Bulletin No. 1997–33

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Internal Revenue

bulletin

Bulletin No. 1997–33

August 18, 1997

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 97–32, page 4.

LIFO; price indexes; department stores. The June

1997 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing

inventories for tax years ended on, or with reference to,

June 30, 1997.

EMPLOYEE PLANS

Rev. Proc. 97–41, page 51.

Plan amendments; discretionary extension of the

remedial amendment period. This procedure provides an

extended remedial amendment period for certain qualified

plans described in sections 401(a) and 403(a) of the Code

and describes the time for making amendments to certain

tax-sheltered annuities described in section 403(b).

Notice 97–45, page 7.

Highly compensated employee; definition. This notice

sets forth the changes in determining who is a highly compensated employee within the meaning of section 414(q) of

the Code as a result of section 1431 of the Small Business

Job Protection Act of 1996.

ADMINISTRATIVE

Rev. Proc. 97–35, page 11.

engaged in the trade or business of retail sales of new automobiles or new light-duty trucks.

Rev. Proc. 97–37, page 18.

Methods of accounting; automatic consent. Procedures

are provided under which a taxpayer may obtain automatic

consent of the Commissioner to change certain methods of

accounting.

Rev. Proc. 97–38, page 43.

Warranty contracts; methods of accounting. Procedures

are provided under which accrual method manufacturers,

wholesalers, and retailers of motor vehicles or other durable

consumer goods may, in certain specified and limited circumstances, include a portion of an advance payment related to

the sale of a multi-year service warranty contract in gross income generally over the life of the service warranty obligation.

Rev. Proc. 97–39, page 48.

Original issue discount; methods of accounting.

Taxpayers are allowed to use an aggregate method of

accounting, termed the “principal-reduction” method, for de

minimis original issue discount on certain loans originated by

the taxpayer.

Rev. Proc. 97–40, page 50.

Late S corporation elections. If an S corporation election is

filed late for a current taxable year, Rev. Proc. 97–40 provides a special procedure to permit taxpayers to request relief instead of applying for a private letter ruling.

Package design costs; methods of accounting. Three

alternative methods of accounting for package design costs

are provided: (1) the capitalization method; (2) the design-bydesign and 60-month amortization method; and (3) the poolof-cost and 48-month amortization method.

Rev. Proc. 97–42, page 57.

Rev. Proc. 97–36, page 14.

Announcement 97–77, page 58.

Last-in, first-out inventory method; methods of

accounting. An alternative last-in, first-out (LIFO) inventory

computation method of accounting is provided for taxpayers

This announces that the Internal Revenue Service will eliminate Form 4782, Employee Moving Expense Information,

effective for tax year 1998.

Finding Lists begin on page 60.

Department of the Treasury

Internal Revenue Service

Low-income housing tax credit. This procedure publishes

the amounts of unused housing credit carryovers allocated

to qualified states under section 42(h)(3)(D) of the Code for

calendar year 1997.

Mission of the Service

ucts and services; and perform in a manner warranting

the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect

the proper amount of tax revenue at the least cost; serve

the public by continually improving the quality of our prod-

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin of the

succeeding quarterly and semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 162.—Trade or

Business Expenses

What procedures must a lawyer, handling cases

on a contingent fee basis, use to obtain automatic

consent of the Commissioner to change its method

of accounting for advances paid to clients. See Rev.

Proc. 97–37, page 18.

Section 165.—Losses

26 CFR 1.165–2: Obsolescence of nondepreciable

property.

When may a taxpayer deduct a loss arising from

the obsolescence of a package design. See Rev.

Proc. 97–35, page 11.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for package design costs.

See Rev. Proc. 97–37, page 18.

Section 166.—Bad Debts

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

from the § 585 reserve method of accounting to the

§ 166 specific charge-off method. See Rev. Proc.

97–37, page 18.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for package design costs.

See Rev. Proc. 97–37, page 18.

Section 263A.—Capitalization

and Inclusion in Inventory Costs

of Certain Expenses

26 CFR §1.263A–1: Uniform capitalization of costs.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting. See Rev. Proc. 97–37,

page 18.

26 CFR 1.263A–2: Rules relating to property produced by the taxpayer.

Are the costs incurred in connection with the development and design of product packages subject

to the rules under section 263A. See Rev. Proc.

97–35, page 11.

Section 401.—Qualified

Pension, Profit-sharing, and

Stock Bonus Plans.

26 CFR 1.401(b)–1: Certain retroactive changes in

plan.

Section 167.—Depreciation

26 CFR 1.167(a)–3: Intangibles.

How may a taxpayer recover the costs of creating

a package design. See Rev. Proc. 97–35, page 11.

A procedure describes when plans that are qualified under § 401(a) or § 403(a) must be amended for

the Small Business Job Protection Act of 1996, Pub.

L. 104–188, the Uruguay Round Agreements Act,

Pub. L. 103–465, and the Uniformed Services Employment and Reemployment Rights Act of 1994,

Pub. L. 103–353. See Rev. Proc. 97–41, page 51.

26 CFR 1.167(e)–1: Change in method.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for depreciation. See Rev.

Proc. 97–37, page 18.

method of accounting for the income from an advance

payment related to the sale of a multi-year service

warranty contract. See Rev. Proc. 97–37, page 18.

Section 454.—Obligations

Issued at a Discount

26 CFR § 1.454–1: Obligations issued at a discount.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for the interest income on

Series E or EE U.S. savings bonds. See Rev. Proc.

97–37, page 18.

Section 455.—Prepaid

Subscription Income

26 CFR § 1.455–6: Time and manner of making

election.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for prepaid subscription income. See Rev. Proc. 97–37, page 18.

Section 461.—General Rule for

Taxable Year of Deduction

26 CFR § 1.461–4: Economic performance.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting. See Rev. Proc. 97–37,

page 18.

Section 471.—General Rule for

Inventories

Section 403.—Taxation of

Employee Annuities

26 CFR § 1.471–1: Need for inventories;

26 CFR § 1.471–3: Inventories at cost.

Section 168.—Accelerated Cost

Recovery System

A procedure describes when tax-sheltered annuity plans within the meaning of § 403(b) must be

amended for the Small Business Job Protection Act

of 1996, Pub. L. 104–188. See Rev. Proc. 97–41,

page 51.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for depreciation. See Rev.

Proc. 97–37, page 18.

Section 446.—General Rule for

Methods of Accounting

Section 197.—Amortization of

Goodwill and Other Intangibles

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for amortization. See Rev.

Proc. 97–37, page 18.

Section 263.—Capital

Expenditures

26 CFR 1.263(a)–2: Examples of capital expenditures.

Must the costs of creating a package design be

capitalized. See Rev. Proc. 97–35, page 11.

August 18, 1997

26 CFR 1.446–1: General rule for methods of accounting.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for package design costs.

See Rev. Proc. 97–35, page 11.

How may an automobile dealer change its

method of accounting to use the Alternative LIFO

Method. See Rev. Proc. 97–36, page 14.

Section 451.—General Rule for

Taxable Year of Inclusion

What procedures must a taxpayer use to obtain automatic consent of the Commissioner to change its

26 CFR § 1.471–2: Valuation of inventories;

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for certain cash discounts.

See Rev. Proc. 97–37, page 18.

Section 472.—Last-in, First-out

Inventories

26 CFR 1.472-1: Last-in, first-out inventories.

LIFO; price indexes; department

stores. The June 1997 Bureau of Labor

Statistics price indexes are accepted for

use by department stores employing the

retail inventory and last-in, first-out inventory methods for valuing inventories

for tax years ended on, or with reference

to, June 30, 1997.

Rev. Rul. 97-32

The following Department Store Inven-

1997–33 I.R.B.

tory Price Indexes for June 1997 were issued by the Bureau of Labor Statistics on

July 16, 1997. The indexes are accepted

by the Internal Revenue Service, under

§1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B.

739, for appropriate application to inventories of department stores employing the

retail inventory and last-in, first-out inventory methods for tax years ended on,

or with reference to, June 30, 1997.

The Department Store Inventory Price

Indexes are prepared on a national basis

and include (a) 23 major groups of departments, (b) three special combinations

of the major groups — soft goods,

durable goods, and miscellaneous goods,

and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy,

foods, liquor, tobacco, and contract departments.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Stan Michaels of the Office of

Assistant Chief Counsel (Income Tax and

Accounting). For further information regarding this revenue ruling, contact Mr.

Michaels on (202) 622-4970 (not a tollfree call).

1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . 551.1

2. Domestics and Draperies . . . . . . . . . . . . 641.0

3. Women’s and Children’s Shoes . . . . . . . 649.3

4. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . 895.4

5. Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . 627.1

6. Women’s Underwear. . . . . . . . . . . . . . . . 535.4

7. Women’s Hosiery . . . . . . . . . . . . . . . . . . 288.0

8. Women’s and Girls’ Accessories. . . . . . . 545.5

9. Women’s Outerwear and Girls’ Wear . . . 401.1

10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . 612.2

11. Men’s Furnishings . . . . . . . . . . . . . . . . . 584.5

12. Boys’ Clothing and Furnishings . . . . . . . 485.7

13. Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . 1011.5

14. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . 774.1

15. Toilet Articles and Drugs . . . . . . . . . . . . 877.8

16. Furniture and Bedding . . . . . . . . . . . . . . 673.6

17. Floor Coverings . . . . . . . . . . . . . . . . . . . 576.4

18. Housewares. . . . . . . . . . . . . . . . . . . . . . . 808.7

19. Major Appliances . . . . . . . . . . . . . . . . . . 245.5

20. Radio and Television . . . . . . . . . . . . . . . . 79.3

21. Recreation and Education2 . . . . . . . . . . . 112.8

22. Home Improvements2 . . . . . . . . . . . . . 127.4

23. Auto Accessories2 . . . . . . . . . . . . . . . . . . 107.5

541.0

644.1

651.0

904.0

642.5

539.3

295.7

569.4

415.3

625.0

589.8

494.5

1002.1

752.1

913.5

673.2

592.4

808.1

243.5

76.2

109.5

132.8

108.0

-1.8

0.5

0.3

1.0

2.5

0.7

2.7

4.4

3.5

2.1

0.9

1.8

-0.9

-2.8

4.1

-0.1

2.8

-0.1

-0.8

-3.9

-2.9

4.2

0.5

Groups 1 – 15: Soft Goods . . . . . . . . . . . . . 592.4

602.5

1.7

Groups 16 – 20: Durable Goods. . . . . . . . . . 469.7

465.9

-0.8

Groups 21 – 23: Misc. Goods2 . . . . . . . . . . . 113.7

112.2

-1.3

554.8

0.8

Store Total . . . . . . . . . . . . . . . . . . . . . . . . . 550.3

Absence of a minus sign before percentage change in this column signifies price increase.

Indexes on a January 1986 = 100 base.

The store total index covers all departments, including some not listed separately, except for the following: candy, foods, liquor, tobacco, and contract departments.

1997–33 I.R.B.

26 CFR §1.472–6: Change from LIFO inventory

method;

26 CFR §1.472–8: Dollar value method of pricing

LIFO inventories.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

from the LIFO method of accounting for all its LIFO

inventory, or to change to an alternate LIFO inventory method. See Rev. Proc. 97–37, page 18.

Section 481.—Adjustments

Required by Changes in

Mehtods of Accounting

26 CFR 1.481–4: Adjustments taken into account

with consent.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE

INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Percent Change

Groups

June

from June 1996

1996

1997

to June 19971

What is the “Alternative LIFO Method.” See

Rev. Proc. 97–36, page 14.

How is the section 481(a) adjustment taken into

account when a taxpayer changes its method of accounting for package design costs. See Rev. Proc.

97–35, page 11.

26 CFR §1.481–1: Adjustments in general;

26 CFR §1.481–4: Adjustments taken into account

with consent.

What procedures must a taxpayer use to obtain automatic consent of the Commissioner to change a

method of accounting. See Rev. Proc. 97–37, page 18.

Section 585.—Reserves for

Losses on Loans of Banks

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

from the § 585 reserve method of accounting to the

§ 166 specific charge-off method. See Rev. Proc.

97–37, page 18.

Section 1273.—Determination

of Amount of Original Issue

Discount

26 CFR §1.1273–1: Definition of OID;

26 CFR §1.1273–2: Determination of issue price

and issue date.

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change its

method of accounting for certain de minimis original

issue discount. See Rev. Proc. 97–37, page 18.

Section 1281.—Current

Inclusion in Income of Discount

on Certain Short-term

Obligations

What procedures must a taxpayer use to obtain

automatic consent of the Commissioner to change

its method of accounting for interest income on

short-term obligations, or for stated interest on

short-term loans of cash method banks in the

Eighth Circuit. See Rev. Proc. 97–37, page 18.

August 18, 1997

Section 1362.—Election;

Revocation; Termination

26 CFR 1.1362–6: Elections and consents.

tory due date, may the taxpayer obtain relief under

§ 1362(b)(5) of the Internal Revenue Code without

applying for a private letter ruling? See Rev. Proc.

97–40, page 50.

If a taxpayer files an S corporation election after

the statutory date, but within 6 months of that statu-

August 18, 1997

Section 1363.—Effect of

Election on Corporation

What procedures must a taxpayer use to obtain automatic consent of the Commissioner to change its

method of accounting. See Rev. Proc. 97–37, page 18.

1997–33 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous

Highly Compensated Employee

Definition

Notice 97–45

I. PURPOSE

This notice provides guidance relating

to the definition of highly compensated

employee (“HCE”) under §414(q) of the

Internal Revenue Code (“Code”), as

amended by §1431 of the Small Business

Job Protection Act of 1996, Pub. L. 104188 (“SBJPA”). The §414(q) definition of

HCE is incorporated by certain provisions

of the Code that apply nondiscrimination

requirements to various employee benefit

plans, entities, or arrangements (“plans”).

Specifically, this notice provides:

• Guidance on making the top-paid

group election permitted by

§414(q)(1)(B)(ii), under which an

employee (other than a 5-percent

owner) with compensation in excess

of the dollar threshold is an HCE

only if the employee is among the

highest paid 20 percent of an employer’s workforce.

• A new calendar year data election

under which an employer that maintains one or more plans on a fiscal

year basis has the option to use calendar year data to simplify the determination of whether an employee is an

HCE on account of compensation

under §414(q)(1)(B).

• Transition relief from certain requirements of the top-paid group election

and the calendar year data election.

• Guidance on plan amendments to reflect the revised definition of HCE, including the application of the remedial

amendment period under § 401(b),

and certain other matters relating to

the determination of HCE status.

II. BACKGROUND

(1) Section 414(q) prior to SBJPA.

Prior to amendment by SBJPA,

§ 414(q)(1) generally provided that an

employee was an HCE if, at any time during the year or the preceding year, the employee:

(A) was a 5-percent owner,

(B) received more than $100,000 (for

1996) in annual compensation from the

employer,

1997–33 I.R.B.

1996) in annual compensation from the

employer and was in the top-paid group

of employees during the same year, or

(D) was an officer of the employer who

received compensation in excess of

$60,000 (for 1996).

(2) Guidance under § 414(q) prior to

SBJPA. Under §1.414(q)–1T, A–14(b) of

the temporary Income Tax Regulations,

employers were allowed to make a calendar year calculation election, under which

the preceding year’s calculations relating

to HCE determinations were made on the

basis of the calendar year ending with or

within the current year. Under section 4 of

Rev. Proc. 93–42, 1993–2 C.B. 540, as

modified by Rev. Proc. 95–34, 1995–2

C.B. 385, an employer was permitted to

use a simplified method for determining

HCEs. Rev. Proc. 95–34 also provided

model plan language for employers to use

the simplified method.

(3) SBJPA amendments to § 414(q).

Section 414(q)(1), as amended by SBJPA,

provides that the term “highly compensated employee” means any employee

who:

(A) was a 5-percent owner at any time

during the year or the preceding year, or

(B) for the preceding year had compensation from the employer in excess of

$80,000 and, if the employer so elects,

was in the top-paid group for the preceding year.

The $80,000 amount is adjusted at the

same time and in the same manner as

under § 415(d), except that the base period is the calendar quarter ending September 30, 1996.

Pursuant to § 414(q)(3), an employee is

in the top-paid group for any year if the

employee is in the group consisting of the

top 20 percent of the employees of the

employer when ranked on the basis of

compensation paid to employees during

such year. An election pursuant to §

414(q)(1)(B)(ii), under which an employee (who is not a 5-percent owner)

who has compensation in excess of

$80,000 is not an HCE if the employee is

not a member of the top-paid group, is referred to in this notice as a “top-paid

group election.”

The amendments made by § 1431 of

SBJPA generally apply to years beginning

after December 31, 1996.

III. EFFECT OF STATUTORY

CHANGES ON PRIOR GUIDANCE

(1) Prior guidance. Because of the

amendments made to § 414(q) by SBJPA,

certain portions of § 1.414(q)–1T do not

reflect current law. Except as provided in

section III(2), the calendar year calculation election under A–14(b) of §

1.414(q)–1T does not apply for years beginning after December 31, 1996. In addition, the guidance provided under section

4 of Rev. Proc. 93–42 and under Rev.

Proc. 95–34 does not apply for years beginning after December 31, 1996. The

Service intends to publish guidance in the

future that will make appropriate modifications to these items of guidance.

(2) Transition relief for 1997. For any

year beginning on or after January 1,

1997 and before January 1, 1998, employers may continue to utilize the calendar

year calculation election, taking into account the statutory amendments to §

414(q)(1)(B), and the elimination of §

414(q)(1)(C) and (D), by SBJPA.

IV. PERIODS FOR DETERMINING

HCE STATUS

(1) Determination years and look-back

years. HCE status is determined on the

basis of the applicable year (as defined

below) of the plan or other entity for

which a determination is being made

(“determination year”) and the preceding

twelve-month period (“look-back year”)

in accordance with § 414(q). Thus, under

§ 414(q), as amended by SBJPA, an employee is an HCE for a determination year

if, (a) at any time during the determination year or the look-back year, the employee was a 5-percent owner or (b) for

the look-back year, the employee had

compensation from the employer in excess of $80,000 (as adjusted) and, if the

employer so elects, was in the top-paid

group.

(2) Applicable year.

(a) Retirement plans. The applicable

year for a retirement plan is the plan year.

For purposes of this notice, a retirement

plan is a plan that is qualified under §

401(a) or 403(a) or described in § 403(b)

or 408(k).

(b) Nonretirement plans. The applica-

August 18, 1997

ble year for a nonretirement plan is the

plan year, as defined in the written plan

document or otherwise identified in the

Code and regulations. If a nonretirement

plan does not have an identified plan year,

then the employer may treat either the calendar year or the employer’s fiscal year as

the applicable year. For purposes of this

notice, a nonretirement plan is any employee benefit arrangement to which the

definition of HCE is applicable under a

provision of the Code, other than a retirement plan.

V. IMPLEMENTATION OF

ELECTIONS

(1) Top-paid group election. An employer may make a top-paid group election for a determination year. The effect

of the top-paid group election is that an

employee (who is not a 5-percent owner

at any time during the determination year

or the look-back year) with compensation

in excess of $80,000 (as adjusted) for the

look-back year is an HCE only if the employee was in the top-paid group for the

look-back year. A top-paid group election,

once made, applies for all subsequent determination years unless changed by the

employer.

(2) Calendar year data election.

(a) This notice provides a new calendar

year data election which an employer may

make for a determination year. The effect

of the calendar year data election is that

the calendar year beginning with or

within the look-back year is treated as the

employer’s look-back year for purposes

of determining whether an employee is an

HCE on account of the employee’s compensation for a look-back year under §

414(q)(1)(B). A calendar year data election, once made, applies for all subsequent determination years unless changed

by the employer.

(b) A calendar year data election made

by an employer does not apply in determining whether the employer’s employees are HCEs under § 414(q)(1)(A) on account of being 5-percent owners.

Accordingly, if an employee is a 5-percent owner in either the look-back year or

the determination year, then the employee

is an HCE, without regard to whether the

employee’s employer makes a calendar

year data election.

determination year, then the immediately

August 18, 1997

preceding calendar year is the look-back

year for the plan. This is the case whether

or not a calendar year data election is

made. Thus, a calendar year data election

would have no effect on the HCE determination for a calendar year plan.

(3) No separate notification requirement. Notification or filing with the Internal Revenue Service of a top-paid group

election or a calendar year data election is

not required in order for the election to be

valid. However, under certain circumstances, plan amendments may be required to reflect the election. See

section VII of this notice.

(4) Cross-references. Section VI of this

notice provides a consistency requirement

that applies if an employer maintains

more than one plan. Section VII of this

notice describes circumstances under

which a top-paid group election or calendar year data election, or changes to such

elections, may have to be reflected in plan

documents.

VI. CONSISTENCY REQUIREMENT

FOR ELECTIONS

(1) Consistency requirement — in general. Except as provided in section VI(3)

and (4), in order to be effective, a top-paid

group election made by an employer must

apply consistently to the determination

years of all plans of the employer that

begin with or within the same calendar

year. Similarly, except as provided in section VI(3) and (4), in order to be effective,

a calendar year data election made by an

employer must apply consistently to the

determination years of all plans of the employer, other than a plan with a calendar

year determination year, that begin within

the same calendar year.

(2) Interaction of top-paid group election and calendar year data election. The

top-paid group election and the calendar

year data election are independent of each

other. Thus, an employer making one of

the elections is not required also to make

the other election. However, if both elections are made, the look-back year in determining the top-paid group must be the

calendar year beginning with or within

the look-back year, in accordance with

section V of this notice.

(3) Multiemployer plans. Satisfaction of

the consistency requirement is determined

without regard to any multiemployer plans

in which the employer participates.

(4) Transition relief for years prior to

2000.

(a) Transition relief for 1997. The consistency requirement will not apply to determination years beginning with or

within the 1997 calendar year. Thus, an

employer may make a top-paid group

election or a calendar year data election

for a plan for a determination year beginning with or within 1997, without regard

to whether the employer makes that election for any other plan.

(b) Transition relief for 1998 and 1999.

For determination years beginning on or

after January 1, 1998, and before January

1, 2000, (i) nonretirement plans are not

subject to the consistency requirement,

and (ii) satisfaction of the consistency requirement with respect to retirement plans

is determined without regard to any plans

of the employer that are nonretirement

plans.

VII. QUALIFIED RETIREMENT

PLAN AMENDMENTS FOR HCE

DEFINITION

(1) Qualified plans that must be

amended. If a retirement plan qualified

under § 401(a) or 403(a) contains the definition of HCE under § 414(q), as in effect before SBJPA, the plan must be

amended to reflect the definition of HCE

under § 414(q), as amended by SBJPA. If

an employer makes either a top-paid

group or calendar year data election for a

determination year, a plan that contains

the definition of HCE must reflect the

election. If the employer changes either a

top-paid group or calendar year data election, the plan must be amended to reflect

the change. However, a plan is not required to add a definition of HCE merely

to reflect a top-paid group or calendar

year data election.

(2) Amendment date. Rev. Proc. 97–41,

1997–33 IRB, provides that qualified retirement plans have a remedial amendment period under § 401(b) so that certain

plan amendments for SBJPA are not required to be adopted before the last day of

the first plan year beginning on or after

January 1, 1999 (with a later date for governmental plans). Pursuant to Rev. Proc.

97–41, a plan provision reflecting the definition of HCE is a disqualifying provision and thus any plan amendments to reflect the definition of HCE in § 414(q), as

amended by SBJPA, and to reflect any

1997–33 I.R.B.

choices regarding the top-paid group or

calendar year data elections, are not required to be made until the end of this remedial amendment period. However,

plans must be operated in accordance

with the SBJPA changes to the HCE definition in § 414(q) as of the statutory effective date, and plans required to be

amended to reflect those changes must be

so amended retroactively effective as of

that date. In addition, under Rev. Proc.

97–41, any retroactive amendments must

reflect the choices made in the operation

of the plan for each determination year,

including choices made with respect to

the top-paid group election and the calendar year data election (and any changes to

those elections), and the first date that the

plan operated in accordance with those

choices (and any such changes).

VIII. OTHER ISSUES RELATING

TO DETERMINATION OF HCE

STATUS

(1) Determining HCE status for 1997.

As noted earlier, the amendments made

by § 1431 of the SBJPA generally apply

to years beginning after December 31,

1996. However, § 1431(d)(1) provides

that, in determining whether an employee

is an HCE for years beginning in 1997,

the amendments to § 414(q) are treated as

having been in effect for years beginning

in 1996. Accordingly, in determining

whether an employee is an HCE for the

determination year beginning with or

within the 1997 calendar year, an employer must consider whether the employee was a 5-percent owner or had

compensation in excess of $80,000 for the

look-back year that began with or within

the 1996 calendar year. An employer also

may make the calendar year data election

and/or the top-paid group election with

respect to determination years beginning

with or within the 1997 calendar year, in

accordance with the guidance in this notice. The SBJPA amendments to § 414(q)

are not applicable in determining the employer’s HCEs for determination years

beginning prior to January 1, 1997.

(2) Highly compensated former employees. For purposes of determining status as a highly compensated former employee under § 1.414(q)–1T, A–4,

whether an employee was a highly compensated active employee for a determination year that ended on or after the em-

1997–33 I.R.B.

ployee’s 55th birthday, or that was a separation year, is based on the rules applicable to determining HCE status as in effect

for that determination year.

(3) Determining 5-percent ownership

by attribution of ownership interest to

family members. The definition of 5-percent owner in § 414(q)(2) refers to §

416(i)(1), which in turn refers to the attribution rules of § 318. Under the rules of

§318, an individual is considered to own

any stock owned directly or indirectly by

the individual’s spouse, children, grandchildren or parents. Consequently, an employee who is the spouse, child, parent or

grandparent (“family member”) of an individual who has a 5-percent interest in

the employer at any time during the lookback year or the determination year is

treated as an HCE under § 414(q)(1)(A),

regardless of the family member’s compensation level. These statutory provisions relating to the definition of 5-percent owner under § 414(q)(2) are different

from the family aggregation rules under

former § 414(q)(6) and are unaffected by

the repeal of those rules under §

1431(b)(1) of SBJPA.

IX. EXAMPLES

The following examples illustrate the

rules in this notice:

Example 1: (a) Employer A has maintained a defined benefit plan qualified

under § 401(a) (Plan M) since 1996 with a

plan year beginning April 1 and ending

March 31. Employer A has never had a 5percent owner. For Plan M’s determination year beginning April 1, 2000 and

ending March 31, 2001, Employer A does

not make a calendar year data election or

a top-paid group election.

(b) Under § 414(q)(1)(B), Employer A

determines HCEs for Plan M’s determination year beginning April 1, 2000, based

upon the compensation of Employer A’s

employees in Plan M’s look-back year.

Thus, the HCEs are those employees who

had compensation over $80,000 (as adjusted) during the period beginning April

1, 1999 and ending March 31, 2000.

Example 2: (a) Assume the same facts

as in Example 1, except that Employer A

hires a new employee, Employee X, on

March 1, 2000 at an annual salary of

$240,000. Employee X is not a 5-percent

owner during the determination year beginning April 1, 2000 or the look-back

year beginning April 1, 1999. During the

month of March, 2000, Employee X’s

compensation was $20,000.

(b) Because Employee X’s compensation during Plan M’s look-back year beginning April 1, 1999 was less than

$80,000 (as adjusted), Employee X is not

an HCE for Plan M’s determination year

beginning April 1, 2000.

Example 3: (a) Employer B has maintained a qualified defined benefit plan

(Plan N) since 1996 that has a calendar

plan year. Employer B makes a top-paid

group election for Plan N’s 1998 determination year, which is the 1998 calendar

year. Employer B had 15 employees in

the 1997 calendar year and has never had

a 5-percent owner. These employees,

along with their compensation for the

1997 calendar year, are listed below.

Employees

5-15

1997 Compensation

$200,000

110,000

101,000

90,000

50,000 or less

(b) In determining Employer B’s HCEs

for the calendar year 1998 under the toppaid group election, Plan N’s relevant

look-back year is the 1997 calendar year.

Employer B must determine whether any

employee had compensation above

$80,000, and was in the group consisting

of the top 20 percent of the employees of

Employer B in the 1997 calendar year,

when ranked on the basis of compensation from Employer B during the 1997

calendar year.

top 20 percent of Employer B’s 15 employees for the 1997 calendar year based

on compensation from Employer B during the 1997 calendar year. Although Employee 4 had compensation over $80,000

in the 1997 calendar year, Employee 4

was not in the top-paid group for the 1997

calendar year and is therefore not an HCE

for Plan N’s 1998 determination year.

This will be the case regardless of

whether Employees 1, 2 and 3 continue to

be employed in the 1998 calendar year.

Example 4: (a) Employer C has a qualified profit sharing plan (Plan O) with a

calendar plan year. Employer C also has a

qualified defined benefit plan (Plan P)

with a plan year beginning April 1 and

ending March 31. Employer C makes the

August 18, 1997

top-paid group election for Plan O for the

calendar year 2000.

(b) Pursuant to the consistency rule requiring that the employer make the same

election for all determination years of all

plans of the employer that begin with or

within the same calendar year, Employer

C must also make the top-paid group election for Plan P’s determination year beginning April 1, 2000 and ending March

31, 2001.

determining whether any of Employer C’s

employees is an HCE under Employer C’s

top-paid group election for Plan O is the

1999 calendar year and for Plan P is the

April 1, 1999 to March 31, 2000 year. The

group of Employer C’s employees that are

HCEs for Plan O’s 2000 determination

year are those employees who had compensation above $80,000 (as adjusted)

and who were in the top 20 percent of employees based on compensation for the

1999 calendar year, while the group of

Employer C’s employees that are HCEs

for Plan P’s determination year beginning

April 1, 2000 are those employees who

had compensation above $80,000 (as adjusted) and who were in the top 20 percent of employees based upon compensation for Plan P’s look-back year beginning

April 1, 1999.

Example 5: (a) Since 1998, Employer

D has maintained a qualified cash or deferred arrangement under § 401(k) (Plan

Q). Plan Q has a calendar plan year. Employer D has never made a calendar year

data election or a top-paid group election

for Plan Q and has never had a 5-percent

owner. Under § 401(k)(3)(A)(ii), as

amended by the SBJPA, unless an employer elects to use current year data for

all eligible employees, the actual deferral

percentage (ADP) test for the plan year is

applied by comparing the ADP for all eligible HCEs for the plan year to the ADP

for all other eligible employees (nonHCEs) for the preceding plan year. Employer D has not elected to use current

year data for the nonHCEs for the 2000

calendar year.

(b) In conducting the ADP test for the

2000 calendar year, Employer D compares the ADP for the 2000 calendar year

for the group of employees who had compensation above $80,000 (as adjusted) for

the 1999 calendar year, and who are eligible under the plan for the 2000 calendar

August 18, 1997

year, with the ADP for the 1999 calendar

year for the group of employees who were

nonHCEs for the 1999 calendar year and

who were eligible under the plan for the

1999 calendar year. Employer D would

have previously determined who the

HCEs were for the 1999 calendar year,

that is, the employees of Employer D who

had compensation above $80,000 (as adjusted) for the 1998 calendar year. The

nonHCEs for the 1999 calendar year are

those employees who were employees in

the 1999 calendar year and who were not

determined to be HCEs for the 1999 calendar year.

Example 6: (a) Employer E has maintained a qualified profit sharing plan (Plan

R) since 1996 with an April 1 to March 31

plan year. Employer E has also maintained a defined benefit plan (Plan S)

since 1996 with an October 1 to September 30 plan year. Employer E decides to

make the calendar year data election for

determination years of Plan R and Plan S

beginning in the 2000 calendar year.

Thus, Employer E makes the election for

Plan R’s determination year beginning

April 1, 2000 and ending March 31, 2001,

and Plan S’s determination year beginning October 1, 2000 and ending September 30, 2001.

(b) The 2000 calendar year begins

within Plan R’s look-back year beginning

April 1, 1999 and ending March 31, 2000,

and Plan S’s look-back year beginning

October 1, 1999 and ending September

30, 2000 and is treated as Employer E’s

look-back year for both Plans R and S for

purposes of determining Employer E’s

HCEs on the basis of compensation.

Thus, in determining HCE status under §

414(q)(1)(B) Employer E determines

whether an employee has compensation

for the look-back year in excess of

$80,000 (as adjusted), and if applicable,

the composition of the top-paid group, on

the basis of compensation for the 2000

calendar year.

Example 7: (a) Assume the same facts

as in Example 6, except that Employer E

also maintains Plan T, a qualified defined

benefit plan with a calendar plan year.

Employer E fails to make the calendar

year data election for Plan T.

(b) Because the consistency requirement for the calendar year data election is

applied without regard to calendar year

plans, the consistency requirement is sat-

isfied regardless of whether Employer E

makes a calendar year data election for

Plan T.

Example 8: Assume the same facts as

in Example 6. For Plan R, in determining

whether any of Employer E’s employees

is an HCE on account of being a 5-percent

owner, the employee’s ownership in Employer E is examined for Plan R’s 2000

and 2001 plan years (April 1, 1999 to

March 31, 2000, and April 1, 2000 to

March 31, 2001). For Plan S, in determining whether any of Employer E’s employees is an HCE on account of being a 5percent owner, the employee’s ownership

in Employer E is examined for Plan S’s

2000 and 2001 plan years (October 1,

1999 to September 30, 2000, and October

1, 2000 to September 30, 2001). This is

because the calendar year data election

does not apply in determining whether an

employee is a 5-percent owner.

Example 9: (a) Employer F maintains

Plan U, a defined benefit plan with a calendar year plan year. Employee Y was

employed by Employer F since 1990.

Employee Y retired at age 65 from employment with Employer F in 1998. Employee Y was an HCE in 1992 under the

rules applicable in 1992 to determine

HCE status, but was not an HCE in any

other year, including 1998.

(b) Because Employee Y was an HCE

for a determination year (1992) ending on

or after Employee Y’s 55th birthday, Employee Y is a highly compensated former

employee for determination years beginning after Employee Y’s retirement.

X. PAPERWORK REDUCTION

ACT

The collection of information contained in this notice has been reviewed

and approved by the Office of Management and Budget in accordance with the

Paperwork Reduction Act (44 U.S.C.

3507) under control number 1545–1550.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

control number.

The collection of information in this

notice is in Section VII. This requirement

to amend plan documents is necessary to

update plan documents to reflect the

amended definition of HCE under §

414(q). This information will be used to

1997–33 I.R.B.

determine which employees are HCEs for

purposes of determining contributions,

benefits, or the availability of other rights

or features under the plan. The collection

of information is required to obtain a benefit. The likely respondents are businesses

or other for-profit institutions, nonprofit

institutions, and small businesses or organizations.

The estimated total annual recordkeeping burden is 65,605 hours.

The estimated annual burden per

recordkeeper varies from 10 minutes to

30 minutes, depending on individual circumstances, with an estimated average of

18 minutes. The estimated number of

recordkeepers is 218,683.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally tax returns and tax

return information are confidential, as required by 26 U.S.C. 6103.

XI. COMMENTS

This notice does not address all of the

procedural requirements that may be necessary to implement the top-paid group

election or the calendar year data election

for future years. However, any additional

requirements would be applied prospectively only. The Treasury and the Service

invite comments and suggestions regarding procedural issues and the other matters discussed in this notice.

Comments can be addressed to

CC:DOM:CORP:R (Notice 97–45), room

5228, Internal Revenue Service, POB

7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, comments

may be hand delivered between the hours

of 8 a.m. and 5 p.m. to CC:DOM:CORP:R

(Notice 97–45), Courier’s Desk, Internal

Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively,

taxpayers may transmit comments electronically via the IRS Internet site at

http://www.irs.ustreas.gov/prod/tax_regs/

comments.html.

phone service at (202) 622-6074 or (202)

622-6075, between the hours of 1:30 p.m.

and 3:30 p.m. Eastern Time, Monday

through Thursday, or Ms. Grinde at (202)

622-6214, or Patricia McDermott of the

Office of the Associate Chief Counsel

(Employee Benefits and Exempt Organizations) at (202) 622-6030. These are not

toll-free numbers.

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, §§ 165, 167, 263, 263A, 446, 481;

1.165-2, 1.167(a)-3, 1.263(a)-2, 1.263A-2, 1.446-1,

1.481-4.)

Rev. Proc. 97-35

SECTION 1. PURPOSE

.01 This revenue procedure describes

three alternative methods of accounting

for package design costs: (1) the capitalization method (see section 5.01 of this

revenue procedure), (2) the design-by-design capitalization and 60-month amortization method (see section 5.02 of this

revenue procedure), and (3) the pool-ofcost capitalization and 48-month amortization method (see section 5.03 of this

revenue procedure). A taxpayer may

change to or adopt any one of these three

methods. The procedures for a taxpayer

to change to one of these three methods

are provided in Rev. Proc. 97–37, page

18, which provides simplified and uniform procedures to obtain automatic consent to make this and other changes in

methods of accounting. This revenue procedure modifies and supersedes Rev.

Proc. 90–63, 1990–2 C.B. 664.

.02 The three methods of accounting

for package design costs described in this

revenue procedure are the same methods

of accounting that were described in Rev.

Proc. 90–63. Accordingly, a taxpayer that

properly changed to or adopted one of

these methods pursuant to Rev. Proc.

90–63 is not required to change its

method of accounting to comply with this

revenue procedure.

SECTION 2. DEFINITIONS

DRAFTING INFORMATION

The principal author of this notice is Ingrid Grinde of the Employee Plans Division. For further information regarding

this notice, please contact the Employee

Plans Division’s taxpayer assistance tele-

1997–33 I.R.B.

For purposes of this revenue procedure,

the terms “package design” and “package

design cost” have the meanings provided

in Rev. Rul. 89–23, 1989–1 C.B. 85. If

the taxpayer develops the package design,

the term includes the cost of materials,

labor, and overhead associated with the

design, including all design exploration

and study (for example, the development

of any related design which, although

abandoned, advances the development of

the design selected), refinement of the

basic design selected, testing, and preparation of the final master comprehensive

design. If an independent contractor performs the work, the term includes all

billings related to the development of the

particular package, including all design

exploration and study (for example, the

development of any related design which,

although abandoned, advances the development of the design selected), refinement of the basic design selected, testing,

and preparation of the final master comprehensive design. If the taxpayer purchases the package, the term includes the

purchase price. The costs associated with

coupon inserts, refund offers, and other

short-lived promotion-related changes are

specifically excepted from the definition

of “package design cost.”

SECTION 3. BACKGROUND

.01 Section 263(a) of the Internal Revenue Code provides that no deduction is

allowed for any amount paid for new

buildings or for permanent improvements

or betterments made to increase the value

of any property or estate. Section

1.263(a)–2 of the Income Tax Regulations

includes in its examples of capital expenditures the costs of acquiring property

having a useful life substantially beyond

the tax year.

.02 An expenditure generally must be

capitalized under § 263 if the expenditure

creates, enhances, or is part of the cost of

acquiring a tangible or intangible asset

having a useful life that extends substantially beyond the end of the tax year in

which the expenditure is incurred. See

INDOPCO, Inc. v. Commissioner, 503

U.S. 79 (1992); Commissioner v. Lincoln

Savings and Loan Association, 403 U.S.

345 (1971), 1971-2 C.B. 116; Central

Texas Savings and Loan Association v.

United States, 731 F.2d 1181 (5th Cir.

1984); Ellis Banking Corp. v. Commissioner, 688 F.2d 1376 (11th Cir. 1982),

cert. denied, 463 U.S. 1207 (1983); and

Cleveland Electric Illuminating Company

v. United States, 7 Cl. Ct. 220 (1985).

Generally, taxpayers must capitalize

package design costs incurred prior to

August 18, 1997

January 1, 1987 under § 263 because

those costs create intangible assets having

useful lives that extend substantially beyond the end of the tax year in which the

costs are incurred. See Rev. Rul. 89-23.

.03 Section 263A, enacted by the Tax

Reform Act of 1986, provides, in part, for

the capitalization of certain direct and indirect costs with respect to real or tangible

personal property produced by the taxpayer. All costs that are incurred with respect to real or tangible personal property

that the taxpayer produces are to be capitalized with respect to the property. The

term “produce” includes construct, build,

install, manufacture, develop, improve,

create, raise, or grow. For purposes of

§263A, “tangible personal property” includes a film, sound recording, video

tape, book, or similar property embodying

words, ideas, concepts, images, or sounds

(see 2 H.R. Conf. Rep. No. 841, 99th

Cong., 2d Sess. II–308 (1986), 1986–3

(Vol. 4) C.B. 308) without regard to

whether the property is treated as tangible

or intangible under other provisions of the

Code. See § 1.263A-2(a)(2)(ii). Section

263A and the regulations thereunder require that costs incurred after December

31, 1986 in connection with the development and design of product packages

must be capitalized. See Rev. Rul. 89–23.

.04 As stated in Rev. Rul. 89–23, package designs generally do not have an ascertainable useful life, and thus no depreciation or amortization is allowed under §

167 and the regulations thereunder. See §

1.167(a)–3. Only when such a package

design is abandoned may the capitalized

costs be deducted. See § 165 and

§1.165–2(a).

.05 Thus, taxpayers are generally required under the Code and regulations to

use the capitalization method of accounting for package design costs described in

section 5.01 of this revenue procedure.

However, to minimize disputes regarding the accounting for package design

costs, the Internal Revenue Service, as a

matter of administrative convenience,

will allow a taxpayer that complies with

the requirements of this revenue procedure to choose one of two alternative

methods of accounting for package design costs:

(1) the capitalization and 60-month

amortization method described in section

5.02 of this revenue procedure, deter-

August 18, 1997

mined on a design-by-design basis for all

package designs or;

(2) the capitalization and 48-month

amortization method described in section

5.03 of this revenue procedure, determined on a pool-of-cost basis for all package design costs.

SECTION 4. SCOPE

This revenue procedure applies to a

taxpayer that wants to change to or adopt

a method of accounting for package design costs. A change in method of accounting for package design costs made

pursuant to this revenue procedure does

not affect the taxpayer’s method of accounting for intangible property other

than package designs described in section

2 of this revenue procedure.

SECTION 5. ALTERNATIVE

METHODS OF ACCOUNTING

.01 The capitalization method.

(1) Description of method. The treatment of the costs of developing new package designs or modifying existing designs

in accordance with the capitalization

method constitutes a permissible method

of accounting. Under the capitalization

method, the taxpayer must capitalize the

costs of developing (or modifying) any

package design if the asset created by

those costs has no ascertainable useful life

or an ascertainable useful life that extends

substantially beyond the end of the tax

year in which the costs are incurred. If

the asset created by the costs has an ascertainable useful life, the taxpayer may

amortize the costs ratably over the useful

life, beginning with the month the package design (or modification to the design)

is placed in service. If the asset created

by the costs has no ascertainable useful

life, the taxpayer may deduct the costs

only upon the disposition or abandonment

of the package design (or modification to

the design). See Rev. Rul. 89-23.

(2) Computation of basis. The basis of

each package design (or modification to

the design) subject to capitalization is determined by applying the provisions of

§ 263 and the regulations thereunder to

costs incurred prior to January 1, 1987,

and § 263A and the regulations thereunder to costs incurred after December 31,

1986 (regardless of the tax year the design

(or modification to the design) is placed

in service). The costs required to be capi-

talized are described in section 2 of this

revenue procedure.

.02 The design-by-design capitalization

and 60-month amortization method.

(1) Description of method. The treatment of the costs of developing new

package designs or modifying existing

designs in accordance with the designby-design capitalization and 60-month

amortization method constitutes a permissible method of accounting. Under

the design-by-design capitalization and

60-month amortization method, the taxpayer must capitalize the costs of developing (or modifying) any package design

if the asset created by those costs has no

ascertainable useful life or an ascertainable useful life that extends substantially

beyond the end of the tax year in which

the costs are incurred. The taxpayer

must amortize the basis of any package

design (or modification to the design)

subject to capitalization over a period of

60 months. Thus, in computing taxable

income, the basis of each package design

(or modification to the design) subject to

capitalization is allowed as a deduction

ratably over a 60-month period, beginning with the month the design (or modification to the design) is treated as

placed in service. See section 5.02(3) of

this revenue procedure. If the package

design (or modification to the design) is

disposed of or abandoned within the 60month period, the taxpayer is permitted

to deduct the unamortized portion of the

basis of the design (or modification to

the design) in the tax year of disposition

or abandonment.

(2) Computation of basis. Under the

design-by-design capitalization and 60month amortization method, the basis of

each package design (or modification of

the design) subject to capitalization must

be determined by applying the provisions

of § 263 and the regulations thereunder to

costs incurred prior to January 1, 1987,

and § 263A and the regulations thereunder to costs incurred after December 31,

1986 (regardless of the tax year the design

(or modification to the design) is placed

in service). The costs required to be capitalized are described in section 2 of this

revenue procedure.

(3) Half-year convention. Under the

design-by-design capitalization and 60month amortization method, the amortization allowance for each package design

1997–33 I.R.B.

(or modification to the design) subject to

capitalization must be determined by

treating a design (or modification to the

design) placed in service during the tax

year as placed in service on the mid-point

of the tax year. If the tax year in which

the package design (or modification to

the design) is placed in service is 12 full

months, the design (or modification to

the design) is treated as placed in service

on the first day of the seventh month of

the tax year. For guidance in computing

the amortization allowance under the design-by- design capitalization and 60month amortization method when a package design (or modification to the design)

is placed in service in a taxable year of

less than 12 months (a short taxable

year), see Rev. Proc. 89-15, 1989-1 C.B.

816.

.03 The pool-of-cost capitalization and

48-month amortization method.

(1) Description of method. The treatment of the costs of developing new package designs or modifying existing designs

in accordance with the pool-of-cost capitalization and 48-month amortization

method constitutes a permissible method

of accounting. Under the pool-of-cost

capitalization and 48-month amortization

method, the taxpayer must capitalize all

its package design costs and amortize the

costs over a period of 48 months. Thus,

in computing taxable income, package

design costs incurred during the tax year

are allowed as a deduction ratably over a

48-month period, beginning with the

month the costs are treated as incurred.

See section 5.03(3) of this revenue procedure. The taxpayer may not deduct the

unamortized portion of the cost of a package design (or modification to the design)

if the design (or modification to the design) is never placed in service or is disposed of or abandoned within the 48month period.

(2) Costs subject to capitalization. All

package design costs are subject to capitalization without regard to whether the

costs create a package design (or modification to the design) having an ascertainable useful life that extends substantially

beyond the end of the tax year in which

the costs are incurred. Thus, all package

design costs incurred prior to January 1,

1987 that would be capitalized under

§ 263 and the regulations thereunder but

for the fact that the costs create a package

1997–33 I.R.B.

design (or modification to the design)

having an ascertainable useful life that

does not extend substantially beyond the

end of the tax year in which the costs are

incurred must be capitalized. All package design costs incurred after December

31, 1986 that would be capitalized

under § 263A and the regulations thereunder but for the fact that the costs create

a package design (or modification to the

design) having an ascertainable useful

life that does not extend substantially beyond the end of the tax year in which the

costs are incurred must be capitalized.

The costs required to be capitalized are

described in section 2 of this revenue

procedure.

(3) Half-year convention. Under the

pool-of-cost capitalization and 48-month

amortization method, the amortization allowance for package design costs must be

determined by treating all package design

costs incurred during the tax year as incurred on the mid-point of the tax year. If

the tax year in which the package design

costs are incurred is 12 full months, the

costs are treated as incurred on the first

day of the seventh month of the tax year.

For guidance in computing the amortization allowance under the pool-of-cost

capitalization and 48-month amortization

method when package design costs are incurred in a taxable year of less than 12

months (a short taxable year), see Rev.

Proc. 89–15.

SECTION 5. CHANGING PACKAGE

DESIGN COSTS METHOD

.01 Automatic change. A taxpayer

wanting to change its method of accounting for package design costs must follow

the provisions in Rev. Proc. 97-37.

.02 Section 481(a) adjustment.

(1) Change to the capitalization

method. If the taxpayer is changing its

method of accounting for package design

costs to the capitalization method, the §

481(a) adjustment (which will be positive) will restore to income the total

amounts deducted or amortized in tax

years prior to the year of change with respect to all package designs (or modifications to designs) subject to capitalization

and not abandoned as of the first day of

the tax year of change, less the amounts

that would have been amortized during

the tax years prior to the year of change

with respect to designs (or modifications

to designs) which had an ascertainable

useful life on the date the designs (or

modifications to the designs) were placed

in service. The § 481(a) adjustment is the

difference at the beginning of the tax year

of change between the basis of all such

package designs (or modifications to designs) determined under the taxpayer’s

present method of accounting and the

basis redetermined under the capitalization method.

(2) Change to the design-by-design

capitalization and 60-month amortization method. If the taxpayer is changing

its method of accounting for package design costs to the design-by-design capitalization and 60-month amortization

method, the § 481(a) adjustment is equal

to the total amounts deducted or amortized in tax years prior to the year of

change with respect to all package designs (or modifications to designs) subject to capitalization and not abandoned

as of the first day of the tax year of

change, less the amounts that would have

been amortized during the tax years prior

to the year of change with respect to such

designs (or modifications to designs) had

the design-by-design capitalization and

60-month amortization method been

used.

(3) Change to the pool-of-cost capitalization and 48-month amortization

method. If the taxpayer is changing its

method of accounting for package design

costs to the pool-of-cost capitalization

and 48-month amortization method, the

§ 481(a) adjustment is equal to the total

amounts deducted or amortized in tax

years prior to the year of change with respect to all package design costs treated

as incurred during the tax years prior to

the year of change, less the amounts that

would have been amortized during the tax

years prior to the year of change with respect to such costs had the pool-of-cost

capitalization and 48-month amortization

method been used.

SECTION 6. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention: Office of Assistant Chief Counsel (Income

Tax and Accounting) CC:DOM:IT&A,

1111 Constitution Avenue, NW, Washington, DC 20224.

August 18, 1997

SECTION 7. EFFECT ON OTHER

DOCUMENTS

Rev. Proc. 90-63, 1990-2 C.B. 664, is

modified, and as modified, is superseded.

However, see the transition rules in section 13.02 of Rev. Proc. 97-37.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective on

August 18, 1997.

DRAFTING INFORMATION

This revenue procedure was drafted in

the Office of Assistant Chief Counsel (Income Tax & Accounting). For further information regarding this revenue procedure, contact Robert A. Testoff on (202)

622-4800 (not a toll free call).

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, §§ 446, 472; 1.446–1, 1.472–1.)

Rev. Proc. 97–36

SECTION 1. PURPOSE

This revenue procedure provides an alternative last-in, first-out (LIFO) inventory

computation method (the “Alternative

LIFO Method”) for a taxpayer engaged in

the trade or business of retail sales of new

automobiles or new light-duty trucks (“automobile dealer”). A taxpayer may change

to or adopt the Alternative LIFO Method.

The procedures for a taxpayer to change to

the Alternative LIFO Method are provided

in Rev. Proc. 97–37, page 18, which provides simplified and uniform procedures to

obtain automatic consent to make this and

other changes in methods of accounting.

This revenue procedure modifies and supersedes Rev. Proc. 92–79, 1992–2 C.B.

457.

.02 The Alternative LIFO Method described in this revenue procedure is the

same method of accounting that was described in Rev. Proc. 92–79. Accordingly,

a taxpayer that properly changed to or

adopted this method pursuant to Rev.

Proc. 92-79 is not required to change its

method of accounting to comply with this

revenue procedure.

SECTION 2. BACKGROUND

.01 In general. Section 472(a) of the

Internal Revenue Code provides that a

August 18, 1997

taxpayer may use the LIFO inventory

method of inventorying goods if, among

other requirements, the change to, and

use of, the method is in accordance with

such regulations as the Secretary may

prescribe as necessary in order that the

use of the method may clearly reflect income.

.02 Dollar-value LIFO method. Section 1.472–8(a) of the Income Tax Regulations provides that any taxpayer may

elect to determine the cost of its LIFO inventories under the dollar-value LIFO

method of accounting, provided such

method is used consistently and clearly

reflects income in accordance with the

rules of that section.

.03 Link-chain method. Section

1.472–8(e)(1) permits the use of a “linkchain” method of computing the LIFO

value of a dollar-value pool if the “double-extension” method and an “index”

method would be impractical or unsuitable in view of the nature of the inventory

in the dollar-value pool. Further, in applying a link-chain method, an index may

be computed by “double extending” a

representative portion of the inventory in

a dollar-value, link-chain pool at both the

current-year cost and the prior-year cost.

Additionally, an index may be computed

under a link-chain method using other

sound and consistent statistical methods.

.04 Acceptable methods. Under existing LIFO inventory provisions, there are

three general dollar-value LIFO methods:

(1) Simplified dollar-value LIFO

method.

(a) Section 474 provides an elective simplified dollar-value LIFO method

for eligible small businesses. In general,

a taxpayer is an eligible small business for

any taxable year if its average annual

gross receipts for the three preceding

years do not exceed $5,000,000.

(b) The simplified dollar-value

LIFO method under § 474 is based on a

so-called link-chain method of computing

the LIFO value of an inventory pool.

Under § 474, inventory pools are established by the major categories in the applicable Government price index, and an

annual index for each pool is obtained

from that Government price index.

Therefore, under § 474, an eligible automobile dealer uses a single inventory pool

for new automobiles and new trucks

under the major category, transportation

equipment, in the Producer Price Index

(“PPI”) published by the Bureau of Labor

Statistics (“BLS”).

two price indexes are computed for each

pool, an annual index and a cumulative

index. The annual index represents the

change in price level of goods in the ending inventory of the pool for the current

year from the price level of comparable

goods for the prior year. Under § 474, the

annual index for computing the LIFO

value of an automobile dealer’s single inventory pool is obtained using the price

change from the preceding taxable year

for the major index category, transportation equipment, from the PPI.

(d) The cumulative index represents the price level change from the beginning of the base year to the end of the

current year and is the product of each of

the annual indexes. The cumulative index

is used to convert the total current-year

cost in an inventory pool at the close of

the taxable year to base-year dollars by

dividing the total current-year cost by the

cumulative index, and also to determine

the value of any incremental increase in

the pool to be added to the ending inventory of the preceding year by multiplying

that increment by the cumulative index.

(2) Inventory price index computation method.

(a) Section 1.472-8(e)(3) provides

another simplified dollar-value LIFO

method, the inventory price index computation (IPIC) method, which is available

to all taxpayers. An automobile dealer

using the IPIC method must use that

method in determining the value of all

goods for which the automobile dealer

has elected to use the LIFO method.

Under the IPIC method, special inventory

pooling rules permit an automobile dealer

to establish a single inventory pool for

new automobiles and new trucks under

the major category of the applicable Government price index published by the

BLS. See § 1.472–8(e)(3)(iv) and Rev.

Proc. 84–57, 1984–2 C.B. 496.

(b) The IPIC method under §

1.472–8(e)(3) is also based on a linkchain method of computing the LIFO

value of an inventory pool. The annual

index for the pool is generally computed

using a stated percentage of the percent

change in the applicable detailed

index(es) for the major category of the ap-

1997–33 I.R.B.

plicable Government price index. The

stated percentage is 80 percent unless a

taxpayer qualifies as an eligible small

business under § 474, in which case the

stated percent is 100 percent.

(3) General dollar-value LIFO

method.

(a) If an automobile dealer does

not want to use either the simplified dollar-value LIFO method for certain small

businesses provided in § 474 of the Code

(if the taxpayer is eligible) or the IPIC

method provided in § 1.472–8(e)(3), the

automobile dealer may use the general

dollar-value LIFO inventory rules contained in § 1.472–8. Under these general

rules, an automobile dealer establishes

inventory pools for each separate trade or

business under § 1.472–8(c) by major

lines, types, or classes of goods (for example, one separate pool for all new automobiles and another separate pool for

all new trucks). See Fox Chevrolet, Inc.

Maryland v. Commissioner, 76 T.C. 708

(1981), acq., 1984–2 C.B. 1, and

Richardson Investments, Inc., and Subsidiaries v. Commissioner, 76 T.C. 736

(1981).

(b) An automobile dealer may use

the double-extension method, an index

method, or a link-chain method, to compute the LIFO value of its inventory

pools. Under all three of these methods,

automobile dealers use their own cost

data to compute the index for each pool.

Because of the nature of the items in their

pools, automobile dealers generally use a

link-chain method. The annual index for

each pool under the link-chain method is

computed by “double extending” (that is,

pricing) the vehicles (or “items”) in each

inventory pool as of the close of the taxable year at the automobile dealer’s own

current year cost and at the automobile

dealer’s own prior-year cost. For each

pool, the total current-year cost of the vehicles in ending inventory is divided by

the total prior-year cost of the vehicles in

ending inventory to compute the annual

index for the current year. The vehicles

used to determine the dealer’s own prioryear cost of vehicles in the current year’s

ending inventory must be comparable to

the vehicles used to compute the currentyear cost of vehicles in the current year’s

ending inventory. For purposes of this

revenue procedure, this is referred to as

the § 1.472-8 “comparability requirement.”

1997–33 I.R.B.

.05 New alternative method. In addition to the three general dollar-value

LIFO methods briefly described in section 2.04 of this revenue procedure, this

revenue procedure provides an additional

dollar-value LIFO method for automobile

dealers, the Alternative LIFO Method.

This method is described in section 4 of

this revenue procedure.

SECTION 3. SCOPE

The Alternative LIFO Method is available to any automobile dealer engaged in

the business of retail sales of new automobiles or new light-duty trucks for its

LIFO inventories of new automobiles and

new light-duty trucks. Light-duty trucks

are trucks with a gross vehicle weight of

14,000 pounds or less, which are also referred to as class 1, 2, or 3 trucks.

SECTION 4. ALTERNATIVE LIFO

METHOD

.01 In general.

(1) The Alternative LIFO Method is

a comprehensive dollar-value, link-chain

LIFO method of accounting that encompasses several LIFO sub-methods and

may only be used by an automobile dealer

engaged in the trade or business of retail

sales of new automobiles or new lightduty trucks to value its inventory of new

automobiles and new light-duty trucks.

(2) The Alternative LIFO Method is

designed to simplify the dollar-value

computations of automobile dealers.

Under the authority of § 1.446–1(c)(2)(ii),

the Commissioner will waive strict adherence of the § 1.472–8 comparability requirement in applying the Alternative

LIFO Method, provided a taxpayer uses

the compensating sub-methods described

in section 4.02 of this revenue procedure,

which, in the opinion of the Commissioner, are necessary to ensure that the Alternative LIFO Method clearly reflects income. These sub-methods include

requirements that (1) the current-year cost

of a new item be used as the prior year

cost for the new item, and (2) the automobile dealer use the manufacturer’s base

model codes to define items for purposes

of § 1.472–8. Generally, the manufacturer’s base model codes used in defining

items and identifying new items under the

Alternative LIFO Method have an average life of approximately five to seven

years.

(3) The Alternative LIFO Method includes, by definition, all its sub-methods.

Individual sub-methods used alone, or in

combination with some but not all of the

sub-methods of the Alternative LIFO

Method, may not clearly reflect income.

Therefore, use of the Alternative LIFO

Method is conditioned upon an automobile dealer computing its LIFO inventory

using all the sub-methods, definitions,

and special rules provided in section 4.02

of this revenue procedure, and the computational methodology provided in section

4.03 of this revenue procedure.

(4) The Alternative LIFO Method

will be accepted by the Commissioner as

an appropriate method of computing an

inventory index, and the use of the Alternative LIFO Method to compute the value

of the inventory pool or pools will be accepted as accurate, reliable, and suitable.

The automobile dealer’s computations

under the Alternative LIFO Method are,

however, subject to verification by the

district director upon examination of the

automobile dealer’s return.

.02 Sub-methods, definitions, and special rules.

(1) LIFO pools. For each separate

trade or business, (a) all new automobiles

(regardless of manufacturer), including

those used as demonstrators, must be included in one dollar-value LIFO pool, and

(b) all new light-duty trucks (regardless of

manufacturer), including those used as

demonstrators, must be included in another separate dollar-value LIFO pool.

(2) Specific identification increment

method. The current-year cost of the

items making up a pool must be determined by reference to the actual cost of

the specific new automobiles or new

light-duty trucks in ending inventory.

Therefore, the actual cost of the specific

vehicles on hand at year end will be the

current-year cost of such vehicles.

(3) Item of inventory. An item of inventory (“item category”) must be determined using the entire manufacturer’s

base model code number that represents

the most detailed description of the base

vehicle’s characteristics, such as model

line, body style, trim level, etc. The manufacturer’s base model code numbers are

almost always used as part of the vehicle

identification on each dealer invoice (for

example, a domestic model, trim level, 4door sedan has a specific model code; a

foreign model, 4-door sedan, trim level,

August 18, 1997

5-speed has a specific model code). In

the case of conversion vans, an item of inventory must be determined using both

(a) the entire manufacturer’s base model

code, as described in the preceding sentence, and (b) the most detailed conversion package designation.

(4) Cost of the vehicle used for purposes of computing the pool index. The

actual base vehicle cost of each of the

specific vehicles in ending inventory is

used to compute the index under the Alternative LIFO Method. The base vehicle

cost of each vehicle is not adjusted for

any options, accessories, or other costs.

The pool index computed from only the

base vehicle cost of vehicles is applied to

the total vehicle cost, including options,

accessories, and other costs, of all vehicles in the pool at the end of the taxable

year.

(5) Definition of a new item. A new

item category, which is an item category

not considered in existence in the prior

taxable year, is one of the following: (a)

any new or reassigned manufacturer’s

model code, as described in section

4.02(3) of this revenue procedure, that is

caused by a change in an existing vehicle,

or (b) a manufacturer’s model code, as described in section 4.02(3) of this revenue

procedure, created or reassigned because

the classified vehicle did not previously

exist. Additionally, if there is no change in

a manufacturer’s model code, but there

has been a change to the platform (i.e., the

piece of metal at the bottom of the chassis

that determines the length and width of

the vehicle and the structural set-up of the

vehicle) that results in a change in track

width or wheel-base, whether or not the

same model name was previously used by

the manufacturer, a new item category is

created.

(6) Treatment of a new item not in

existence in the prior year. The automobile dealer must use the current-year base

vehicle cost of the new item category as

the prior-year base vehicle cost of that

item category.

(7) Item in existence in the prior

year, but not stocked. If an item in ending

inventory was not stocked by the automobile dealer at the end of the prior year, but

was in existence in the prior year, the automobile dealer must determine the prioryear base vehicle cost for that item by reconstructing what the base vehicle cost

August 18, 1997

for the item category would have been

using a manufacturer’s price list that provides dealer purchase prices. For each

such item category, the manufacturer’s

price list that must be used by the automobile dealer is the list in effect as of the beginning of the last month of the prior taxable year.

.03 Computational methodology.

The following rules are applied to compute the LIFO value for each pool of an

automobile dealer’s ending inventory

under the Alternative LIFO Method:

STEP 1. Obtain the actual invoice for

each vehicle in the automobile dealer’s

ending inventory.

STEP 2. For each pool, group all the

invoices from Step l by item category, as

defined in section 4.02(3) of this revenue

procedure.

STEP 3. For each item category, add

together the dealer’s base vehicle costs of

all vehicles within each item category,

from Step 2.

STEP 4. Within each pool, compute an

average base vehicle cost for each item

category by dividing the result from Step

3 for each item category by the number of

vehicles in the item category. This average base vehicle cost for each item will be

used in Step 6 of the succeeding year’s

computations using the Alternative LIFO

Method.

STEP 5. For each pool, compute the

total current-year base vehicle cost of the

pool by adding together the separate item

category totals from Step 3.

STEP 6. For each pool, compute the

total base vehicle cost of the ending inventory at prior-year’s base vehicle cost.

First, multiply the number of vehicles in

the current year’s ending inventory for

each item category by the average base

vehicle cost of the same item category

from Step 4 of the preceding year’s inventory calculation. If the same item was not

in the prior year’s ending inventory, see

sections 4.02(6) and 4.02(7) of this revenue procedure. Then, add together the

total prior-year base vehicle cost of all of

the item categories.

STEP 7. For each pool, compute the

current-year (annual) index by dividing

the amount from Step 5 by the amount

from Step 6.

STEP 8. For each pool, compute the

cumulative index by multiplying the current-year index from Step 7 by the cumu-

lative index at the end of the preceding

year (from Step 8 of the preceding year’s

computation).

STEP 9. For each pool, compute the

total current-year total- vehicle cost by

adding together the total invoice cost, including installed options, accessories, and

other inventoriable cost(s), of all the vehicles in inventory at the end of the current

year.

STEP 10. For each pool, compute the

total cost of the current-year’s ending inventory at base-year cost by dividing the

total current-year total-vehicle cost of all

the vehicles in ending inventory, from

Step 9, by the cumulative index from Step

STEP 11. For each pool, determine if

there is an increment for the current year

by comparing the total cost of the pool’s

current-year ending inventory at baseyear cost, from Step 10, with the total cost

of the pool’s preceding year’s ending inventory at base-year cost, using the

amount from Step 10 of the preceding

year’s calculation. If the amount from

Step 10 of the current year’s calculation is

greater, there is an increment.

STEP 12. For each pool, value the current year’s increment at current-year cost

by multiplying the increment amount

from Step 11 by the cumulative index

from Step 8.

STEP 13. If there is no increment for a

pool, but, rather, a liquidation (also referred to as a decrement), reduce the LIFO

layers in reverse chronological order until

the liquidation is fully absorbed.

STEP 14. For each pool, add together

the current year’s increment, if any, at

current-year cost and the prior years’ increments at each prior year’s current-year

cost to compute the total LIFO value for

the pool.

SECTION 5. CHANGING TO

ALTERNATIVE LIFO METHOD

.01 Automatic change. Except as provided in section 5.02 of this revenue procedure, an automobile dealer wanting to

change to the Alternative LIFO Method

must follow the provisions in Rev. Proc.

97–37.

.02 Nonautomatic change. An automobile dealer that uses the IPIC method for

goods other than new automobiles, new

light-duty trucks, parts and accessories,

used automobiles, and used trucks, must

1997–33 I.R.B.

change to the Alternative LIFO Method

under Rev. Proc. 97–27, 1997–21 I.R.B.

10.

.03 Conditions. An automobile dealer

changing to the Alternative LIFO Method

must comply with the following conditions:

(1) the automobile dealer must keep

its books and records for the year of

change and for later taxable years on the

LIFO inventory method and use the

LIFO inventory method for all reports,

including consolidated financial statements, if any, and statements for credit

purposes, in conformity with the provisions of § 1.472–2(e) of the regulations;

(2) the automobile dealer must value

its inventory of new automobiles and

new light-duty trucks as of the end of the

year of change and for later taxable years

under the Alternative LIFO Method, as

provided in section 4 of this revenue procedure, unless it obtains permission to

change to another recognized method;

(3) the automobile dealer changing

from the IPIC method for its inventory of

parts and accessories, used automobiles,

and used trucks must value its inventory

of parts and accessories, used automobiles and used trucks as of the end of the

year of change and for later taxable years

under the methods provided in section

10.03(2)(b) of the APPENDIX of Rev.

Proc. 97–37, unless it obtains permission

to change to another recognized method;

(4) the conversion from the specific

goods method, if applicable, to the dollar-value method must be made in accordance with § 1.472–8(f)(2);

(5) the automobile dealer must file

Form 970, Application to Use LIFO Inventory Method, with its federal income

tax return for the year of change and otherwise comply with the provisions of §

472(d) and § 1.472–3 (see also Rev. Rul.

76–282, 1976–2 C.B. 137) to extend the

LIFO election (i) to include any new automobiles and new light-duty trucks (for

example, demonstrators) to which the

LIFO election did not previously apply

but that are required to be included in

LIFO pools under the Alternative LIFO

Method, and (ii) for an automobile

dealer changing from the IPIC method,

to include any parts and accessories,

used automobiles, and used trucks, to

which the LIFO election did not previously apply but that are required to be in-

1997–33 I.R.B.

cluded in LIFO pools under section

10.03 of the APPENDIX to Rev. Proc.

97–37, as of the beginning of the year of

change;

(6) the automobile dealer must effect the change to the Alternative LIFO

Method, and in the case of an automobile

dealer changing from the IPIC method to

the methods provided in section

10.03(2)(b) of the APPENDIX of Rev.

Proc. 97–37, using the cut-off method.

Under the cut-off method, the value of

the automobile dealer’s new automobile

and new light-duty truck inventory, and

in the case of an automobile dealer

changing from the IPIC method, the parts

and accessories, used automobile, and

used truck inventory, at the beginning of

the year of change must be the same as

the value of such inventory at the end of

the preceding taxable year plus market

value restorations, if any, required pursuant to section 5.03(5) of this revenue

procedure;

(7) the automobile dealer must combine and/or separate the dollar-value inventory pool or pools, including any pool

resulting from section 5.03(4) of this revenue procedure, if applicable, to conform

to the inventory pooling rules provided in

section 4 of this revenue procedure, and

in the case of an automobile dealer

changing from the IPIC method, to the

inventory pooling rules provided in section 10.03(2)(b) of the APPENDIX of

Rev. Proc. 97–37, in accordance with the

provisions of § 1.472–8(g)(2);

(8) in effecting the changes, any layers of inventory increments previously

determined and the LIFO value of such

increments must be retained. Instead of

using the earliest taxable year for which

the automobile dealer adopted the LIFO

method for any items in the inventory

pool or pools, the year of change must be

used as the base year in determining the

LIFO value of the inventory pool or

pools for the year of change and later taxable years (the cumulative index at the

beginning of the year of change will be

1.00). The base-year costs of layers of

increments in the pool or pools at the beginning of the year of change must be restated in terms of the new base-year

costs, using the year of change as the new

base year; and

(9) the automobile dealer must

maintain and retain complete records of

the computations of the LIFO inventory

under the Alternative LIFO Method, as

well as copies of the actual purchase invoice for each vehicle used in the computation.

SECTION 6. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention:

CC:DOM:IT&A, 1111 Constitution Avenue, NW, Washington, DC 20224.

SECTION 7. EFFECT ON OTHER

DOCUMENTS

Rev. Proc. 92–79, 1992–2 C.B. 457, is

modified, and as modified, is superseded.

However, see the transition rules in section 13.02 of Rev. Proc. 97–37.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective on

August 18, 1997.

SECTION 9. ELECTING LIFO AND

ADOPTING THE ALTERNATIVE LIFO

METHOD

.01 In general. An automobile dealer

that adopts the Alternative LIFO Method

provided in this revenue procedure at the

time the automobile dealer makes an

election to use (or extend) the dollarvalue LIFO inventory method must complete and file a statement of election

made on a current Form 970, pursuant to

the instructions for Form 970, or in such

other manner as may be acceptable to the

Commissioner. The use of the Alternative LIFO Method should be clearly indicated on the Form 970, or an attachment

to the Form 970, and reference should be

made to this revenue procedure. Appropriate LIFO sub-method elections that

are an integral part of the Alternative

LIFO Method, which are contained on

the Form 970, must be selected on the

Form 970 upon adoption of the Alternative LIFO Method.

.02 Conditions. A taxpayer adopting

the Alternative LIFO Method must comply with the conditions stated in section

5.03(1), (2), and (9) of this revenue procedure.

SECTION 10. PAPERWORK

REDUCTION ACT

The collections of information con-

August 18, 1997

tained in this revenue procedure have

been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act

(44 U.S.C. 3507) under control number

1545–1551.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

OMB control number.

The collections of information in this

revenue procedure are in section 5. This

information is necessary and will be used

to determine whether the taxpayer is

properly using the Alternative LIFO

Method. The collections of information

are required for the taxpayer to use the Alternative LIFO Method. The likely

recordkeepers are individuals, business or

other for-profit institutions, and small

businesses or organizations.

The estimated total annual recordkeeping burden is 200,000 hours.

The estimated annual burden per

recordkeeper is 25 hours. The estimated

number of recordkeepers is 8,000.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

DRAFTING INFORMATION

This revenue procedure was drafted in

the Office of Assistant Chief Counsel (Income Tax and Accounting). For further

information regarding this revenue procedure, contact Richard H. Berken on 202622-4970 (not a toll-free call).

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, §§ 162, 165, 166, 167, 168, 197, 263,

263A, 446, 451, 454, 455, 461, 471, 472, 481, 585,

1273, 1281, 1363; 1.165–2, 1.167(e)–1, 1.263(a)–2,

1.263A–1, 1.263A–3, 1.446–1, 1.454–1, 1.455–6,

1.461–4, 1.461–5, 1.471–1, 1.471–2, 1.471–3,

1.472–6, 1.472–8, 1.481–1, 1.481–4, 1.1273–1,

1.1273–2.)

Rev. Proc. 97–37

TABLE OF CONTENTS

PAGE

SECTION 1. PURPOSE . . . . . . . . . . . 19

SECTION 2. BACKGROUND. . . . . . 19

August 18, 1997

.01 Change in method of accounting

defined. . . . . . . . . . . . . . . . . . . 19

.02 Securing permission to make a

method change . . . . . . . . . . . . 19

.03 Terms and conditions of a

method change . . . . . . . . . . . . 19

.04 No retroactive method

change . . . . . . . . . . . . . . . . . . . 19

.05 Method change with a § 481(a)

adjustment . . . . . . . . . . . . . . . . 19

(1) Need for adjustment . . . . . 19

(2) Adjustment period . . . . . . . 20

.06 Method change using a cut-off

method. . . . . . . . . . . . . . . . . . . 20

.07 Consistency and clear reflection

of income. . . . . . . . . . . . . . . . . 20

.08 Separate trades or businesses . 20

.09 Penalties. . . . . . . . . . . . . . . . . . 20

.10 Change made as part of an

examination . . . . . . . . . . . . . . . 20

SECTION 3. DEFINITIONS . . . . . . . 20

.01 Application . . . . . . . . . . . . . . . 20

.02 Taxpayer . . . . . . . . . . . . . . . . . 20

(1) In general . . . . . . . . . . . . . . 20

(2) Consolidated group . . . . . . 20

.03 Filed. . . . . . . . . . . . . . . . . . . . . 20

.04 Mailed . . . . . . . . . . . . . . . . . . . 20

.05 Timely performance of acts. . . 20

.06 Year of change . . . . . . . . . . . . . 21

.07 Section 481(a) adjustment

period. . . . . . . . . . . . . . . . . . . . 21

.08 Under examination . . . . . . . . . 21

(1) In general . . . . . . . . . . . . . . 21

(2) Partnerships and S corporations subject to TEFRA . . . . . . 21

.09 Issue under consideration . . . . 21

(1) Under examination . . . . . . 21

(2) Before an appeals office . . 21

(3) Before a federal court . . . . 21

.10 Change within the LIFO inventory method . . . . . . . . . . . . . . . 21

SECTION 4. SCOPE . . . . . . . . . . . . . 22

.01 Applicability . . . . . . . . . . . . . . 22

.02 Inapplicability . . . . . . . . . . . . . 22

(1) Under examination . . . . . . 22

(2) Before an appeals office . . 22

(3) Before a federal court . . . . 22

(4) Consolidated group

member . . . . . . . . . . . . . . . . . . 22

(5) Partnerships and S

corporations. . . . . . . . . . . . . . . 22

(6) Prior change. . . . . . . . . . . . 22

(7) Section 381(a) transaction . 22

.03 Nonautomatic changes . . . . . . 22

SECTION 5. TERMS AND CONDITIONS OF CHANGE . . . . . . . . . . . . . 22

.01 In general . . . . . . . . . . . . . . . . . 22

.02 Year of change . . . . . . . . . . . . . 22

.03 Section 481(a) adjustment . . . . 22

.04 Section 481(a) adjustment

period. . . . . . . . . . . . . . . . . . . . 22

(1) In general . . . . . . . . . . . . . . 22

(2) Short period as a separate

taxable year . . . . . . . . . . . . . . . 22

(3) Shortened or accelerated adjustment periods . . . . . . . . . . . 22

.05 NOL carryback limitation for

taxpayer subject to criminal

investigation . . . . . . . . . . . . . . 23

.06 Change treated as initiated by the

taxpayer . . . . . . . . . . . . . . . . . . 24

SECTION 6. GENERAL

APPLICATION PROCEDURES . . . . 24

.01 Consent . . . . . . . . . . . . . . . . . . 24

.02 Filing requirements . . . . . . . . . 24

(1) Waiver of taxable year

filing requirement . . . . . . . . . . 24

(2) Timely duplicate filing

requirement . . . . . . . . . . . . . . . 24

(3) Label . . . . . . . . . . . . . . . . . 24

(4) Signature requirements . . . 24

(5) Additional statement

required . . . . . . . . . . . . . . . . . . 24

(6) Where to file . . . . . . . . . . . 24

(7) No user fee. . . . . . . . . . . . . 24

(8) Single application for certain

consolidated groups. . . . . . . . . 24

.03 Taxpayer under examination . . 24

(1) In general . . . . . . . . . . . . . . 24

(2) 90-day window period. . . . 25

(3) 120-day window period. . . 25

(4) Consent of district director 25

.04 Taxpayer before an appeals

office . . . . . . . . . . . . . . . . . . . . 25

.05 Taxpayer before a federal

court. . . . . . . . . . . . . . . . . . . . . 25

.06 Compliance with provisions . . 25

SECTION 7. AUDIT PROTECTION

FOR TAXABLE YEARS PRIOR TO

YEAR OF CHANGE . . . . . . . . . . . . . 25

.01 In general. . . . . . . . . . . . . . . . . 25

.02 Exceptions . . . . . . . . . . . . . . . . 26

(1) Change not made or made

improperly . . . . . . . . . . . . . . . . 26

(2) Change in sub-method. . . . 26

(3) Prior year Service-initiated

change . . . . . . . . . . . . . . . . . . . 26

(4) Criminal investigation . . . . 26

SECTION 8. EFFECT OF

CONSENT . . . . . . . . . . . . . . . . . . . . . 26

.01 In general. . . . . . . . . . . . . . . . . 26

.02 Retroactive change or modification. . . . . . . . . . . . . . . . . . . . . . 26

1997–33 I.R.B.

SECTION 9. REVIEW BY DISTRICT

DIRECTOR. . . . . . . . . . . . . . . . . . . . . 26

.01 In general. . . . . . . . . . . . . . . . . 26

.02 National office consideration . 26

SECTION 10. REVIEW BY NATIONAL

OFFICE . . . . . . . . . . . . . . . . . . . . . . . . 26

.01 In general. . . . . . . . . . . . . . . . . 26

.02 Incomplete application—21 day

rule. . . . . . . . . . . . . . . . . . . . . . 26

.03 Conference in the national

office . . . . . . . . . . . . . . . . . . . . 27

.04 National office determination . 27

SECTION 11. APPLICABILITY OF

REV. PROCS. 97–1 AND 97–4 . . . . . 27

SECTION 12. INQUIRIES. . . . . . . . . 27

SECTION 13. EFFECTIVE DATE. . . 27

.01 In general. . . . . . . . . . . . . . . . . 27

.02 Transition rules . . . . . . . . . . . . 27

(1) Previously filed

applications . . . . . . . . . . . . . . . 27

(2) New applications . . . . . . . . 27

.03 Timing of incurring liabilities for

payroll taxes . . . . . . . . . . . . . . 28

SECTION 14. EFFECT ON OTHER

DOCUMENTS . . . . . . . . . . . . . . . . . . 28

.01 Modified and superseded. . . . . 28

.02 Obsoleted. . . . . . . . . . . . . . . . . 28

SECTION 15. PAPERWORK

REDUCTION ACT. . . . . . . . . . . . . . . 28

DRAFTING INFORMATION . . . . . . 28

APPENDIX (TABLE OF

CONTENTS). . . . . . . . . . . . . . . . . . . . 28

SECTION 1. PURPOSE

This revenue procedure provides the

procedures by which a taxpayer may obtain automatic consent to change the

methods of accounting described in the

APPENDIX of this revenue procedure.

This revenue procedure consolidates and

supersedes most published automatic consent guidance for changes in methods of

accounting, and generally provides simplified, uniform procedures and terms and

conditions to obtain automatic consent to

make these changes. It also provides new

automatic consent procedures for changes

in several other methods of accounting. A

taxpayer complying with all the applicable provisions of this revenue procedure

has obtained the consent of the Commissioner of Internal Revenue to change its

method of accounting under § 446(e) of

the Internal Revenue Code and the Income Tax Regulations thereunder.

1997–33 I.R.B.

SECTION 2. BACKGROUND

.01 Change in method of accounting

defined.

(1) Section 1.446–1(e)(2)(ii)(a) of

the Income Tax Regulations provides that

a change in method of accounting includes a change in the overall plan of accounting for gross income or deductions,

or a change in the treatment of any material item. A material item is any item that

involves the proper time for the inclusion

of the item in income or the taking of the

item as a deduction. In determining

whether a taxpayer’s accounting practice

for an item involves timing, generally the

relevant question is whether the practice

permanently changes the amount of the

taxpayer’s lifetime income. If the practice does not permanently affect the taxpayer’s lifetime income, but does or could

change the taxable year in which income

is reported, it involves timing and is

therefore a method of accounting. See

Rev. Proc. 91–31, 1991–1 C.B. 566.

(2) Although a method of accounting

may exist under this definition without a

pattern of consistent treatment of an item,

a method of accounting is not adopted in

most instances without consistent treatment. The treatment of a material item in

the same way in determining the gross income or deductions in two or more consecutively filed tax returns (without regard to any change in status of the method

as permissible or impermissible) represents consistent treatment of that item for

purposes of § 1.446–1(e)(2)(ii)(a). If a

taxpayer treats an item properly in the

first return that reflects the item, however,

it is not necessary for the taxpayer to treat

the item consistently in two or more consecutive tax returns to have adopted a

method of accounting. If a taxpayer has

adopted a method of accounting under

these rules, the taxpayer may not change

the method by amending its prior income

tax return(s). See Rev. Rul. 90–38,

1990–1 C.B. 57.

(3) A change in the characterization

of an item may also constitute a change in

method of accounting if the change has

the effect of shifting income from one period to another. For example, a change

from treating an item as income to treating the item as a deposit is a change in

method of accounting. See Rev. Proc.

91–31.

(4) A change in method of account-

ing does not include correction of mathematical or posting errors, or errors in the

computation of tax liability (such as errors in computation of the foreign tax

credit, net operating loss, percentage depletion, or investment credit). See

§ 1.446–1(e)(2)(ii)(b).

.02 Securing permission to make a

method change. Section 446(e) and §

1.446–1(e) state that, except as otherwise

provided, a taxpayer must secure the consent of the Commissioner before changing

a method of accounting for federal income

tax purposes. Section 1.446–1T(e)(3)(i)(B) requires that, in order to obtain the

Commissioner’s consent to a method

change, a taxpayer must file a Form 3115,

Application for Change in Accounting

Method, during the taxable year in which

the taxpayer wants to make the proposed

change.

.03 Terms and conditions of a method

change. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the

limitations, terms, and conditions deemed

necessary to permit a taxpayer to obtain

consent to change a method of accounting

in accordance with § 446(e). The terms

and conditions the Commissioner may

prescribe include the year of change,

whether the change is to be made with a §

481(a) adjustment or on a cut-off basis,

and the § 481(a) adjustment period.

.04 No retroactive method change.

Unless specifically authorized by the

Commissioner, a taxpayer may not request, or otherwise make, a retroactive

change in method of accounting, regardless of whether the change is from a permissible or an impermissible method. See

generally Rev. Rul. 90–38.

.05 Method change with a § 481(a) adjustment.

(1) Need for adjustment. Section

481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account

when the taxpayer’s taxable income is

computed under a method of accounting

different from the method used to compute taxable income for the preceding taxable year. When there is a change in

method of accounting to which § 481(a) is

applied, income for the taxable year preceding the year of change must be determined under the method of accounting

that was then employed, and income for

August 18, 1997

the year of change and the following taxable years must be determined under the

new method of accounting as if the new

method had always been used.

Example. A taxpayer that is not required to use

inventories uses the overall cash receipts and disbursements method and changes to an overall accrual method. The taxpayer has $120,000 of income

earned but not yet received (accounts receivable)

and $100,000 of expenses incurred but not yet paid

(accounts payable) as of the end of the taxable year

preceding the year of change. A positive § 481(a)

adjustment of $20,000 ($120,000 accounts receivable less $100,000 accounts payable) is required as a

result of the change.

(2) Adjustment period. Section

481(c) and §§ 1.446–1T(e)(3)(i) and

1.481–4 provide that the adjustment required by § 481(a) may be taken into account in determining taxable income in

the manner and subject to the conditions

agreed to by the Commissioner and the

taxpayer. Generally, in the absence of

such an agreement, the § 481(a) adjustment is taken into account completely in

the year of change, subject to § 481(b)

which limits the amount of tax where the

§ 481(a) adjustment is substantial. However, under the Commissioner’s authority

in § 1.446–1(e)(3)(ii) to prescribe terms

and conditions for changes in methods of

accounting, this revenue procedure provides specific adjustment periods that are

intended to achieve an appropriate balance between the goals of mitigating distortions of income that result from accounting method changes and providing

appropriate incentives for voluntary compliance.

.06 Method change using a cut-off

method. The Commissioner may determine that certain changes in methods of

accounting will be made without a §

481(a) adjustment, using a “cut-off

method.” Under a cut-off method, only

the items arising on or after the beginning

of the year of change (or other operative

date) are accounted for under the new

method of accounting. Any items arising

before the year of change (or other operative date) continue to be accounted for

under the taxpayer’s former method of accounting. See, for example, § 263A

(which generally applies to costs incurred

after December 31, 1986, for noninventory property), § 461(h) (which generally

applies to amounts incurred on or after

July 18, 1984), and § 1.446–3 (which applies to notional principal contracts entered into on or after December 13, 1993).

August 18, 1997

Because no items are duplicated or omitted from income when a cut-off method is

used to effect a change in accounting

method, no § 481(a) adjustment is necessary.

.07 Consistency and clear reflection of

income. Methods of accounting should

clearly reflect income on a continuing

basis, and the Internal Revenue Service

exercises its discretion under §§ 446(e)

and 481(c) in a manner that generally

minimizes distortions of income across

taxable years and on an annual basis.

.08 Separate trades or businesses.

(1) Sections 1.446–1(d)(1) and (2)

provide that when a taxpayer has two or

more separate and distinct trades or businesses, a different method of accounting

may be used for each trade or business

provided the method of accounting used

for each trade or business clearly reflects

the overall income of the taxpayer as well

as that of each particular trade or business. No trade or business is separate and

distinct unless a complete and separable

set of books and records is kept for that

trade or business.

(2) Section 1.446–1(d)(3) provides

that if, by reason of maintaining different

methods of accounting, there is a creation

or shifting of profits or losses between the

trades or businesses of the taxpayer (for

example, through inventory adjustments,

sales, purchases, or expenses) so that income of the taxpayer is not clearly reflected, the trades or businesses of the

taxpayer are not separate and distinct.

.09 Penalties. Any otherwise applicable penalty for the failure of a taxpayer to

change its method of accounting (for example, the accuracy-related penalty under

§ 6662 or the fraud penalty under § 6663)

may be imposed if the taxpayer does not

timely file a request to change a method

of accounting. See § 446(f). Additionally, the taxpayer’s return preparer may

also be subject to the preparer penalty

under § 6694. However, penalties will

not be imposed when a taxpayer changes

from an impermissible method of accounting to a permissible one by complying with all applicable provisions of this

revenue procedure.

.10 Change made as part of an examination. Section 446(b) and § 1.446–1(b)(1) provide that if a taxpayer does not

regularly employ a method of accounting

that clearly reflects its income, the compu-

tation of taxable income must be made in a

manner that, in the opinion of the Commissioner, does clearly reflect income. If a

taxpayer under examination is not eligible

to change a method of accounting under

this revenue procedure, the change may be

made by the district director. A change resulting in a positive § 481(a) adjustment

will ordinarily be made in the earliest taxable year under examination with a oneyear § 481(a) adjustment period.

SECTION 3. DEFINITIONS

.01 Application. The term “application” includes a Form 3115, or any statement that is authorized under the APPENDIX of this revenue procedure to be filed

in lieu of a Form 3115, and any attachments.

.02 Taxpayer.

(1) In general. The term “taxpayer”

has the same meaning as the term “person” defined in § 7701(a)(1) (rather than

the meaning of the term “taxpayer” defined in § 7701(a)(14)).

(2) Consolidated group. For purposes of (a) sections 3.08(1), 3.09(1), and

4.02(1) of this revenue procedure (taxpayer under examination), (b) sections

3.09(2) and 4.02(2) of this revenue procedure (taxpayer before an appeals office),

or (c) sections 3.09(3) and 4.02(3) of this

revenue procedure (taxpayer before a federal court), the term “taxpayer” includes a

consolidated group.

.03 Filed. Any form (including an application), statement, or other document

required to be filed under this revenue

procedure is filed on the date it is mailed

to the proper address (or an address similar enough to complete delivery). If the

form, statement, or other document is not

mailed (or the date it is mailed cannot be

reasonably determined), it is filed on the

date it is delivered to the Service.

.04 Mailed. The date of mailing will

be determined under the rules of § 7502.

For example, the date of mailing is the

date of the U.S. postmark or the applicable date recorded or marked by a designated private delivery service. See Notice

97–26, 1997–17 I.R.B. 6.

.05 Timely performance of acts. The

rules of § 7503 apply when the last day

for the taxpayer’s timely performance of

any act (for example, filing an application

or submitting additional information) falls

on a Saturday, Sunday, or legal holiday.

1997–33 I.R.B.

The performance of any act is timely if

the act is performed on the next succeeding day that is not a Saturday, Sunday, or

legal holiday.

.06 Year of change. The year of

change is the taxable year for which a

change in method of accounting is effective, that is, the first taxable year the new

method is to be used, even if no affected

items are taken into account for that year.

.07 Section 481(a) adjustment period.

The § 481(a) adjustment period is the applicable number of taxable years for taking into account the § 481(a) adjustment

required as a result of the change in

method of accounting. The year of

change is the first taxable year in the adjustment period and the § 481(a) adjustment is taken into account ratably over

the number of taxable years in the adjustment period. The applicable adjustment

periods are set forth in section 5.04 of this

revenue procedure.

.08 Under examination.

(1) In general.

(a) Except as provided in section

3.08(2) of this revenue procedure, an examination of a taxpayer with respect to a

federal income tax return begins on the

date the taxpayer is contacted in any manner by a representative of the Service for

the purpose of scheduling any type of examination of the return. An examination

ends:

(i) in a case in which the Service accepts the return as filed, on the

date of the “no change” letter sent to the

taxpayer;

(ii) in a fully agreed case, on the

earliest of the date the taxpayer executes a

waiver of restrictions on assessment or

acceptance of overassessment (for example, Form 870, 4549, or 4605), the date

the taxpayer makes a payment of tax that

equals or exceeds the proposed deficiency, or the date of the “closing” letter

(for example, Letter 891 or 987) sent to

the taxpayer; or

(iii) in an unagreed or a partially agreed case, on the earliest of the

date the taxpayer (or its representative) is

notified by Appeals that the case has been

referred to Appeals from Examination,

the date the taxpayer files a petition in the

Tax Court, the date on which the period

for filing a petition with the Tax Court expires, or the date of the notice of claim

disallowance.

1997–33 I.R.B.

(b) An examination does not end

as a result of the early referral of an issue

to Appeals under the provisions of Rev.

Proc. 96–9, 1996–1 C.B. 575.

the date the taxpayer (or its representative) is notified by Appeals (or otherwise)

that the case has been referred to Examination for reconsideration.

(2) Partnerships and S corporations

subject to TEFRA. For an entity (including a limited liability company), treated

as a partnership or an S corporation for

federal income tax purposes, that is subject to the TEFRA unified audit and litigation provisions for partnerships and S corporations, an examination begins on the

date of the notice of the beginning of an

administrative proceeding sent to the Tax

Matters Partner/Tax Matters Person

(TMP). An examination ends:

(a) in a case in which the Service

accepts the partnership or S corporation

return as filed, on the date of the “no adjustments” letter or the “no change” notice of final administrative adjustment

sent to the TMP;

(b) in a fully agreed case, when all

the partners, members, or shareholders

execute a Form 870–P, 870–L, or 870–S;

agreed case, on the earliest of the date the

TMP (or its representative) is notified by

Appeals that the case has been referred to

Appeals from Examination, the date the

TMP (or a partner, member, or shareholder) requests judicial review, or the

date on which the period for requesting

judicial review expires.

But see section 4.02(5) of this revenue

procedure for certain rules that preclude

an entity from requesting a change in accounting method. Also note that S corporations are not subject to the TEFRA unified audit and litigation provisions for

taxable years beginning after December

31, 1996. See Small Business Job Protection Act of 1996, Pub. L. No. 104–188, §

1317(a), 110 Stat. 1755, 1787 (1996).

.09 Issue under consideration.

(1) Under examination. A taxpayer’s method of accounting for an item

is an issue under consideration for the taxable years under examination if the taxpayer receives written notification (for

example, by examination plan, information document request (IDR), or notifica-

tion of proposed adjustments or income

tax examination changes) from the examining agent(s) specifically citing the treatment of the item as an issue under consideration. For example, a taxpayer ’s

method of pooling under the dollar-value,

last-in, first-out (LIFO) inventory method

is an issue under consideration as a result

of an examination plan that identifies

LIFO pooling as a matter to be examined,

but it is not an issue under consideration

as a result of an examination plan that

merely identifies LIFO inventories as a

matter to be examined. Similarly, a taxpayer’s method of determining inventoriable costs under § 263A is an issue under

consideration as a result of an IDR that requests documentation supporting the

costs included in inventoriable costs, but

it is not an issue under consideration as a

result of an IDR that requests documentation supporting the amount of cost of

goods sold reported on the return. The

question of whether a method of accounting is an issue under consideration may be

referred to the national office as a request

for technical advice under the provisions

of Rev. Proc. 97–2, 1997–1 I.R.B. 64 (or

any successor).

(2) Before an appeals office. A taxpayer’s method of accounting for an item

is an issue under consideration for the taxable years before an appeals office if the

treatment of the item is included as an

item of adjustment in the examination report referred to Appeals or is specifically

identified in writing to the taxpayer by

Appeals.

(3) Before a federal court. A taxpayer’s method of accounting for an item

is an issue under consideration for the taxable years before a federal court if the

treatment of the item is included in the

statutory notice of deficiency, the notice

of claim disallowance, the notice of final

administrative adjustment, the pleadings

(for example, the petition, complaint, or

answer) or amendments thereto, or is

specifically identified in writing to the

taxpayer by the counsel for the government.

.10 Change within the LIFO inventory

method. A change within the LIFO inventory method is a change from one

LIFO inventory method or sub-method to

another LIFO inventory method or submethod. A change within the LIFO inventory method does not include a

August 18, 1997

change in method of accounting that

could be made by a taxpayer that does

not use the LIFO inventory method (for

example, a method governed by § 471 or

§ 263A).

SECTION 4. SCOPE

.01 Applicability. Except as otherwise

provided in section 4.02 of this revenue

procedure, this revenue procedure applies

to a taxpayer requesting the Commissioner’s consent to change to a method of

accounting described in the APPENDIX

of this revenue procedure. Except as otherwise provided in this revenue procedure

(see, for example, section 2.01 of the APPENDIX of this revenue procedure), this

revenue procedure is the exclusive procedure for a taxpayer within its scope to obtain the Commissioner’s consent.

.02 Inapplicability. Except as otherwise provided in the APPENDIX of this

revenue procedure (see, for example, sections 4.01 and 12.01 of the APPENDIX of

this revenue procedure), this revenue procedure does not apply in the following situations:

(1) Under examination. If, on the

date the taxpayer would otherwise file a

copy of the application with the national

office, the taxpayer is under examination

(as provided in section 3.08 of this revenue procedure), except as provided in

sections 6.03(2) (90-day window),

6.03(3) (120-day window), and 6.03(4)

(district director consent) of this revenue

procedure;

(2) Before an appeals office. If, on

the date the taxpayer would otherwise

file a copy of the application with the national office, the taxpayer is before an appeals office with respect to any income

tax issue and the method of accounting to

be changed is an issue under consideration by the appeals office (as provided in

section 3.09(2) of this revenue procedure);

(3) Before a federal court. If, on the

date the taxpayer would otherwise file a

copy of the application with the national

office, the taxpayer is before a federal

court with respect to any income tax issue

and the method of accounting to be

changed is an issue under consideration

by the federal court (as provided in section 3.09(3) of this revenue procedure);

(4) Consolidated group member. A

corporation that is (or was formerly) a

August 18, 1997

member of a consolidated group is under

examination, before an appeals office, or

before a federal court (for purposes of

sections 4.02(1), (2), and (3) of this revenue procedure) if the consolidated group

is under examination, before an appeals

office, or before a federal court for a taxable year(s) that the corporation was a

member of the group;

(5) Partnerships and S corporations.

For an entity (including a limited liability

company) treated as a partnership or an S

corporation for federal income tax purposes, if, on the date the entity would otherwise file a copy of the application with

the national office, the entity’s accounting

method to be changed is an issue under

consideration in an examination of a partner, member, or shareholder’s federal income tax return or an issue under consideration by an appeals office or by a

federal court with respect to a partner,

member, or shareholder’s federal income

tax return;

(6) Prior change. If the taxpayer,

within the last four taxable years prior to

the year of change, (a) has made a change

in the same method of accounting (with or

without obtaining the Commissioner’s

consent) or (b) has applied to change the

same method of accounting without effecting the change (whether the application to change was withdrawn, not perfected, not granted, or denied); or

(7) Section 381(a) transaction. If

the taxpayer engages in a transaction to

which § 381(a) applies within the proposed taxable year of change (determined

without regard to any potential closing of

the year under § 381(b)(1)).

.03 Nonautomatic changes. If either

section 4.02(6) or 4.02(7) of this revenue

procedure precludes a taxpayer from

using this revenue procedure to make a

change in method of accounting, the taxpayer requesting such a change must file a

Form 3115 with the Commissioner in accordance with the requirements of §

1.446–1(e)(3)(i) and Rev. Proc. 97–27,

1997–21 I.R.B. 10 (or any other applicable Code, regulation, or administrative

provision).

SECTION 5. TERMS AND

CONDITIONS OF CHANGE

.01 In general. An accounting method

change filed under this revenue procedure

must be made pursuant to the terms and

conditions provided in this revenue procedure.

.02 Year of change. The year of change

is the taxable year designated on the application and for which the application is

timely filed under section 6.02(2).

.03 Section 481(a) adjustment. Unless

otherwise provided in this revenue procedure, a taxpayer making a change in

method of accounting under this revenue

procedure must take into account a §

481(a) adjustment in the manner provided

in section 5.04 of this revenue procedure.

.04 Section 481(a) adjustment period.

(1) In general. Except as otherwise

provided in section 5.04(3) or the APPENDIX of this revenue procedure, the §

481(a) adjustment period for positive and

negative § 481(a) adjustments is four taxable years.

(2) Short period as a separate taxable year. If the year of change, or any

taxable year during the § 481(a) adjustment period, is a short taxable year, the §

481(a) adjustment must be included in income as if that short taxable year were a

full 12-month taxable year. See Rev. Rul.

78–165, 1978–1 C.B. 276.

Example 1. A calendar year taxpayer received

permission to change an accounting method beginning with the 1997 calendar year. The § 481(a) adjustment is $30,000 and the adjustment period is

four taxable years. The taxpayer subsequently receives permission to change its annual accounting

period to September 30, effective for the taxable

year ending September 30, 1998. The taxpayer must

include $7,500 of the § 481(a) adjustment in gross

income for the short period from January 1, 1998,

through September 30, 1998.

Example 2. Corporation X, a calendar year taxpayer, received permission to change an accounting

method beginning with the 1997 calendar year. The

§ 481(a) adjustment is $30,000 and the adjustment

period is four taxable years. On July 1, 1999, Corporation Z acquires Corporation X in a transaction to

which § 381(a) applies. Corporation Z is a calendar

year taxpayer that uses the same method of accounting to which Corporation X changed in 1997. Corporation X must include $7,500 of the § 481(a) adjustment in gross income for its short period income

tax return for January 1, 1999, through June 30,

1999. In addition, Corporation Z must include

$7,500 of the § 481(a) adjustment in gross income in

its income tax return for calendar year 1999.

(3) Shortened or accelerated adjustment periods. The § 481(a) adjustment

period provided in section 5.04(1) or the

APPENDIX of this revenue procedure

will be shortened or accelerated in the following situations.

(a) De minimis rule. A taxpayer

may elect to use a one-year adjustment

period in lieu of the § 481(a) adjustment

1997–33 I.R.B.

period otherwise provided by this revenue

procedure if the entire § 481(a) adjustment is less than $25,000 (either positive

or negative). A taxpayer makes an election under this de minimis rule by so indicating on the application. For example,

for a taxpayer filing a Form 3115, the taxpayer must complete the appropriate line

on the Form 3115 to elect this de minimis

rule.

(b) Cooperatives. A cooperative

within the meaning of § 1381(a) generally

must take the entire amount of a § 481(a)

adjustment into account in computing taxable income for the year of change. See

Rev. Rul. 79–45, 1979–1 C.B. 284.

or business.

(i) In general. A taxpayer that

ceases to engage in a trade or business or

terminates its existence must take the remaining balance of any § 481(a) adjustment relating to the trade or business into

account in computing taxable income in

the taxable year of the cessation or termination. Except as provided in sections

5.04(3)(c)(iv) and (v) of this revenue procedure, a taxpayer is treated as ceasing to

engage in a trade or business if the operations of the trade or business cease or substantially all the assets of the trade or

business are transferred to another taxpayer. For this purpose, “substantially

all” has the same meaning as in section

3.01 of Rev. Proc. 77–37, 1977–2 C.B.

568.

(ii) Examples of transactions

that are treated as the cessation of a trade

or business. The following is a nonexclusive list of transactions that are treated as

the cessation of a trade or business for

purposes of accelerating the § 481(a) adjustment under section 5.04(3)(c) of this

revenue procedure:

(A) the trade or business to

which the § 481(a) adjustment relates is

incorporated;

(B) the trade or business to

which the § 481(a) adjustment relates is

purchased by another taxpayer in a transaction to which § 1060 applies;

which the § 481(a) adjustment relates is

terminated or transferred pursuant to a

taxable liquidation;

(D) a division of a corporation ceases to operate the trade or business to which the § 481(a) adjustment re-

1997–33 I.R.B.

lates; or

(E) the assets of a trade or

business to which the § 481(a) adjustment

relates are contributed to a partnership.

(iii) Conversion to or from S

corporation status. Except as provided in

section 10.01 of the APPENDIX of this

revenue procedure, no acceleration of a §

481(a) adjustment is required under section 5.04(3)(c) of this revenue procedure

when a C corporation elects to be treated

as an S corporation or an S corporation

terminates its S election and is then

treated as a C corporation.

(iv) Certain transfers to which

§ 381(a) applies. No acceleration of the §

481(a) adjustment is required under section 5.04(3)(c) of this revenue procedure

when a taxpayer transfers substantially all

the assets of the trade or business that

gave rise to the § 481(a) adjustment to another taxpayer in a transfer to which §

381(a) applies and the accounting method

(the change to which gave rise to the §

481(a) adjustment) is a tax attribute that is

carried over and used by the acquiring

corporation immediately after the transfer

pursuant to § 381(c). The acquiring corporation is subject to any terms and conditions imposed on the transferor (or any

predecessor of the transferor) as a result

of its change in method of accounting.

(v) Certain transfers pursuant

to § 351 within a consolidated group.

(A) In general. No acceleration of the § 481(a) adjustment is required

under section 5.04(3)(c) of this revenue

procedure when one member of an affiliated group filing a consolidated return

transfers substantially all the assets of the

trade or business that gave rise to the §

481(a) adjustment to another member of

the same consolidated group in an exchange qualifying under § 351 and the

transferee member adopts and uses the

same method of accounting (the change to

which gave rise to the § 481(a) adjustment) used by the transferor member.

The transferor member must continue to

take the § 481(a) adjustment into account

pursuant to the terms and conditions set

forth in this revenue procedure. The

transferor member must take into account

activities of the transferee member (or

any successor) in determining whether acceleration of the § 481(a) adjustment is

required. For example, except as provided in the following sentence, the trans-

feror member must take any remaining §

481(a) adjustment into account in computing taxable income in the taxable year

in which the transferee member ceases to

engage in the trade or business to which

the § 481(a) adjustment relates. The §

481(a) adjustment is not accelerated when

the transferee member engages in a transaction described in section 5.04(3)(c)(iv)

or 5.04(3)(c)(v)(A) of this revenue procedure.

(B) Exception. The provisions of section 5.04(3)(c)(v)(A) of this

revenue procedure cease to apply and the

transferor member must take any remaining balance of the § 481(a) adjustment

into account in the taxable year immediately preceding any of the following: (1)

the taxable year the transferor member

ceases to be a member of the group; (2)

the taxable year any transferee member

owning substantially all the assets of the

trade or business which gave rise to the §

481(a) adjustment ceases to be a member

of the group; or (3) a separate return year

of the common parent of the group. In

applying the preceding sentence, the rules

of paragraphs (j)(2), (j)(5), and (j)(6) of §

1.1502–13 apply, but only if the method

of accounting to which the transferor

member changed and to which the §

481(a) adjustment relates is adopted, carried over, or used by any transferee member acquiring the assets of the trade or

business that gave rise to the § 481(a) adjustment immediately after acquisition of

such assets. For example, the transferor

member is not required to accelerate the §

481(a) adjustment if a transferee member

ceases to be a member of a consolidated

group by reason of an acquisition to

which § 381(a) applies and the acquiring

corporation (1) is a member of the same

group as the transferor member, and (2)

continues, under § 381(c)(4) and the regulations thereunder, to use the same

method of accounting as that used by the

transferor member with respect to the assets of the trade or business to which the §

481(a) adjustment relates.

.05 NOL carryback limitation for taxpayer subject to criminal investigation.

Generally, no portion of any net operating

loss that is attributable to a negative §

481(a) adjustment may be carried back to

a taxable year prior to the year of change

that is the subject of any pending or future

criminal investigation or proceeding con-

August 18, 1997

cerning (1) directly or indirectly, any

issue relating to the taxpayer’s federal tax

liability, or (2) the possibility of false or

fraudulent statements made by the taxpayer with respect to any issue relating to

its federal tax liability.

.06 Change treated as initiated by the

taxpayer. For purposes of § 481, a change

in method of accounting made under this

revenue procedure is a change in method

of accounting initiated by the taxpayer.

SECTION 6. GENERAL

APPLICATION PROCEDURES

.01 Consent. Pursuant to § 1.446–1(e)(2)(i), the consent of the Commissioner is

hereby granted to any taxpayer within the

scope of this revenue procedure to change

a method of accounting, provided the taxpayer complies with all the applicable provisions of this revenue procedure.

.02 Filing requirements.

(1) Waiver of taxable year filing requirement. The requirement under §

1.446–1T(e)(3)(i)(B) to file a Form 3115

within the taxable year for which the

change is requested is waived for any application for a change in method of accounting filed pursuant to this revenue

procedure. See § 1.446–1(e)(3)(ii).

(2) Timely duplicate filing requirement.

(a) In general. A taxpayer changing a method of accounting pursuant to

this revenue procedure must complete and

file an application in duplicate. The original must be attached to the taxpayer’s

timely filed (including extensions) original federal income tax return for the year

of change. A copy of the application must

be filed with the national office (see section 6.02(6) of this revenue procedure for

the address) no earlier than the first day of

the year of change and no later than when

the original is filed with the federal income tax return for the year of change.

(b) Limited relief for late application. A taxpayer that fails to file the application for the year of change as provided in section 6.02(2)(a) of this revenue

procedure will not be granted an extension of time to file under § 301.9100 of

the Procedure and Administration Regulations, except in unusual and compelling

circumstances. See § 301.9100–3T(c)(2).

(3) Label.

(a) In order to assist in processing

an application under this revenue proce-

August 18, 1997

dure, the section of the APPENDIX of

this revenue procedure describing the specific change in method of accounting

should be included in the application. For

example, a phrase such as “Section 1.01

of the APPENDIX of Rev. Proc. 97–37”

should be included on the appropriate line

on the Form 3115.

(b) If a taxpayer is authorized

under the APPENDIX of this revenue

procedure to file a statement in lieu of a

Form 3115, the taxpayer must include the

taxpayer’s name and employer identification number (or social security number in

the case of an individual) at the top of the

first page of the statement underneath any

other required label.

(4) Signature requirements. The application must be signed by, or on behalf

of, the taxpayer requesting the change by

an individual with authority to bind the

taxpayer in such matters. For example, an

officer must sign on behalf of a corporation, a general partner on behalf of a state

law partnership, a member-manager on

behalf of a limited liability company, a

trustee on behalf of a trust, or an individual taxpayer on behalf of a sole proprietorship. If the taxpayer is a member of a

consolidated group, an application submitted on behalf of the taxpayer must be

signed by a duly authorized officer of the

common parent. See the signature requirements set forth in the General Instructions attached to a current Form 3115

regarding those who are to sign. If an

agent is authorized to represent the taxpayer before the Service, receive the original or a copy of the correspondence concerning the application, or perform any

other act(s) regarding the application filed

on behalf of the taxpayer, a power of attorney reflecting such authorization(s)

must be attached to the application. A

taxpayer’s representative without a power

of attorney to represent the taxpayer as indicated in this section will not be given

any information regarding the application.

(5) Additional statement required. In

addition to providing all the information

that is required by the application, a taxpayer must attach to the application a

written statement providing as follows:

(a) the taxpayer agrees to all of the

terms and conditions in this revenue procedure; and

(b) if a § 481(a) adjustment is re-

quired, the reason for claiming the §

481(a) adjustment period over which the

taxpayer agrees to take the applicable §

481(a) adjustment into account.

(6) Where to file. A taxpayer, other

than an exempt organization, changing a

method of accounting pursuant to this

revenue procedure must file a copy of the

application with the national office addressed to the Commissioner of Internal

Revenue, Attention: CC:DOM:IT&A,

P.O. Box 7604, Benjamin Franklin Station, Washington, DC 20044 (or, in the

case of a designated private delivery service: Commissioner of Internal Revenue,

Attention: CC:DOM:IT&A, 1111 Constitution Avenue, NW, Washington, DC

20224). An exempt organization must address the application to the Assistant

Commissioner (Employee Plans and Exempt Organizations), Attention: E:EO,

P.O. Box 120, Benjamin Franklin Station,

Washington, DC 20044 (or, in the case of

a designated private delivery service: Assistant Commissioner (Employee Plans

and Exempt Organizations), Attention:

E:EO, 1111 Constitution Avenue, NW,

Washington, DC 20224).

(7) No user fee. A user fee is not required for an application filed under this

revenue procedure, and the receipt of an

application filed under this revenue procedure will not be acknowledged.

(8) Single application for certain

consolidated groups. A parent corporation may file a single application to

change an identical method of accounting

on behalf of more than one member of a

consolidated group. To qualify, the taxpayers in the consolidated group must be

members of the same affiliated group

under § 1504(a) that join in the filing of a

consolidated tax return, and they must be

changing from the identical present

method of accounting to the identical proposed method of accounting. All aspects

of the change in method of accounting,

including the present and proposed methods, the underlying facts, and the authority for the change, must be identical, except for the § 481(a) adjustment. See

section 15.07(3) of Rev. Proc. 97–1,

1997–1 I.R.B. at 49 (or any successor),

for the information required to be submitted with the application.

.03 Taxpayer under examination.

(1) In general. Except as otherwise

provided in the APPENDIX of this rev-

1997–33 I.R.B.

enue procedure (see, for example, sections 4.01 and 12.01 of the APPENDIX of

this revenue procedure), a taxpayer that is

under examination may file an application

to change a method of accounting under

section 6 of this revenue procedure if the

taxpayer is within the provisions of section 6.03(2) (90-day window), 6.03(3)

(120-day window), or 6.03(4) (district director consent) of this revenue procedure.

A taxpayer that files an application beyond the time periods provided in the 90day and 120-day windows will not be

granted an extension of time to file under

§ 301.9100, except in unusual and compelling circumstances.

(2) 90-day window period.

(a) A taxpayer may file a copy of

the application with the national office to

change a method of accounting under this

revenue procedure during the first 90days of any taxable year (the “90-day

window”) if the taxpayer has been under

examination for at least 12 consecutive

months as of the first day of the taxable

year. This 90-day window is not available if the method of accounting the taxpayer is changing is an issue under consideration at the time the copy of the

application is filed or an issue the examining agent(s) has placed in suspense at

the time the copy of the application is

filed.

(b) A taxpayer changing a method

of accounting under this 90-day window

must provide a copy of the application to

the examining agent(s) at the same time it

files the copy of the application with the

national office. The application must

contain the name(s) and telephone number(s) of the examining agent(s). The taxpayer must attach to the application a separate statement signed by the taxpayer

certifying that, to the best of the taxpayer’s knowledge, the same method of

accounting is not an issue under consideration or an issue placed in suspense by the

examining agent(s).

(3) 120-day window period.

(a) A taxpayer may file a copy of

the application with the national office to

change a method of accounting under this

revenue procedure during the 120-day

period following the date an examination

ends (the “120-day window”), regardless

of whether a subsequent examination has

commenced. This 120-day window is

not available if the method of accounting

1997–33 I.R.B.

the taxpayer is changing is an issue under

consideration at the time a copy of the

application is filed or an issue the examining agent(s) has placed in suspense at

the time the copy of the application is

filed.

(b) A taxpayer changing a method

of accounting under this 120-day window

must provide a copy of the application to

the examining agent(s) for any examination that is in process at the same time it

files the copy of the application with the

national office. The application must

contain the name(s) and telephone number(s) of the examining agent(s). The taxpayer must attach to the application a separate statement signed by the taxpayer

certifying that, to the best of the taxpayer’s knowledge, the same method of

accounting is not an issue under consideration or an issue placed in suspense by the

examining agent(s).

(4) Consent of district director.

(a) A taxpayer under examination

may change its method of accounting

under this revenue procedure if the district director consents to the change. The

district director will consent to the change

unless, in the opinion of the district director, the method of accounting to be

changed would ordinarily be included as

an item of adjustment in the year(s) for

which the taxpayer is under examination.

For example, the district director will

consent to a change from a clearly permissible method of accounting. The district director will also consent to a change

from an impermissible method of accounting where the impermissible method

was adopted subsequent to the years

under examination. The question of

whether the method of accounting from

which the taxpayer is changing is permissible or was adopted subsequent to the

years under examination may be referred

to the national office as a request for technical advice under the provisions of Rev.

Proc. 97–2 (or any successor).

(b) A taxpayer changing a method

of accounting under this revenue procedure with the consent of the district director must attach to the application a statement from the district director consenting

to the change. The taxpayer must provide

a copy of the application to the district director at the same time it files a copy of

the application with the national office.

The application must contain the name(s)

and telephone number(s) of the examining agent(s).

.04 Taxpayer before an appeals office.

A taxpayer that is before an appeals office

must attach to the application a separate

statement signed by the taxpayer certifying that, to the best of the taxpayer’s

knowledge, the same method of accounting is not an issue under consideration by

the appeals office. The taxpayer must

provide a copy of the application to the

appeals officer at the same time it files a

copy of the application with the national

office. The application must contain the

name and telephone number of the appeals officer.

.05 Taxpayer before a federal court. A

taxpayer that is before a federal court

must attach to the application a separate

statement signed by the taxpayer certifying that, to the best of the taxpayer’s

knowledge, the same method of accounting is not an issue under consideration by

the federal court. The taxpayer must provide a copy of the application to the counsel for the government at the same time it

files a copy of the application with the national office. The application must contain the name and telephone number of

the counsel for the government.

.06 Compliance with provisions. If a

taxpayer to which this revenue procedure

applies changes to a method of accounting without complying with all the applicable provisions of this revenue procedure

(for example, the taxpayer changes to a

method of accounting that varies from the

applicable accounting method described

in this revenue procedure or the taxpayer

is outside the scope of this revenue procedure), the taxpayer has initiated a change

in method of accounting without obtaining the consent of the Commissioner as

required by § 446(e). Upon examination,

a taxpayer that has initiated an unauthorized change in method of accounting

may be required to effect the change in an

earlier or later taxable year and may be

denied the benefit of spreading the §

481(a) adjustment over the number of taxable years otherwise prescribed by this

revenue procedure.

SECTION 7. AUDIT PROTECTION

FOR TAXABLE YEARS PRIOR TO

YEAR OF CHANGE

.01 In general. Except as provided in

section 7.02 or the APPENDIX of this

August 18, 1997

revenue procedure, when a taxpayer

timely files a copy of the application with

the national office in compliance with all

the applicable provisions of this revenue

procedure, the Service will not require the

taxpayer to change its method of accounting for the same item for a taxable year

prior to the year of change.

.02 Exceptions.

(1) Change not made or made improperly. The Service may change a taxpayer’s method of accounting for prior

taxable years if (a) the taxpayer fails to

implement the change; (b) the taxpayer

implements the change but does not

comply with all the applicable provisions

of this revenue procedure, or (c) the

method of accounting is changed or

modified because there has been a misstatement or omission of material facts

(see section 8.02(2) of this revenue procedure).

(2) Change in sub-method. The Service may change a taxpayer’s method of

accounting for prior taxable years if the

taxpayer is changing a sub-method of accounting within the method. For example, an examining agent may propose to

terminate the taxpayer’s use of the LIFO

inventory method during a prior taxable

year even though the taxpayer changes its

method of valuing increments in the current year.

(3) Prior year Service-initiated

change. The Service may make adjustments to the taxpayer’s returns for the

same item for taxable years prior to the

requested year of change to reflect a prior

year Service-initiated change.

(4) Criminal investigation. The Service may change a taxpayer’s method of

accounting for the same item for taxable

years prior to the year of change if there is

any pending or future criminal investigation or proceeding concerning (a) directly

or indirectly, any issue relating to the taxpayer’s federal tax liability for any taxable year prior to the year of change, or

(b) the possibility of false or fraudulent

statements made by the taxpayer with respect to any issue relating to its federal

tax liability for any taxable year prior to

the year of change.

SECTION 8. EFFECT OF CONSENT

.01 In general. A taxpayer that

changes to a method of accounting pursuant to this revenue procedure may be

August 18, 1997

required to change or modify that method

of accounting for the following reasons:

(1) the enactment of legislation;

(2) a decision of the United States

Supreme Court;

(3) the issuance of temporary or final

regulations;

(4) the issuance of a revenue ruling,

revenue procedure, notice, or other statement published in the Internal Revenue

Bulletin;

(5) the issuance of written notice to

the taxpayer that the change in method of

accounting was not in compliance with all

the applicable provisions of this revenue

procedure or is not in accord with the current views of the Service; or

(6) a change in the material facts on

which the consent was based.

.02 Retroactive change or modification. Except in rare or unusual circumstances, if a taxpayer that changes its

method of accounting under this revenue

procedure is subsequently required under

section 8.01 of this revenue procedure to

change or modify that method of accounting, the required change or modification

will not be applied retroactively, provided

that:

(1) the taxpayer complied with all

the applicable provisions of this revenue

procedure;

(2) there has been no misstatement

or omission of material facts;

(3) there has been no change in the

material facts on which the consent was

based;

(4) there has been no change in the

applicable law; and

(5) the taxpayer to whom consent

was granted acted in good faith in relying

on the consent, and applying the change

or modification retroactively would be to

the taxpayer’s detriment.

SECTION 9. REVIEW BY DISTRICT

DIRECTOR

.01 In general. The district director

must apply a change in method of accounting made in compliance with all the

applicable provisions of this revenue procedure in determining the taxpayer’s liability, unless the district director recommends that the change in method of

accounting should be modified or revoked. (See section 6.06 of this revenue

procedure if a change in method of accounting is made without complying with

all the applicable provisions of this revenue procedure.) The district director will

ascertain if:

(1) the representations on which the

change was based reflect an accurate

statement of the material facts;

(2) the amount of the § 481(a) adjustment was properly determined;

(3) the change in method of accounting was implemented in compliance with

all the applicable provisions of this revenue procedure;

(4) there has been any change in the

material facts on which the change was

based during the period the method of accounting was used; and

(5) there has been any change in the

applicable law during the period the

method of accounting was used.

.02 National office consideration. If

the district director recommends that a

change in method of accounting (other

than the § 481(a) adjustment) made in

compliance with all the applicable provisions of this revenue procedure should be

modified or revoked, the district director

will forward the matter to the national office for consideration before any further

action is taken. Such a referral to the national office will be treated as a request

for technical advice, and the provisions of

Rev. Proc. 97–2 (or any successor) will be

followed.

SECTION 10. REVIEW BY NATIONAL

OFFICE

.01 In general. Any application filed

under this revenue procedure may be reviewed by the national office. If the application is reviewed by the national office, the procedures in sections 10.02

through 10.04 of this revenue procedure

apply.

.02 Incomplete application—21 day

rule. If the Service reviews an application and determines that the application is

not properly completed in accordance

with the instructions of the Form 3115 or

the provisions of this revenue procedure,

or if supplemental information is needed,

the Service will notify the taxpayer. The

notification will specify the information

that needs to be provided, and the taxpayer will be permitted 21 days from the

date of the notification to furnish the necessary information. The Service reserves

the right to impose shorter reply periods if

subsequent requests for additional infor-

1997–33 I.R.B.

mation are made. An extension of the 21day period to furnish information, not to

exceed 15 days, may be granted to a taxpayer. A request for an extension of the

21-day period must be made in writing

and submitted within the 21-day period.

If the extension request is denied, there is

no right of appeal.

.03 Conference in the national office.

If the national office tentatively determines that the taxpayer has changed its

method of accounting without complying

with all the applicable provisions of this

revenue procedure (for example, the taxpayer changed to a method of accounting

that varies from the applicable accounting

method described in this revenue procedure or the taxpayer is outside the scope

of this revenue procedure), the national

office will notify the taxpayer of its tentative adverse determination and will offer

the taxpayer a conference of right, if the

taxpayer has requested a conference. For

conference procedures for taxpayers other

than exempt organizations, see section 11

of Rev. Proc. 97–1 (or any successor).

For conference procedures for exempt organizations, see section 12 of Rev. Proc.

97–4, 1997–1 I.R.B. 96 (or any successor).

.04 National office determination. If

the national office determines that the

taxpayer has changed its method of accounting without complying with all the

applicable provisions of this revenue

procedure, the national office will notify

the taxpayer that consent to make the

change in method of accounting either

(1) is not granted, or (2) is granted, provided the taxpayer makes appropriate adjustments to conform its change in

method of accounting to the applicable

provisions of this revenue procedure.

Any adjustments so made must be accompanied by conforming amendments

to any federal income tax returns filed

for the year of change and subsequent

taxable years.

SECTION 11. APPLICABILITY OF

REV. PROCS. 97–1 AND 97–4

Rev. Procs. 97–1 and 97–4 (or any successors) are applicable to applications

filed under this revenue procedure, unless

specifically excluded or overridden by

other published guidance (including the

special procedures in this document).

1997–33 I.R.B.

SECTION 12. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention:

CC:DOM:IT&A, 1111 Constitution Avenue, NW, Washington, DC 20224.

SECTION 13. EFFECTIVE DATE

.01 In general. Except as provided in

sections 13.02 and 13.03 of this revenue

procedure, this revenue procedure is effective for taxable years ending on or

after August 18, 1997. Except as provided in sections 13.02 and 13.03 of this

revenue procedure, the Service will return

any application that is filed on or after

August 18, 1997, if the application is filed

with the national office pursuant to the

Code, regulations, or administrative guidance other than this revenue procedure

and the change in method of accounting is

within the scope of this revenue procedure.

.02 Transition rules.

(1) Previously filed applications.

(a) Applications for advance consent. If a taxpayer filed an application

with the national office under Rev. Proc.

97–27 or Rev. Proc. 92–20, 1992–1 C.B.

685, to make a change in method of accounting authorized by this revenue procedure, and the application is pending

with the national office on August 18,

1997, the taxpayer may make the change

under this revenue procedure. However,

the national office will process the application in accordance with the revenue

procedure under which the application

was filed, unless prior to the later of September 30, 1997, or the issuance of the

letter ruling granting or denying consent

to the change, the taxpayer notifies the

national office that it wants to make the

change under this revenue procedure. If

the taxpayer timely notifies the national

office that it wants to make the method

change under this revenue procedure, the

national office will require the taxpayer to

make appropriate modifications to the application to comply with the applicable

provisions of this revenue procedure. In

addition, any user fee that was submitted

with the application will be returned to

the taxpayer.

(b) Applications for automatic

consent. If a taxpayer filed an application

with the national office (or a service cen-

ter) previously authorized by an automatic consent procedure listed in section

14.01 of this revenue procedure, before

August 18, 1997, to make a change in

method of accounting authorized by this

revenue procedure, the taxpayer may

make the change under this revenue procedure. However, the national office will

process the application in accordance

with the automatic consent procedure

under which the application was filed, unless prior to September 30, 1997, the taxpayer notifies the national office in writing (at the address provided in section

6.02(6) of this revenue procedure) that it

wants to make the change under this revenue procedure. If the taxpayer timely

notifies the national office that it wants to

make the method change under this revenue procedure, the national office will

require the taxpayer to make appropriate

modifications to the application to comply with the applicable provisions of this

revenue procedure.

(2) New applications.

(a) Prior automatic consent procedures. A taxpayer that wants to make a

change in method of accounting previously authorized by an automatic consent

procedure listed in section 14.01 of this

revenue procedure, for a taxable year that

ends on or after August 18, 1997, may

make the change under that automatic

consent procedure by complying with that

procedure and the following additional

filing requirement. In lieu of filing the

application with the national office (or a

service center) pursuant to that automatic

consent procedure, the taxpayer must file

a copy of the application with the national

office no earlier than the first day of the

year of change, and no later than the earlier of December 31, 1997, or when the

original application is filed with the

timely filed original federal income tax

return (including extensions) for the year

of change. A taxpayer changing its

method of accounting under Rev. Proc.

85–8, 1985–1 C.B. 495, for a taxable year

ending on or before December 31, 1997,

may file under that revenue procedure.

The additional filing requirement described above does not apply to this

change.

(b) New automatic consent procedures. A taxpayer making a change in

method of accounting authorized by this

revenue procedure, other than a change

August 18, 1997

previously authorized by an automatic

consent procedure listed in section 14.01

of this revenue procedure or a change authorized by section 13.01 of the APPENDIX of this revenue procedure, that files a

copy of an application under the provisions of this revenue procedure no later

than the earlier of December 31, 1997, or

when the original application is filed with

the timely filed original federal income

tax return (including extensions) for the

year of change, may apply the § 481(a)

adjustment period determined under sections 5 and 8 of Rev. Proc. 92–20. The

taxpayer must affirmatively state in an attachment to the application (a) that it requests to apply the § 481(a) adjustment

period determined under sections 5 and 8

of Rev. Proc. 92–20, and (b) the applicable § 481(a) adjustment period and the authority therefor.

.03 Timing of incurring liabilities for

payroll taxes. To change a method of accounting under section 8.04 of the APPENDIX of this revenue procedure, a taxpayer may use the provisions of this

revenue procedure for taxable years ending on or after October 21, 1996.

SECTION 14. EFFECT ON OTHER

DOCUMENTS

.01 Modified and superseded. Rev.

Procs. 96–31, 1996–1 C.B. 714; 95–33,

1995–2 C.B. 380; 94–29, 1994–1 C.B.

616; 92–98, 1992–2 C.B. 512; 92–97,

1992–2 C.B. 510; 92–79, 1992–2 C.B.

457; 92–75, 1992–2 C.B. 448; 92–74,

1992–2 C.B. 442; 90–63, 1990–2 C.B.

664; 90–37, 1990–2 C.B. 361; 89–46,

1989–2 C.B. 597; 88–15, 1988–1 C.B.

683; 84–76, 1984–2 C.B. 751; and 74–11,

1974–1 C.B. 420; and Notice 95–57,

1995–2 C.B. 337; are modified, and as

modified, are superseded.

.02 Obsoleted. The following revenue

procedures are obsoleted:

(1) Rev. Proc. 85–8, 1985–1 C.B.

495 (a revenue procedure that allows a

taxpayer to change its method of accounting for bad debts);

(2) Rev. Proc. 84–30, 1984–1 C.B.

482 (a revenue procedure that allows a

taxpayer to change its method of accounting for interest on certain consumer loans

from the Rule of 78’s method to the economic accrual method);

(3) Rev. Proc. 84–29, 1984–1 C.B.

480 (a revenue procedure that provides a

August 18, 1997

simplified procedure for an individual

borrower to use to compute interest deductions for certain loans if the taxpayer

has been reporting interest deductions on

these loans based on the Rule of 78’s

method);

(4) Rev. Proc. 84–28, 1984–1 C.B.

475 (a revenue procedure that allows a

taxpayer to change its method of accounting for interest from the Rule of

78’s method to the economic accrual

method, b

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