state law, regardless of whether the notice is in 
fact filed. However, an S corporation is not treated as a tax shelter 
for purposes of section 448(d)(3) or this section merely by reason of 
being required to file a notice of exemption from registration with a 
state agency described in section 461(i)(3)(A), but only if all 
corporations offering securities for sale in the state must file such a 
notice in order to be exempt from such registration.
    (iii) Syndicate--(A) In general. For purposes of paragraph 
(b)(2)(i)(B) of this section, the term syndicate means a partnership or 
other entity (other than a C corporation) if more than 35 percent of 
the losses of such entity during the taxable year (for taxable years 
beginning after December 31, 1986) are allocated to limited partners or 
limited entrepreneurs. For purposes of this paragraph (b)(2)(iii), the 
term limited entrepreneur has the same meaning given such term in 
section 461(k)(4). In addition, in determining whether an interest in a 
partnership is held by a limited partner, or an interest in an entity 
or enterprise is held by a limited entrepreneur, section 461(k)(2) 
applies in the case of the trade or business of farming (as defined in 
paragraph (d)(2) of this section), and section 1256(e)(3)(C) applies in 
all other cases. Moreover, for purposes of paragraph (b)(2) of this 
section, the losses of a partnership, entity, or enterprise (entities) 
means the excess of the deductions allowable to the entities over the 
amount of income recognized by such entities under the entities' method 
of accounting used for Federal income tax purposes (determined without 
regard to this section). For this purpose, gains or losses from the 
sale of capital assets or assets described in section 1221(a)(2) are 
not taken into account.
    (B) Election to test the allocation of losses from prior taxable 
year. For purposes of paragraph (b)(2)(iii)(A) of this section, to 
determine if more than 35 percent of the losses of a venture are 
allocated to limited partners or limited entrepreneurs, instead of 
using the current taxable year's allocation of losses, entities may 
elect to use the allocations made in the immediately preceding taxable 
year instead of using the current taxable year's allocation. An 
election under this paragraph (b)(2)(iii)(B) applies to the first 
taxable year for which the election is made and to all subsequent 
taxable years, unless the Commissioner of Internal Revenue or his 
delegate (Commissioner) permits a revocation of the election in 
accordance with this paragraph. An election under this paragraph 
(b)(2)(iii)(B) may never be revoked earlier than the fifth taxable year 
following the first taxable year for which the election was made unless 
extraordinary circumstances are demonstrated to the satisfaction of the 
Commissioner. Once an election has been revoked, a new election under 
this paragraph (b)(2)(iii)(B) cannot be made until the fifth taxable 
year following the taxable year for which the previous election was 
revoked unless extraordinary circumstances are demonstrated to the 
satisfaction of the Commissioner. A taxpayer making this election must 
attach a statement to its timely filed Federal income tax return 
(including extension) that this election is made beginning with that 
taxable year. If such a statement is not attached, the election is not 
valid and has no effect for any purpose. No late elections will be 
permitted. Further, an election cannot be made by filing an amended 
Federal income tax return. In addition to section 448, this election 
also applies for purposes of all provisions of the Code that refer to 
section 448(a)(3) to define tax shelter. An election made under this 
paragraph (b)(2)(iii)(B) may only be revoked with the written consent 
of the Commissioner. Requests for consent must follow the applicable 
administrative procedures for requesting a letter ruling (for example, 
see Revenue Procedure 2020-1, 2020-01 IRB 1 (or its successor)).
    (C) Example. Taxpayer B is a calendar year limited partnership, 
with no active management from its limited partner. In 2019, B is 
profitable and allocates 80 percent of its profits to its general 
partner and 20 percent of its profits to its limited partner. In 2020, 
B has a loss and allocates 60 percent of losses to its general partner 
and 40 percent of its losses to its limited partner. In 2020 B makes an 
election under paragraph (b)(2)(iii)(B) of this section to use its 
prior year allocated amounts. For 2020, B is not a syndicate because B 
is treated as having allocated 20 percent of its profits to its limited 
partner in 2020 for purposes of paragraph (b)(2)(iii) of this section. 
For 2021, B is a syndicate because B is treated as having allocated 40 
percent of its losses to its limited partner for purposes of paragraph 
(b)(2)(iii) of this section.
    (iv) Presumed tax avoidance. For purposes of (b)(2)(i)(C) of this 
section, marketed arrangements in which persons carrying on farming 
activities using the services of a common managerial or administrative 
service will be presumed to have the principal purpose of tax avoidance 
if such persons use borrowed funds to prepay a substantial portion of 
their farming expenses (for example, payment for farm supplies that 
will not be used or consumed until a taxable year subsequent to the 
taxable year of payment).
    (v) Taxable year tax shelter must change accounting method. A tax 
shelter must change from the cash method for the taxable year that it 
becomes a tax shelter, as determined under paragraph (b)(2) of this 
section.
    (vi) Determination of loss amount. For purposes of section 
448(d)(3), the amount of losses to be allocated under section 
1256(e)(3)(B) is calculated without regard to section 163(j).
    (c) Exception for entities with gross receipts not in excess of the 
amount provided in section 448(c)--(1) In general. Except in the case 
of a tax shelter, this section does not apply to any C corporation or 
partnership with a C corporation as a partner for any taxable year if 
such corporation or partnership (or any predecessor thereof) meets the 
gross receipts test of paragraph (c)(2) of this section.
    (2) Gross receipts test--(i) In general. A corporation meets the 
gross receipts test of this paragraph (c)(2) if the average annual 
gross receipts of such corporation for the 3 taxable years (or, if 
shorter, the taxable years during which such corporation was in 
existence, annualized as required) ending with such prior taxable year 
does not exceed the gross receipts test amount provided in paragraph 
(c)(2)(v) of this section (section 448(c) gross receipts test). In the 
case of a C corporation exempt from Federal income taxes under section 
501(a), or a trust subject to tax under section 511(b) that is treated 
as a C corporation under paragraph (b)(1) of this section, only gross 
receipts from the activities of such corporation or trust that 
constitute unrelated trades or businesses are taken into account in 
determining whether the gross receipts test is satisfied. A partnership 
with a C corporation as a partner meets the gross receipts test of 
paragraph (c)(2) of this section if the average annual gross receipts 
of such partnership for the 3 taxable years (or, if shorter, the 
taxable years during which such partnership was in existence annualized 
as required) ending with such prior year does not exceed the gross 
receipts test amount of paragraph (c)(2)(v) of this section. Except as 
provided in paragraph (c)(2)(ii) of this section, the gross receipts of 
the corporate partner are not taken into account in determining whether 
a partnership meets the gross

[[Page 47528]]

receipts test of paragraph (c)(2) of this section.
    (ii) Aggregation of gross receipts. The aggregation rules in Sec.  
1.448-1T(f)(2)(ii) apply for purposes of aggregating gross receipts for 
purposes of this section.
    (iii) Treatment of short taxable year. The short taxable year rules 
in Sec.  1.448-1T(f)(2)(iii) apply for purposes of this section.
    (iv) Determination of gross receipts. The determination of gross 
receipts rules in Sec.  1.448-1T(f)(2)(iv) apply for purposes of this 
section.
    (v) Gross receipts test amount--(A) In general. For purposes of 
paragraph (c) of this section, the term gross receipts test amount 
means $25,000,000, adjusted annually for inflation in the manner 
provided in section 448(c)(4). The inflation adjusted gross receipts 
test amount is published annually in guidance published in the Internal 
Revenue Bulletin (see Sec.  601.601(d)(2)(ii) of this chapter).
    (B) Example. Taxpayer A, a C corporation, is a plumbing contractor 
that installs plumbing fixtures in customers' homes or businesses. A's 
gross receipts for the 2017-2019 taxable years are $20 million, $16 
million, and $30 million, respectively. A's average annual gross 
receipts for the three taxable-year period preceding the 2020 taxable 
year is $22 million (($20 million + $16 million + $30 million)/3 = $22 
million. A may use the cash method for its trade or business for the 
2020 taxable year because its average annual gross receipts for the 
preceding three taxable years is not more than the gross receipts test 
amount of paragraph (c)(2)(vi) of this section, which is $26 million 
for 2020.
    (d) Exception for farming businesses--(1) In general. Except in the 
case of a tax shelter, this section does not apply to any farming 
business. A taxpayer engaged in a farming business and a separate non-
farming business is not prohibited by this section from using the cash 
method with respect to the farming business, even though the taxpayer 
may be prohibited by this section from using the cash method with 
respect to the non-farming business.
    (2) Farming business--(i) In general. For purposes of paragraph (d) 
of this section, the term farming business means--
    (A) The trade or business of farming as defined in section 
263A(e)(4) (including the operation of a nursery or sod farm, or the 
raising or harvesting of trees bearing fruit, nuts or other crops, or 
ornamental trees),
    (B) The raising, harvesting, or growing of trees described in 
section 263A(c)(5) (relating to trees raised, harvested, or grown by 
the taxpayer other than trees described in paragraph (d)(2)(i)(A) of 
this section),
    (C) The raising of timber, or
    (D) Processing activities which are normally incident to the 
growing, raising, or harvesting of agricultural products.
    (ii) Example. Assume a taxpayer is in the business of growing 
fruits and vegetables. When the fruits and vegetables are ready to be 
harvested, the taxpayer picks, washes, inspects, and packages the 
fruits and vegetables for sale. Such activities are normally incident 
to the raising of these crops by farmers. The taxpayer will be 
considered to be in the business of farming with respect to the growing 
of fruits and vegetables, and the processing activities incident to the 
harvest.
    (iii) Processing activities excluded from farming businesses--(A) 
In general. For purposes of this section, a farming business does not 
include the processing of commodities or products beyond those 
activities normally incident to the growing, raising, or harvesting of 
such products.
    (B) Examples. (1) Example 1. Assume that a C corporation taxpayer 
is in the business of growing and harvesting wheat and other grains. 
The taxpayer processes the harvested grains to produce breads, cereals, 
and similar food products which it sells to customers in the course of 
its business. Although the taxpayer is in the farming business with 
respect to the growing and harvesting of grain, the taxpayer is not in 
the farming business with respect to the processing of such grains to 
produce breads, cereals, and similar food products which the taxpayer 
sells to customers.
    (2) Example 2. Assume that a taxpayer is in the business of raising 
livestock. The taxpayer uses the livestock in a meat processing 
operation in which the livestock are slaughtered, processed, and 
packaged or canned for sale to customers. Although the taxpayer is in 
the farming business with respect to the raising of livestock, the 
taxpayer is not in the farming business with respect to the meat 
processing operation.
    (e) Exception for qualified personal service corporation. The rules 
in Sec.  1.448-1T(e) relating to the exception for qualified personal 
service corporations apply for taxable years beginning after December 
31, 2017.
    (f) Effect of section 448 on other provisions. Except as provided 
in paragraph (b)(2)(iii)(B) of this section, nothing in section 448 
shall have any effect on the application of any other provision of law 
that would otherwise limit the use of the cash method, and no inference 
shall be drawn from section 448 with respect to the application of any 
such provision. For example, nothing in section 448 affects the 
requirement of section 447 that certain corporations must use an 
accrual method of accounting in computing taxable income from farming, 
or the requirement of Sec.  1.446-1(c)(2) that, in general, an accrual 
method be used with regard to purchases and sales of inventory. 
Similarly, nothing in section 448 affects the authority of the 
Commissioner under section 446(b) to require the use of an accounting 
method that clearly reflects income, or the requirement under section 
446(e) that a taxpayer secure the consent of the Commissioner before 
changing its method of accounting. For example, a taxpayer using the 
cash method may be required to change to an accrual method of 
accounting under section 446(b) because such method clearly reflects 
the taxpayer's income, even though the taxpayer is not prohibited by 
section 448 from using the cash method. Similarly, a taxpayer using an 
accrual method of accounting that is not prohibited by section 448 from 
using the cash method may not change to the cash method unless the 
taxpayer secures the consent of the Commissioner under section 446(e).
    (g) Treatment of accounting method change and rules for section 
481(a) adjustment--(1) In general. Any taxpayer to whom section 448 
applies must change its method of accounting in accordance with the 
provisions of this paragraph (g). In the case of any taxpayer required 
by this section to change its method of accounting for any taxable 
year, the change shall be treated as a change initiated by the 
taxpayer. A taxpayer must change to an overall accrual method of 
accounting for the first taxable year the taxpayer is subject to this 
section or a subsequent taxable year in which the taxpayer is newly 
subject to this section after previously making a change in method of 
accounting that complies with section 448 (mandatory section 448 year). 
A taxpayer may have more than one mandatory section 448 year. For 
example, a taxpayer may exceed the gross receipts test of section 
448(c) in non-consecutive taxable years. If the taxpayer complies with 
the provisions of paragraph (g)(3) of this section for its mandatory 
section 448 year, the change shall be treated as made with the consent 
of the Commissioner. The change shall be implemented pursuant to the 
applicable administrative procedures to obtain the automatic

[[Page 47529]]

consent of the Commissioner to change a method of accounting under 
section 446(e) as published in the Internal Revenue Bulletin (See 
Revenue Procedure 2015-13, 2015-5 IRB 419 (or successor) (see Sec.  
601.601(d)(2) of this chapter)). This paragraph (g) applies only to a 
taxpayer who changes from the cash method as required by this section. 
This paragraph (g) does not apply to a change in method of accounting 
required by any Code section (or applicable regulation) other than this 
section.
    (2) Section 481(a) adjustment. The amount of the net section 481(a) 
adjustment and the adjustment period necessary to implement a change in 
method of accounting required under this section are determined under 
Sec.  1.446-1(e) and the applicable administrative procedures to obtain 
the Commissioner's consent to change a method of accounting as 
published in the Internal Revenue Bulletin (see also Sec.  
601.601(d)(2) of this chapter).
    (3) Prior change in overall method of accounting under this 
section. A taxpayer that otherwise meets the requirements of paragraph 
(c) of this section, and that had during any of the five taxable years 
ending with the taxable year changed its overall method of accounting 
from the cash method because it no longer met the gross receipts test 
of section 448(c) provided under paragraph (c) of this section or 
because it was a tax shelter as provided under paragraph (b)(2) of this 
section, may not change its overall method of accounting back to the 
cash method without the written consent of the Commissioner. Requests 
for consent must follow the applicable administrative procedures to 
obtain the written consent of the Commissioner to change a method of 
accounting under section 446(e) as published in the Internal Revenue 
Bulletin (see also Sec.  601.601(d)(2) of this chapter). For rules 
relating to the clear reflection of income and the pattern of 
consistent treatment of an item, see section 446 and Sec.  1.446-1.
    (h) Applicability dates. The rules of this section apply for 
taxable years beginning on or after [date the Treasury Decision 
adopting these proposed regulations as final is published in the 
Federal Register].
0
Par. 16. Newly redesignated Sec.  1.448-3 is amended by revising 
paragraphs (a)(2) and (h) to read as follows:


Sec.  1.448-3  Nonaccrual of certain amounts by service providers.

    (a) * * *
    (2) The taxpayer meets the gross receipts test of section 448(c) 
and Sec.  1.448-1T(f)(2) (in the case of taxable years beginning before 
January 1, 2018), or Sec.  1.448-2(c) (in the case of taxable years 
beginning after December 31, 2017) for all prior taxable years.
* * * * *
    (h) Applicability dates. (1) Except as provided in paragraph (h)(2) 
of this section, this section is applicable for taxable years ending on 
or after August 31, 2006. (2) The rules of paragraph (a)(2) of this 
section apply for taxable years beginning on or after [date the 
Treasury Decision adopting these proposed regulations as final is 
published in the Federal Register]. For taxable years beginning before 
[date the Treasury Decision adopting these regulations as final is 
published in the Federal Register], see Sec.  1.448-2 as contained in 
26 CFR part 1, revised April 1, 2019.
0
Par. 17. Section 1.460-0 is amended by:
0
1. Adding an entry for Sec.  1.460-1(h)(3).
0
2. Revising the entries for Sec.  1.460-3(b)(3), Sec.  1.460-3(b)(3)(i) 
and (ii), and adding entries for Sec.  1.460-3(b)(3)(ii)(A), (B), (C) 
and (D).
0
3. Removing the entry for Sec.  1.460-3(b)(3)(iii).
0
4. Adding entries for Sec.  1.460-3(d), Sec.  1.460-4(i), and Sec.  
1.460-6(k).
    The additions and revisions read as follows:


Sec.  1.460-0  Outline of regulations under section 460.

* * * * *
Sec.  1.460-1 Long-term contracts.

* * * * *
    (h) * * *
    (3) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97).
* * * * *
Sec.  1.460-3 Long-term construction contracts.

* * * * *
    (b) * * *
    (3) Gross receipts test of section 448(c)
    (i) In general
    (ii) Application of gross receipts test
    (A) In general
    (B) Gross receipts of individuals, etc.
    (C) Partners and S corporation shareholders
    (D) Examples
    (1) Example 1.
    (2) Example 2.
* * * * *
    (d) Applicability dates.

Sec.  1.460-4 Methods of Accounting for long-term contracts.

* * * * *
    (i) Applicability date.
* * * * *
Sec.  1.460-6 Look-back method.

* * * * *
    (k) Applicability date.


Sec.  1.460-1  

0
Par. 18. Section 1.460-1 is amended by adding three sentences to the 
end of paragraph (f)(3) and adding paragraph (h)(3) to read as follows:


Sec.  1.460-1   Long-term contracts.

    (f) * * *
    (3) * * * A taxpayer may adopt any permissible method of accounting 
for each classification of contract. Such adoption is not a change in 
method of accounting under section 446 and the accompanying 
regulations. For example, a taxpayer that has had only contracts 
classified as nonexempt long-term contracts and has used the PCM for 
these contracts may adopt an exempt contract method in the taxable year 
it first enters into an exempt long-term contract.
* * * * *
    (h) * * *
    (3) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97). 
Paragraph (f)(3) of this section, and Sec.  1.460-5(d)(1) and (d)(3), 
apply for taxable years beginning on or after [date the Treasury 
Decision adopting these proposed regulations as final is published in 
the Federal Register].
* * * * *
0
Par. 19. Section 1.460-3 is amended by revising paragraphs (b)(1)(ii) 
and (b)(3) and adding paragraph (d) to read as follows:


Sec.  1.460-3   Long-term construction contracts.

* * * * *
    (b) * * *
    (1) * * *
    (ii) Other construction contract, entered into after December 31, 
2017, in a taxable year ending after December 31, 2017, by a taxpayer, 
other than a tax shelter prohibited from using the cash receipts and 
disbursements method of accounting (cash method) under section 
448(a)(3), who estimates at the time such contract is entered into that 
such contract will be completed within the 2-year period beginning on 
the contract commencement date, and who meets the gross receipts test 
described in paragraph (b)(3) of this section.
    (3) Gross receipts test of section 448(c)--(i) In general. A 
taxpayer, other than a tax shelter prohibited from using the cash 
method under section 448(a)(3), satisfies the gross receipts test of 
this paragraph (b)(3) if it meets the gross receipts test of section 
448(c) and Sec.  1.448-2(c)(2).
    (ii) Application of gross receipts test--(A) In general. In the 
case of any taxpayer that is not a corporation or a

[[Page 47530]]

partnership, and except as provided in paragraphs (b)(3)(ii)(B) and (C) 
of this section, the gross receipts test of section 448(c) and the 
accompanying regulations are applied in the same manner as if each 
trade or business of such taxpayer were a corporation or partnership.
    (B) Gross receipts of individuals, etc. Except when the aggregation 
rules of section 448(c)(2) apply, the gross receipts of a taxpayer 
other than a corporation or partnership are the amount derived from all 
trades or businesses of such taxpayer. Amounts not related to a trade 
or business are excluded from the gross receipts the taxpayer. For 
example, an individual taxpayer's gross receipts do not include 
inherently personal amounts, such as personal injury awards or 
settlements with respect to an injury of the individual taxpayer, 
disability benefits, Social Security benefits received by the taxpayer 
during the taxable year, and wages received as an employee that are 
reported on Form W-2.
    (C) Partners and S corporation shareholders. Except when the 
aggregation rules of section 448(c)(2) apply, each partner in a 
partnership includes a share of partnership gross receipts in 
proportion to such partner's distributive share (as determined under 
section 704) of items of gross income that were taken into account by 
the partnership under section 703. Similarly, a shareholder includes 
the pro rata share of S corporation gross receipts taken into account 
by the S corporation under section 1363(b).
    (D) Example. The operation of this paragraph (b)(3) is illustrated 
by the following examples:
    (1) Example 1. Taxpayer A is an individual who operates two 
separate and distinct trades or business that are reported on Schedule 
C, Profit or Loss from Business, of A's Federal income tax return. For 
2020, one trade or business has annual average gross receipts of $5 
million, and the other trade or business has average annual gross 
receipts of $35 million. Under paragraph (b)(3)(ii)(B) of this section, 
for 2020, neither of A's trades or businesses meets the gross receipts 
test of paragraph (b)(3) of this section ($5 million + $35 million = 
$40 million, which is greater than the inflation-adjusted gross 
receipts test amount for 2020, which is $26 million).
    (2) Example 2. Taxpayer B is an individual who operates three 
separate and distinct trades or business that are reported on Schedule 
C of B's Federal income tax return. For 2020, Business X is a retail 
store with average annual gross receipts of $15 million, Business Y is 
a dance studio with average annual gross receipts of $6 million, and 
Business Z is a car repair shop with average annual gross receipts of 
$12 million. Under paragraph (b)(3)(ii)(B) of this section, B's gross 
receipts are the combined amount derived from all three of B's trades 
or businesses. Therefore, for 2020, X, Y and Z do not meet the gross 
receipts test of paragraph (b)(3)(i) of this section ($15 million + $6 
million + $12 million = $33 million, which is greater than the 
inflation-adjusted gross receipts test amount for 2020, which is $26 
million).
* * * * *
    (d) Applicability Dates. Paragraphs (b)(1)(ii) and (b)(3) of this 
section apply, for taxable years beginning on or after [date the 
Treasury Decision adopting these proposed regulations as final is 
published in the Federal Register]. For contracts entered into before 
January 1, 2018, see Sec.  1.460-3(b)(1)(ii) and (b)(3) as contained in 
26 CFR part 1, revised April 1, 2019.
0
Par. 20. Section 1.460-4 is amended by revising the first sentence of 
paragraph (f)(1) and adding paragraph (i) to read as follows:


Sec.  1.460-4   Methods of Accounting for long-term contracts.

    (f) * * *
    (1) * * * Under section 56(a)(3), a taxpayer subject to the AMT 
must use the PCM to determine its AMTI from any long-term contract 
entered into on or after March 1, 1986, that is not a home construction 
contract, as defined in Sec.  1.460-3(b)(2). * * *
* * * * *
    (i) Applicability date. Paragraph (f)(1) of this section applies 
for taxable years beginning on or after [date the Treasury Decision 
adopting these proposed regulations as final is published in the 
Federal Register]. For taxable years beginning before January 1, 2018, 
see Sec.  1.460-4(f)(1) as contained in 26 CFR part 1, revised April 1, 
2019.
* * * * *
0
Par. 21. Section 1.460-5 is amended:
0
1. In paragraph (d)(1), by removing the language ``(concerning 
contracts of homebuilders that do not satisfy the $10,000,000 gross 
receipts test described in Sec.  1.460-3(b)(3) or will not be completed 
within two years of the contract commencement date)''.
0
2. By revising paragraph (d)(3).
    The revision reads as follows:


Sec.  1.460-5   Cost allocation rules.

* * * * *
    (d) * * *
    (3) Large homebuilders. A taxpayer must capitalize the costs of 
home construction contracts under section 263A, unless the taxpayer 
estimates, when entering into the contract, that it will be completed 
within two years of the contract commencement date, and the taxpayer 
satisfies the gross receipts test of section 448(c) described in Sec.  
1.460-3(b)(3) for the taxable year in which the contract is entered 
into.
* * * * *
0
Par. 22. Section 1.460-6 is amended:
0
1. In paragraph (b)(2) introductory text, by removing the language 
``section 460(e)(4)'' and adding in its place the language ``section 
460(e)(3)''.
0
2. By revising the first and last sentences of paragraph (b)(2)(ii).
0
3. By designating the undesignated text after paragraph (b)(3)(ii) as 
paragraph (b)(3)(iii).
0
4. In newly designated paragraph (b)(3)(iii), by adding a sentence to 
the end of the paragraph.
0
5. In paragraph (c)(1)(i), by revising the fifth sentence.
0
6. In paragraph (c)(2)(i), by revising the third sentence.
0
7. In paragraph (c)(2)(iv), by revising the first sentence.
0
8. In paragraph (c)(3)(ii), by revising the first sentence.
0
9. In paragraph (c)(3)(vi), by revising the first sentence.
0
10. In paragraph (d)(2)(i), by removing the language ``whether or not 
the taxpayer would have been subject to the alternative minimum tax'' 
and adding in its place the language ``for taxpayers subject to the 
alternative minimum tax without regard to whether tentative minimum tax 
exceeds regular tax for the redetermination year''.
0
11. By revising paragraph (d)(4)(i)(A).
0
12. By designating paragraph (h)(8)(ii) Example 7 as paragraph 
(h)(8)(iii).
0
13. By revising newly designated paragraph (h)(8)(iii).
0
14. By adding paragraph (k).
    The revisions and additions read as follows:


Sec.  1.460-6   Look-back method.

* * * * *
    (b) * * *
    (2) * * *
    (ii) is not a home construction contract but is estimated to be 
completed within a 2-year period by a taxpayer, other than a tax 
shelter prohibited from using the cash receipts and disbursements 
method of accounting under section 448(a)(3), who meets the gross 
receipts test of section 448(c) and Sec.  1.460-3(b)(3) for the taxable 
year in which such contract is entered into. * * * The look-back 
method, however, applies to the alternative minimum taxable income from 
a contract of this type, for those taxpayers subject to the AMT in 
taxable

[[Page 47531]]

years prior to the filing taxable year in which the look-back method is 
required, unless the contract is exempt from required use of the 
percentage of completion method under section 56(a)(3).
    (3) * * *
    (iii) * * * For contracts entered into after December 31, 2017, in 
a taxable year ending after December 31, 2017, a taxpayer's gross 
receipts are determined in the manner required by regulations under 
section 448(c).
* * * * *
    (c) * * *
    (1) * * *
    (i) * * * Based on this reapplication, the taxpayer determines the 
amount of taxable income (and, when applicable, alternative minimum 
taxable income and modified taxable income under section 59A(c)) that 
would have been reported for each year prior to the filing year that is 
affected by contracts completed or adjusted in the filing year if the 
actual, rather than estimated, total contract price and costs had been 
used in applying the percentage of completion method to these 
contracts, and to any other contracts completed or adjusted in a year 
preceding the filing year. * * *
* * * * *
    (2) * * *
    (i) * * * The taxpayer then must determine the amount of taxable 
income (and, when applicable, alternative minimum taxable income and 
modified taxable income under section 59A(c)) that would have been 
reported for each affected tax year preceding the filing year if the 
percentage of completion method had been applied on the basis of actual 
contract price and contract costs in reporting income from all 
contracts completed or adjusted in the filing year and in any preceding 
year. * * *
* * * * *
    (iv) * * * In general, because income under the percentage of 
completion method is generally reported as costs are incurred, the 
taxable income and, when applicable, alternative minimum taxable income 
and modified taxable income under section 59A(c), are recomputed only 
for each year in which allocable contract costs were incurred. * * *
* * * * *
    (3) * * *
    (ii) * * * Under the method described in this paragraph (c)(3) 
(actual method), a taxpayer first must determine what its regular and, 
when applicable, its alternative minimum tax and base erosion minimum 
tax liability would have been for each redetermination year if the 
amounts of contract income allocated in Step One for all contracts 
completed or adjusted in the filing year and in any prior year were 
substituted for the amounts of contract income reported under the 
percentage of completion method on the taxpayer's original return (or 
as subsequently adjusted on examination, or by amended return). * * *
* * * * *
    (vi) * * * For purposes of Step Two, the income tax liability must 
be redetermined by taking into account all applicable additions to tax, 
credits, and net operating loss carrybacks and carryovers. Thus, the 
taxes, if any, imposed under sections 55 and 59A (relating to 
alternative and base erosion minimum tax, respectively) must be taken 
into account. * * *
* * * * *
    (d) * * *
    (4) * * *
    (i) * * *
    (A) General rule. The simplified marginal impact method is required 
to be used with respect to income reported from domestic contracts by a 
pass-through entity that is either a partnership, an S corporation, or 
a trust, and that is not closely held. With respect to contracts 
described in the preceding sentence, the simplified marginal impact 
method is applied by the pass-through entity at the entity level. The 
pass-through entity determines the amount of any hypothetical 
underpayment or overpayment for a redetermination year using the 
highest rate of tax in effect for corporations under section 11. 
However, for redetermination years beginning before January 1, 2018, 
the pass-through entity uses the highest rates of tax in effect for 
corporations under section 11 and section 55(b)(1). Further, the pass-
through entity uses the highest rates of tax imposed on individuals 
under section 1 and section 55(b)(1) if, at all times during the 
redetermination year involved (that is, the year in which the 
hypothetical increase or decrease in income arises), more than 50 
percent of the interests in the entity were held by individuals 
directly or through 1 or more pass-through entities.
* * * * *
    (h) * * *
    (8) * * *
    (iii) Example 7. X, a calendar year C corporation, is engaged in 
the construction of real property under contracts that are completed 
within a 24-month period. Its average annual gross receipts for the 
prior 3-taxable-year period does not exceed $25,000,000. As permitted 
by section 460(e)(1)(B), X uses the completed contract method (CCM) for 
regular tax purposes. However, X is engaged in the construction of 
commercial real property and, for years beginning before January 1, 
2018, is required to use the percentage of completion method (PCM) for 
alternative minimum tax (AMT) purposes. Assume that for 2017, 2018, and 
2019, X has only one long-term contract, which is entered into in 2017 
and completed in 2019 and that in 2017 X's average annual gross 
receipts for the prior 3-taxable-years do not exceed $10,000,000. 
Assume further that X estimates gross income from the contract to be 
$2,000, total contract costs to be $1,000, and that the contract is 25 
percent complete in 2017 and 70 percent complete in 2018, and 5 percent 
complete in 2019. In 2019, the year of completion, gross income from 
the contract is actually $3,000, instead of $2,000, and costs are 
actually $1,000. Because X was required to use the PCM for 2017 for AMT 
purposes, X must apply the look-back method to its AMT reporting for 
that year. X has elected to use the simplified marginal impact method. 
For 2017, X's income using estimated contract price and costs is as 
follows:

                    Table 1 to Paragraph (h)(8)(iii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Estimates.................................  2017
Gross Income..............................  $500 = ($2,000 x 25%)
Deductions................................  $(250) = ($1,000 x 25%)
Contract Income-PCM.......................  $250
------------------------------------------------------------------------

    (A) When X files its federal income tax return for 2019, the 
contract completion year, X applies the look-back method. For 2017, X's 
income using actual contract price and costs is as follows:

                   Table 2 to Paragraph (h)(8)(iii)(A)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Actual....................................  2017
Gross Income..............................  $750 = ($3,000 x 25%)
Deductions................................  $(250) = ($1,000 x 25%)
Contract Income-PCM.......................  $500
------------------------------------------------------------------------

    (B) Accordingly, the reallocation of contract income under the 
look-back method results in an increase of income for AMT purposes for 
2017 of $250 ($500 - $250). Under the simplified marginal impact 
method, X applies the highest rate of tax under section 55(b)(1) to 
this increase, which produces a hypothetical underpayment for 2017 of 
$50 (.20 x $250). Interest is charged to X on this $50 underpayment 
from the

[[Page 47532]]

due date of X's 2017 return until the due date of X's 2019 return. X, a 
C corporation, is not subject to the AMT in 2018. X does not compute 
alternative minimum taxable income or use the PCM in that year. 
Accordingly, look-back does not apply to 2018.
* * * * *
    (k) Applicability date. Paragraphs (b)(2), (b)(2)(ii), (b)(3)(ii), 
(c)(1)(i), (c)(2)(i), (c)(2)(iv), (c)(3)(ii), (c)(3)(vi), (d)(2)(i), 
(d)(4)(i)(A), and (h)(8)(iii) of this section, apply for taxable years 
beginning on or after [date the Treasury decision adopting these 
proposed regulations as final is published in the Federal Register]. 
For taxable years beginning before January 1, 2018, see Sec. Sec.  
1.460-6(b)(2), 1.460-6(b)(2)(ii), 1.460-6(b)(3)(ii), 1.460-6(c)(1)(i), 
1.460-6(c)(2)(i) and (iv), 1.460-6(c)(3)(ii) and (vi), 1.460-
6(d)(2)(i), 1.460-6(d)(4)(i)(A), and 1.460-6(h)(8)(iii) as contained in 
26 CFR part 1, revised April 1, 2019.
0
Par. 23. Sec.  1.471-1 is amended by:
0
1. Designating the undesignated paragraph as paragraph (a).
0
2. Adding a heading to newly designated paragraph (a) and revising the 
first sentence.
0
3. Adding paragraph (b).
    The revision and addition read as follows:


Sec.  1.471-1   Need for inventories.

    (a) In general. Except as provided in paragraph (b) of this 
section, in order to reflect taxable income correctly, inventories at 
the beginning and end of each taxable year are necessary in every case 
in which the production, purchase, or sale of merchandise is an income-
producing factor. * * *
    (b) Exemption for certain small business taxpayers--(1) In general. 
Paragraph (a) of this section shall not apply to a taxpayer, other than 
a tax shelter prohibited from using the cash receipts and disbursements 
method of accounting (cash method) under section 448(a)(3), in any 
taxable year if the taxpayer meets the gross receipts test provided in 
paragraph (b)(2) of this section, and uses as a method of accounting 
for its inventory a method that is described in paragraph (b)(3) of 
this section.
    (2) Gross receipts test--(i) In general. A taxpayer, other than a 
tax shelter prohibited from using the cash method under section 
448(a)(3), meets the gross receipts test of paragraph (b)(1) of this 
section if it meets the gross receipts test of section 448(c) and Sec.  
1.448-2(c). The gross receipts test applies to determine whether a 
taxpayer is eligible to use the exemption provided in paragraph (b) of 
this section even if the taxpayer is not otherwise subject to section 
448(a).
    (ii) Application of the gross receipts test--(A) In general. In the 
case of any taxpayer that is not a corporation or partnership, and 
except as otherwise provided in paragraphs (b)(2)(ii)(B) and (C) of 
this section, the gross receipts test of section 448(c) and the 
accompanying regulations are applied in the same manner as each trade 
or business of the taxpayer were a corporation or partnership.
    (B) Gross receipts of individuals, etc. Except when the aggregation 
rules of section 448(c)(2) apply, the gross receipts of a taxpayer 
other than a corporation or partnership are the amount derived from all 
trades or businesses of such taxpayer. Amounts not related to a trade 
or businesses are excluded from the gross receipts of the taxpayer. For 
example, an individual taxpayer's gross receipts do not include 
inherently personal amounts, such as: personal injury awards or 
settlements with respect to an injury of the individual taxpayer, 
disability benefits, Social Security benefits received by the taxpayer 
during the taxable year, and wages received as an employee that are 
reported on Form W-2.
    (C) Partners and S corporation shareholders--(1) In general. Except 
when the aggregation rules of section 448(c)(2) apply, each partner in 
a partnership includes a share of the partnership's gross receipts in 
proportion to such partner's distributive share (as determined under 
section 704) of items of gross income that were taken into account by 
the partnership under section 703. Similarly, a shareholder includes 
the pro rata share of S corporation gross receipts taken into account 
by the S corporation under section 1363(b).
    (2) [Reserved]
    (D) Examples. The operation of this paragraph (b)(2) is illustrated 
by the following examples:
    (1) Example 1. Taxpayer A, a calendar year S corporation, is a 
reseller and maintains inventories. In 2017, 2018, and 2019, S's gross 
receipts were $10 million, $11 million, and $13 million respectively. A 
is not prohibited from using the cash method under section 448(a)(3). 
For 2020, A meets the gross receipts test of paragraph (b)(2) of this 
section.
    (2) Example 2. Taxpayer B operates two separate and distinct trades 
or businesses that are reported on Schedule C, Profit or Loss from 
Business, of B's Federal income tax return. For 2020, one trade or 
business has annual average gross receipts of $5 million, and the other 
trade or business has average annual gross receipts of $35 million. 
Under paragraph (b)(2)(ii)(B) of this section, for 2020, neither of B's 
trades or businesses meets the gross receipts test of paragraph (b)(2) 
of this section ($5 million + $35 million = $40 million, which is 
greater than the inflation-adjusted gross receipts test amount for 
2020, which is $26 million).
    (3) Example 3. Taxpayer C is an individual who operates three 
separate and distinct trades or business that are reported on Schedule 
C of C's Federal income tax return. For 2020, Business X is a retail 
store with average annual gross receipts of $15 million, Business Y is 
a dance studio with average annual gross receipts of $6 million, and 
Business Z is a car repair shop with average annual gross receipts of 
$12 million. Under paragraph (b)(2)(ii)(B) of this section, C's gross 
receipts are the combined amount derived from all three of C's trades 
or businesses. Therefore, for 2020, X, Y and Z do not meet the gross 
receipts test of paragraph (b)(2)(i) of this section ($15 million + $6 
million + $12 million = $33 million, which is greater than the 
inflation-adjusted gross receipts test amount for 2020, which is $26 
million).
    (3) Methods of accounting under the small business taxpayer 
exemption. A taxpayer eligible to use, and that chooses to use, the 
exemption described in paragraph (b) of this section may account for 
its inventory by either:
    (i) Accounting for its inventory items as non-incidental materials 
and supplies, as described in paragraph (b)(4) of this section; or
    (ii) Using the method for each item that is reflected in the 
taxpayer's applicable financial statement (AFS) (AFS section 471(c) 
inventory method); or, if the taxpayer does not have an AFS for the 
taxable year, the books and records of the taxpayer prepared in 
accordance with the taxpayer's accounting procedures, as defined in 
paragraph (b)(6)(ii) of this section (non-AFS section 471(c) inventory 
method).
    (4) Inventory treated as non-incidental materials and supplies--(i) 
In general. Inventory treated as non-incidental materials and supplies 
(section 471(c) materials and supplies) is recovered through costs of 
goods sold only in the taxable year in which such inventory is actually 
used or consumed in the taxpayer's business, or in the taxable year in 
which the taxpayer pays for or incurs the costs of the items, whichever 
is later. Section 471 materials and supplies are used or consumed in 
the taxable year in which the taxpayer provides the items to its 
customer. Inventory treated as non-incidental materials and supplies 
under this paragraph (b)(4) is not eligible for the de

[[Page 47533]]

minimis safe harbor election under Sec.  1.263(a)-1(f)(2).
    (ii) Identification and valuation of section 471(c) materials and 
supplies. A taxpayer may determine the amount of the section 471(c) 
materials and supplies that are recoverable through costs of goods sold 
by using either a specific identification method, a first-in, first-out 
(FIFO) method, or an average cost method, provided that method is used 
consistently. See Sec.  1.471-2(d). A taxpayer that uses the section 
471 materials and supplies method may not use any other method 
described in the regulations under section 471, or the last-in, first-
out (LIFO) method described in section 472 and the accompanying 
regulations, to either identify section 471(c) materials and supplies, 
or to value those section 471(c) materials and supplies. The inventory 
costs includible in the section 471(c) materials and supplies method 
are the direct costs of the property produced or property acquired for 
resale. However, an inventory cost does not include a cost for which a 
deduction would be disallowed, or that is not otherwise recoverable but 
for paragraph (b)(4) of this section, in whole or in part, under a 
provision of the Internal Revenue Code.
    (iii) Allocation methods. The section 471 materials and supplies 
method may allocate the costs of such inventory items by using specific 
identification or using any reasonable method.
    (iv) Example. Taxpayer D is a baker that reports its baking trade 
or business on Schedule C, Profit or Loss From Business, of the Form 
1040, Individual Tax Return, and D's baking business has average annual 
gross receipts for the 3-taxable years prior to 2019 of less than 
$100,000. D meets the gross receipts test of section 448(c) and is not 
prohibited from using the cash method under section 448(a)(3) in 2019. 
Therefore, D qualifies as a small business taxpayer under paragraph 
(b)(2) of this section. D uses the overall cash method, and the section 
471(c) non-incidental materials and supplies method. D purchases $50 of 
peanut butter in November 2019. In December 2019, D uses all of the 
peanut butter to bake cookies available for immediate sale. D sells the 
peanut butter cookies to customers in January 2020. The peanut butter 
cookies are used or consumed under paragraph (b)(4)(i) of this section 
in January 2020 when the cookies are sold to customers, and D may 
recover the cost of the peanut butter in 2020.
    (5) AFS section 471(c) method--(i) In general. A taxpayer that 
meets the gross receipts test described in paragraph (b)(2) of this 
section and that has an AFS for such taxable year may use the AFS 
section 471(c) method described in this paragraph to account for its 
inventory costs for the taxable year. For purposes of the AFS section 
471(c) method, an inventory cost is a cost that a taxpayer capitalizes 
to property produced or property acquired for resale in its AFS. 
However, an inventory cost does not include a cost that is neither 
deductible nor otherwise recoverable but for paragraph (b)(5) of this 
section, in whole or in part, under a provision of the Internal Revenue 
Code (for example, section 162(c), (e), (f), (g), or 274). In lieu of 
the inventory method described in section 471(a), a taxpayer using the 
AFS section 471(c) method recovers its inventory costs in accordance 
with the inventory method used in its AFS.
    (ii) Definition of AFS. The term AFS is defined in section 
451(b)(3) and the accompanying regulations. See Sec.  1.451-3(c)(1). 
The rules relating to additional AFS issues provided in Sec.  1.451-
3(h) apply to the AFS section 471(c) method. A taxpayer has an AFS for 
the taxable year if all of the taxpayer's taxable year is covered by an 
AFS.
    (iii) Timing of inventory costs. Notwithstanding the timing rules 
used in the taxpayer's AFS, the amount of any inventoriable cost may 
not be capitalized or otherwise taken into account for Federal income 
tax purposes any earlier than the taxable year during which the amount 
is paid or incurred under the taxpayer's overall method of accounting, 
as described in Sec.  1.446-1(c)(1). For example, in the case of an 
accrual method taxpayer, inventoriable costs must satisfy the all 
events test, including economic performance, of section 461. See Sec.  
1.446-1(c)(1)(ii) and section 461 and the accompanying regulations.
    (iv) Example. H is a calendar year C corporation that is engaged in 
the trade or business of selling office supplies and providing copier 
repair services. H meets the gross receipts test of section 448(c) and 
is not prohibited from using the cash method under section 448(a)(3) 
for 2019 or 2020. For Federal income tax purposes, H chooses to account 
for purchases and sales of inventory using an accrual method of 
accounting and for all other items using the cash method. For AFS 
purposes, H uses an overall accrual method of accounting. H uses the 
AFS section 471(c) method of accounting. In H's 2019 AFS, H incurred $2 
million in purchases of office supplies held for resale and recovered 
the $2 million as cost of goods sold. On January 5, 2020, H makes 
payment on $1.5 million of these office supplies. For purposes of the 
AFS section 471(c) method of accounting, H can recover the $2 million 
of office supplies in 2019 because the amount has been included in cost 
of goods sold in its AFS inventory method and section 461 has been 
satisfied.
    (6) Non-AFS section 471(c) method--(i) In general. A taxpayer that 
meets the gross receipts test described in paragraph (b)(2) of this 
section for a taxable year and that does not have an AFS, as defined in 
paragraph (b)(5)(ii) of this section, for such taxable year may use the 
non-AFS section 471(c) method to account for its inventories for the 
taxable year in accordance with this paragraph (b)(6). The non-AFS 
section 471(c) method is the method of accounting used for inventory in 
the taxpayer's books and records that properly reflect its business 
activities for non-tax purposes and are prepared in accordance with the 
taxpayer's accounting procedures. For purposes of the non-AFS section 
471(c) method, an inventory cost is a cost that the taxpayer 
capitalizes to property produced or property acquired for resale in its 
books and records, except as provided in paragraph (b)(6)(ii) of this 
section. In lieu of the inventory method described in section 471(a), a 
taxpayer using the non-AFS section 471(c) method recovers its costs 
through its book inventory method of accounting. A taxpayer that has an 
AFS for such taxable year may not use the non-AFS section 471(c) 
method.
    (ii) Timing and amounts of costs. Notwithstanding the timing of 
costs reflected in the taxpayer's books and records, a taxpayer may not 
deduct or recover any costs that have not been paid or incurred under 
the taxpayer's overall method of accounting, as described in Sec.  
1.446-1(c)(1), or that are neither deductible nor otherwise recoverable 
but for the application of this paragraph (b)(6), in whole or in part, 
under a provision of the Internal Revenue Code (for example, section 
162(c), (e), (f), (g) or 274). For example, in the case of an accrual 
method taxpayer or a taxpayer using an accrual method for purchases and 
sales, inventory costs must satisfy the all events test, including 
economic performance, under section 461(h). See Sec.  1.446-
1(c)(1)(ii), and section 461 and the accompanying regulations.
    (iii) Examples. The following examples illustrate the rules of 
paragraph (b)(6) of this section.
    (A) Example 1. Taxpayer E is a C corporation that is engaged in the 
retail trade or business of selling beer, wine, and liquor. In 2019, E 
has average annual gross receipts for the prior 3-taxable-years of less 
than $15 million,

[[Page 47534]]

and is not otherwise prohibited from using the cash method under 
section 448(a)(3). E does not have an AFS for the 2019 taxable year. E 
is eligible to use the non-AFS section 471(c) method of accounting. E 
uses the overall cash method, and the non-AFS section 471(c) method of 
accounting for Federal income tax purposes. In E's electronic 
bookkeeping software, E treats all costs paid during the taxable year 
as presently deductible. As part of its regular business practice, E's 
employees take a physical count of inventory on E's selling floor and 
its warehouse on December 31, 2019, and E also makes representations to 
its creditor of the amount of inventory on hand for specific categories 
of product it sells. E may not expense all of its costs paid during the 
2019 taxable year because its books and records do not accurately 
reflect the inventory records used for non-tax purposes in its regular 
business activity. E must use the physical inventory count taken at the 
end of 2019 to determine its ending inventory. E may include in cost of 
goods sold for 2019 those inventory costs that are not properly 
allocated to ending inventory.
    (B) Example 2. F is a C corporation that is engaged in the 
manufacture of baseball bats. In 2019, F has average annual gross 
receipts for the prior 3-taxable-years of less than $25 million, and is 
not otherwise prohibited from using the cash method under section 
448(a)(3). F does not have an AFS for the 2019 taxable year. For 
Federal income tax purposes, F uses the overall cash method of 
accounting, and the non-AFS section 471(c) method of accounting. For 
its books and records, F uses an overall accrual method and maintains 
inventories. In December 2019, F's financial statements show $500,000 
of direct and indirect material costs. F pays its supplier in January 
2020. Under paragraph (b)(6)(ii) of this section, F recovers its direct 
and indirect material costs in 2020.
    (7) Effect of section 471(c) on other provisions. Nothing in 
section 471(c) shall have any effect on the application of any other 
provision of law that would otherwise apply, and no inference shall be 
drawn from section 471(c) with respect to the application of any such 
provision. For example, a taxpayer that includes inventory costs in its 
AFS is required to satisfy section 461 before such cost can be included 
in cost of goods sold for the taxable year. Similarly, nothing in 
section 471(c) affects the requirement under section 446(e) that a 
taxpayer secure the consent of the Commissioner before changing its 
method of accounting. If an item of income or expense is not treated 
consistently from year to year, that treatment may not clearly reflect 
income, notwithstanding the application of this section.
    (8) Method of accounting. A change in the method of treating 
inventory under this paragraph (b) is a change in method of accounting 
under section 446 and the accompanying regulations. A taxpayer may 
change its method of accounting only with the consent of the 
Commissioner as required under section 446(e) and Sec.  1.446-1. For 
example, if a taxpayer is using the AFS section 471(c) method or non-
AFS section 471(c) method, and that taxpayer changes the method of 
accounting for inventory in its AFS, or its books and records, 
respectively, is required to secure the consent of the Commissioner 
before using this new method for Federal income tax purposes. However, 
a change from having an AFS to not having an AFS, or vice versa, 
without a change in the underlying method for inventory for financial 
reporting purposes is not a change in method of accounting under 
section 446(e). For rules relating to the clear reflection of income 
and the pattern of consistent treatment of an item, see section 446 and 
Sec.  1.446-1.
    (c) Applicability dates. This section applies for taxable years 
beginning on or after [date the Treasury Decision adopting these 
proposed regulations as final is published in the Federal Register]. 
For taxable years beginning before January 1, 2018, see Sec.  1.471-1 
as contained in 26 CFR part 1, revised April 1, 2019.

Sunita Lough,
Deputy Commissioner of Services and Enforcement.
[FR Doc. 2020-16364 Filed 7-30-20; 4:15 pm]
BILLING CODE 4830-01-P