SECTION 2. BACKGROUND

.01 Section 446(a) provides that taxable income must be determined under the method of accounting on the basis of which the taxpayer regularly computes income in keeping its 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) of the Income Tax Regulations requires that a taxpayer use an accrual method with regard to purchases and sales of merchandise whenever § 471 requires the taxpayer

2001–52 I.R.B 613 December 26, 2001

use the cash method as described in this revenue procedure for all of its trades or businesses. The ineligible NAICS codes are as follows:

(a) mining activities within the meaning of NAICS codes 211 and 212;

(b) manufacturing within the meaning of NAICS codes 31 - 33;

(c) wholesale trade within the meaning of NAICS code 42;

(d) retail trade within the meaning of NAICS codes 44 - 45; and,

(e) information industries within the meaning of NAICS codes 5111 and 5122.

Information regarding the NAICS codes can be found at www.census.gov. Visitors to the site should select “Subjects A to Z,” followed by “N,” and then should select “NAICS (North America).” Taxpayers also may find a partial list of NAICS codes, described as “Principal Business Activity Codes,” in the instructions to their tax return forms.

(2) A qualifying small business taxpayer may use the cash method as described in this revenue procedure for all of its trades or businesses if its principal business activity is the provision of services, including the provision of property incident to those services. For example, a publisher whose principal business activity is the sale of advertising space in its publications is eligible to use the cash method as described in this revenue procedure, notwithstanding that the taxpayer’s principal business activity is described in an ineligible NAICS code.

(3) A qualifying small business taxpayer may use the cash method as described in this revenue procedure (subject to the potential application of § 460) for all of its trades or businesses if its principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. For purposes of this rule, tangible personal property is not fabricated or modified in accordance with customer design or specifications if the customer merely chooses among pre-selected options ( e.g., size, color, or materials) offered by the taxpayer or if the taxpayer must make only minor modifications to its basic design to meet the customer’s specifications.

(4) Notwithstanding the taxpayer’s principal business activity, a qualifying

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

.07 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 taxable year.

.08 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 are not required to capitalize costs under § 263A and certain producers with $200,000 or less of indirect costs are not required to capitalize certain costs under § 263A. See §§ 263A(b)(2)(B) and 1.263A– 2(b)(3)(iv). .09 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).

.10 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 determined under a method of accounting different from the method used to determine taxable income for the preceding taxable year.