SECTION 3. CAPITAL

EXPENDITURES (§ 263)

.01 Package design costs.

(1) Description of change and scope. This change applies to a taxpayer that wants to change to one of the three alternative methods of accounting for package design costs described in section 5 of Rev. Proc. 97–35, page 11. The three alternative methods of accounting for package design costs described are: (1) the capitalization method, (2) the design-by-design capitalization and 60-month amortization method, and (3) the pool-of-cost capitalization and 48-month amortization method. This change was formerly provided in Rev. Proc. 90–63, 1990–2 C.B. 664. (2) Additional requirements. If a taxpayer is changing its method of accounting for package design costs to the capitalization method or the design-bydesign capitalization and 60-month amortization method, the taxpayer must attach a statement to its timely filed application. The statement must provide a description of each package design, the date on which

(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 personal property changing from a permissible UNICAP method to a permissible nonUNICAP inventory capitalization method in any taxable year that it qualifies as a small reseller;

(ii) a formerly small reseller changing from a permissible non-UNICAP inventory capitalization method to a permissible UNICAP method in the first taxable year that it does not qualify as a small reseller;

(iii) a reseller-producer changing from a permissible UNICAP method for both its production and resale activities to a permissible simplified resale method described in § 1.263A–3(d)(3) in any taxable year that it qualifies to use a simplified resale method for both its production and resale activities under § 1.263A–3(a)(4) (resellers with de minimis production activities); or

(iv) a reseller-producer changing from a permissible simplified resale method described in § 1.263A–3(d)(3) for both its production and resale activities to a permissible UNICAP method for both its production and resale activities in the first taxable year that it does not qualify to use a simplified resale method for both its production and resale activities under § 1.263A–3(a)(4). (b) Scope limitations inapplicable . A taxpayer that wants to make this change is not subject to the scope limitations in section 4.02 of this revenue procedure. However, if the taxpayer is under examination, before an appeals office, or before a federal court, the taxpayer must provide a copy of the application to the examining agent(s), appeals officer, or counsel for the government, as appropriate, at the

August 18, 1997 34 1997–33 I.R.B.

sonal property, incorporated January 2, 1991, adopted a taxable year ending December 31. X determines that its average annual gross receipts for the three taxable years (or fewer, if applicable) immediately preceding taxable years 1991 through 2000 are as shown in the table below:

AVERAGE Annual Gross Receipts for the Current Three Taxable Years Taxable Immediately Preceding Year the Current Taxable Year

1991 $ 0 1992 5,000,000 1993 6,000,000 1994 7,000,000 1995 11,000,000 1996 11,000,000 1997 9,000,000 1998 8,000,000 1999 11,000,000 2000 12,000,000

Furthermore, X, which adopted the dollar-value LIFO inventory method, has the following LIFO inventory balances determined without considering the effects of the UNICAP method:

Beginning Ending

1995 $1,000,000 $1,100,000 1996 1,100,000 1,200,000 1997 1,200,000 1,300,000 1998 1,300,000 1,400,000 1999 1,400,000 1,500,000 2000 1,500,000 1,600,000

X was required by § 263A to change to the UNICAP method for 1995 because its average annual gross receipts for the three taxable years immediately preceding 1995 were $11,000,000, which exceeded the $10,000,000 ceiling permitted by the small reseller exception. Assume that X was required to capitalize $80,000 of “additional § 263A costs” to the cost of its 1995 beginning inventory because of this change in inventory method. In addition, X was required to include one-fourth of the § 481(a) adjustment when computing taxable income for each of the four taxable years beginning with 1995. Thus, X was required to include a $20,000 positive § 481(a) adjustment in its 1995 taxable income.

X elected to use the simplified resale method without a historic absorption ratio

election under § 1.263A–3(d)(3) for determining the amount of additional § 263A costs to be capitalized to each LIFO layer. Assume that X was required to add $10,000 of additional § 263A costs to the cost of its 1995 ending inventory because of the $100,000 increment for 1995.

X’s 1995 Ending Inventory:

Beginning Inventory (Without

UNICAP costs) $1,000,000

1995 Increment 100,000

Additional § 263A Costs in Beginning

Inventory 80,000

Additional § 263A Costs in 1995

Increment ________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 reseller exception for 1996, X was required to continue using the UNICAP method for its inventory costs. Furthermore, X was required to include $20,000 of the unamortized 1995 positive § 481(a) adjustment in 1996 taxable income. Assume that X was required to add $10,000 of additional § 263A costs to the cost of its 1996 ending inventory because of the $100,000 increment for 1996.

X’s 1996 Ending Inventory:

Beginning Inventory (With

UNICAP costs) $1,190,000

1996 Increment 100,000

Additional § 263ACosts in 1996 Increment ________10,000

Total 1996 Ending Inventory $1,300,000________________

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

Unamortized 1995 § 481(a)

Adjustment—12/31/95 $60,000

Amount Included in 1996 Taxable Income ________<20,000>

Unamortized 1995 § 481(a)

Adjustment—12/31/96 ________________$40,000

Because X satisfies the small reseller exception for 1997, X may change voluntarily from the UNICAP method to a permissible non-UNICAP inventory capitalization method under section 4.01 of this APPENDIX. To reflect the removal of the additional § 263A costs from the cost of its 1997 beginning inventory, X must compute a corresponding § 481(a) adjustment, which is a negative $100,000

($1,200,000 — $1,300,000). Because X used the UNICAP method for only two years (that is, 1995 and 1996), X must include one-half of the § 481(a) adjustment when computing taxable income for each of the two taxable years beginning with 1997. Thus, X must include a $50,000 negative § 481(a) adjustment in 1997 taxable income. In addition, X must include $20,000 of the unamortized 1995 § 481(a) adjustment in 1997 taxable income.

X’s 1997 Ending Inventory:

Beginning Inventory (With

UNICAP costs) $1,300,000

1997 Increment 100,000

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

Total 1997 Ending Inventory $1,300,000________________

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

Unamortized 1995 § 481(a)

Adjustment—12/31/96 $40,000

Amount Included in 1997 Taxable Income ________<20,000>

Unamortized 1995 § 481(a)

Adjustment—12/31/97 ________________$20,000

X’s Unamortized 1997 § 481(a) Adjustment:

1997 § 481(a) Adjustment $<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 exception for 1998 and, therefore, is not required to return to the UNICAP method for 1998. X, however, must include $20,000 of the unamortized 1995 positive § 481(a) adjustment and $50,000 of the unamortized 1997 negative § 481(a) adjustment in 1998 taxable income.

X’s 1998 Ending Inventory:

Beginning Inventory (Without

UNICAP costs) $1,300,000

1998 Increment ________100,000

Total 1998 Ending Inventory $1,400,000________________

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

Unamortized 1995 § 481(a)

Adjustment—12/31/97 $20,000

Amount Included in 1998 Taxable Income ________<20,000>

Unamortized 1995 § 481(a)

Adjustment—12/31/98 $ 0________________

X’s Unamortized 1997 § 481(a) Adjustment:

Unamortized 1997 § 481(a)

Adjustment—12/31/97 $<50,000>

Amount Included in 1998 Taxable Income________50,000

Unamortized 1997 § 481(a)

Adjustment—12/31/98 $ 0________________

1997–33 I.R.B. 35 August 18, 1997

In 1999, X fails to satisfy the small reseller exception and, therefore, must return to the UNICAP method as provided under section 4.01 of this APPENDIX. X changes to the simplified resale method without a historic absorption ratio election under § 1.263A–3(d)(3). Assume that X must capitalize $120,000 of additional § 263A costs to the cost of its 1999 beginning inventory because of this change in inventory method. In addition, X must determine the appropriate adjustment period for the corresponding positive § 481(a) adjustment. Because X used its former inventory method for two taxable years before 1999 (that is, 1997 and 1998), X must include one-half of the § 481(a) adjustment when computing taxable income for each of the two taxable years beginning with 1999. Thus, X must include a $60,000 positive § 481(a) adjustment in its 1999 taxable income. Assume that X must add $10,000 of additional § 263A costs to the cost of its 1999 ending inventory because of the $100,000 increment for 1999.

X’s 1999 Ending Inventory:

Beginning Inventory (Without

UNICAP costs) $1,400,000

1999 Increment 100,000

Additional § 263A costs in Beginning

Inventory 120,000

Additional § 263A costs in 1999

Increment ________10,000

Total 1999 Ending Inventory $1,630,000________________

X’s Unamortized 1999 § 481(a) Adjustment:

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 reseller exception for 2000, X must continue using the UNICAP method for its inventory costs. Furthermore, X is required to include $60,000 of the unamortized 1999 positive § 481(a) adjustment in 2000 taxable income. Assume that X is required to add $10,000 of additional § 263A costs to the cost of its 2000 ending inventory because of the $100,000 increment for 2000.

X’s 2000 Ending Inventory:

Beginning Inventory (With

UNICAP costs) $1,630,000

2000 Increment 100,000

Additional § 263A Costs in

(a) Applicability. Except as provided in section 5.01(1)(b) of this APPENDIX, this change, which was formerly 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 to change to an overall accrual method, or to an overall accrual method in conjunction with the recurring item exception under § 461(h)(3), from the cash receipts and disbursements method (cash method), or from a hybrid method (under which certain items of income or expense are reported on the cash method and other items of income or expense are reported on an accrual method or other methods); or

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

(b) Inapplicability. This change does not apply to:

(i) a financial institution described in § 581 or 591;

(ii) a farmer; (iii) a cooperative organization described in § 501(c)(12), 521, or 1381; (iv) an individual taxpayer, except for activities conducted as a sole proprietorship;

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

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

(a) In general. The § 481(a) adjustment takes into account the accounts receivable, accounts payable, inventory, and any other item determined to be necessary in order to prevent items from being duplicated or omitted. The § 481(a) adjustment does not include any item of income accrued but not received that was worthless or partially worthless (within the meaning of § 166(a)) on the last day of the year preceding the year of change.

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

2000 Increment ________10,000

Total 2000 Ending Inventory $1,740,000________________

X’s Unamortized 1999 § 481(a) Adjustment:

Unamortized 1999 § 481(a)

Adjustment—12/31/99 $60,000

Amount Included in 2000 Taxable Income ________<60,000>

Unamortized 1999 § 481(a)

Adjustment—12/31/00 ________________$ 0

.02 Reserved.