Reg. § 1.263A-7 Changing a method of accounting under section 263A.
(a) Introduction
(1) Purpose These regulations provide guidance to taxpayers changing their methods of accounting for costs subject to section . The principal purpose of these regulations is to provide guidance regarding how taxpayers are to revalue property on hand at the beginning of the taxable year in which they change their method of accounting for costs subject to section . of this section provides guidance regarding how items or costs included in beginning inventory in the year of change must be revalued. of this section provides guidance regarding how non-inventory property should be revalued in the year of change.
(2) Taxpayers that adopt a method of accounting under section 263A Taxpayers may adopt a method of accounting for costs subject to section in the first taxable year in which they engage in resale or production activities. For purposes of this section, the adoption of a method of accounting has the same meaning as provided in . Taxpayers are not subject to the provisions of these regulations to the extent they adopt, as opposed to change, a method of accounting.
(3) Taxpayers that change a method of accounting under section 263A Taxpayers changing their method of accounting for costs subject to section are subject to the revaluation and other provisions of this section. Taxpayers subject to these regulations include, but are not limited to—
(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 and the accompanying regulations where the taxpayer was not subject to section in the prior taxable year;
(ii) Resellers of real or personal property that are using a method that fails to comply with section and desire to change to a method of accounting that complies with section ;
(iii) Producers of real or tangible personal property that are using a method that fails to comply with section and desire to change to a method of accounting that complies with section ; and
(iv) Resellers and producers that desire to change from one permissible method of accounting for costs subject to section to another permissible method.
(4) Applicability dates
(i) In general The provisions of this section are effective for taxable years beginning on or after August 5, 1997. For taxable years beginning before August 5, 1997, the rules of contained in the 26 CFR part 1 edition revised as of April 1, 1997, as modified by other administrative guidance, will apply.
(ii) Changes made by Tax Cuts and Jobs Act (Pub. L. 115-97) of this section applies to taxable years beginning on or after January 5, 2021. However, for a taxable year beginning after December 31, 2017, and before January 5, 2021, a taxpayer may apply the paragraph described in the first sentence of this , provided that the taxpayer follows all the applicable rules contained in the regulations under section for such taxable year and all subsequent taxable years.
(5) Definition of change in method of accounting For purposes of this section, a change in method of accounting has the same meaning as provided in . Changes in method of accounting for costs subject to section include changes to methods required or permitted by section and the regulations thereunder. Changes in method of accounting may be described in the preceding sentence irrespective of whether the taxpayer's previous method of accounting resulted in the capitalization of more (or fewer) costs than the costs required to be capitalized under section and the regulations thereunder, and irrespective of whether the taxpayer's previous method of accounting was a permissible method under the law in effect when the method was being used. However, changes in method of accounting for costs subject to section do not include changes relating to factors other than those described therein. For example, a change in method of accounting for costs subject to section does not include a change from one inventory identification method to another inventory identification method, such as a change from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method, or vice versa, or a change from one inventory valuation method to another inventory valuation method under section , such as a change from valuing inventory at cost to valuing the inventory at cost or market, whichever is lower, or vice versa. In addition, a change in method of accounting for costs subject to section does not include a change within the LIFO inventory method, such as a change from the double extension method to the link-chain method, or a change in the method used for determining the number of pools. Further, a change from the modified resale method set forth in Notice 89-67 (1989-1 C.B. 723), see , to the simplified resale method set forth in is not a change in method of accounting within the meaning of and is therefore not subject to the provisions of this section. However, a change from the simplified resale method set forth in former to the simplified resale method set forth in is a change in method of accounting within the meaning of and is subject to the provisions of this section.
(b) Rules applicable to a change in method of accounting
(1) General rules All changes in method of accounting for costs subject to section are subject to the rules and procedures provided by the Code, regulations, and administrative procedures applicable to such changes. The Internal Revenue Service has issued specific revenue procedures that govern certain accounting method changes for costs subject to section . Where a specific revenue procedure is not applicable, changes in method of accounting for costs subject to section are subject to the same rules and procedures that govern other accounting method changes. See Revenue Procedure 2015-13 (2015-5 IRB 419) and .
(2) Special rules
(i) Ordering rules when multiple changes in method of accounting occur in the year of change
(A) In general A change in method of accounting for costs subject to section is generally deemed to occur (including the computation of the adjustment under section ) before any other change in method of accounting is deemed to occur for that same taxable year.
(B) Exceptions to the general ordering rule
(1) Change from the LIFO inventory method In the case of a taxpayer that is discontinuing its use of the LIFO inventory method in the same taxable year it is changing its method of accounting for costs subject to section , the change from the LIFO method may be made before the change in method of accounting (and the computation of the corresponding adjustment under section (a)) under section is made.
(2) Change from the specific goods LIFO inventory method In the case of a taxpayer that is changing from the specific goods LIFO inventory method to the dollar-value LIFO inventory method in the same taxable year it is changing its method of accounting for costs subject to section , the change from the specific goods LIFO inventory method may be made before the change in method of accounting under section is made.
(3) Change in overall method of accounting In the case of a taxpayer that is changing its overall method of accounting from the cash receipts and disbursements method to an accrual method in the same taxable year it is changing its method of accounting for costs subject to section , the taxpayer must change to an accrual method for capitalizable costs (see ) before the change in method of accounting (and the computation of the corresponding adjustment under section ) under section is made.
(4) Change in method of accounting for depreciation In the case of a taxpayer that is changing its method of accounting for depreciation in the same taxable year it is changing its method of accounting for costs subject to section and any portion of the depreciation is subject to section , the change in method of accounting for depreciation must be made before the change in method of accounting (and the computation of the corresponding adjustment under section ) under section is made.
(ii) Adjustment required by section 481(a) In the case of any taxpayer required or permitted to change its method of accounting for any taxable year under section and the regulations thereunder, the change will be treated as initiated by the taxpayer for purposes of the adjustment required by section . The taxpayer must take the net section adjustment into account over the section adjustment period as determined under the applicable administrative procedures issued under for obtaining the Commissioner's consent to a change in accounting method (for example, see Revenue Procedure 2015-13, 2015-5 IRB 419 (or successor) (also see )). This paragraph applies to taxable years ending on or after June 16, 2004.
(iii) Base year
(A) Need for a new base year Certain dollar-value LIFO taxpayers (whether using double extension or link-chain) must establish a new base year when they revalue their inventories under section .
(1) Facts and circumstances revaluation method used A dollar-value LIFO taxpayer that uses the facts and circumstances revaluation method is permitted, but not required, to establish a new base year.
(2) 3-year average method used
(i) Simplified method not used A dollar-value LIFO taxpayer using the 3-year average method but not the simplified production method or the simplified resale method to revalue its inventory is required to establish a new base year.
(ii) Simplified method used A dollar-value LIFO taxpayer using the 3-year average method and the simplified production method, the modified simplified production method, or the simplified resale method to revalue its inventory is permitted, but not required, to establish a new base year.
(B) Computing a new base year For purposes of determining future indexes, the year of change becomes the new base year (that is, the index at the beginning of the year of change generally must be 1.00) and all costs are restated in new base year costs for purposes of extending such costs in future years. However, when a new base year is established, costs associated with old layers retain their separate identity within the base year, with such layers being restated in terms of the new base year index. For example, for purposes of determining whether a particular layer has been invaded, each layer must retain its separate identity. Thus, if a decrement in an inventory pool occurs, layers accumulated in more recent years must be viewed as invaded first, in order of priority.
(c) Inventory
(1) Need for adjustments When a taxpayer changes its method of accounting for costs subject to section , the taxpayer generally must, in computing its taxable income for the year of change, take into account the adjustments required by section . The adjustments required by section relate to revaluations of inventory property, whether the taxpayer produces the inventory or acquires it for resale. See of this section in regard to the adjustments required by section that relate to non-inventory property.
(2) Revaluing beginning inventory
(i) In general If a taxpayer changes its method of accounting for costs subject to section , the taxpayer must revalue the items or costs included in its beginning inventory in the year of change as if the new method (that is, the method to which the taxpayer is changing) had been in effect during all prior years. In revaluing inventory costs under this procedure, all of the capitalization provisions of section and the regulations thereunder apply to all inventory costs accumulated in prior years. The necessity to revalue beginning inventory as if these capitalization rules had been in effect for all prior years includes, for example, the revaluation of costs or layers incurred in taxable years preceding the transition period to the full absorption method of inventory costing as described in , regardless of whether a taxpayer employed a cut-off method under those regulations. The difference between the inventory as originally valued using the former method (that is, the method from which the taxpayer is changing) and the inventory as revalued using the new method is equal to the amount of the adjustment required under section .
(ii) Methods to revalue inventory There are three methods available to revalue inventory. The first method, the facts and circumstances revaluation method, may be used by all taxpayers. Under this method, a taxpayer determines the direct and indirect costs that must be assigned to each item of inventory based on all the facts and circumstances. This method is described in of this section. The second method, the weighted average method, is available only in certain situations to taxpayers using the FIFO inventory method or the specific goods LIFO inventory method. This method is described in of this section. The third method, the 3-year average method, is available to all taxpayers using the dollar-value LIFO inventory method of accounting. This method is described in of this section. The weighted average method and the 3-year average method revalue inventory through processes of estimation and extrapolation, rather than based on the facts and circumstances of a particular year's data. All three methods are available regardless of whether the taxpayer elects to use a simplified method to capitalize costs under section .
(iii) Facts and circumstances revaluation method
(A) In general Under the facts and circumstances revaluation method, a taxpayer generally is required to revalue inventories by applying the capitalization rules of section and the regulations thereunder to the production and resale activities of the taxpayer, with the same degree of specificity as required of inventory manufacturers under the law immediately prior to the effective date of the Tax Reform Act of 1986 (Pub. L. 99-514, 100 Stat. 2085, 1986-3 C.B. (Vol. 1)). Thus, for example, with respect to any prior year that is relevant in determining the total amount of the revalued balance as of the beginning of the year of change, the taxpayer must analyze the production and resale data for that particular year and apply the rules and principles of section and the regulations thereunder to determine the appropriate revalued inventory costs. However, under the facts and circumstances revaluation method, a taxpayer may utilize reasonable estimates and procedures in valuing inventory costs if—
(1) The taxpayer lacks, and is not able to reconstruct from its books and records, actual financial and accounting data which is required to apply the capitalization rules of section and the regulations thereunder to the relevant facts and circumstances surrounding a particular item of inventory or cost; and
(2) The total amounts of costs for which reasonable estimates and procedures are employed are not significant in comparison to the total restated value (including costs previously capitalized under the taxpayer's former method) of the items or costs for the period in question.
(B) Exception A taxpayer that is not able to comply with the requirement of of this section because of the existence of a significant amount of costs that would require the use of estimates and procedures must revalue its inventories under the procedures provided in or of this section.
(C) Estimates and procedures allowed The estimates and procedures of this include—
(1) The use of available information from more recent years to estimate the amount and nature of inventory costs applicable to earlier years; and
(2) The use of available information with respect to comparable items of inventory produced or acquired during the same year in order to estimate the costs associated with other items of inventory.
(D) Use by dollar-value LIFO taxpayers Generally, a dollar-value LIFO taxpayer must recompute its LIFO inventory for each taxable year that the LIFO inventory method was used.
(E) Examples The provisions of this are illustrated by the following three examples. The principles set forth in these examples are applicable both to production and resale activities and the year of change in all three examples is 1997. The examples read as follows:
Example 1. Taxpayer X lacks information for the years 1993 and earlier, regarding the amount of costs incurred in transporting finished goods from X's factory to X's warehouse and in storing those goods at the warehouse until their sale to customers. X determines that, for 1994 and subsequent years, these transportation and storage costs constitute 4 percent of the total costs of comparable goods under X's method of accounting for such years. Under this , X may assume that transportation and storage costs for the years 1993 and earlier constitute 4 percent of the total costs of such goods.
Example 2.
Assume the same facts as in Example 1, except that for the year 1993 and earlier, X used a different method of accounting for inventory costs whereunder significantly fewer costs were capitalized than amounts capitalized in later years. Thus, the application of transportation and storage based on a percentage of costs for 1994 and later years would not constitute a reasonable estimate for use in earlier years. X may use the information from 1994 and later years, if appropriate adjustments are made to reflect the differences in inventory costs for the applicable years, including, for example—
(i) Increasing the percentage of costs that are intended to represent transportation and storage costs to reflect the aggregate differences in capitalized amounts under the two methods of accounting; or
(ii) Taking the absolute dollar amount of transportation and storage costs for comparable goods in inventory and applying that amount (adjusted for changes in general price levels, where appropriate) to goods associated with 1993 and prior periods.
Example 3. Taxpayer Z lacks information for certain years with respect to factory administrative costs, subject to capitalization under section and the regulations thereunder, incurred in the production of inventory in factory A. Z does have sufficient information to determine factory administrative costs with respect to production of inventory in factory B, wherein inventory items were produced during the same years as factory A. Z may use the information from factory B to determine the appropriate amount of factory administrative costs to capitalize as inventory costs for comparable items produced in factory A during the same years.
(iv) Weighted average method
(A) In general A taxpayer using the FIFO method or the specific goods LIFO method of accounting for inventories may use the weighted average method as provided in this to estimate the change in the amount of costs that must be allocated to inventories for prior years. The weighted average method under this is only available to a taxpayer that lacks sufficient data to revalue its inventory costs under the facts and circumstances revaluation method provided for in of this section. Moreover, a taxpayer that qualifies for the use of the weighted average method under this must utilize such method only with respect to items or costs for which it lacks sufficient information to revalue under the facts and circumstances revaluation method. Particular items or costs must be revalued under the facts and circumstances revaluation method if sufficient information exists to make such a revaluation. If a taxpayer lacks sufficient information to otherwise apply the weighted average method under this (for example, the taxpayer is unable to revalue the costs of any of its items in inventory due to a lack of information), then the taxpayer must use reasonable estimates and procedures, as described in the facts and circumstances revaluation method, to whatever extent is necessary to allow the taxpayer to apply the weighted average method.
(B) Weighted average method for FIFO taxpayers
(1) In general This sets forth the mechanics of the weighted average method as applicable to FIFO taxpayers. Under the weighted average method, an item in ending inventory for which sufficient data is not available for revaluation under section and the regulations thereunder must be revalued by using the weighted average percentage increase or decrease with respect to such item for the earliest subsequent taxable year for which sufficient data is available. With respect to an item for which no subsequent data exists, such item must be revalued by using the weighted average percentage increase or decrease with respect to all reasonably comparable items in the taxpayer's inventory for the same year or the earliest subsequent taxable year for which sufficient data is available.
(2) Example The provisions of this are illustrated by the following example. The principles set forth in this example are applicable both to production and resale activities and the year of change in the example is 1997. The example reads as follows:
Example. Taxpayer A manufactures bolts and uses the FIFO method to identify inventories. Under A's former method, A did not capitalize all of the costs required to be capitalized under section . A maintains inventories of bolts, two types of which it no longer produces. Bolt A was last produced in 1994. The revaluation of the costs of Bolt A under this section for bolts produced in 1994 results in a 20 percent increase of the costs of Bolt A. A portion of the inventory of Bolt A, however, is attributable to 1993. A does not have sufficient data for revaluation of the 1993 cost for Bolt A. With respect to Bolt A, A may apply the 20 percent increase determined for 1994 to the 1993 production as an acceptable estimate. Bolt B was last produced in 1992 and no data exists that would allow revaluation of the inventory cost of Bolt B. The inventories of all other bolts for which information is available are attributable to 1994 and 1995. Revaluation of the costs of these other bolts using available data results in an average increase in inventory costs of 15 percent for 1994 production. With respect to Bolt B, the overall 15 percent increase for A's inventory for 1994 may be used in revaluing the cost of Bolt B.
(C) Weighted average method for specific goods LIFO taxpayers
(1) In general This sets forth the mechanics of the weighted average method as applicable to LIFO taxpayers using the specific goods method of valuing inventories. Under the weighted average method, the inventory layers with respect to an item for which data is available are revalued under this section and the increase or decrease in amount for each layer is expressed as a percentage of change from the cost in the layer as originally valued. A weighted average of the percentage of change for all layers for each type of good is computed and applied to all earlier layers for each type of good that lack sufficient data to allow for revaluation. In the case of earlier layers for which sufficient data exists, such layers are to be revalued using actual data. In cases where sufficient data is not available to make a weighted average estimate with respect to a particular item of inventory, a weighted average increase or decrease is to be determined using all other inventory items revalued by the taxpayer in the same specific goods grouping. This percentage increase or decrease is then used to revalue the cost of the item for which data is lacking. If the taxpayer lacks sufficient data to revalue any of the inventory items contained in a specific goods grouping, then the weighted average increase or decrease of substantially similar items (as determined by principles similar to the rules applicable to dollar-value LIFO taxpayers in ) must be applied in the revaluation of the items in such grouping. If insufficient data exists with respect to all the items in a specific goods grouping and to all items that are substantially similar (or such items do not exist), then the weighted average for all revalued items in the taxpayer's inventory must be applied in revaluing items for which data is lacking.
(2) Example The provisions of this are illustrated by the following example. The principles set forth in this example are applicable both to production and resale activities and the year of change in the example is 1997. The example reads as follows:
Example.
(i) Taxpayer M is a manufacturer that produces two different parts. Under M's former method, M did not capitalize all of the costs required to be capitalized under section . Work-in-process inventory is recorded in terms of equivalent units of finished goods. M's records show the following at the end of 1996 under the specific goods LIFO inventory method:
| LIFO Product and layer | Number | Cost | Carryingvalues |
|---|---|---|---|
| Product #1: | |||
| 1993 | 150 | $5.00 | $750 |
| 1994 | 100 | 6.00 | 600 |
| 1995 | 100 | 6.50 | 650 |
| 1996 | 50 | 7.00 | 350 |
| $2,350 | |||
| Product #2: | |||
| 1993 | 200 | $4.00 | $800 |
| 1994 | 200 | 4.50 | 900 |
| 1995 | 100 | 5.00 | 500 |
| 1996 | 100 | 6.00 | 600 |
| 2,800 | |||
| Total carrying value of Products #1 and #2 under M's former method | 5,150 |
(ii) M has sufficient data to revalue the unit costs of Product #1 using its new method for 1994, 1995 and 1996. These costs are: $7.00 in 1994, $7.75 in 1995, and $9.00 in 1996. This data for Product #1 results in a weighted average percentage change of 20.31 percent ((100 × ($7.00−$6.00)) + (100 × ($7.75−$6.50)) + (50 × ($9.00−$7.00)) divided by (100 × $6.00) + (100 × $6.50) + (50 × $7.00)]. M has sufficient data to revalue the unit costs of Product #2 only in 1995 and 1996. These costs are: $6.00 in 1995 and $7.00 in 1996. This data for Product #2 results in a weighted average percentage change of 18.18 percent [(100 × ($6.00−$5.00)) + (100 × ($7.00−$6.00)) divided by (100 × $5.00) + (100 × $6.00)].
(iii) M can estimate its revalued costs for Product #1 for 1993 by applying the weighted average increase computed for Product #1 (20.31 percent) to the unit costs originally carried on M's records for 1993 under M's former method. The estimated revalued unit cost of Product #1 would be $6.02 ($5.00 × 1.2031). M estimates its revalued costs for Product #2 for 1993 and 1994 in a similar fashion. M applies the weighted average increase determined for Product #2 (18.18 percent) to the unit costs of $4.00 and $4.50 for 1993 and 1994 respectively. The revalued unit costs of Product #2 are $4.73 for 1993 ($4.00 × 1.1818) and $5.32 for 1994 ($4.50 × 1.1818).
(iv) M's inventory would be revalued as follows:
| LIFO product and layer | Number | Cost | Carryingvalues |
|---|---|---|---|
| Product #1: | |||
| 1993 | 150 | $6.02 | $903 |
| 1994 | 100 | 7.00 | 700 |
| 1995 | 100 | 7.75 | 775 |
| 1996 | 50 | 9.00 | 450 |
| $2,828 | |||
| Product #2: | |||
| 1993 | 200 | 4.73 | 946 |
| 1994 | 200 | 5.32 | 1,064 |
| 1995 | 100 | 6.00 | 600 |
| 1996 | 100 | 7.00 | 700 |
| 3,310 | |||
| Total value of Products #1 and #2 as revalued under M's new method | 6,138 | ||
| Total amount of adjustment required under section 481(a) [$6,138−$5,150] | 988 |
(D) Adjustments to inventory costs from prior years For special rules applicable when a revaluation using the weighted average method includes costs not incurred in prior years, see of this section.
(v) 3-year average method
(A) In general A taxpayer using the dollar-value LIFO method of accounting for inventories may revalue all existing LIFO layers of a trade or business based on the 3-year average method as provided in this . The 3-year average method is based on the average percentage change (the 3-year revaluation factor) in the current costs of inventory for each LIFO pool based on the three most recent taxable years for which the taxpayer has sufficient information (typically, the three most recent taxable years of such trade or business). The 3-year revaluation factor is applied to all layers for each pool in beginning inventory in the year of change. The 3-year average method is available to any dollar-value taxpayer that complies with the requirements of this regardless of whether such taxpayer lacks sufficient data to revalue its inventory costs under the facts and circumstances revaluation method prescribed in of this section. The 3-year average method must be applied with respect to all inventory in a taxpayer's trade or business. A taxpayer is not permitted to apply the method for the revaluation of some, but not all, inventory costs on the basis of pools, business units, or other measures of inventory amounts that do not constitute a separate trade or business. Generally, a taxpayer revaluing its inventory using the 3-year average method must establish a new base year. See, of this section. However, a dollar-value LIFO taxpayer using the 3-year average method and either the simplified production method or the simplified resale method to revalue its inventory is permitted, but not required, to establish a new base year. See, of this section. If a taxpayer lacks sufficient information to otherwise apply the 3-year average method under this (for example, the taxpayer is unable to revalue the costs of any of its LIFO pools for three years due to a lack of information), then the taxpayer must use reasonable estimates and procedures, as described in the facts and circumstances revaluation method under of this section, to whatever extent is necessary to allow the taxpayer to apply the 3-year average method.
(B) Consecutive year requirement Under the 3-year average method, if sufficient data is available to calculate the revaluation factor for more than three years, the taxpayer may use data from such additional years in determining the average percentage increase or decrease only if the additional years are consecutive to and prior to the year of change. The requirement under the preceding sentence to use consecutive years is applicable under this method regardless of whether any inventory costs in beginning inventory as of the year of change are viewed as incurred in, or attributable to, those consecutive years under the LIFO inventory method. Thus, the requirement to use data from consecutive years may result in using information from a year in which no LIFO increment occurred. For example, if a taxpayer is changing its method of accounting in 1997 and has sufficient data to revalue its inventory for the years 1991 through 1996, the taxpayer may calculate the revaluation factor using all six years. If, however, the taxpayer has sufficient data to revalue its inventory for the years 1990 through 1992, and 1994 through 1996, only the three years consecutive to the year of change, that is, 1994 through 1996, may be used in determining the revaluation factor. Similarly, for example, a taxpayer with LIFO increments in 1995, 1993, and 1992 may not calculate the revaluation factor based on the data from those years alone, but instead must use the data from consecutive years for which the taxpayer has information.
(C) Example The provisions of this are illustrated by the following example. The principles set forth in this example are applicable both to production and resale activities and the year of change in the example is 1997. The example reads as follows:
Example.
(i) Taxpayer G, a calendar year taxpayer, is a reseller that is required to change its method of accounting under section . G will not use either the simplified production method or the simplified resale method. G adopted the dollar-value LIFO inventory method in 1991, using a single pool and the double extension method. G's beginning LIFO inventory as of January 1, 1997, computed using its former method, for the year of change is as follows:
| Base year costs | Index | LIFO carrying value | |
|---|---|---|---|
| Base layer | $14,000 | 1.00 | $14,000 |
| 1991 layer | 4,000 | 1.20 | 4,800 |
| 1992 layer | 5,000 | 1.30 | 6,500 |
| 1993 layer | 2,000 | 1.35 | 2,700 |
| 1994 layer | 0 | 1.40 | 0 |
| 1995 layer | 4,000 | 1.50 | 6,000 |
| 1996 layer | 5,000 | 1.60 | 8,000 |
| Total | 34,000 | 42,000 |
(ii) G is able to recompute total inventoriable costs incurred under its new method for the three preceding taxable years as follows:
| Current cost as recorded (formermethod) | Current cost as adjusted (new method) | Percentage change | |
|---|---|---|---|
| 1994 | $35,000 | $45,150 | .29 |
| 1995 | 43,500 | 54,375 | .25 |
| 1996 | 54,400 | 70,720 | .30 |
| Total | 132,900 | 170,245 | .28 |
(iii) Applying the average revaluation factor of .28 to each layer, G's inventory is restated as follows:
| Restated base year costs | Index | Restated LIFO carrying value | |
|---|---|---|---|
| Base layer | $17,920 | 1.00 | $17,920 |
| 1991 layer | 5,120 | 1.20 | 6,144 |
| 1992 layer | 6,400 | 1.30 | 8,320 |
| 1993 layer | 2,560 | 1.35 | 3,456 |
| 1994 layer | 0 | 1.40 | 0 |
| 1995 layer | 5,120 | 1.50 | 7,680 |
| 1996 layer | 6,400 | 1.60 | 10,240 |
| Total | 43,520 | 53,760 |
(iv) The adjustment required by section is $11,760. This amount may be computed by multiplying the average percentage of .28 by the LIFO carrying value of G's inventory valued using its former method ($42,000). Alternatively, the adjustment required by section may be computed by the difference between—
(A) The revalued costs of the taxpayer's inventory under its new method ($53,760), and
(B) The costs of the taxpayer's inventory using its former method ($42,000).
(v) In addition, the inventory as of the first day of the year of change (January 1, 1997) becomes the new base year cost for purposes of determining the LIFO index in future years. See, and of this section. This requires that layers in years prior to the base year be restated in terms of the new base year index. The current year cost of G's inventory, as adjusted, is $70,720. Such cost must be apportioned to each layer in proportion to the restated base year cost of that layer to total restated base year costs ($43,520), as follows:
| Restated base year costs | Restated index | Restated LIFO carrying value | |
|---|---|---|---|
| Old base layer | $29,120 | .615 | $17,920 |
| 1991 layer | 8,320 | .738 | 6,144 |
| 1992 layer | 10,400 | .80 | 8,320 |
| 1993 layer | 4,160 | .831 | 3,456 |
| 1994 layer | 0 | 0 | |
| 1995 layer | 8,320 | .923 | 7,680 |
| 1996 layer | 10,400 | .985 | 10,240 |
| Total | 70,720 | 53,760 |
(D) Short taxable years A short taxable year is treated as a full 12 months.
(E) Adjustments to inventory costs from prior years
(1) General rule
(i) The use of the revaluation factor, based on current costs, to estimate the revaluation of prior inventory layers under the 3-year average method, as described in of this section, may result in an allocation of costs that include amounts attributable to costs not incurred during the year in which the layer arose. To the extent a taxpayer can demonstrate that costs that contributed to the determination of the revaluation factor could not have affected a prior year, the revaluation factor as applied to that year may be adjusted under the restatement adjustment procedure, as described in of this section. The determination that a cost could not have affected a prior year must be made by a taxpayer only upon showing that the type of cost incurred during the years used to calculate the revaluation factor (revaluation years) was not present during such prior year. An item of cost will not be eligible for the restatement adjustment procedure simply because the cost varies in amount from year to year or the same type of cost is described or referred to by a different name from year to year. Thus, the restatement adjustment procedure allowed under of this section is not available in a prior year with respect to a particular cost if the same type of cost was incurred both in the revaluation years and in such prior year, although the amount of such cost and the name or description thereof may vary.
(ii) The provisions of this are also applicable to taxpayers using the weighted average method in revaluing inventories under of this section. Thus, to the extent a taxpayer can demonstrate that costs that contributed to the determination of the restatement of a particular year or item could not have affected a prior year or item, the taxpayer may adjust the revaluation of that prior year or item accordingly under the weighted average method. All the requirements and definitions, however, applicable to the restatement adjustment procedure under this fully apply to a taxpayer using the weighted average method to revalue inventories.
(2) Examples of costs eligible for restatement adjustment procedure The provisions of this are illustrated by the following four examples. The principles set forth in these examples are applicable both to production and resale activities and the year of change in the four examples is 1997. The examples read as follows:
Example 1. Taxpayer A is a reseller that introduced a defined benefit pension plan in 1994, and made the plan available to personnel whose labor costs were (directly or indirectly) properly allocable to resale activities. A determines the revaluation factor based on data available for the years 1994 through 1996, for which the pension plan was in existence. Based on these facts, the costs of the pension plan in the revaluation years are eligible for the restatement adjustment procedure for years prior to 1994.
Example 2. Assume the same facts as in Example 1, except that a defined contribution plan was available, during prior years, to personnel whose labor costs were properly allocable to resale activities. The defined contribution plan was terminated before the introduction of the defined benefit plan in 1994. Based on these facts, the costs of the defined benefit pension plan in the revaluation years are not eligible for the restatement adjustment procedure with respect to years for which the defined contribution plan existed.
Example 3. Taxpayer C is a manufacturer that established a security department in 1995 to patrol and safeguard its production and warehouse areas used in C's trade or business. Prior to 1995, C had not been required to utilize security personnel in its trade or business; C established the security department in 1995 in response to increasing vandalism and theft at its plant locations. Based on these facts, the costs of the security department are eligible for the restatement adjustment procedure for years prior to 1995.
Example 4. Taxpayer D is a reseller that established a payroll department in 1995 to process the company's weekly payroll. In the years 1991 through 1994, D engaged the services of an outside vendor to process the company's payroll. Prior to 1991, D's payroll processing was done by D's accounting department, which was responsible for payroll processing as well as for other accounting functions. Based on these facts, the costs of the payroll department are not eligible for the restatement adjustment procedure. D was incurring the same type of costs in earlier years as D was incurring in the payroll department in 1995 and subsequent years, although these costs were designated by a different name or description.
(F) Restatement adjustment procedure
(1) In general
(i) This provides a restatement adjustment procedure whereunder a taxpayer may adjust the restatement of inventory costs in prior taxable years in order to produce a different restated value than the value that would otherwise occur through application of the revaluation factor to such prior taxable years.
(ii) Under the restatement adjustment procedure as applied to a particular prior year, a taxpayer must determine the particular items of cost that are eligible for the restatement adjustment with respect to such prior year. The taxpayer must then recompute, using reasonable estimates and procedures, the total inventoriable costs that would have been incurred for each revaluation year under the taxpayer's former method and the taxpayer's new method by making appropriate adjustments in the data for such revaluation year to reflect the particular costs eligible for adjustment.
(iii) The taxpayer must then compute the total percentage change with respect to each revaluation year, using the revised estimates of total inventoriable costs for such year as described in of this section. The percentage change must be determined by calculating the ratio of the revised total of the inventoriable costs for such revaluation year under the taxpayer's new method to the revised total of the inventoriable costs for such revaluation year under the taxpayer's former method.
(iv) An average of the resulting percentage change for all revaluation years is then calculated, and the resulting average is applied to the prior year in issue.
(2) Examples of restatement adjustment procedure The provisions of this are illustrated by the following two examples. The principles set forth in these examples are applicable both to production and resale activities and the year of change in the two examples is 1997. The examples read as follows:
Example 1. Taxpayer A is a reseller that is eligible to make a restatement adjustment by reason of the costs of a defined benefit pension plan that was introduced in 1994, during the revaluation period. The revaluation factor, before adjustment of data to reflect the pension costs, is as provided in the example in of this section. Thus, for example, with respect to the year 1994, the total inventoriable costs under A's former method is $35,000, the total inventoriable costs under A's new method is $45,150, and the percentage change is .29. Under the method of accounting used by A during 1994 (the former method), none of the pension costs were included as inventoriable costs. Thus, under the restatement adjustment procedure, the total inventoriable cost under A's former method would remain at $35,000 if the pension plan had not been in existence. Similarly, A determines that the total inventoriable costs for 1994 under A's new method, if the pension plan had not been in existence, would have been $42,000. The restatement adjustment for 1994 determined under this would then be equal to .20 ([$42,000-$35,000]/$35,000). A would make similar calculations with respect to 1995 and 1996. The average of such amounts for each of the three years in the revaluation period would then be determined as in the example in of this section. Such average would be used to revalue cost layers for years for which the pension plan was not in existence. Such revalued layers would then be viewed as restated in compliance with the requirements of this paragraph. With respect to cost layers incurred during years for which the pension plan was in existence, no adjustment of the revaluation factor would occur.
Example 2. Assume the same facts as in Example 1, except that a portion of the pension costs were included as inventoriable costs under the method used by A during 1994 (the former method). Under the restatement adjustment procedure, A determines that the total inventoriable costs for 1994 under the former method, if the pension plan had not been in existence, would have been $34,000. Similarly, A determines that the total inventoriable costs for 1994 under A's new method, if the pension plan had not been in existence, would have been $42,000. The restatement adjustment for 1994 determined under this would then be equal to .24 ([$42,000-$34,000]/$34,000). A would make similar calculations with respect to 1995 and 1996. The average of such amounts for each of the three years in the revaluation period would then be determined as in the example in of this section. Such average would be used to revalue cost layers for years for which the pension plan was not in existence.
(3) Intercompany items
(i) Revaluing intercompany transactions Pursuant to any change in method of accounting for costs subject to section , taxpayers are required to revalue the amount of any intercompany item resulting from the sale or exchange of inventory property in an intercompany transaction to an amount equal to the intercompany item that would have resulted, had the cost of goods sold for that inventory property been determined under the taxpayer's new method. The requirement of the preceding sentence applies with respect to both inventory produced by a taxpayer and inventory acquired by the taxpayer for resale. In addition, the requirements of this apply only to any intercompany item of the taxpayer as of the beginning of the year of change in method of accounting. See . A taxpayer must revalue the amount of any intercompany item only if the inventory property sold in the intercompany transaction is held as inventory by a buying member as of the date the taxpayer changes its method of accounting under section . Corresponding changes to the adjustment required under section must be made with respect to any adjustment of the intercompany item required under this . Moreover, the requirements of this apply regardless of whether the taxpayer has any items in beginning inventory as of the year of change in method of accounting. See for the definition of intercompany transaction.
(ii) Example The provisions of this are illustrated by the following example. The principles set forth in this example are applicable both to production and resale activities and the year of change in the example is 1997. The example reads as follows:
Example.
(i) Assume that S, a member of a consolidated group filing its federal income tax return on a calendar year, manufactures and sells inventory property to B, a member of the same consolidated group, in 1996. The sale between S and B is an intercompany transaction as defined under . The gain from the intercompany transaction is an intercompany item to S under . As of the beginning of the year of change in method of accounting (January 1, 1997), the inventory property is still held by B based on the particular inventory method of accounting used by B for federal income tax purposes (for example, the LIFO or FIFO inventory method). The property was sold by S to B in 1996 for $150; the cost of goods sold with respect to the property under the method in effect at the time the inventory was produced was $100, resulting in an intercompany item of $50 to S under . As of January 1, 1997, S still has an intercompany item of $50.
(ii) S is required to revalue the amount of its intercompany item to an amount equal to what the intercompany item would have been had the cost of goods sold for that inventory property been determined under S's new method. Assume that the cost of the inventory under this method would have been $110, had the method applied to S's manufacture of the property in 1996. Thus, S is required to revalue the amount of its intercompany item to $40 (that is, $150 less $110), necessitating a negative adjustment to the intercompany item of $10. Moreover, S is required to increase its adjustment under section by $10 in order to prevent the omission of such amount by virtue of the decrease in the intercompany item.
(iii) Availability of revaluation methods In revaluing the amount of any intercompany item resulting from the sale or exchange of inventory property in an intercompany transaction to an amount equal to the intercompany item that would have resulted had the cost of goods sold for that inventory property been determined under the taxpayer's new method, a taxpayer may use the other methods and procedures otherwise properly available to that particular taxpayer in revaluing inventory under section and the regulations thereunder, including, if appropriate, the various simplified methods provided in section and the regulations thereunder and the various procedures described in this .
(4) Anti-abuse rule
(i) In general Section provides that the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of section , including regulations to prevent the use of related parties, pass-thru entities, or intermediaries to avoid the application of section and the regulations thereunder. One way in which the application of section and the regulations thereunder would be otherwise avoided is through the use of entities described in the preceding sentence in such a manner as to effectively avoid the necessity to restate beginning inventory balances under the change in method of accounting required or permitted under section and the regulations thereunder.
(ii) Deemed avoidance of this section
(A) Scope For purposes of this , the avoidance of the application of section and the regulations thereunder will be deemed to occur if a taxpayer using the LIFO method of accounting for inventories, transfers inventory property to a related corporation in a transaction described in section , and such transfer occurs:
(1) On or before the beginning of the transferor's taxable year beginning in 1987; and
(2) After September 18, 1986.
(B) General rule Any transaction described in of this section will be treated in the following manner:
(1) Notwithstanding any provision to the contrary (for example, section ), the transferee corporation is required to revalue the inventories acquired from the transferor under the provisions of this relating to the change in method of accounting and the adjustment required by section , as if the inventories had never been transferred and were still in the hands of the transferor; and
(2) Absent an election as described in of this section, the transferee must account for the inventories acquired from the transferor by treating such inventories as if they were contained in the transferee's LIFO layer(s).
(iii) Election to use transferor's LIFO layers If a transferee described in of this section so elects, the transferee may account for the inventories acquired from the transferor by allocating such inventories to LIFO layers corresponding to the layers to which such properties were properly allocated by the transferor, prior to their transfer. The transferee must account for such inventories for all subsequent periods with reference to such layers to which the LIFO costs were allocated. Any such election is to be made on a statement attached to the timely filed federal income tax return of the transferee for the first taxable year for which section and the regulations thereunder applies to the transferee.
(iv) Tax avoidance intent not required The provisions of of this section will apply to any transaction described therein, without regard to whether such transaction was consummated with an intention to avoid federal income taxes.
(v) Related corporation For purposes of this , a taxpayer is related to a corporation if—
(A) the relationship between such persons is described in section , or
(B) such persons are engaged in trades or businesses under common control (within the meaning of paragraphs (a) and (b) of section ).
(d) Non-inventory property
(1) Need for adjustments A taxpayer that changes its method of accounting for costs subject to section with respect to non-inventory property must revalue the non-inventory property on hand at the beginning of the year of change as set forth in of this section, and compute an adjustment under section . The adjustment under section will equal the difference between the adjusted basis of the property as revalued using the taxpayer's new method and the adjusted basis of the property as originally valued using the taxpayer's former method.
(2) Revaluing property A taxpayer must revalue its non-inventory property as of the beginning of the year of change in method of accounting. The facts and circumstances revaluation method of of this section must be used to revalue this property. In revaluing non-inventory property, however, the only additional section costs that must be taken into account are those additional section costs incurred after the later of December 31, 1986, or the date the taxpayer first becomes subject to section , in taxable years ending after that date. See for the definition of additional section costs.
[T.D. 8728, 62 FR 42054, Aug. 5, 1997, as amended by T.D. 9131, 69 FR 33572, June 16, 2004; T.D. 9843, 83 FR 58498, Nov. 20, 2018; T.D. 9942, 86 FR 268, Jan. 5, 2021]