SECTION 2. BACKGROUND AND

CHANGES

.01 Section 446(a) provides that taxable income must be computed under the method of accounting on the basis of which the taxpayer regularly computes income in keeping the taxpayer’s books.

.02 Section 446(c) generally allows a taxpayer to select the method of accounting it will use to compute its taxable income. A taxpayer is entitled to adopt any one of the permissible methods for each separate trade or business, including the cash method and an accrual method, subject to certain restrictions. For example, § 446(b) provides that the selected method must clearly reflect income. In addition, § 1.446– 1(c)(2)(i) requires that a taxpayer use an accrual method of accounting with regard to purchases and sales of merchandise whenever § 471 requires the taxpayer to account for inventories, unless otherwise authorized by the Commissioner under §1.446– 1(c)(2)(ii). Under § 1.446–1(c)(2)(ii), the Commissioner has the authority to permit a taxpayer to use a method of accounting that clearly reflects income even though the method is not specifically authorized by the regulations.

.03 The cash method generally requires an item to be included in income when actually or constructively received and permits a deduction for an expense when paid. § 1.446–1(c)(1)(i).

.04 Section 471 provides that whenever, in the opinion of the Secretary, the use of inventories is necessary to clearly determine the income of the taxpayer, inventories must be taken by the taxpayer. Section 1.471–1 requires a taxpayer to account for inventories when the production, purchase, or sale of merchandise is

January 8, 2001 272 2001–2 I.R.B.

an income-producing factor in the taxpayer’s business.

.05 Section 1.162–3 requires taxpayers carrying materials and supplies (other than incidental materials and supplies) on hand to deduct the cost of materials and supplies only in the amount that they are actually consumed and used in operations during the tax year.

.06 Section 263A generally requires direct costs and an allocable portion of indirect costs of certain property produced or acquired for resale by a taxpayer to be included in inventory costs, in the case of property that is inventory, or to be capitalized, in the case of other property. However, resellers with gross receipts of $10,000,000 or less and producers with $200,000 or less of indirect costs are not required to capitalize costs under § 263A. See §§ 263A(b)(2)(B) and 1.263A– 2(b)(3)(iv). .07 Sections 446(e) and 1.446–1(e) state that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting in accordance with § 446(e).

.08 Section 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account when the taxpayer’s taxable income is computed under a method of accounting different from the method used to compute taxable income for the preceding tax year.

.09 Rev. Proc. 2000–22 is modified in the following respects:

(1) Section 3 is modified to make clear that this revenue procedure does not apply to taxpayers described in § 448(a)(3) (tax shelters).

(2) Section 4.02 is added to clarify the proper time to take into account the cost of inventoriable items ( i.e ., merchandise purchased for resale and raw materials purchased for use in producing finished goods) that are treated as materials and supplies that are not incidental under § 1.162–3;

(3) The conformity requirement of section 5.07 has been removed. Taxpay

ers are reminded that they must comply with the requirements under § 446(a) and the regulations thereunder to maintain adequate books and records, which may include a reconciliation of any differences between such books and records and their return. See § 1.446–1(a)(4);

(4) Section 6.02(1) is modified to provide that qualifying taxpayers using an accrual method of accounting that are not required under § 471 to account for inventories may use the automatic consent provisions of this revenue procedure to change to the cash method;

(5) Section 6.02(2) is modified to provide that qualifying taxpayers (including taxpayers not currently accounting for inventories) may use the automatic consent provisions of this revenue procedure to change to the method of accounting for inventoriable items as materials and supplies that are not incidental under § 1.162–3;

(6) Section 6.03 is added to provide guidance on the computation of the adjustment required under § 481(a) in connection with the automatic changes in method of accounting under this revenue procedure; and

(7) Section 8 is modified in accordance with the removal of the conformity requirement of section 5.07.