Small Business Taxpayer Exceptions Under Sections 263A, 448, 460 and 471
| Citation | 85 FR 47508 |
| Record Number | 2020-16364 |
| Published date | 05 August 2020 |
| Court | Internal Revenue Service,Treasury Department |
Federal Register, Volume 85 Issue 151 (Wednesday, August 5, 2020)
[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
