SECTION 7. SECTION — Internal Revenue Bulletin 1997-21

ADJUSTMENT PERIOD

.01 In general . The § 481(a) adjustment periods are provided in sections 5.02(3) and 6.04 of this revenue procedure.

.02 Short period as a separate tax- able year . If the year of change, or any taxable year during the § 481(a) adjustment period, is a short taxable year, the § 481(a) adjustment must be included in income as if that short taxable year were a full 12-month taxable year. See Rev. Rul. 78–165, 1978–1 C.B. 276. Example 1. A calendar year taxpayer received permission to change an accounting method beginning with the 1997 calendar year. The § 481(a) adjustment is $30,000 and the adjustment period is four taxable years. The taxpayer subsequently receives permission to change its annual accounting period to September 30, effective for the taxable year ending September 30, 1998. The taxpayer must include $7,500 of the § 481(a) adjustment in gross income for the short period from January 1, 1998, through September 30, 1998. Example 2. Corporation X, a calendar year taxpayer, received permission to change an accounting method beginning with the 1997 calendar year. The § 481(a) adjustment is $30,000 and the adjustment period is four taxable years. On July 1, 1999, Corporation Z acquires Corporation X in a transaction to which § 381(a) applies. Corporation Z is a calendar year taxpayer that uses the same method of accounting to which Corporation X changed in 1997. Corporation X must include $7,500 of the § 481(a) adjustment in gross income for its short period income tax return for January 1, 1999, through June 30, 1999. In addition, Corporation Z must include $7,500 of the § 481(a) adjustment in gross income in its income tax return for calendar year 1999.

.03 Shortened or accelerated adjust- ment periods . The four-year § 481(a) adjustment period provided in sections 5.02(3) and 6.04 of this revenue procedure will be shortened or accelerated in the following situations.

(1) De minimis rule . A taxpayer may elect to use a one-year adjustment period in lieu of the § 481(a) adjustment period otherwise provided by this revenue procedure if the entire § 481(a) adjustment is less than $25,000 (either positive or negative). The taxpayer must complete the appropriate line on the Form 3115 to elect this de minimis rule.

(2) Cooperatives . A cooperative within the meaning of § 1381(a) generally must take the entire amount of a § 481(a) adjustment into account in computing taxable income for the year of change. See Rev. Rul. 79–45, 1979–1 C.B. 284.

(3) Ceasing to engage in the trade or business .

(a) In general . A taxpayer that ceases to engage in a trade or business

or terminates its existence must take the remaining balance of any § 481(a) adjustment relating to the trade or business into account in computing taxable income in the taxable year of the cessation or termination. Except as provided in sections 7.03(3)(d) and (e) of this revenue procedure, a taxpayer is treated as ceasing to engage in a trade or business if the operations of the trade or business cease or substantially all the assets of the trade or business are transferred to another taxpayer. For this purpose, ‘‘substantially all’’ has the same meaning as in section 3.01 of Rev. Proc. 77–37, 1977–2 C.B. 568.

(b) Examples of transactions that are treated as the cessation of a trade or business . The following is a nonexclusive list of transactions that are treated as the cessation of a trade or business for purposes of accelerating the § 481(a) adjustment under this section 7.03(3): (i) the trade or business to which the § 481(a) adjustment relates is incorporated;

(ii) the trade or business to which the § 481(a) adjustment relates is purchased by another taxpayer in a transaction to which § 1060 applies;

(iii) the trade or business to which the § 481(a) adjustment relates is terminated or transferred pursuant to a taxable liquidation;

(iv) a division of a corporation ceases to operate the trade or business to which the § 481(a) adjustment relates; or

(v) the assets of a trade or business to which the § 481(a) adjustment relates are contributed to a partnership.

(i) In general . Except as provided in sections 7.03(3)(c)(ii) and (iii) of this revenue procedure, no acceleration of a § 481(a) adjustment is required under this section 7.03(3)(c) when a C corporation elects to be treated as an S corporation or an S corporation terminates its S election and is then treated as a C corporation.

(ii) S election effective for year of LIFO discontinuance . If a C corporation elects to be treated as an S corporation for the taxable year in which it discontinues use of the LIFO inventory method, § 1363(d) requires an increase in the taxpayer’s gross income for the LIFO recapture amount (as defined in § 1363(d)(3)) for the taxable year preceding the year of change (the

taxpayer’s last taxable year as a C corporation), and a corresponding adjustment to the basis of the taxpayer’s inventory as of the end of the taxable year preceding the year of change. Any increase in income tax as a result of the inclusion of the LIFO recapture amount is payable in four equal installments, beginning with the taxpayer’s last taxable year as a C corporation as provided in § 1363(d)(2). Any corresponding basis adjustment is taken into account in computing the § 481(a) adjustment (if any) that results upon the discontinuance of the LIFO method by the corporation.

(iii) S election effective for a year after LIFO discontinuance . If a C corporation elects to be treated as an S corporation for a taxable year after the taxable year in which it discontinued use of the LIFO inventory method, the remaining balance of any positive § 481(a) adjustment must be included in its gross income in its last taxable year as a C corporation. If this inclusion results in an increase in tax for its last taxable year as a C corporation, this increase in tax is payable in four equal installments, beginning with the taxpayer’s last taxable year as a C corporation as provided in § 1363(d)(2), unless the taxpayer is required to take the remaining balance of the § 481(a) adjustment into account in the last taxable year as a C corporation under another acceleration provision in section 7.03(3) of this revenue procedure.

(d) Certain transfers to which § 381(a) applies . No acceleration of the § 481(a) adjustment is required under this section 7.03(3) when a taxpayer transfers substantially all the assets of the trade or business that gave rise to the § 481(a) adjustment to another taxpayer in a transfer to which § 381(a) applies and the accounting method (the change to which gave rise to the § 481(a) adjustment) is a tax attribute that is carried over and used by the acquiring corporation immediately after the transfer pursuant to § 381(c). The acquiring corporation is subject to any terms and conditions imposed on the transferor (or any predecessor of the transferor) as a result of its change in method of accounting.

(e) Certain transfers pursuant to § 351 within a consolidated group .

(i) In general . No acceleration of the § 481(a) adjustment is required under this section 7.03(3) when one member of an affiliated group filing a consolidated return transfers substantially all the assets of the trade or

business that gave rise to the § 481(a) adjustment to another member of the same consolidated group in an exchange qualifying under § 351 and the transferee member adopts and uses the same method of accounting (the change to which gave rise to the § 481(a) adjustment) used by the transferor member. The transferor member must continue to take the § 481(a) adjustment into account pursuant to the terms and conditions set forth in its Consent Agreement (as provided in section 8.11 of this revenue procedure). The transferor member must take into account activities of the transferee member (or any successor) in determining whether acceleration of the § 481(a) adjustment is required. For example, except as provided in the following sentence, the transferor member must take any remaining § 481(a) adjustment into account in computing taxable income in the taxable year in which the transferee member ceases to engage in the trade or business to which the § 481(a) adjustment relates. The § 481(a) adjustment is not accelerated when the transferee member engages in a transaction described in section 7.03(3)(d) or section 7.03(3)(e)(i) of this revenue procedure. (ii) Exception . The provisions of section 7.03(3)(e)(i) of this revenue procedure cease to apply and the transferor member must take any remaining balance of the § 481(a) adjustment into account in the taxable year immediately preceding any of the following: (A) the taxable year the transferor member ceases to be a member of the group; (B) the taxable year any transferee member owning substantially all the assets of the trade or business which gave rise to the § 481(a) adjustment ceases to be a member of the group; or (C) a separate return year of the common parent of the group. In applying the preceding sentence, the rules of paragraphs (j)(2), (j)(5), and (j)(6) of § 1.1502–13 apply, but only if the method of accounting to which the transferor member changed and to which the § 481(a) adjustment relates is adopted, carried over, or used by any transferee member acquiring the assets of the trade or business that gave rise to the § 481(a) adjustment immediately after acquisition of such assets. For example, the transferor member is not required to accelerate the § 481(a) adjustment if a transferee member ceases to be a member of a consolidated group by reason of an acquisition to which § 381(a) applies and the acquiring cor

poration (A) is a member of the same group as the transferor member, and (B) continues, under § 381(c)(4) and the regulations thereunder, to use the same method of accounting as that used by the transferor member with respect to the assets of the trade or business to which the § 481(a) adjustment relates.