SECTION 4. UNIFORM — Internal Revenue Bulletin 2002-3

CAPITALIZATION (§ 263A)

.01 Certain uniform capitalization (UNICAP) methods used by resellers and reseller-producers .

(1) Description of change and scope .

to use a simplified resale method for both its production and resale activities under § 1.263A–3(a)(4);

(v) a reseller that wants to change its permissible UNICAP method to include a special reseller cost allocation rule; or

(vi) a reseller changing from a non-UNICAP method to a UNICAP method specifically described in the regulations in any taxable year, other than the first taxable year, that it does not qualify as a small reseller.

(b) Scope limitations inapplicable . A taxpayer that wants to make a change described in sections 4.01(1)(a)(i) through 4.01(1)(a)(iv) of this APPENDIX is not subject to the scope limitations in section 4.02 of this revenue procedure. (c) Inapplicability . This change does not apply to a taxpayer making an historic absorption ratio election under §§ 1.263 A–2(b)(4) or 1.263A–3(d)(4), or to a taxpayer that wants to revoke an election to use the historic absorption ratio with the simplified resale method ( see § 1.263A– 3(d)(4)(iii)(B)). (2) Definitions . (a) “Reseller” means a taxpayer that acquires real or personal property described in § 1221(1) for resale.

(b) “Small reseller” means a reseller whose average annual gross receipts for the three immediately preceding taxable years (or fewer, if the taxpayer has not been in existence during the three preceding taxable years) do not exceed $10,000,000. See § 263A(b)(2)(B).

(d) “Producer” means a taxpayer that produces real or tangible personal property.

(e) “Reseller-producer” means a taxpayer that is both a producer and a reseller.

(f) “Permissible UNICAP method” means a method of capitalizing costs that is permissible under § 263A.

(g) “UNICAP method specifically described in the regulations” includes the simplified service cost method using a labor-based allocation ratio (§ 1.263A– 1(h)) and the simplified resale method without an historic absorption ratio election (§ 1.263A–3(d)), but does not

.03 Removal costs .

(1) Description of change . This change applies to a taxpayer that wants to change its method of accounting for certain costs incurred in the retirement and removal of depreciable assets to conform with Rev. Rul. 2000–7 (2000–9 I.R.B. 712). (2) Additional requirements .

(a) Except for assets for which depreciation is determined in accordance with § 1.167(a)–11 (ADR), the taxpayer’s

(a) Applicability . This change 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 nonUNICAP 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);

(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

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(4) Multiple changes . Taxpayers making both this change and another change in method of accounting in the same year of change must comply with the ordering rules of § 1.263A–7(b)(2).

(5) Example . The following example illustrates the principles of section 4.01 of this APPENDIX for small resellers and formerly small resellers.

Assume X, a corporate reseller of personal 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:

include any other reasonable allocation method within the meaning of § 1.263A– 1(f)(4). (h) “Special reseller cost allocation rule” means the 90–10 de minimis rule to allocate a mixed service department’s costs to property acquired for resale (§ 1.263A–1(g)(4)(ii)), the 1/3 - 2/3 rule to allocate labor costs of personnel to purchasing activities (§ 1.263A– 3(c)(3)(ii)(A)), and the 90–10 de minimis rule to allocate a dual-function storage facility’s costs to property acquired for resale (§ 1.263A–3(c)(5)(iii)(C)).

(i) “Permissible non-UNICAP inventory capitalization method” means a method of capitalizing inventory costs that is permissible under § 471.

(3) Section 481(a) adjustment . Beginning with the year of change, a taxpayer changing its method of accounting for costs pursuant to sections 4.01(1)(a)(i), 4.01(1)(a)(iii), or 4.01(1)(a)(iv) of this APPENDIX generally must take any applicable § 481(a) adjustment into account ratably over the same number of taxable years, not to exceed four, that the taxpayer used its former method of accounting. A taxpayer changing its method of accounting for costs pursuant to sections 4.01(1)(a)(ii), 4.01(1)(a)(v), or 4.01(1)(a)(vi) of this APPENDIX generally must taken any applicable § 481(a) adjustment into account ratably over four taxable years. See section 5.04(3) of this revenue procedure for exceptions to this general rule.

Average Annual Gross Receipts for the Three Taxable Years Immediately Preceding 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 an historic absorption ratio election under § 1.263A–3(d)(3) for

2002–3 I.R.B. 356 January 22, 2002

ing inventory because of the $100,000 increment for 1995.

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 end

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

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

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: $1,190,000

Beginning Inventory (With UNICAP costs) 100,000

1996 Increment

Additional § 263A Costs in 1996 Increment 10,000

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

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.

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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

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

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

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 include one-fourth of the § 481(a) adjustment when computing taxable income for each of the four taxable years beginning with 1999. Thus, X must include a $30,000 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.

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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 <30,000> Unamortized 1999 § 481(a) Adjustment—12/31/99 $ 90,000

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 $30,000 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 2000 Increment 10,000

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

hands of the taxpayer), or the first taxable year beginning after August 21, 2000 (in the case of property that is inventory in the hands of the taxpayer), whichever is applicable.

(3) Scope limitations inapplicable . The scope limitations in section 4.02 of this revenue procedure do not apply, provided the taxpayer’s method of accounting for property produced in a farming business is not an issue under consideration within the meaning of section 3.09 of this revenue procedure.

(4) Manner of making change; audit protection .

(a) Non-inventory property . In the case of property that is not inventory in the hands of the taxpayer, the change applies to costs incurred after August 21, 2000, is made on a cut-off basis as described in section 2.06 of this revenue procedure, and is not subject to the audit protection provisions of section 7 of this revenue procedure. However, a taxpayer

.02 Certain uniform capitalization (UNICAP) methods used by producers .

(1) Applicability . This change applies to a producer of real or tangible personal property described in § 1.263A–2 that wants to change to a UNICAP method (or methods) specifically described in the regulations.

(2) Inapplicability . This change does not apply to a producer of real or tangible personal property described in § 1.263A–2 that wants to revoke an election to use the historic absorption ratio with the simplified production method ( see § 1.263A–2(b)(4)(iii)(B)).

(3) Definition . A “UNICAP method specifically described in the regulations” includes the specific identification method (§ 1.263A–1(f)(2)), the burden rate method (§ 1.263A–1(f)(3)), the standard cost method (§ 1.263A–1(f)(3)), the direct reallocation method (§ 1.263A– 1(g)(4)(iii)(A)), the step-allocation method (§ 1.263A–1(g)(4)(iii)(B)), the

simplified service-cost method (§ 1.263A–1(h)), and the simplified production method without the historic absorption ratio election (§ 1.263A–2(b)), but does not include any other reasonable allocation method within the meaning of § 1.263A–1(f)(4).

(4) Multiple changes . Taxpayers making both this change and another change in method of accounting in the same year of change must comply with the ordering rules of § 1.263A–7(b)(2).

.03 Certain uniform capitalization (UNICAP) methods used by taxpayers in a farming business .

(1) Description of change and scope . This change applies to a taxpayer in a farming business that wants to change its method or methods of accounting to comply with § 1.263A–4.

(2) Year of change . This change only applies to the taxpayer’s first taxable year ending after August 21, 2000 (in the case of property that is not inventory in the

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may receive such audit protection for non-inventory property by taking into account any § 481(a) adjustment that results from the change in method of accounting for non-inventory property to comply with § 1.263A–4. A taxpayer that opts to determine a § 481(a) adjustment (and, thus, obtain audit protection) for non-inventory property must take into account only additional section 263A costs incurred after December 31, 1986, in taxable years ending after December 31, 1986. (b) Inventory property . In the case of property that is inventory in the hands of the taxpayer, the change applies to costs incurred after December 31, 1986, in taxable years ending after December 31, 1986, and is made by taking into account an adjustment under § 481(a). Such adjustment must take into account only additional section 263A costs incurred after December 31, 1986, in taxable years ending after December 31, 1986. (5) Multiple changes . Taxpayers making both this change and another change in method of accounting in the same year of change must comply with the ordering rules of § 1.263A–7(b)(2).

.04 Change to no longer capitalize research and experimental expenditures under uniform capitalization (UNICAP)

(1) Description of change and scope . This change applies to a taxpayer who no longer wants to capitalize research and experimental expenditures to inventory under § 263A and the regulations thereunder. A taxpayer making this change must be in compliance with all other aspects of § 263A and the regulations thereunder and must have an effective election under either § 174(a) or § 174(b).

(2) Manner of making the change . A taxpayer must attach to the application the following:

(a) a representation that the § 174 costs the taxpayer proposes not to capitalize to inventory under § 263A and the regulations thereunder are costs that are subject to the taxpayer’s effective election under either § 174(a) or § 174(b) and the regulations thereunder (Indicate which section applies to the taxpayer); and

(b) for the § 174 costs that it proposes to remove from inventory costs, a representation that the taxpayer had identified the § 174 costs as § 174 costs at the

time that the costs were capitalized to inventory under § 263A and the regulations thereunder.

(3) No audit protection . A taxpayer does not receive audit protection under section 7 of this revenue procedure in connection with this change.

SECTION 4A. LOSSES, EXPENSES AND INTEREST WITH RESPECT TO TRANSACTIONS BETWEEN RELATED TAXPAYERS (§ 267)

not subject to the scope limitations in section 4.02 of this revenue procedure.

(2) Section 481(a) adjustment period . A taxpayer must take the § 481(a) adjustment into account ratably over three taxable years.

(3) No audit protection . A taxpayer does not receive audit protection under section 7 of this revenue procedure in connection with this change.

.02 Deferred compensation .

.01 Change to comply with § 267 . This change applies to a taxpayer that wants to change its method or methods of accounting to comply with the requirements of § 267, which disallows or defers certain deductions attributable to transactions between related taxpayers. However, this change applies to a change for stated interest only to the extent the stated interest is qualified stated interest (as defined in § 1.1273–1(c)).

.02 Reserved .

SECTION 4B. DEFERRED COMPENSATION (§ 404)

.01 Change to comply with § 404(a)(11) .

(1) Description of change and scope .

(1) Applicability . This change applies to an accrual method taxpayer that wants to change its method of accounting to treat bonuses or vacation pay as follows (see § 404(a)(5) and § 1.404(b)–1T, Q&A 2): (a) Bonuses .

(i) Bonuses not subject to capitali- zation under § 263A . If by the end of the taxable year all the events have occurred that establish the fact of the liability to pay a bonus and the amount of the liability can be determined with reasonable accuracy (see § 1.446–1(c)(1)(ii)), and the bonus is otherwise deductible, but the bonus is received by the employee after the 15th day of the 3rd calendar month after the end of that taxable year, to treat the bonus as deductible in the taxable year of the employer in which or with which ends the taxable year of the employee in which the bonus is includible in the gross income of the employee; or

(ii) Bonuses that are subject to capitalization under § 263A . If by the end of the taxable year all the events have occurred that establish the fact of the liability to pay a bonus and the amount of the liability can be determined with reasonable accuracy (see § 1.446– 1(c)(1)(ii)), and the bonus is otherwise deductible (without regard to § 263A), but the bonus is received by the employee after the 15th day of the 3rd calendar month after the end of that taxable year, to treat the bonus as capitalizable (within the meaning of § 1.263A–1(c)(3)) in the taxable year of the employer in which or with which ends the taxable year of the employee in which the bonus is includible in the gross income of the employee; or

(a) Applicability . This change applies to a taxpayer required to change its method of accounting for its first taxable year ending after July 22, 1998, to comply with § 404(a)(11). Section 404(a)(11) provides that, for purposes of determining under § 404 whether compensation of an employee is deferred compensation and when deferred compensation is paid, no amount is treated as received by the employee, or paid, until it is actually received by the employee. Section 404(a)(11) overturns the decision in Schmidt Baking Co. v. Commissioner, 107 T.C. 271 (1996), in which the court held that a § 83(a) income inclusion event upon securitization of vacation and severance pay benefits with a letter of credit constitutes receipt of those benefits by employees for purposes of determining whether an employer’s deduction for the benefits is subject to § 404. See Notice 99–16 (1999–1 C.B. 687) (March 29, 1999). (b) Scope limitations inapplicable . A taxpayer changing its method of accounting to comply with § 404(a)(11) is

(i) Vacation pay not subject to capitalization under § 263A . If by the end of the taxable year all the events have occurred that establish the fact of the liability to pay vacation pay and the

(b) Vacation pay .

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(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 method, a taxpayer may adopt the recurring item exception for the year of change if the taxpayer is eligible and follows the procedures of § 1.461–5(d). If the taxpayer is eligible and wants to adopt this method as specified in § 461(h)(3), the amount of the § 481(a) adjustment must

amount of the liability can be determined with reasonable accuracy (see § 1.446– 1(c)(1)(ii)), and the vacation pay is otherwise deductible, but the vacation pay is received by the employee after the 15th day of the 3rd calendar month after the end of that taxable year, to treat the vacation pay as deductible in the taxable year of the employer in which the vacation pay is paid to the employee; or

(ii) Vacation pay that is subject to capitalization under § 263A . If by the end of the taxable year all the events have occurred that establish the fact of the liability to pay vacation pay and the amount of the liability can be determined with reasonable accuracy (see § 1.446– 1(c)(1)(ii)), and the vacation pay is otherwise deductible (without regard to § 263A), but the vacation pay is received by the employee after the 15th day of the 3rd calendar month after the end of that taxable year, to treat the vacation pay as capitalizable (within the meaning of § 1.263A–1(c)(3)) in the taxable year of the employer in which the vacation pay is paid to the employee.

(2) Inapplicability . This change does not apply to the extent that it is also described in section 4B.01 of this APPENDIX. This change also does not apply to a taxpayer that is subject to § 263A and that is required to capitalize the costs with respect to which the taxpayer wants to change its method of accounting if the taxpayer is not capitalizing the costs as required.