Highly Compensated Employee

INCOME TAX

Rev. Rul. 97–32, page 4.LIFO; price indexes; department stores. The June1997 Bureau of Labor Statistics price indexes are accept-ed for use by department stores employing the retail inven-tory and last-in, first-out inventory methods for valuinginventories 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 theremedial amendment period. This procedure provides anextended remedial amendment period for certain qualifiedplans described in sections 401(a) and 403(a) of the Codeand describes the time for making amendments to certaintax-sheltered annuities described in section 403(b).

Notice 97–45, page 7.Highly compensated employee; definition. This noticesets forth the changes in determining who is a highly com-pensated employee within the meaning of section 414(q) ofthe Code as a result of section 1431 of the Small BusinessJob Protection Act of 1996.

ADMINISTRATIVE

Rev. Proc. 97–35, page 11.Package design costs; methods of accounting. Threealternative methods of accounting for package design costsare provided: (1) the capitalization method; (2) the design-by-design and 60-month amortization method; and (3) the pool-of-cost and 48-month amortization method.

Rev. Proc. 97–36, page 14.Last-in, first-out inventory method; methods ofaccounting. An alternative last-in, first-out (LIFO) inventorycomputation method of accounting is provided for taxpayers

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

Rev. Proc. 97–37, page 18.Methods of accounting; automatic consent. Proceduresare provided under which a taxpayer may obtain automaticconsent of the Commissioner to change certain methods ofaccounting.

Rev. Proc. 97–38, page 43.Warranty contracts; methods of accounting. Proceduresare provided under which accrual method manufacturers,wholesalers, and retailers of motor vehicles or other durableconsumer goods may, in certain specified and limited circum-stances, include a portion of an advance payment related tothe sale of a multi-year service warranty contract in gross in-come generally over the life of the service warranty obliga-tion.

Rev. Proc. 97–39, page 48.Original issue discount; methods of accounting.Taxpayers are allowed to use an aggregate method ofaccounting, termed the “principal-reduction” method, for deminimis original issue discount on certain loans originated bythe taxpayer.

Rev. Proc. 97–40, page 50.Late S corporation elections. If an S corporation election isfiled late for a current taxable year, Rev. Proc. 97–40 pro-vides a special procedure to permit taxpayers to request re-lief instead of applying for a private letter ruling.

Rev. Proc. 97–42, page 57.Low-income housing tax credit. This procedure publishesthe amounts of unused housing credit carryovers allocatedto qualified states under section 42(h)(3)(D) of the Code forcalendar year 1997.

Announcement 97–77, page 58.This announces that the Internal Revenue Service will elimi-nate Form 4782, Employee Moving Expense Information,effective for tax year 1998.

Internal Revenue

bbuulllleettiinnBulletin No. 1997–33

August 18, 1997

Finding Lists begin on page 60.

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

Department of the TreasuryInternal Revenue Service

Mission of the Service

The purpose of the Internal Revenue Service is to collectthe proper amount of tax revenue at the least cost; servethe public by continually improving the quality of our prod-

ucts and services; and perform in a manner warrantingthe highest degree of public confidence in our integrity, effi-ciency, and fairness.

2

Statement of Principlesof Internal RevenueTax AdministrationThe function of the Internal Revenue Service is to adminis-ter the Internal Revenue Code. Tax policy for raising revenueis determined by Congress.

With this in mind, it is the duty of the Service to carry out thatpolicy by correctly applying the laws enacted by Congress;to determine the reasonable meaning of various Code provi-sions in light of the Congressional purpose in enacting them;and to perform this work in a fair and impartial manner, withneither a government nor a taxpayer point of view.

At the heart of administration is interpretation of the Code. Itis the responsibility of each person in the Service, chargedwith the duty of interpreting the law, to try to find the truemeaning of the statutory provision and not to adopt astrained construction in the belief that he or she is “protect-ing the revenue.” The revenue is properly protected onlywhen we ascertain and apply the true meaning of the statute.

The Service also has the responsibility of applying andadministering the law in a reasonable, practical manner.Issues should only be raised by examining officers whenthey have merit, never arbitrarily or for trading purposes.At the same time, the examining officer should never hesi-tate to raise a meritorious issue. It is also important thatcare be exercised not to raise an issue or to ask a court toadopt a position inconsistent with an established Serviceposition.

Administration should be both reasonable and vigorous. Itshould be conducted with as little delay as possible andwith great courtesy and considerateness. It should nevertry to overreach, and should be reasonable within thebounds of law and sound administration. It should, howev-er, be vigorous in requiring compliance with law and itshould be relentless in its attack on unreal tax devices andfraud.

The Internal Revenue Bulletin is the authoritative instrumentof the Commissioner of Internal Revenue for announcing offi-cial rulings and procedures of the Internal Revenue Serviceand for publishing Treasury Decisions, Executive Orders, TaxConventions, legislation, court decisions, and other items ofgeneral interest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscriptionbasis. Bulletin contents of a permanent nature are consoli-dated semiannually into Cumulative Bulletins, which are soldon a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-stantive rulings necessary to promote a uniform applicationof the tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in theBulletin. All published rulings apply retroactively unless other-wise indicated. Procedures relating solely to matters of in-ternal management are not published; however, statementsof internal practices and procedures that affect the rightsand duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in therevenue ruling. In those based on positions taken in rulingsto taxpayers or technical advice to Service field offices,identifying details and information of a confidential natureare deleted to prevent unwarranted invasions of privacy andto comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not havethe force and effect of Treasury Department Regulations,but they may be used as precedents. Unpublished rulingswill not be relied on, used, or cited as precedents by Servicepersonnel in the disposition of other cases. In applying pub-lished rulings and procedures, the effect of subsequent leg-islation, regulations, court decisions, rulings, and proce-

dures must be considered, and Service personnel and oth-ers concerned are cautioned against reaching the same con-clusions in other cases unless the facts and circumstancesare substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisionsof the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions, and Subpart B, Legislation and RelatedCommittee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts and Sub-parts. Also included in this part are Bank Secrecy Act Admin-istrative Rulings. Bank Secrecy Act Administrative Rulingsare issued by the Department of the Treasury’s Office of theAssistant Secretary (Enforcement).

Part IV.—Items of General Interest.With the exception of the Notice of Proposed Rulemakingand the disbarment and suspension list included in this part,none of these announcements are consolidated in the Cumu-lative Bulletins.

The first Bulletin for each month includes a cumulative indexfor the matters published during the preceding months.These monthly indexes are cumulated on a quarterly andsemiannual basis, and are published in the first Bulletin of thesucceeding quarterly and semiannual period, respectively.

3

Introduction

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.

August 18, 1997 4 1997–33 I.R.B.

Section 162.—Trade orBusiness Expenses

What procedures must a lawyer, handling caseson a contingent fee basis, use to obtain automaticconsent of the Commissioner to change its methodof accounting for advances paid to clients. See Rev.Proc. 97–37, page 18.

Section 165.—Losses26 CFR 1.165–2: Obsolescence of nondepreciableproperty.

When may a taxpayer deduct a loss arising fromthe obsolescence of a package design. See Rev.Proc. 97–35, page 11.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for package design costs.See Rev. Proc. 97–37, page 18.

Section 166.—Bad DebtsWhat procedures must a taxpayer use to obtain

automatic consent of the Commissioner to changefrom the § 585 reserve method of accounting to the§ 166 specific charge-off method. See Rev. Proc.97–37, page 18.

Section 167.—Depreciation26 CFR 1.167(a)–3: Intangibles.

How may a taxpayer recover the costs of creatinga package design. See Rev. Proc. 97–35, page 11.

26 CFR 1.167(e)–1: Change in method.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for depreciation. See Rev.Proc. 97–37, page 18.

Section 168.—Accelerated CostRecovery System

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for depreciation. See Rev.Proc. 97–37, page 18.

Section 197.—Amortization ofGoodwill and Other Intangibles

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for amortization. See Rev.Proc. 97–37, page 18.

Section 263.—CapitalExpenditures26 CFR 1.263(a)–2: Examples of capital expenditures.

Must the costs of creating a package design becapitalized. See Rev. Proc. 97–35, page 11.


Section 263A.—Capitalizationand Inclusion in Inventory Costsof Certain Expenses26 CFR §1.263A–1: Uniform capitalization of costs.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting. See Rev. Proc. 97–37,page 18.

26 CFR 1.263A–2: Rules relating to property pro-duced by the taxpayer.

Are the costs incurred in connection with the de-velopment and design of product packages subjectto the rules under section 263A. See Rev. Proc.97–35, page 11.

Section 401.—QualifiedPension, Profit-sharing, andStock Bonus Plans.26 CFR 1.401(b)–1: Certain retroactive changes inplan.

A procedure describes when plans that are quali-fied under § 401(a) or § 403(a) must be amended forthe Small Business Job Protection Act of 1996, Pub.L. 104–188, the Uruguay Round Agreements Act,Pub. L. 103–465, and the Uniformed Services Em-ployment and Reemployment Rights Act of 1994,Pub. L. 103–353. See Rev. Proc. 97–41, page 51.

Section 403.—Taxation ofEmployee Annuities

A procedure describes when tax-sheltered annu-ity plans within the meaning of § 403(b) must beamended for the Small Business Job Protection Actof 1996, Pub. L. 104–188. See Rev. Proc. 97–41,page 51.

Section 446.—General Rule forMethods of Accounting26 CFR 1.446–1: General rule for methods of ac-counting.


How may an automobile dealer change itsmethod of accounting to use the Alternative LIFOMethod. See Rev. Proc. 97–36, page 14.

Section 451.—General Rule forTaxable Year of Inclusion

What procedures must a taxpayer use to obtain au-tomatic consent of the Commissioner to change its

method of accounting for the income from an advancepayment related to the sale of a multi-year servicewarranty contract. See Rev. Proc. 97–37, page 18.

Section 454.—ObligationsIssued at a Discount26 CFR § 1.454–1: Obligations issued at a discount.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for the interest income onSeries E or EE U.S. savings bonds. See Rev. Proc.97–37, page 18.

Section 455.—PrepaidSubscription Income26 CFR § 1.455–6: Time and manner of makingelection.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for prepaid subscription in-come. See Rev. Proc. 97–37, page 18.

Section 461.—General Rule forTaxable Year of Deduction26 CFR § 1.461–4: Economic performance.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting. See Rev. Proc. 97–37,page 18.

Section 471.—General Rule forInventories26 CFR § 1.471–1: Need for inventories;

26 CFR § 1.471–2: Valuation of inventories;

26 CFR § 1.471–3: Inventories at cost.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for certain cash discounts.See Rev. Proc. 97–37, page 18.

Section 472.—Last-in, First-outInventories 26 CFR 1.472-1: Last-in, first-out inventories.

LIFO; price indexes; departmentstores. The June 1997 Bureau of LaborStatistics price indexes are accepted foruse by department stores employing theretail inventory and last-in, first-out in-ventory methods for valuing inventoriesfor tax years ended on, or with referenceto, June 30, 1997.

Rev. Rul. 97-32

The following Department Store Inven-

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

1997–33 I.R.B. 5 August 18, 1997

tory Price Indexes for June 1997 were is-sued by the Bureau of Labor Statistics onJuly 16, 1997. The indexes are acceptedby the Internal Revenue Service, under§1.472–1(k) of the Income Tax Regula-tions and Rev. Proc. 86–46, 1986–2 C.B.739, for appropriate application to inven-tories of department stores employing theretail inventory and last-in, first-out in-ventory methods for tax years ended on,or with reference to, June 30, 1997.

The Department Store Inventory PriceIndexes are prepared on a national basisand include (a) 23 major groups of de-partments, (b) three special combinationsof the major groups — soft goods,

durable goods, and miscellaneous goods,and (c) a store total, which covers all de-partments, including some not listed sep-arately, except for the following: candy,foods, liquor, tobacco, and contract de-partments.

DRAFTING INFORMATION

The principal author of this revenueruling is Stan Michaels of the Office ofAssistant Chief Counsel (Income Tax andAccounting). For further information re-garding this revenue ruling, contact Mr.Michaels on (202) 622-4970 (not a toll-free call).

What is the “Alternative LIFO Method.” SeeRev. Proc. 97–36, page 14.

26 CFR §1.472–6: Change from LIFO inventorymethod;

26 CFR §1.472–8: Dollar value method of pricingLIFO inventories.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changefrom the LIFO method of accounting for all its LIFOinventory, or to change to an alternate LIFO inven-tory method. See Rev. Proc. 97–37, page 18.

Section 481.—AdjustmentsRequired by Changes inMehtods of Accounting26 CFR 1.481–4: Adjustments taken into accountwith consent.

How is the section 481(a) adjustment taken intoaccount when a taxpayer changes its method of ac-counting 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 accountwith consent.

What procedures must a taxpayer use to obtain au-tomatic consent of the Commissioner to change amethod of accounting. See Rev. Proc. 97–37, page 18.

Section 585.—Reserves forLosses on Loans of Banks

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changefrom the § 585 reserve method of accounting to the§ 166 specific charge-off method. See Rev. Proc.97–37, page 18.

Section 1273.—Determinationof Amount of Original IssueDiscount26 CFR §1.1273–1: Definition of OID;

26 CFR §1.1273–2: Determination of issue priceand issue date.

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to change itsmethod of accounting for certain de minimis originalissue discount. See Rev. Proc. 97–37, page 18.

Section 1281.—CurrentInclusion in Income of Discounton Certain Short-termObligations

What procedures must a taxpayer use to obtainautomatic consent of the Commissioner to changeits method of accounting for interest income onshort-term obligations, or for stated interest onshort-term loans of cash method banks in theEighth Circuit. See Rev. Proc. 97–37, page 18.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted) Percent Change

Groups June June from June 19961996 1997 to June 19971

1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . 551.1 541.0 -1.82. Domestics and Draperies . . . . . . . . . . . . 641.0 644.1 0.53. Women’s and Children’s Shoes . . . . . . . 649.3 651.0 0.34. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . 895.4 904.0 1.05. Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . 627.1 642.5 2.56. Women’s Underwear. . . . . . . . . . . . . . . . 535.4 539.3 0.77. Women’s Hosiery . . . . . . . . . . . . . . . . . . 288.0 295.7 2.78. Women’s and Girls’Accessories. . . . . . . 545.5 569.4 4.49. Women’s Outerwear and Girls’ Wear . . . 401.1 415.3 3.5

10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . 612.2 625.0 2.111. Men’s Furnishings . . . . . . . . . . . . . . . . . 584.5 589.8 0.912. Boys’ Clothing and Furnishings . . . . . . . 485.7 494.5 1.813. Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . 1011.5 1002.1 -0.914. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . 774.1 752.1 -2.815. Toilet Articles and Drugs . . . . . . . . . . . . 877.8 913.5 4.116. Furniture and Bedding . . . . . . . . . . . . . . 673.6 673.2 -0.117. Floor Coverings . . . . . . . . . . . . . . . . . . . 576.4 592.4 2.818. Housewares. . . . . . . . . . . . . . . . . . . . . . . 808.7 808.1 -0.119. Major Appliances . . . . . . . . . . . . . . . . . . 245.5 243.5 -0.820. Radio and Television . . . . . . . . . . . . . . . . 79.3 76.2 -3.921. Recreation and Education2 . . . . . . . . . . . 112.8 109.5 -2.922. Home Improvements2 . . . . . . . . . . . . . 127.4 132.8 4.223. Auto Accessories2 . . . . . . . . . . . . . . . . . . 107.5 108.0 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

Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . 550.3 554.8 0.81 Absence of a minus sign before percentage change in this column signifies price increase. 2 Indexes on a January 1986 = 100 base.3 The store total index covers all departments, including some not listed separately, ex-cept for the following: candy, foods, liquor, tobacco, and contract departments.

August 18, 1997 6 1997–33 I.R.B.

Section 1362.—Election;Revocation; Termination26 CFR 1.1362–6: Elections and consents.

If a taxpayer files an S corporation election afterthe statutory date, but within 6 months of that statu-

tory due date, may the taxpayer obtain relief under § 1362(b)(5) of the Internal Revenue Code withoutapplying for a private letter ruling? See Rev. Proc.97–40, page 50.

Section 1363.—Effect ofElection on Corporation

What procedures must a taxpayer use to obtain au-tomatic consent of the Commissioner to change itsmethod of accounting. See Rev. Proc. 97–37, page 18.

Highly Compensated EmployeeDefinitionNotice 97–45

I. PURPOSEThis notice provides guidance relating

to the definition of highly compensatedemployee (“HCE”) under §414(q) of theInternal Revenue Code (“Code”), asamended by §1431 of the Small BusinessJob Protection Act of 1996, Pub. L. 104-188 (“SBJPA”). The §414(q) definition ofHCE is incorporated by certain provisionsof the Code that apply nondiscriminationrequirements to various employee benefitplans, 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 anemployee (other than a 5-percentowner) with compensation in excessof the dollar threshold is an HCEonly if the employee is among thehighest paid 20 percent of an em-ployer’s workforce.

• A new calendar year data electionunder which an employer that main-tains one or more plans on a fiscalyear basis has the option to use calen-dar year data to simplify the determi-nation of whether an employee is anHCE on account of compensationunder §414(q)(1)(B).

• Transition relief from certain require-ments of the top-paid group electionand the calendar year data election.

• Guidance on plan amendments to re-flect the revised definition of HCE, in-cluding the application of the remedialamendment period under § 401(b),and certain other matters relating tothe determination of HCE status.

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

Prior to amendment by SBJPA,§ 414(q)(1) generally provided that anemployee was an HCE if, at any time dur-ing the year or the preceding year, the em-ployee:

(A) was a 5-percent owner,(B) received more than $100,000 (for

1996) in annual compensation from theemployer,

(C) received more than $66,000 (for1996) in annual compensation from theemployer and was in the top-paid groupof employees during the same year, or

(D) was an officer of the employer whoreceived compensation in excess of$60,000 (for 1996).

(2) Guidance under § 414(q) prior toSBJPA. Under §1.414(q)–1T, A–14(b) ofthe temporary Income Tax Regulations,employers were allowed to make a calen-dar year calculation election, under whichthe preceding year’s calculations relatingto HCE determinations were made on thebasis of the calendar year ending with orwithin the current year. Under section 4 ofRev. Proc. 93–42, 1993–2 C.B. 540, asmodified by Rev. Proc. 95–34, 1995–2C.B. 385, an employer was permitted touse a simplified method for determiningHCEs. Rev. Proc. 95–34 also providedmodel plan language for employers to usethe simplified method.

(3) SBJPA amendments to § 414(q).Section 414(q)(1), as amended by SBJPA,provides that the term “highly compen-sated employee” means any employeewho:

(A) was a 5-percent owner at any timeduring the year or the preceding year, or

(B) for the preceding year had compen-sation from the employer in excess of$80,000 and, if the employer so elects,was in the top-paid group for the preced-ing year.

The $80,000 amount is adjusted at thesame time and in the same manner asunder § 415(d), except that the base pe-riod is the calendar quarter ending Sep-tember 30, 1996.

Pursuant to § 414(q)(3), an employee isin the top-paid group for any year if theemployee is in the group consisting of thetop 20 percent of the employees of theemployer when ranked on the basis ofcompensation paid to employees duringsuch year. An election pursuant to §414(q)(1)(B)(ii), under which an em-ployee (who is not a 5-percent owner)who has compensation in excess of$80,000 is not an HCE if the employee isnot a member of the top-paid group, is re-ferred to in this notice as a “top-paidgroup election.”

The amendments made by § 1431 ofSBJPA generally apply to years beginning

after December 31, 1996.

III. EFFECT OF STATUTORYCHANGES ON PRIOR GUIDANCE

(1) Prior guidance. Because of theamendments made to § 414(q) by SBJPA,certain portions of § 1.414(q)–1T do notreflect current law. Except as provided insection III(2), the calendar year calcula-tion election under A–14(b) of §1.414(q)–1T does not apply for years be-ginning after December 31, 1996. In addi-tion, the guidance provided under section4 of Rev. Proc. 93–42 and under Rev.Proc. 95–34 does not apply for years be-ginning after December 31, 1996. TheService intends to publish guidance in thefuture that will make appropriate modifi-cations to these items of guidance.

(2) Transition relief for 1997. For anyyear beginning on or after January 1,1997 and before January 1, 1998, employ-ers may continue to utilize the calendaryear calculation election, taking into ac-count the statutory amendments to §414(q)(1)(B), and the elimination of §414(q)(1)(C) and (D), by SBJPA.

IV. PERIODS FOR DETERMININGHCE STATUS

(1) Determination years and look-backyears. HCE status is determined on thebasis of the applicable year (as definedbelow) of the plan or other entity forwhich a determination is being made(“determination year”) and the precedingtwelve-month period (“look-back year”)in accordance with § 414(q). Thus, under§ 414(q), as amended by SBJPA, an em-ployee is an HCE for a determination yearif, (a) at any time during the determina-tion year or the look-back year, the em-ployee was a 5-percent owner or (b) forthe look-back year, the employee hadcompensation from the employer in ex-cess of $80,000 (as adjusted) and, if theemployer so elects, was in the top-paidgroup.

(2) Applicable year.(a) Retirement plans. The applicable

year for a retirement plan is the plan year.For purposes of this notice, a retirementplan 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-

1997–33 I.R.B. 7 August 18, 1997

Part III. Administrative, Procedural, and Miscellaneous

ble year for a nonretirement plan is theplan year, as defined in the written plandocument or otherwise identified in theCode and regulations. If a nonretirementplan does not have an identified plan year,then the employer may treat either the cal-endar year or the employer’s fiscal year asthe applicable year. For purposes of thisnotice, a nonretirement plan is any em-ployee benefit arrangement to which thedefinition of HCE is applicable under aprovision of the Code, other than a retire-ment plan.

V. IMPLEMENTATION OF ELECTIONS

(1) Top-paid group election. An em-ployer may make a top-paid group elec-tion for a determination year. The effectof the top-paid group election is that anemployee (who is not a 5-percent ownerat any time during the determination yearor the look-back year) with compensationin excess of $80,000 (as adjusted) for thelook-back year is an HCE only if the em-ployee was in the top-paid group for thelook-back year. A top-paid group election,once made, applies for all subsequent de-termination years unless changed by theemployer.

(2) Calendar year data election. (a) This notice provides a new calendar

year data election which an employer maymake for a determination year. The effectof the calendar year data election is thatthe calendar year beginning with orwithin the look-back year is treated as theemployer’s look-back year for purposesof determining whether an employee is anHCE on account of the employee’s com-pensation for a look-back year under §414(q)(1)(B). A calendar year data elec-tion, once made, applies for all subse-quent determination years unless changedby the employer.

(b) A calendar year data election madeby an employer does not apply in deter-mining whether the employer’s employ-ees are HCEs under § 414(q)(1)(A) on ac-count of being 5-percent owners.Accordingly, if an employee is a 5-per-cent owner in either the look-back year orthe determination year, then the employeeis an HCE, without regard to whether theemployee’s employer makes a calendaryear data election.

(c) If a plan has a calendar year as itsdetermination year, then the immediately

preceding calendar year is the look-backyear for the plan. This is the case whetheror not a calendar year data election ismade. Thus, a calendar year data electionwould have no effect on the HCE deter-mination for a calendar year plan.

(3) No separate notification require-ment. Notification or filing with the Inter-nal Revenue Service of a top-paid groupelection or a calendar year data election isnot required in order for the election to bevalid. However, under certain circum-stances, plan amendments may be re-quired to reflect the election. Seesection VII of this notice.

(4) Cross-references. Section VI of thisnotice provides a consistency requirementthat applies if an employer maintainsmore than one plan. Section VII of thisnotice describes circumstances underwhich a top-paid group election or calen-dar year data election, or changes to suchelections, may have to be reflected in plandocuments.

VI. CONSISTENCY REQUIREMENTFOR ELECTIONS

(1) Consistency requirement — in gen-eral. Except as provided in section VI(3)and (4), in order to be effective, a top-paidgroup election made by an employer mustapply consistently to the determinationyears of all plans of the employer thatbegin with or within the same calendaryear. Similarly, except as provided in sec-tion VI(3) and (4), in order to be effective,a calendar year data election made by anemployer must apply consistently to thedetermination years of all plans of the em-ployer, other than a plan with a calendaryear determination year, that begin withinthe same calendar year.

(2) Interaction of top-paid group elec-tion and calendar year data election. Thetop-paid group election and the calendaryear data election are independent of eachother. Thus, an employer making one ofthe elections is not required also to makethe other election. However, if both elec-tions are made, the look-back year in de-termining the top-paid group must be thecalendar year beginning with or withinthe look-back year, in accordance withsection V of this notice.

(3) Multiemployer plans. Satisfaction ofthe consistency requirement is determinedwithout regard to any multiemployer plansin which the employer participates.

(4) Transition relief for years prior to2000.

(a) Transition relief for 1997. The con-sistency requirement will not apply to de-termination years beginning with orwithin the 1997 calendar year. Thus, anemployer may make a top-paid groupelection or a calendar year data electionfor a plan for a determination year begin-ning with or within 1997, without regardto whether the employer makes that elec-tion for any other plan.

(b) Transition relief for 1998 and 1999.For determination years beginning on orafter January 1, 1998, and before January1, 2000, (i) nonretirement plans are notsubject to the consistency requirement,and (ii) satisfaction of the consistency re-quirement with respect to retirement plansis determined without regard to any plansof the employer that are nonretirementplans.

VII. QUALIFIED RETIREMENTPLAN AMENDMENTS FOR HCEDEFINITION

(1) Qualified plans that must beamended. If a retirement plan qualifiedunder § 401(a) or 403(a) contains the def-inition of HCE under § 414(q), as in ef-fect before SBJPA, the plan must beamended to reflect the definition of HCEunder § 414(q), as amended by SBJPA. Ifan employer makes either a top-paidgroup or calendar year data election for adetermination year, a plan that containsthe definition of HCE must reflect theelection. If the employer changes either atop-paid group or calendar year data elec-tion, the plan must be amended to reflectthe change. However, a plan is not re-quired to add a definition of HCE merelyto reflect a top-paid group or calendaryear data election.

(2) Amendment date. Rev. Proc. 97–41,1997–33 IRB, provides that qualified re-tirement plans have a remedial amend-ment period under § 401(b) so that certainplan amendments for SBJPA are not re-quired to be adopted before the last day ofthe first plan year beginning on or afterJanuary 1, 1999 (with a later date for gov-ernmental plans). Pursuant to Rev. Proc.97–41, a plan provision reflecting the def-inition of HCE is a disqualifying provi-sion and thus any plan amendments to re-flect the definition of HCE in § 414(q), asamended by SBJPA, and to reflect any

August 18, 1997 8 1997–33 I.R.B.

choices regarding the top-paid group orcalendar year data elections, are not re-quired to be made until the end of this re-medial amendment period. However,plans must be operated in accordancewith the SBJPA changes to the HCE defi-nition in § 414(q) as of the statutory effec-tive date, and plans required to beamended to reflect those changes must beso amended retroactively effective as ofthat date. In addition, under Rev. Proc.97–41, any retroactive amendments mustreflect the choices made in the operationof the plan for each determination year,including choices made with respect tothe top-paid group election and the calen-dar year data election (and any changes tothose elections), and the first date that theplan operated in accordance with thosechoices (and any such changes).

VIII. OTHER ISSUES RELATINGTO DETERMINATION OF HCESTATUS

(1) Determining HCE status for 1997.As noted earlier, the amendments madeby § 1431 of the SBJPA generally applyto years beginning after December 31,1996. However, § 1431(d)(1) providesthat, in determining whether an employeeis an HCE for years beginning in 1997,the amendments to § 414(q) are treated ashaving been in effect for years beginningin 1996. Accordingly, in determiningwhether an employee is an HCE for thedetermination year beginning with orwithin the 1997 calendar year, an em-ployer must consider whether the em-ployee was a 5-percent owner or hadcompensation in excess of $80,000 for thelook-back year that began with or withinthe 1996 calendar year. An employer alsomay make the calendar year data electionand/or the top-paid group election withrespect to determination years beginningwith or within the 1997 calendar year, inaccordance with the guidance in this no-tice. The SBJPA amendments to § 414(q)are not applicable in determining the em-ployer’s HCEs for determination yearsbeginning prior to January 1, 1997.

(2) Highly compensated former em-ployees. For purposes of determining sta-tus as a highly compensated former em-ployee under § 1.414(q)–1T, A–4,whether an employee was a highly com-pensated active employee for a determi-nation year that ended on or after the em-

ployee’s 55th birthday, or that was a sepa-ration year, is based on the rules applica-ble to determining HCE status as in effectfor that determination year.

(3) Determining 5-percent ownershipby attribution of ownership interest tofamily members. The definition of 5-per-cent owner in § 414(q)(2) refers to §416(i)(1), which in turn refers to the attri-bution rules of § 318. Under the rules of§318, an individual is considered to ownany stock owned directly or indirectly bythe individual’s spouse, children, grand-children or parents. Consequently, an em-ployee who is the spouse, child, parent orgrandparent (“family member”) of an in-dividual who has a 5-percent interest inthe employer at any time during the look-back year or the determination year istreated as an HCE under § 414(q)(1)(A),regardless of the family member’s com-pensation level. These statutory provi-sions relating to the definition of 5-per-cent owner under § 414(q)(2) are differentfrom the family aggregation rules underformer § 414(q)(6) and are unaffected bythe repeal of those rules under §1431(b)(1) of SBJPA.

IX. EXAMPLESThe following examples illustrate the

rules in this notice:Example 1: (a) Employer A has main-

tained a defined benefit plan qualifiedunder § 401(a) (Plan M) since 1996 with aplan year beginning April 1 and endingMarch 31. Employer A has never had a 5-percent owner. For Plan M’s determina-tion year beginning April 1, 2000 andending March 31, 2001, Employer A doesnot make a calendar year data election ora top-paid group election.

(b) Under § 414(q)(1)(B), Employer Adetermines HCEs for Plan M’s determina-tion year beginning April 1, 2000, basedupon the compensation of Employer A’semployees in Plan M’s look-back year.Thus, the HCEs are those employees whohad compensation over $80,000 (as ad-justed) during the period beginning April1, 1999 and ending March 31, 2000.

Example 2: (a) Assume the same factsas in Example 1, except that Employer Ahires a new employee, Employee X, onMarch 1, 2000 at an annual salary of$240,000. Employee X is not a 5-percentowner during the determination year be-ginning April 1, 2000 or the look-back

year beginning April 1, 1999. During themonth of March, 2000, Employee X’scompensation was $20,000.

(b) Because Employee X’s compensa-tion during Plan M’s look-back year be-ginning April 1, 1999 was less than$80,000 (as adjusted), Employee X is notan HCE for Plan M’s determination yearbeginning April 1, 2000.

Example 3: (a) Employer B has main-tained a qualified defined benefit plan(Plan N) since 1996 that has a calendarplan year. Employer B makes a top-paidgroup election for Plan N’s 1998 determi-nation year, which is the 1998 calendaryear. Employer B had 15 employees inthe 1997 calendar year and has never hada 5-percent owner. These employees,along with their compensation for the1997 calendar year, are listed below.

Employees 1997 Compensation 1 $200,0002 110,0003 101,0004 90,000

5-15 50,000 or less

(b) In determining Employer B’s HCEsfor the calendar year 1998 under the top-paid group election, Plan N’s relevantlook-back year is the 1997 calendar year.Employer B must determine whether anyemployee had compensation above$80,000, and was in the group consistingof the top 20 percent of the employees ofEmployer B in the 1997 calendar year,when ranked on the basis of compensa-tion from Employer B during the 1997calendar year.

(c) Employees 1, 2 and 3 comprise thetop 20 percent of Employer B’s 15 em-ployees for the 1997 calendar year basedon compensation from Employer B dur-ing the 1997 calendar year. Although Em-ployee 4 had compensation over $80,000in the 1997 calendar year, Employee 4was not in the top-paid group for the 1997calendar year and is therefore not an HCEfor Plan N’s 1998 determination year.This will be the case regardless ofwhether Employees 1, 2 and 3 continue tobe employed in the 1998 calendar year.

Example 4: (a) Employer C has a quali-fied profit sharing plan (Plan O) with acalendar plan year. Employer C also has aqualified defined benefit plan (Plan P)with a plan year beginning April 1 andending March 31. Employer C makes the

1997–33 I.R.B. 9 August 18, 1997

top-paid group election for Plan O for thecalendar year 2000.

(b) Pursuant to the consistency rule re-quiring that the employer make the sameelection for all determination years of allplans of the employer that begin with orwithin the same calendar year, EmployerC must also make the top-paid group elec-tion for Plan P’s determination year be-ginning April 1, 2000 and ending March31, 2001.

(c) The look-back year for purposes ofdetermining whether any of Employer C’semployees is an HCE under Employer C’stop-paid group election for Plan O is the1999 calendar year and for Plan P is theApril 1, 1999 to March 31, 2000 year. Thegroup of Employer C’s employees that areHCEs for Plan O’s 2000 determinationyear are those employees who had com-pensation above $80,000 (as adjusted)and who were in the top 20 percent of em-ployees based on compensation for the1999 calendar year, while the group ofEmployer C’s employees that are HCEsfor Plan P’s determination year beginningApril 1, 2000 are those employees whohad compensation above $80,000 (as ad-justed) and who were in the top 20 per-cent of employees based upon compensa-tion for Plan P’s look-back year beginningApril 1, 1999.

Example 5: (a) Since 1998, EmployerD has maintained a qualified cash or de-ferred arrangement under § 401(k) (PlanQ). Plan Q has a calendar plan year. Em-ployer D has never made a calendar yeardata election or a top-paid group electionfor Plan Q and has never had a 5-percentowner. Under § 401(k)(3)(A)(ii), asamended by the SBJPA, unless an em-ployer elects to use current year data forall eligible employees, the actual deferralpercentage (ADP) test for the plan year isapplied by comparing the ADP for all eli-gible HCEs for the plan year to the ADPfor all other eligible employees (non-HCEs) for the preceding plan year. Em-ployer D has not elected to use currentyear data for the nonHCEs for the 2000calendar year.

(b) In conducting the ADP test for the2000 calendar year, Employer D com-pares the ADP for the 2000 calendar yearfor the group of employees who had com-pensation above $80,000 (as adjusted) forthe 1999 calendar year, and who are eligi-ble under the plan for the 2000 calendar

year, with the ADP for the 1999 calendaryear for the group of employees who werenonHCEs for the 1999 calendar year andwho were eligible under the plan for the1999 calendar year. Employer D wouldhave previously determined who theHCEs were for the 1999 calendar year,that is, the employees of Employer D whohad compensation above $80,000 (as ad-justed) for the 1998 calendar year. ThenonHCEs for the 1999 calendar year arethose employees who were employees inthe 1999 calendar year and who were notdetermined to be HCEs for the 1999 cal-endar year.

Example 6: (a) Employer E has main-tained a qualified profit sharing plan (PlanR) since 1996 with an April 1 to March 31plan year. Employer E has also main-tained a defined benefit plan (Plan S)since 1996 with an October 1 to Septem-ber 30 plan year. Employer E decides tomake the calendar year data election fordetermination years of Plan R and Plan Sbeginning in the 2000 calendar year.Thus, Employer E makes the election forPlan R’s determination year beginningApril 1, 2000 and ending March 31, 2001,and Plan S’s determination year begin-ning October 1, 2000 and ending Septem-ber 30, 2001.

(b) The 2000 calendar year beginswithin Plan R’s look-back year beginningApril 1, 1999 and ending March 31, 2000,and Plan S’s look-back year beginningOctober 1, 1999 and ending September30, 2000 and is treated as Employer E’slook-back year for both Plans R and S forpurposes of determining Employer E’sHCEs on the basis of compensation.Thus, in determining HCE status under §414(q)(1)(B) Employer E determineswhether an employee has compensationfor the look-back year in excess of$80,000 (as adjusted), and if applicable,the composition of the top-paid group, onthe basis of compensation for the 2000calendar year.

Example 7: (a) Assume the same factsas in Example 6, except that Employer Ealso maintains Plan T, a qualified definedbenefit plan with a calendar plan year.Employer E fails to make the calendaryear data election for Plan T.

(b) Because the consistency require-ment for the calendar year data election isapplied without regard to calendar yearplans, the consistency requirement is sat-

isfied regardless of whether Employer Emakes a calendar year data election forPlan T.

Example 8: Assume the same facts asin Example 6. For Plan R, in determiningwhether any of Employer E’s employeesis an HCE on account of being a 5-percentowner, the employee’s ownership in Em-ployer E is examined for Plan R’s 2000and 2001 plan years (April 1, 1999 toMarch 31, 2000, and April 1, 2000 toMarch 31, 2001). For Plan S, in determin-ing whether any of Employer E’s employ-ees is an HCE on account of being a 5-percent owner, the employee’s ownershipin Employer E is examined for Plan S’s2000 and 2001 plan years (October 1,1999 to September 30, 2000, and October1, 2000 to September 30, 2001). This isbecause the calendar year data electiondoes not apply in determining whether anemployee is a 5-percent owner.

Example 9: (a) Employer F maintainsPlan U, a defined benefit plan with a cal-endar year plan year. Employee Y wasemployed by Employer F since 1990.Employee Y retired at age 65 from em-ployment with Employer F in 1998. Em-ployee Y was an HCE in 1992 under therules applicable in 1992 to determineHCE status, but was not an HCE in anyother year, including 1998.

(b) Because Employee Y was an HCEfor a determination year (1992) ending onor after Employee Y’s 55th birthday, Em-ployee Y is a highly compensated formeremployee for determination years begin-ning after Employee Y’s retirement.

X. PAPERWORK REDUCTIONACT

The collection of information con-tained in this notice has been reviewedand approved by the Office of Manage-ment and Budget in accordance with thePaperwork 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 col-lection of information displays a validcontrol number.

The collection of information in thisnotice is in Section VII. This requirementto amend plan documents is necessary toupdate plan documents to reflect theamended definition of HCE under §414(q). This information will be used to

August 18, 1997 10 1997–33 I.R.B.

determine which employees are HCEs forpurposes of determining contributions,benefits, or the availability of other rightsor features under the plan. The collectionof information is required to obtain a ben-efit. The likely respondents are businessesor other for-profit institutions, nonprofitinstitutions, and small businesses or orga-nizations.

The estimated total annual recordkeep-ing burden is 65,605 hours.

The estimated annual burden perrecordkeeper varies from 10 minutes to30 minutes, depending on individual cir-cumstances, with an estimated average of18 minutes. The estimated number ofrecordkeepers is 218,683.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally tax returns and taxreturn information are confidential, as re-quired by 26 U.S.C. 6103.

XI. COMMENTSThis notice does not address all of the

procedural requirements that may be nec-essary to implement the top-paid groupelection or the calendar year data electionfor future years. However, any additionalrequirements would be applied prospec-tively only. The Treasury and the Serviceinvite comments and suggestions regard-ing procedural issues and the other mat-ters discussed in this notice.

Comments can be addressed toCC:DOM:CORP:R (Notice 97–45), room5228, Internal Revenue Service, POB7604, Ben Franklin Station, Washington,DC 20044. In the alternative, commentsmay be hand delivered between the hoursof 8 a.m. and 5 p.m. to CC:DOM:CORP:R(Notice 97–45), Courier’s Desk, InternalRevenue Service, 1111 Constitution Av-enue, NW, Washington, DC. Alternatively,taxpayers may transmit comments elec-tronically via the IRS Internet site athttp://www.irs.ustreas.gov/prod/tax_regs/comments.html.

DRAFTING INFORMATIONThe principal author of this notice is In-

grid Grinde of the Employee Plans Divi-sion. For further information regardingthis notice, please contact the EmployeePlans Division’s taxpayer assistance tele-

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, Mondaythrough Thursday, or Ms. Grinde at (202)622-6214, or Patricia McDermott of theOffice of the Associate Chief Counsel(Employee Benefits and Exempt Organi-zations) at (202) 622-6030. These are nottoll-free numbers.

26 CFR 601.204: Changes in accounting periodsand 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 describesthree alternative methods of accountingfor package design costs: (1) the capital-ization method (see section 5.01 of thisrevenue procedure), (2) the design-by-de-sign capitalization and 60-month amorti-zation method (see section 5.02 of thisrevenue procedure), and (3) the pool-of-cost capitalization and 48-month amorti-zation method (see section 5.03 of thisrevenue procedure). A taxpayer maychange to or adopt any one of these threemethods. The procedures for a taxpayerto change to one of these three methodsare provided in Rev. Proc. 97–37, page18, which provides simplified and uni-form procedures to obtain automatic con-sent to make this and other changes inmethods of accounting. This revenue pro-cedure modifies and supersedes Rev.Proc. 90–63, 1990–2 C.B. 664.

.02 The three methods of accountingfor package design costs described in thisrevenue procedure are the same methodsof accounting that were described in Rev.Proc. 90–63. Accordingly, a taxpayer thatproperly changed to or adopted one ofthese methods pursuant to Rev. Proc.90–63 is not required to change itsmethod of accounting to comply with thisrevenue procedure.

SECTION 2. DEFINITIONS

For purposes of this revenue procedure,the terms “package design” and “packagedesign cost” have the meanings providedin Rev. Rul. 89–23, 1989–1 C.B. 85. Ifthe taxpayer develops the package design,the term includes the cost of materials,

labor, and overhead associated with thedesign, including all design explorationand study (for example, the developmentof any related design which, althoughabandoned, advances the development ofthe design selected), refinement of thebasic design selected, testing, and prepa-ration of the final master comprehensivedesign. If an independent contractor per-forms the work, the term includes allbillings related to the development of theparticular package, including all designexploration and study (for example, thedevelopment of any related design which,although abandoned, advances the devel-opment of the design selected), refine-ment of the basic design selected, testing,and preparation of the final master com-prehensive design. If the taxpayer pur-chases the package, the term includes thepurchase price. The costs associated withcoupon inserts, refund offers, and othershort-lived promotion-related changes arespecifically excepted from the definitionof “package design cost.”

SECTION 3. BACKGROUND

.01 Section 263(a) of the Internal Rev-enue Code provides that no deduction isallowed for any amount paid for newbuildings or for permanent improvementsor betterments made to increase the valueof any property or estate. Section1.263(a)–2 of the Income Tax Regulationsincludes in its examples of capital expen-ditures the costs of acquiring propertyhaving a useful life substantially beyondthe tax year.

.02 An expenditure generally must becapitalized under § 263 if the expenditurecreates, enhances, or is part of the cost ofacquiring a tangible or intangible assethaving a useful life that extends substan-tially beyond the end of the tax year inwhich the expenditure is incurred. SeeINDOPCO, Inc. v. Commissioner, 503U.S. 79 (1992); Commissioner v. LincolnSavings and Loan Association, 403 U.S.345 (1971), 1971-2 C.B. 116; CentralTexas Savings and Loan Association v.United States, 731 F.2d 1181 (5th Cir.1984); Ellis Banking Corp. v. Commis-sioner, 688 F.2d 1376 (11th Cir. 1982),cert. denied, 463 U.S. 1207 (1983); andCleveland Electric Illuminating Companyv. United States, 7 Cl. Ct. 220 (1985).Generally, taxpayers must capitalizepackage design costs incurred prior to

1997–33 I.R.B. 11 August 18, 1997

January 1, 1987 under § 263 becausethose costs create intangible assets havinguseful lives that extend substantially be-yond the end of the tax year in which thecosts are incurred. See Rev. Rul. 89-23.

.03 Section 263A, enacted by the TaxReform Act of 1986, provides, in part, forthe capitalization of certain direct and in-direct costs with respect to real or tangiblepersonal property produced by the tax-payer. All costs that are incurred with re-spect to real or tangible personal propertythat the taxpayer produces are to be capi-talized with respect to the property. Theterm “produce” includes construct, build,install, manufacture, develop, improve,create, raise, or grow. For purposes of§263A, “tangible personal property” in-cludes a film, sound recording, videotape, book, or similar property embodyingwords, ideas, concepts, images, or sounds(see 2 H.R. Conf. Rep. No. 841, 99thCong., 2d Sess. II–308 (1986), 1986–3(Vol. 4) C.B. 308) without regard towhether the property is treated as tangibleor intangible under other provisions of theCode. See § 1.263A-2(a)(2)(ii). Section263A and the regulations thereunder re-quire that costs incurred after December31, 1986 in connection with the develop-ment and design of product packagesmust be capitalized. See Rev. Rul. 89–23.

.04 As stated in Rev. Rul. 89–23, pack-age designs generally do not have an as-certainable useful life, and thus no depre-ciation or amortization is allowed under §167 and the regulations thereunder. See §1.167(a)–3. Only when such a packagedesign is abandoned may the capitalizedcosts be deducted. See § 165 and§1.165–2(a).

.05 Thus, taxpayers are generally re-quired under the Code and regulations touse the capitalization method of account-ing for package design costs described insection 5.01 of this revenue procedure.However, to minimize disputes regard-ing the accounting for package designcosts, the Internal Revenue Service, as amatter of administrative convenience,will allow a taxpayer that complies withthe requirements of this revenue proce-dure to choose one of two alternativemethods of accounting for package de-sign costs:

(1) the capitalization and 60-monthamortization method described in section5.02 of this revenue procedure, deter-

mined on a design-by-design basis for allpackage designs or;

(2) the capitalization and 48-monthamortization method described in section5.03 of this revenue procedure, deter-mined on a pool-of-cost basis for all pack-age design costs.

SECTION 4. SCOPE

This revenue procedure applies to ataxpayer that wants to change to or adopta method of accounting for package de-sign costs. A change in method of ac-counting for package design costs madepursuant to this revenue procedure doesnot affect the taxpayer’s method of ac-counting for intangible property otherthan package designs described in section2 of this revenue procedure.

SECTION 5. ALTERNATIVE METHODS OF ACCOUNTING

.01 The capitalization method. (1) Description of method. The treat-

ment of the costs of developing new pack-age designs or modifying existing designsin accordance with the capitalizationmethod constitutes a permissible methodof accounting. Under the capitalizationmethod, the taxpayer must capitalize thecosts of developing (or modifying) anypackage design if the asset created bythose costs has no ascertainable useful lifeor an ascertainable useful life that extendssubstantially beyond the end of the taxyear in which the costs are incurred. Ifthe asset created by the costs has an ascer-tainable useful life, the taxpayer mayamortize the costs ratably over the usefullife, beginning with the month the pack-age design (or modification to the design)is placed in service. If the asset createdby the costs has no ascertainable usefullife, the taxpayer may deduct the costsonly upon the disposition or abandonmentof the package design (or modification tothe design). See Rev. Rul. 89-23.

(2) Computation of basis. The basis ofeach package design (or modification tothe design) subject to capitalization is de-termined by applying the provisions of§ 263 and the regulations thereunder tocosts incurred prior to January 1, 1987,and § 263A and the regulations thereun-der to costs incurred after December 31,1986 (regardless of the tax year the design(or modification to the design) is placedin service). The costs required to be capi-

talized are described in section 2 of thisrevenue procedure.

.02 The design-by-design capitalizationand 60-month amortization method.

(1) Description of method. The treat-ment of the costs of developing newpackage designs or modifying existingdesigns in accordance with the design-by-design capitalization and 60-monthamortization method constitutes a per-missible method of accounting. Underthe design-by-design capitalization and60-month amortization method, the tax-payer must capitalize the costs of devel-oping (or modifying) any package designif the asset created by those costs has noascertainable useful life or an ascertain-able useful life that extends substantiallybeyond the end of the tax year in whichthe costs are incurred. The taxpayermust amortize the basis of any packagedesign (or modification to the design)subject to capitalization over a period of60 months. Thus, in computing taxableincome, the basis of each package design(or modification to the design) subject tocapitalization is allowed as a deductionratably over a 60-month period, begin-ning with the month the design (or modi-fication to the design) is treated asplaced in service. See section 5.02(3) ofthis revenue procedure. If the packagedesign (or modification to the design) isdisposed of or abandoned within the 60-month period, the taxpayer is permittedto deduct the unamortized portion of thebasis of the design (or modification tothe design) in the tax year of dispositionor abandonment.

(2) Computation of basis. Under thedesign-by-design capitalization and 60-month amortization method, the basis ofeach package design (or modification ofthe design) subject to capitalization mustbe determined by applying the provisionsof § 263 and the regulations thereunder tocosts incurred prior to January 1, 1987,and § 263A and the regulations thereun-der to costs incurred after December 31,1986 (regardless of the tax year the design(or modification to the design) is placedin service). The costs required to be capi-talized are described in section 2 of thisrevenue procedure.

(3) Half-year convention. Under thedesign-by-design capitalization and 60-month amortization method, the amorti-zation allowance for each package design

August 18, 1997 12 1997–33 I.R.B.

(or modification to the design) subject tocapitalization must be determined bytreating a design (or modification to thedesign) placed in service during the taxyear as placed in service on the mid-pointof the tax year. If the tax year in whichthe package design (or modification tothe design) is placed in service is 12 fullmonths, the design (or modification tothe design) is treated as placed in serviceon the first day of the seventh month ofthe tax year. For guidance in computingthe amortization allowance under the de-sign-by- design capitalization and 60-month amortization method when a pack-age design (or modification to the design)is placed in service in a taxable year ofless than 12 months (a short taxableyear), see Rev. Proc. 89-15, 1989-1 C.B.816.

.03 The pool-of-cost capitalization and48-month amortization method.

(1) Description of method. The treat-ment of the costs of developing new pack-age designs or modifying existing designsin accordance with the pool-of-cost capi-talization and 48-month amortizationmethod constitutes a permissible methodof accounting. Under the pool-of-costcapitalization and 48-month amortizationmethod, the taxpayer must capitalize allits package design costs and amortize thecosts over a period of 48 months. Thus,in computing taxable income, packagedesign costs incurred during the tax yearare allowed as a deduction ratably over a48-month period, beginning with themonth the costs are treated as incurred.See section 5.03(3) of this revenue proce-dure. The taxpayer may not deduct theunamortized portion of the cost of a pack-age design (or modification to the design)if the design (or modification to the de-sign) is never placed in service or is dis-posed of or abandoned within the 48-month period.

(2) Costs subject to capitalization. Allpackage design costs are subject to capi-talization without regard to whether thecosts create a package design (or modifi-cation to the design) having an ascertain-able useful life that extends substantiallybeyond the end of the tax year in whichthe costs are incurred. Thus, all packagedesign costs incurred prior to January 1,1987 that would be capitalized under§ 263 and the regulations thereunder butfor the fact that the costs create a package

design (or modification to the design)having an ascertainable useful life thatdoes not extend substantially beyond theend of the tax year in which the costs areincurred must be capitalized. All pack-age design costs incurred after December31, 1986 that would be capitalizedunder § 263A and the regulations there-under but for the fact that the costs createa package design (or modification to thedesign) having an ascertainable usefullife that does not extend substantially be-yond the end of the tax year in which thecosts are incurred must be capitalized.The costs required to be capitalized aredescribed in section 2 of this revenueprocedure.

(3) Half-year convention. Under thepool-of-cost capitalization and 48-monthamortization method, the amortization al-lowance for package design costs must bedetermined by treating all package designcosts incurred during the tax year as in-curred on the mid-point of the tax year. Ifthe tax year in which the package designcosts are incurred is 12 full months, thecosts are treated as incurred on the firstday of the seventh month of the tax year.For guidance in computing the amortiza-tion allowance under the pool-of-costcapitalization and 48-month amortizationmethod when package design costs are in-curred in a taxable year of less than 12months (a short taxable year), see Rev.Proc. 89–15.

SECTION 5. CHANGING PACKAGEDESIGN COSTS METHOD

.01 Automatic change. A taxpayerwanting to change its method of account-ing for package design costs must followthe provisions in Rev. Proc. 97-37.

.02 Section 481(a) adjustment. (1) Change to the capitalization

method. If the taxpayer is changing itsmethod of accounting for package designcosts to the capitalization method, the §481(a) adjustment (which will be posi-tive) will restore to income the totalamounts deducted or amortized in taxyears prior to the year of change with re-spect to all package designs (or modifica-tions to designs) subject to capitalizationand not abandoned as of the first day ofthe tax year of change, less the amountsthat would have been amortized duringthe tax years prior to the year of changewith respect to designs (or modifications

to designs) which had an ascertainableuseful life on the date the designs (ormodifications to the designs) were placedin service. The § 481(a) adjustment is thedifference at the beginning of the tax yearof change between the basis of all suchpackage designs (or modifications to de-signs) determined under the taxpayer’spresent method of accounting and thebasis redetermined under the capitaliza-tion method.

(2) Change to the design-by-designcapitalization and 60-month amortiza-tion method. If the taxpayer is changingits method of accounting for package de-sign costs to the design-by-design capi-talization and 60-month amortizationmethod, the § 481(a) adjustment is equalto the total amounts deducted or amor-tized in tax years prior to the year ofchange with respect to all package de-signs (or modifications to designs) sub-ject to capitalization and not abandonedas of the first day of the tax year ofchange, less the amounts that would havebeen amortized during the tax years priorto the year of change with respect to suchdesigns (or modifications to designs) hadthe design-by-design capitalization and60-month amortization method beenused.

(3) Change to the pool-of-cost capital-ization and 48-month amortizationmethod. If the taxpayer is changing itsmethod of accounting for package designcosts to the pool-of-cost capitalizationand 48-month amortization method, the§ 481(a) adjustment is equal to the totalamounts deducted or amortized in taxyears prior to the year of change with re-spect to all package design costs treatedas incurred during the tax years prior tothe year of change, less the amounts thatwould have been amortized during the taxyears prior to the year of change with re-spect to such costs had the pool-of-costcapitalization and 48-month amortizationmethod been used.

SECTION 6. INQUIRIES

Inquiries regarding this revenue proce-dure may be addressed to the Commis-sioner of Internal Revenue, Attention: Of-fice of Assistant Chief Counsel (IncomeTax and Accounting) CC:DOM:IT&A,1111 Constitution Avenue, NW, Washing-ton, DC 20224.

1997–33 I.R.B. 13 August 18, 1997

SECTION 7. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 90-63, 1990-2 C.B. 664, ismodified, and as modified, is superseded.However, see the transition rules in sec-tion 13.02 of Rev. Proc. 97-37.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective onAugust 18, 1997.


This revenue procedure was drafted inthe Office of Assistant Chief Counsel (In-come Tax & Accounting). For further in-formation regarding this revenue proce-dure, contact Robert A. Testoff on (202)622-4800 (not a toll free call).


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

Rev. Proc. 97–36

SECTION 1. PURPOSE

This revenue procedure provides an al-ternative last-in, first-out (LIFO) inventorycomputation method (the “AlternativeLIFO Method”) for a taxpayer engaged inthe trade or business of retail sales of newautomobiles or new light-duty trucks (“au-tomobile dealer”). A taxpayer may changeto or adopt the Alternative LIFO Method.The procedures for a taxpayer to change tothe Alternative LIFO Method are providedin Rev. Proc. 97–37, page 18, which pro-vides simplified and uniform procedures toobtain automatic consent to make this andother changes in methods of accounting.This revenue procedure modifies and su-persedes Rev. Proc. 92–79, 1992–2 C.B.457.

.02 The Alternative LIFO Method de-scribed in this revenue procedure is thesame method of accounting that was de-scribed in Rev. Proc. 92–79. Accordingly,a taxpayer that properly changed to oradopted this method pursuant to Rev.Proc. 92-79 is not required to change itsmethod of accounting to comply with thisrevenue procedure.


.01 In general. Section 472(a) of theInternal Revenue Code provides that a

taxpayer may use the LIFO inventorymethod of inventorying goods if, amongother requirements, the change to, anduse of, the method is in accordance withsuch regulations as the Secretary mayprescribe as necessary in order that theuse of the method may clearly reflect in-come.

.02 Dollar-value LIFO method. Sec-tion 1.472–8(a) of the Income Tax Regu-lations provides that any taxpayer mayelect to determine the cost of its LIFO in-ventories under the dollar-value LIFOmethod of accounting, provided suchmethod is used consistently and clearlyreflects income in accordance with therules of that section.

.03 Link-chain method. Section1.472–8(e)(1) permits the use of a “link-chain” method of computing the LIFOvalue of a dollar-value pool if the “dou-ble-extension” method and an “index”method would be impractical or unsuit-able in view of the nature of the inventoryin the dollar-value pool. Further, in ap-plying a link-chain method, an index maybe computed by “double extending” arepresentative portion of the inventory ina dollar-value, link-chain pool at both thecurrent-year cost and the prior-year cost.Additionally, an index may be computedunder a link-chain method using othersound and consistent statistical methods.

.04 Acceptable methods. Under exist-ing LIFO inventory provisions, there arethree general dollar-value LIFO methods:

(1) Simplified dollar-value LIFOmethod.

(a) Section 474 provides an elec-tive simplified dollar-value LIFO methodfor eligible small businesses. In general,a taxpayer is an eligible small business forany taxable year if its average annualgross receipts for the three precedingyears do not exceed $5,000,000.

(b) The simplified dollar-valueLIFO method under § 474 is based on aso-called link-chain method of computingthe LIFO value of an inventory pool.Under § 474, inventory pools are estab-lished by the major categories in the ap-plicable Government price index, and anannual index for each pool is obtainedfrom that Government price index.Therefore, under § 474, an eligible auto-mobile dealer uses a single inventory poolfor new automobiles and new trucksunder the major category, transportation

equipment, in the Producer Price Index(“PPI”) published by the Bureau of LaborStatistics (“BLS”).

(c) Under this link-chain method,two price indexes are computed for eachpool, an annual index and a cumulativeindex. The annual index represents thechange in price level of goods in the end-ing inventory of the pool for the currentyear from the price level of comparablegoods for the prior year. Under § 474, theannual index for computing the LIFOvalue of an automobile dealer’s single in-ventory pool is obtained using the pricechange from the preceding taxable yearfor the major index category, transporta-tion equipment, from the PPI.

(d) The cumulative index repre-sents the price level change from the be-ginning of the base year to the end of thecurrent year and is the product of each ofthe annual indexes. The cumulative indexis used to convert the total current-yearcost in an inventory pool at the close ofthe taxable year to base-year dollars bydividing the total current-year cost by thecumulative index, and also to determinethe value of any incremental increase inthe pool to be added to the ending inven-tory of the preceding year by multiplyingthat increment by the cumulative index.

(2) Inventory price index computa-tion method.

(a) Section 1.472-8(e)(3) providesanother simplified dollar-value LIFOmethod, the inventory price index compu-tation (IPIC) method, which is availableto all taxpayers. An automobile dealerusing the IPIC method must use thatmethod in determining the value of allgoods for which the automobile dealerhas elected to use the LIFO method.Under the IPIC method, special inventorypooling rules permit an automobile dealerto establish a single inventory pool fornew automobiles and new trucks underthe major category of the applicable Gov-ernment price index published by theBLS. 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 link-chain method of computing the LIFOvalue of an inventory pool. The annualindex for the pool is generally computedusing a stated percentage of the percentchange in the applicable detailedindex(es) for the major category of the ap-

August 18, 1997 14 1997–33 I.R.B.

plicable Government price index. Thestated percentage is 80 percent unless ataxpayer qualifies as an eligible smallbusiness under § 474, in which case thestated percent is 100 percent.

(3) General dollar-value LIFOmethod.

(a) If an automobile dealer doesnot want to use either the simplified dol-lar-value LIFO method for certain smallbusinesses provided in § 474 of the Code(if the taxpayer is eligible) or the IPICmethod provided in § 1.472–8(e)(3), theautomobile dealer may use the generaldollar-value LIFO inventory rules con-tained in § 1.472–8. Under these generalrules, an automobile dealer establishesinventory pools for each separate trade orbusiness under § 1.472–8(c) by majorlines, types, or classes of goods (for ex-ample, one separate pool for all new au-tomobiles and another separate pool forall new trucks). See Fox Chevrolet, Inc.Maryland v. Commissioner, 76 T.C. 708(1981), acq., 1984–2 C.B. 1, andRichardson Investments, Inc., and Sub-sidiaries v. Commissioner, 76 T.C. 736(1981).

(b) An automobile dealer may usethe double-extension method, an indexmethod, or a link-chain method, to com-pute the LIFO value of its inventorypools. Under all three of these methods,automobile dealers use their own costdata to compute the index for each pool.Because of the nature of the items in theirpools, automobile dealers generally use alink-chain method. The annual index foreach pool under the link-chain method iscomputed by “double extending” (that is,pricing) the vehicles (or “items”) in eachinventory pool as of the close of the tax-able year at the automobile dealer’s owncurrent year cost and at the automobiledealer’s own prior-year cost. For eachpool, the total current-year cost of the ve-hicles in ending inventory is divided bythe total prior-year cost of the vehicles inending inventory to compute the annualindex for the current year. The vehiclesused to determine the dealer’s own prior-year cost of vehicles in the current year’sending inventory must be comparable tothe vehicles used to compute the current-year cost of vehicles in the current year’sending inventory. For purposes of thisrevenue procedure, this is referred to asthe § 1.472-8 “comparability require-ment.”

.05 New alternative method. In addi-tion to the three general dollar-valueLIFO methods briefly described in sec-tion 2.04 of this revenue procedure, thisrevenue procedure provides an additionaldollar-value LIFO method for automobiledealers, the Alternative LIFO Method.This method is described in section 4 ofthis revenue procedure.

SECTION 3. SCOPE

The Alternative LIFO Method is avail-able to any automobile dealer engaged inthe business of retail sales of new auto-mobiles or new light-duty trucks for itsLIFO inventories of new automobiles andnew light-duty trucks. Light-duty trucksare trucks with a gross vehicle weight of14,000 pounds or less, which are also re-ferred to as class 1, 2, or 3 trucks.

SECTION 4. ALTERNATIVE LIFOMETHOD

.01 In general. (1) The Alternative LIFO Method is

a comprehensive dollar-value, link-chainLIFO method of accounting that encom-passes several LIFO sub-methods andmay only be used by an automobile dealerengaged in the trade or business of retailsales of new automobiles or new light-duty trucks to value its inventory of newautomobiles and new light-duty trucks.

(2) The Alternative LIFO Method isdesigned to simplify the dollar-valuecomputations of automobile dealers.Under the authority of § 1.446–1(c)(2)(ii),the Commissioner will waive strict adher-ence of the § 1.472–8 comparability re-quirement in applying the AlternativeLIFO Method, provided a taxpayer usesthe compensating sub-methods describedin section 4.02 of this revenue procedure,which, in the opinion of the Commis-sioner, are necessary to ensure that the Al-ternative LIFO Method clearly reflects in-come. These sub-methods includerequirements that (1) the current-year costof a new item be used as the prior yearcost for the new item, and (2) the automo-bile dealer use the manufacturer’s basemodel codes to define items for purposesof § 1.472–8. Generally, the manufac-turer’s base model codes used in definingitems and identifying new items under theAlternative LIFO Method have an aver-age life of approximately five to sevenyears.

(3) The Alternative LIFO Method in-cludes, by definition, all its sub-methods.Individual sub-methods used alone, or incombination with some but not all of thesub-methods of the Alternative LIFOMethod, may not clearly reflect income.Therefore, use of the Alternative LIFOMethod is conditioned upon an automo-bile dealer computing its LIFO inventoryusing all the sub-methods, definitions,and special rules provided in section 4.02of this revenue procedure, and the compu-tational methodology provided in section4.03 of this revenue procedure.

(4) The Alternative LIFO Methodwill be accepted by the Commissioner asan appropriate method of computing aninventory index, and the use of the Alter-native LIFO Method to compute the valueof the inventory pool or pools will be ac-cepted as accurate, reliable, and suitable.The automobile dealer’s computationsunder the Alternative LIFO Method are,however, subject to verification by thedistrict director upon examination of theautomobile dealer’s return.

.02 Sub-methods, definitions, and spe-cial rules.

(1) LIFO pools. For each separatetrade or business, (a) all new automobiles(regardless of manufacturer), includingthose used as demonstrators, must be in-cluded in one dollar-value LIFO pool, and(b) all new light-duty trucks (regardless ofmanufacturer), including those used asdemonstrators, must be included in an-other separate dollar-value LIFO pool.

(2) Specific identification incrementmethod. The current-year cost of theitems making up a pool must be deter-mined by reference to the actual cost ofthe specific new automobiles or newlight-duty trucks in ending inventory.Therefore, the actual cost of the specificvehicles on hand at year end will be thecurrent-year cost of such vehicles.

(3) Item of inventory. An item of in-ventory (“item category”) must be deter-mined using the entire manufacturer’sbase model code number that representsthe most detailed description of the basevehicle’s characteristics, such as modelline, body style, trim level, etc. The man-ufacturer’s base model code numbers arealmost always used as part of the vehicleidentification on each dealer invoice (forexample, a domestic model, trim level, 4-door sedan has a specific model code; aforeign model, 4-door sedan, trim level,

1997–33 I.R.B. 15 August 18, 1997

5-speed has a specific model code). Inthe case of conversion vans, an item of in-ventory must be determined using both(a) the entire manufacturer’s base modelcode, as described in the preceding sen-tence, and (b) the most detailed conver-sion package designation.

(4) Cost of the vehicle used for pur-poses of computing the pool index. Theactual base vehicle cost of each of thespecific vehicles in ending inventory isused to compute the index under the Al-ternative LIFO Method. The base vehiclecost of each vehicle is not adjusted forany options, accessories, or other costs.The pool index computed from only thebase vehicle cost of vehicles is applied tothe total vehicle cost, including options,accessories, and other costs, of all vehi-cles in the pool at the end of the taxableyear.

(5) Definition of a new item. A newitem category, which is an item categorynot considered in existence in the priortaxable year, is one of the following: (a)any new or reassigned manufacturer’smodel code, as described in section4.02(3) of this revenue procedure, that iscaused by a change in an existing vehicle,or (b) a manufacturer’s model code, as de-scribed in section 4.02(3) of this revenueprocedure, created or reassigned becausethe classified vehicle did not previouslyexist. Additionally, if there is no change ina manufacturer’s model code, but therehas been a change to the platform (i.e., thepiece of metal at the bottom of the chassisthat determines the length and width ofthe vehicle and the structural set-up of thevehicle) that results in a change in trackwidth or wheel-base, whether or not thesame model name was previously used bythe manufacturer, a new item category iscreated.

(6) Treatment of a new item not inexistence in the prior year. The automo-bile dealer must use the current-year basevehicle cost of the new item category asthe prior-year base vehicle cost of thatitem category.

(7) Item in existence in the prioryear, but not stocked. If an item in endinginventory was not stocked by the automo-bile dealer at the end of the prior year, butwas in existence in the prior year, the au-tomobile dealer must determine the prior-year base vehicle cost for that item by re-constructing what the base vehicle cost

for the item category would have beenusing a manufacturer’s price list that pro-vides dealer purchase prices. For eachsuch item category, the manufacturer’sprice list that must be used by the automo-bile dealer is the list in effect as of the be-ginning of the last month of the prior tax-able year.

.03 Computational methodology. The following rules are applied to com-

pute the LIFO value for each pool of anautomobile dealer’s ending inventoryunder the Alternative LIFO Method:

STEP 1. Obtain the actual invoice foreach vehicle in the automobile dealer’sending inventory.

STEP 2. For each pool, group all theinvoices from Step l by item category, asdefined in section 4.02(3) of this revenueprocedure.

STEP 3. For each item category, addtogether the dealer’s base vehicle costs ofall vehicles within each item category,from Step 2.

STEP 4. Within each pool, compute anaverage base vehicle cost for each itemcategory by dividing the result from Step3 for each item category by the number ofvehicles in the item category. This aver-age base vehicle cost for each item will beused in Step 6 of the succeeding year’scomputations using the Alternative LIFOMethod.

STEP 5. For each pool, compute thetotal current-year base vehicle cost of thepool by adding together the separate itemcategory totals from Step 3.

STEP 6. For each pool, compute thetotal base vehicle cost of the ending in-ventory at prior-year’s base vehicle cost.First, multiply the number of vehicles inthe current year’s ending inventory foreach item category by the average basevehicle cost of the same item categoryfrom Step 4 of the preceding year’s inven-tory calculation. If the same item was notin the prior year’s ending inventory, seesections 4.02(6) and 4.02(7) of this rev-enue procedure. Then, add together thetotal prior-year base vehicle cost of all ofthe item categories.

STEP 7. For each pool, compute thecurrent-year (annual) index by dividingthe amount from Step 5 by the amountfrom Step 6.

STEP 8. For each pool, compute thecumulative index by multiplying the cur-rent-year index from Step 7 by the cumu-

lative index at the end of the precedingyear (from Step 8 of the preceding year’scomputation).

STEP 9. For each pool, compute thetotal current-year total- vehicle cost byadding together the total invoice cost, in-cluding installed options, accessories, andother inventoriable cost(s), of all the vehi-cles in inventory at the end of the currentyear.

STEP 10. For each pool, compute thetotal cost of the current-year’s ending in-ventory at base-year cost by dividing thetotal current-year total-vehicle cost of allthe vehicles in ending inventory, fromStep 9, by the cumulative index from Step8.

STEP 11. For each pool, determine ifthere is an increment for the current yearby comparing the total cost of the pool’scurrent-year ending inventory at base-year cost, from Step 10, with the total costof the pool’s preceding year’s ending in-ventory at base-year cost, using theamount from Step 10 of the precedingyear’s calculation. If the amount fromStep 10 of the current year’s calculation isgreater, there is an increment.

STEP 12. For each pool, value the cur-rent year’s increment at current-year costby multiplying the increment amountfrom Step 11 by the cumulative indexfrom Step 8.

STEP 13. If there is no increment for apool, but, rather, a liquidation (also re-ferred to as a decrement), reduce the LIFOlayers in reverse chronological order untilthe liquidation is fully absorbed.

STEP 14. For each pool, add togetherthe current year’s increment, if any, atcurrent-year cost and the prior years’ in-crements at each prior year’s current-yearcost to compute the total LIFO value forthe pool.

SECTION 5. CHANGING TO ALTERNATIVE LIFO METHOD

.01 Automatic change. Except as pro-vided in section 5.02 of this revenue pro-cedure, an automobile dealer wanting tochange to the Alternative LIFO Methodmust follow the provisions in Rev. Proc.97–37.

.02 Nonautomatic change. An automo-bile dealer that uses the IPIC method forgoods other than new automobiles, newlight-duty trucks, parts and accessories,used automobiles, and used trucks, must

August 18, 1997 16 1997–33 I.R.B.

change to the Alternative LIFO Methodunder Rev. Proc. 97–27, 1997–21 I.R.B.10.

.03 Conditions. An automobile dealerchanging to the Alternative LIFO Methodmust comply with the following condi-tions:

(1) the automobile dealer must keepits books and records for the year ofchange and for later taxable years on theLIFO inventory method and use theLIFO inventory method for all reports,including consolidated financial state-ments, if any, and statements for creditpurposes, in conformity with the provi-sions of § 1.472–2(e) of the regulations;

(2) the automobile dealer must valueits inventory of new automobiles andnew light-duty trucks as of the end of theyear of change and for later taxable yearsunder the Alternative LIFO Method, asprovided in section 4 of this revenue pro-cedure, unless it obtains permission tochange to another recognized method;

(3) the automobile dealer changingfrom the IPIC method for its inventory ofparts and accessories, used automobiles,and used trucks must value its inventoryof parts and accessories, used automo-biles and used trucks as of the end of theyear of change and for later taxable yearsunder the methods provided in section10.03(2)(b) of the APPENDIX of Rev.Proc. 97–37, unless it obtains permissionto change to another recognized method;

(4) the conversion from the specificgoods method, if applicable, to the dol-lar-value method must be made in accor-dance with § 1.472–8(f)(2);

(5) the automobile dealer must fileForm 970, Application to Use LIFO In-ventory Method, with its federal incometax return for the year of change and oth-erwise comply with the provisions of §472(d) and § 1.472–3 (see also Rev. Rul.76–282, 1976–2 C.B. 137) to extend theLIFO election (i) to include any new au-tomobiles and new light-duty trucks (forexample, demonstrators) to which theLIFO election did not previously applybut that are required to be included inLIFO pools under the Alternative LIFOMethod, and (ii) for an automobiledealer changing from the IPIC method,to include any parts and accessories,used automobiles, and used trucks, towhich the LIFO election did not previ-ously apply but that are required to be in-

cluded in LIFO pools under section10.03 of the APPENDIX to Rev. Proc.97–37, as of the beginning of the year ofchange;

(6) the automobile dealer must ef-fect the change to the Alternative LIFOMethod, and in the case of an automobiledealer changing from the IPIC method tothe methods provided in section10.03(2)(b) of the APPENDIX of Rev.Proc. 97–37, using the cut-off method.Under the cut-off method, the value ofthe automobile dealer’s new automobileand new light-duty truck inventory, andin the case of an automobile dealerchanging from the IPIC method, the partsand accessories, used automobile, andused truck inventory, at the beginning ofthe year of change must be the same asthe value of such inventory at the end ofthe preceding taxable year plus marketvalue restorations, if any, required pur-suant to section 5.03(5) of this revenueprocedure;

(7) the automobile dealer must com-bine and/or separate the dollar-value in-ventory pool or pools, including any poolresulting from section 5.03(4) of this rev-enue procedure, if applicable, to conformto the inventory pooling rules provided insection 4 of this revenue procedure, andin the case of an automobile dealerchanging from the IPIC method, to theinventory pooling rules provided in sec-tion 10.03(2)(b) of the APPENDIX ofRev. Proc. 97–37, in accordance with theprovisions of § 1.472–8(g)(2);

(8) in effecting the changes, any lay-ers of inventory increments previouslydetermined and the LIFO value of suchincrements must be retained. Instead ofusing the earliest taxable year for whichthe automobile dealer adopted the LIFOmethod for any items in the inventorypool or pools, the year of change must beused as the base year in determining theLIFO value of the inventory pool orpools for the year of change and later tax-able years (the cumulative index at thebeginning of the year of change will be1.00). The base-year costs of layers ofincrements in the pool or pools at the be-ginning of the year of change must be re-stated in terms of the new base-yearcosts, using the year of change as the newbase year; and

(9) the automobile dealer mustmaintain and retain complete records of

the computations of the LIFO inventoryunder the Alternative LIFO Method, aswell as copies of the actual purchase in-voice for each vehicle used in the compu-tation.


Inquiries regarding this revenue proce-dure may be addressed to the Commis-sioner of Internal Revenue, Attention:CC:DOM:IT&A, 1111 Constitution Av-enue, NW, Washington, DC 20224.


Rev. Proc. 92–79, 1992–2 C.B. 457, ismodified, and as modified, is superseded.However, see the transition rules in sec-tion 13.02 of Rev. Proc. 97–37.



SECTION 9. ELECTING LIFO ANDADOPTING THE ALTERNATIVE LIFOMETHOD

.01 In general. An automobile dealerthat adopts the Alternative LIFO Methodprovided in this revenue procedure at thetime the automobile dealer makes anelection to use (or extend) the dollar-value LIFO inventory method must com-plete and file a statement of electionmade on a current Form 970, pursuant tothe instructions for Form 970, or in suchother manner as may be acceptable to theCommissioner. The use of the Alterna-tive LIFO Method should be clearly indi-cated on the Form 970, or an attachmentto the Form 970, and reference should bemade to this revenue procedure. Appro-priate LIFO sub-method elections thatare an integral part of the AlternativeLIFO Method, which are contained onthe Form 970, must be selected on theForm 970 upon adoption of the Alterna-tive LIFO Method.

.02 Conditions. A taxpayer adoptingthe Alternative LIFO Method must com-ply with the conditions stated in section5.03(1), (2), and (9) of this revenue proce-dure.

SECTION 10. PAPERWORKREDUCTION ACT

The collections of information con-

1997–33 I.R.B. 17 August 18, 1997

tained in this revenue procedure havebeen reviewed and approved by the Of-fice of Management and Budget in accor-dance with the Paperwork Reduction Act(44 U.S.C. 3507) under control number1545–1551.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validOMB control number.

The collections of information in thisrevenue procedure are in section 5. Thisinformation is necessary and will be usedto determine whether the taxpayer isproperly using the Alternative LIFOMethod. The collections of informationare required for the taxpayer to use the Al-ternative LIFO Method. The likelyrecordkeepers are individuals, business orother for-profit institutions, and smallbusinesses or organizations.

The estimated total annual recordkeep-ing burden is 200,000 hours.

The estimated annual burden perrecordkeeper is 25 hours. The estimatednumber of recordkeepers is 8,000.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.


This revenue procedure was drafted inthe Office of Assistant Chief Counsel (In-come Tax and Accounting). For furtherinformation regarding this revenue proce-dure, contact Richard H. Berken on 202-622-4970 (not a toll-free call).


(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

.01 Change in method of accounting defined. . . . . . . . . . . . . . . . . . . 19

.02 Securing permission to make amethod change . . . . . . . . . . . . 19

.03 Terms and conditions of amethod 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-offmethod. . . . . . . . . . . . . . . . . . . 20

.07 Consistency and clear reflectionof 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) adjustmentperiod. . . . . . . . . . . . . . . . . . . . 21

.08 Under examination . . . . . . . . . 21(1) In general . . . . . . . . . . . . . . 21(2) Partnerships and S corpora-tions 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 inven-tory 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 CONDI-TIONS 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 ad-justment periods . . . . . . . . . . . 22

.05 NOL carryback limitation for taxpayer subject to criminal investigation . . . . . . . . . . . . . . 23

.06 Change treated as initiated by thetaxpayer . . . . . . . . . . . . . . . . . . 24

SECTION 6. GENERALAPPLICATION 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 certainconsolidated 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 PROTECTIONFOR TAXABLE YEARS PRIOR TOYEAR 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-initiatedchange . . . . . . . . . . . . . . . . . . . 26(4) Criminal investigation . . . . 26

SECTION 8. EFFECT OF CONSENT . . . . . . . . . . . . . . . . . . . . . 26

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

.02 Retroactive change or modifica-tion. . . . . . . . . . . . . . . . . . . . . . 26

August 18, 1997 18 1997–33 I.R.B.

SECTION 9. REVIEW BY DISTRICTDIRECTOR. . . . . . . . . . . . . . . . . . . . . 26

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

.02 National office consideration . 26

SECTION 10. REVIEW BY NATIONALOFFICE. . . . . . . . . . . . . . . . . . . . . . . . 26

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

.02 Incomplete application—21 dayrule. . . . . . . . . . . . . . . . . . . . . . 26

.03 Conference in the national office . . . . . . . . . . . . . . . . . . . . 27

.04 National office determination . 27

SECTION 11. APPLICABILITY OFREV. 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 forpayroll taxes . . . . . . . . . . . . . . 28

SECTION 14. EFFECT ON OTHERDOCUMENTS . . . . . . . . . . . . . . . . . . 28

.01 Modified and superseded. . . . . 28

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

SECTION 15. PAPERWORKREDUCTION ACT. . . . . . . . . . . . . . . 28

DRAFTING INFORMATION . . . . . . 28

APPENDIX (TABLE OF CONTENTS). . . . . . . . . . . . . . . . . . . . 28

SECTION 1. PURPOSE

This revenue procedure provides theprocedures by which a taxpayer may ob-tain automatic consent to change themethods of accounting described in theAPPENDIX of this revenue procedure.This revenue procedure consolidates andsupersedes most published automatic con-sent guidance for changes in methods ofaccounting, and generally provides sim-plified, uniform procedures and terms andconditions to obtain automatic consent tomake these changes. It also provides newautomatic consent procedures for changesin several other methods of accounting. Ataxpayer complying with all the applica-ble provisions of this revenue procedurehas obtained the consent of the Commis-sioner of Internal Revenue to change itsmethod of accounting under § 446(e) ofthe Internal Revenue Code and the In-come Tax Regulations thereunder.


.01 Change in method of accountingdefined.

(1) Section 1.446–1(e)(2)(ii)(a) ofthe Income Tax Regulations provides thata change in method of accounting in-cludes a change in the overall plan of ac-counting for gross income or deductions,or a change in the treatment of any mater-ial item. A material item is any item thatinvolves the proper time for the inclusionof the item in income or the taking of theitem as a deduction. In determiningwhether a taxpayer’s accounting practicefor an item involves timing, generally therelevant question is whether the practicepermanently changes the amount of thetaxpayer’s lifetime income. If the prac-tice does not permanently affect the tax-payer’s lifetime income, but does or couldchange the taxable year in which incomeis reported, it involves timing and istherefore a method of accounting. SeeRev. Proc. 91–31, 1991–1 C.B. 566.

(2) Although a method of accountingmay exist under this definition without apattern of consistent treatment of an item,a method of accounting is not adopted inmost instances without consistent treat-ment. The treatment of a material item inthe same way in determining the gross in-come or deductions in two or more con-secutively filed tax returns (without re-gard to any change in status of the methodas permissible or impermissible) repre-sents consistent treatment of that item forpurposes of § 1.446–1(e)(2)(ii)(a). If ataxpayer treats an item properly in thefirst return that reflects the item, however,it is not necessary for the taxpayer to treatthe item consistently in two or more con-secutive tax returns to have adopted amethod of accounting. If a taxpayer hasadopted a method of accounting underthese rules, the taxpayer may not changethe method by amending its prior incometax return(s). See Rev. Rul. 90–38,1990–1 C.B. 57.

(3) A change in the characterizationof an item may also constitute a change inmethod of accounting if the change hasthe effect of shifting income from one pe-riod to another. For example, a changefrom treating an item as income to treat-ing the item as a deposit is a change inmethod of accounting. See Rev. Proc.91–31.

(4) A change in method of account-

ing does not include correction of mathe-matical or posting errors, or errors in thecomputation of tax liability (such as er-rors in computation of the foreign taxcredit, net operating loss, percentage de-pletion, or investment credit). See § 1.446–1(e)(2)(ii)(b).

.02 Securing permission to make amethod change. Section 446(e) and §1.446–1(e) state that, except as otherwiseprovided, a taxpayer must secure the con-sent of the Commissioner before changinga method of accounting for federal incometax purposes. Section 1.446–1T(e)(3)-(i)(B) requires that, in order to obtain theCommissioner’s consent to a methodchange, a taxpayer must file a Form 3115,Application for Change in AccountingMethod, during the taxable year in whichthe taxpayer wants to make the proposedchange.

.03 Terms and conditions of a methodchange. Section 1.446–1(e)(3)(ii) autho-rizes the Commissioner to prescribe ad-ministrative procedures setting forth thelimitations, terms, and conditions deemednecessary to permit a taxpayer to obtainconsent to change a method of accountingin accordance with § 446(e). The termsand conditions the Commissioner mayprescribe 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 theCommissioner, a taxpayer may not re-quest, or otherwise make, a retroactivechange in method of accounting, regard-less of whether the change is from a per-missible or an impermissible method. Seegenerally Rev. Rul. 90–38.

.05 Method change with a § 481(a) ad-justment.

(1) Need for adjustment. Section481(a) requires those adjustments neces-sary to prevent amounts from being dupli-cated or omitted to be taken into accountwhen the taxpayer’s taxable income iscomputed under a method of accountingdifferent from the method used to com-pute taxable income for the preceding tax-able year. When there is a change inmethod of accounting to which § 481(a) isapplied, income for the taxable year pre-ceding the year of change must be deter-mined under the method of accountingthat was then employed, and income for

1997–33 I.R.B. 19 August 18, 1997

the year of change and the following tax-able years must be determined under thenew method of accounting as if the newmethod had always been used.

Example. A taxpayer that is not required to useinventories uses the overall cash receipts and dis-bursements method and changes to an overall ac-crual method. The taxpayer has $120,000 of incomeearned 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 yearpreceding the year of change. A positive § 481(a)adjustment of $20,000 ($120,000 accounts receiv-able less $100,000 accounts payable) is required as aresult of the change.

(2) Adjustment period. Section481(c) and §§ 1.446–1T(e)(3)(i) and1.481–4 provide that the adjustment re-quired by § 481(a) may be taken into ac-count in determining taxable income inthe manner and subject to the conditionsagreed to by the Commissioner and thetaxpayer. Generally, in the absence ofsuch an agreement, the § 481(a) adjust-ment is taken into account completely inthe year of change, subject to § 481(b)which limits the amount of tax where the§ 481(a) adjustment is substantial. How-ever, under the Commissioner’s authorityin § 1.446–1(e)(3)(ii) to prescribe termsand conditions for changes in methods ofaccounting, this revenue procedure pro-vides specific adjustment periods that areintended to achieve an appropriate bal-ance between the goals of mitigating dis-tortions of income that result from ac-counting method changes and providingappropriate incentives for voluntary com-pliance.

.06 Method change using a cut-offmethod. The Commissioner may deter-mine that certain changes in methods ofaccounting will be made without a §481(a) adjustment, using a “cut-offmethod.” Under a cut-off method, onlythe items arising on or after the beginningof the year of change (or other operativedate) are accounted for under the newmethod of accounting. Any items arisingbefore the year of change (or other opera-tive date) continue to be accounted forunder the taxpayer’s former method of ac-counting. See, for example, § 263A(which generally applies to costs incurredafter December 31, 1986, for noninven-tory property), § 461(h) (which generallyapplies to amounts incurred on or afterJuly 18, 1984), and § 1.446–3 (which ap-plies to notional principal contracts en-tered into on or after December 13, 1993).

Because no items are duplicated or omit-ted from income when a cut-off method isused to effect a change in accountingmethod, no § 481(a) adjustment is neces-sary.

.07 Consistency and clear reflection ofincome. Methods of accounting shouldclearly reflect income on a continuingbasis, and the Internal Revenue Serviceexercises its discretion under §§ 446(e)and 481(c) in a manner that generallyminimizes distortions of income acrosstaxable 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 ormore separate and distinct trades or busi-nesses, a different method of accountingmay be used for each trade or businessprovided the method of accounting usedfor each trade or business clearly reflectsthe overall income of the taxpayer as wellas that of each particular trade or busi-ness. No trade or business is separate anddistinct unless a complete and separableset of books and records is kept for thattrade or business.

(2) Section 1.446–1(d)(3) providesthat if, by reason of maintaining differentmethods of accounting, there is a creationor shifting of profits or losses between thetrades or businesses of the taxpayer (forexample, through inventory adjustments,sales, purchases, or expenses) so that in-come of the taxpayer is not clearly re-flected, the trades or businesses of thetaxpayer are not separate and distinct.

.09 Penalties. Any otherwise applica-ble penalty for the failure of a taxpayer tochange its method of accounting (for ex-ample, the accuracy-related penalty under§ 6662 or the fraud penalty under § 6663)may be imposed if the taxpayer does nottimely file a request to change a methodof accounting. See § 446(f). Addition-ally, the taxpayer’s return preparer mayalso be subject to the preparer penaltyunder § 6694. However, penalties willnot be imposed when a taxpayer changesfrom an impermissible method of ac-counting to a permissible one by comply-ing with all applicable provisions of thisrevenue procedure.

.10 Change made as part of an exami-nation. Section 446(b) and § 1.446–1-(b)(1) provide that if a taxpayer does notregularly employ a method of accountingthat clearly reflects its income, the compu-

tation of taxable income must be made in amanner that, in the opinion of the Commis-sioner, does clearly reflect income. If ataxpayer under examination is not eligibleto change a method of accounting underthis revenue procedure, the change may bemade by the district director. A change re-sulting in a positive § 481(a) adjustmentwill ordinarily be made in the earliest tax-able year under examination with a one-year § 481(a) adjustment period.


.01 Application. The term “applica-tion” includes a Form 3115, or any state-ment that is authorized under the APPEN-DIX of this revenue procedure to be filedin lieu of a Form 3115, and any attach-ments.

.02 Taxpayer.(1) In general. The term “taxpayer”

has the same meaning as the term “per-son” defined in § 7701(a)(1) (rather thanthe meaning of the term “taxpayer” de-fined in § 7701(a)(14)).

(2) Consolidated group. For pur-poses of (a) sections 3.08(1), 3.09(1), and4.02(1) of this revenue procedure (tax-payer under examination), (b) sections3.09(2) and 4.02(2) of this revenue proce-dure (taxpayer before an appeals office),or (c) sections 3.09(3) and 4.02(3) of thisrevenue procedure (taxpayer before a fed-eral court), the term “taxpayer” includes aconsolidated group.

.03 Filed. Any form (including an ap-plication), statement, or other documentrequired to be filed under this revenueprocedure is filed on the date it is mailedto the proper address (or an address simi-lar enough to complete delivery). If theform, statement, or other document is notmailed (or the date it is mailed cannot bereasonably determined), it is filed on thedate it is delivered to the Service.

.04 Mailed. The date of mailing willbe determined under the rules of § 7502.For example, the date of mailing is thedate of the U.S. postmark or the applica-ble date recorded or marked by a desig-nated private delivery service. See Notice97–26, 1997–17 I.R.B. 6.

.05 Timely performance of acts. Therules of § 7503 apply when the last dayfor the taxpayer’s timely performance ofany act (for example, filing an applicationor submitting additional information) fallson a Saturday, Sunday, or legal holiday.

August 18, 1997 20 1997–33 I.R.B.

The performance of any act is timely ifthe act is performed on the next succeed-ing day that is not a Saturday, Sunday, orlegal holiday.

.06 Year of change. The year ofchange is the taxable year for which achange in method of accounting is effec-tive, that is, the first taxable year the newmethod is to be used, even if no affecteditems are taken into account for that year.

.07 Section 481(a) adjustment period.The § 481(a) adjustment period is the ap-plicable number of taxable years for tak-ing into account the § 481(a) adjustmentrequired as a result of the change inmethod of accounting. The year ofchange is the first taxable year in the ad-justment period and the § 481(a) adjust-ment is taken into account ratably overthe number of taxable years in the adjust-ment period. The applicable adjustmentperiods are set forth in section 5.04 of thisrevenue procedure.

.08 Under examination.(1) In general.

(a) Except as provided in section3.08(2) of this revenue procedure, an ex-amination of a taxpayer with respect to afederal income tax return begins on thedate the taxpayer is contacted in any man-ner by a representative of the Service forthe purpose of scheduling any type of ex-amination of the return. An examinationends:

(i) in a case in which the Ser-vice accepts the return as filed, on thedate of the “no change” letter sent to thetaxpayer;

(ii) in a fully agreed case, on theearliest of the date the taxpayer executes awaiver of restrictions on assessment oracceptance of overassessment (for exam-ple, Form 870, 4549, or 4605), the datethe taxpayer makes a payment of tax thatequals or exceeds the proposed defi-ciency, or the date of the “closing” letter(for example, Letter 891 or 987) sent tothe taxpayer; or

(iii) in an unagreed or a par-tially agreed case, on the earliest of thedate the taxpayer (or its representative) isnotified by Appeals that the case has beenreferred to Appeals from Examination,the date the taxpayer files a petition in theTax Court, the date on which the periodfor filing a petition with the Tax Court ex-pires, or the date of the notice of claimdisallowance.

(b) An examination does not endas a result of the early referral of an issueto Appeals under the provisions of Rev.Proc. 96–9, 1996–1 C.B. 575.

(c) An examination resumes onthe date the taxpayer (or its representa-tive) is notified by Appeals (or otherwise)that the case has been referred to Exami-nation for reconsideration.

(2) Partnerships and S corporationssubject to TEFRA. For an entity (includ-ing a limited liability company), treatedas a partnership or an S corporation forfederal income tax purposes, that is sub-ject to the TEFRA unified audit and litiga-tion provisions for partnerships and S cor-porations, an examination begins on thedate of the notice of the beginning of anadministrative proceeding sent to the TaxMatters Partner/Tax Matters Person(TMP). An examination ends:

(a) in a case in which the Serviceaccepts the partnership or S corporationreturn as filed, on the date of the “no ad-justments” letter or the “no change” no-tice of final administrative adjustmentsent to the TMP;

(b) in a fully agreed case, when allthe partners, members, or shareholdersexecute a Form 870–P, 870–L, or 870–S;or

(c) in an unagreed or a partiallyagreed case, on the earliest of the date theTMP (or its representative) is notified byAppeals that the case has been referred toAppeals from Examination, the date theTMP (or a partner, member, or share-holder) requests judicial review, or thedate on which the period for requestingjudicial review expires. But see section 4.02(5) of this revenueprocedure for certain rules that precludean entity from requesting a change in ac-counting method. Also note that S corpo-rations are not subject to the TEFRA uni-fied audit and litigation provisions fortaxable years beginning after December31, 1996. See Small Business Job Protec-tion Act of 1996, Pub. L. No. 104–188, §1317(a), 110 Stat. 1755, 1787 (1996).

.09 Issue under consideration.(1) Under examination. A tax-

payer’s method of accounting for an itemis an issue under consideration for the tax-able years under examination if the tax-payer receives written notification (forexample, by examination plan, informa-tion document request (IDR), or notifica-

tion of proposed adjustments or incometax examination changes) from the exam-ining agent(s) specifically citing the treat-ment of the item as an issue under consid-eration. For example, a taxpayer’smethod of pooling under the dollar-value,last-in, first-out (LIFO) inventory methodis an issue under consideration as a resultof an examination plan that identifiesLIFO pooling as a matter to be examined,but it is not an issue under considerationas a result of an examination plan thatmerely identifies LIFO inventories as amatter to be examined. Similarly, a tax-payer’s method of determining inventori-able costs under § 263A is an issue underconsideration as a result of an IDR that re-quests documentation supporting thecosts included in inventoriable costs, butit is not an issue under consideration as aresult of an IDR that requests documenta-tion supporting the amount of cost ofgoods sold reported on the return. Thequestion of whether a method of account-ing is an issue under consideration may bereferred to the national office as a requestfor technical advice under the provisionsof Rev. Proc. 97–2, 1997–1 I.R.B. 64 (orany successor).

(2) Before an appeals office. A tax-payer’s method of accounting for an itemis an issue under consideration for the tax-able years before an appeals office if thetreatment of the item is included as anitem of adjustment in the examination re-port referred to Appeals or is specificallyidentified in writing to the taxpayer byAppeals.

(3) Before a federal court. A tax-payer’s method of accounting for an itemis an issue under consideration for the tax-able years before a federal court if thetreatment of the item is included in thestatutory notice of deficiency, the noticeof claim disallowance, the notice of finaladministrative adjustment, the pleadings(for example, the petition, complaint, oranswer) or amendments thereto, or isspecifically identified in writing to thetaxpayer by the counsel for the govern-ment.

.10 Change within the LIFO inventorymethod. A change within the LIFO in-ventory method is a change from oneLIFO inventory method or sub-method toanother LIFO inventory method or sub-method. A change within the LIFO in-ventory method does not include a

1997–33 I.R.B. 21 August 18, 1997

change in method of accounting thatcould be made by a taxpayer that doesnot use the LIFO inventory method (forexample, a method governed by § 471 or§ 263A).

SECTION 4. SCOPE

.01 Applicability. Except as otherwiseprovided in section 4.02 of this revenueprocedure, this revenue procedure appliesto a taxpayer requesting the Commis-sioner’s consent to change to a method ofaccounting described in the APPENDIXof this revenue procedure. Except as oth-erwise provided in this revenue procedure(see, for example, section 2.01 of the AP-PENDIX of this revenue procedure), thisrevenue procedure is the exclusive proce-dure for a taxpayer within its scope to ob-tain the Commissioner’s consent.

.02 Inapplicability. Except as other-wise provided in the APPENDIX of thisrevenue procedure (see, for example, sec-tions 4.01 and 12.01 of the APPENDIX ofthis revenue procedure), this revenue pro-cedure does not apply in the following sit-uations:

(1) Under examination. If, on thedate the taxpayer would otherwise file acopy of the application with the nationaloffice, the taxpayer is under examination(as provided in section 3.08 of this rev-enue procedure), except as provided insections 6.03(2) (90-day window),6.03(3) (120-day window), and 6.03(4)(district director consent) of this revenueprocedure;

(2) Before an appeals office. If, onthe date the taxpayer would otherwisefile a copy of the application with the na-tional office, the taxpayer is before an ap-peals office with respect to any incometax issue and the method of accounting tobe changed is an issue under considera-tion by the appeals office (as provided insection 3.09(2) of this revenue proce-dure);

(3) Before a federal court. If, on thedate the taxpayer would otherwise file acopy of the application with the nationaloffice, the taxpayer is before a federalcourt with respect to any income tax issueand the method of accounting to bechanged is an issue under considerationby the federal court (as provided in sec-tion 3.09(3) of this revenue procedure);

(4) Consolidated group member. Acorporation that is (or was formerly) a

member of a consolidated group is underexamination, before an appeals office, orbefore a federal court (for purposes ofsections 4.02(1), (2), and (3) of this rev-enue procedure) if the consolidated groupis under examination, before an appealsoffice, or before a federal court for a tax-able year(s) that the corporation was amember of the group;

(5) Partnerships and S corporations.For an entity (including a limited liabilitycompany) treated as a partnership or an Scorporation for federal income tax pur-poses, if, on the date the entity would oth-erwise file a copy of the application withthe national office, the entity’s accountingmethod to be changed is an issue underconsideration in an examination of a part-ner, member, or shareholder’s federal in-come tax return or an issue under consid-eration by an appeals office or by afederal court with respect to a partner,member, or shareholder’s federal incometax return;

(6) Prior change. If the taxpayer,within the last four taxable years prior tothe year of change, (a) has made a changein the same method of accounting (with orwithout obtaining the Commissioner’sconsent) or (b) has applied to change thesame method of accounting without ef-fecting the change (whether the applica-tion to change was withdrawn, not per-fected, not granted, or denied); or

(7) Section 381(a) transaction. Ifthe taxpayer engages in a transaction towhich § 381(a) applies within the pro-posed taxable year of change (determinedwithout regard to any potential closing ofthe year under § 381(b)(1)).

.03 Nonautomatic changes. If eithersection 4.02(6) or 4.02(7) of this revenueprocedure precludes a taxpayer fromusing this revenue procedure to make achange in method of accounting, the tax-payer requesting such a change must file aForm 3115 with the Commissioner in ac-cordance with the requirements of §1.446–1(e)(3)(i) and Rev. Proc. 97–27,1997–21 I.R.B. 10 (or any other applica-ble Code, regulation, or administrativeprovision).

SECTION 5. TERMS AND CONDITIONS OF CHANGE

.01 In general. An accounting methodchange filed under this revenue proceduremust be made pursuant to the terms and

conditions provided in this revenue proce-dure.

.02 Year of change. The year of changeis the taxable year designated on the ap-plication and for which the application istimely filed under section 6.02(2).

.03 Section 481(a) adjustment. Unlessotherwise provided in this revenue proce-dure, a taxpayer making a change inmethod of accounting under this revenueprocedure must take into account a §481(a) adjustment in the manner providedin 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 AP-PENDIX of this revenue procedure, the §481(a) adjustment period for positive andnegative § 481(a) adjustments is four tax-able years.

(2) Short period as a separate tax-able year. If the year of change, or anytaxable year during the § 481(a) adjust-ment period, is a short taxable year, the §481(a) adjustment must be included in in-come as if that short taxable year were afull 12-month taxable year. See Rev. Rul.78–165, 1978–1 C.B. 276.

Example 1. A calendar year taxpayer receivedpermission to change an accounting method begin-ning with the 1997 calendar year. The § 481(a) ad-justment is $30,000 and the adjustment period isfour taxable years. The taxpayer subsequently re-ceives permission to change its annual accountingperiod to September 30, effective for the taxableyear ending September 30, 1998. The taxpayer mustinclude $7,500 of the § 481(a) adjustment in grossincome for the short period from January 1, 1998,through September 30, 1998.

Example 2. Corporation X, a calendar year tax-payer, received permission to change an accountingmethod beginning with the 1997 calendar year. The§ 481(a) adjustment is $30,000 and the adjustmentperiod is four taxable years. On July 1, 1999, Cor-poration Z acquires Corporation X in a transaction towhich § 381(a) applies. Corporation Z is a calendaryear taxpayer that uses the same method of account-ing to which Corporation X changed in 1997. Cor-poration X must include $7,500 of the § 481(a) ad-justment in gross income for its short period incometax 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 inits income tax return for calendar year 1999.

(3) Shortened or accelerated adjust-ment periods. The § 481(a) adjustmentperiod provided in section 5.04(1) or theAPPENDIX of this revenue procedurewill be shortened or accelerated in the fol-lowing situations.

(a) De minimis rule. A taxpayermay elect to use a one-year adjustmentperiod in lieu of the § 481(a) adjustment

August 18, 1997 22 1997–33 I.R.B.

period otherwise provided by this revenueprocedure if the entire § 481(a) adjust-ment is less than $25,000 (either positiveor negative). A taxpayer makes an elec-tion under this de minimis rule by so indi-cating on the application. For example,for a taxpayer filing a Form 3115, the tax-payer must complete the appropriate lineon the Form 3115 to elect this de minimisrule.

(b) Cooperatives. A cooperativewithin the meaning of § 1381(a) generallymust take the entire amount of a § 481(a)adjustment into account in computing tax-able income for the year of change. SeeRev. Rul. 79–45, 1979–1 C.B. 284.

(c) Ceasing to engage in the tradeor business.

(i) In general. A taxpayer thatceases to engage in a trade or business orterminates its existence must take the re-maining balance of any § 481(a) adjust-ment relating to the trade or business intoaccount in computing taxable income inthe taxable year of the cessation or termi-nation. Except as provided in sections5.04(3)(c)(iv) and (v) of this revenue pro-cedure, a taxpayer is treated as ceasing toengage in a trade or business if the opera-tions of the trade or business cease or sub-stantially all the assets of the trade orbusiness are transferred to another tax-payer. For this purpose, “substantiallyall” has the same meaning as in section3.01 of Rev. Proc. 77–37, 1977–2 C.B.568.

(ii) Examples of transactionsthat are treated as the cessation of a tradeor business. The following is a nonexclu-sive list of transactions that are treated asthe cessation of a trade or business forpurposes of accelerating the § 481(a) ad-justment under section 5.04(3)(c) of thisrevenue procedure:

(A) the trade or business towhich the § 481(a) adjustment relates isincorporated;

(B) the trade or business towhich the § 481(a) adjustment relates ispurchased by another taxpayer in a trans-action to which § 1060 applies;

(C) the trade or business towhich the § 481(a) adjustment relates isterminated or transferred pursuant to ataxable liquidation;

(D) a division of a corpora-tion ceases to operate the trade or busi-ness to which the § 481(a) adjustment re-

lates; or (E) the assets of a trade or

business to which the § 481(a) adjustmentrelates are contributed to a partnership.

(iii) Conversion to or from Scorporation status. Except as provided insection 10.01 of the APPENDIX of thisrevenue procedure, no acceleration of a §481(a) adjustment is required under sec-tion 5.04(3)(c) of this revenue procedurewhen a C corporation elects to be treatedas an S corporation or an S corporationterminates its S election and is thentreated as a C corporation.

(iv) Certain transfers to which§ 381(a) applies. No acceleration of the §481(a) adjustment is required under sec-tion 5.04(3)(c) of this revenue procedurewhen a taxpayer transfers substantially allthe assets of the trade or business thatgave rise to the § 481(a) adjustment to an-other 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 iscarried over and used by the acquiringcorporation immediately after the transferpursuant to § 381(c). The acquiring cor-poration is subject to any terms and con-ditions imposed on the transferor (or anypredecessor of the transferor) as a resultof its change in method of accounting.

(v) Certain transfers pursuantto § 351 within a consolidated group.

(A) In general. No accelera-tion of the § 481(a) adjustment is requiredunder section 5.04(3)(c) of this revenueprocedure when one member of an affili-ated group filing a consolidated returntransfers substantially all the assets of thetrade or business that gave rise to the §481(a) adjustment to another member ofthe same consolidated group in an ex-change qualifying under § 351 and thetransferee member adopts and uses thesame method of accounting (the change towhich gave rise to the § 481(a) adjust-ment) used by the transferor member.The transferor member must continue totake the § 481(a) adjustment into accountpursuant to the terms and conditions setforth in this revenue procedure. Thetransferor member must take into accountactivities of the transferee member (orany successor) in determining whether ac-celeration of the § 481(a) adjustment isrequired. For example, except as pro-vided in the following sentence, the trans-

feror member must take any remaining §481(a) adjustment into account in com-puting taxable income in the taxable yearin which the transferee member ceases toengage in the trade or business to whichthe § 481(a) adjustment relates. The §481(a) adjustment is not accelerated whenthe transferee member engages in a trans-action described in section 5.04(3)(c)(iv)or 5.04(3)(c)(v)(A) of this revenue proce-dure.

(B) Exception. The provi-sions of section 5.04(3)(c)(v)(A) of thisrevenue procedure cease to apply and thetransferor member must take any remain-ing balance of the § 481(a) adjustmentinto account in the taxable year immedi-ately preceding any of the following: (1)the taxable year the transferor memberceases to be a member of the group; (2)the taxable year any transferee memberowning substantially all the assets of thetrade or business which gave rise to the §481(a) adjustment ceases to be a memberof the group; or (3) a separate return yearof the common parent of the group. Inapplying the preceding sentence, the rulesof paragraphs (j)(2), (j)(5), and (j)(6) of §1.1502–13 apply, but only if the methodof accounting to which the transferormember changed and to which the §481(a) adjustment relates is adopted, car-ried over, or used by any transferee mem-ber acquiring the assets of the trade orbusiness that gave rise to the § 481(a) ad-justment immediately after acquisition ofsuch assets. For example, the transferormember is not required to accelerate the §481(a) adjustment if a transferee memberceases to be a member of a consolidatedgroup by reason of an acquisition towhich § 381(a) applies and the acquiringcorporation (1) is a member of the samegroup as the transferor member, and (2)continues, under § 381(c)(4) and the regu-lations thereunder, to use the samemethod of accounting as that used by thetransferor member with respect to the as-sets of the trade or business to which the §481(a) adjustment relates.

.05 NOL carryback limitation for tax-payer subject to criminal investigation.Generally, no portion of any net operatingloss that is attributable to a negative §481(a) adjustment may be carried back toa taxable year prior to the year of changethat is the subject of any pending or futurecriminal investigation or proceeding con-

1997–33 I.R.B. 23 August 18, 1997

cerning (1) directly or indirectly, anyissue relating to the taxpayer’s federal taxliability, or (2) the possibility of false orfraudulent statements made by the tax-payer with respect to any issue relating toits federal tax liability.

.06 Change treated as initiated by thetaxpayer. For purposes of § 481, a changein method of accounting made under thisrevenue procedure is a change in methodof accounting initiated by the taxpayer.

SECTION 6. GENERALAPPLICATION PROCEDURES

.01 Consent. Pursuant to § 1.446–1(e)-(2)(i), the consent of the Commissioner ishereby granted to any taxpayer within thescope of this revenue procedure to changea method of accounting, provided the tax-payer complies with all the applicable pro-visions of this revenue procedure.

.02 Filing requirements.(1) Waiver of taxable year filing re-

quirement. The requirement under §1.446–1T(e)(3)(i)(B) to file a Form 3115within the taxable year for which thechange is requested is waived for any ap-plication for a change in method of ac-counting filed pursuant to this revenueprocedure. See § 1.446–1(e)(3)(ii).

(2) Timely duplicate filing require-ment.

(a) In general. A taxpayer chang-ing a method of accounting pursuant tothis revenue procedure must complete andfile an application in duplicate. The origi-nal must be attached to the taxpayer’stimely filed (including extensions) origi-nal federal income tax return for the yearof change. A copy of the application mustbe filed with the national office (see sec-tion 6.02(6) of this revenue procedure forthe address) no earlier than the first day ofthe year of change and no later than whenthe original is filed with the federal in-come tax return for the year of change.

(b) Limited relief for late applica-tion. A taxpayer that fails to file the ap-plication for the year of change as pro-vided in section 6.02(2)(a) of this revenueprocedure will not be granted an exten-sion of time to file under § 301.9100 ofthe Procedure and Administration Regula-tions, except in unusual and compellingcircumstances. See § 301.9100–3T(c)(2).

(3) Label. (a) In order to assist in processing

an application under this revenue proce-

dure, the section of the APPENDIX ofthis revenue procedure describing the spe-cific change in method of accountingshould be included in the application. Forexample, a phrase such as “Section 1.01of the APPENDIX of Rev. Proc. 97–37”should be included on the appropriate lineon the Form 3115.

(b) If a taxpayer is authorizedunder the APPENDIX of this revenueprocedure to file a statement in lieu of aForm 3115, the taxpayer must include thetaxpayer’s name and employer identifica-tion number (or social security number inthe case of an individual) at the top of thefirst page of the statement underneath anyother required label.

(4) Signature requirements. The ap-plication must be signed by, or on behalfof, the taxpayer requesting the change byan individual with authority to bind thetaxpayer in such matters. For example, anofficer must sign on behalf of a corpora-tion, a general partner on behalf of a statelaw partnership, a member-manager onbehalf of a limited liability company, atrustee on behalf of a trust, or an individ-ual taxpayer on behalf of a sole propri-etorship. If the taxpayer is a member of aconsolidated group, an application sub-mitted on behalf of the taxpayer must besigned by a duly authorized officer of thecommon parent. See the signature re-quirements set forth in the General In-structions attached to a current Form 3115regarding those who are to sign. If anagent is authorized to represent the tax-payer before the Service, receive the orig-inal or a copy of the correspondence con-cerning the application, or perform anyother act(s) regarding the application filedon behalf of the taxpayer, a power of at-torney reflecting such authorization(s)must be attached to the application. Ataxpayer’s representative without a powerof attorney to represent the taxpayer as in-dicated in this section will not be givenany information regarding the applica-tion.

(5) Additional statement required. Inaddition to providing all the informationthat is required by the application, a tax-payer must attach to the application awritten statement providing as follows:

(a) the taxpayer agrees to all of theterms and conditions in this revenue pro-cedure; and

(b) if a § 481(a) adjustment is re-

quired, the reason for claiming the §481(a) adjustment period over which thetaxpayer agrees to take the applicable §481(a) adjustment into account.

(6) Where to file. A taxpayer, otherthan an exempt organization, changing amethod of accounting pursuant to thisrevenue procedure must file a copy of theapplication with the national office ad-dressed to the Commissioner of InternalRevenue, Attention: CC:DOM:IT&A,P.O. Box 7604, Benjamin Franklin Sta-tion, Washington, DC 20044 (or, in thecase of a designated private delivery ser-vice: Commissioner of Internal Revenue,Attention: CC:DOM:IT&A, 1111 Consti-tution Avenue, NW, Washington, DC20224). An exempt organization must ad-dress the application to the AssistantCommissioner (Employee Plans and Ex-empt Organizations), Attention: E:EO,P.O. Box 120, Benjamin Franklin Station,Washington, DC 20044 (or, in the case ofa designated private delivery service: As-sistant Commissioner (Employee Plansand Exempt Organizations), Attention:E:EO, 1111 Constitution Avenue, NW,Washington, DC 20224).

(7) No user fee. A user fee is not re-quired for an application filed under thisrevenue procedure, and the receipt of anapplication filed under this revenue pro-cedure will not be acknowledged.

(8) Single application for certainconsolidated groups. A parent corpora-tion may file a single application tochange an identical method of accountingon behalf of more than one member of aconsolidated group. To qualify, the tax-payers in the consolidated group must bemembers of the same affiliated groupunder § 1504(a) that join in the filing of aconsolidated tax return, and they must bechanging from the identical presentmethod of accounting to the identical pro-posed method of accounting. All aspectsof the change in method of accounting,including the present and proposed meth-ods, the underlying facts, and the author-ity for the change, must be identical, ex-cept for the § 481(a) adjustment. Seesection 15.07(3) of Rev. Proc. 97–1,1997–1 I.R.B. at 49 (or any successor),for the information required to be submit-ted with the application.

.03 Taxpayer under examination.(1) In general. Except as otherwise

provided in the APPENDIX of this rev-

August 18, 1997 24 1997–33 I.R.B.

enue procedure (see, for example, sec-tions 4.01 and 12.01 of the APPENDIX ofthis revenue procedure), a taxpayer that isunder examination may file an applicationto change a method of accounting undersection 6 of this revenue procedure if thetaxpayer is within the provisions of sec-tion 6.03(2) (90-day window), 6.03(3)(120-day window), or 6.03(4) (district di-rector consent) of this revenue procedure.A taxpayer that files an application be-yond the time periods provided in the 90-day and 120-day windows will not begranted an extension of time to file under§ 301.9100, except in unusual and com-pelling circumstances.

(2) 90-day window period.(a) A taxpayer may file a copy of

the application with the national office tochange a method of accounting under thisrevenue procedure during the first 90-days of any taxable year (the “90-daywindow”) if the taxpayer has been underexamination for at least 12 consecutivemonths as of the first day of the taxableyear. This 90-day window is not avail-able if the method of accounting the tax-payer is changing is an issue under con-sideration at the time the copy of theapplication is filed or an issue the exam-ining agent(s) has placed in suspense atthe time the copy of the application isfiled.

(b) A taxpayer changing a methodof accounting under this 90-day windowmust provide a copy of the application tothe examining agent(s) at the same time itfiles the copy of the application with thenational office. The application mustcontain the name(s) and telephone num-ber(s) of the examining agent(s). The tax-payer must attach to the application a sep-arate statement signed by the taxpayercertifying that, to the best of the tax-payer’s knowledge, the same method ofaccounting is not an issue under consider-ation or an issue placed in suspense by theexamining agent(s).

(3) 120-day window period. (a) A taxpayer may file a copy of

the application with the national office tochange a method of accounting under thisrevenue procedure during the 120-dayperiod following the date an examinationends (the “120-day window”), regardlessof whether a subsequent examination hascommenced. This 120-day window isnot available if the method of accounting

the taxpayer is changing is an issue underconsideration at the time a copy of theapplication is filed or an issue the exam-ining agent(s) has placed in suspense atthe time the copy of the application isfiled.

(b) A taxpayer changing a methodof accounting under this 120-day windowmust provide a copy of the application tothe examining agent(s) for any examina-tion that is in process at the same time itfiles the copy of the application with thenational office. The application mustcontain the name(s) and telephone num-ber(s) of the examining agent(s). The tax-payer must attach to the application a sep-arate statement signed by the taxpayercertifying that, to the best of the tax-payer’s knowledge, the same method ofaccounting is not an issue under consider-ation or an issue placed in suspense by theexamining agent(s).

(4) Consent of district director. (a) A taxpayer under examination

may change its method of accountingunder this revenue procedure if the dis-trict director consents to the change. Thedistrict director will consent to the changeunless, in the opinion of the district direc-tor, the method of accounting to bechanged would ordinarily be included asan item of adjustment in the year(s) forwhich the taxpayer is under examination.For example, the district director willconsent to a change from a clearly per-missible method of accounting. The dis-trict director will also consent to a changefrom an impermissible method of ac-counting where the impermissible methodwas adopted subsequent to the yearsunder examination. The question ofwhether the method of accounting fromwhich the taxpayer is changing is permis-sible or was adopted subsequent to theyears under examination may be referredto the national office as a request for tech-nical advice under the provisions of Rev.Proc. 97–2 (or any successor).

(b) A taxpayer changing a methodof accounting under this revenue proce-dure with the consent of the district direc-tor must attach to the application a state-ment from the district director consentingto the change. The taxpayer must providea copy of the application to the district di-rector at the same time it files a copy ofthe application with the national office.The application must contain the name(s)

and telephone number(s) of the examin-ing agent(s).

.04 Taxpayer before an appeals office.A taxpayer that is before an appeals officemust attach to the application a separatestatement signed by the taxpayer certify-ing that, to the best of the taxpayer’sknowledge, the same method of account-ing is not an issue under consideration bythe appeals office. The taxpayer mustprovide a copy of the application to theappeals officer at the same time it files acopy of the application with the nationaloffice. The application must contain thename and telephone number of the ap-peals officer.

.05 Taxpayer before a federal court. Ataxpayer that is before a federal courtmust attach to the application a separatestatement signed by the taxpayer certify-ing that, to the best of the taxpayer’sknowledge, the same method of account-ing is not an issue under consideration bythe federal court. The taxpayer must pro-vide a copy of the application to the coun-sel for the government at the same time itfiles a copy of the application with the na-tional office. The application must con-tain the name and telephone number ofthe counsel for the government.

.06 Compliance with provisions. If ataxpayer to which this revenue procedureapplies changes to a method of account-ing without complying with all the applic-able provisions of this revenue procedure(for example, the taxpayer changes to amethod of accounting that varies from theapplicable accounting method describedin this revenue procedure or the taxpayeris outside the scope of this revenue proce-dure), the taxpayer has initiated a changein method of accounting without obtain-ing the consent of the Commissioner asrequired by § 446(e). Upon examination,a taxpayer that has initiated an unautho-rized change in method of accountingmay be required to effect the change in anearlier or later taxable year and may bedenied the benefit of spreading the §481(a) adjustment over the number of tax-able years otherwise prescribed by thisrevenue procedure.

SECTION 7. AUDIT PROTECTIONFOR TAXABLE YEARS PRIOR TOYEAR OF CHANGE

.01 In general. Except as provided insection 7.02 or the APPENDIX of this

1997–33 I.R.B. 25 August 18, 1997

revenue procedure, when a taxpayertimely files a copy of the application withthe national office in compliance with allthe applicable provisions of this revenueprocedure, the Service will not require thetaxpayer to change its method of account-ing for the same item for a taxable yearprior to the year of change.

.02 Exceptions. (1) Change not made or made im-

properly. The Service may change a tax-payer’s method of accounting for priortaxable years if (a) the taxpayer fails toimplement the change; (b) the taxpayerimplements the change but does notcomply with all the applicable provisionsof this revenue procedure, or (c) themethod of accounting is changed ormodified because there has been a mis-statement or omission of material facts(see section 8.02(2) of this revenue pro-cedure).

(2) Change in sub-method. The Ser-vice may change a taxpayer’s method ofaccounting for prior taxable years if thetaxpayer is changing a sub-method of ac-counting within the method. For exam-ple, an examining agent may propose toterminate the taxpayer’s use of the LIFOinventory method during a prior taxableyear even though the taxpayer changes itsmethod of valuing increments in the cur-rent year.

(3) Prior year Service-initiatedchange. The Service may make adjust-ments to the taxpayer’s returns for thesame item for taxable years prior to therequested year of change to reflect a prioryear Service-initiated change.

(4) Criminal investigation. The Ser-vice may change a taxpayer’s method ofaccounting for the same item for taxableyears prior to the year of change if there isany pending or future criminal investiga-tion or proceeding concerning (a) directlyor indirectly, any issue relating to the tax-payer’s federal tax liability for any tax-able year prior to the year of change, or(b) the possibility of false or fraudulentstatements made by the taxpayer with re-spect to any issue relating to its federaltax liability for any taxable year prior tothe year of change.

SECTION 8. EFFECT OF CONSENT

.01 In general. A taxpayer thatchanges to a method of accounting pur-suant to this revenue procedure may be

required to change or modify that methodof 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 state-ment published in the Internal RevenueBulletin;

(5) the issuance of written notice tothe taxpayer that the change in method ofaccounting was not in compliance with allthe applicable provisions of this revenueprocedure or is not in accord with the cur-rent views of the Service; or

(6) a change in the material facts onwhich the consent was based.

.02 Retroactive change or modifica-tion. Except in rare or unusual circum-stances, if a taxpayer that changes itsmethod of accounting under this revenueprocedure is subsequently required undersection 8.01 of this revenue procedure tochange or modify that method of account-ing, the required change or modificationwill not be applied retroactively, providedthat:

(1) the taxpayer complied with allthe applicable provisions of this revenueprocedure;

(2) there has been no misstatementor omission of material facts;

(3) there has been no change in thematerial facts on which the consent wasbased;

(4) there has been no change in theapplicable law; and

(5) the taxpayer to whom consentwas granted acted in good faith in relyingon the consent, and applying the changeor modification retroactively would be tothe taxpayer’s detriment.

SECTION 9. REVIEW BY DISTRICTDIRECTOR

.01 In general. The district directormust apply a change in method of ac-counting made in compliance with all theapplicable provisions of this revenue pro-cedure in determining the taxpayer’s lia-bility, unless the district director recom-mends that the change in method ofaccounting should be modified or re-voked. (See section 6.06 of this revenueprocedure if a change in method of ac-counting is made without complying with

all the applicable provisions of this rev-enue procedure.) The district director willascertain if:

(1) the representations on which thechange was based reflect an accuratestatement of the material facts;

(2) the amount of the § 481(a) ad-justment was properly determined;

(3) the change in method of account-ing was implemented in compliance withall the applicable provisions of this rev-enue procedure;

(4) there has been any change in thematerial facts on which the change wasbased during the period the method of ac-counting was used; and

(5) there has been any change in theapplicable law during the period themethod of accounting was used.

.02 National office consideration. Ifthe district director recommends that achange in method of accounting (otherthan the § 481(a) adjustment) made incompliance with all the applicable provi-sions of this revenue procedure should bemodified or revoked, the district directorwill forward the matter to the national of-fice for consideration before any furtheraction is taken. Such a referral to the na-tional office will be treated as a requestfor technical advice, and the provisions ofRev. Proc. 97–2 (or any successor) will befollowed.

SECTION 10. REVIEW BY NATIONALOFFICE

.01 In general. Any application filedunder this revenue procedure may be re-viewed by the national office. If the ap-plication is reviewed by the national of-fice, the procedures in sections 10.02through 10.04 of this revenue procedureapply.

.02 Incomplete application—21 dayrule. If the Service reviews an applica-tion and determines that the application isnot properly completed in accordancewith the instructions of the Form 3115 orthe provisions of this revenue procedure,or if supplemental information is needed,the Service will notify the taxpayer. Thenotification will specify the informationthat needs to be provided, and the tax-payer will be permitted 21 days from thedate of the notification to furnish the nec-essary information. The Service reservesthe right to impose shorter reply periods ifsubsequent requests for additional infor-

August 18, 1997 26 1997–33 I.R.B.

mation are made. An extension of the 21-day period to furnish information, not toexceed 15 days, may be granted to a tax-payer. A request for an extension of the21-day period must be made in writingand submitted within the 21-day period.If the extension request is denied, there isno right of appeal.

.03 Conference in the national office.If the national office tentatively deter-mines that the taxpayer has changed itsmethod of accounting without complyingwith all the applicable provisions of thisrevenue procedure (for example, the tax-payer changed to a method of accountingthat varies from the applicable accountingmethod described in this revenue proce-dure or the taxpayer is outside the scopeof this revenue procedure), the nationaloffice will notify the taxpayer of its tenta-tive adverse determination and will offerthe taxpayer a conference of right, if thetaxpayer has requested a conference. Forconference procedures for taxpayers otherthan exempt organizations, see section 11of Rev. Proc. 97–1 (or any successor).For conference procedures for exempt or-ganizations, see section 12 of Rev. Proc.97–4, 1997–1 I.R.B. 96 (or any succes-sor).

.04 National office determination. Ifthe national office determines that thetaxpayer has changed its method of ac-counting without complying with all theapplicable provisions of this revenueprocedure, the national office will notifythe taxpayer that consent to make thechange in method of accounting either(1) is not granted, or (2) is granted, pro-vided the taxpayer makes appropriate ad-justments to conform its change inmethod of accounting to the applicableprovisions of this revenue procedure.Any adjustments so made must be ac-companied by conforming amendmentsto any federal income tax returns filedfor the year of change and subsequenttaxable years.

SECTION 11. APPLICABILITY OFREV. PROCS. 97–1 AND 97–4

Rev. Procs. 97–1 and 97–4 (or any suc-cessors) are applicable to applicationsfiled under this revenue procedure, unlessspecifically excluded or overridden byother published guidance (including thespecial procedures in this document).




.01 In general. Except as provided insections 13.02 and 13.03 of this revenueprocedure, this revenue procedure is ef-fective for taxable years ending on orafter August 18, 1997. Except as pro-vided in sections 13.02 and 13.03 of thisrevenue procedure, the Service will returnany application that is filed on or afterAugust 18, 1997, if the application is filedwith the national office pursuant to theCode, regulations, or administrative guid-ance other than this revenue procedureand the change in method of accounting iswithin the scope of this revenue proce-dure.

.02 Transition rules.(1) Previously filed applications.

(a) Applications for advance con-sent. If a taxpayer filed an applicationwith 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 ac-counting authorized by this revenue pro-cedure, and the application is pendingwith the national office on August 18,1997, the taxpayer may make the changeunder this revenue procedure. However,the national office will process the appli-cation in accordance with the revenueprocedure under which the applicationwas filed, unless prior to the later of Sep-tember 30, 1997, or the issuance of theletter ruling granting or denying consentto the change, the taxpayer notifies thenational office that it wants to make thechange under this revenue procedure. Ifthe taxpayer timely notifies the nationaloffice that it wants to make the methodchange under this revenue procedure, thenational office will require the taxpayer tomake appropriate modifications to the ap-plication to comply with the applicableprovisions of this revenue procedure. Inaddition, any user fee that was submittedwith the application will be returned tothe taxpayer.

(b) Applications for automaticconsent. If a taxpayer filed an applicationwith the national office (or a service cen-

ter) previously authorized by an auto-matic consent procedure listed in section14.01 of this revenue procedure, beforeAugust 18, 1997, to make a change inmethod of accounting authorized by thisrevenue procedure, the taxpayer maymake the change under this revenue pro-cedure. However, the national office willprocess the application in accordancewith the automatic consent procedureunder which the application was filed, un-less prior to September 30, 1997, the tax-payer notifies the national office in writ-ing (at the address provided in section6.02(6) of this revenue procedure) that itwants to make the change under this rev-enue procedure. If the taxpayer timelynotifies the national office that it wants tomake the method change under this rev-enue procedure, the national office willrequire the taxpayer to make appropriatemodifications to the application to com-ply with the applicable provisions of thisrevenue procedure.

(2) New applications. (a) Prior automatic consent pro-

cedures. A taxpayer that wants to make achange in method of accounting previ-ously authorized by an automatic consentprocedure listed in section 14.01 of thisrevenue procedure, for a taxable year thatends on or after August 18, 1997, maymake the change under that automaticconsent procedure by complying with thatprocedure and the following additionalfiling requirement. In lieu of filing theapplication with the national office (or aservice center) pursuant to that automaticconsent procedure, the taxpayer must filea copy of the application with the nationaloffice no earlier than the first day of theyear of change, and no later than the ear-lier of December 31, 1997, or when theoriginal application is filed with thetimely filed original federal income taxreturn (including extensions) for the yearof change. A taxpayer changing itsmethod of accounting under Rev. Proc.85–8, 1985–1 C.B. 495, for a taxable yearending on or before December 31, 1997,may file under that revenue procedure.The additional filing requirement de-scribed above does not apply to thischange.

(b) New automatic consent proce-dures. A taxpayer making a change inmethod of accounting authorized by thisrevenue procedure, other than a change

1997–33 I.R.B. 27 August 18, 1997

previously authorized by an automaticconsent procedure listed in section 14.01of this revenue procedure or a change au-thorized by section 13.01 of the APPEN-DIX of this revenue procedure, that files acopy of an application under the provi-sions of this revenue procedure no laterthan the earlier of December 31, 1997, orwhen the original application is filed withthe timely filed original federal incometax return (including extensions) for theyear of change, may apply the § 481(a)adjustment period determined under sec-tions 5 and 8 of Rev. Proc. 92–20. Thetaxpayer must affirmatively state in an at-tachment to the application (a) that it re-quests to apply the § 481(a) adjustmentperiod determined under sections 5 and 8of Rev. Proc. 92–20, and (b) the applica-ble § 481(a) adjustment period and the au-thority therefor.

.03 Timing of incurring liabilities forpayroll taxes. To change a method of ac-counting under section 8.04 of the AP-PENDIX of this revenue procedure, a tax-payer may use the provisions of thisrevenue procedure for taxable years end-ing on or after October 21, 1996.


.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 asmodified, are superseded.

.02 Obsoleted. The following revenueprocedures are obsoleted:

(1) Rev. Proc. 85–8, 1985–1 C.B.495 (a revenue procedure that allows ataxpayer to change its method of account-ing for bad debts);

(2) Rev. Proc. 84–30, 1984–1 C.B.482 (a revenue procedure that allows ataxpayer to change its method of account-ing for interest on certain consumer loansfrom the Rule of 78’s method to the eco-nomic accrual method);

(3) Rev. Proc. 84–29, 1984–1 C.B.480 (a revenue procedure that provides a

simplified procedure for an individualborrower to use to compute interest de-ductions for certain loans if the taxpayerhas been reporting interest deductions onthese loans based on the Rule of 78’smethod);

(4) Rev. Proc. 84–28, 1984–1 C.B.475 (a revenue procedure that allows ataxpayer to change its method of ac-counting for interest from the Rule of78’s method to the economic accrualmethod, but only for those loans inwhich the interest computed using theRule of 78’s method exceeds the loanpayments during any year of the term ofthe loan);

(5) Rev. Proc. 84–27, 1984–1 C.B.469 (a revenue procedure that allows ataxpayer to change its method of account-ing for interest from the Rule of 78’smethod to the economic accrual method);and

(6) Rev. Proc. 83–40, 1983–1 C.B.774 (a revenue procedure that allows ataxpayer to use the Rule of 78’s method tocompute interest on certain short-termconsumer loans).

SECTION 15. PAPERWORK REDUC-TION ACT

The collections of information con-tained in this revenue procedure havebeen reviewed and approved by the Of-fice of Management and Budget in accor-dance with the Paperwork Reduction Act(44 U.S.C. 3507) under control number1545–1551.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validOMB control number.

The collections of information in thisrevenue procedure are in sections 6, 10,13, and sections 2, 3, 5, 6, 7, 10, and 12 ofthe APPENDIX. This information is nec-essary and will be used to determinewhether the taxpayer properly changed toa permitted method of accounting. Thecollections of information are required forthe taxpayer to obtain consent to changeits method of accounting. The likely re-spondents are the following: individuals,farms, business or other for-profit institu-tions, nonprofit institutions, and smallbusinesses or organizations.

The estimated total annual reportingand/or recordkeeping burden is 5,464

hours. The estimated annual burden per re-

spondent/recordkeeper varies from 1/10hour to 5 7/10 hours, depending on indi-vidual circumstances, with an estimatedaverage of 1 1/2 hours. The estimatednumber of respondents is 2,000.

The estimated annual frequency of re-sponses is on occasion.



The principal author of this revenueprocedure is Dwight N. Mersereau of theOffice of Assistant Chief Counsel (In-come Tax and Accounting). For furtherinformation regarding this revenue proce-dure, contact the following individuals:(1) for changes in methods of accountingunder sections 2.01 and 2.02 of the AP-PENDIX of this revenue procedure, PeterFriedman of the Office of Assistant ChiefCounsel (Passthroughs and Special Indus-tries) on (202) 622-3110 (not a toll-freecall); (2) for changes in methods of ac-counting under sections 6 and 11 of theAPPENDIX of this revenue procedure,Nicholas Bogos of the Office of AssistantChief Counsel (Financial Institutions andProducts) on (202) 622-3920 (not a toll-free call); (3) for changes in methods ofaccounting under sections 12 and 13 ofthe APPENDIX of this revenue proce-dure, William Blanchard of the Office ofAssistant Chief Counsel (Financial Insti-tutions and Products) on (202) 622-3950(not a toll-free call); and (4) for all othermatters, Mr. Mersereau on (202) 622-4970 (not a toll-free call).

APPENDIX

CHANGES IN METHODS OF ACCOUNTING TO WHICH THIS

REVENUE PROCEDURE APPLIES

SECTION 1. TRADE OR BUSINESSEXPENSES (§ 162) . . . . . . . . . . . . . . 30

.01 Advances made by a lawyer onbehalf of clients — Descriptionof change and scope . . . . . . . . 30

.02 Reserved . . . . . . . . . . . . . . . . . 30

August 18, 1997 28 1997–33 I.R.B.

SECTION 2. DEPRECIATION ORAMORTIZATION (§ 167, 168, OR 197). . . . . . . . . . . . . . . . . . . . . . . . 30

.01 Claiming less than the depreciation or amortization allowable . . . . . . . . . . . . . . . . . 30(1) Description of change . . . . 30(2) Scope . . . . . . . . . . . . . . . . . 30(3) Taxpayer with under- andover-depreciated properties . . 31(4) Additional requirements . . 31(5) Section 481(a) adjustment . 32(6) Basis adjustment . . . . . . . . 32(7) Meaning of depreciation allowable . . . . . . . . . . . . . . . . . 32

.02 Permissible to permissible method of accounting for depreciation. . . . . . . . . . . . . . . 32(1) Description of change . . . . 32(2) Scope . . . . . . . . . . . . . . . . . 32(3) Changes covered . . . . . . . . 33(4) Additional requirements . . 33(5) Section 481(a) adjustment . 33

.03 Sale or lease transactions . . . . 33(1) Description of change and scope. . . . . . . . . . . . . . . . . 33(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 34(3) No audit or ruling protection . . . . . . . . . . . . . . . . 34

SECTION 3. CAPITALEXPENDITURES (§ 263) . . . . . . . . . 34

.01 Package design costs. . . . . . . . 34(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 34(2) Additional requirements . . 34

.02 Reserved . . . . . . . . . . . . . . . . . 34

SECTION 4. UNIFORM CAPITALIZATION (§ 263A). . . . . . . 34

.01 Certain uniform capitalization(UNICAP) methods used by smallresellers, formerly small resellers,and reseller-producers . . . . . . 34(1) Description of change and scope . . . . . . . . . . . . . . . . . . . . 34(2) Definitions . . . . . . . . . . . . . 34(3) Section 481(a) adjustment . 34(4) No audit protection . . . . . . 34(5) Example . . . . . . . . . . . . . . . 34

.02 Reserved . . . . . . . . . . . . . . . . . 36

SECTION 5. METHODS OF ACCOUNTING (§ 446) . . . . . . . . . . . 36

.01 Cash or hybrid method to accrual method . . . . . . . . . . . . 36(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 36

(2) Section 481(a) adjustment . 36(3) Change to a special method of accounting. . . . . . . . . . . . . . 37

.02 Multi-year service warranty contracts . . . . . . . . . . . . . . . . . 37(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 37(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 37

.03 Multi-year insurance policies formulti-year service warranty contracts — Description ofchange and scope . . . . . . . . . . 37(1) Applicability . . . . . . . . . . . 37(2) Inapplicability . . . . . . . . . . 37(3) Description of method . . . . 37

SECTION 6. OBLIGATIONS ISSUEDAT DISCOUNT (§ 454) . . . . . . . . . . . 37

.01 Series E or EE U.S. savingsbonds . . . . . . . . . . . . . . . . . . . . 37(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 37(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 37

.02 Reserved . . . . . . . . . . . . . . . . . 38

SECTION 7. PREPAID SUBSCRIPTION INCOME (§ 455). . 38

.01 Prepaid subscription income . . 38(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 38(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 38

.02 Reserved . . . . . . . . . . . . . . . . . 38

SECTION 8. TAXABLE YEAR OF DEDUCTION (§ 461). . . . . . . . . . . . . 38

.01 Timing of incurring liabilities foremployee compensation . . . . . 38(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 38(2) Amounts taken into account . . . . . . . . . . . . . . . . . . 38

.02 Timing of incurring liabilities for real property taxes . . . . . . . 38(1) Description of change . . . . 38(2) Scope . . . . . . . . . . . . . . . . . 38(3) Amounts taken into account . . . . . . . . . . . . . . . . . . 38

.03 Timing of incurring liabilitiesunder a workers’ compensationact, tort, breach of contract, or violation of law . . . . . . . . . . . . 38(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 38(2) Amounts taken into

account . . . . . . . . . . . . . . . . . . 39.04 Timing of incurring liabilities for

payroll taxes . . . . . . . . . . . . . . 39(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 39(2) Recurring item exception. . 39(3) Amounts taken into account . . . . . . . . . . . . . . . . . . 39

SECTION 9. INVENTORIES (§ 471) 39

.01 Cash discounts — Description of change and scope . . . . . . . . 39

.02 Reserved . . . . . . . . . . . . . . . . . 39

SECTION 10. LAST-IN, FIRST-OUT(LIFO) INVENTORIES (§ 472) . . . . . 39

.01 Change from the LIFO inventorymethod . . . . . . . . . . . . . . . . . . . 39(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 39(2) Limitation on LIFO election . . . . . . . . . . . . . . . . . . 40(3) Effect of subchapter S election by corporation . . . . . . 40(4) Additional requirements . . 40

.02 Determining the cost of used vehicles purchased or taken asa trade-in . . . . . . . . . . . . . . . . . 40(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 40(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 40

.03 Alternative LIFO inventorymethod for retail automobile dealers . . . . . . . . . . . . . . . . . . . 40(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 40(2) Manner of making thechange . . . . . . . . . . . . . . . . . . . 40

.04 Inventory price index computation(IPIC) method under the LIFO in-ventory method . . . . . . . . . . . . 40(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 40(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 41

.05 Determining current-year costunder the LIFOinventorymethod . . . . . . . . . . . . . . . . . . . 41(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 41(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 41

SECTION 11. BANK RESERVES FORBAD DEBTS (§ 585) . . . . . . . . . . . . . 41

.01 Changing from the § 585 reserve method to the § 166 specific charge-off method . . . 41

1997–33 I.R.B. 29 August 18, 1997

(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 41(2) Certain scope limitations inapplicable. . . . . . . . . . . . . . . 41(3) Section 481(a) adjustment . 41(4) Change from § 585 requiredwhen electing S corporation status . . . . . . . . . . . . . . . . . . . . 41

.02 Reserved . . . . . . . . . . . . . . . . . 42

SECTION 12. ORIGINAL ISSUEDISCOUNT (§ 1273) . . . . . . . . . . . . . 42

.01 De minimis original issue dis-count (OID) . . . . . . . . . . . . . . . 42(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 42(2) Manner of making the change . . . . . . . . . . . . . . . . . . . 42(3) Additional requirements . . 42(4) No audit protection . . . . . . 42

.02 Reserved . . . . . . . . . . . . . . . . . 42

SECTION 13. SHORT-TERMOBLIGATIONS (§ 1281) . . . . . . . . . . 42

.01 Interest income on short-termobligations. . . . . . . . . . . . . . . . 42(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 42

(2) Section 481(a) adjustment period . . . . . . . . . . . . . . . . . . . 42

.02 Stated interest on short-term loansof cash method banks in theEighth Circuit . . . . . . . . . . . . . 42(1) Description of change andscope . . . . . . . . . . . . . . . . . . . . 42(2) Section 481(a) adjustment period . . . . . . . . . . . . . . . . . . . 42(3) No ruling protection . . . . . 42

SECTION 1. TRADE OR BUSINESS EXPENSES (§ 162)

.01 Advances made by a lawyer on be-half of clients — Description of changeand scope. This change applies to alawyer handling cases on a contingent feebasis that advances money to pay forcosts of litigation or for other expenses onbehalf of clients and that wants to changethe method of accounting for such ad-vances from treating them as deductiblebusiness expenses to treating them asloans. See Boccardo v. United States, 12Cl. Ct. 184 (1987); Canelo v. Commis-sioner, 53 T.C. 217 (1969), aff’d per cu-riam, 447 F.2d 484 (9th Cir. 1971).

.02 Reserved.

SECTION 2. DEPRECIATION ORAMORTIZATION (§ 167, 168, OR 197)

.01 Claiming less than the deprecia-tion or amortization allowable.

(1) Description of change. (a) This change applies to a tax-

payer that wants to change from an imper-missible method of accounting for depre-ciation or amortization (depreciation)under which the taxpayer claimed lessthan the depreciation allowable, to a per-missible method of accounting for depre-ciation under which the taxpayer willclaim the depreciation allowable. Thetaxpayer has the option of either makingthe change in method of accounting underthis revenue procedure or requesting per-mission to make the change under Rev.Proc. 97–27, 1997–21 I.R.B. 10. Thischange was formerly provided in Rev.Proc. 96–31, 1996–1 C.B. 714.

(b) A change from a taxpayer’simpermissible method of accounting fordepreciation under which the taxpayerdid not claim the depreciation allowableto a permissible method of accountingfor depreciation under which the tax-payer will claim the depreciation allow-able is a change in method of accountingfor which the consent of the Commis-sioner is required. Sections 1.167(e)–1(a)and 1.446–1(e)(2)(ii)(b). This methodchange, however, does not include anycorrection of mathematical or posting er-rors. Section 1.446–1(e)(2)-(ii)(b).

(2) Scope.(a) Applicability. Except as pro-

vided in section 2.01(2)(b) of this AP-PENDIX, this change applies to any tax-payer that has used an impermissiblemethod of accounting for depreciation inat least the two taxable years immediatelypreceding the year of change, and ischanging that accounting method to a per-missible method of accounting for depre-ciation, for any item of property:

(i) for which, under the tax-payer’s impermissible method of account-ing, the taxpayer has not taken into ac-count any depreciation allowance or hastaken into account some depreciation butless than the depreciation allowable(claimed less than the depreciation allow-able);

(ii) for which depreciation isdetermined under § 167, 168, 197, or 168prior to its amendment in 1986 (former §168); and

(iii) that is owned by the tax-payer at the beginning of the year of

change.(b) Inapplicability. This change

does not apply to:(i) any property to which §

1016(a)(3) (regarding property held by atax-exempt organization) applies;

(ii) any taxpayer that is subjectto § 263A and that is required to capital-ize the costs with respect to which thetaxpayer wants to change its method ofaccounting under section 2.01 of this AP-PENDIX, if the taxpayer is not capitaliz-ing the costs as required;

(iii) any intangible propertysubject to § 167, except for property sub-ject to § 167(f) (regarding certain prop-erty excluded from § 197);

(iv) any property subject to §167(g) (regarding property depreciatedunder the income forecast method);

(v) any § 1250 property that ataxpayer is reclassifying to an asset classof Rev. Proc. 87–56, 1987–2 C.B. 674, orRev. Proc. 83–35, 1983–1 C.B. 745, asappropriate, that does not explicitly in-clude § 1250 property (for example, assetclass 57.0, Distributive Trades and Ser-vices);

(vi) any property for which ataxpayer is revoking a timely valid elec-tion, or making a late election, under §167, 168, former § 168, or § 13261(g)(2)or (3) of the Revenue Reconciliation Actof 1993 (1993 Act), 1993–3 C.B. 1, 128(relating to amortizable § 197 intangi-bles). A taxpayer may request consent torevoke or make the election by submittinga request for a letter ruling under Rev.Proc. 97–1, 1997–1 I.R.B. 11 (or any suc-cessor);

(vii) any property subject to §167 (other than § 167(f), regarding cer-tain property excluded from § 197), forwhich a taxpayer is changing only theestimated useful life of the property. Achange in the estimated useful life ofproperty for which depreciation is deter-mined under § 167 (other than § 167(f))must be made prospectively (see, for ex-ample, § 1.167(b)–2(c)) (In contrast, sec-tion 2.01 of this APPENDIX generallyapplies to a change in the recovery pe-riod of property for which depreciationis determined under § 168 or former § 168);

(viii) any depreciable propertythat changes use but continues to beowned by the same taxpayer (see, for ex-

August 18, 1997 30 1997–33 I.R.B.

ample, § 168(i)(5));(ix) any property for which a

taxpayer has claimed depreciation in ex-cess of the depreciation allowable;

(x) any change in method of ac-counting involving a change from deduct-ing the cost or other basis of any propertyas an expense to capitalizing and depreci-ating the cost or other basis;

(xi) any change in method ofaccounting involving a change from onepermissible method of accounting for theproperty to another permissible method ofaccounting for the property. For example:

(A) a change from thestraight-line method of depreciation to theincome forecast method of depreciationfor videocassettes. See Rev. Rul. 89–62,1989–1 C.B. 78;

(B) a change in the classifica-tion of a retail motor fuels outlet placed inservice before August 20, 1996, fromnonresidential real property to 15–yearproperty under § 168 (see Rev. Proc.97–10, 1997–2 I.R.B. 59, for the exclu-sive procedures for making this change);or

(C) a change from chargingthe depreciation reserve with costs of re-moval and crediting the depreciation re-serve with salvage proceeds to deductingcosts of removal as an expense (providedthe costs of removal are not required to becapitalized under any provision of theCode, such as, § 263(a)) and includingsalvage proceeds in taxable income (seesection 2.02 of this APPENDIX for mak-ing this change for property for which de-preciation is determined under § 167); or

(xii) any change in method ofaccounting for an item of income or de-duction other than depreciation, even if ataxpayer’s present method of accountingmay have resulted in the taxpayer claim-ing less than the depreciation allowable.For example, a change in method of ac-counting involving:

(A) a change in inventorycosts (for example, when property is re-classified from inventory property to de-preciable property); or

(B) a change in the characterof a transaction from sale to lease (seesection 2.03 of this APPENDIX for mak-ing this change).

(3) Taxpayer with under- and over-depreciated properties.

(a) Because this revenue proce-

dure is not the exclusive procedure tochange a method of accounting to whichsection 2.01 of this APPENDIX applies,a taxpayer that wants to change a methodof accounting for depreciation to whichsection 2.01 of this APPENDIX applieson some items of property and to changean impermissible method of accountingfor depreciation under which the tax-payer claimed more than the depreciationallowable on other items of property, mayfile:

(i) one application under Rev.Proc. 97–27 for both the under- and over-depreciated properties; or

(ii) two applications—one ap-plication under this revenue procedure forthe under-depreciated property and oneapplication under Rev. Proc. 97–27 forthe over-depreciated property.

(b) In either situation, the omitteddepreciation for the under-depreciatedproperty and the excess depreciation forthe over-depreciated property from tax-able years prior to the year of change willbe taken into account through a § 481(a)adjustment.

(4) Additional requirements. A tax-payer also must comply with the follow-ing:

(a) Permissible depreciationmethod. A taxpayer must change to a per-missible method of accounting for depre-ciation for the item of property. Thismethod is the same method that deter-mines the depreciation allowable for theitem of property (as provided in section2.01(7) of this APPENDIX).

(b) Statements required. A tax-payer must provide the following state-ments, if applicable, and attach them tothe completed application:

(i) a detailed description of theformer and new methods of accounting.A general description of these methods ofaccounting is unacceptable (for example,MACRS to MACRS or erroneous methodto proper method);

(ii) to the extent not providedelsewhere on the application, a statementdescribing the taxpayer’s business or in-come-producing activities. Also, if thetaxpayer has more than one business orincome-producing activity, a statementdescribing the taxpayer’s business or in-come-producing activity in which theitem of property at issue is primarily usedby the taxpayer;

(iii) to the extent not providedelsewhere on the application, a statementof the facts and law supporting the newmethod of accounting, new classificationof the item of property, and new assetclass in, as appropriate, Rev. Proc. 87–56or Rev. Proc. 83–35. If the taxpayer is theowner and lessor of the item of propertyat issue, the statement of the facts and lawsupporting the new asset class also mustdescribe the business or income-produc-ing activity in which that item of propertyis primarily used by the lessee;

(iv) to the extent not providedelsewhere on the application, a statementidentifying the year in which the item ofproperty was placed in service;

(v) if the item of property is de-preciated under former § 168, a statementidentifying the asset class in Rev. Proc.83–35 that applies under the taxpayer’sformer and new methods of accounting (ifnone, state and explain);

(vi) if the taxpayer is changingthe classification of an item of § 1250property to a retail motor fuels outletunder § 168(e)(3)(E)(iii), a statement con-taining the following representation: “Forpurposes of § 168(e)(3)(E)(iii) of the In-ternal Revenue Code, the taxpayer repre-sents that (A) 50 percent or more of thegross revenue generated from the item of§ 1250 property is from the sale of petro-leum products (not including gross rev-enue from related services, such as thelabor cost of oil changes and gross rev-enue from the sale of nonpetroleum prod-ucts such as tires and oil filters), (B) 50percent or more of the floor space in theitem of property is devoted to the sale ofpetroleum products (not including floorspace devoted to related services, such asoil changes and floor space devoted tononpetroleum products such as tires andoil filters), or (C) the item of § 1250 prop-erty is 1,400 square feet or less.”; and

(vii) if the taxpayer is changingthe classification of an item of propertyfrom § 1250 property to § 1245 propertyunder § 168 or former § 168, a statementof the facts and law supporting the new §1245 property classification, and a state-ment containing the following representa-tion: “Each item of property that is thesubject of the application filed under sec-tion 2.01 of the APPENDIX of Rev. Proc.97–37 for the year of change beginning[Insert the date], and that is reclassified

1997–33 I.R.B. 31 August 18, 1997

from [Insert, as appropriate: nonresiden-tial real property, residential rental prop-erty, 19-year real property, 18- year realproperty, or 15-year real property] to anasset class of [Insert, as appropriate, ei-ther: Rev. Proc. 87–56, 1987–2 C.B. 674,or Rev. Proc. 83–35, 1983–1 C.B. 745]that does not explicitly include § 1250property, is § 1245 property for deprecia-tion purposes.”

(5) Section 481(a) adjustment. The§ 481(a) adjustment is a negative §481(a) adjustment (a decrease in taxableincome) to prevent the omission of the al-lowable but unclaimed depreciation foropen and closed years prior to the year ofchange. This negative § 481(a) adjust-ment equals the difference between thetotal amount of depreciation taken intoaccount in computing taxable income forthe property under the taxpayer’s formermethod of accounting, and the totalamount of depreciation allowable for theproperty under the taxpayer ’s newmethod of accounting (as determinedunder section 2.01(7) of this APPEN-DIX), for all taxable years prior to theyear of change. The amount of the nega-tive § 481(a) adjustment, however, mustbe offset by any allowable but unclaimeddepreciation that is required to be capital-ized under any provision of the Code (forexample, § 263A) at the beginning of theyear of change.

(6) Basis adjustment. The basis ofdepreciable property to which section2.01 of this APPENDIX applies must re-flect the reductions required by §1016(a)(2) for the depreciation allowablefor the property (as determined under sec-tion 2.01(7) of this APPENDIX).

(7) Meaning of depreciation allow-able.

(a) In general. Section 2.01(7) ofthis APPENDIX provides the amount ofthe depreciation allowable, determinedunder § 167, 168, 197, or former § 168.This amount, however, may be limited byother provisions of the Code (for exam-ple, § 280F).

(b) Section 167 property. Gener-ally, for any taxable year, the depreciationallowable for property for which depreci-ation is determined under § 167, is deter-mined either:

(i) under the depreciationmethod adopted by a taxpayer for theproperty; or

(ii) if that depreciation methoddoes not result in a reasonable allowancefor depreciation or a taxpayer has notadopted a depreciation method for theproperty, under the straight-line deprecia-tion method.For determining the estimated useful lifeand salvage value of the property, see §§1.167(a)–1(b) and (c), respectively. Thedepreciation allowable for any taxableyear for property subject to § 167(f) (re-garding certain property excluded from §197) is determined by using the deprecia-tion method and useful life prescribed in §167(f).

(c) Section 168 property. The de-preciation allowable for any taxable yearfor property for which depreciation is de-termined under § 168, is determined byusing either:

(i) the general depreciation sys-tem in § 168(a); or

(ii) the alternative depreciationsystem in § 168(g) if the property is re-quired to be depreciated under the alter-native depreciation system pursuant to §168(g)(1) or other provisions of the Code(for example, property described in §263A(e)(2)(A) or 280F(b)(1)). Propertyrequired to be depreciated under the al-ternative depreciation system pursuant to§ 168(g)(1) includes property in a class(as set out in § 168(e)) for which the tax-payer made a timely election under §168(g)(7).

(d) Section 197 property. The de-preciation allowable for any taxable yearfor an amortizable § 197 intangible (in-cluding any property for which a timelyelection under § 13261(g)(2) of the 1993Act was made) is determined by using thestraight-line method over a 15-year pe-riod.

(e) Former § 168 property. Thedepreciation allowable for any taxableyear for property subject to former § 168is determined by using either:

(i) the accelerated method ofcost recovery applicable to the property(for example, for 5-year property, the re-covery method under former § 168(b)(1));or

(ii) the straight-line method ap-plicable to the property if the property isrequired to be depreciated under thestraight-line method (for example, prop-erty described in former § 168(f)(12) orformer § 280F(b)(2)) or if the taxpayer

elected to determine the depreciation al-lowance under the optional straight-linepercentage (for example, the straight-linemethod in former § 168(b)(3)).

.02 Permissible to permissible methodof accounting for depreciation.

(1) Description of change. Thischange applies to a taxpayer that wants tochange from a permissible method of ac-counting for depreciation under § 167 toanother permissible method of accountingfor depreciation under § 167. Pursuant to§§ 1.167(a)–7(a) and (c), a taxpayer mayaccount for depreciable property either bytreating each individual asset as an ac-count or by combining two or more assetsin a single account and, for each account,depreciation allowances are computedseparately. This change was formerlyprovided in Rev. Proc. 74–11, 1974–1C.B. 420.

(2) Scope. (a) Applicability. Except as pro-

vided in section 2.02(2)(b) of this AP-PENDIX, this change applies to any tax-payer wanting to make a change inmethod of accounting for depreciationspecified in section 2.02(3) of this AP-PENDIX for the property in an account:

(i) for which the present andproposed methods of accounting for de-preciation specified in section 2.02(3) ofthis APPENDIX are permissible methodsfor the property under § 167; and

(ii) that is owned by the tax-payer at the beginning of the year ofchange.

(b) Inapplicability. This changedoes not apply to:

(i) any taxpayer that is subjectto § 263A and that is required to capitalizethe costs with respect to which the tax-payer wants to change its method of ac-counting under section 2.02 of this AP-PENDIX, if the taxpayer is notcapitalizing the costs as required;

(ii) any property to which §1016(a)(3) (regarding property held by atax-exempt organization) applies;

(iii) any intangible property;(iv) any property described in §

167(f) (regarding certain property ex-cluded from § 197);

(v) any property subject to §167(g) (regarding property depreciatedunder the income forecast method);

(vi) any property for which de-preciation is determined under § 168 or

August 18, 1997 32 1997–33 I.R.B.

168 prior to its amendment in 1986 (for-mer § 168);

(vii) any property that the tax-payer elected under § 168(f)(1) or former§ 168(e)(2) to exclude from the applica-tion of, respectively, § 168 or former §168;

(viii) any property for whichdepreciation is determined in accordancewith § 1.167(a)–11 (regarding the ClassLife Asset Depreciation Range System(ADR)); or

(ix) any depreciable propertyfor which the taxpayer is changing the de-preciation method pursuant to §1.167(e)–1(b) (change from declining-balance method to straight-line method),§ 1.167(e)–1(c) (certain changes for §1245 property), or § 1.167(e)–1(d) (cer-tain changes for § 1250 property). Thesechanges must be made prospectively andare not permitted under the cited regula-tions for property for which the deprecia-tion is determined under § 168 or former§ 168.

(3) Changes covered. Section 2.02of this APPENDIX only applies to the fol-lowing changes in methods of accountingfor depreciation:

(a) a change from the straight-linemethod to the sum-of-the-years-digitsmethod, the sinking fund method, theunit-of-production method, or the declin-ing-balance method using any proper per-centage of the straight-line rate;

(b) a change from the declining-balance method using any percentage ofthe straight-line rate to the sum-of-the-years-digits method, the sinking fundmethod, or the declining-balance methodusing a different proper percentage of thestraight-line rate;

(c) a change from the sum-of-the-years-digits method to the sinking fundmethod, the declining-balance methodusing any proper percentage of thestraight-line rate, or the straight-linemethod;

(d) a change from the unit-of-pro-duction method to the straight-linemethod;

(e) a change from the sinking fundmethod to the straight-line method, theunit-of-production method, the sum-of-the-years-digits method, or the declining-balance method using any proper percent-age of the straight-line rate;

(f) a change in the interest factor

used in connection with a compound in-terest method or sinking fund method;

(g) a change in averaging conven-tion as set forth in § 1.167(a)–10(b).However, as specifically provided in §1.167(a)–10(b), in any taxable year inwhich an averaging convention substan-tially distorts the depreciation allowancefor the taxable year, it may not be used(see Rev. Rul. 73–202, 1973–1 C.B. 81);

(h) a change from charging the de-preciation reserve with costs of removaland crediting the depreciation reservewith salvage proceeds to deducting costsof removal as an expense and includingsalvage proceeds in taxable income as setforth in § 1.167(a)–8(e)(2). See Rev. Rul.74–455, 1974–2 C.B. 63. This change,however, may be made under this revenueprocedure only if:

(i) the change is applied to allitems in the account for which the changeis being made; and

(ii) the removal costs are not re-quired to be capitalized under any provi-sion of the Code (for example, § 263(a),263A, or 280B);

(i) a change from crediting the de-preciation reserve with the salvage pro-ceeds realized on normal retirement salesto computing and recognizing gains andlosses on such sales (see Rev. Rul.70–165, 1970–1 C.B. 43);

(j) a change from crediting ordi-nary income (including the combinationmethod of crediting the lesser of esti-mated salvage value or actual salvageproceeds to the depreciation reserve, withany excess of salvage proceeds over esti-mated salvage value credited to ordinaryincome) with the salvage proceeds real-ized on normal retirement sales, to com-puting and recognizing gains and losseson such sales (see Rev. Rul. 70–166,1970–1 C.B. 44); or

(k) a change from item accountingfor specific assets to multiple asset ac-counting for the same assets, or viceversa.

(4) Additional requirements. A tax-payer also must comply with the follow-ing:

(a) Basis for depreciation. At thebeginning of the year of change, thebasis for depreciation of property towhich this change applies is the adjustedbasis of the property as provided in §1011 at the end of the taxable year im-

mediately preceding the year of change(determined under the taxpayer’s presentmethod of accounting for depreciation).If applicable under the taxpayer’s pro-posed method of accounting for depreci-ation, this adjusted basis is reduced bythe estimated salvage value of the prop-erty (for example, a change to thestraight-line method).

(b) Rate of depreciation. The rateof depreciation for property changed to:

(i) the straight-line or sum-of-the-years-digits method of depreciationmust be based on the remaining useful lifeof the property as of the beginning of theyear of change; or

(ii) the declining-balancemethod of depreciation must be based onthe useful life of the property measuredfrom the placed-in-service date, and notthe expected remaining life from the datethe change becomes effective.

(c) Regulatory requirements. Forchanges in method of depreciation to thesum-of-the-years-digits or declining-bal-ance method, the property must meet therequirements of § 1.167(b)–0 or1.167(c)–1, as appropriate.

(5) Section 481(a) adjustment. Be-cause the adjusted basis of the property isnot changed as a result of a methodchange made under section 2.02 of thisAPPENDIX, no items are being dupli-cated or omitted. Accordingly, the §481(a) adjustment is zero.

.03 Sale or lease transactions. (1) Description of change and scope.

(a) Applicability. Except as pro-vided in section 2.03(1)(b) of this AP-PENDIX, this change applies to a tax-payer that wants to change its method ofaccounting from treating property as soldby the taxpayer to treating property asleased by the taxpayer, and vice versa,and to a taxpayer that wants to change itsmethod of accounting from treating prop-erty as purchased by the taxpayer to treat-ing property as leased by the taxpayer,and vice versa.


(i) a rent-to-own dealer thatwants to change its method of accountingfor rent-to-own contracts described insection 3 of Rev. Proc. 95–38, 1995–2C.B. 397; or

(ii) a taxpayer that holds assetsfor sale or lease, if any asset so held is not

1997–33 I.R.B. 33 August 18, 1997

the subject of a sale or lease transaction asof the beginning of the year of change.

(2) Manner of making the change. (a) The change in method of ac-

counting under section 2.03 of this AP-PENDIX is made using a cut-off methodand applies to transactions entered into onor after the beginning of the year ofchange. See section 2.06 of this revenueprocedure.

(b) If a taxpayer wants to changeits method of accounting for existing saleor lease transactions, the taxpayer mustfile an application with the Commissionerin accordance with the requirements of §1.446–1T(e)(3)(i) and Rev. Proc. 97–27.A change involving existing sale or leasetransactions will require a § 481(a) adjust-ment. Consent to change a method of ac-counting for an existing sale or leasetransaction is granted only in unusual andcompelling circumstances.

(3) No audit or ruling protection. Ataxpayer does not receive audit protectionunder section 7 of this revenue procedurein connection with this change. Further-more, the Commissioner’s consent to thischange does not constitute acceptance orapproval of the taxpayer’s characteriza-tion of any transaction as a sale or lease.

SECTION 3. CAPITALEXPENDITURES (§ 263)

.01 Package design costs.(1) Description of change and scope.

This change applies to a taxpayer thatwants to change to one of the three alter-native methods of accounting for packagedesign costs described in section 5 of Rev.Proc. 97–35, page 11. The three alterna-tive methods of accounting for packagedesign costs described are: (1) the capi-talization method, (2) the design-by-de-sign capitalization and 60-month amorti-zation method, and (3) the pool-of-costcapitalization and 48-month amortizationmethod. This change was formerly pro-vided in Rev. Proc. 90–63, 1990–2 C.B.664.

(2) Additional requirements. If ataxpayer is changing its method of ac-counting for package design costs to thecapitalization method or the design-by-design capitalization and 60-month amor-tization method, the taxpayer must attacha statement to its timely filed application.The statement must provide a descriptionof each package design, the date on which

each was placed in service, and the costbasis of each (as determined under sec-tions 5.01(2) or 5.02(2) of Rev. Proc.97–35).

.02 Reserved.

SECTION 4. UNIFORM CAPITALIZATION (§ 263A)

.01 Certain uniform capitalization(UNICAP) methods used by small re-sellers, formerly small resellers, and re-seller-producers.

(1) Description of change and scope. (a) Applicability. This change,

which was formerly provided in Rev.Proc. 95–33, 1995–2 C.B. 380, applies to:

(i) a small reseller of personalproperty changing from a permissibleUNICAP method to a permissible non-UNICAP inventory capitalization methodin any taxable year that it qualifies as asmall reseller;

(ii) a formerly small resellerchanging from a permissible non-UNI-CAP inventory capitalization method to apermissible UNICAP method in the firsttaxable year that it does not qualify as asmall reseller;

(iii) a reseller-producer chang-ing from a permissible UNICAP methodfor both its production and resale activi-ties to a permissible simplified resalemethod described in § 1.263A–3(d)(3) inany taxable year that it qualifies to use asimplified resale method for both its pro-duction and resale activities under §1.263A–3(a)(4) (resellers with de min-imis production activities); or

(iv) a reseller-producer chang-ing from a permissible simplified resalemethod described in § 1.263A–3(d)(3) forboth its production and resale activities toa permissible UNICAP method for bothits production and resale activities in thefirst taxable year that it does not qualify touse a simplified resale method for both itsproduction and resale activities under §1.263A–3(a)(4).

(b) Scope limitations inapplicable.A taxpayer that wants to make this changeis not subject to the scope limitations insection 4.02 of this revenue procedure.However, if the taxpayer is under exami-nation, before an appeals office, or beforea federal court, the taxpayer must providea copy of the application to the examiningagent(s), appeals officer, or counsel forthe government, as appropriate, at the

same time that it files the copy of the ap-plication with the national office. The ap-plication must contain the name(s) andtelephone number(s) of the examiningagent(s), appeals officer, or counsel forthe government, as appropriate.

(c) Inapplicability. This changedoes not apply to a taxpayer making a his-toric absorption ratio election under §1.263A–2(b)(4) or 1.263A–3(d)(4).

(2) Definitions.(a) “Reseller” means a taxpayer

that acquires real or personal property de-scribed in § 1221(1) for resale.

(b) “Small reseller” means a re-seller whose average annual gross re-ceipts for the three immediately precedingtaxable years (or fewer, if the taxpayerhas not been in existence during the threepreceding taxable years) do not exceed$10,000,000. See § 263A(b)(2)(B).

(c) “Formerly small reseller”means a reseller that no longer qualifiesas a small reseller.

(d) “Producer” means a taxpayerthat produces real or tangible personalproperty.

(e) “Reseller-producer” means ataxpayer that is both a producer and a re-seller.

(f) “Permissible UNICAPmethod” means a method of capitalizingcosts that is permissible under § 263A.

(g) “Permissible non-UNICAP in-ventory capitalization method” means amethod of capitalizing inventory coststhat is permissible under § 471.

(3) Section 481(a) adjustment. Be-ginning with the year of change, a tax-payer changing its method of accountingfor costs pursuant to section 4.01 of thisAPPENDIX generally must take any ap-plicable § 481(a) adjustment into accountratably over the same number of taxableyears, not to exceed four, that the tax-payer used its former method of account-ing. See section 5.04(3) of this revenueprocedure for exceptions to this generalrule.

(4) No audit protection. A taxpayerdoes not receive audit protection undersection 7 of this revenue procedure inconnection with this change.

(5) Example. The following exam-ple illustrates the principles of section4.01 of this APPENDIX for small re-sellers and formerly small resellers.

Assume X, a corporate reseller of per-

August 18, 1997 34 1997–33 I.R.B.

sonal property, incorporated January 2,1991, adopted a taxable year ending De-cember 31. X determines that its averageannual gross receipts for the three taxableyears (or fewer, if applicable) immedi-ately preceding taxable years 1991through 2000 are as shown in the tablebelow:

AVERAGE Annual Gross Receipts for the

Current Three Taxable YearsTaxable Immediately Preceding

Year the Current Taxable Year

1991 $ 01992 5,000,0001993 6,000,0001994 7,000,0001995 11,000,0001996 11,000,0001997 9,000,0001998 8,000,0001999 11,000,0002000 12,000,000

Furthermore, X, which adopted the dol-lar-value LIFO inventory method, has thefollowing LIFO inventory balances deter-mined without considering the effects ofthe UNICAP method:

Beginning Ending

1995 $1,000,000 $1,100,0001996 1,100,000 1,200,0001997 1,200,000 1,300,0001998 1,300,000 1,400,0001999 1,400,000 1,500,0002000 1,500,000 1,600,000

X was required by § 263A to change tothe UNICAP method for 1995 because itsaverage annual gross receipts for the threetaxable years immediately preceding1995 were $11,000,000, which exceededthe $10,000,000 ceiling permitted by thesmall reseller exception. Assume that Xwas required to capitalize $80,000 of “ad-ditional § 263A costs” to the cost of its1995 beginning inventory because of thischange in inventory method. In addition,X was required to include one-fourth ofthe § 481(a) adjustment when computingtaxable income for each of the four tax-able years beginning with 1995. Thus, Xwas required to include a $20,000 posi-tive § 481(a) adjustment in its 1995 tax-able income.

X elected to use the simplified resalemethod without a historic absorption ratio

election under § 1.263A–3(d)(3) for de-termining the amount of additional §263A costs to be capitalized to each LIFOlayer. Assume that X was required to add$10,000 of additional § 263A costs to thecost of its 1995 ending inventory becauseof the $100,000 increment for 1995.

X’s 1995 Ending Inventory:

Beginning Inventory (WithoutUNICAP costs) $1,000,000

1995 Increment 100,000

Additional § 263A Costs in Beginning Inventory 80,000

Additional § 263A Costs in 1995Increment 10,000________

Total 1995 Ending Inventory $1,190,000________________

X’s Unamortized 1995 § 481(a) adjustment:

1995 § 481(a) Adjustment $80,000

Amount Included in 1995 Taxable Income <20,000>________

Unamortized 1995 § 481(a) Adjustment—12/31/95 $60,000________________

Because X failed to satisfy the small re-seller exception for 1996, X was requiredto continue using the UNICAP methodfor its inventory costs. Furthermore, Xwas required to include $20,000 of theunamortized 1995 positive § 481(a) ad-justment in 1996 taxable income. As-sume that X was required to add $10,000of additional § 263A costs to the cost ofits 1996 ending inventory because of the$100,000 increment for 1996.


Beginning Inventory (With UNICAP costs) $1,190,000


Additional § 263A Costs in 1996 Increment 10,000________


X’s Unamortized 1995 § 481(a) Adjustment:

Unamortized 1995 § 481(a) Adjustment—12/31/95 $60,000



Because X satisfies the small resellerexception for 1997, X may change volun-tarily from the UNICAP method to a per-missible non-UNICAP inventory capital-ization method under section 4.01 of thisAPPENDIX. To reflect the removal ofthe additional § 263A costs from the costof its 1997 beginning inventory, X mustcompute a corresponding § 481(a) adjust-ment, which is a negative $100,000

($1,200,000 — $1,300,000). Because Xused the UNICAP method for only twoyears (that is, 1995 and 1996), X must in-clude one-half of the § 481(a) adjustmentwhen computing taxable income for eachof the two taxable years beginning with1997. Thus, X must include a $50,000negative § 481(a) adjustment in 1997 tax-able income. In addition, X must include$20,000 of the unamortized 1995 § 481(a)adjustment in 1997 taxable income.




1997 § 481(a) Adjustment <Negative> <100,000>________







1997 § 481(a) Adjustment <Negative> $<100,000>

Amount Included in 1997 Taxable Income 50,000________

Unamortized 1997 § 481(a) Adjustment—12/31/97 $< 50,000>________________

X also satisfies the small reseller ex-ception for 1998 and, therefore, is not re-quired to return to the UNICAP methodfor 1998. X, however, must include$20,000 of the unamortized 1995 positive§ 481(a) adjustment and $50,000 of theunamortized 1997 negative § 481(a) ad-justment in 1998 taxable income.


Beginning Inventory (WithoutUNICAP costs) $1,300,000

1998 Increment 100,000________





Unamortized 1995 § 481(a) Adjustment—12/31/98 $ 0________________


Unamortized 1997 § 481(a) Adjustment—12/31/97 $<50,000>

Amount Included in 1998 Taxable Income 50,000________


1997–33 I.R.B. 35 August 18, 1997

In 1999, X fails to satisfy the small re-seller exception and, therefore, must re-turn to the UNICAP method as providedunder section 4.01 of this APPENDIX. Xchanges to the simplified resale methodwithout a historic absorption ratio elec-tion under § 1.263A–3(d)(3). Assumethat X must capitalize $120,000 of addi-tional § 263A costs to the cost of its 1999beginning inventory because of thischange in inventory method. In addition,X must determine the appropriate adjust-ment period for the corresponding posi-tive § 481(a) adjustment. Because X usedits former inventory method for two tax-able years before 1999 (that is, 1997 and1998), X must include one-half of the §481(a) adjustment when computing tax-able income for each of the two taxableyears beginning with 1999. Thus, X mustinclude a $60,000 positive § 481(a) ad-justment in its 1999 taxable income. As-sume that X must add $10,000 of addi-tional § 263A costs to the cost of its 1999ending inventory because of the $100,000increment for 1999.


Beginning Inventory (Without UNICAP costs) $1,400,000


Additional § 263A costs in Beginning Inventory 120,000

Additional § 263A costs in 1999 Increment 10,000________



1999 § 481(a) Adjustment $120,000

Amount Included in 1999 Taxable Income < 60,000>________

Unamortized 1999 § 481(a) Adjustment—12/31/99 $ 60,000________________

Because X fails to satisfy the small re-seller exception for 2000, X must con-tinue using the UNICAP method for itsinventory costs. Furthermore, X is re-quired to include $60,000 of the unamor-tized 1999 positive § 481(a) adjustment in2000 taxable income. Assume that X isrequired to add $10,000 of additional §263A costs to the cost of its 2000 endinginventory because of the $100,000 incre-ment for 2000.




Additional § 263A Costs in

2000 Increment 10,000________



Unamortized 1999 § 481(a)Adjustment—12/31/99 $60,000



.02 Reserved.

SECTION 5. METHODS OF ACCOUNTING (§ 446)

.01 Cash or hybrid method to accrualmethod.

(1) Description of change and scope.(a) Applicability. Except as pro-

vided in section 5.01(1)(b) of this AP-PENDIX, this change, which was for-merly provided, in part, in Rev. Proc.92–75, 1992–2 C.B. 448, and Rev. Proc.92–74, 1992–2 C.B. 442, applies to:

(i) a taxpayer that wants tochange to an overall accrual method, orto an overall accrual method in conjunc-tion with the recurring item exceptionunder § 461(h)(3), from the cash receiptsand disbursements method (cashmethod), or from a hybrid method (underwhich certain items of income or expenseare reported on the cash method andother items of income or expense are re-ported on an accrual method or othermethods); or

(ii) a taxpayer that is required tochange to an overall accrual methodunder § 448, but is ineligible to make thechange under § 1.448–1(h)(2) (relating tothe “first § 448 year”).

(b) Inapplicability. Thischange does not apply to:

(i) a financial institutiondescribed in § 581 or 591;

(ii) a farmer; (iii) a cooperative organi-

zation described in § 501(c)(12), 521, or1381;

(iv) an individual taxpayer,except for activities conducted as a soleproprietorship;

(v) a taxpayer required touse an inventory method of accounting,unless:

(A) the taxpayer adoptsa proper inventory method under § 471and the regulations thereunder, the tax-payer is a small reseller within the mean-

ing of § 1.263A–3(a), and, if the taxpayerhas production activities, the taxpayer’sproduction activities qualify under the deminimis presumption of § 1.263A–3(a)-(2)(iii); or

(B) the taxpayer adoptsa proper inventory method under § 471and the regulations thereunder, the tax-payer is a reseller eligible to use the sim-plified resale method under §1.263A–3(d), and the taxpayer adopts aproper method under that section for theyear of change;

(vi) a taxpayer required touse a long-term contract method in accor-dance with § 460, if the taxpayer is not incompliance with that section and any re-lated administrative guidance;

(vii) a taxpayer required orwanting to use a special method of ac-counting, unless the taxpayer is permittedto change automatically to the specialmethod under this revenue procedure. Aspecial method of accounting is a methodthat deviates from the normal tax account-ing rules, such as the method of account-ing for advance payments pursuant to ei-ther Rev. Proc. 71–21, 1971–2 C.B. 549,or § 1.451–5, the installment method ofaccounting under § 453, or a long-termcontract method under § 460; or

(viii) a taxpayer required tochange to an overall accrual method under§ 448 and eligible to make the changeunder § 1.448–1(h)(2). See § 1.448–1(h)-(2), which provides an automatic consentprocedure for a taxpayer changing for thefirst taxable year that it is subject to § 448.See also § 1.448–1(h)(1), which providesthat § 1.448–1(h) does not apply to achange required under any Code section(or regulations thereunder) other than §448 (for example, a taxpayer with invento-ries).

(2) Section 481(a) adjustment.(a) In general. The § 481(a) ad-

justment takes into account the accountsreceivable, accounts payable, inventory,and any other item determined to be nec-essary in order to prevent items frombeing duplicated or omitted. The § 481(a)adjustment does not include any item ofincome accrued but not received that wasworthless or partially worthless (withinthe meaning of § 166(a)) on the last dayof the year preceding the year of change.

(b) Recurring item exception. Aspart of the change to an overall accrual

August 18, 1997 36 1997–33 I.R.B.

method, a taxpayer may adopt the recur-ring item exception for the year of changeif the taxpayer is eligible and follows theprocedures of § 1.461–5(d). If the tax-payer is eligible and wants to adopt thismethod as specified in § 461(h)(3), theamount of the § 481(a) adjustment mustbe modified to account for the amount ofany additional deduction.

(3) Change to a special method ofaccounting. If a taxpayer that wants tochange to an accrual method in conjunc-tion with a change to a special method ofaccounting is not permitted to make thechange under this revenue procedure, thetaxpayer may request to make bothchanges only by filing one applicationunder the provisions of Rev. Proc. 97–27,1997–21 I.R.B. 10. Only one user feewill be required for these changes.

.02 Multi-year service warranty con-tracts.

(1) Description of change and scope. (a) Applicability. This change

applies to an eligible accrual methodmanufacturer, wholesaler, or retailer ofmotor vehicles or other durable con-sumer goods that wants to change to theservice warranty income method de-scribed in section 5 of Rev. Proc. 97–38,page 43. Under the service warranty in-come method, a qualifying taxpayermay, in certain specified and limited cir-cumstances, include a portion of an ad-vance payment related to the sale of amulti-year service warranty contract ingross income generally over the life ofthe service warranty obligation. Thischange was formerly provided in Rev.Proc. 92–98, 1992–2 C.B. 512.

(b) Inapplicability. This changedoes not apply to a taxpayer outside thescope of Rev. Proc. 97–38.

(2) Manner of making the change. (a) This change is made using a

cut-off method, under which the taxpayerbegins the use of the service warranty in-come method for all qualified advancepayment amounts received in the year ofchange and thereafter. See section 2.06 ofthis revenue procedure.

(b) In accordance with § 1.446–1-(e)(3)(ii), the requirement of § 1.446–1(e)-(3)(i) to file an application on Form 3115 iswaived and a statement in lieu of the Form3115 is authorized for this change. Thestatement must be identified at the top asfollows: “CHANGE TO THE SERVICE

WARRANTY INCOME METHODUNDER SECTION 5.02 OF THE AP-PENDIX OF REV. PROC. 97–37.” Thestatement must set forth the informationrequired under section 6.03 of Rev. Proc.97–38, except that the statement under sec-tion 6.03(2) (that the taxpayer agrees to allof the terms and conditions of the revenueprocedure) also should refer to Rev. Proc.97–37.

(c) A taxpayer changing to the ser-vice warranty income method of account-ing under section 5.02 of this APPENDIXmust satisfy the annual reporting require-ment set forth in section 6.04 of Rev.Proc. 97–38.

.03 Multi-year insurance policies formulti-year service warranty contracts —Description of change and scope.

(1) Applicability. Except as pro-vided in section 5.03(2) of this APPEN-DIX, this change applies to a manufac-turer, wholesaler, or retailer of motorvehicles or other durable consumer goodsthat wants to change its method of ac-counting for insurance costs paid or in-curred to insure its risks under multi-yearservice warranty contracts to the methoddescribed in section 5.03(3) of this AP-PENDIX. Multi-year service warrantycontracts to which this change applies in-clude only those separately priced con-tracts sold by a manufacturer, wholesaler,or retailer also selling the motor vehiclesor other durable consumer goods (to theultimate customer or to an intermediary)underlying the contracts. The classifica-tion of goods as “durable consumergoods” for purposes of this change de-pends on the common usage of the goods,rather than the purchaser’s actual in-tended use of the goods. This change wasformerly provided in Rev. Proc. 92–97,1992–2 C.B. 510.

(2) Inapplicability. This changedoes not apply to a taxpayer that coversits risks under its multi-year service war-ranty contracts through arrangements notconstituting insurance.

(3) Description of method. If a tax-payer purchases a multi-year service war-ranty insurance policy (in connection withits sale of multi-year service warrantycontracts to customers) by paying a lump-sum premium in advance, the taxpayermust capitalize the amount paid or in-curred and may only obtain deductionsfor that amount by prorating (or amortiz-

ing) it over the life of the insurance policy(whether the cash method or an accrualmethod of accounting is used to accountfor service warranty transactions).

SECTION 6. OBLIGATIONS ISSUEDAT DISCOUNT (§ 454)

.01 Series E or EE U.S. savings bonds. (1) Description of change and scope.

This change applies to a cash method tax-payer that wants to change its method ofaccounting for interest income on SeriesE or EE U.S. savings bonds. However,this change only applies to a taxpayer thathas previously made an election under §454 to report as interest income the in-crease in redemption price on a bond oc-curring in a taxable year, and that nowwants to report this income in the taxableyear in which the bond is redeemed, dis-posed of, or finally matures, whichever isearliest. This change was formerly pro-vided in Rev. Proc. 89–46, 1989–2 C.B.597.


cut-off method and is effective for any in-crease in redemption price occurring afterthe beginning of the year of change for allSeries E and EE U.S. savings bonds heldby the taxpayer on or after the beginningof the year of change. See section 2.06 ofthis revenue procedure.

(b) In accordance with § 1.446–1-(e)(3)(ii), the requirement of § 1.446–1(e)-(3)(i) to file an application on Form 3115 iswaived and a statement in lieu of the Form3115 is authorized for this change. Thestatement must be identified at the top asfollows: “CHANGE IN METHOD OFACCOUNTING UNDER SECTION 6.01OF THE APPENDIX OF REV. PROC.97–37.” The statement must set forth:

(i) the Series E or EE U.S. sav-ings bonds for which this change in ac-counting method is requested;

(ii) an agreement to report allinterest on any bonds acquired during orafter the year of change when the interestis realized upon disposition, redemption,or final maturity, whichever is earliest;and

(iii) an agreement to report allinterest on the bonds acquired before theyear of change when the interest is real-ized upon disposition, redemption, orfinal maturity, whichever is earliest, withthe exception of any interest income pre-

1997–33 I.R.B. 37 August 18, 1997

viously reported in prior taxable years.

.02 Reserved.

SECTION 7. PREPAID SUBSCRIPTION INCOME (§ 455)

.01 Prepaid subscription income. (1) Description of change and scope.

This change applies to an accrual methodtaxpayer that wants to change its methodof accounting for prepaid subscription in-come to the method described in § 455and the regulations thereunder, includingan eligible taxpayer that wants to makethe “within 12 months” election under §1.455–2. This change was formerly pro-vided, in part, in Rev. Proc. 84–76,1984–2 C.B. 751.


cut-off method and does not apply to anyprepaid subscription income received be-fore the first taxable year to which thechange applies. Any prepaid subscriptionincome arising prior to the year of changeis accounted for under the taxpayer’s for-mer method of accounting. See section2.06 of this revenue procedure.

(b) In accordance with § 1.446–1-(e)(3)(ii), the requirement of § 1.446–1(e)-(3)(i) to file an application on Form 3115 iswaived and a statement in lieu of the Form3115 is authorized for this change. Thestatement must be identified at the top asfollows: “CHANGE IN METHOD OFACCOUNTING FOR PREPAID SUB-SCRIPTION INCOME UNDER SEC-TION 7.01 OF THE APPENDIX OF REV.PROC. 97–37.” The statement must setforth the information required under §1.455–6(b).

.02 Reserved.

SECTION 8. TAXABLE YEAR OF DEDUCTION (§ 461)

.01 Timing of incurring liabilities foremployee compensation.

(1) Description of change and scope. (a) Applicability. This change ap-

plies to an accrual method taxpayer thatwants to change its method of accountingto treat bonuses or self-insured medicalbenefits as follows:

(i) Bonuses. If the obligation topay a bonus becomes fixed and certain bythe end of the taxable year (see Rev. Rul.61–27, 1961–2 C.B. 36), and the bonus isotherwise deductible, but the bonus is

paid after the 15th day of the third calen-dar month after the end of that taxableyear, to treat the bonus as deductible inthe taxable year of the employer in whichor with which ends the taxable year of theemployee in which the bonus is includiblein the gross income of the employee; or

(ii) Self-insured medical bene-fits. If the obligation to pay an em-ployee’s medical expenses is neither in-sured nor paid from a welfare benefit fundwithin the meaning of § 419(e), to treatthe liability as incurred in the taxable yearin which the employee files the claimwith the employer. See United States v.General Dynamics Corp., 481 U.S. 239(1987), 1987–2 C.B. 134.

(b) Inapplicability. This changedoes not apply to a taxpayer that is subjectto § 263A and that is required to capitalizethe costs with respect to which the tax-payer wants to change its method of ac-counting under section 8.01 of this AP-PENDIX, if the taxpayer is notcapitalizing the costs as required.

(2) Amounts taken into account. Ap-plicable provisions of the Code, regula-tions, and other published guidance pre-scribe the manner in which a liability thathas been incurred is taken into account.For example, for a taxpayer with invento-ries, direct labor costs must be included ininventory costs and may be recoveredthrough cost of goods sold. See § 1.263A–1(e)(2)(i)(B). A taxpayer maynot rely on the provisions of section 8.01of this APPENDIX to take a current yeardeduction.

.02 Timing of incurring liabilities forreal property taxes.

(1) Description of change. An ac-crual method taxpayer generally incurs aliability in the taxable year that all theevents have occurred that establish thefact of the liability, the amount of the lia-bility can be determined with reasonableaccuracy, and economic performance hasoccurred with respect to the liability. See§ 1.446–1(c)(1)(ii). Under § 1.461–4-(g)(6), if the liability of the taxpayer is topay a tax, economic performance occursas the tax is paid to the government au-thority that imposed the tax.

(2) Scope. (a) Applicability. This change ap-

plies to an accrual method taxpayer thatwants to change its method of accountingto:

(i) treat a liability for real prop-erty taxes as incurred in the taxable yearin which the taxes are paid, under §§ 461and 1.461–4(g)(6);

(ii) account for real propertytaxes under the recurring item exceptionto the economic performance rules under§§ 461(h)(3) and 1.461–5(b)(1); or

(iii) revoke an election under §461(c) (ratable accrual election).


(3) Amounts taken into account.Applicable provisions of the Code, regu-lations, and other published guidanceprescribe the manner in which a liabilitythat has been incurred is taken into ac-count. For example, for a taxpayer withinventories, certain real property taxesmust be included in inventory costs andmay be recovered through cost of goodssold. See § 1.263A–1(e)(3)(ii)(L). A tax-payer may not rely on the provisions ofsection 8.02 of this APPENDIX to take acurrent year deduction.

.03 Timing of incurring liabilitiesunder a workers’ compensation act, tort,breach of contract, or violation of law.

(1) Description of change andscope.

(a) Applicability. This change ap-plies to an accrual method taxpayer thatwants to change its method of accountingfor self-insured liabilities (including anyamounts not covered by insurance, suchas a “deductible” amount under an insur-ance policy) arising under any workers’compensation act or out of any tort,breach of contract, or violation of law, totreating the liability for the workers’compensation, tort, breach of contract, orviolation of law as being incurred in thetaxable year in which all the events haveoccurred which establish the fact of theliability, the amount of the liability canbe determined with reasonable accuracy,and payment is made to the person towhich the liability is owed. See § 461and § 1.461–4(g)(2).

(b) Inapplicability. This changedoes not apply:

(i) to a taxpayer that is subject

August 18, 1997 38 1997–33 I.R.B.

to § 263A and that is required to capitalizethe costs with respect to which the tax-payer wants to change its method of ac-counting under section 8.03 of this AP-PENDIX, if the taxpayer is notcapitalizing the costs as required;

(ii) if payment is made to a thirdparty rather than to the person to whichthe liability is owed. See § 1.461–4(g)(1);or

(iii) if payment is made by athird party.

(2) Amounts taken into account. Ap-plicable provisions of the Code, regula-tions, and other published guidance pre-scribe the manner in which a liability thathas been incurred is taken into account.For example, for a taxpayer with invento-ries, certain employee benefit costs (in-cluding workers’ compensation) must beincluded in inventory costs and may berecovered through costs of goods sold.See § 1.263A–1(e)(3)(ii)(D). A taxpayermay not rely on the provisions of section8.03 of this APPENDIX to take a currentyear deduction.

.04 Timing of incurring liabilities forpayroll taxes.

(1) Description of change and scope. (a) Applicability. This change ap-

plies to an accrual method employer thatwants to change its method of accountingfor FICA and FUTA taxes to a methodconsistent with the holding in Rev. Rul.96–51, 1996–43 I.R.B. 5. Rev. Rul.96–51 holds that, under the all events testof § 461, an accrual method employermay deduct in Year 1 its otherwise de-ductible FICA and FUTA taxes imposedwith respect to year-end wages properlyaccrued in Year 1, but paid in Year 2, ifthe requirements of the recurring item ex-ception are met.


(2) Recurring item exception. Aspart of this change, a taxpayer that previ-ously has not changed to or adopted therecurring item exception for FICA andFUTA taxes must change to the recurringitem exception method for FICA andFUTA taxes as specified in § 461(h)(3).

(3) Amounts taken into account. Ap-plicable provisions of the Code, regula-tions, and other published guidance pre-scribe the manner in which a liability thathas been incurred is taken into account.For example, for a taxpayer with invento-ries, certain taxes must be included in in-ventory costs and may be recoveredthrough cost of goods sold. See §1.263A–1(e)(3)(ii)(L). A taxpayer maynot rely on the provisions of section 8.04of this APPENDIX to take a current yeardeduction.

SECTION 9. INVENTORIES (§ 471)

.01 Cash discounts — Description ofchange and scope. This change applies toa taxpayer that wants to change itsmethod of accounting for cash discounts(discounts granted for timely payment)when they approximate a fair interest rate,from a method of consistently includingthe price of the goods before discount inthe cost of the goods and including ingross income any discounts taken (the“gross invoice method”), to a method ofreducing the cost of the goods by the cashdiscounts and deducting as an expenseany discounts not taken (the “net invoicemethod”), or vice versa. See Rev. Rul.73–65, 1973–1 C.B. 216.

.02 Reserved.

SECTION 10. LAST-IN, FIRST-OUT(LIFO) INVENTORIES (§ 472)

.01 Change from the LIFO inventorymethod.

(1) Description of change and scope. (a) In general. This change,

which was formerly provided in Rev.Proc. 88–15, 1988–1 C.B. 683, applies toany taxpayer that wants to:

(i) change from the LIFO in-ventory method for all its LIFO inven-tory; and

(ii) change to the permittedmethod as determined in section10.01(1)(b) of this APPENDIX.

(b) Method to be used. (i) Determining method to be

used. The inventory method to be usedby a taxpayer is determined as follows:

(A) If the taxpayer has inven-toriable goods not included in its LIFO in-ventory computations (non-LIFO inven-tory) and, for all the taxpayer’s non-LIFOinventory, the taxpayer uses an inventory

method that is a permitted method, thenthe taxpayer must use that same inventorymethod for its entire inventory.

(B) If the LIFO inventorymethod is used by the taxpayer with re-spect to all its inventoriable goods, thenthe taxpayer must use the same inventorymethod it used prior to the adoption of theLIFO inventory method, if that priormethod is a permitted method.

(C) If the taxpayer has onlyLIFO inventory and the method used bythe taxpayer prior to the adoption of theLIFO inventory method is not a permittedmethod, then the taxpayer must use a per-mitted method.

(D) If the taxpayer did notuse an inventory method prior to theadoption of the LIFO inventory methodand has no inventoriable goods other thanits LIFO inventory, then the taxpayermust use a permitted method.

(ii) Permitted method defined.For purposes of section 10.01 of this AP-PENDIX, a permitted method is a methodunder which:

(A) the identification methodis either the first-in, first-out (FIFO) in-ventory method or the specific identifica-tion inventory method; and

(B) the valuation method iscost; cost or market, whichever is lower;market (but only if the taxpayer is a dealerin securities, as defined in § 1.471–5); the“farm price method” or the “unit-live-stock-price method” (but only if the tax-payer is a farmer permitted to use suchmethods); or the retail method, reduced toeither approximate cost or approximatecost or market, whichever is lower (butonly if the taxpayer is a retail merchant).

(iii) Method not to be used. Theaverage cost method (sometimes also re-ferred to as “the rolling average method”)described in Rev. Rul. 71–234, 1971–1C.B. 148, is not a permitted method.

(iv) Determining permittedmethod. Whether an inventory method isa permitted method is determined by thetaxpayer’s method of inventory identifi-cation and valuation, and not by whichtypes and amounts of costs are capitalizedunder the taxpayer’s method of comput-ing inventory cost. See § 263A and theregulations thereunder, which govern thetypes and amounts of costs required to beincluded in inventory cost for taxpayerssubject to those provisions.

1997–33 I.R.B. 39 August 18, 1997

(2) Limitation on LIFO election.The taxpayer may not re-elect the LIFOinventory method for a period of at leastfive taxable years beginning with the yearof change, unless based on a showing ofunusual and compelling circumstances,consent is specifically granted by theCommissioner to change the method ofaccounting at an earlier time. The requestfor consent to readopt the LIFO inventorymethod must comply with Rev. Proc.97–27.

(3) Effect of subchapter S election bycorporation.

(a) S election effective for year ofLIFO discontinuance. If a C corporationelects to be treated as an S corporationfor the taxable year in which it discontin-ues use of the LIFO inventory method, §1363(d) requires an increase in the tax-payer’s gross income for the LIFO re-capture amount (as defined in §1363(d)(3)) for the taxable year preced-ing the year of change (the taxpayer’slast taxable year as a C corporation), anda corresponding adjustment to the basisof the taxpayer’s inventory as of the endof the taxable year preceding the year ofchange. Any increase in income tax as aresult of the inclusion of the LIFO recap-ture amount is payable in four equal in-stallments, beginning with the taxpayer’slast taxable year as a C corporation asprovided in § 1363(d)(2). Any corre-sponding basis adjustment is taken intoaccount in computing the § 481(a) ad-justment (if any) that results upon thediscontinuance of the LIFO method bythe corporation.

(b) S election effective for a yearafter LIFO discontinuance. If a C corpo-ration elects to be treated as an S corpora-tion for a taxable year after the taxableyear in which it discontinued use of theLIFO inventory method, the remainingbalance of any positive § 481(a) adjust-ment must be included in its gross incomein its last taxable year as a C corporation.If this inclusion results in an increase intax for its last taxable year as a C corpora-tion, this increase in tax is payable in fourequal installments, beginning with thetaxpayer’s last taxable year as a C corpo-ration as provided in § 1363(d)(2), unlessthe taxpayer is required to take the re-maining balance of the § 481(a) adjust-ment into account in the last taxable yearas a C corporation under another accelera-

tion provision in section 5.02(3)(c) of thisrevenue procedure.

(4) Additional requirements. Thetaxpayer must complete the followingstatements and attach them to the applica-tion:

(a) “The new method of identify-ing inventory goods is the [insert method;that is, specific identification; FIFO; re-tail; etc.] method.”

(b) “The new method of valuinginventory goods is [insert method; that is,cost; cost or market, whichever is lower;etc.].”

(c) “The new method conforms tothe requirements of section 10.01(1)(b)(i)[insert either (A), (B), (C), or (D)] of theAPPENDIX of Rev. Proc. 97–37 because[explain in detail how the new methodconforms to the specific subdivision].”

.02 Determining the cost of used vehi-cles purchased or taken as a trade-in.

(1) Description of change and scope.This change applies to a LIFO taxpayerthat wants to:

(a) determine the cost of used ve-hicles acquired by trade-in using the aver-age wholesale price listed by an officialused car guide on the date of the trade-in.See Rev. Rul. 67–107, 1967–1 C.B. 115.The official used car guide selected mustbe consistently used;

(b) determine the cost of used ve-hicles purchased for cash using the actualpurchase price of the vehicle; or

(c) reconstruct the beginning-of-the-year cost of used vehicles purchasedfor cash using values computed by na-tional auto auction companies based onvehicles purchased for cash. The nationalauto auction company selected must beconsistently used.

(2) Manner of making the change.This change is made using a cut-offmethod and applies to used vehicles ac-quired during the year of change and allsubsequent years. See section 2.06 of thisrevenue procedure.

.03 Alternative LIFO inventory methodfor retail automobile dealers.


which was formerly provided in Rev.Proc. 92–79, 1992–2 C.B. 457, applies toa taxpayer engaged in the trade or busi-ness of retail sales of new automobiles ornew light-duty trucks (“automobiledealer”) that wants to change to the “Al-

ternative LIFO Method” described insection 4 of Rev. Proc. 97–36, page 14,for its LIFO inventories of new automo-biles and new light-duty trucks. Light-duty trucks are trucks with a gross vehi-cle weight of 14,000 pounds or less,which also are referred to as class 1, 2, or3 trucks.

(b) Inapplicability. This changedoes not apply to an automobile dealerthat uses the inventory price index com-putation (IPIC) method for goods otherthan new automobiles, new light-dutytrucks, parts and accessories, used auto-mobiles, and used trucks.

(2) Manner of making the change. (a) Cut-off method. This change is

made using a cut-off method. See section2.06 of this revenue procedure and sec-tion 5.03(6) of Rev. Proc. 97–36.

(b) IPIC method changes. An au-tomobile dealer that uses the IPIC methodalso must change from the IPIC methodunder section 10.03 of this APPENDIX toanother acceptable method for its goodsother than new automobiles and newlight-duty trucks. For parts and acces-sories, the automobile dealer must changeto the dollar-value, index method, with allparts and accessories within each separatetrade or business in a separate LIFO pool.For used vehicles, the automobile dealermust change to the dollar-value, link-chain method, with all used automobileswithin each separate trade or business inone LIFO pool and all used trucks withineach separate trade or business in anotherseparate LIFO pool.

(c) Additional requirements. Anautomobile dealer also must comply withthe following:

(i) the conditions in section5.03 of Rev. Proc. 97–36; and

(ii) for an automobile dealerchanging from the IPIC method, the auto-mobile dealer also must attach to the ap-plication a schedule setting forth theclasses of goods for which the automobiledealer has elected to use the LIFO methodand the accounting method changes beingmade under section 10.03 of this APPEN-DIX for each class of goods.

.04 Inventory price index computation(IPIC) method under the LIFO inventorymethod.

(1) Description of change and scope. (a) This change applies to an eligi-

ble taxpayer that wants to change its

August 18, 1997 40 1997–33 I.R.B.

LIFO inventory method to use the IPICmethod for its entire LIFO inventory inaccordance with all the provisions of §1.472–8(e)(3) and Rev. Proc. 84–57,1984–2 C. B. 496. The taxpayer must:

(i) in the case of the CPI De-tailed Report, select an index from Table3 (Consumer Price Index for All UrbanConsumers (CPI–U): U.S. city average,detailed expenditure categories); and

(ii) in the case of the ProducerPrice Indexes, select an index from Table6 (Producer price indexes and percentchanges for commodity groupings and in-dividual items).

(b) A taxpayer using the IPICmethod must apply the inventory priceindex to its ending inventory valued at cur-rent-year cost, under the taxpayer’s methodof determining current-year cost. See §1.472–8(e)(2)(ii). Furthermore, there mustbe a nexus between the taxpayer’s methodof determining current-year costs and themonth to be used in selecting indexes. See§ 1.472–8(e)(3)(iii)(C) and Rev. Rul.89–29, 1989–1 C.B. 168. For example, if ataxpayer determines current-year cost byreference to the actual cost of goods pur-chased or produced during the taxable yearin the order of acquisition (earliest acquisi-tions cost), then the inventory price indexmust be applied to the earliest acquisitionscost of ending inventory. In computing theinventory price index, such a taxpayer mustselect indexes from a month toward the be-ginning of its taxable year.

(c) A taxpayer may not change itsmethod of pooling as part of a changemade under section 10.04 of this APPEN-DIX, except to a method specifically au-thorized by § 1.472–8(e)(3)(iv) or section3.04(1)(b) of Rev. Proc. 84–57. Thesespecial pooling rules do not apply togoods manufactured by the taxpayer. See§ 1.472–8(b) for principles for establish-ing pools of manufacturers and proces-sors.

(d) A taxpayer may change itsmethod of determining current-year costas part of a change made under section10.04 of this APPENDIX by also follow-ing the provisions of section 10.05 of thisAPPENDIX. These changes may bemade using a single application, providedthe application is labeled as being filedunder both sections 10.04 and 10.05 ofthis APPENDIX. See section 6.02(3) ofthis revenue procedure.

(2) Manner of making the change.This change is made using a cut-offmethod. See section 2.06 of this revenueprocedure.

.05 Determining current-year costunder the LIFO inventory method.

(1) Description of change andscope. This change applies to a LIFOtaxpayer that wants to change to amethod of determining current year cost:

(a) by reference to the actual costof the goods most recently purchased orproduced;

(b) by reference to the actual costof the goods purchased or produced dur-ing the taxable year in the order of acqui-sition; or

(c) by application of an averageunit cost equal to the aggregate actual costof all the goods purchased or producedthroughout the taxable year divided by thetotal number of units so purchased or pro-duced. See § 1.472–8(e)(2)(ii).

(2) Manner of making the change.This change is made using a cut-offmethod. See section 2.06 of this revenueprocedure.

SECTION 11. BANK RESERVES FORBAD DEBTS (§ 585)

.01 Changing from the § 585 reservemethod to the § 166 specific charge-offmethod.

(1) Description of change andscope.

(a) Applicability. Except as pro-vided in section 11.01(1)(b) of this AP-PENDIX, this change applies to a bank(as defined in § 581, including a bank forwhich a qualified subchapter S subsidiary(QSSS) election is filed) that wants tochange its method of accounting for baddebts from the § 585 reserve method tothe § 166 specific charge-off method.


(i) a large bank as defined in §585(c)(2); or

(ii) any bank within the scopeof Rev. Proc. 97–18, 1997–10 I.R.B. 53,which applies to banks making thischange in method of accounting in 1997to become eligible to elect S corporationstatus for 1997. A bank is not outside thescope of Rev. Proc. 97–18 solely becauseit is a qualified subchapter S subsidiary.In that event, the S corporation (the par-ent) should follow the application proce-

dures required by Rev. Proc. 97–18 onbehalf of the bank.

(2) Certain scope limitations inap-plicable. A bank that changed from the §593 reserve method under § 593(g) to the§ 585 reserve method will not be prohib-ited under section 4.02(6) of this revenueprocedure from changing its method ofaccounting for bad debts under section11.01 of this APPENDIX solely becauseof the § 593(g) change. A bank for whicha QSSS election is filed will not be pro-hibited under section 4.02(7) of this rev-enue procedure from changing its methodof accounting for bad debts under section11.01 of this APPENDIX solely becauseof the deemed liquidation of the bankarising from a QSSS election.

(3) Section 481(a) adjustment. Gen-erally, the amount of the § 481(a) adjust-ment for a change in method of account-ing under section 11.01 of thisAPPENDIX is the amount of the bank’sreserve for bad debts as of the close of thetaxable year immediately before the yearof change. However, the amount of the §481(a) adjustment does not include theamount of a bank’s pre–1988 reserves (asdescribed in § 593(g)(2)(A)(ii), withouttaking into account § 593(g)(2)(B)) if thebank changed in a prior year from the §593 reserve method to the § 585 reservemethod and § 593(g) applied to thatchange. The deemed liquidation of abank occurring solely because its parentmakes a QSSS election does not acceler-ate the § 481(a) adjustment. In accor-dance with section 5.04(3)(c) of this rev-enue procedure, a bank that ceases to be abank under § 581 must accelerate its §481(a) adjustment.

(4) Change from § 585 requiredwhen electing S corporation status. Abank electing S corporation status (or abank for which a QSSS election is filed)cannot use the § 585 reserve method. Thefiling by a bank of a Form 2553 (Electionby a Small Business Corporation) or thefiling by a bank’s parent of a QSSS elec-tion with respect to the bank will consti-tute an agreement by the bank to changeits method of accounting for bad debtsfrom the § 585 reserve method to the§ 166 specific charge-off method effec-tive as of the taxable year for which the Scorporation election or QSSS election iseffective (year of change) in accordancewith all of the applicable provisions of

1997–33 I.R.B. 41 August 18, 1997

this revenue procedure. The § 481(a) ad-justment is recognized built-in gain under§ 1374. See § 1.1374–4(d).

.02 Reserved.

SECTION 12. ORIGINAL ISSUE DISCOUNT (§ 1273)

.01 De minimis original issue discount(OID).


which was formerly provided in Rev.Proc. 94–29, 1994–1 C.B. 616, applies toa taxpayer that wants to change to theprincipal-reduction method of accountingdescribed in section 5 of Rev. Proc.97–39, page 48. The principal-reductionmethod of accounting is an aggregatemethod of accounting for de minimis OID(discount) on certain loans originated bythe taxpayer.

(b) Scope limitations inapplicable.A taxpayer that wants to make this changeis not subject to the scope limitations insection 4.02 of this revenue procedure.However, if the taxpayer is under exami-nation, before an appeals office, or beforea federal court, the taxpayer must providea copy of the application to the examiningagent(s), appeals officer, or counsel forthe government, as appropriate, at thesame time that it files the copy of the ap-plication with the national office. The ap-plication must contain the name(s) andtelephone number(s) of the examiningagent(s), appeals officer, or counsel forthe government, as appropriate.

(c) Description. The principal-re-duction method of accounting is a permis-sible method for use by taxpayers to ac-count for discount on one or morecategories of loans described in section4.02 or 4.03 of Rev. Proc. 97–39. If theprincipal-reduction method is used to ac-count for any loans in a category of loans,the method must be used for the entirecategory of loans. The principal-reduc-tion method applies only to loans de-scribed in section 3 of Rev. Proc. 97–39.


cut-off method and applies only to loansdescribed in section 3 of Rev. Proc. 97–39that were acquired on or after the first dayof the year of change. See section 2.06 ofthis revenue procedure.

(b) The taxpayer must maintainbooks and records sufficient to satisfy the

district director that old and new loanshave been adequately segregated.

(3) Additional requirements. On astatement attached to the application, thetaxpayer must:

(a) identify the categories of loansto which the new method will apply; and

(b) describe any “additional cate-gories” permitted under section 4.03 ofRev. Proc. 97–39.

(4) No audit protection. A taxpayerdoes not receive audit protection undersection 7 of this revenue procedure inconnection with this change.

.02 Reserved.

SECTION 13. SHORT-TERM OBLIGATIONS (§ 1281)

.01 Interest income on short-termobligations.

(1) Description of change and scope. (a) This change applies to a tax-

payer that wants to change its method ofaccounting to comply with § 1281 for in-terest income on short-term obligations.This change was formerly provided inRev. Proc. 90–37, 1990–2 C.B. 361.

(b) Under § 1281, a holder of cer-tain short-term obligations, including abank as defined in § 581, must include ingross income any accrued interest incomeon such obligations, regardless of theholder’s overall method of accounting.Section 1281 applies to all types of inter-est income, including acquisition dis-count, original issue discount (OID), andstated interest. See S. Rep. No. 99–313,99th Cong., 2d Sess. 903 (1986), 1986–3(Vol. 3) C.B. 903.

(c) Section 1283(a)(1) generallydefines a short-term obligation as anybond, debenture, note, certificate, or otherevidence of indebtedness that matures inone year or less from its issue date. Ashort-term loan, including a short-termloan made in the ordinary course of thetaxpayer’s business, is a short-term oblig-ation.

(d) Under §§ 1281(a) and1283(c), a holder of a short-term obliga-tion subject to § 1281 must include ingross income an amount equal to the sumof the daily portions of the acquisitiondiscount or OID, whichever is applicable,on the obligation for each day during thetaxable year that the obligation is held bythe holder. See § 1283(b), as modified by§ 1283(c), to determine the daily portions

of acquisition discount or OID. In addi-tion, § 1281(a) requires the holder to in-clude in gross income any stated interestthat is payable on the short-term obliga-tion (other than stated interest taken intoaccount to determine the amount of theacquisition discount or OID) as it ac-crues.

(2) Section 481(a) adjustment pe-riod. A taxpayer must take the entire §481(a) adjustment into account in com-puting taxable income for the year ofchange.

.02 Stated interest on short-term loansof cash method banks in the Eighth Cir-cuit.

(1) Description of change and scope. (a) This change applies to a cash

method bank in the Eighth Circuit thatwants to change its method of account-ing from accruing stated interest onshort-term loans made in the ordinarycourse of business to using the cashmethod for that interest. This changewas formerly provided in Notice 95–57,1995–2 C.B. 337.

(b) In Security Bank Minnesota v.Commissioner, 994 F.2d 432 (8th Cir.1993), aff’g 98 T.C. 33 (1992), the U.S.Circuit Court of Appeals for the EighthCircuit held that § 1281 does not requirea cash method bank to include in grossincome stated interest on short-termloans made in the ordinary course ofbusiness as that interest accrues. TheService disagrees with the interpretationof § 1281 in Security Bank Minnesotaand intends to pursue this issue in othercircuits. In light of Security Bank Min-nesota, however, cash method banks inthe Eighth Circuit will be granted permis-sion to change to the cash method of ac-counting for stated interest on short-termloans made in the ordinary course ofbusiness. If this change was made on orbefore November 6, 1995, the Servicewill not seek to deny cash method banksin the Eighth Circuit the use of the cashmethod on the ground that there was anunauthorized change in method of ac-counting.

(2) Section 481(a) adjustment pe-riod. A taxpayer must take the entire §481(a) adjustment into account in com-puting taxable income for the year ofchange.

(3) No ruling protection. If the Ser-vice is later successful in further litigation

August 18, 1997 42 1997–33 I.R.B.

on this issue in other circuits, or there is achange in law, then cash method banks inthe Eighth Circuit may be required to usean accrual method of accounting for anytaxable year not barred by the statute oflimitations.


(Also Part I, §§ 446; 1.446–1.)

Rev. Proc. 97–38

SECTION 1. PURPOSE

.01 This revenue procedure imple-ments an administrative decision, madeby the Commissioner in the exercise ofdiscretion under section 446 of the Inter-nal Revenue Code. Under this revenueprocedure, accrual method manufactur-ers, wholesalers, and retailers of motorvehicles or other durable consumer goodsmay, in certain specified and limited cir-cumstances, include a portion of an ad-vance payment related to the sale of amulti-year service warranty contract ingross income generally over the life ofthe service warranty obligation. A tax-payer may change to or adopt the servicewarranty income method. The proce-dures for a taxpayer to change to the ser-vice warranty income method are pro-vided in Rev. Proc. 97–37, page 18,which provides simplified and uniformprocedures to obtain automatic consent tomake this and other changes in methodsof accounting. This revenue proceduremodifies and supersedes Rev. Proc.92–98, 1992–2 C.B. 512.

.02 The service warranty incomemethod described in this revenue proce-dure is the same method of accountingthat was described in Rev. Proc. 92–98.Accordingly, a taxpayer that properlychanged to or adopted this method pur-suant to Rev. Proc. 92–98 is not requiredto change its method of accounting tocomply with this revenue procedure.


.01 In general, payments received byan accrual method taxpayer for servicesto be performed in the future must be in-cluded in gross income in the taxableyear of receipt. The Commissioner rec-ognizes that this treatment has resulted ina significant and unique cash flow prob-

lem for certain accrual method taxpayersthat sell multi-year service warranty con-tracts to customers in connection with thesale of motor vehicles or other durableconsumer goods and immediately pay athird-party to insure their risks under thecontracts.

.02 Accordingly, these taxpayers willbe permitted to adopt or change to a spe-cial method of accounting for advancepayments that would alleviate the cashflow problem arising in these situationsbut would generally conform economi-cally to the tax treatment of advance pay-ments under current law. In general, thismethod of accounting permits these tax-payers to recognize and include in grossincome, generally over the period of theirservice warranty contracts, a series ofequal payments, the present value ofwhich equals the portion of the advancepayment qualifying for deferral. Thismethod of accounting is described in fur-ther detail in section 5 of this revenue pro-cedure.


.01 The “service warranty incomemethod” for advance payments is themethod of accounting permitted by thisrevenue procedure and described in sec-tion 5 of this revenue procedure.

.02 The “qualified advance paymentamount” is the portion of an advance pay-ment received by a taxpayer under amulti-year service warranty contract thatis paid by that taxpayer to an unrelatedthird party within 60 days after receipt forinsurance costs associated with a policyinsuring that taxpayer’s obligations underthe contract.

.03 The classification of goods as“durable consumer goods” for purposesof this revenue procedure depends on thecommon usage of the goods, rather thanthe purchaser’s actual intended use of thegoods. Thus, a taxpayer qualifying underthis revenue procedure does not have tosegregate, as non-qualifying advance pay-ments, those payments under multi-yearservice warranty contracts entered intowith a purchaser that will use the underly-ing durable consumer goods in its trade orbusiness.

SECTION 4. SCOPE

.01 Except as provided in sections 4.03and 4.04 of this revenue procedure, the

use of the service warranty incomemethod is available to any accrual methodmanufacturer, wholesaler, or retailer ofmotor vehicles or other durable consumergoods with respect to qualified advancepayment amounts received on servicewarranty contracts:

(1) that are fixed-term servicearrangements with respect to a motor ve-hicle or other durable consumer good pur-chased by a customer;

(2) that are separately priced, suchthat customers have the option to pur-chase the service warranty contracts foran expressly stated amount separate fromthe price of the underlying motor vehicleor other durable consumer good;

(3) for which the service period be-gins in the taxable year the advance pay-ment is received or upon expiration of afixed-term manufacturer’s warranty be-ginning in the taxable year the advancepayment is received;

(4) for which the taxpayer purchasesa policy that constitutes insurance forfederal income tax purposes from an un-related third party to insure its obligationunder the service warranty contract; and

(5) for which the taxpayer makespayment to the unrelated third party in-surer within 60 days after receipt of theadvance payment for the entire amount ofthe insurance costs associated with thepolicy insuring its obligations under theservice warranty contract.

.02 For purposes of section 4.01 of thisrevenue procedure, a service warrantycontract will be treated as a fixed-termarrangement even if the contract providesfor a reasonable mileage or other usagecap that is generally commensurate withaverage consumer mileage or usage overthe term of the contract and which causestermination of the fixed-term arrange-ment when exceeded. Also for purposesof section 4.01 of this revenue procedure,a taxpayer has not made payment to anunrelated third party insurer if the tax-payer and the payee are related personswithin the meaning of § 267(b) or707(b)(1).

.03 A taxpayer is not within the scopeof this revenue procedure unless the tax-payer either (1) has never previously re-ceived advance payments under servicewarranty contracts prior to the taxableyear of an adoption under this revenueprocedure, or (2) uses the proper method

1997–33 I.R.B. 43 August 18, 1997

of accounting for advance paymentsunder its service warranty contracts (seeSchlude v. Commissioner, 372 U.S. 128(1963), 1963–1 C.B. 99).

.04 A taxpayer also is not within thescope of this revenue procedure unless thetaxpayer uses the proper method of ac-counting for amounts paid or incurred forinsurance costs that cover the taxpayer’srisks under service warranty contracts.See section 5.03 of the APPENDIX ofRev. Proc. 97–37 for a description of thatproper method.

SECTION 5. DESCRIPTION OF THESERVICE WARRANTY INCOMEMETHOD

.01 In general. Taxpayers with an ad-vance payment within the scope of sec-tion 4 of this revenue procedure may electto include a qualified advance paymentamount, increased by an imputed incomeamount, in gross income on a level basisover the shorter of:

(1) the period beginning in the tax-able year the advance payment is receivedand ending when the service warrantycontract terminates; or

(2) a 6-taxable-year period begin-ning in the taxable year the advance pay-ment is received. This method of accounting permits thesetaxpayers to recognize and include ingross income, generally over the period oftheir service warranty contracts, a seriesof equal payments, the present value ofwhich equals the qualified advance pay-ment amounts received by the taxpayer.A taxpayer using the service warranty in-come method provided by section 5 ofthis revenue procedure must include in in-come, in the taxable year of receipt, theexcess of aggregate advance payments re-ceived during a taxable year over aggre-gate qualified advance payment amountsfor the taxable year.

.02 Simplifying table. (1) An electing taxpayer must use the

table in the APPENDIX of this revenueprocedure to determine the amount of thegross income (attributable to a qualifiedadvance payment amount) that must bereported annually under the service war-ranty income method.

(2) To use the table for a particularcontract, a taxpayer first uses the columnheaded by the “Term of Service Agree-ment in Years.” The taxpayer determines

which column to use by ascertaining thelength (the number of years) of its servicewarranty contract (limited to six years)without regard to whether there is a pe-riod for which there are no obligationsunder the contract. For example, if a ser-vice warranty contract begins in the thirdyear after payment is received and ends inthe fifth year after payment, the taxpayeruses the column headed “5.” The tax-payer then finds the factor in the rowheaded by “The Applicable InterestRate,” which is defined in section 5.04 ofthis revenue procedure. If the applicableinterest rate in this instance is 8 percent,the resulting factor would be .2319. Thisfactor is multiplied by the qualified ad-vance payment amount to determine the“annual equal payment amount” includedin gross income each year for the numberof years at the top of the column.

(3) A taxpayer may calculate the ag-gregate amount to be included in gross in-come each year by aggregating the quali-fied advance payment amounts withrespect to contracts of the same class (thatis, 2-year contracts, 3-year contracts,etc.). See section 5.08 of this revenueprocedure for examples of the servicewarranty income method.

.03 Special rule for when the taxpayer’strade or business ceases. In the year inwhich the taxpayer’s trade or businessceases (as defined in section 5.02(3) ofRev. Proc. 97–37), the remaining quali-fied advance payment amounts that havebeen deferred must be accelerated and in-cluded in gross income, along with appro-priate imputed income amounts. Theseamounts must be determined using the ap-plicable interest rates specified in section5.04 of this revenue procedure and mustbe sufficient to ensure that the net presentvalue of all amounts included in incomeover the period of deferral equals thequalified advance payment amounts thatwould have been reported and included inincome upon receipt in the absence of anelection under this revenue procedure.See the example in section 5.08(1)(c) ofthis revenue procedure. The Service willcompute the amounts to be included in theyear of cessation for any taxpayer thatsubmits a request for a ruling pursuant toRev. Proc. 97–1, 1997–1 I.R.B. 11 (or anysuccessor). The Service waives the ap-plicable user fee required under Rev.Proc. 97–1 for these requests.

.04 Applicable interest rate. The ap-plicable interest rate to be applied to thequalified advance payment amount re-ceived for a particular contract in a partic-ular taxable year under the service war-ranty income method is the applicablefederal rate in effect for purposes of §1274(d) (compounded annually) for themonth with or within which the taxableyear ends. For purposes of this revenueprocedure, the applicable federal rate isrounded to the nearest full percent (or if amultiple of 1/2 of 1 percent, such rateshall be increased to the next highest fullpercent).

.05 Effects of the imputed income. Anyincome imputed on a qualified advancepayment amount under this service war-ranty income method must not be takeninto account for any purpose under the In-ternal Revenue Code other than the deter-mination of a taxpayer’s income. Thus,for example, the income imputed on aqualified advance payment amount maynot increase the basis of any asset held bythe taxpayer and may not be recovered asa deduction in any taxable year. Addi-tionally, any income imputed on a quali-fied advance payment amount may not betaken into account, for example, in deter-mining:

(1) the earnings and profits of anycorporation under § 312;

(2) the adjustments to a share-holder’s stock basis in an S corporationunder § 1367;

(3) the adjustments to a partner’s in-terest in a partnership under § 705; or

(4) the investment adjustments (oradjustments to an excess loss account)under § 1.1502–32 of the Income TaxRegulations with respect to the stock ofany consolidated group member ownedby another member of the group.

.06 Special rules for customer cancel-lations of service warranty contracts andterminations of service warranty con-tracts because of mileage or usage limita-tions.

(1) Customer cancellations. If a cus-tomer cancels a service warranty contractduring the taxable year of sale and, in thatyear, receives a refund of amounts paid,the amount refunded is not included in thetaxpayer’s income for the year of the sale.If a customer cancels a service warrantycontract after the year in which the tax-payer sold the contract, the taxpayer must

August 18, 1997 44 1997–33 I.R.B.

continue to include the annual equal pay-ment amount obtained from the APPEN-DIX table in gross income for the originallength of the cancelled contract. Anyamount refunded to the customer reducesincome in the year paid. Imputed incomeamounts added to a qualified advancepayment amount are not considered in(and have no effect on) the determinationof this reduction of income. Thus, reduc-tions for refunds upon customer cancella-tion of a multi-year service warranty con-tract are to be determined in the samemanner as if the taxpayer did not make anelection under this revenue procedure.

(2) Terminations. If a contract termi-nates because of a mileage or usage limi-tation during or after the year in which thetaxpayer sold the contract, the taxpayermust continue to include the annual equalpayment amount obtained from the AP-PENDIX table in gross income for theoriginal length of the terminated contract.See paragraph (b) of Example 1 in section5.08 of this revenue procedure.

.07 Short taxable years. If a taxpayerusing the table in the APPENDIX of thisrevenue procedure has a short taxableyear during the term of its service war-ranty contract, the applicable table factorfor the short period must be multiplied bya fraction, the numerator of which is thenumber of months in the short period, andthe denominator of which is 12. After ashort taxable year for which the table fac-tor adjustment of the preceding sentencehas been made, the taxpayer must con-tinue to determine its gross income on aprior year’s qualified advance paymentamount using the applicable table factorfor each 12-month taxable year (or thattable factor multiplied by an appropriatefraction for any other short periods), untilthe number of months for which the qual-ified advance payment amount is takeninto account (determined as if the quali-fied advance payment amount is firsttaken into account in the first month ofthe year in which the advance payment isreceived) is equal to the number ofmonths in the original contract term (asdetermined under section 5.02 of this rev-enue procedure). If less than 12-months’inclusion remains for the final year, theapplicable table factor for that year maybe determined as if it were a short periodcontaining the number of months remain-ing on the contract not yet taken into ac-

count. See Example 2 in section 5.08 ofthis revenue procedure.

.08 Examples of the service warrantyincome method.

(1) Example 1. (a) A, a calendar year accrual basis

taxpayer, elects under this revenue proce-dure to use the service warranty incomemethod of accounting for its qualified ad-vance payment amounts on service war-ranty contracts. A sold 5 service warrantycontracts on January 1, 1997, for $800each. A also sold 5 service warranty con-tracts on December 31, 1997, for $800each. All the service warranty contractssold by A in 1997 carry a term of 5 yearsand run concurrently with the manufac-turer’s warranties. Further, A pays, within60 days of the receipt of each advancepayment, $600 per contract to an unrelatedthird party to insure (in an arrangementthat constitutes insurance) its obligationsunder the service warranty contracts. Theapplicable interest rate, determined in ac-cordance with section 5.04 of this revenueprocedure, is 10 percent.

A aggregates all its qualified ad-vance payment amounts on its 5-year ser-vice warranty contracts, thus determiningthat $6,000 of qualified advance paymentamounts were received in 1997 with re-spect to the class of 5-year service warrantycontracts. Applying the “10% and 5-year”factor of .2398 found in the table in the AP-PENDIX of this revenue procedure, A de-termines that it must report gross income of$1,439 ($6,000 x .2398) in 1997 through2001 under the election provided in thisrevenue procedure. In addition, A must in-clude in gross income in 1997 the $2,000payment received for services that is notdeferred under this revenue procedure.Gross income is reported by A as follows:

Assuming that A is an S corporationwith a single shareholder and that A re-

ported no income other than that arisingfrom the above service warranty transac-tions, the shareholder would report thefollowing § 1367 adjustments to stockbasis:

The stock basis adjustment for the de-ferred advance payment amount is deter-mined by ratably spreading the stockbasis adjustment over the term of the ser-vice warranty contract. Since the servicewarranty contract is treated as sold at thebeginning of the taxable year, the stockbasis adjustment each year would be$1,200 ($6,000/5). The aggregate im-puted income of $1,195 ($239 x 5) on the$6,000 of aggregate qualified advancepayment amounts for 1997 is not takeninto account at any time by the share-holder in determining its basis in the Astock.

(b) If one of the service warrantycontracts described in paragraph (a) ter-minates because of a mileage or usagelimitation in 1999, there is no effect onthe amounts that A must include in grossincome each year. Under section 5.06 ofthis revenue procedure, A would continueto report the amounts of gross income setforth in section 5.08(1)(a) of this revenueprocedure even if one or more of its ser-vice warranty contracts is terminated.

(c) If A’s business ceases in 1999,A must include the $2,000 non-qualifiedadvance payment amount in gross incomein 1997 and the $1,439 annual equal pay-ment amount in gross income in 1997 and1998, as in section 5.08(1)(a) of this rev-enue procedure above. However, in 1999,A must accelerate and include in gross in-come the remaining advance paymentamount plus an appropriate imputed in-come amount.

To calculate this amount, A must firstdetermine the portion of the qualified ad-vance payment amount and the portion of

Description of Item 1997 1998 1999 2000 2001Non-deferred Income $2,000Deferred Income 1,439 $1,439 $1,439 $1,439 $1,439________________________________________________Gross Income $3,439 $1,439 $1,439 $1,439 $1,439________________________________________________________________________________________________

Description of Item 1997 1998 1999 2000 2001Non-deferred Income $2,000Deferred Income 1,200 $1,200 $1,200 $1,200 $1,200________________________________________________Gross Income $3,200 $1,200 $1,200 $1,200 $1,200________________________________________________________________________________________________

1997–33 I.R.B. 45 August 18, 1997

imputed income included in each annualequal payment amount. For 1997, the an-nual equal payment amount included inincome, $1,439, is entirely from the qual-ified advance payment amount becauseno income is imputed to the taxpayer inthe first taxable year. Thus, the $6,000deferred qualified advance paymentamount is reduced for A’s inclusion of$1,439 in 1997 leaving $4,561 of de-ferred qualified advance payment amountremaining.

For 1998, A multiplies the applicableinterest rate of 10% by the 1997 remain-ing qualified advance payment amount of$4,561. That product, $456, constitutesthe imputed income portion of the 1998annual equal payment amount of $1,439.The difference between $1,439 and $456($983) is the portion of the annual equalpayment amount that constitutes thequalified advance payment amount. The$983 reduces the qualified advance pay-ment amount remaining after 1997 to$3,578.

When A’s business ceases in 1999, Amust include in gross income the quali-fied advance payment amount remainingafter 1998 and an appropriate imputed in-come amount. The appropriate imputedincome amount is the product of the qual-ified advance payment amount remainingafter 1998 and the applicable interest rate($3,578 x 10%), which is $358. Thus, in1999, A includes in gross income $3,936($3,578 + $358).

(2) Example 2. X, a calendar yearaccrual basis taxpayer, elects under thisrevenue procedure to use the service war-ranty income method of accounting for itsqualified advance payment amounts onservice warranty contracts. X sold 5 ser-vice warranty contracts on January 1,1997, for $800 each. X also sold 5 ser-vice warranty contracts on December 31,1997, for $800 each. All the service war-ranty contracts sold by X in 1997 carry aterm of 5 years and run concurrently withthe manufacturer’s warranties. Further, Xpays, within 60 days of the receipt of eachadvance payment, $600 per contract to anunrelated third party to insure (in anarrangement that constitutes insurance) itsobligations under the service warrantycontracts. The applicable interest rate,determined in accordance with section5.04 of this revenue procedure, is 10 per-cent.

X aggregates all its qualified advancepayment amounts on its 5-year servicewarranty contracts, thus determining that$6,000 of qualified advance paymentamounts were received in 1997 with re-spect to the class of 5-year service war-ranty contracts. Applying the “10% and5-year” factor of .2398 found in the tablein the APPENDIX of this revenue proce-dure, X determines that it has annualequal payment amounts of $1,439 in-cludible in gross income in 1997 through2001 under the election provided in thisrevenue procedure. In addition, X mustinclude in gross income in 1997 the$2,000 payment received for services thatis not deferred as a qualified advance pay-ment amount by this revenue procedure.

After making the initial determinationsabove, X experiences a short taxable yearof 7 months beginning on January l, 1999,and ending on July 31, 1999. After the 7-month short period, X’s taxable year endson July 31. When X experiences the 7-month short period, X must multiply thefactor in the table in the APPENDIX ofthis revenue procedure by a fraction, thenumerator of which is the number of themonths in the short period, and the de-nominator of which is 12. This adjustedfactor of .1399 (7/12 x .2398) is applied tothe qualified advance payment amount of$6,000. The product, $839, is included inX’s gross income for the short taxableyear. Because X’s contracts had a term of5 years or 60 months (and are assumedunder this revenue procedure to havebegun at the beginning of the 1997 taxableyear), there are 5 additional months in thetaxable year ending July 31, 2002, forwhich a portion of the annual equal pay-ment amount must be taken into account.Thus, X includes $600 (5/12 x .2398 x$6,000) in gross income. Gross income is

reported by X in each taxable year as fol-lows:

SECTION 6. CHANGING TO ORADOPTING SERVICE WARRANTYINCOME METHOD

.01 Automatic change. A taxpayerwanting to change its method of account-ing to the service warranty incomemethod must follow the provisions ofRev. Proc. 97–37.

.02 Adoption of method. A qualifyingtaxpayer may adopt the service warrantyincome method in any taxable year end-ing on or after August 18, 1997 by attach-ing a statement to its timely filed originalfederal income tax return (including ex-tensions) for the year of adoption.

.03 Statement. The statement referredto in section 6.02 of this revenue proce-dure should be identified at the top as fol-lows: “ELECTION OF THE SERVICEWARRANTY INCOME METHODUNDER REV. PROC. 97–38.” The state-ment should set forth:

(1) a paragraph stating that the tax-payer is electing the service warranty in-come method for all advance payments(as defined in this revenue procedure) re-ceived in the current taxable year and tobe received in subsequent taxable years;

(2) a paragraph stating that the tax-payer agrees to all the terms and condi-tions of this Rev. Proc. 97–38, and specif-ically stating that the taxpayer agrees toinclude in gross income all imputed in-come amounts necessary at the applicableinterest rate determined in accordancewith section 5.04 of this revenue proce-dure so that the net present value of grossincome inclusions in taxable years towhich qualified advance paymentamounts are being deferred equals theamount of qualified advance payment

August 18, 1997 46 1997–33 I.R.B.

7-monthShort Yr. End Yr. End

Description of Item 1997 1998 Yr. 7/31/00 7/31/01Non-deferred Income $2,000Deferred Income 1,439 $1,439 $ 839 $1,439 $1,439________________________________________________Gross Income $3,439 $1,439 $ 839 $1,439 $1,439________________________________________________________________________________________________

Description of Item Yr. End7/31/02

Non-deferred IncomeDeferred Income $ 600________Gross Income $ 600________________

amounts received in earlier taxable years; (3) a description of the service war-

ranty contracts sold during the taxableyear the service warranty income methodis elected;

(4) the aggregate amount of the qual-ified advance payment amounts receivedfor each class (3-year contracts, 4-yearcontracts, etc.) of service warranty con-tracts sold during the taxable year of elec-tion;

(5) the future value factors that are tobe applied to the aggregate qualified ad-vance payment amounts for each class ofservice warranty contracts sold during theelection year; and

(6) the signature by or on behalf ofthe taxpayer making the election by an in-dividual with the authority to bind the tax-payer in such matters. For example, anofficer must sign on behalf of a corpora-tion, a general partner on behalf of a statelaw partnership, a member-manager onbehalf of a limited liability company, atrustee on behalf of a trust, or an individ-ual taxpayer on behalf of a sole propri-etorship. If the taxpayer is a member of aconsolidated group, the statement submit-ted on behalf of the taxpayer must besigned by a duly authorized officer of thecommon parent. See section 6.02(4) ofRev. Proc. 97–37.

.04 Annual reporting requirement.Upon election of the service warranty in-come method of accounting, a taxpayermust satisfy an annual reporting require-ment. For each taxable year after electionof the service warranty income method,the taxpayer must attach a statement to itstimely filed original federal income taxreturn setting forth:

(1) a description of the service war-ranty contracts sold during the taxableyear;

(2) the aggregate amount of thequalified advance payment amounts re-ceived for each class of service warrantycontracts sold during the taxable year;and

(3) the future value factors that are tobe applied to the aggregate qualified ad-vance payment amounts for each class ofservice warranty contracts sold during thetaxable year.

SECTION 7. EFFECT OF AND REVOCATION OF ELECTION

The election of the service warranty in-

come method under this revenue proce-dure constitutes a change to or adoptionof a method of accounting. Because theservice warranty income method consti-tutes a method of accounting, an electingtaxpayer must use that method for all itsqualified advance payment amounts onservice warranty contracts described insection 4.01 of this revenue procedure.The election of the service warranty in-come method may only be revoked withthe consent of the Commissioner. Thus,to request revocation of an election underthis revenue procedure, a taxpayer mustapply to the Commissioner to change itsmethod of accounting under the proce-dures prescribed in Rev. Proc. 97–27,1997–21 I.R.B. 10.

SECTION 8. FAILURE TO COMPLY

Failure of the taxpayer (and, in thecase of, for example, an S corporation orpartnership, any of its shareholders orpartners) to comply with all the require-ments of this revenue procedure will con-stitute grounds for revocation of the ser-vice warranty income method election bythe Commissioner and may result in revo-cation of the election by an examiningagent beginning in the first open taxableyear of noncompliance.

SECTION 9. APPLICABILITY OF REV.PROC. 97–37

The definitions in Rev. Proc. 97–37apply for purposes of this revenue proce-

dure, except to the extent provided other-wise in this revenue procedure.






This revenue procedure is effective forany taxable year of a qualifying taxpayerending on or after August 18, 1997.

SECTION 13. PAPERWORK REDUC-TION ACT


An agency may not conduct or spon-sor, and a person is not required to re-spond to, a collection of information un-less the collection of information displays

APPENDIX(Table)

Applicable Term of Service Agreement in YearsInterest

Rate 1 2 3 4 5 6

1.0% 1.0000 0.5025 0.3367 0.2537 0.2040 0.17082.0% 1.0000 0.5050 0.3400 0.2575 0.2080 0.17503.0% 1.0000 0.5074 0.3432 0.2612 0.2120 0.17924.0% 1.0000 0.5098 0.3465 0.2649 0.2160 0.18345.0% 1.0000 0.5122 0.3497 0.2686 0.2200 0.18766.0% 1.0000 0.5146 0.3529 0.2723 0.2240 0.19197.0% 1.0000 0.5169 0.3561 0.2759 0.2279 0.19618.0% 1.0000 0.5192 0.3593 0.2796 0.2319 0.20039.0% 1.0000 0.5215 0.3624 0.2832 0.2359 0.204510.0% 1.0000 0.5238 0.3656 0.2868 0.2398 0.208711.0% 1.0000 0.5261 0.3687 0.2904 0.2438 0.213012.0% 1.0000 0.5283 0.3717 0.2940 0.2477 0.217213.0% 1.0000 0.5305 0.3748 0.2975 0.2516 0.221414.0% 1.0000 0.5327 0.3778 0.3011 0.2555 0.225615.0% 1.0000 0.5349 0.3808 0.3046 0.2594 0.2298

1997–33 I.R.B. 47 August 18, 1997

a valid OMB control number.The collections of information in this

revenue procedure are in section 6. Thisinformation is necessary and will be usedto determine whether the taxpayer isproperly using the service warranty in-come method. The collections of infor-mation are required for the taxpayer touse the service warranty income method.The likely respondents are the following:individuals, business or other for-profitinstitutions, and small businesses or orga-nizations.

The estimated total annual reportingburden is 5,000 hours.

The estimated annual burden per re-spondent varies from 2 hours to 3 hours,depending on individual circumstances,with an estimated average of 2.5 hours.The estimated number of respondents is2,000.

The estimated annual frequency of re-sponses is once.



This revenue procedure was drafted inthe Office of Assistant Chief Counsel (In-come Tax & Accounting). For further in-formation regarding this revenue proce-dure, contact Michael F. Schmit on (202)622-4960 (not a toll free call).


(Also Part I, §§ 1273; 1.1273–1, 1.1273–2.)

Rev. Proc. 97–39

SECTION 1. PURPOSE

.01 This revenue procedure allows ataxpayer to use the principal-reductionmethod of accounting — an aggregatemethod of accounting for de minimisoriginal issue discount on certain loansoriginated by the taxpayer. The principal-reduction method is based on the rulethat, if a taxpayer holds a debt instrumentwith de minimis original issue discount,the taxpayer must include that discount inincome as stated principal payments aremade. See § 1.1273–1(d)(5) of the In-

come Tax Regulations. A taxpayer maychange to or adopt the principal-reductionmethod. The procedures for a taxpayer tochange to the principal-reduction methodare provided in Rev. Proc. 97–37, page18, which provides simplified and uni-form procedures to obtain automatic con-sent to make this and other changes inmethods of accounting. This revenue pro-cedure modifies and supersedes Rev.Proc. 94–29, 1994–1 C.B. 616.

.02 The principal-reduction method de-scribed in this revenue procedure is thesame method of accounting that was de-scribed in Rev. Proc. 94–29. Accordingly,a taxpayer that properly changed to oradopted this method pursuant to Rev.Proc. 94–29 is not required to change itsmethod of accounting to comply with thisrevenue procedure.


.01 A debt instrument (loan) is issuedwith original issue discount (OID) if theloan’s issue price is less than its stated re-demption price at maturity. See §1273(a)(1) of the Internal Revenue Code.In some cases, although a loan is issuedwith OID, the amount of OID is treated aszero. See § 1273(a)(3) and § 1.1273–1(d)(concerning de minimis OID).

.02 Points treated as paid when a loanis originated generally reduce the issueprice of the loan. See § 1.1273–2(g) (con-cerning the effect of certain cash pay-ments on the issue price of a loan). Thus,all points charged on a loan create or in-crease OID on the loan. As used in thisrevenue procedure, the term “points”refers only to amounts charged for the useor forbearance of money.

.03 Section 1.1272–3 allows a holder ofa debt instrument to elect to use a constantyield method to account for all interestthat accrues on the instrument. For pur-poses of this election, interest includesstated interest, acquisition discount, OID,de minimis OID, market discount, deminimis market discount, and unstated in-terest, as adjusted by any amortizablebond premium or acquisition premium. Aholder may make the election only for adebt instrument acquired on or after April4, 1994. Section 1.1272–3(d) providesrules for the time and manner of makingthe election under § 1.1272–3.

.04 Section 6001 and the regulationsthereunder require taxpayers to keep per-

manent books of account or records to es-tablish the amount of gross income for ataxable year.

SECTION 3. SCOPE

The principal-reduction method (de-scribed in section 5 of this revenue proce-dure) applies only to loans that—

(1) are acquired by the taxpayer at orig-ination,

(2) do not have OID or, because theOID is de minimis under § 1.1273–1(d),are treated as not having OID,

(3) are not issued at a premium,(4) are not subject to the election under

§ 1.1272–3, and (5) produce ordinary gain or loss when

sold or exchanged by the taxpayer.

SECTION 4. USE OF THEPRINCIPAL-REDUCTION METHOD

.01 Permissibility. (1) In general. The principal-reduction

method of accounting (described in sec-tion 5 of this revenue procedure) is a per-missible method for use by taxpayers toaccount for de minimis OID (discount) onone or more categories of loans describedin section 4.02 or 4.03 of this revenueprocedure. If the principal-reductionmethod is used to account for any loans ina category of loans, the method must beused for the entire category of loans. Asis more fully described in section 5 of thisrevenue procedure, if the method is usedfor more than one category, separate datafor each category must be kept, and thecomputations must be made separately foreach category.

(2) Adopting principal-reductionmethod. If a taxpayer does not alreadyhave a method of accounting for discounton one or more categories of loans, thetaxpayer may adopt the principal-reduc-tion method for discount on all or any ofthose categories of loans by using it on afederal income tax return. The taxpayermust attach to this return a statementidentifying the categories of loans towhich the new method will apply and de-scribing any “additional categories” per-mitted under section 4.03 of this revenueprocedure.

(3) Changes to principal-reductionmethod. A taxpayer wanting to change tothe principal-reduction method must fol-low the provisions of Rev. Proc. 97–37.

.02 Standard categories of loans. The

August 18, 1997 48 1997–33 I.R.B.

standard categories of loans are: Category (1). Loans that are secured

by 1- to 4-family residential real propertyand are not home equity lines of credit orconstruction loans.

Category (2). Construction loans withoriginal terms not greater than threeyears.

Category (3). Loans that are securedby real property, are not contained in cate-gory (1) or (2), and are not home equitylines of credit.

Category (4). Loans that are consumerloans with original terms not greater thanseven years, are not secured by real prop-erty, and are not revolving credit loans.

.03 Additional categories of loans.The principal-reduction method also maybe used for discount on loans that are de-scribed in section 3 of this revenue proce-dure but are not in one of the standardcategories described in section 4.02 ofthis revenue procedure. This use is per-missible, however, only if the taxpayerdefines one or more additional categoriesof loans that are sufficiently homoge-neous so that use of the principal- reduc-tion method for those additional cate-gories clearly reflects the taxpayer’sincome. In particular, each additionalcategory must consist solely of loans ofcomparable duration. For this purpose,duration means the weighted averagetime to expected payments of principal(including expected prepayments of prin-cipal). The weighted average is com-puted using the present value at issue ofthe expected payments and prepayments.

SECTION 5. PRINCIPAL-REDUCTIONMETHOD OF ACCOUNTING

Under the principal-reduction methodof accounting for discount —

.01 As of the date each loan in a cate-gory is acquired, the taxpayer’s basis inthe loan is deemed to be the loan’s statedprincipal amount. All the gain repre-sented by the discount on the loan is rec-ognized solely under the principal-reduc-tion method described in this revenueprocedure.

.02 The required computations must bemade monthly. Thus, the computation pe-riod referred to in this revenue procedureis the month (or that portion of a monththat falls within a short taxable year).

.03 At the start of each computation pe-riod, the taxpayer must record and retain

the following information for each cate-gory of loans for which the taxpayer isusing the principal-reduction method:

(1) Unpaid stated principal as of theend of the prior period of all loans in thecategory that were held at the end of theprior period (Starting Principal); and

(2) Unrecognized discount as of theend of the prior period (Starting Dis-count).

For the initial computation period,Starting Principal and Starting Discountare zero.

.04 During each computation period,the taxpayer must record and retain thefollowing information for each categoryof loans for which the taxpayer is usingthe principal-reduction method:

(1) The stated principal amount at thetime of acquisition of all loans in the cate-gory that were acquired at origination bythe taxpayer at any time during the pe-riod, whether or not they are still held bythe taxpayer at the end of the period (Cur-rent Principal). This amount includesloans in the category that are acquired asrefinancings of, or in exchange for, loanspreviously held by the taxpayer. Thus, ifa loan (whether or not in the category) ismodified and the modification resultsunder § 1001 in a deemed sale or ex-change of the old loan for a new one thatis in the category, the stated principalamount of the new loan is included inCurrent Principal.

(2) The aggregate discount (includingdiscount attributable to points) at the timeof acquisition on all loans described insection 5.04(1) of this revenue procedure(Current Discount).

(3) The unpaid stated principalamount of all loans in the category thatare still held by the taxpayer at the end ofthe period (Ending Principal). Thus,Ending Principal does not include thestated principal amount of loans dis-posed of in refinancings or exchangesduring the period. Ending Principal doesnot include rights (such as mortgage ser-vicing rights) that are retained on thesale of a loan, except to the extent thatthose rights represent a participation in-terest in the stated principal amount ofthe original loan. Ending Principal doesnot include the stated principal amountof any loan to the extent charged off bythe taxpayer during the period. Exceptas provided in the following sentence, if

the taxpayer has foreclosed on the prop-erty securing a loan, neither the unpaidstated principal on the loan nor any re-maining deficiency on the loan iscounted as part of Ending Principal. Ifproperty securing a loan is acquired in atransaction governed by former § 595and the property has not been disposedof before the end of the period, EndingPrincipal includes the unpaid stated prin-cipal of the loan immediately before thetransaction in which the property was ac-quired.

.05 The discount taken into account asgain (Recognized Discount) during eachcomputation period is the portion of totaldiscount that corresponds to the portion ofprincipal recovered during the period.For this purpose, Recognized Discount isthe product of the sum of Starting Dis-count plus Current Discount times a frac-tion the denominator of which is the sumof Starting Principal plus Current Princi-pal and the numerator of which is the ex-cess of the denominator over Ending Prin-cipal. This can be restated as:

R = (DStart + DCurrent) x ([PStart +

PCurrent – PEnd] / [PStart + PCurrent])

where —

PStart = Starting Principal

DStart = Starting Discount

PCurrent = Current Principal

DCurrent = Current Discount

PEnd = Ending Principal

R = Recognized Discount

.06 The unrecognized discount at theend of the period (Ending Discount) is theexcess of the sum of Starting Discountplus Current Discount over RecognizedDiscount. This amount must be used asStarting Discount for the next period.This can be restated as:

DEnd = DStart + DCurrent – R

where —

DEnd = Ending Discount

.07 Ending Principal for the current pe-riod must be used as Starting Principal forthe following period.

.08 The discount recognized as gainduring a taxable year is the sum of theRecognized Discount for all computationperiods comprising the year.

.09 For each period, the amounts re-ferred to above must be recorded and sep-

1997–33 I.R.B. 49 August 18, 1997

arately retained as part of the taxpayer’stax books and records. See § 6001 andthe regulations thereunder. These recordsmust be maintained as separate taxrecords and not merely as a set of adjust-ments to book figures. These recordsmust affirmatively demonstrate the pe-riod-to-period consistency required bysections 5.06 and 5.07 of this revenueprocedure.

SECTION 6. EXAMPLE

.01 T properly adopts the method de-scribed in section 5 of this revenue proce-dure for all the loans that it acquires thatare described in Category (1) in section4.02 of this revenue procedure.

.02 For T’s first month in operation, itacquired at origination loans in Category(1) with an aggregate stated principalamount of $10,000,000 at the time of ac-quisition. The sum of the discount withwhich these loans were acquired is$400,000. At the end of the month,$9,000,000 was the outstanding statedprincipal amount on the Category (1)loans still held by T. Thus, the discountrecognized during the month is $40,000.That figure is derived as follows:

R = (DStart + DCurrent) x ( [PStart +

PCurrent – PEnd] / [PStart + PCurrent] )

= ($0 + $400,000) x ([$0 + $10,000,000 -$9,000,000] / [$0 + $10,000,000])

= ($400,000) x ($1,000,000 / $10,000,000)

= $400,000 x 0.1

= $40,000

The amount of unrecognized discount atthe end of the month is $360,000. Thisfigure is derived as follows:


= $0 + $400,000 – $40,000

= $360,000

.03 In the second month of operation, Tacquired at origination $23,000,000 inCategory (1) loans with a total of$760,000 in discount at the time of acqui-sition. At the end of the month,$28,000,000 was the outstanding statedprincipal amount on Category (1) loansstill held by T. Thus, the discount recog-nized during the second month is$140,000. This figure is derived as fol-lows:

R = (DStart + DCurrent) x ( [PStart +

PCurrent – PEnd] / [PStart + PCurrent] )

= ($360,000 + $760,000) x ($9,000,000 + $23,000,000 – $28,000,000)/ ($9,000,000 + $23,000,000)

= $1,120,000 x ($4,000,000 / $32,000,000)

= $1,120,000 x 0.125

= $140,000

The amount of unrecognized discount atthe end of the month is $980,000 of dis-count. This figure is derived as follows:


= $360,000 + $760,000 – $140,000

= $980,000

SECTION 7. INTERACTION WITH § 475

If a loan is subject to both the mark-to-market rules under § 475 and the princi-pal-reduction method, see Notice 96–23,1996–1 C.B. 374.


Inquiries regarding this revenue proce-dure may be addressed to the Commis-sioner of Internal Revenue, Attention:CC:DOM:FI&P, 1111 Constitution Av-enue, NW, Washington, DC 20224.





SECTION 11. PAPERWORK REDUCTION ACT


An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-

lection of information displays a validOMB control number.

The collections of information in thisrevenue procedure are in sections 4 and 5.This information is necessary and will beused to determine whether the taxpayerproperly has adopted the principal-reduc-tion method of accounting. The collec-tions of information are required for thetaxpayer to use the principal-reductionmethod of accounting. The likely respon-dents are business or other for-profit insti-tutions.

The estimated total annual reportingand/or recordkeeping burden is 3,650hours.

The estimated annual burden per re-spondent/record keeper varies from 12hours to 14 hours depending on individ-ual circumstances, with an estimated av-erage of 12 hours. The estimated numberof respondents and/or recordkeepers is350.

The estimated annual frequency of re-sponses is on occasion.



This revenue procedure was drafted inthe Office of Assistant Chief Counsel (Fi-nancial Institutions and Products). Forfurther information regarding this revenueprocedure, contact

William E. Blanchard on (202) 622-3950 (not a toll free call).

26 CFR 601.105: Examination of returns andclaims for refund, credit or abatement; determina-tion of correct tax liability.

(Also Part I, § 1362; 1.1362–6.)

Rev. Proc. 97–40

SECTION 1. PURPOSE

This revenue procedure provides guid-ance under § 1362(b)(5) of the InternalRevenue Code for requesting relief for lateS corporation elections that are filedwithin 6 months of the due date of theelection.

August 18, 1997 50 1997–33 I.R.B.


Section 1361(a)(1) defines an “S corpo-ration,” with respect to any taxable year,as a small business corporation for whichan S election is in effect for that year.

Section 1362(a)(1) provides that, ex-cept in a situation described in § 1362(g),a small business corporation may elect tobe treated as an S corporation.

Section 1362(b)(1) provides that thecorporation may make an election to betreated as an S corporation (A) at any timeduring the preceding taxable year, or (B)at any time during the taxable year and onor before the 15th day of the 3rd month ofthe taxable year. Under § 1362(b)(3), ifan S corporation election is made for ataxable year after the 15th day of the 3rdmonth of that taxable year and on or be-fore the 15th day of the 3rd month of thefollowing taxable year, then the S corpo-ration election is treated as made for thefollowing taxable year.

Section 1362(b)(5) provides that if (A)an election under § 1362(a) is made forany taxable year (determined without re-gard to § 1362(b)(3)) after the date pre-scribed by § 1362(b) for making the elec-tion for the taxable year or no election ismade for any taxable year, and (B) theSecretary determines that there was rea-sonable cause for the failure to timelymake the election, the Secretary may treatthe election as timely made for the taxableyear (and § 1362(b)(3) shall not apply).

SECTION 3. SCOPE

This revenue procedure provides a spe-cial procedure to request relief for a late Scorporation election. This revenue proce-dure applies only to a corporation (1) thathas not filed a timely S corporation elec-tion under § 1362(a)(1), and (2) for whichan S corporation election is filed within 6months of the original due date for theelection. This revenue procedure does notprovide relief for late shareholder electionsincluding a qualified subchapter S trust(QSST) election or electing small businesstrust (ESBT) election. This special proce-dure is in lieu of the letter ruling procedurethat is used to obtain relief for a late S cor-poration election under § 1362(b)(5). Ac-cordingly, user fees do not apply to correc-tive action under this revenue procedure.A corporation that is not eligible for reliefunder this revenue procedure, or is denied

relief, may request relief by applying for aprivate letter ruling. The procedural re-quirements for requesting a private letterruling are described in Rev. Proc. 97–1,1997–1 I.R.B. 11 (or its successor).

SECTION 4. RELIEF FOR LATE SCORPORATION ELECTIONS UNDERTHIS REVENUE PROCEDURE

.01 Eligibility for Relief. A corporationis eligible for relief if it meets the follow-ing requirements:

(1) The corporation fails to qualify asan S corporation solely because the Form2553 (Election by a Small Business Cor-poration) was not filed timely pursuant to§ 1362(b)(1); and

(2) The due date for the tax return (ex-cluding extensions) for the first year thecorporation intended to be an S corpora-tion has not passed.

.02 Procedural Requirements for Re-lief. Within 6 months of the original duedate for the S corporation election, thecorporation must file with the applicableservice center a completed Form 2553,signed by an officer of the corporation au-thorized to sign and all persons who wereshareholders (or deemed to have beenshareholders) at any time during the pe-riod that began on the first day of the tax-able year for which the election is to beeffective and ends on the day the electionis made. The Form 2553 must state at thetop of the document “FILED PUR-SUANT TO REV. PROC. 97–40.” At-tached to the Form 2553 must be a state-ment explaining the reason for the failureto file a timely S corporation election.

.03 Relief for Late S Corporation Elec-tions. Upon receipt of a completed appli-cation requesting relief under this revenueprocedure, the Internal Revenue Servicewill determine if there was reasonablecause for the failure to file a timely S cor-poration election and will notify the cor-poration of the result of the reasonablecause determination.


This revenue procedure is effective forall applications for relief satisfying the re-quirements of section 4 of this revenueprocedure, including those applicationsnow being considered by the Service.

SECTION 6. PAPERWORK REDUCTION ACT

The collection of information con-tained in this revenue procedure has beenreviewed and approved by the Office ofManagement and Budget in accordancewith the Paperwork Reduction Act (44U.S.C. 3507) under control number1545–1548.

An agency may not conduct or sponsor,and a person is not required to respond to,a collection of information unless the col-lection of information displays a validcontrol number.

The collection of information in thisrevenue procedure is in Section 4.02. Thisinformation is required to be submitted tothe applicable service center in order toobtain relief for late S corporation elec-tions. This information will be used to de-termine if the reasonable cause require-ment in § 1362(b)(5) has been met. Thecollection of information is required to ob-tain a benefit. The likely respondents arebusiness or other for-profit institutions.

The estimated total annual reportingburden is 200 hours.

The estimated annual burden per re-spondent varies from .5 hours to 1.5hours, depending on individual circum-stances, with an estimated average of 1hour. The estimated number of respon-dents is 200.

The estimated annual frequency of re-sponses is one.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mater-ial in the administration of any internalrevenue law. Generally, tax returns andtax return information are confidential, asrequired by 26 U.S.C. 6103.


The principal author of this revenueprocedure is Mark D. Harris of the Officeof Assistant Chief Counsel (Passthroughsand Special Industries). For further infor-mation regarding this revenue procedurecontact Mr. Harris at (202) 622-3050 (nota toll-free call).

26 CFR 601.601: Rules and regulations.

(Also, Part I, §§ 401, 403; 1.401(b)–1.)

Rev. Proc. 97–41

SECTION 1. PURPOSE

.01 This revenue procedure provides

1997–33 I.R.B. 51 August 18, 1997

guidance to sponsors of pension, profit-sharing and stock bonus plans qualifiedunder § 401(a) or 403(a) of the InternalRevenue Code (qualified plans) and tax-sheltered annuity plans described in§ 403(b) (§ 403(b) plans) with respect tothe date by which they must adoptamendments to comply with changes inthe law made by the Small Business JobProtection Act of 1996, Pub. L. 104–188(SBJPA), the Uruguay Round Agree-ments Act, Pub. L. 103–465 (GATT), andthe Uniformed Services Employment andReemployment Rights Act of 1994, Pub.L. 103–353 (USERRA). This revenueprocedure provides that:

1 In general, there is a single deadlinefor adopting SBJPA, GATT andUSERRA amendments to qualified plans.

2 The deadline for adopting SBJPA,GATT and USERRA amendments is thesame as the date by which certain plansthat have extended reliance on Tax Re-form Act of 1986 (TRA ‘86) determina-tion letters must be amended.

3 Plan sponsors are allowed, for quali-fication purposes, to anticipate in planoperation certain plan amendments thatthey intend to adopt as a result of changesin the qualification requirements.

.02 Specifically, under this revenueprocedure:

1 Qualified plans have a remedialamendment period under § 401(b) withrespect to certain amendments forSBJPA, GATT or USERRA through thelast day of the first plan year beginningon or after January 1, 1999. Thus, theseamendments will not have to be adoptedbefore the last day of a plan’s 1999 planyear.

2 The deadline for adopting planamendments to reflect certain limitationsunder § 415(b), as amended by GATTand SBJPA, is also the last day of the firstplan year beginning on or after January 1,1999. In addition, relief is provided sothat a plan amendment described in §1449(d)(2) of SBJPA repealing an earlierplan amendment that implemented cer-tain amendments made by GATT to §415(b) need not be adopted before thelast day of the first plan year beginningon or after January 1, 1999.

3 Plan sponsors are advised of the Ser-vice’s intention to publish procedures forobtaining determination letters that in-clude consideration of the changes to the

qualification requirements made bySBJPA and GATT as soon as possibleafter necessary guidance is issued.

4 Amendments for SBJPA to § 403(b)plans, or to annuity contracts purchasedunder § 403(b) plans, are not required tobe adopted before the first day of the firstplan year beginning on or after January 1,1998.

PART I. BACKGROUND

SECTION 2. SBJPA

.01 SBJPA changed several of the re-quirements of the Code that apply to pen-sion, profit-sharing and stock bonus plansqualified under § 401(a) or 403(a). Whilea number of these changes are effective inplan years beginning after December 31,1996, others are not effective until lateryears.

.02 Section 1465 of SBJPA generallyprovides an extended period for amendingplans and annuity contracts as required bySBJPA. Under § 1465, if any provision ofsubtitle D (Pension Simplification) ofSBJPA requires an amendment to anyplan or annuity contract, the amendmentis not required to be made before the firstday of the first plan year beginning on orafter January 1, 1998, provided (1) theamendment is made effective retroac-tively to the date on which the provisionof SBJPA became effective with respectto the plan or contract and (2) the plan orcontract is operated in accordance withthe requirements of the provision as of itseffective date. For a governmental plan(as defined in § 414(d) of the Code), theyear “2000” is substituted for the year“1998” in § 1465. Section 1465 appliesto plans and contracts in existence on orafter the date of enactment of SBJPA, Au-gust 20, 1996.

.03 In Rev. Proc. 96–49, 1996–43I.R.B. 74, the Service stated that planamendments to reflect the provisions ofUSERRA and § 414(u), which was addedby § 1704(n) in subtitle G (Technical Cor-rections) of SBJPA, are not required to bemade before the date plan amendmentsare required to be made under § 1465 ofSBJPA.

SECTION 3. GATT

.01 GATT, which was enacted Decem-ber 8, 1994, also changed several of theCode’s qualification requirements. These

included the rules relating to the determi-nation of certain benefits under §§ 411(a)-(11)(B), 415(b)(2)(E) and 417(e)(3).

.02 The changes to §§ 411(a)(11)(B)and 417(e)(3), relating to the determina-tion of the present value of certain plandistributions, were generally effective forplan years beginning after December 31,1994. However, § 767(a)(2) of GATTprovided a transition rule with respect tothe determination under §§ 411(a)(11)(B)and 417(e)(3) of the present value of dis-tributions from plans that were adoptedand in effect as of December 7, 1994(“pre-GATT plans”). In general, underthis transition rule, the present value of adistribution from a pre-GATT plan that ismade before the earlier of (i) the firstplan year beginning after December 31,1999, or (ii) the later of the adoption oreffective date of a plan amendment ap-plying the GATT changes to §§ 411(a)-(11)(B) and 417(e)(3) to the plan is to bedetermined under the plan’s pre-GATTterms. Thus, for pre-GATT plans,amendments applying the GATT changesto §§ 411(a)-(11)(B) and 417(e)(3) to theplan cannot be adopted retroactively. Asa result, these plans are not permitted tooperate in accordance with these changesprior to the adoption of plan amend-ments.

.03 Under section 767(d) of GATT, thechanges to § 415(b)(2)(E), relating to re-quired adjustments to certain benefits forlimitation purposes, were effective forlimitation years beginning after Decem-ber 31, 1994. In addition, § 767(d) ofGATT required plans to be operated in ac-cordance with the GATT changes to§ 415(b)(2)(E) as of the first limitationyear beginning after December 31, 1994,even though, under § 767(d)(3)(B) ofGATT, plan amendments applying thesechanges to the plan would not be requireduntil such date as the Secretary provides.

.04 Section 1449 of SBJPA amended§ 767(d)(3)(A) of GATT, however, topermit plan sponsors to delay the imple-mentation of the GATT changes to §415(b)(2). Section 1449 provides that apre-GATT plan is not required to applythe GATT changes to § 415(b)(2)(E)with respect to benefits accrued beforethe earlier of (i) the later of the date aplan amendment applying the changes isadopted or effective or (ii) the first dayof the first limitation year beginning

August 18, 1997 52 1997–33 I.R.B.

after December 31, 1999. Further,§ 1449(d) of SBJPA provides that anamendment applying specified GATTchanges that was adopted or effective be-fore August 20, 1996, will be disre-garded in applying § 767(d)(3)(A) ofGATT, as modified by § 1449(a) ofSBJPA, if that amendment is repealed byanother plan amendment that is adoptedno later than August 20, 1997.

SECTION 4. THE REMEDIALAMENDMENT PERIOD UNDER SECTION 401(B)

.01 Section 401(b) provides a reme-dial amendment period during which aplan may be amended retroactively,under certain circumstances, to complywith the Code’s qualification require-ments. Temporary and proposed amend-ments to the regulations under § 401(b)were published in the Federal Register onAugust 1, 1997. Section 1.401(b)–1(f) ofthe regulations grants the Commissionerthe discretion to extend the remedialamendment period. Absent such an ex-tension, however, the remedial amend-ment period is generally determined asdescribed below.

.02 Section 1.401(b)–1 provides that aplan that fails to satisfy the requirementsof § 401(a) solely as a result of a disquali-fying provision defined under§ 1.401(b)–1(b) need not be amended tocomply with those requirements until thelast day of the remedial amendment pe-riod with respect to the disqualifying pro-vision, provided the amendment is maderetroactively effective to the beginning ofthe remedial amendment period. Under§ 1.401(b)–1T(b)(3), a disqualifying pro-vision includes a plan provision desig-nated, at the Commissioner’s discretion,as a disqualifying provision that either (i)results in the failure of the plan to satisfythe qualification requirements of the Codeby reason of a change in those require-ments; or (ii) is integral to a qualificationrequirement of the Code that has beenchanged. For this purpose, § 1.401(b)–1T(c)(1) provides that a disqualifyingprovision includes the absence from aplan of a provision required by or, if ap-plicable, integral to the applicable changein the qualification requirements of theCode, if the plan was in effect on the datethe change in those requirements becameeffective with respect to the plan.

.03 For a disqualifying provision de-scribed in § 1.401(b)–1T(b)(3), the reme-dial amendment period generally beginswith the date on which the change be-comes effective with respect to the planor, in the case of a provision that is inte-gral to a qualification requirement thathas been changed, the first day on whichthe plan was operated in accordance withthe provision as amended. The remedialamendment period for a disqualifyingprovision described in §1.401(b)–1T(b)-(3) generally ends with the later of (1) thedue date (including extensions) for filingthe income tax return for the employer’staxable year that includes the date onwhich the remedial amendment period be-gins or (2) the last day of the plan yearthat includes the date on which the reme-dial amendment period begins. A planmaintained by more than one employerneed not be amended until the last day ofthe tenth month following the last day ofthe plan year in which the remedialamendment period begins.

.04 Section 1.401(b)–1 also providesthat in the case of a new plan which con-tains (or fails to contain) a provision thatcauses the plan to fail to satisfy the re-quirements of § 401(a) as of the date theplan is put into effect, the plan need notbe amended to comply with those require-ments until the later of the due date in-cluding extensions for filing the em-ployer’s tax return for the taxable year inwhich the plan is put into effect or the lastday of the plan year in which the plan isput into effect. A new plan maintained bymore than one employer need not beamended until the last day of the tenthmonth following the last day of the planyear in which falls the date the plan is putinto effect.

.05 Section 1.401(b)–1 also providesthat in the case of an amendment to an ex-isting plan which causes the plan to fail tosatisfy the requirements of § 401(a) as ofthe date the amendment is adopted or ef-fective (whichever is earlier), the planneed not be amended to correct theamendment until the later of the due datefor filing the employer’s tax return (in-cluding extensions) for the taxable year inwhich the amendment is adopted or effec-tive (whichever is later) or the last day ofthe plan year in which the amendment isadopted or effective (whichever is later).In the case of an amendment to an exist-

ing plan maintained by more than one em-ployer, the plan need not be amendeduntil the last day of the tenth month fol-lowing the last day of the plan year inwhich the amendment is adopted or effec-tive (whichever is later).

SECTION 5. EXTENDED RELIANCE

.01 Under Rev. Proc. 89–9, 1989–1C.B. 780, Rev. Proc. 89–13, 1989–1 C.B.801 (both as modified by Rev. Proc. 93–9,1993–1 C.B. 474), Rev. Proc. 93–39,1993–2 C.B. 513, Announcement 94–85,1994–26 I.R.B. 23, and Rev. Proc. 95–12,1995–1 C.B. 508, plans that were submit-ted to the Service within certain deadlinesfor determination, opinion, or notificationletters under the Tax Reform Act of 1986,Pub. L. 99–514 (TRA ’86), and receivedfavorable letters are entitled to extendedreliance. During the extended relianceperiod, a plan is generally not required tooperationally comply with or be amendedfor regulations or administrative guidanceof general applicability issued after thedate of the plan’s letter which interpret thequalification requirements in effect whenthe letter was issued. The extended re-liance period continues until the earlier ofthe last day of the last plan year com-mencing prior to January 1, 1999, or thedate established for plan amendment byany legislation that is effective after thedate of the plan’s letter.

PART II. TIME FOR AMENDINGQUALIFIED PLANS FOR SBJPA,

GATT, AND USERRA

SECTION 6. DESIGNATION OFCERTAIN PLAN PROVISIONS RELATING TO SBJPA, GATTAND USERRA CHANGES AS DISQUALIFYING PROVISIONS

.01 Pursuant to the Commissioner’sauthority under § 1.401(b)–1T(b)(3), aplan provision is hereby designated as adisqualifying provision under §1.401(b)–1(b) if the plan provision causesa plan to fail to satisfy the qualificationrequirements of the Code because ofchanges made to those requirements bySBJPA or GATT that are effective beforethe first day of the first plan year begin-ning on or after January 1, 1999.

.02 A plan provision is also herebydesignated as a disqualifying provision ifthe plan provision is integral to a qualifi-

1997–33 I.R.B. 53 August 18, 1997

cation requirement changed by SBJPA,but only to the extent the change in thequalification requirement is effective be-fore the first day of the first plan year be-ginning on or after January 1, 1999, andthe plan provision as amended is effectiveprior to the end of the remedial amend-ment period as described in section 6.04,below. For purposes of this paragraph,the changes in the qualification require-ments made by SBJPA include § 414(u)and USERRA. In accordance with §1.401(b)–1T(d)(1)(v), an amendment of adisqualifying provision described in thisparagraph may be made retroactively ef-fective only to the first day on which theplan was operated in accordance with theprovision. For example, Announcement97–24, 1997–11 I.R.B. 24, and An-nouncement 97–70, 1997–29 I.R.B. 14,provide that an employer may offer cer-tain employees an option to defer com-mencement of benefits under its qualifiedplan provided the employer amends theplan retroactively to conform the plan toits pre-amendment operation regardingthe option to defer. These announcementsalso state that future guidance will pro-vide the date by which such a retroactiveamendment must be adopted. Theretroactive amendment described in An-nouncements 97–24 and 97–70 is anamendment to a plan provision that is in-tegral to a qualification requirementchanged by SBJPA and must therefore beadopted by the end of the remedialamendment period as described below.Generally, plan provisions reflecting thefamily aggregation rules as in effect priorto 1997 would also be integrally related toSBJPA qualification changes. See section6.09.

.03 A plan provision that causes a planto fail to satisfy § 401(a) because of achange made by SBJPA or GATT to thequalification requirements that is effec-tive on or after the first day of the firstplan year beginning on or after January 1,1999, is not a disqualifying provisionunder section 6.01. A plan provision thatis integral to a qualification requirementchanged by SBJPA is not a disqualifyingprovision under section 6.02 if thechange in the qualification requirement iseffective on or after the first day of thefirst plan year beginning on or after Janu-ary 1, 1999, or if the plan provision asamended is not effective prior to the end

of the remedial amendment period as de-scribed in section 6.04, below. Thus, forexample, § 401(b) and the regulationsthereunder would not apply to permit theadoption of the § 401(k) and § 401(m)safe harbors described in § 1433(a) and(b) of SBJPA on a retroactive basis, be-cause the provisions of § 1433(a) and (b)are effective for plan years beginningafter December 31, 1998. A plan provi-sion that is integral to the limitationunder § 415(e), which was repealed by §1452(a) of SBJPA effective for limitationyears beginning after December 31,1999, also is not a disqualifying provi-sion under section 6.02.

.04 Pursuant to the Commissioner’sauthority under § 1.401(b)–1(f), with re-spect to plans other than governmentalplans, the remedial amendment periodfor disqualifying provisions described insections 6.01 and 6.02 is hereby ex-tended to the last day of the first planyear beginning on or after January 1,1999. Thus, for example, a single em-ployer calendar year nongovernmentalplan that does not satisfy the require-ments of § 401(a) because of a disquali-fying provision described in section 6.01or 6.02 may be retroactively amended tomeet those requirements by December31, 1999. For governmental plans, theremedial amendment period for disquali-fying provisions described in sections6.01 and 6.02 is extended to the later of(i) the first day of the first plan year be-ginning on or after January 1, 2000, or(ii) the last day of the first plan year be-ginning on or after the “1999 legislativedate” (that is, the 90th day after theopening of the first legislative sessionbeginning on or after January 1, 1999, ofthe governing body with authority toamend the plan, if that body does notmeet continuously).

.05 In addition, the remedial amend-ment period with respect to all disqualify-ing provisions of new plans adopted or ef-fective after December 7, 1994, and alldisqualifying provisions of existing plansarising from a plan amendment adoptedafter December 7, 1994, that causes theplan to fail to satisfy the requirements of §401(a) as of the date the amendment isadopted or effective (whichever is ear-lier), will not expire earlier than the lastday of the first plan year beginning on orafter January 1, 1999. For a governmen-

tal plan, this period will not expire beforethe later of (i) the first day of the first planyear beginning on or after January 1,2000, or (ii) the last day of the first planyear beginning on or after the 1999 leg-islative date.

.06 Although plan amendments are notrequired before the end of the remedialamendment period, plan sponsors mustoperate their plans in compliance with theprovisions of SBJPA or GATT prior to thetime plan amendments are required to theextent earlier operational compliance isrequired by law or regulation or by rev-enue ruling, notice or other guidance pub-lished in the Internal Revenue Bulletin.In these cases, any retroactive amend-ments will have to reflect the choices theplan sponsor has already made in the op-eration of the plan. The following are ex-amples where earlier operational compli-ance is required.

1 Section 1465 of SBJPA generally re-quires plans to be operated in compliancewith any provision of SBJPA that is effec-tive before the first day of the first planyear beginning on or after January 1,1998 (or January 1, 2000, in the case of agovernmental plan), as of such provi-sion’s effective date.

2 Section 401(m)(6)(A) requires cor-rection of excess aggregate contributionsto § 401(m) plans to be accomplishedwithin 12 months of the end of the planyear in which the contributions weremade. Thus, to this extent, for example, asponsor of a § 401(m) plan will have tooperate the plan in a manner that satisfies§ 401(a) as amended by SBJPA and anyretroactive amendments must reflect thechoices that the plan sponsor has alreadymade in the operation of the plan (for ex-ample, the definition of highly compen-sated employee).

3 Section 1.401(b)–1T(d)(1)(v) per-mits a remedial amendment of a disquali-fying provision that is integral to a quali-fication requirement changed by SBJPA(including § 414(u) and USERRA) to bemade retroactively effective only to thefirst day on which the plan was operatedin accordance with the provision asamended.

.07 Earlier plan amendment may berequired by law or regulation or by rev-enue ruling, notice or other guidancepublished in the Internal Revenue Bul-letin. In these cases plan sponsors may

August 18, 1997 54 1997–33 I.R.B.

not rely on the remedial amendment pe-riod as a basis for making an amendmentretroactively effective. The following areexamples where the remedial amendmentperiod may not be relied on as a basis formaking an amendment retroactively ef-fective.

1 Except as provided in Rev. Proc.97–9, 1997–2 I.R.B. 55, a plan sponsormay not retroactively amend a § 401(k)plan to adopt the alternative (“SIMPLE”)method of satisfying the § 401(k) and §401(m) nondiscrimination tests added by§ 1422 of SBJPA.

2 As provided in § 417(e)(3)(B), thepresent value of a distribution from a pre-GATT plan that is made prior to the firstplan year beginning after December 31,1999, and before a plan amendment ap-plying the GATT changes to § 417(e)(3)to the plan has been adopted and made ef-fective generally must be determinedunder the plan’s pre-GATT terms.

.08 Any amendment that would resultin an elimination or reduction of§ 411(d)(6) protected benefits may not bemade retroactively effective unlessspecifically permitted by law or regula-tion or by revenue ruling, notice, or otherguidance published in the Internal Rev-enue Bulletin.

.09 Section 1431(b)(1) of SBJPA elim-inated the family aggregation require-ments of § 414(q)(6), effective for yearsbeginning after December 31, 1996. Sec-tion 1431(b)(2) of SBJPA also eliminatedthe family aggregation requirement thatformerly applied under § 401(a)(17)(A),effective for years beginning after De-cember 31, 1996. A plan’s family aggre-gation provisions generally would be dis-qualifying provisions under § 401(b)because they would be integrally relatedto a qualification requirement of the Codethat has been changed by SBJPA, effec-tive before 1999. In certain limited cir-cumstances, the continued application ofthe family aggregation rules in the opera-tion of a plan could result in the loss ofqualified status. The plan’s family aggre-gation provisions also would then be dis-qualifying provisions because they wouldcause disqualification as a result ofSBJPA changes to the qualification re-quirements effective before 1999. Re-gardless of whether a plan’s family aggre-gation provisions are disqualifyingprovisions because they are integrally re-

lated to SBJPA qualification changes orbecause they would cause plan disqualifi-cation, a plan amendment eliminating theprovisions will not violate the require-ments of § 411(d)(6) provided the amend-ment is effective no earlier than the firstday on which the plan was operated in ac-cordance with the amendment, and in noevent earlier than the first day of the firstplan year beginning after December 31,1996.

SECTION 7. TIME FOR ADOPTINGCERTAIN AMENDMENTS RELATINGTO SECTION 415

For purposes of § 767(d)(3)(B) ofGATT, the date provided by the Secretaryfor adopting plan amendments reflectingthe changes to § 415(b)(2)(E) is the lastday of the plan’s remedial amendment pe-riod under section 6.04. Moreover, as dis-cussed in section 3.04, § 1449(d) ofSBJPA provides that an amendment ap-plying specified GATT changes that wasadopted or effective before August 20,1996, will be disregarded in applying §767(d)(3)(A) of GATT, as modified by §1449(a) of SBJPA, if that amendment isrepealed by another plan amendment thatis adopted no later than August 20, 1997.Pursuant to this revenue procedure, a planamendment applying the amendmentsmade by § 767 of GATT which wasadopted or made effective on or beforeAugust 20, 1996, also shall not be takeninto account in applying § 767(d)(3)(A)of GATT as amended by § 1449(a) ofSBJPA, if the amendment is repealed byanother plan amendment that is adoptedon or before the last day of the plan’s re-medial amendment period under section6.04. This relief will not fail to be avail-able merely because a plan is not operatedin accordance with the repealing amend-ment prior to the date specified in futureguidance. The Service intends to issueadditional guidance concerning the GATTand SBJPA changes to the limitationsunder § 415(b) in the near future.

SECTION 8. MINIMUM FUNDINGREQUIREMENTS

Section 412 provides minimum fund-ing standards applicable to pension plansthat are or were qualified plans under §401. Section 1.412(c)(3)–1 provides rulesconcerning the reasonable funding meth-ods for defined benefit pension plans.

Section 1.412(c)(3)–1(d)(1)(i) providesthat, except as provided by the Commis-sioner, a reasonable funding method doesnot anticipate changes in plan benefitsthat become effective, whether or notretroactively, in a future plan year or thatbecome effective during a plan year butafter the first day thereof. Section412(c)(12), which was added by GATT,provides that the funding method of a col-lectively bargained plan described in§ 413(a) (other than a multiemployerplan) must anticipate benefit increasesscheduled to take effect during the term ofthe collective bargaining agreement ap-plicable to the plan. Therefore, except tothe extent required by § 412(c)(12) or asotherwise provided by the Commissioner,in determining the minimum fundingstandards for a defined benefit plan under§ 412, amendments that become effective,whether or not retroactively, in a futureplan year may not be anticipated, eventhough the amendments are made beforethe end of any applicable remedialamendment period. Contributions to adefined benefit plan will be deductiblesubject to the limitations of § 404, withthe § 412 minimum funding standards de-termined without anticipating such futureamendments.

SECTION 9. TERMINATING PLANS

A plan (including a master or proto-type, regional prototype, or volume sub-mitter plan) that is terminated after the ef-fective date of changes in thequalification requirements made bySBJPA or GATT but before the date thatplan amendments would otherwise be re-quired must be amended in connectionwith the plan termination to comply withthe changes as of their effective date withrespect to the plan. For this purpose, anyamendment that is adopted after the dateof plan termination in order to receive afavorable determination letter will be con-sidered as adopted in connection with theplan termination. In addition, annuitycontracts distributed from such termi-nated plans also must meet all the applica-ble requirements of SBJPA and GATT. Inthe case of changes in the qualification re-quirements to which § 1465 of SBJPA ap-plies, the operational compliance require-ment of § 1465 must also be satisfied.(See Notice 87–57, 1987–2 C.B. 368, andAnnouncement 88–8, 1988–4 I.R.B. 32,

1997–33 I.R.B. 55 August 18, 1997

which enunciated the same principleswith respect to plans that terminated be-fore the amendment date described in§ 1140 of TRA ’86.)

SECTION 10. PLANS WITH EX-TENDED RELIANCE

As described above, the sponsor of aplan that is entitled to extended relianceon a favorable TRA ’86 letter may rely onthat letter until the earlier of the last dayof the last plan year commencing prior toJanuary 1, 1999, or the date establishedfor plan amendment by any legislationthat is effective after the date of the plan’sletter. A plan with extended reliance mustbe amended by the last day of the firstplan year beginning on or after January 1,1999, to the extent necessary to complywith regulations or administrative guid-ance of general applicability that has beenissued since the date of the plan’s favor-able TRA ’86 letter. These amendmentsmust be made effective no later than thefirst day of the first plan year beginningon or after January 1, 1999, and no earlierthan the first day of the plan year in whichthe amendments are adopted. (But seeRev. Rul. 94–76, 1994–2 C.B. 46, andRev. Rul. 96–48, 1996–40 I.R.B. 7.) Alsosee section 11, below, regarding preap-proved plans.

SECTION 11. DETERMINATION ANDOPINION LETTER PROGRAMS

.01 Effective with the date of enact-ment of SBJPA or GATT, as applicable,and until further notice is given, determi-nation, opinion, notification, and advisoryletters, other than determination letters is-sued for terminating plans, will not in-clude consideration by the Service of anyamendments to the qualification require-ments made by SBJPA or GATT, with thefollowing two exceptions. First, determi-nation letters will include consideration ofthe changes made to § 401(a)(26) by§ 1432 of SBJPA, which limited the ap-plicability of § 401(a)(26) to defined ben-efit plans and made certain other changes.See Announcement 97–2, 1997–2, I.R.B.62. Second, determinations of leased em-ployee status under § 414(n) will reflectthe “primary direction or control” testunder § 414(n)(2)(C), as amended by§ 1454 of SBJPA, that replaces the former“historically performed” test.

.02 Until further notice is given, plans

(including master or prototype, regionalprototype, and volume submitter plans),other than terminating plans, that includeprovisions that reflect the SBJPA orGATT amendments to the qualificationrequirements will not be subject to ad-verse letters by reason of the inclusion ofthe provisions. This will not preclude theissuance of adverse letters for other rea-sons, such as an impermissible elimina-tion or reduction of § 411(d)(6) protectedbenefits resulting from the adoption ofamendments for SBJPA or GATT. How-ever, favorable letters issued for plans,other than terminating plans, may not berelied upon with respect to whether theplans satisfy the qualification require-ments as amended by SBJPA or GATT.

.03 The Service will begin reviewingboth preapproved plans and individuallydesigned plans for compliance with thequalification requirements as amended bySBJPA and GATT as soon as possibleafter the issuance of additional guidancepertaining to the requirements of SBJPA.Prior to that time, the Service intends topublish procedures relating to the is-suance of determination, opinion, notifi-cation and advisory letters for plans thattake into account the requirements ofSBJPA and GATT. The procedures arealso expected to include rules pertainingto the required time for sponsors to amendpreapproved plans for SBJPA and GATTand actions that may be required ofadopters of these plans.

PART III. TIME FOR AMENDINGSECTION 403(B) PLANS

SECTION 12. SECTION 403(B)PLANS

.01 SBJPA also made certain changesthat may require the amendment of tax-sheltered annuity plans described in§ 403(b) or annuity contracts purchasedunder these plans. The provisions of§ 1465 of SBJPA apply with respect toany plan or annuity contract that is re-quired to be amended by any provision ofsubtitle D of SBJPA. Section 1465 thusapplies not only to qualified plans but alsoto § 403(b) plans and annuity contractspurchased under these plans. Therefore, ifa provision of subtitle D of SBJPA re-quires an amendment to a § 403(b) plan oran annuity contract purchased under theplan, the amendment will not be required

to be made before the time described in§ 1465 of SBJPA, provided the retroactiveamendment and operational compliancerequirements of § 1465 are satisfied. Forthis purpose, the time described in § 1465with respect to a § 403(b) plan that is agovernmental plan will be treated as notexpiring before the last day of the firstplan year beginning on or after the 1999legislative date, that is, the 90th day afterthe opening of the first legislative sessionbeginning on or after January 1, 1999, ofthe governing body with authority toamend the plan, if that body does notmeet continuously.

.02 For example, § 1450(c)(1) ofSBJPA amended § 403(b)(1)(E) to pro-vide that each contract purchased under a§ 403(b) plan salary reduction agreementmust provide that elective deferrals madeunder the contract may not exceed the an-nual limit on elective deferrals under§ 402(g)(1). Prior to this amendment, the§ 403(b) plan, not each contract, was re-quired to provide this limitation. Section1450(c)(2) provides that this amendmentapplies to years beginning after December31, 1995, except a contract will not be re-quired to meet any change in any require-ment by reason of the amendment beforethe 90th day after enactment of SBJPA(that is, November 18, 1996). Because§ 1465 applies to any annuity contractpurchased under a § 403(b) plan, such acontract is not required to be amended tocomply with § 1450(c)(1) before the firstday of the first plan year beginning on orafter January 1, 1998 (or, in the case of acontract purchased under a § 403(b) planthat is a governmental plan, the later of (i)the first day of the first plan year begin-ning on or after January 1, 2000, or (ii)the last day of the first plan year begin-ning on or after the 1999 legislative date),provided the retroactive amendment andoperational compliance requirements of§ 1465 are satisfied with respect to thecontract.


This revenue procedure is effective Au-gust 18, 1997.


The principal author of this revenueprocedure is James Flannery of the Em-ployee Plans Division. For further infor-mation regarding this revenue procedure,

August 18, 1997 56 1997–33 I.R.B.

please contact the Employee Plans Divi-sion’s taxpayer assistance telephone ser-vice between the hours of 1:30 p.m. and 4p.m. Eastern Time, Monday throughThursday, by calling (202) 622-6074/6075, or Mr. Flannery on (202) 622-6214. (These telephone numbers are nottoll-free numbers.)

26 CFR 601.105: Examination of returns andclaims for refund, credit, or abatement; determina-tion of correct tax liability.

(Also Part I, § 42; 1.42–14.)

Rev. Proc. 97–42

SECTION 1. PURPOSE

This revenue procedure publishes theamounts of unused housing credit carry-overs allocated to qualified states under § 42(h)(3)(D) of the Internal RevenueCode for calendar year 1997.


Rev. Proc. 92–31, 1992–1 C.B. 775,provides guidance to state housing creditagencies of qualified states on the proce-dure for requesting an allocation of un-used housing credit carryovers under §42(h)(3)(D). Section 4.06 of Rev. Proc.92–31 provides that the Internal RevenueService will publish in the Internal Rev-enue Bulletin the amount of unused hous-

ing credit carryovers allocated to quali-fied states for a calendar year from a na-tional pool of unused credit authority (theNational Pool). This revenue procedurepublishes these amounts for calendar year1997.

SECTION 3. PROCEDURE

The unused housing credit carryoveramount allocated from the National Poolby the Secretary to each qualified state forcalendar year 1997 is as follows:

Qualified State Amount Allocated

Alabama $ 77,659Alaska 11,032California 579,360Colorado 69,480Connecticut 59,503Delaware 13,176Florida 261,710Georgia 133,636Idaho 21,609Illinois 215,311Indiana 106,156Iowa 51,833Kansas 46,744Maryland 92,180Massachusetts 110,718Michigan 174,364Minnesota 84,656Mississippi 49,361Missouri 97,396

Nebraska 30,024Nevada 29,133New Hampshire 21,119New Jersey 145,176New York 330,500North Carolina 133,090Ohio 203,061Oregon 58,230Pennsylvania 219,109Rhode Island 17,993South Carolina 67,227South Dakota 13,304Texas 347,638Utah 36,349Vermont 10,705Virginia 121,313Washington 100,558


This revenue procedure is effective forallocations of housing credit dollaramounts attributable to the National Poolcomponent of a qualified state’s housingcredit ceiling for calendar year 1997.


The principal author of this revenueprocedure is Christopher J. Wilson of theOffice of Assistant Chief Counsel(Passthroughs and Special Industries).For further information regarding thisrevenue procedure, contact Mr. Wilson on(202) 622-3040 (not a toll-free call).

1997–33 I.R.B. 57 August 18, 1997

August 18, 1997 58 1997–33 I.R.B.

Changes in Employer Reportingof Moving ExpenseReimbursements—Elimination ofForm 4782 and Changes toForm W–2 Reporting

Announcement 97–77

Purpose

This announces that the Internal Rev-enue Service will eliminate Form 4782,Employee Moving Expense Information,effective for tax year 1998. Also includedare changes to the reporting of movingexpense reimbursements by employers toemployees on Form W–2. These changesare effective for 1998 Forms W–2 thatemployees will receive in 1999.

Background

Form 4782 is used by employers to re-port moving expense reimbursementsmade to employees. P.L. 103–66 modi-fied IRC Section 132 to exclude from anemployee’s gross income employer reim-bursements for qualified moving ex-penses. After that change in law, some

employers still found Form 4782 to behelpful to employees in understanding theamounts that appear on their Forms W–2.However, many employers also told usthat Form 4782 was no longer needed,was burdensome to file, and that it shouldbe eliminated.

As a result of input received from theemployer community, the Service has de-cided to eliminate Form 4782. However,employers may continue providing simi-lar information to employees in any for-mat they wish if they deem it helpful toemployees.

Form W–2 ReportingWith the elimination of Form 4782, the

IRS is further simplifying the reporting ofqualified moving expenses on Form W–2.The IRS instructions for employerspreparing Forms W–2 for tax year 1998will reflect that:

• Qualified moving expenses an em-ployer pays to a third party on behalf ofthe employee (e.g., to a moving com-pany) and services that an employer fur-nishes in kind to an employee will not bereported at all on Form W–2.

• Qualified moving expenses reim-bursements an employer pays directly toan employee will be reported in Box 13of Form W–2 and will be identified usingCode P. (Currently, all qualified movingexpense reimbursements are identifiedwith Code P, regardless of whether or notthey were paid directly to the employee.)

• Other moving expense reimburse-ments (so-called nonqualified expenses),whether or not paid directly to a thirdparty, will continue to be included inwages (Form W–2, box 1) and are subjectto income tax withholding and social se-curity and Medicare taxes.

Employee Reporting on Form3903

As a result of the simplification of em-ployer reporting, the deduction for quali-fied moving expenses by employees willalso be simplified. Beginning with 1998returns filed in 1999, employees will re-port on Form 3903, Moving Expenses,only the qualified moving expenses paiddirectly by them. On Form 3903, em-ployees will reduce these expenses by theamounts reimbursed by their employersand reported in box 13 of Form W–2.

Part IV. Items of General Interest

1997–33 I.R.B. 59 August 18, 1997

Revenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe theeffect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus,if an earlier ruling held that a principleapplied to A, and the new ruling holdsthat the same principle also applies to B,the earlier ruling is amplified. (Comparewith modified, below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previouslypublished ruling and points out an essen-tial difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A but notto B, and the new ruling holds that it ap-

plies to both A and B, the prior ruling ismodified because it corrects a publishedposition. (Compare with amplified andclarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly usedin a ruling that lists previously publishedrulings that are obsoleted because ofchanges in law or regulations. A rulingmay also be obsoleted because the sub-stance has been included in regulationssubsequently adopted.

Revoked describes situations where theposition in the previously published rul-ing is not correct and the correct positionis being stated in the new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the

new ruling does more than restate thesubstance of a prior ruling, a combinationof terms is used. For example, modifiedand superseded describes a situationwhere the substance of a previously pub-lished ruling is being changed in part andis continued without change in part and itis desired to restate the valid portion ofthe previously published ruling in a newruling that is self contained. In this casethe previously published ruling is firstmodified and then, as modified, is super-seded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling andthat list is expanded by adding furthernames in subsequent rulings. After theoriginal ruling has been supplementedseveral times, a new ruling may be pub-lished that includes the list in the originalruling and the additions, and supersedesall prior rulings in the series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in current use and for-merly used will appear in material published in theBulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C.—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contribution Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign Corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statements of Procedral Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

Definition of Terms

August 18, 1997 60 1997–33 I.R.B.

Numerical Finding List1

Bulletins 1997–27 through 1997–32

Announcements:

97–61, 1997–29 I.R.B. 1397–67, 1997–27 I.R.B. 3797–68, 1997–28 I.R.B. 1397–69, 1997–28 I.R.B. 1397–70, 1997–29 I.R.B. 1497–71, 1997–29 I.R.B. 1597–72, 1997–29 I.R.B. 1597–73, 1997–30 I.R.B. 8697–74, 1997–31 I.R.B. 1697–75, 1997–32 I.R.B. 2897–76, 1997–32 I.R.B. 28

Court Decisions:

2061, 1997–31 I.R.B. 52062, 1997–32 I.R.B. 8

Delegation Orders:

172 (Rev. 5), 1997–28 I.R.B. 6

Notices:

97–37, 1997–27 I.R.B. 497–38, 1997–27 I.R.B. 897–39, 1997–27 I.R.B. 897–40, 1997–28 I.R.B. 697–41, 1997–28 I.R.B. 697–42, 1997–29 I.R.B. 1297–43, 1997–30 I.R.B. 997–44, 1997–31 I.R.B. 15

Railroad Retirement Quarterly Rate:

1997–28 I.R.B. 5

Proposed Regulations:

REG–104893–97, 1997–29 I.R.B. 13REG–107644–97, 1997–32 I.R.B. 24

Revenue Procedures:

97–32, 1997–27 I.R.B. 997–33, 1997–30 I.R.B. 1097–34, 1997–30 I.R.B. 14

Revenue Rulings:

97–27, 1997–27 I.R.B. 497–28, 1997–28 I.R.B. 497–29, 1997–28 I.R.B. 497–30, 1997–31 I.R.B. 1297–31, 1997–32 I.R.B. 4

Treasury Decisions:

8722, 1997–29 I.R.B. 48723, 1997–30 I.R.B. 4

1 A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., published inInternal Revenue Bulletins 1997–1 through 1997–26will be found in Internal Revenue Bulletin 1997–27,dated July 7, 1997.

1997–33 I.R.B. 61 August 18, 1997

Finding List of Current Action onPreviously Published Items1

Bulletins 1997–27 through 1997–32

*Denotes entry since last publication

Revenue Procedures:

96–36Superseded by97–34, 1997–30 I.R.B. 14

96–42Superseded by97–27, 1997–27 I.R.B. 9

Revenue Rulings:

89–42Supplemented by97–31, 1997–32 I.R.B. 4

1 A cumulative finding list for previously publisheditems mentioned in Internal Revenue Bulletins1997–1 through 1997–26 will be found in InternalRevenue Bulletin 1997–27, dated July 7, 1997.

Notes

August 18, 1997 62 1997–33 I.R.B.

INTERNAL REVENUE BULLETINThe Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold

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INTERNAL REVENUE BULLETINThe Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold

on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent ofDocuments when their subscriptions must be renewed.

CUMULATIVE BULLETINSThe contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are

sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of printand are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from theSuperintendent of Documents.

HOW TO ORDERCheck the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,

detach entire page, and mail to the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Pleaseallow two to six weeks, plus mailing time, for delivery.

WE WELCOME COMMENTS ABOUT THEINTERNAL REVENUE BULLETIN

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, wewould be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page(www.irs.ustreas.gov) or write to the IRS Bulletin Unit, T:FP:F:CD, Room 5560, 1111 Constitution Avenue NW, Washington, DC20224. You can also leave a recorded message 24 hours a day, 7 days a week at 1–800–829–9043.

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First Class MailPostage and Fees PaidGPOPermit No. G–26