Final Regs on AMTI ACE Adjustment

 [4830-01]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations relating to the alternative minimum tax (AMT) for corporations. The Tax Reform Act of 1986, the Technical and Miscellaneous Revenue Act of 1988, the Revenue Reconciliation Act of 1989 and the Revenue Reconciliation Act of 1990 all made changes to the applicable law. These regulations affect corporate taxpayers and provide them with guidance necessary to determine their alternative minimum tax.

 DATES: These regulations are effective for taxable years beginning after December 31, 1989. However, the paragraphs relating to the LIFO recapture adjustment, section 1.56(g)-1(f)(3), are effective for taxable years beginning after December 18, 1992 a taxpayer may choose to apply that paragraph for all taxable years beginning after December 31, 1989.

 FOR FURTHER INFORMATION CONTACT: Nicholas G. Bogos of the Office of the Assistant Chief Counsel (Income Tax and Accounting) (202) 622-4960 (not a toll-free call).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

 The collection of information requirement contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)) under control number 1545-1233. The estimated annual burden per respondent varies from one-half hour to one and one-half hours, depending on individual circumstances, with an estimated average of one hour. These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based upon such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer TR:P, Washington, D.C. 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503.

BACKGROUND

 This document contains final regulations amending the Income Tax Regulations (26 CFR part 1) under section 56 of the Internal Revenue Code of 1986 (Code). The amendments will conform the regulations to section 701 of the Tax Reform Act of 1986 (Pub. L. 99-514; 100 Stat. 2320), sections 1007 and 6079 of the Technical and Miscellaneous Revenue Act of 1988 (Pub. L. 100-647, 102 Stat. 3342), sections 7205 and 7611 of the Revenue Reconciliation Act of 1989 (Pub. L. 101-239, 103 Stat. 2106), and sections 11301 and 11531 of the Revenue Reconciliation Act of 1990 (Pub. L. 101-508).

 On March 15, 1991, the Internal Revenue Service published in the Federal Register a Notice of Proposed Rulemaking (56 FR 11122) regarding the computation of adjusted current earnings (ACE). The Service received four written comments. No public hearing was requested and none was held. The amendments to the regulations contained in this document are adopted after consideration of the written comments.

COMMENTS ON PROPOSED REGULATIONS.

A. LIFO RECAPTURE ADJUSTMENT: SECTION 1.56(g)-1(f)(3).

 Section 56(g)(4)(D)(iii) of the Code requires taxpayers to compute adjusted current earnings (ACE) with the adjustments in section 312(n)(4). Section 312(n)(4) requires taxpayers to increase or decrease their earnings and profits by the increase or decrease in their LIFO (last-in, first-out) reserve during the taxable year.

 The proposed regulations provide that ACE is increased or decreased by the increase or decrease in the LIFO recapture amount as of the close of the taxable year. The proposed regulations also provide that ACE is not decreased to the extent of any decrease in the LIFO recapture amount below the baseline LIFO recapture amount. Further, increases in the LIFO recapture amount will increase ACE only to the extent of any increase above the baseline LIFO recapture amount. The baseline LIFO recapture amount is defined in the proposed regulations as the excess, if any, of the taxpayer's beginning FIFO inventory amount for the first taxable year beginning after December 31, 1989, over the taxpayer's beginning LIFO inventory amount for the first taxable year beginning after December 31, 1989.

 Commentators asked whether a taxpayer with more than one category of LIFO inventory computes a single LIFO recapture amount or a separate LIFO recapture amount for each grouping or pool of LIFO inventory. If each grouping or pool had its own LIFO recapture amount, the proposed regulations' baseline LIFO recapture limitation could result in a positive ACE adjustment for a taxpayer that experienced a $100 increase in one pool's LIFO recapture amount in the same year that another pool's LIFO recapture amount decreased by $200. The final regulations clarify that a taxpayer (i.e., a corporation) computes a single LIFO recapture amount for all of its assets that are accounted for under LIFO.

 Commentators also suggested that: (1) a partner in a partnership that uses LIFO should be permitted to include its share of any change in the partnership's LIFO recapture amount in its LIFO recapture adjustment, and (2) corporations that file a consolidated return should be permitted to compute a single LIFO recapture adjustment for the consolidated group. Implementing these suggestions without eliminating the proposed regulations' baseline LIFO recapture limitation, however, would be unduly complex.

 Therefore, for purposes of computing ACE, the final regulations do not limit the LIFO recapture adjustment by the baseline LIFO recapture amount. Thus, the full amount of any increase or decrease in the LIFO recapture amount will increase or decrease the taxpayer's ACE for the taxable year regardless of whether the increase or decrease is below the taxpayer's beginning LIFO recapture amount for the first taxable year beginning after December 31, 1989. This change significantly simplifies the computation of the ACE LIFO recapture adjustment.

 The removal of the baseline LIFO recapture limitation also allows a consolidated group to net all changes in its members' LIFO recapture amounts in determining the group's ACE LIFO recapture adjustment. Thus, increases or decreases in a member's LIFO recapture amount below that member's beginning LIFO recapture amount for the first taxable year beginning after December 31, 1989, are taken into account in determining the group's LIFO recapture adjustment. This treatment furthers the single entity view of the consolidated group by treating the group the same as a single corporation with several divisions or multiple groupings or pools of LIFO inventory. Similarly, a corporate partner takes into account its proportionate share of the partnership's LIFO inventory assets for the partnership taxable year that ends within or with the corporation's taxable year.

 Some commentators requested that the final regulations provide guidance on the ACE LIFO recapture implications of a transfer of LIFO inventory in an exchange qualifying under section 351 or section 721. For example, they expressed concern that in the absence of further regulatory guidance, a new company formed in a section 351 transaction would potentially experience a large and unwarranted ACE LIFO recapture adjustment due solely to the interaction of that adjustment with the rules governing exchanges under section 351. In response to these comments, the final regulations provide a special adjustment, only for purposes of computing ACE, to the LIFO recapture adjustments of both the transferor and the transferee in the case of an exchange under section 351 or 721.

 These changes to paragraph (f)(3) of section 1.56(g)-1 from the proposed regulations are effective for taxable years beginning after December 18, 1992. However, a taxpayer may choose to apply the final regulations for all taxable years beginning after December 31, 1989.

 One commentator was concerned about the interaction of transfers of LIFO inventory subject to the deferred intercompany transaction rules of section 1.1502-13 with the ACE LIFO adjustment. Issues relating to these transfers arise only in the context of consolidated groups and are not addressed in these final regulations. The Service expects to address the treatment of deferred intercompany transactions in forthcoming proposed regulations on the AMT and consolidated groups.

B. ELECTION TO USE REGULAR TAX INVENTORIES FOR ALTERNATIVE MINIMUM TAX: SECTION 1.56(g)-1(r).

 Section 1.56(g)-1(r) of the proposed regulations provides that taxpayers may elect to use their regular tax inventory amounts to compute pre-adjustment alternative minimum taxable income ("AMTI") and ACE, including the ACE LIFO adjustment of section 1.56(g)- 1(f)(3). The election eliminates the need to compute separate inventory amounts for pre-adjustment AMTI and ACE. Taxpayers making the election, however, determine each adjustment under sections 56 and 58 and each tax preference item under section 57 without reduction for that portion of the adjustment or preference that would have been capitalized in inventory but for the election.

 Some commentators questioned whether only LIFO taxpayers could make the election under section 1.56(g)-1(r). The final regulations make it clear that the election is available to and taxpayer that properly follows the procedures required to make the election.

 Some commentators were unsure about which taxpayers could make a prospective election, and which could make only a retroactive election. The final regulations clarify that taxpayers that have computed their AMT and ACE inventories for all prior taxable years using the elective method may make a prospective election. Additionally, taxpayers that have not used the elective method to compute their AMT and ACE inventories, if any, in prior taxable years may make a prospective election if their tax liability in all open prior taxable years would not have changed had the elective method been used in all prior taxable years. The regulations require all other taxpayers who wish to make the election to make a retroactive election.

 One commentator suggested that the Service allow taxpayers to elect to use pre-adjustment AMTI inventories for ACE (while using regular tax inventories only for regular tax). The commentator argued that taxpayers that have already set up accounting systems to compute their pre-adjustment AMTI inventories should not be required to use their regular tax inventories for AMT purposes in order to avoid having to compute ACE inventories. The final regulations thus provide an election to use pre-adjustment AMTI inventories for ACE, using rules similar to those for electing to use regular tax inventories for pre-adjustment AMTI and ACE. Taxpayers who make this election will continue to use regular tax inventories for regular tax purposes only.

 Finally, one commentator thought that taxpayers subject to the Coordinated Examination Program, (CEP) should be allowed to make retroactive elections without amending their prior year returns for open years. While the Service appreciates the unique scope of CEP examinations, the Service feels that all taxpayers under examination should be able to make the simplified inventory election in the same manner. The final regulations therefore include procedures for taxpayers to follow if their return for any year for which they want to make the simplified inventory election is under examination and they otherwise would be required to file amended returns to make the election. In all cases, however, it is the taxpayer's responsibility to make a timely election, either by filing an amended return or by proposing an examination adjustment.

C. ADJUSTMENT FOR ALTERNATIVE TAX ENERGY PREFERENCE DEDUCTION: SECTION 1.56(g)-1(s).

 Section 1.56(g)-1(s) of the proposed regulations provides taxpayers with guidance on adjustments they must make for ACE if the taxpayer claims a deduction under section 56(h) (the alternative tax energy preference deduction). The proposed regulations require taxpayers to adjust basis by the portion of the deduction allowed under section 56(h) that is attributable to adjustments under section 56(g)(4). The purpose of the basis adjustment is to ensure that no double benefit is allowed by reason of the section 56(h) deduction. Commentators expressed concern that any precise method of adjusting basis would be complex and difficult to administer.

 On October 24, 1992, the President signed H.R. 776 (Pub. L. 102-486), which repealed section 56(h) effective for taxable years beginning after December 31, 1992. Thus, the deduction under section 56(h) is allowed only for taxable years beginning after December 31, 1990, and before January 1, 1993. Because of the short time period for which section 56(h) is effective, section 1.56(g)-1(s) of the proposed regulations is being finalized without change.

D. OTHER MATTERS

A clarification has been made to section 1.56(g)-1(d)(2)(ii)(B) of the regulations to conform the example at the end of the text to the rule provided in the regulation.

SPECIAL ANALYSES

It has been determined that these regulations are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

The principal author of these regulations is Nicholas G. Bogos of the Office of Assistant Chief Counsel (Income Tax and Accounting), Internal Revenue Service. Other personnel from the Service and the Treasury, however, assisted in developing these regulations, on matters of both substance and style.

LIST OF SUBJECTS

26 CFR 1.56-0 through 1.58-9

Income taxes, reporting and recordkeeping requirements

26 CFR part 602

Reporting and Recordkeeping requirements

Treasury Decision 8454

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1 -- INCOME TAXES; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority citation for part 1 continues to read in part:

Authority: 26 U.S.C. 7805 * * * Section 1.56(g)-1 also issued under section 7611(g)(3) of the Omnibus Budget Reconciliation Act of 1989 (Pub. L. 101-239, 103 Stat. 2373) * * *

Par. 2. In section 1.56(g)-0, the entry for section 1.56(g)-1 is amended as follows:

1. Paragraphs (a)(7), (r) and (s) are added;

2. Paragraphs (f)(3) and (m) are revised;

3. The additions and revisions read as follows:

 SECTION 1.56(g)-0 TABLE OF CONTENTS.

1. The text of paragraph (a)(6)(i) is revised.

2. Paragraph (a)(7) is added.

3. The text of paragraph (d)(2)(ii)(B) is revised.

4. The text of paragraphs (f)(3) and (m) are added.

5. Paragraphs (r) and (s) are added.

6. The additions and revisions read as follows:

SECTION 1.56(g)-1 ADJUSTED CURRENT EARNINGS.

(a) * * *

(6) * * *

(i) * * * Pre-adjustment alternative minimum taxable income is the alternative minimum taxable income of the taxpayer for the taxable year, determined under section 55(b)(2), but without the adjustment for adjusted current earnings under section 56(g) and this section, without the alternative tax net operating loss deduction under section 56(a)(4), and without the alternative tax energy preference deduction under section 56(h).

* * * * *

(7) APPLICATION TO FOREIGN CORPORATIONS. See paragraph (m) of this section for rules relating to the application of this section to foreign corporations.

* * * * *

(d) * * *

(2) * * *

(ii) * * *

(B) * * * For example, assume that a section 936 corporation earns $100 of income in its current taxable year, $10 of which is not eligible for the credit under section 936. If the section 936 corporation makes a distribution of $50 during that year, $5 of that distribution ($10 of income not eligible for the section 936 credit divided by $100 of income, times $50 distributed) is deemed to be attributable to earnings of the paying corporation that are subject to federal income tax.

* * * * *

(f) * * *

(3) LIFO RECAPTURE ADJUSTMENT -- (i) IN GENERAL. Adjusted current earnings are generally increased or decreased by the increase or decrease in the taxpayer's LIFO recapture amount (as defined in paragraph (f)(3)(iii)(A) of this section) as of the close of each taxable year.

(ii) BEGINNING LIFO AND FIFO INVENTORY. For purposes of computing the increase or decrease in the LIFO recapture amount, the beginning LIFO and FIFO inventory amounts for the first taxable year beginning after December 31, 1989, are --

(A) The ending LIFO inventory amount used in computing pre- adjustment alternative minimum taxable income for the last year beginning before January 1, 1990; and

(B) The ending FIFO inventory amount for the last year beginning before January 1, 1990, computed with the adjustments described in section 56 (other than the adjustment described in section 56(g)) and section 58, the items of tax preference described in section 57 and using the methods used in computing pre-adjustment alternative minimum taxable income.

(iii) DEFINITIONS -- (A) LIFO RECAPTURE AMOUNT -- (1) DEFINITION. The taxpayer's LIFO recapture amount is the excess, if any, of --

(i) the inventory amount of its assets under the FIFO method, computed using the rules of this section; over

(ii) the inventory amount of its assets under the LIFO method, computed using the rules of this section.

(2) ASSETS INCLUDED. Only the assets for which the taxpayer uses the LIFO method to compute pre-adjustment alternative minimum taxable income are taken into account in determining the LIFO recapture amount.

(B) FIFO METHOD. For purposes of this paragraph, the FIFO method is the first in, first out method described in section 471, determined by using --

(1) The retail method if that is the method the taxpayer uses in computing pre-adjustment alternative minimum taxable income; or

(2) The lower of cost or market method for all other taxpayers.

(C) LIFO METHOD. The LIFO method is the last in, first out method authorized by section 472.

(D) INVENTORY AMOUNTS. Except as otherwise provided, inventory amounts are computed using the methods used in computing pre- adjustment alternative minimum taxable income. To the extent inventory is treated as produced or acquired during taxable years beginning after December 31, 1989, the inventory amount is determined with the adjustments described in sections 56 and 58 and the items of tax preference described in section 57. Thus, for example, the amount of depreciation to be capitalized under section 263A with respect to inventory produced in taxable years beginning after December 31, 1989, is based on the depreciation allowed under the rules of paragraph (b) of this section. See paragraph (a)(5) of this section.

(iv) EXCHANGES UNDER SECTIONS 351 AND 721. For purposes of this section, any decrease in a transferor's LIFO recapture amount that occurs as a result of a transfer of inventories in an exchange to which section 351 or section 721 applies cannot be used to decrease the adjusted current earnings of the transferor. A decrease that is disallowed under the preceding sentence is instead carried over to reduce any LIFO recapture adjustment that the transferee (or its corporate partners, if section 721 applies) would otherwise make (in the absence of this paragraph (f)(3)(iv)) solely by reason of its carryover basis in inventories received in the section 351 or section 721 exchange. Nothing in this paragraph (f)(3)(iv), however, alters the computation of the LIFO recapture amount of the transferor or transferee as of the close of any taxable year.

(v) EXAMPLES. The following examples illustrate the provisions of this paragraph (f)(3).

EXAMPLE 1. M Corporation, a calendar-year taxpayer, uses the LIFO method of accounting for its inventory for purposes of computing pre-adjustment alternative minimum taxable income. M's ending LIFO inventory for all of its pools for purposes of computing pre-adjustment alternative minimum taxable income on December 31, 1989, is $300. M computes a $500 FIFO inventory amount on that date, after applying the provisions of section 263A along with the adjustments and preferences required in computing pre-adjustment alternative minimum taxable income. M's FIFO and LIFO ending inventory amounts at the close of its taxable years, its LIFO reserves, and its adjustment under this paragraph (f)(3), are as follows:

                            1989      1990      1991      1992

/1/ Beginning FIFO inventory amount under paragraph (f)(3)(ii).

/2/ Beginning LIFO inventory amount under paragraph (f)(3)(ii).

END OF FOOTNOTES

EXAMPLE 2. (A) X Corporation, a calendar-year taxpayer, uses the LIFO method for purposes of computing pre-adjustment alternative minimum taxable income. X's LIFO recapture amount is $300 as of December 31, 1992, and is $200 as of December 31, 1993. Immediately prior to calculating its LIFO recapture amount as of December 31, 1993, X transfers inventory with an adjusted current earnings (ACE) basis of $500 to Y Corporation in an exchange to which section 351 applies. X determines that the $100 decrease in its LIFO recapture amount occurred as a result of its transfer of inventories to Y in the section 351 exchange. Thus, under paragraph (f)(3)(iv) of this section, X cannot decrease its adjusted current earnings by that amount. In computing its 1994 LIFO recapture adjustment, X will use $200 as its LIFO recapture amount as of December 31, 1993, even though it was not entitled to reduce adjusted current earnings by the $100 decrease in its LIFO recapture amount in 1993.

(B) For purposes of computing its ACE, Y takes a $500 carryover basis in the inventories received from X. If Y, a newly-formed calendar-year taxpayer, engages in no other inventory transactions in 1993 and adopts the LIFO inventory method on its 1993 tax return, it will have a LIFO recapture amount of $0 as of December 31, 1993 (because its FIFO inventory amount and its LIFO inventory amount are both $500). Assume that at December 31, 1994, Y has a LIFO recapture amount of $200 ($1,000 FIFO inventory amount -- $800 LIFO inventory amount). Under paragraph (f)(3)(i) of this section, Y computes a LIFO recapture adjustment for 1994 of $200 ($200 -- $0). If any portion of Y's $200 LIFO recapture adjustment occurs solely by reason of its carryover basis in the inventories it received from X, Y reduces its $200 LIFO recapture adjustment by that portion under paragraph (f)(3)(iv). In any event, however, Y will use its $200 LIFO recapture amount as of December 31, 1994, in computing its 1995 LIFO recapture adjustment.

(vi) EFFECTIVE DATE. Paragraph (f)(3) is effective for taxable years beginning after December 18, 1992. A taxpayer may choose to apply this paragraph, however, to all taxable years beginning after December 31, 1989.

* * * * *

(m) ADJUSTED CURRENT EARNINGS OF A FOREIGN CORPORATION -- (1) IN GENERAL. The alternative minimum taxable income of a foreign corporation is increased by 75 percent of the excess of --

(i) Its effectively connected adjusted current earnings for the taxable year; over

(ii) Its effectively connected pre-adjustment alternative minimum taxable income for the taxable year.

(2) DEFINITIONS -- (i) EFFECTIVELY CONNECTED PRE-ADJUSTMENT ALTERNATIVE MINIMUM TAXABLE INCOME. Effectively connected pre- adjustment alternative minimum taxable income is the effectively connected taxable income of the foreign corporation for the taxable year, determined with the adjustments under sections 56 and 58 (except for the adjustment for adjusted current earnings, the alternative tax net operating loss and the alternative tax energy preference deduction) and increased by the tax preference items of section 57, but taking into account only items of income of the foreign corporation that are effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States, and any expense, loss or deduction that is properly allocated and apportioned to that income.

(ii) EFFECTIVELY CONNECTED ADJUSTED CURRENT EARNINGS. Effectively connected adjusted current earnings is the effectively connected pre-adjustment alternative minimum taxable income of the foreign corporation for the taxable year, adjusted under section 56 (g) and this section, but taking into account only items of income of the foreign corporation that are effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States, and any expense, loss or deduction that is properly allocated and apportioned to that income.

(3) RULES TO DETERMINE EFFECTIVELY CONNECTED PRE-ADJUSTMENT ALTERNATIVE MINIMUM TAXABLE INCOME AND EFFECTIVELY CONNECTED ADJUSTED CURRENT EARNINGS. The principles of section 864(c) (and the regulations thereunder) and any other applicable provision of the Internal Revenue Code apply to determine whether items of income of the foreign corporation are effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States, and whether any expense, loss or deduction is properly allocated and apportioned to that income.

(4) CERTAIN EXEMPT AMOUNTS. Effectively connected adjusted current earnings and effectively connected pre-adjustment alternative minimum taxable income do not include any item of income, or any expense, loss or deduction that is properly allocated and apportioned to income that is exempt from United States taxation under section 883 or an applicable income tax treaty. See section 894.

* * * *

(r) ELECTIONS TO USE SIMPLIFIED INVENTORY METHODS TO COMPUTE ALTERNATIVE MINIMUM TAX -- (1) IN GENERAL. If a taxpayer makes an election under this paragraph (r)(and does not make the election in paragraph (r)(5) of this section), the rules of paragraph (r)(2) of this section apply in computing the taxpayer's pre-adjustment alternative minimum taxable income and adjusted current earnings.

(2) EFFECT OF ELECTION -- (i) INVENTORIES. The taxpayer's inventory amounts as determined for purposes of computing taxable income are used for purposes of computing pre-adjustment alternative minimum taxable income and adjusted current earnings. Subject to the further modification described in paragraph (r)(2)(ii) of this section, the taxpayer's cost of sales as determined for purposes of computing taxable income is also used for purposes of computing pre- adjustment alternative minimum taxable income and adjusted current earnings.

(ii) MODIFICATIONS REQUIRED -- (A) IN GENERAL. If a taxpayer makes an election under this paragraph (r), preadjustment alternative minimum taxable income and adjusted current earnings are computed with the modifications described in this paragraph. The items of adjustment under sections 56 and 58 and the items of tax preference under section 57 are computed without regard to the portion of those adjustments and preferences which, but for the election described in this paragraph, would have been capitalized in ending inventory. For example, pre-adjustment alternative minimum taxable income is increased by the excess of the depreciation allowable for the taxable year under section 168 for purposes of computing taxable income (determined without regard to section 263A) over the depreciation allowable for the taxable year under section 56(a)(1) and section 57 for purposes of computing pre-adjustment alternative minimum taxable income (determined without regard to section 263A). Similarly, adjusted current earnings is further increased by the excess of the depreciation allowable for the taxable year under section 56(a)(1) and section 57 for purposes of computing pre-adjustment alternative minimum taxable income (determined without regard to section 263A) over the depreciation allowable for the taxable year under section 56(g)(4)(A) for purposes of computing adjusted current earnings (determined without regard to section 263A). Thus, the modifications described in the preceding sentence do not duplicate amounts that are taken into account in computing pre-adjustment alternative minimum taxable income. See paragraph (a)(6)(ii) of this section.

(B) NEGATIVE MODIFICATIONS ALLOWED. An election under this paragraph (r) does not affect the taxpayer's ability to make negative adjustments. Thus, if an election is made under this paragraph (r) and the amount of any adjustment under section 56 or 58, determined after modification under paragraph (r)(2)(ii)(A) of this section, is a negative amount, then this amount reduces pre-adjustment alternative minimum taxable income or adjusted current earnings. However, no negative adjustment under this paragraph (r)(2)(ii)(B) is allowed for the items of tax preference under section 57.

(iii) LIFO RECAPTURE ADJUSTMENT. If a taxpayer makes an election under this paragraph (r) and uses the LIFO method for some assets, for purposes of computing the LIFO recapture adjustment under paragraph (f)(3) of this section for taxable years beginning after December 31, 1989 --

(A) The LIFO inventory amount as determined for purposes of computing taxable income is used in lieu of the LIFO inventory amount as determined under paragraph (f)(3)(iii) of this section;

(B) The FIFO inventory amount is computed without regard to the adjustments under sections 56 (including the adjustments of section 56(g)(4)) and 58 and the items of tax preference of section 57; and

(C) The beginning LIFO and FIFO inventory amounts under paragraph (f)(3)(ii) of this section are the ending LIFO inventory amount as determined for purposes of computing taxable income and the ending FIFO inventory amount computed without regard to the adjustments under sections 56 (including the adjustments of section 56(g)(4)) and 58 and the items of tax preference of section 57 for the last taxable year beginning before January l, 1990.

(3) TIME AND MANNER OF MAKING ELECTION -- (i) PROSPECTIVE ELECTION. (A) A prospective election under this paragraph (r) may be made by any taxpayer --

(1) That has computed pre-adjustment alternative minimum taxable income and adjusted current earnings for all prior taxable years in accordance with the method described in this paragraph (r); or

(2) That has not computed pre-adjustment alternative minimum taxable income and adjusted current earnings for all prior tax years in accordance with the method described in this paragraph (r), but for which the use of the method described in this paragraph (r) for all prior taxable years would not have changed the taxpayer's tax liability (as shown on returns filed as of the date the election is made) for any prior taxable year for which the period of limitations under section 6501(a) has not expired (as of the date the election is made).

(B) A prospective election under this paragraph (r) may only be made by attaching a statement to the taxpayer's timely filed (including extensions) original Federal income tax return for any taxable year that is no later than its first taxable year to which this paragraph (r) applies and in which the taxpayer's tentative minimum tax (computed under the provisions of this paragraph (r)) exceeds its regular tax. However, in the case of a taxpayer described in paragraph (r)(3)(i)(A)(1) of this section that had tentative minimum tax in excess of its regular tax for any prior taxable year, the election may only be made by attaching a statement to its timely filed (including extensions) original Federal income tax return for the first taxable year ending after December 18, 1992. The statement must --

(1) Give the name, address and employer identification number of the taxpayer; and

(2) Identify the election as made under this paragraph (r).

(C) The determination of whether a taxpayer is described in paragraph (r)(3)(i)(A)(2) of this section is to be made as of the time the taxpayer makes a prospective election in accordance with the procedures in paragraph (r)(3)(i)(B) of this section.

(D) Any taxpayer described in paragraph (r)(3)(i)(A)(2) of this section that makes a prospective election will be deemed to have used the method described in this paragraph (r) in computing pre- adjustment alternative minimum taxable income and adjusted current earnings for all prior taxable years.

(ii) RETROACTIVE ELECTION -- (A) A retroactive election under this paragraph (r) may be made by any taxpayer not described in paragraph (r)(3)(i)(A)(1) or (2) of this section. Except as provided in paragraph (r)(3)(iii) of this section, a retroactive election may only be made by attaching a statement to the taxpayer's amended Federal income tax return for the earliest taxable year for which the period of limitations under section 6501(a) has not expired and which begins after December 31, 1986. The amended return to which the election under this paragraph (r)(3)(ii) is attached must be filed no later than June 19, 1993.

(B) The amended return must contain the statement described in paragraph (r)(3)(i)(B) of this section. In addition, the statement must contain a representation that the taxpayer will modify its pre- adjustment alternative minimum taxable income and adjusted current earnings for all open taxable years in accordance with paragraph (r)(2) of this section. Upon this change in method of accounting, the taxpayer must include the entire adjustment required under section 481(a), if any, in pre-adjustment alternative minimum taxable income and adjusted current earnings on the amended return for the year of the election. The taxpayer must also reflect the method of accounting described in paragraph (r)(2) of this section on amended returns filed for all taxable years after the year of the election for which returns were originally filed before making the election (and for which the period of limitations under section 6501(a) has not expired).

(C) Provided a taxpayer meets the requirements of this paragraph (r), any change in method of accounting arising as a result of making a retroactive election will be treated as made with the advance consent of the Commissioner.

(D) Any retroactive election under this paragraph (r) that is made without filing amended returns required under this paragraph (r)(3)(ii) shall constitute a change in method of accounting made without the consent of the Commissioner.

(iii) TAXPAYERS UNDER EXAMINATION -- (A) IN GENERAL. A taxpayer that wishes to make a retroactive election under section (r)(3)(ii) of this section may use the procedures in paragraph (r)(3)(iii)(A)(1) or (2) in lieu of filing an amended return for any taxable year that is under examination by the Internal Revenue Service.

(1) YEAR OF CHANGE UNDER EXAMINATION. If the year of the change is under examination at the time the taxpayer timely makes the election, the taxpayer may (in lieu of filing an amended return for the year of the change) furnish the written statement described in paragraph (r)(3)(iii)(B) of this section to the revenue agent responsible for examining the taxpayer's return no later than June 19, 1993. It is the taxpayer's responsibility to make a timely election either by furnishing the statement to the revenue agent or by filing amended returns by June 19, 1993.

(2) OTHER OPEN YEARS UNDER EXAMINATION. If any other year for which the taxpayer must modify its pre-adjustment alternative minimum taxable income and adjusted current earnings (see paragraph (r)(3)(ii)(B) of this section) is examined, the taxpayer may (in lieu of filing an amended return) furnish the amount of the conforming adjustment to the revenue agent responsible for examining the taxpayer's return. It is the taxpayer's responsibility to timely modify its pre-adjustment alternative minimum taxable income and adjusted current earnings for each year other than the year of change, either by furnishing the amount of the adjustment to the revenue agent or by filing amended returns.

(B) STATEMENT REQUIRED. The statement required under paragraph (r)(3)(iii)(A)(1) of this section must include all of the items required under paragraph (r)(3)(ii)(B) of this section, as well as --

(1) The caption "Election to use regular tax inventories for AMT purposes;"

(2) A description of the nature and amount of all items that would result in adjustments and that the taxpayer would have reported if the taxpayer had used the method described in this paragraph (r) for all prior taxable years for which the period of limitations under section 6501(a) has not expired and which begin after December 31, 1986; and

(3) The following declaration signed by the person authorized to sign the return for the taxpayer: "Under penalties of perjury, I declare that I have examined this written statement, and to the best of my knowledge and belief this written statement is true, correct, and complete."

(C) YEAR OF CHANGE. The year of change is the earliest taxable year for which the period of limitations under section 6501(a) has not expired at the time the statement is submitted to the appropriate revenue agent and that begins after December 31, 1986. Thus, the adjustments required to be included on the statement must include any adjustment under section 481(a) determined as if the method described in this paragraph (r) had been used in all taxable years prior to the year of change that begin after December 31, 1986.

(D) TREATMENT OF ADDITIONAL TAX LIABILITY. Any additional tax liability that results from the adjustments identified in the written statement described in paragraph (r)(3)(iii)(B) of this section is treated as an additional amount of tax shown on an amended return.

(iv) ELECTION AS METHOD OF ACCOUNTING. The elections provided in paragraphs (r)(3)(i) and (ii) of this section constitute either adoptions of, or changes in, methods of accounting. These elections, once made, may be revoked only with the consent of the Commissioner in accordance with the rules of section 446(e) and section 1.446-1(e).

(v) UNTIMELY ELECTION TO USE SIMPLIFIED INVENTORY METHOD. If a taxpayer makes an election described in this paragraph (r) after the times set forth in paragraph (r)(3)(i) or (ii) of this section, the taxpayer must comply with the requirements of section 1.446-1(e)(3) in order to secure the consent of the Commissioner to change to the method of accounting prescribed in this paragraph (r). The taxpayer generally will be subject to terms and conditions designed to place the taxpayer in a position no more favorable than a taxpayer that timely complied with paragraph (r)(3)(i) or (ii) of this section, whichever is applicable.

(4) EXAMPLE. The following example illustrates the provisions of this paragraph (r).

EXAMPLE. (i) Corporation L is a calendar year manufacturer of baseball bats and uses the LIFO method of accounting for inventories. During 1987, 1988, and 1989, L's cost of goods sold in computing taxable income was as follows:

                                 1987      1988      1989

                                          1987       1988       1989

(iv) L is eligible to make the election under paragraph (r)(1) of this section in accordance with paragraph (r)(3)(i) of this section (a prospective election).

(v) L must compute its LIFO recapture adjustment for each year by reference to --

(A) The FIFO inventory amount after applying the provisions of section 263A but before applying the adjustments of sections 56 and 58 and the items of preference in section 57; and

(B) The LIFO inventory amount-used in computing taxable income.

(5) ELECTION TO USE ALTERNATIVE MINIMUM TAX INVENTORIES TO COMPUTE ADJUSTED CURRENT EARNINGS. A taxpayer may elect under this paragraph (r)(5) to use the inventory amounts used to compute pre-adjustment alternative minimum taxable income in computing its adjusted current earnings. Rules similar to those of paragraphs (r)(2) and (r)(3) of this section apply for purposes of this election.

(s) ADJUSTMENT FOR ALTERNATIVE TAX ENERGY PREFERENCE DEDUCTION -- (1) IN GENERAL. For purposes of computing adjusted current earnings, any taxpayer claiming a deduction under section 56(h) must properly decrease basis by the portion of the deduction allowed under section 56(h) which is attributable to adjustments under section 56(g)(4). In taxable years following the taxable year in which the section 56(h) deduction is claimed, basis recovery (including amortization, depletion, and gain on sale) must properly take into account this basis reduction.

(2) EXAMPLE. The following example illustrates the provisions of this paragraph (s):

EXAMPLE. Corporation A, a calendar year taxpayer, incurs $100 of intangible drilling costs on January 1, 1994 and as a result of these intangible drilling costs A claims a deduction under section 56(h) of $40. Assume that $20 of A's deduction under section 56(h) is attributable to the adjustment under paragraph (f)(1) of this section. A must reduce by $20 the amount of intangible drilling costs to be amortized under paragraph (f)(1) of this section in 1995 through 1998 (the balance of the 60 month amortization period).

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT.

Par. 4. The authority citation for part 602 continues to read:

Authority: 26 U.S.C. 7805.

Par. 5. The table in section 602.101(c) is amended by adding the entry "1.56(g)-1 . . . 1545-1233".