Small Business Taxpayer Exceptions Under Sections 263A, 448, 460 and 471
| Published date | 05 January 2021 |
| Citation | 86 FR 254 |
| Record Number | 2020-28888 |
| Section | Rules and Regulations |
| Court | Internal Revenue Service,Treasury Department |
Federal Register, Volume 86 Issue 2 (Tuesday, January 5, 2021)
[Federal Register Volume 86, Number 2 (Tuesday, January 5, 2021)]
[Rules and Regulations]
[Pages 254-278]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-28888]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9942]
RIN 1545-BP53
Small Business Taxpayer Exceptions Under Sections 263A, 448, 460
and 471
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final 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 final regulations regarding certain special
accounting rules for long-term contracts under section 460 to implement
legislative changes applicable to corporate taxpayers. The final
regulations generally affect taxpayers with average annual gross
receipts of not more than $25 million, as adjusted for inflation.
DATES:
Effective date: The regulations are effective on January 5, 2021.
Applicability dates: For dates of applicability, see Sec. Sec.
1.263A-1(a)(2)(i), 1.263A-1(m)(6), 1.263A-2(g)(4), 1.263A-3(f)(2),
1.263A-4(g)(2), 1.263A-7(a)(4)(ii), 1.381(c)(5)-1(f), 1.446-1(c)(3),
1.448-2(h), 1.448-3(h), 1.460-1(h)(3), 1.460-3(d), 1.460-4(i), 1.460-
6(k), and 1.471-1(c).
FOR FURTHER INFORMATION CONTACT: Concerning Sec. Sec. 1.460-1 through
1.460-6, Innessa Glazman, (202) 317-7006; concerning all other
regulations in this document, Anna Gleysteen, (202) 317-7007.
SUPPLEMENTARY INFORMATION:
Background
This document contains 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.
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.
Before the enactment of the TCJA, certain types of taxpayers and
certain types of property were exempt from UNICAP, but there was no
generally applicable exemption based on gross receipts.
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 gross receipts test of section 448(c). 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.
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. Prior to the TCJA, section 460(e)(1)(B) provided an
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).
Section 471(a) requires inventories to be taken by a taxpayer when,
in the opinion of the Secretary of the Treasury or his delegate
(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. Prior to the enactment of the TCJA, there were no
regulatory exceptions from the requirement to take an inventory under
Sec. 1.471-1.
The statutory amendments of the TCJA increase the gross receipts
test amount under section 448(c) to $25,000,000, adjusted for
inflation, for eligibility to use the cash method and also exempt
taxpayers, other than a tax shelter under section 448(a)(3), meeting
the gross receipts test (Section 448(c) Gross Receipts Test) from: (1)
The UNICAP rules under section 263A; (2) the requirement to use the
percentage-of-completion method under section 460 provided other
requirements of section 460(e) are satisfied; and (3) the requirement
to take inventories under section 471(a) if their inventory is treated
as non-incidental materials and supplies, or if the method of
accounting for their inventory conforms with the method reflected on
their applicable financial statement (AFS), or if they do not have an
AFS, their books and records prepared in accordance with their
accounting procedures. These amendments generally apply to taxable
years beginning after December 31, 2017. The amendments to section 460
apply to contracts entered into after December 31, 2017, in taxable
years ending after December 31, 2017.
On August 20, 2018, the Department of the Treasury (Treasury
Department)
[[Page 255]]
and the IRS issued Revenue Procedure 2018-40 (2018-34 IRB 320), which
provided administrative procedures for a taxpayer, other than a tax
shelter under section 448(a)(3), meeting the requirements of section
448(c) to obtain the consent to change the taxpayer's method of
accounting to a method of accounting permitted by section 263A, 448,
460 or 471. The revenue procedure also requested comments for future
guidance regarding the implementation of the TCJA modifications to
sections 263A, 448, 460, and 471. The record of public comments
received in response to Revenue Procedure 2018-40 may be requested by
sending an email to [email protected].
On August 5, 2020, the Treasury Department and the IRS published a
notice of proposed rulemaking (REG-132766-18) in the Federal Register
(85 FR 47608), correction published in the Federal Register (85 FR
58307) on September 18, 2020, containing proposed regulations under
sections 263A, 448, 460, and 471 (proposed regulations). The proposed
regulations reflect consideration of the comments that were received in
response to Revenue Procedure 2018-40.
The Treasury Department and the IRS received nine written comments
responding to the proposed regulations. The Treasury Department and the
IRS received one request to speak at a public hearing, which was later
withdrawn. Therefore, no public hearing was held. Comments received
before these final regulations were substantially developed, including
all comments received on or before the deadline for comments on
September 14, 2020, were carefully considered in developing these final
regulations.
Copies of the comments received are available for public inspection
at http://www.regulations.gov or upon request. After consideration of
the comments received, this Treasury decision adopts the proposed
regulations as revised in response to such comments. Those comments and
the revisions are discussed in the Summary of Comments and Explanation
of Revisions section of this preamble.
Summary of Comments and Explanation of Revisions
I. Overview
This Summary of Comments and Explanation of Revisions section
summarizes the formal written comments that were received addressing
the proposed regulations. However, comments merely summarizing or
interpreting the proposed regulations or recommending statutory
revisions generally are not discussed in this preamble. These final
regulations provide guidance under sections 263A, 448, 460, and 471 to
implement the TCJA's amendments to those provisions. These final
regulations also modify Sec. Sec. 1.381(c)(5)-1 and 1.446-1 to reflect
these statutory amendments. The rationale for provisions in these final
regulations that are not discussed in this Explanation of Revisions
remains the same as described in the Explanation of Provisions section
of the preamble to the proposed regulations.
A. Section 263A(i)
1. Costing Rules for Self-Constructed Assets
In response to Revenue Procedure 2018-40, a commenter stated that a
small business taxpayer that is exempted from section 263A pursuant to
section 263A(i) would be subject to the costing rules prior to the
enactment of section 263A (pre-section 263A costing rules) for self-
constructed assets used in the taxpayer's trade or business. However,
according to the commenter, the pre-section 263A costing rules were
unclear as to what costs are capitalizable to self-constructed assets.
In light of this comment, the preamble to the proposed regulations
requested comments on specific clarifications needed regarding the pre-
section 263A costing rules. Only one comment was received in response
to this request. The sole commenter noted that one of the reasons for
the enactment of section 263A was that courts had reached different
conclusions as to the types of costs that were required to be
capitalized under the pre-section 263A costing rules. Compare Adolph
Coors Co. v. Commissioner, 519 F.2d 1280 (10th Cir. 1975), cert. denied
423 U.S. 1087 (1976) (requiring the full inclusion of all overhead
costs in the cost basis of self-constructed assets) with Fort Howard
Paper Co. v. Commissioner, 49 T.C. 275 (1967) (requiring only the
inclusion of overhead costs directly attributable to the self-
constructed asset). The commenter suggested that taxpayers who used the
exemption under section 263A(i) to not capitalize costs under section
263A be permitted to use an incremental costing method to determine the
costs of self-constructed assets, consistent with the approach in Fort
Howard Paper. The commenter stated that identifying indirect costs not
directly attributable to the construction of specific self-constructed
assets would be difficult.
After considering this comment, the Treasury Department and the IRS
have determined that the requested clarification is beyond the scope of
these regulations, which is to implement section 263A(i) as enacted by
TCJA. For taxpayers that elect under section 263A(i) to not apply
section 263A, the requirement to capitalize certain costs to self-
constructed assets comes from other provisions of the Code, such as
section 263(a). TCJA did not amend such provisions and thus the
clarification of permissible capitalization methods and the types of
costs required to be capitalized to self-constructed assets under such
provisions is beyond the scope of these final regulations.
2. Changes to Regulations Under Section 448
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. Sections 1.448-1T(b)(3) (for
taxable years beginning before January 1, 2018) and proposed 1.448-
2(b)(2)(iii) (for taxable years beginning after December 31, 2017)
narrow 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 under
section 448 only for a taxable year in which it has losses.
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 under
section 448(d)(3) for the current taxable year. Under the proposed
regulations, 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.
Several comments were received concerning issues related to tax
shelters, including the definition of ``syndicate,'' under proposed
Sec. 1.448-2(b)(2)(i)(B). Some commenters recommend using the
authority granted under section 1256(e)(3)(C)(v) to provide a deemed
active participation rule to disregard certain interests held by
limited
[[Page 256]]
entrepreneurs or limited partners for applying the Section 448(c) Gross
Receipts Test if certain conditions were met. For example, conditions
of the rule could include that the entity had not been classified as a
syndicate within the last three taxable years, and that the average
taxable income of the entity for that period was greater than zero.
The final regulations do not adopt this recommendation. The
Treasury Department and the IRS have determined that it would be
inappropriate to provide an exception to the active participation rules
in section 1256(e)(3)(C)(v) by ``deeming'' active participation for
small business taxpayers. The Treasury Department and the IRS believe
that the deeming of active participation in this context would be
overbroad and would run counter to Congressional intent. Sections
448(b)(3) and (d)(3), 461(i)(3) and 1256(e)(3)(C) were not modified by
the TCJA, and the legislative history to section 13012 of the TCJA does
not indicate any Congressional intent to modify the definition of ``tax
shelter'' or ``syndicate.'' By not modifying those provisions, Congress
presumably meant to exclude tax shelters, including syndicates, from
being eligible to use the cash method of accounting and the small
business taxpayer exemptions in section 13102 of the TCJA, even while
otherwise expanding eligibility to meet the Section 448(c) Gross
Receipts Test.
Other comments requested clarification generally of what ``active
participation'' means and the circumstances, if any, under which a
member of a limited liability company is treated as a ``limited
partner'' or ``limited entrepreneur'' under section 461(k)(4). The
Treasury Department and the IRS have determined that such guidance is
outside the scope of these final regulations, which are to implement
the changes made by section 13102 of the TCJA.
The Treasury Department and the IRS remain aware of the increased
relevance of the definition of tax shelter under section 448(d)(3)
after enactment of the TCJA and the practical concerns regarding the
determination of tax shelter status for the taxable year. To ameliorate
these practical concerns, these final regulations modify the syndicate
election provided in proposed Sec. 1.448-2(b)(2)(iii)(B) to provide
additional relief by making the election an annual election. The
Treasury Department and the IRS have determined that an annual election
appropriately balances the statutory language with the consistency
requirement for use of a method of accounting under section 446(a) and
Sec. 1.446-1. A cash method taxpayer that is generally profitable
year-to-year may experience an unforeseen taxable loss for an anomalous
year but return to its profitable position in subsequent years. If the
taxpayer allocated more than 35 percent of the taxable loss to limited
partners or limited entrepreneurs, the taxpayer would be required to
change from the cash method to another method for the anomalous year in
accordance with section 448(a)(3). However, that taxpayer would
otherwise not be prohibited under section 448(a)(3) to use the cash
method in the next profitable taxable year. An annual election under
Sec. 1.448-2(b)(2)(iii)(B) allows a taxpayer to elect in the loss year
to use the allocated taxable income or loss of the immediately
preceding taxable year to determine whether the taxpayer is a syndicate
under section 448(d)(3) for the current taxable year. The Treasury
Department and the IRS have determined that permitting taxpayers to
continue to use the cash method, as well as other methods impacted by a
determination under section 448(d)(3), in such situations is consistent
with the requirements under section 446(a).
This election applies for all provisions of the Code that
specifically refer to section 448(a)(3) to define tax shelter, such as
the small business exemptions under sections 163(j)(3), 263A(i)(1),
460(e)(1)(B) and 471(c)(1). A taxpayer is required to file a statement
with the original timely filed Federal income tax return, with
extensions, to affirmatively make this election under Sec. 1.448-
2(b)(2)(iii)(B) for such taxable year. The election is valid only for
the taxable year for which it is made, and once made, cannot be
revoked. The Treasury Department and the IRS intend to issue procedural
guidance to address the revocation of an election made under proposed
Sec. 1.448-2(b)(2)(iii)(B) as a result of the application of the final
regulations.
Other commenters noted for some taxpayers who took advantage of the
small business exception in section 448(b)(3) to change to the cash
method, the change in method of accounting resulted in a negative
section 481(a) adjustment, which triggered an allocated loss and made
the taxpayer a tax shelter under section 448(a)(3). As a result, the
taxpayers became ineligible to use the cash method for the year in
which the negative section 481(a) adjustment was recognized but may be
otherwise eligible to use the cash method for future years. Under
proposed Sec. 1.448-2(g)(3), these taxpayers would be ineligible for
the automatic change procedures to make a subsequent change back to the
cash method once they are no longer tax shelters within a five-year
period. The commenters recommend relief for taxpayers with this
situation.
The commenters propose an exception to the tax shelter rules for a
taxpayer that satisfies the Section 448 Gross Receipts Test if a
negative section 481(a) adjustment from a change in method of
accounting under the small business taxpayer exemptions (for example,
sections 263A(i), 471(c), 448(b)) results in the taxpayer being
considered a tax shelter under section 448(d)(3) and proposed Sec.
1.448-2(b)(2)(iii). These final regulations do not adopt this
suggestion. As described in the Preamble to the proposed regulations,
the Treasury Department and the IRS have determined that no exception
was provided in the TCJA to limit the definition of tax shelter in
section 448(d)(3) for taxpayers making method changes related to the
small business taxpayer exemptions. However, the Treasury Department
and the IRS expect that the annual election under Sec. 1.448-
2(b)(2)(iii)(B), described earlier, will provide relief for many
taxpayers in this situation.
Additionally, the Treasury Department and the IRS have reconsidered
the 5-year restriction on automatic method changes in light of these
comments. Section 446(a), unmodified by the TCJA, provides that taxable
income shall be computed under the method of accounting on the basis of
which the taxpayer regularly computes his income in keeping his books.
A taxpayer that changes its method of accounting for the same item with
regular frequency (for example, annually or every other taxable year)
is not adhering to the consistency requirement of section 446. The
consistency requirement of section 446(a) is distinct from the
authority granted the Commissioner under section 446(b) to determine
whether the method of accounting used by a taxpayer clearly reflects
income. See e.g., Advertisers Exchange, Inc. v. Commissioner, 25 T.C.
1086, 1092 (1956) (``Consistency is the key and is required regardless
of the method or system of accounting used.'') (citations omitted);
Huntington Securities Corporation v. Busey, 112 F.2d 368, 370 (1940)
(``. . . whatever method the taxpayer adopts must be consistent from
year to year unless the Commissioner authorizes a change.'')
The Treasury Department and the IRS are aware that the 5-year
restriction in proposed Sec. 1.448-2(g)(3) could be burdensome for a
small business taxpayer that was required to change from the cash
method as a result of
[[Page 257]]
section 448(a)(3) or not meeting the Section 448 Gross Receipts Test in
a taxable year but that becomes eligible to use the cash method under
section 448 in the subsequent taxable year. Proposed Sec. 1.448-
2(g)(3) would have required this small business taxpayer to request
consent to change back to the cash method using the non-automatic
change procedures in Revenue Procedure 2015-13 (or successor). These
final regulations remove the 5-year restriction on making automatic
method changes for certain situations.
Sections 263A(i)(3), 448(d)(7), 460(e)(2)(B) and 471(c)(4) provide
that certain changes in method of accounting for the small business
exemptions are made with the consent of the Secretary. A taxpayer must
follow the applicable administrative procedures related to a change in
method of accounting notwithstanding the deemed consent of the
Secretary. See, e.g., Capital One Financial Corporation and
Subsidiaries v. Commissioner of Internal Revenue, 130 T.C. 147, 157
(2008) (``a taxpayer forced to change its method of accounting under
section 448 must still file a Form 3115 with its return''). The
Treasury Department and the IRS intend to provide procedural rules
relating to changes in method of accounting to implement the final
regulations using the automatic method change procedures of Revenue
Procedure 2015-13. Those procedural rules will address whether a waiver
of the 5-year overall method eligibility rule in section 5.01(1)(e) of
Revenue Procedure 2015-13 is appropriate for small business taxpayers
that were required to change from the cash method in one taxable year
but are not subsequently limited by section 448.
The Treasury Department and the IRS have determined that taxpayers
that are voluntarily changing (that is, not required by section 448 to
no longer use the cash method) between overall methods are
distinguishable from taxpayers that are required to change from the
cash method to another method because they no longer meet the Section
448(c) Gross Receipts Test or become a tax shelter under section
448(d)(3). The procedural guidance is expected to address both fact
patterns. Additionally, the Treasury Department and the IRS intend for
the procedural guidance to address similar fact patterns for taxpayers
making changes related to the regulations under sections 263A(i),
460(e)(1)(B) and 471(c), as discussed in this Summary of Comments and
Explanation of Revisions.
3. Section 471 Small Business Taxpayer Exemptions
A. Inventory Treated as Non-Incidental Materials and Supplies
The preamble to the proposed regulations notes that the Treasury
Department and the IRS interpret the statutory language of section
471(c)(1)(B) to mean that the property excepted from section 471(a) by
that provision continues to be inventory property even though the
general inventory rules under section 471(a) are not required to be
applied to that property. Section 471(c)(1)(B) provides that a
qualifying taxpayer's ``method of accounting for inventory for such
taxable year'' (emphasis added) will not be treated as failing to
clearly reflect income if the method ``treats inventory as non-
incidental materials and supplies'' (emphasis added). The Treasury
Department and the IRS read the repeated use of the word ``inventory''
to mean that Congress intended that inventory property remains
inventory property while relieving taxpayers from the general inventory
rules of section 471(a). To reduce confusion about the nature of
property treated as non-incidental materials and supplies under section
471(c)(1)(B)(i), these final regulations refer to the method under that
provision of the Code as the ``section 471(c) NIMS inventory method.''
The Treasury Department and the IRS interpret section
471(c)(1)(B)(i) as providing three distinct benefits for taxpayers.
First, the provision significantly expanded the types of taxpayers
permitted to treat their inventory as non-incidental materials and
supplies. Under prior administrative guidance, as discussed later in
section 3.A.i of this Summary of Comments and Explanation of Revisions,
taxpayers with gross receipts of no more than $1 million and taxpayers
in certain industries (generally not producers or resellers) with gross
receipts of no more than $10 million were permitted to treat their
inventory as non-incidental materials and supplies. Section 471(c)
greatly expanded the availability of this method of accounting to
taxpayers in all types of trades or businesses, including producers and
resellers, by reference to the increased cap on gross receipts under
the Section 448(c) Gross Receipts Test. Second, treating inventory as
non-incidental materials and supplies under Sec. 1.471-1(b)(5)
provides simplification and burden reduction for taxpayers by requiring
only certain costs to be capitalized to inventory. For example, a
taxpayer using the section 471(c) NIMS inventory method does not
capitalize direct labor costs or any indirect costs to inventory costs.
See discussion of direct labor costs later in section 3.A.iii of this
Summary of Comments and Explanation of Revisions. Simplification does
not indicate that the nature of the property was changed by the TCJA,
or that the intent of Congress was to provide immediate expensing of
inventory costs. Thirdly, taxpayers, other than a tax shelter under
section 448(a)(3), treating inventory as non-incidental materials and
supplies under Sec. 1.471-1(b)(5) are eligible to use the overall cash
method of accounting for purchases and sales of merchandise, rather
than being required to use an accrual method. See Sec. 1.446-
1(a)(4)(i).
i. Definition of the Term ``Used or Consumed''
The preamble to the proposed regulations provides that the Treasury
Department and IRS interpret section 471(c)(1)(B)(i) as generally
codifying the administrative guidance existing at the time of its
enactment (that is, Revenue Procedure 2001-10 (2001-2 IRB 272) and
Revenue Procedure 2002-28 (2002-18 IRB 815)) and making that method
available to significantly more taxpayers. Accordingly, the proposed
regulations provided that items of inventory treated as materials and
supplies under section 471(c) 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 taxable year or the taxable year in
which the taxpayer pays for or incurs such cost, whichever is later.
Comments were received on the definition of ``used or consumed'' in
proposed Sec. 1.471-1(b)(4)(i) as it relates to producers. A commenter
asserted that the meaning of the term ``used or consumed'' for a
producer using the section 471(c) NIMS inventory supplies method should
be consistent with the meaning of the term ``used or consumed'' in
Sec. 1.162-3. The commenter states that a producer's raw materials are
``used or consumed'' when the raw materials enter the taxpayer's
production process. The commenter states that under section
471(c)(1)(B)(i) and Sec. 1.162-3(a)(1), only section 263A would limit
a producer's ability to recover the cost of its raw materials when the
raw materials are first used in the production process, and the final
regulations should be modified to provide that a producer does not wait
until the finished product is provided to a customer to recover the
costs of its raw materials. In addition, the commenter states that the
policy considerations
[[Page 258]]
underlying this provision were to provide small business taxpayers with
simplification, and the definition of ``used or consumed'' for
producers in proposed Sec. 1.471-1(b)(4)(i) does not result in
simplification.
The Treasury Department and IRS decline to change the definition of
used or consumed for a producer in these final regulations. As
discussed previously, the Treasury Department and the IRS interpret
section 471(c)(1)(B)(i) as generally codifying the administrative
guidance existing at the time of enactment of TCJA (that is, Revenue
Procedure 2001-10 and Revenue Procedure 2002-28) and making it
applicable to significantly more taxpayers, in addition to the other
benefits discussed in section 3.A of this Summary of Comments and
Explanation of Revisions. The commenter's recommendation that the term
``used or consumed'' for a producer should be treated as occurring when
the raw material is used or consumed in the taxpayer's production
process would allow a producer to recover production costs earlier than
was previously allowed under the administrative guidance of Revenue
Procedure 2001-10 and Revenue Procedure 2002-28. Additionally, the
commenter's recommendation suggests that the term ``used or consumed''
should be interpreted literally by looking to actual use or consumption
by the taxpayer. However, under such an interpretation a reseller,
unlike a producer, would not be able to recover any inventory costs as
a reseller does not acquire raw materials for use in a production
process nor does it use or consume finished inventory; rather a
reseller acquires and resells finished inventory, unchanged, to
customers. The Treasury Department and the IRS have determined that the
statute and legislative history do not support a reading of the
provision that would provide such a disparity in the recovery of
inventory costs between producers and resellers.
In addition, the commenter's argument interprets the words
``inventory treated as non-incidental materials and supplies'' to mean
that the components used to produce the finished goods inventory,
rather than the finished goods inventory itself, are treated as
materials and supplies. The interpretation advocated by the commenter
would result in producers being permitted to recover the cost inputs of
their units of inventory in the same manner as they recover the costs
of their materials and supplies (that is, when the cost input is used
or consumed in producing the unit of inventory). The Treasury
Department and the IRS do not believe Congress intended to break down
the traditional definition of the word ``inventory,'' particularly
since that position benefits only a certain group of taxpayers
(producers). The Treasury Department and the IRS determined that the
definition for used or consumed should provide an equitable rule for
the timing of the recovery of the inventory between producers and
resellers. Accordingly, these final regulations adopt the proposed
regulations without change.
ii. De Minimis Safe Harbor Under Sec. 1.263(a)-1(f)
Several comments were received regarding the applicability of the
de minimis safe harbor under Sec. 1.263(a)-1(f) (de minimis safe
harbor) to inventory treated as non-incidental materials and supplies.
The commenters assert that the final regulations should permit a
taxpayer that uses the section 471(c) NIMS inventory method to use the
de minimis safe harbor for its inventory treated as non-incidental
materials and supplies. The commenters point to footnote 465 of the
Bluebook, which described the law, both before and after TCJA, as
generally permitting deduction of the cost of non-incidental materials
and supplies in the taxable year in which they are first used or are
consumed in the taxpayer's operations in accordance with Sec. 1.162-
3(a)(1). Furthermore, under Sec. 1.162-3(a)(1), a taxpayer may also be
able to elect to deduct such non-incidental materials and supplies in
the taxable year the amount is paid under the de minimis safe harbor
election under Sec. 1.263(a)-1(f). General Explanation of Public Law
115-97, at 113 fn. 465.
The Treasury Department and the IRS were aware of footnote 465 in
the Bluebook when drafting the proposed regulations, but have a
different understanding of the rule for ``inventory treated as non-
incidental materials and supplies'' under Section 471(c)(1)(B)(i) as
explained in section 3.A.i of this Summary of Comments and Explanation
of Revisions. The Treasury Department and the IRS interpret section
471(c)(1)(B)(i) as generally codifying the administrative procedures
that established the non-incidental materials and supplies method for
inventoriable items, and prior pronouncements of Sec. Sec. 1.162-3 and
1.263(a)-1(f) that these regulations do not apply to inventory
property, including inventory property treated as non-incidental
materials and supplies. See, e.g., Tangible Property Regulations--
Frequently Asked Questions, available at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations#Ademinimis.
A commenter states that the de minimis safe harbor was created
after Revenue Procedure 2001-10 and Revenue Procedure 2002-28 were
released, and therefore, did not address the issue of the applicability
of the de minimis safe harbor. The Treasury Department and the IRS
agree with the timeline described by the commenter. However, as
discussed in the immediately preceding paragraph, the IRS' position on
the de minimis safe harbor has been addressed in a prior pronouncement.
As described previously in section 3.A of this Summary of Comments and
Explanation of Revisions, inventory treated as non-incidental materials
and supplies retains its character as inventory property. The de
minimis safe harbor, which is a regulatory election rather than a
statutory one, does not apply to inventory. Section 1.263(a)-
1(f)(2)(i).
Finally, the Treasury Department and the IRS note that for amounts
paid to qualify for the de minimis safe harbor, the amounts must have
been expensed on the taxpayer's applicable financial statement or books
and records, as applicable. Sections 1.263(a)-1(f)(1)(i)(B) and
(ii)(B). This applicable financial statement or books and records
expensing requirement under Sec. 1.263(a)-1(f) would be an impediment
to the application of the de minimis safe harbor under the section
471(c) NIMS inventory method for taxpayers who maintain records of
their inventory in their applicable financial statement or books and
records, even if the section 471(c) NIMS inventory method permitted the
use of the de minimis safe harbor method. In addition, there is no need
for the separate de minimis safe harbor because small business
taxpayers may use the inventory method provided in section 471(c)(1)(B)
which generally provides that a taxpayer who expenses inventory costs
in its applicable financial statement or books and records may
generally expense that cost for Federal income tax purposes. For
example, a small business taxpayer that expenses the cost of ``freight-
in'' in its books and records and wants to expense the item for Federal
income tax purposes may generally do so using the non-AFS section
471(c) inventory method, as permitted by section 471(c)(1)(B)(ii) and
discussed later in section 3.C.ii of this Summary of Comments and
Explanation of Revisions.
iii. Direct Labor
Proposed Sec. 1.471-1(b)(4)(ii) provides that inventory costs
includible in the
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section 471(c) NIMS inventory 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, in whole or in part,
but for Sec. 1.471-1(b)(4), under another provision of the Code.
Some comments were received on the types of direct costs required
to be included as an inventory cost under the section 471(c) NIMS
inventory method. These commenters recommended the final regulations
exclude direct labor costs from the definition of an inventory cost
under proposed Sec. 1.471-1(b)(4)(ii). The commenters reasoned that
the preamble to the proposed regulation indicated that section
471(c)(1)(B)(i) was generally a codification of Revenue Procedure 2001-
10 and Revenue Procedure 2002-28. However, the commenters point out
that this administrative guidance did not provide for direct labor or
overhead costs to be included in the non-incidental materials and
supplies method.
One commenter asserted that inventory treated as non-incidental
materials and supplies are not inventory property but are to be
characterized as a material and supply. The commenter discussed Example
1, in Section III.D of Notice 88-86 (1988-2 CB 401) to determine the
treatment of non-incidental materials and supplies prior to the
enactment of section 263A. Example 1 involves an architect providing
design services that include blueprints and drawings and deals with the
provision of de minimis amounts of property by a service provider. This
commenter cites to Notice 88-86 to provide, by analogy, that inventory
treated as non-incidental materials and supplies under section
471(c)(1)(B)(i) should not include direct labor costs.
The Treasury Department and the IRS disagree with the application
by analogy to Example 1 in Section III.D of Notice 88-86. That example
illustrates that an individual providing services, such as an
architect, is not a producer despite providing a de minimis amount of
property to the client as part of the provision of services. As
discussed in section 3.A of this Summary of Comments and Explanation of
Revisions, the Treasury Department and the IRS believe that inventory
property treated as non-incidental materials and supplies retains its
character as inventory property, and so Example 1 is inapposite.
The Treasury Department and the IRS acknowledge that there was
uncertainty under Revenue Procedure 2001-10 and Revenue Procedure 2002-
28 as to whether direct labor and overhead costs were required to be
capitalized under the non-incidental materials and supplies method
permitted by those revenue procedures. The Treasury Department and the
IRS are also aware that tracking of direct labor costs may be
burdensome, and in some cases, difficult to do for many small
businesses. The Treasury Department and the IRS agree with the
commenters' request that direct labor costs be excluded from the
inventory costs required to be included in inventory treated as non-
incidental materials and supplies. As a result, these final regulations
provide that inventory costs includible in the section 471(c) NIMS
inventory method are direct material costs of the property produced or
the costs of property acquired for resale.
B. Treatment of Inventory by Taxpayers With an Applicable Financial
Statement (AFS)
Under proposed Sec. 1.471-1(b)(5), a taxpayer other than a tax
shelter, that has 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 its AFS.
Proposed Sec. 1.471-1(b)(5)(ii) defines AFS by reference to section
451(b)(3) and the accompanying regulations, which included the
additional AFS rules provided in proposed Sec. 1.451-3(h).
In section 4.C.i of the preamble to the proposed regulations, the
Treasury Department and the IRS requested comments on a proposed
consistency rule for a taxpayer with an AFS that has a financial
accounting year that differs from the taxpayer's taxable year, and on
other issues related to the application of proposed Sec. 1.451-3(h) to
the AFS section 471(c) inventory method. The Treasury Department and
the IRS proposed to require a taxpayer with an AFS that uses the AFS
section 471(c) inventory method to consistently apply the same
mismatched reportable period method of accounting provided in proposed
Sec. 1.451-3(h)(4) for its AFS section 471(c) inventory method of
accounting that is used for section 451 purposes. No comments were
received on the consistency rule or other issues related to the
application of proposed Sec. 1.451-3(h) to the AFS section 471(c)
inventory method.
These final regulations adopt this consistency rule. The Treasury
Department and the IRS have determined that a taxpayer using an accrual
method with an AFS that has a mismatched reporting period with its
taxable year should apply the same mismatched reportable period method
of accounting for revenue recognition purposes and inventory purposes
because there is better matching of income and cost of goods sold by
applying the same reportable period method.
C. Treatment of Inventory by Taxpayers Without an AFS
Under proposed Sec. 1.471-1(b)(6), 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 use the non-AFS section 471(c) inventory
method to account for its inventory. The non-AFS section 471(c)
inventory method is the method of accounting for inventory reflected in
the taxpayer's books and records that are prepared in accordance with
the taxpayer's accounting procedures and that properly reflect the
taxpayer's business activities for non-tax purposes. For example, 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(c) inventory method.
(i) Definition of Books and Records
Some comments were received on the non-AFS section 471(c) inventory
method and the standard used in proposed Sec. 1.471-1(b)(6) for
``books and records.'' One commenter reasoned that the purpose of
section 471(c)(1)(B)(ii) was to provide simplification, and the
reliance on the definition of books and records used in case law is too
complex, creates audit risks, and uncertainties as to what books and
records means. The commenter recommended using a standard in which
``books and records'' is a flexible term and something the taxpayer and
his accounting professional can agree on that is consistent from year
to year. For example, the commenter suggests that any financial
statement reporting of inventory that is consistently applied be
acceptable as books and records.
Some comments discuss the issue of work papers and physical counts
of inventory, and whether either should be used if a taxpayer is
expensing these items for books and records purposes. The commenters
asserted that even though a taxpayer takes a physical count of
inventory, the taxpayer should be allowed to expense the inventory for
Federal income tax purposes if the inventory is expensed on its books
and records.
The Treasury Department and the IRS decline to change the
definition of the
[[Page 260]]
term ``books and records'' in these final regulations, and the rules
continue to generally include both work papers and physical counts of
inventory. The term books and records is used elsewhere in the Code and
regulations, and there is no indication in the statute or legislative
history to section 471(c)(1)(B)(ii) that a different definition is
intended from the general usage of this term used elsewhere in the
Code. Consequently, these final regulations use the well-established
definition of books and records of a taxpayer, which includes 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. Commissioner, 103 T.C. 441 (1994), and Sec. 1.6001-1(a).
Certain commenters requested that the final regulations provide
additional clarification on the significance of the taking of a
physical count of inventory under the non-AFS section 471(c) inventory
method. For example, commenters requested that Example 1 in proposed
Sec. 1.471-1(b)(6)(iii) be modified to provide that the physical count
is ignored if the taxpayer does not provide inventory information to a
creditor. These final regulations provide additional examples,
including variations on Example 1, to clarify the relevance of a
physical count of inventory under the non-AFS section 471(c) inventory
method. For example, a taxpayer that takes a physical count of
inventory for reordering purposes but does not allocate cost to such
inventory is not required to use the physical count for the non-AFS
section 471(c) inventory method, regardless of whether the information
is otherwise used for an internal report purpose or provided to an
external third party, such as a creditor. Alternatively, a taxpayer
that takes an end-of-year physical count and uses this information in
its accounting procedures to allocate costs to inventory is required to
use this inventory information for the non-AFS section 471(c) inventory
method regardless of whether the taxpayer makes reconciling entries to
expense these costs in its financial statements. Thus, the examples in
these final regulations clarify the principle that a taxpayer may not
ignore its regular accounting procedures or portions of its books and
records under the non-AFS section 471(c) inventory method.
(ii) Inventory Costs
The proposed regulations defined ``inventory costs'' for the non-
AFS section 471(c) inventory method generally as costs that the
taxpayer capitalizes to property produced or property acquired for
resale in its books and records. Certain commenters requested that the
final regulations clarify how a taxpayer treats costs to acquire or
produce tangible property that the taxpayer does not capitalize in its
books and records because the proposed regulations did not specifically
address these costs.
These final regulations clarify in Sec. 1.471-1(b)(6)(i) that
costs that are generally required to be capitalized to inventory under
section 471(a) but that the taxpayer is not capitalizing in its books
and records are not required to be capitalized to inventory. The
Treasury Department and the IRS have also determined that, under this
method, such costs are not treated as amounts paid to acquire or
produce tangible property under Sec. 1.263(a)-2, and therefore, are
generally deductible when they are paid or incurred if such costs may
be otherwise deducted or recovered notwithstanding Sec. 1.471-1(b)(4)
under another provision of the Code and Regulations. Additionally,
these final regulations clarify that costs capitalized for the non-AFS
section 471(c) inventory method are those costs that related to the
production or resale of the inventory to which they are capitalized in
the taxpayer's books and records. Similar clarifications have been made
in Sec. 1.471-1(b)(5) regarding the AFS section 471(c) inventory
method.
Applicability Dates
These final regulations are applicable for taxable years beginning
on or after January 5, 2021. However, a taxpayer may apply these
regulations for a taxable year beginning after December 31, 2017, and
before January 5, 2021, provided that if the taxpayer applies any
aspect of these final regulations under a particular Code provision,
the taxpayer must follow all the applicable rules contained in these
regulations that relate to that Code provision for such taxable year
and all subsequent taxable years, and must follow the administrative
procedures for filing a change in method of accounting in accordance
with Sec. 1.446-1(e)(3)(ii). For example, a taxpayer that wants to
apply Sec. 1.263A-1(j) to be exempt from capitalizing costs under
section 263A must apply Sec. 1.448-2 to determine whether it is
eligible for the exemption. The same taxpayer must apply Sec. 1.448-2
to determine whether it is eligible to apply Sec. 1.471-1(b) to be
exempt from the general inventory rules under section 471(a). However,
it may choose not to apply Sec. 1.471-1(b) even though it chooses to
apply Sec. 1.263A-1(j) and Sec. 1.448-2.
Alternatively, a taxpayer may rely on the proposed regulations for
a taxable year beginning after December 31, 2017 and before January 5,
2021, provided that if the taxpayer applies any aspect of the proposed
regulations under a particular Code provision, the taxpayer must follow
all of the applicable rules contained in the proposed regulations that
relate to that Code provision for such taxable year, and follow the
administrative procedures for filing a change in method of accounting
in accordance with Sec. 1.446-1(e)(3)(ii).
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 Analyses
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
Section 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 (including
extensions) for the taxable year that the election is made. The
election is an annual election and, if made for a taxable year, cannot
be revoked. 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: 224,165 hours.
Estimated average annual burden hours per respondent: 1 hour.
Estimated number of respondents: 224,165.
Estimated annual frequency of responses: Once.
Other than the election statement, these regulations do not impose
any additional information collection
[[Page 261]]
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 IRB 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. See also the
revenue procedure accompanying these regulations for similar method
change procedures to make a change in method of accounting to comply
with these final regulations.
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 earlier, 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 these OMB control numbers 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
regulations. These numbers are therefore not specific to the burden
imposed by these 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 TCJA. No burden
estimates specific to the forms affected by the 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 TCJA and those
that arise out of discretionary authority exercised in the final
regulations and other regulations that affect the compliance burden for
that form.
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.
At the proposed rule stage, the Treasury Department and the IRS had not
determined whether the proposed rules, when finalized, would 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, and the regulations providing
guidance with respect to such exemptions, will have a significant
economic impact on a substantial number of small entities requires
further study. However, because there is a possibility of significant
economic impact on a substantial number of small entities, an IRFA was
provided at the proposed rule stage. In accordance with section 604 of
the RFA, following is the final regulatory flexibility analysis.
1. Reasons for and Objectives of the Rule
As discussed earlier in the preamble, these 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 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 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 regulations. Thus, the Treasury
Department and the IRS expect that, at the time these regulations are
published, many small business taxpayers may have already implemented
some aspects of the regulations.
2. Significant Issues Raised by the Public Comments in Response to the
IRFA and Comments Filed by the Chief Counsel for Advocacy of the Small
Business Administration
No public comments were received in response to the IRFA.
Additionally, no comments were filed by the Chief Counsel for Advocacy
of the Small Business Administration in response to the proposed
regulations.
3. 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
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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 3,200,000 and 3,575,000 respondents
with gross receipts of not more than $25 million (adjusted for
inflation) that have inventories. The Treasury Department and the IRS
estimate that of these taxpayers there are between 28,900 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 28,900 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 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.
Section 1.263A-9 modifies the current regulation to increase the
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 28,900 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 section
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 605,000 respondents
with gross receipts of not more than $5 million presently using an
accrual method, and between 70,000 and 76,500 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 from
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 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 224,165 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
[[Page 263]]
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 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 19,500 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 3,575,000 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 11,500 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.
4. Projected Reporting, Recordkeeping, Other Compliance Requirements,
and Costs
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 final regulations implementing
these exemptions. The taxpayer may expend time to read and understand
the final regulations. The cost to comply with these regulations are
reflected in modest reporting activities. Taxpayers needing to make
method changes pursuant to these regulations will be required to file a
Form 3115. The Treasury Department and the IRS are minimizing the cost
to comply with the regulations by providing administrative procedures
that allow taxpayers to make multiple changes in method of accounting
related to the statutory exemptions under sections 263A, 448, 460, and
471 for the same tax year on a single Form 3115, instead of filing a
separate Form 3115 for each exemption. Although there is a nominal
implementation cost, the Treasury Department and the IRS anticipate
that the statutory exemptions and the final regulations implementing
these exemptions will reduce overall 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. For example, a taxpayer that applies section
471(c)(1)(B)(i) to treat inventory as non-incidental materials and
supplies will only need to capitalize the direct material cost of
producing inventory instead of also having to capitalize the direct
labor and indirect costs of producing inventory under the general rules
of section 471(a). Additionally, a taxpayer that applies section
471(c)(1)(B)(ii) can follow the inventory method used in its applicable
financial statement, or its books and records if it does not have an
applicable financial statement, in lieu of keeping a separate inventory
method under the general rules of section 471(a).
5. Steps Taken To Minimize the Economic Impact on Small Entities
As discussed earlier in the preamble, section 448 provides a
general restriction for C corporations, 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 (for example, 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 of approximately $2,375 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 regulations, it will no longer
need to pay an accountant for the annual section 263A analysis.
The regulations implementing these exemptions are completely
voluntary because small business taxpayers may continue using an
accrual method of accounting, and applying the general rules under
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
[[Page 264]]
businesses. The regulations provide clarity and certainty for small
business taxpayers implementing the exemptions.
As described in more detail earlier in the preamble, the Treasury
Department and the IRS considered a number of alternatives under the
final 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 (for example, 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.
III. Section 7805(f)
Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding this Treasury Decision was submitted to the Chief
Counsel of the Office of Advocacy of the Small Business Administration
for comment on its impact on small business.
IV. 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.
Drafting Information
The principal author of these 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.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is 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 adding an entry for (m)(6).
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) * * *
(6) Exemption for certain small business taxpayers.
Sec. 1.263A-3 Rules Relating to Property Acquired for Resale.
(a) * * *
(2) * * *
(ii) Exemption for small business taxpayers.
* * * * *
(5) De minimis production activities.
[[Page 265]]
(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 to permit
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 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).
0
7. In newly-redesignated paragraph (m), adding paragraph (m)(6).
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. This section 448(c)
gross receipts test applies even if the taxpayer is not otherwise
subject to section 448(a).
(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 changing its method of accounting
under paragraph (j) of this section may do so only with the consent of
the Commissioner as required under section 446(e) and Sec. 1.446-1. 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. For rules relating to the clear
reflection
[[Page 266]]
of income and the pattern of consistent treatment of an item, see
section 446 and Sec. 1.446-1. 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 Revenue Procedure 2015-
13 (2015-5 IRB 419) (or successor) (see also Sec. 601.601(d)(2) of
this chapter).
(ii) Automatic consent for certain method changes. Certain changes
in method of accounting made under paragraph (j) of this section may be
made under the procedures to obtain the automatic consent of the
Commissioner to change a method of accounting. See Revenue Procedure
2015-13 (2015-5 IRB 419) (or successor) (see also Sec. 601.601(d)(2)
of this chapter)). In certain situations, special terms and conditions
may apply.
* * * * *
(m) * * *
(6) Exemption for certain small business taxpayers. The second and
third sentence in paragraph (a)(2)(i), paragraphs (b)(1) and (j) of
this section apply to taxable years beginning on or after January 5,
2021. However, for a taxable year beginning after December 31, 2017,
and before January 5, 2021, a taxpayer may apply the paragraphs
described in the first sentence of this paragraph (m)(6), provided that
the taxpayer follows all the applicable rules contained in the
regulations under section 263A for such taxable year and all subsequent
taxable years.
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 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 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. Except as otherwise provided in this paragraph
(a)(1)(ii)(C), section 263A applies to such a contract even if the
contractor is not considered the owner of the property produced under
the contract under Federal income tax principles.
* * * * *
(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 January 5,
2021. However, for a taxable year beginning after December 31, 2017,
and before January 5, 2021, a taxpayer may apply the paragraphs
described in the first sentence of this paragraph (g)(4), provided that
the taxpayer follows all the applicable rules contained in the
regulations under section 263A for such taxable year and all subsequent
taxable years.
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), 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:
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
[[Page 267]]
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 January 5, 2021 . However, for a taxable
year beginning after December 31, 2017, and before January 5, 2021, a
taxpayer may apply the paragraphs described in the first sentence of
this paragraph (f)(2), provided the taxpayer follows all the applicable
rules contained in the regulations under section 263A for such taxable
year and all subsequent taxable years.
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
sentence at the end of the paragraph.
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 paragraphs (d)(5) and (6)
0
11. By adding paragraph (e)(5).
0
12. By redesignating paragraph (f) as paragraph (g).
0
13. By adding new paragraph (f).
0
14. By revising the subject headings of newly-redesignated paragraphs
(g) and (g)(1), and by 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 to permit 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 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 beginning on or after January 5, 2021. However, for a
taxable year beginning after December 31, 2017, and before January 5,
2021, a taxpayer may apply the paragraphs described in the first
sentence of this paragraph (g)(2), provided that the taxpayer follows
all the applicable rules contained in the regulations under section
263A for such taxable year and all subsequent taxable years.
[[Page 268]]
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 ``Revenue Procedure 2015-13, 2015-5 IRB 419 (or
successor)'' 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 beginning
on or after January 5, 2021. However, for a taxable year beginning
after December 31, 2017, and before January 5, 2021, a taxpayer may
apply the paragraph described in the first sentence of this paragraph
(a)(4)(ii), provided that the taxpayer follows all the applicable rules
contained in the regulations under section 263A for such taxable year
and all subsequent taxable years.
* * * * *
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 to 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 January 5,
2021. However, for a taxable year beginning after December 31, 2017,
and before January 5, 2021, a taxpayer may apply the last sentence of
each of Sec. 1.263A-8(a)(1) and Sec. 1.263A-9(e)(2), provided that
the taxpayer follows all the applicable rules contained in the
regulations under section 263A for such taxable year and all subsequent
taxable years.
* * * * *
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)
------------------------------------------------------------------------
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
4. By adding a sentence to the end of paragraph (f).
The addition reads as follows:
Sec. 1.381(c)(5)-1 Inventory method.
* * * * *
(f) * * * The designations of paragraphs (a)(6)(ii)(A) and (B) of
this section and removal of the term ``small reseller'' and replacement
with the term ``small business taxpayer'' apply to taxable years
beginning on or after January 5, 2021.
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 additions 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 January 5, 2021. However, for a
taxable year beginning after December 31, 2017, and before January 5,
2021, a taxpayer may apply the rules provided in the first sentence of
this paragraph (c)(3), provided that the taxpayer follows all the
applicable rules contained in the regulations under section 446 for
such taxable year and all subsequent taxable years.
* * * * *
0
Par. 13. Section 1.448-1 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
[[Page 269]]
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 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) Irrevocable annual election to test the allocation of losses
from prior taxable year--(1) In general. 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, 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 only to the taxable year for which the election is made. Except
as otherwise provided in guidance published in the Internal Revenue
Bulletin (see Sec. 601.601(d)(2) of this chapter), a taxpayer that
makes an
[[Page 270]]
election under this paragraph (b)(2)(iii)(B) must apply this election
for other provisions of the Code that specifically apply the definition
of tax shelter in section 448(a)(3).
(2) Time and manner of making election. A taxpayer makes this
election for the taxable year by attaching a statement to its timely
filed original Federal income tax return (including extensions) for
such taxable year. The statement must state that the taxpayer is making
the election under Sec. 1.448-2(b)(2)(iii)(B). In the case of an S
corporation or partnership, the election is made by the S corporation
or the partnership and not by the shareholders or partners. An election
under this paragraph (b)(2)(iii)(B) may not be made by the taxpayer in
any other manner. For example, the election cannot be made through a
request under section 446(e) to change the taxpayer's method of
accounting. A taxpayer may not revoke an election under this paragraph
(b)(2)(iii)(B).
(3) Administrative guidance. The IRS may publish procedural
guidance in the Internal Revenue Bulletin (see Sec. 601.601(d)(2) of
this chapter) that provides alternative procedures for complying with
paragraph (b)(2)(iii)(B)(2) of this section.
(C) Examples. The following examples illustrate the rules of
paragraph (b)(2)(iii) of this section. For purposes of the examples,
the term ``losses'' has the meaning stated in paragraph (b)(2)(iii)(A)
of this section.
(1) Example 1. Taxpayer B is a calendar year limited partnership,
with no active management from its limited partner. For 2019, B is
profitable and has no losses to allocate to its limited partner. For
2020, B is not profitable and allocates 60 percent of its losses to its
general partner and 40 percent of its losses to its limited partner.
For 2021, B is not profitable and allocates 50 percent of its losses to
its general partner and 50 percent of its losses to its limited
partner. For taxable year 2020, B makes an election under paragraph
(b)(2)(iii)(B) of this section to use its prior year allocated amounts.
Accordingly, for 2020, B is not a syndicate because B was profitable
for 2019 and did not allocate any losses to its limited partner in
2019. For 2021, B is a syndicate because B allocated 50 percent of its
2021 losses to its limited partner under paragraph (b)(2)(ii)(3)(A) of
this section. Even if B made an election under paragraph (b)(2)(iii)(B)
of this section to use prior year allocated amounts, B is a syndicate
for 2021 because B allocated 40 percent of its 2020 losses to its
limited partner in 2020. Because B is a syndicate under paragraph
(b)(2)(iii)(A) of this section for 2021, B is a tax shelter prohibited
from using the cash method for taxable year 2021 under paragraph
(b)(2)(i)(B) of this section.
(2) Example (2). Same facts as Example (1) in paragraph
(b)(2)(iii)(C)(1) of this section, except for 2021, B is profitable and
has no losses to allocate to its limited partner. For 2020, B makes an
election under paragraph (b)(2)(iii)(B) of this section to use its
prior year allocated amounts. Accordingly, for 2020, B is not a
syndicate because it did not any allocate any losses to its limited
partner in 2019. For 2021, B chooses not to make the election under
paragraph (b)(2)(iii)(B) of this section. For 2021, B is not a
syndicate because it does not have any 2021 losses to allocate to a
limited partner. For taxable years 2019, 2020 and 2021, B is not a
syndicate under paragraph (b)(2)(iii)(A) of this section and is not
prohibited from using the cash method for taxable years 2019, 2020 or
2021 under paragraph (b)(2)(i)(B) 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. Payments for farm supplies that will not be
used or consumed until a taxable year subsequent to the taxable year of
payment are an example of one type of such prepayment.
(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 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
[[Page 271]]
+ $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, the change shall be
treated as a change initiated by the taxpayer to compute the adjustment
required under section 481. 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 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)). 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 Revenue Procedure 2015-
13 (2015-5 IRB 419) (or successor) (see also Sec. 601.601(d)(2) of
this chapter).
(h) Applicability dates. The rules of this section apply for
taxable years beginning on or after January 5, 2021. However, for a
taxable year beginning after December 31, 2017, and before January 5,
2021, a taxpayer may apply the rules provided in this section
[[Page 272]]
provided that the taxpayer follows all the applicable rules contained
in the regulations under section 448 for such taxable year and all
subsequent taxable years.
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 January 5, 2021. However, for a taxable
year beginning after December 31, 2017, and before January 5, 2021, a
taxpayer may apply the paragraph described in the first sentence of
this paragraph (h)(2), provided that the taxpayer follows all the
applicable rules contained in the regulations under section 448 for
such taxable year and all subsequent taxable years.
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.
(iii) Method of accounting.
* * * * *
(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.
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 contracts entered into in taxable years beginning on or after
January 5, 2021. However, for contracts entered into after December 31,
2017, in a taxable year ending after December 31, 2017, and before
January 5, 2021, a taxpayer may apply paragraph (f)(3) of this section,
and Sec. 1.460-5(d)(1) and (d)(3), provided that the taxpayer also
applies the applicable rules contained in the regulations under section
460 for such taxable year and all subsequent taxable years.
* * * * *
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 for the taxable year in
which such contract is entered into.
* * * * *
(3) 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 this paragraph (b)(3) if it
meets the gross receipts test of section 448(c) and Sec. 1.448-
2(c)(2). This gross receipts test applies even if the taxpayer is not
otherwise subject to section 448(a).
(ii) Application of gross receipts test--(A) In general. In the
case of any taxpayer that is not a corporation or a 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 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. 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
[[Page 273]]
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).
(iii) Method of accounting. A change in the method of accounting
used for exempt construction contracts described in paragraph
(b)(1)(ii) of this section is a change in method of accounting under
section 446 and the accompanying regulations. For rules distinguishing
a change in method from adoption of a method, see Sec. 1.460-1(f)(3).
A taxpayer changing its method of accounting must obtain the consent of
the Commissioner in accordance with Sec. 1.446-1(e)(3). 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. A
change in method of accounting shall be implemented pursuant to 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 (IRB) (see Revenue Procedure
2015-13 (2015-5 IRB 419) (or successor) (see Sec. 601.601(d)(2) of
this chapter)). A taxpayer that uses the percentage of completion
method for exempt contracts described in paragraph (b)(1)(ii) of this
section that wants to change to another exempt contract method is to
use the applicable administrative procedures to obtain the automatic
consent of the Commissioner to change such method under section 446(e)
as published in the IRB. A taxpayer-initiated change in method of
accounting will be permitted only on a cut-off basis, and thus, a
section 481(a) adjustment will not be permitted or required. See Sec.
1.460-4(g).
* * * * *
(d) Applicability Dates. Paragraphs (b)(1)(ii) and (b)(3) of this
section apply, for contracts entered into in taxable years beginning on
or after January 5, 2021. However, for contracts entered into after
December 31, 2017, in a taxable year ending after December 31, 2017,
and before January 5, 2021, a taxpayer may apply the paragraphs
described in the first sentence of this paragraph (d), provided that
the taxpayer follows all the applicable rules contained in the
regulations under section 460 for such taxable year and all subsequent
taxable years.
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 to
taxable years beginning on or after January 5, 2021. However, for a
taxable year beginning after December 31, 2017, and before January 5,
2021, a taxpayer may apply the paragraph described in the first
sentence of this paragraph (i), provided that the taxpayer follows all
the applicable rules contained in the regulations under section 460 for
such taxable year and all subsequent taxable years.
* * * * *
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
[[Page 274]]
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 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
------------------------------------------------------------------------
[[Page 275]]
(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 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)(iii),
(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 to taxable years
beginning on or after January 5, 2021. However, for a taxable year
beginning after December 31, 2017, and before January 5, 2021, a
taxpayer may apply the paragraphs described in the first sentence of
this paragraph (k), provided that the taxpayer follows all the
applicable rules contained in the regulations under section 460 for
such taxable year and all subsequent taxable years. Further, a taxpayer
may apply those portions of paragraphs (b)(2)(ii) and (b)(3)(iii) of
this section that relate to section 460(e)(1)(B) for contracts entered
into after December 31, 2017, in a taxable year ending after December
31, 2017, provided that the taxpayer follows all the applicable rules
contained in the regulations under section 460 for such taxable year
and all subsequent taxable years.
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 paragraphs (b) and (c).
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 described 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 this paragraph (b)(2) if it
meets the gross receipts test of section 448(c) and Sec. 1.448-2(c).
This gross receipts test applies 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, A'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) Using a method that treats its inventory as non-incidental
materials and supplies (section 471(c) NIMS inventory method), 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
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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. The costs of inventory treated as non-incidental materials
and supplies are recovered through cost of goods sold only in the
taxable year in which the inventory is used or consumed in the
taxpayer's business, or in the taxable year in which the taxpayer pays
for or incurs the cost of the inventory, whichever is later. Inventory
treated as non-incidental materials and supplies is used or consumed in
the taxpayer's business in the taxable year in which the taxpayer
provides the inventory to its customer. The costs of inventory are
treated as non-incidental materials and supplies under this paragraph
(b)(4) are not eligible for the de minimis safe harbor election under
Sec. 1.263(a)-1(f)(2).
(ii) Identification and valuation of inventory treated as non-
incidental materials and supplies. A taxpayer may determine the amount
of the costs of its inventory treated as non-incidental 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(c) NIMS inventory 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 inventory treated as non-incidental materials and
supplies, or to value that inventory treated as non-incidental
materials and supplies. The inventory costs includible in the section
471(c) NIMS inventory method are the direct material costs of the
property produced or the costs of 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. A taxpayer treating its inventory as non-
incidental materials and supplies under this paragraph (b)(4) may
allocate the costs of such inventory by using specific identification
or any other 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) NIMS inventory 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 those 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) inventory 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) inventory method described in this paragraph to account
for its inventory costs for the taxable year. For purposes of the AFS
section 471(c) inventory method, an inventory cost is a cost of
production or resale that a taxpayer capitalizes to inventory property
produced or property acquired for resale in its AFS. For purposes of
the AFS section 471(c) inventory method, costs that are generally
required to be capitalized to inventory under section 471(a) but that
the taxpayer does not capitalize to inventory on its AFS are not
required to be capitalized to inventory. 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)
inventory method recovers its inventory costs in accordance with the
inventory method used in its AFS.
(ii) Definition of Applicable Financial Statement (AFS). The term
applicable financial statement (AFS) is defined in section 451(b)(3)
and the accompanying regulations. See Sec. 1.451-3(a)(5). The rules
relating to additional AFS issues provided in Sec. 1.451-3(h) apply to
the AFS section 471(c) inventory method. In the case of a taxpayer with
a financial accounting year that differs from the taxpayer's taxable
year, the taxpayer must consistently use the same method of accounting
described in Sec. 1.451-3(h)(4)(i)(A) through (C) that is used for
section 451(b) purposes to also determine its inventory for the taxable
year under this paragraph (b)(5)(ii). 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) inventory 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) inventory 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) inventory 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) inventory method to
account for its inventories for the taxable year in accordance with
this paragraph (b)(6). The non-AFS section 471(c) inventory 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
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accordance with the taxpayer's accounting procedures. For purposes of
the non-AFS section 471(c) inventory method, an inventory cost is a
cost of production or resale that the taxpayer capitalizes to inventory
property produced or property acquired for resale in its books and
records, except as provided in paragraph (b)(6)(ii) of this section.
Costs that are generally required to be capitalized to inventory under
section 471(a), but that the taxpayer does not capitalize in its books
and records are not required to be capitalized to inventory. 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 non-
AFS section 471(c) inventory method recovers its applicable 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)
inventory method.
(ii) Timing and amounts of costs. Notwithstanding the timing of
costs reflected in the taxpayer's books and records, a taxpayer may not
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). 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 $15
million 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) inventory method
of accounting. E uses the overall cash method, and the non-AFS section
471(c) inventory 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 uses
this physical count as part of its books and records for purposes of
capitalizing and allocating costs to inventory. E also makes
representations to its creditor of the cost 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. Instead, E must use the
physical inventory count taken at the end of 2019 to determine how its
capitalized costs are allocated and recovered.
(B) Example 2. Same facts as Example (1) in paragraph
(b)(6)(iii)(A) of this section but E does not use the physical count to
capitalize and allocate costs to inventory and does not make any
representations about inventory on hand to any creditors. Although E
pays or incurs costs that are generally required to be capitalized to
inventory under section 471(a), because such costs are not capitalized
to inventory in E's books and records, they are not required to be
capitalized to inventory under paragraph (b)(6)(i) of this section.
(C) Example 3. Same facts as Example (1) in paragraph
(b)(6)(iii)(A) of this section but E does not use the physical count to
capitalize and allocate costs to inventory in its electronic
bookkeeping software and does not make any representations about
inventory on hand to any external parties. E does use the physical
count to value inventory on hand for internal reports to its
shareholders. The internal reports to its shareholders are part of E's
books and records and must be taken into account for E's non-AFS
section 471(c) inventory method. E recovers its inventory costs
consistent with its non-AFS section 471(c) inventory method.
(D) Example 4. Taxpayer 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) inventory 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.
(E) Example 5. Taxpayer G 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. In 2020, G's baking business has average
annual gross receipts for the prior 3-taxable years of less than
$100,000 and is not otherwise prohibited from using the cash method
under section 448(a)(3). G does not have an AFS for the 2020 taxable
year. For Federal income tax purposes, G uses the overall cash method
of accounting and the non-AFS section 471(c) inventory method. In G's
books and records for 2020 that properly reflects its business
activities for non-tax purposes, G capitalizes the cost of its cookie
ingredients to inventory but immediately expenses the cost of labor for
G's employee who bakes the cookies. Under paragraphs (b)(6)(i) and (ii)
of this section, G treats as an inventory cost the cost of its cookie
ingredients and recovers such costs in accordance with the accounting
procedures used to prepare its books and records, or, if later, when
paid. Additionally, although the cost of direct labor is generally
required to be capitalized to inventory under section 471(a), because
such cost is not capitalized to inventory in G's books and records, it
is not required to be capitalized to inventory under paragraph
(b)(6)(i) of this section. Further, because such direct labor cost is
generally deductible under section 162, and not otherwise required to
be capitalized under section 263(a), G may deduct the cost of labor in
the year G pays that expense.
(F) Example 6. Taxpayer H is a partnership engaged in the resale of
beer, wine, and liquor. In 2020, H 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). H does not have an AFS for the 2020 taxable year. For
Federal income tax purposes, H uses the overall cash method of
accounting, and the non-AFS section 471(c) inventory method of
accounting. For its books and records, H uses the overall cash method.
As part of its regular business practice, H's employees take regular
physical counts of the inventory on the shop floor and in the
storeroom, however H's method of accounting for inventory for its books
and records does not allocate costs between ending inventory and cost
of goods sold, and instead expenses the cost of the inventory in the
year it was paid for. Prior to December 2020, H acquires and pays for
$500,000 of beer, wine, and liquor. In addition, on
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December 1, 2020, H acquires $50,000 in beer and wine, and pays for
this beer and wine on December 20, 2020. H may recover as deductions in
2020 the $550,000 of inventory costs.
(G) Example 7. Taxpayer J is a partnership engaged in the resale of
beer, wine, and liquor. In 2020, J 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). J does not have an AFS for the 2020 taxable year. For
Federal income tax purposes, J uses the overall cash method of
accounting, and the non-AFS section 471(c) inventory method of
accounting. For its books and records, J uses the overall cash method.
J maintains a point-of-sale computer system that tracks acquisition
costs and inventory levels of the beer, wine, and liquor. The ledger is
periodically reconciled with physical counts performed by J's
employees. J must use the physical inventory count and ledger to
determine its ending inventory. J includes in cost of goods sold for
2020 those inventory costs that are not properly allocated to ending
inventory.
(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, an accrual method 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. Finally, nothing in section 471(c) permits the deduction or
recovery of any cost that a taxpayer is otherwise precluded from
deducting or recovering under any other provision in the Code or
Regulations.
(8) Method of accounting--(i) In general. A change in the method of
treating inventory under this paragraph (b) is a change in method of
accounting under sections 446 and 481 and the accompanying regulations.
A taxpayer changing its method of accounting under paragraph (b) of
this section may do so only with the consent of the Commissioner as
required under section 446(e) and Sec. 1.446-1. For example, a
taxpayer using the AFS section 471(c) inventory method or non-AFS
section 471(c) inventory method that wants to change its 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 that affects Federal income tax is not a change in
method of accounting for such inventory under section 446(e). 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. 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. 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 Revenue
Procedure 2015-13 (2015-5 IRB 419) (or successor) (see also Sec.
601.601(d)(2) of this chapter).
(ii) Automatic consent for certain method changes. Certain changes
in method of accounting made under paragraph (b) of this section may be
made under the procedures to obtain the automatic consent of the
Commissioner to change a method of accounting. See Revenue Procedure
2015-13 (2015-5 IRB 419) (or successor) (see Sec. 601.601(d)(2) of
this chapter)). In certain situations, special terms and conditions may
apply.
(c) Applicability dates. This section applies for taxable years
beginning on or after January 5, 2021. However, for a taxable year
beginning after December 31, 2017, and before January 5, 2021, a
taxpayer may apply this section provided that the taxpayer follows all
the applicable rules contained in this section for such taxable year
and all subsequent taxable years.
Douglas W. O'Donnell,
Acting Deputy Commissioner for Services and Enforcement.
Approved: December 18, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-28888 Filed 12-31-20; 8:45 am]
BILLING CODE P
