PROCEDURES FOR AUTOMATIC DISCONTINUANCE OF LIFO METHOD FOR TAXPAYERS ISSUING NONCONFORMING FINANCIAL STATEMENTS ARE PROVIDED

Rev. Proc. 85-54

SECTION 1. PURPOSE AND SCOPE

The purpose of this revenue procedure is to provide a procedure by which taxpayers that use the last-in, first-out method of accounting for inventory (LIFO) and that issued nonconforming financial statements can automatically discontinue the use of the LIFO inventory method for their first tax year beginning on or after July 18, 1984, because of the enactment of section 95 of the Tax Reform Act of 1984 (the Act).

SEC. 2. BACKGROUND

01 Section 472(c) of the Internal Revenue Code requires a taxpayer using the LIFO inventory method to use no other procedure in inventorying its goods to ascertain the income, profit, or loss of the first tax year for which the LIFO inventory method is to be used, for the purpose of a report or statement covering such tax year to shareholders, partners, or other proprietors, or to beneficiaries, or for credit purposes. Subsection (3) extends this conformity requirement to subsequent tax years.

02 In Insilco Corp. v. Commissioner, 73 T.C. 589 (1979), nonacq., 1982-1 C.B. 1, aff'd No. 2231-77 (2d Cir. 1980), three subsidiaries used the LIFO inventory method to compute their income for their financial reports. The subsidiaries issued these financial reports to their parent company. The parent company, however, reported the subsidiaries' earnings in its consolidated financial statements using a non-LIFO inventory method. The Tax Court held that this situation did not violate the LIFO conformity provisions of section 472(e) of the Code.

03 Section 95(a) of the Act added a new subsection, (g), to section 472 of the Code. Section 472(g)(1), effective for tax years beginning on or after July 18, 1984, provides that all members of the same group of financially related corporations shall generally be treated as one taxpayer for purposes of section 472(c) and 472(e)(2). Section 472(g)(2) defines the term "group of financially related corporations" as (A) any affiliated group as defined in section 1504 determined by substituting "50 percent" for "80 percent" each place it appears in section 1504(a) and without regard to section 1504(b), and (B) any other group of corporations which consolidate or combine for purposes of financial statements.

04 The Senate Committee on Finance, 98th Cong., 2d Sess., Deficit Reduction Act of 1984, Explanation of Provisions Approved by the Committee on March 21, 1984, 487 (Comm. Print 1984), expresses an expectation that taxpayers who elect to change from the LIFO method for tax purposes as a result of the enactment of section 472(g) will be allowed by the Service to spread over a period not to exceed four years any adjustments required under section 481 of the Code.

05 Section 1.472-6 of the Income Tax Regulations provides that if a taxpayer is granted permission by the Commissioner to discontinue the use of the LIFO inventory method of taking inventories, and thereafter to use some other method, or if the taxpayer is required by the Commissioner to discontinue the use of the LIFO inventory method by reason of the taxpayer's failure to conform to the requirements detailed in section 1.472-2 (concerning the adoption and use of the LIFO inventory method), the inventory of the specified goods for the first tax year affected by the change and for each tax year thereafter shall be taken:

(a) In conformity with the method used by the taxpayer under section 471 in inventorying goods not included in its LIFO inventory computations; or

(b) If the LIFO inventory method was used by the taxpayer with respect to all of the taxpayer's goods subject to the inventory, then in conformity, with the inventory method used by the taxpayer prior to the taxpayer's adoption of the LIFO inventory method; or

(c) If the taxpayer had not used inventories prior to adoption of the LIFO inventory method and had no goods currently subject to inventory by a method other than the LIFO inventory method, then in conformity with such inventory method as may be selected by the taxpayer and approved by the Commissioner as resulting in a clear reflection of income; or

(d) In any event, in conformity with any inventory method to which the taxpayer may change pursuant to application approved by the Commissioner.

06 Section 446(e) of the Code and section 1.446-1(e)(2)(i) of the regulations 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- 1(e)(3)(i) provides that except as otherwise provided in section 1.446-1(e)(3)(ii), in order to secure the Commissioner's consent, the taxpayer must file an application on Form 3115, Application for Change in Accounting Method, with the National Office within 180 days after the beginning of the tax year in which the taxpayer desires to make the change. Section 1.446-1(e)(3)(ii) provides that, notwithstanding section 1.446-1(e)(3)(i), the Commissioner may prescribe administrative procedures, subject to such limitations, terms, and conditions as he deems necessary to obtain his consent, to permit taxpayers to change their accounting methods to an acceptable method consistent with applicable regulations.

07 Section 481(a) of the Code provides that if a taxpayer's taxable income for any tax year is computed under a method of accounting different from the method used for the preceding tax year, then there shall be taken into account those adjustments which are determined to be necessary solely by the reason of the change in order to prevent amounts from being duplicated or omitted. Section 481(c) provides that in the case of any change described in subsection (a), the taxpayer may, in such manner and subject to such conditions as the Secretary may by regulations prescribe, take the adjustments required by subsection (a)(2) into account in computing the tax for the tax year or years permitted under such regulations.

SEC. 3. APPLICATION

01 CONSENT. In accordance with section 1.446-1(e)(3)(ii) of the regulations, the 180-day rule is waived, and under section 1.446- (e)(2)(i) consent is hereby granted to taxpayers to change from the LIFO method of accounting for inventory to another permissible method. This consent is given only to those taxpayers who now choose to discontinue using the LIFO inventory method because of the enactment of section 472(g) of the Code. Such consent is granted for the first tax year beginning on or after July 18, 1984, and the change shall be made in accordance with the provisions of this revenue procedure, including the adjustment under section 481(a) described in section 3.04 below.

02 CHANGE IN ACCOUNTING METHOD. Such a change is a change in method of accounting within the meaning of sections 446 and 481 of the Code. Consent to discontinue the use of the LIFO inventory method and change to another acceptable method of inventory accounting will be granted automatically subject to the requirements of section 1.472-6 of the regulations and the provisions of this revenue procedure.

03 YEAR OF CHANGE. Pursuant to the consent granted in section 3.01 above, the taxpayers to whom this revenue procedure applies and who choose to change from the LIFO inventory method of accounting for inventory must make the change on their federal income tax return for their first tax year beginning on or after July 18, 1984.

04 SECTION 481(a) ADJUSTMENT. An adjustment is required to prevent amounts of income and deductions from being duplicated or omitted within the meaning of section 481 of the Code and the regulations thereunder when, pursuant to the provisions set forth in this revenue procedure, the change in method of accounting is made. That adjustment, whether positive or negative, is referred to as the "section 481(a) adjustment." It shall be taken into account in computing taxable income and in computing corporate earnings and profits. As to taxable income, the adjustment is taken into account in the manner provided in sections 3.05 and 3.06 below. As to corporate earnings and profits, the adjustment is taken into account in the manner provided in Rev. Proc. 79-47, 1979-2 C.B. 528. The change in method of accounting shall be considered to be a change in method of accounting initiated by the taxpayer.

05 SECTION 481(a) ADJUSTMENT PERIOD.

(1) The appropriate period for taking into account the section 481(a) adjustment, whether positive or negative, referred to in section 3.04 is to be determined as follows:

(a) When the entire net amount of the section 481(a) adjustment is attributable to the tax year immediately preceding the year of change (first preceding year), the total net adjustment is to be taken into account in computing taxable income for the year of change. The amount attributable to the tax year immediately preceding the year of change is the difference in the amount of the adjustment determined under section 481(a) of the Code for the year of change and the amount that would have been required under section 481(a) if the same change to an acceptable method had been made in the preceding year.

(b) When subparagraph (a) above does not apply, the taxpayer has continuously used the LIFO inventory method for four tax years or more, and 75 percent or more of the net amount of the section 481(a) adjustment is attributable to the 1-tax-year period immediately preceding the year of change, the highest percent attributable to the 1-,2-, or 3-tax-year period will be taken into account ratably over a 3-tax-year period beginning with the year of change. Any remaining balance will be taken into account in the fourth year. An amount attributable to the 1-, 2-, or 3-tax-year period is the difference in the amount of the adjustment determined under section 481(a) of the Code for the year of change and the amount that would have been required under section 481(a) if the same change to an acceptable method had been made at the beginning of the preceding 1-, 2-, or 3- tax-year period.

(c) In all situations in which subparagraphs (a) and (b) do not apply, the net section 481(a) adjustment is to be taken into account ratably over the number of years (not to exceed four) the taxpayer has continuously used the LIFO inventory method.

(2) In applying section 3.05(1), if a taxpayer's books and records do not contain sufficient information to compute the section 481(a) adjustment attributable to the 1-, 2-, 3-tax-year period immediately preceding the year of change, the taxpayer may reasonably estimate these amounts. The taxpayer must submit the computations upon which the estimates are based with the Form 3115, and sign and attach to the Form 3115 the following statement:

Under penalty of perjury, I hereby certify that:

(a) The books and records of (name of the taxpayer) do not contain sufficient information to permit a computation of the section 481(a) adjustment attributable to the 1-tax-year period, 2-tax-year period, or 3-tax-year period immediately preceding the year of change as required by paragraph 3.05(1) of Rev. Proc. 85-54.

(b) Based on the information that is contained in such records, to the best of my information and belief, the entire amount of the section 481(a) adjustment for the year of change (indicate "is" or "is not," as the case may be) attributable to the tax year immediately preceding the year of change, and 75 percent or more of the section 481(a) adjustment for the year of change (indicate "is" or "is not," as the case may be) attributable to the 1-tax-year period, 2-tax-year period, or 3-tax-year period immediately preceding the year of change.

(3) If, on the last day of the two tax years of the adjustment period, the value of the taxpayer's inventory to which the section 481(a) adjustment relates is reduced by more than 33 1/3 percent of the inventory value at the beginning of the first tax year of the adjustment period and is so reduced by at least such percentage at the end of the following tax year (temporary fluctuations are not controlling; permanent reductions are controlling), the remaining balance of the section 481(a) adjustment must be taken into account in determining taxable income in the year succeeding the year of the reduction. If the value of the inventory does not remain reduced for one year, the reduction is not considered permanent and the provisions of this paragraph do not apply.

06 CEASING TO ENGAGE IN THE TRADE OR BUSINESS. If, at any time prior to the expiration of the adjustment period (as defined in sections 3.05 and 3.06 above), a taxpayer ceases to engage in the trade or business to which the section 481(a) adjustment (as defined in section 3.04 above) relates, the taxpayer shall take into account in the year of such cessation the balance of the adjustment that was not previously taken into account in computing taxable income. See Rev. Rul. 80-39, 1980-1 C.B. 112, which holds that, if a division of a corporation for which a change in method of accounting had been granted ceases to operate the trade or business for which the change in method was granted, the remaining section 481(a) adjustment applicable to the business conducted by that division of the corporation must be taken into account in the year the corporation ceases to engage in that trade or business. For purposes of this condition, the taxpayer is not considered to have ceased the trade or business if the cessation is the result of a transaction to which section 381 of the Code applies. In that case, however, the acquiring corporation shall continue to be subject to this revenue procedure as though it were the acquired corporation.

SEC. 4. RECORDS

01 Taxpayers must maintain adequate records so that the Internal Revenue Service may, upon examination, verify the data concerning the change in method of accounting.

02 Taxpayers must keep their books and records for the year of change and for later tax years on the acceptable method that they have chosen and must use this method for all shareholder reports, financial statements, and statements for credit purposes.

SEC. 5. COMPLIANCE WITH CONDITIONS

Taxpayers making a change from the LIFO inventory method to an acceptable method without complying with all the conditions of this revenue procedure will be deemed to have made the change without obtaining the consent of the Commissioner.

SEC. 6. MANNER OF EFFECTING CHANGE

01 Taxpayer to which this revenue procedure applies must effect the change in their methods of accounting for their first tax year beginning on or after July 18, 1984. The change is effected pursuant to the provisions set forth in this revenue procedure by filing a current Form 3115, in duplicate. The original of the Form 3115 shall be attached to the taxpayer's timely filed federal income tax return for such year (determined with regard to extensions) or to an amended return for such year filed no later than the extended time period prescribed in section 6081 of the Code and the regulations thereunder. Solely for this purpose, a federal income tax return which is filed late, but within the time period described in section 6081 of the Code and the regulations thereunder, shall be treated as timely, regardless of the fact that the taxpayer has not been granted an extension of time for filing its income tax return. At the time the original of the Form 3115 is filed with the federal income tax return, a copy of the Form 3115 shall be filed with the National Office, addressed to the Commissioner of Internal Revenue Attention: CC:C:C:1, 1111 Constitution Avenue, N.W., Washington, D.C. 20224. In addition to the information required on Form 3115, the taxpayer must provide (1) a computation of the section 481(a) adjustment and (2) the period over which the section 481(a) adjustment will be taken into account and the basis for such conclusion. This additional information must accompany both the original Form 3115 and the required copy of Form 3115. The National office will sample the Forms 3115 to determine whether the requirements of this revenue procedure have been followed.

02 In order to assist in the processing of these changes in method of accounting and to ensure proper handling, reference to this revenue procedure shall be made a part of the Form 3115 by either typing or legibly printing the following statement at the top of page 1 of Form 3115: "FILED UNDER REV. PROC. 85-54."

03 Taxpayers who apply the provisions of this revenue procedure to change their methods of accounting must attach and sign (or have signed by an officer who has personal knowledge of the facts) the following statement to the Form 3115:

Under penalty of perjury, I hereby certify that:

(name of taxpayer) is discontinuing the use of LIFO because of the provisions of section 472(g) of the Code.

04 Taxpayers requesting to discontinue LIFO for reasons other than section 472(g) of the Code must timely file a Form 3115 with the National Office pursuant to section 1.446-1(e)(3)(i) of the regulations. See Rev. Proc. 84-74, 1984-2 C.B. 736. Such taxpayers must also attach a statement to their Form 3115 that under penalties of perjury they did not issue nonconforming financial statements as a result of the operation of section 472(g) of the Code.

SEC. 7. MISCELLANEOUS

01 Where a taxpayer's change in method of accounting falls within the scope set forth in section 1 of this revenue procedure, the taxpayer must use this revenue procedure to effectuate such change in method of accounting and may not use the provisions of Rev. Proc. 84-74. Thus, the original of the application for permission to change the method of accounting described in this revenue procedure, if filed with the National Office under the general provisions of Rev. Proc. 84-74, will not be considered a valid application. Any such original applications filed by taxpayers with the National Office prior to or after November 18, 1985 (the date of publication of this revenue procedure) will not be processed and these taxpayers will be notified by the National Office to comply with this revenue procedure.

02 The taxpayer may not elect the LIFO inventory method of accounting for a period of at least 10 tax years beginning with the year of change, unless consent is granted by the Commissioner to change its method of accounting at an earlier time based on a showing of extraordinary circumstances.

03 The taxpayer shall value its inventory at the beginning and the end of the year of change and for later tax years under the method granted herein unless it obtains permission to change to another recognized method, including the LIFO inventory method (see section 1.446-1 of the regulations and section 7.02 above).

04 For purposes of section 312 of the Code, the computation of earnings and profits available for the payment of dividends shall follow the new method of accounting and the taxpayer shall take the section 481(a) adjustment into account over the same period as it does for purposes of computing taxable income.

SEC. 8. CHANGE FROM LIFO INVENTORY METHOD NOT MADE UNDER THIS REVENUE PROCEDURE

Taxpayers who use the LIFO inventory method and issued nonconforming financial statements in violation of section 472(g) of the Code for tax years subsequent to their first tax year beginning on or after July 18, 1984, must request permission to change from the LIFO inventory method by filing an application (Form 3115) with the Commissioner in accordance with the requirements of section 1.446- 1(e)(3) of the regulations and Rev. Proc. 84-74. Such taxpayers will receive an adjustment period not to exceed two tax years.

SEC. 9. INQUIRIES

Inquiries regarding this revenue procedure may be addressed to the Commissioner of Internal Revenue, Attention CC:C:C:1, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.

SEC. 10. EFFECTIVE DATE

This revenue procedure is effective November 18, 1985, the date of its publication in the Internal Revenue Bulletin.