254 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

§ 212.40 Use of guidance documents. 

Guidance documents cannot create 

binding requirements that do not 

already exist by statute or regulation. 

Accordingly, non-compliance with 

guidance documents cannot be used as 

a basis for proving violations of 

applicable law. Guidance documents 

can do no more, with respect to 

prohibition of conduct, than articulate 

USAID’s understanding of how a statute 

or regulation applies to particular 

circumstances. 

Ruth Buckley, 

Acting Performance Improvement Officer/ 

Acting Office Director, Bureau for 

Management Office of Management Policy, 

Budget and Operational Performance. 

[FR Doc. 2020–26352 Filed 1–4–21; 8:45 am] 

BILLING CODE P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9942] 

RIN 1545–BP53 

Small Business Taxpayer Exceptions 

Under Sections 263A, 448, 460 and 471 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations to implement legislative 

changes to sections 263A, 448, 460, and 

471 of the Internal Revenue Code (Code) 

that simplify the application of those tax 

accounting provisions for certain 

businesses having average annual gross 

receipts that do not exceed $25,000,000, 

adjusted for inflation. This document 

also contains final regulations regarding 

certain special accounting rules for 

long-term contracts under section 460 to 

implement legislative changes 

applicable to corporate taxpayers. The 

final regulations generally affect 

taxpayers with average annual gross 

receipts of not more than $25 million, 

as adjusted for inflation. 

DATES: 

Effective date: The regulations are 

effective on January 5, 2021. 

Applicability dates: For dates of 

applicability, see §§ 1.263A–1(a)(2)(i), 

1.263A–1(m)(6), 1.263A–2(g)(4), 

1.263A–3(f)(2), 1.263A–4(g)(2), 1.263A– 

7(a)(4)(ii), 1.381(c)(5)–1(f), 1.446–1(c)(3), 

1.448–2(h), 1.448–3(h), 1.460–1(h)(3), 

1.460–3(d), 1.460–4(i), 1.460–6(k), and 

1.471–1(c). 

FOR FURTHER INFORMATION CONTACT: 

Concerning §§ 1.460–1 through 1.460–6, 

Innessa Glazman, (202) 317–7006; 

concerning all other regulations in this 

document, Anna Gleysteen, (202) 317– 

7007. 

SUPPLEMENTARY INFORMATION: 

Background 

This document contains amendments 

to the Income Tax Regulations (26 CFR 

part 1) to implement statutory 

amendments to sections 263A, 448, 460, 

and 471 of the Code made by section 

13102 of Public Law 115–97 (131 Stat. 

2054), commonly referred to as the Tax 

Cuts and Jobs Act (TCJA). These 

statutory amendments generally 

simplify the application of the method 

of accounting rules under those 

provisions to certain businesses (other 

than tax shelters) with average annual 

gross receipts that do not exceed 

$25,000,000, adjusted for inflation. 

The uniform capitalization (UNICAP) 

rules of section 263A provide that, in 

general, the direct costs and the 

properly allocable share of the indirect 

costs of real or tangible personal 

property produced, or real or personal 

property described in section 1221(a)(1) 

acquired for resale, cannot be deducted 

but must either be capitalized into the 

basis of the property or included in 

inventory costs, as applicable. Before 

the enactment of the TCJA, certain types 

of taxpayers and certain types of 

property were exempt from UNICAP, 

but there was no generally applicable 

exemption based on gross receipts. 

Section 448(a) generally prohibits C 

corporations, partnerships with a C 

corporation as a partner, and tax 

shelters from using the cash receipts 

and disbursements method of 

accounting (cash method). However, 

section 448(b)(3) provides that section 

448(a) does not apply to C corporations 

and partnerships with a C corporation 

as a partner that meet the gross receipts 

test of section 448(c). Prior to the TCJA’s 

enactment, a taxpayer met the gross 

receipts test of section 448(c) if, for all 

taxable years preceding the current 

taxable year, the average annual gross 

receipts of the taxpayer (or any 

predecessor) for any 3-taxable-year 

period did not exceed $5 million. 

Section 460(a) provides that income 

from a long-term contract must be 

determined using the percentage-ofcompletion method (PCM). A long-term 

contract is defined in section 460(f) as 

generally any contract for the 

manufacture, building, installation, or 

construction of property if such contract 

is not completed within the taxable year 

in which such contract is entered into. 

Subject to special rules in section 

460(b)(3), section 460(b)(1)(A) generally 

provides that the percentage of 

completion of a long-term contract is 

determined by comparing costs 

allocated to the contract under section 

460(c) and incurred before the close of 

the taxable year with the estimated total 

contract costs. Prior to the TCJA, section 

460(e)(1)(B) provided an exemption 

from the PCM for a long-term 

construction contract of a taxpayer who 

estimated that the contract would be 

completed within the 2-year period 

from the commencement of the contract 

(two-year rule), and whose average 

annual gross receipts for the 3-taxableyear period ending with the year 

preceding the year the contract was 

entered into did not exceed $10 million 

(Section 460(e) gross receipts test). 

Section 471(a) requires inventories to 

be taken by a taxpayer when, in the 

opinion of the Secretary of the Treasury 

or his delegate (Secretary), taking an 

inventory is necessary to determine the 

income of the taxpayer. Section 1.471– 

1 requires the taking of an inventory at 

the beginning and end of each taxable 

year in which the production, purchase, 

or sale of merchandise is an incomeproducing factor. Additionally, when an 

inventory is required to be taken, 

§ 1.446–1(c)(1)(iv) and (c)(2) require that 

an accrual method be used for 

purchases and sales. Prior to the 

enactment of the TCJA, there were no 

regulatory exceptions from the 

requirement to take an inventory under 

§ 1.471–1. 

The statutory amendments of the 

TCJA increase the gross receipts test 

amount under section 448(c) to 

$25,000,000, adjusted for inflation, for 

eligibility to use the cash method and 

also exempt taxpayers, other than a tax 

shelter under section 448(a)(3), meeting 

the gross receipts test (Section 448(c) 

Gross Receipts Test) from: (1) The 

UNICAP rules under section 263A; (2) 

the requirement to use the percentageof-completion method under section 

460 provided other requirements of 

section 460(e) are satisfied; and (3) the 

requirement to take inventories under 

section 471(a) if their inventory is 

treated as non-incidental materials and 

supplies, or if the method of accounting 

for their inventory conforms with the 

method reflected on their applicable 

financial statement (AFS), or if they do 

not have an AFS, their books and 

records prepared in accordance with 

their accounting procedures. These 

amendments generally apply to taxable 

years beginning after December 31, 

2017. The amendments to section 460 

apply to contracts entered into after 

December 31, 2017, in taxable years 

ending after December 31, 2017. 

On August 20, 2018, the Department 

of the Treasury (Treasury Department) 


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and the IRS issued Revenue Procedure 

2018–40 (2018–34 IRB 320), which 

provided administrative procedures for 

a taxpayer, other than a tax shelter 

under section 448(a)(3), meeting the 

requirements of section 448(c) to obtain 

the consent to change the taxpayer’s 

method of accounting to a method of 

accounting permitted by section 263A, 

448, 460 or 471. The revenue procedure 

also requested comments for future 

guidance regarding the implementation 

of the TCJA modifications to sections 

263A, 448, 460, and 471. The record of 

public comments received in response 

to Revenue Procedure 2018–40 may be 

requested by sending an email to 

Notice.Comments@irs.gov. 

On August 5, 2020, the Treasury 

Department and the IRS published a 

notice of proposed rulemaking (REG– 

132766–18) in the Federal Register (85 

FR 47608), correction published in the 

Federal Register (85 FR 58307) on 

September 18, 2020, containing 

proposed regulations under sections 

263A, 448, 460, and 471 (proposed 

regulations). The proposed regulations 

reflect consideration of the comments 

that were received in response to 

Revenue Procedure 2018–40. 

The Treasury Department and the IRS 

received nine written comments 

responding to the proposed regulations. 

The Treasury Department and the IRS 

received one request to speak at a public 

hearing, which was later withdrawn. 

Therefore, no public hearing was held. 

Comments received before these final 

regulations were substantially 

developed, including all comments 

received on or before the deadline for 

comments on September 14, 2020, were 

carefully considered in developing these 

final regulations. 

Copies of the comments received are 

available for public inspection at http:// 

www.regulations.gov or upon request. 

After consideration of the comments 

received, this Treasury decision adopts 

the proposed regulations as revised in 

response to such comments. Those 

comments and the revisions are 

discussed in the Summary of Comments 

and Explanation of Revisions section of 

this preamble. 

Summary of Comments and 

Explanation of Revisions 

I. Overview 

This Summary of Comments and 

Explanation of Revisions section 

summarizes the formal written 

comments that were received addressing 

the proposed regulations. However, 

comments merely summarizing or 

interpreting the proposed regulations or 

recommending statutory revisions 

generally are not discussed in this 

preamble. These final regulations 

provide guidance under sections 263A, 

448, 460, and 471 to implement the 

TCJA’s amendments to those provisions. 

These final regulations also modify 

§§ 1.381(c)(5)–1 and 1.446–1 to reflect 

these statutory amendments. The 

rationale for provisions in these final 

regulations that are not discussed in this 

Explanation of Revisions remains the 

same as described in the Explanation of 

Provisions section of the preamble to 

the proposed regulations. 

A. Section 263A(i) 

1. Costing Rules for Self-Constructed 

Assets 

In response to Revenue Procedure 

2018–40, a commenter stated that a 

small business taxpayer that is 

exempted from section 263A pursuant 

to section 263A(i) would be subject to 

the costing rules prior to the enactment 

of section 263A (pre-section 263A 

costing rules) for self-constructed assets 

used in the taxpayer’s trade or business. 

However, according to the commenter, 

the pre-section 263A costing rules were 

unclear as to what costs are 

capitalizable to self-constructed assets. 

In light of this comment, the preamble 

to the proposed regulations requested 

comments on specific clarifications 

needed regarding the pre-section 263A 

costing rules. Only one comment was 

received in response to this request. The 

sole commenter noted that one of the 

reasons for the enactment of section 

263A was that courts had reached 

different conclusions as to the types of 

costs that were required to be 

capitalized under the pre-section 263A 

costing rules. Compare Adolph Coors 

Co. v. Commissioner, 519 F.2d 1280 

(10th Cir. 1975), cert. denied 423 U.S. 

1087 (1976) (requiring the full inclusion 

of all overhead costs in the cost basis of 

self-constructed assets) with Fort 

Howard Paper Co. v. Commissioner, 49 

T.C. 275 (1967) (requiring only the 

inclusion of overhead costs directly 

attributable to the self-constructed 

asset). The commenter suggested that 

taxpayers who used the exemption 

under section 263A(i) to not capitalize 

costs under section 263A be permitted 

to use an incremental costing method to 

determine the costs of self-constructed 

assets, consistent with the approach in 

Fort Howard Paper. The commenter 

stated that identifying indirect costs not 

directly attributable to the construction 

of specific self-constructed assets would 

be difficult. 

After considering this comment, the 

Treasury Department and the IRS have 

determined that the requested 

clarification is beyond the scope of 

these regulations, which is to 

implement section 263A(i) as enacted 

by TCJA. For taxpayers that elect under 

section 263A(i) to not apply section 

263A, the requirement to capitalize 

certain costs to self-constructed assets 

comes from other provisions of the 

Code, such as section 263(a). TCJA did 

not amend such provisions and thus the 

clarification of permissible 

capitalization methods and the types of 

costs required to be capitalized to selfconstructed assets under such 

provisions is beyond the scope of these 

final regulations. 

2. Changes to Regulations Under Section 

448 

Under section 448(a)(3), a tax shelter 

is prohibited from using the cash 

method. Section 448(d)(3) cross 

references section 461(i)(3) to define the 

term ‘‘tax shelter.’’ Section 461(i)(3)(B), 

in turn, includes a cross reference to the 

definition of ‘‘syndicate’’ in section 

1256(e)(3)(B), which defines a syndicate 

as a partnership or other entity (other 

than a C corporation) if more than 35 

percent of the losses of that entity 

during the taxable year are allocable to 

limited partners or limited 

entrepreneurs. Sections 1.448–1T(b)(3) 

(for taxable years beginning before 

January 1, 2018) and proposed 1.448– 

2(b)(2)(iii) (for taxable years beginning 

after December 31, 2017) narrow this 

definition by providing that a taxpayer 

is a syndicate only if more than 35 

percent of its losses are allocated to 

limited partners or limited 

entrepreneurs. Consequently, a 

partnership or other entity (other than a 

C corporation) may be considered a 

syndicate under section 448 only for a 

taxable year in which it has losses. 

Proposed § 1.448–2(b)(2)(iii)(B) 

permits a taxpayer to elect to use the 

allocated taxable income or loss of the 

immediately preceding taxable year to 

determine whether the taxpayer is a 

syndicate under section 448(d)(3) for the 

current taxable year. Under the 

proposed regulations, a taxpayer that 

makes this election must apply the rule 

to all subsequent taxable years, and for 

all purposes for which status as a tax 

shelter under section 448(d)(3) is 

relevant, unless the Commissioner 

permits a revocation of the election. 

Several comments were received 

concerning issues related to tax shelters, 

including the definition of ‘‘syndicate,’’ 

under proposed § 1.448–2(b)(2)(i)(B). 

Some commenters recommend using the 

authority granted under section 

1256(e)(3)(C)(v) to provide a deemed 

active participation rule to disregard 

certain interests held by limited 


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256 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

entrepreneurs or limited partners for 

applying the Section 448(c) Gross 

Receipts Test if certain conditions were 

met. For example, conditions of the rule 

could include that the entity had not 

been classified as a syndicate within the 

last three taxable years, and that the 

average taxable income of the entity for 

that period was greater than zero. 

The final regulations do not adopt this 

recommendation. The Treasury 

Department and the IRS have 

determined that it would be 

inappropriate to provide an exception to 

the active participation rules in section 

1256(e)(3)(C)(v) by ‘‘deeming’’ active 

participation for small business 

taxpayers. The Treasury Department 

and the IRS believe that the deeming of 

active participation in this context 

would be overbroad and would run 

counter to Congressional intent. 

Sections 448(b)(3) and (d)(3), 461(i)(3) 

and 1256(e)(3)(C) were not modified by 

the TCJA, and the legislative history to 

section 13012 of the TCJA does not 

indicate any Congressional intent to 

modify the definition of ‘‘tax shelter’’ or 

‘‘syndicate.’’ By not modifying those 

provisions, Congress presumably meant 

to exclude tax shelters, including 

syndicates, from being eligible to use 

the cash method of accounting and the 

small business taxpayer exemptions in 

section 13102 of the TCJA, even while 

otherwise expanding eligibility to meet 

the Section 448(c) Gross Receipts Test. 

Other comments requested 

clarification generally of what ‘‘active 

participation’’ means and the 

circumstances, if any, under which a 

member of a limited liability company 

is treated as a ‘‘limited partner’’ or 

‘‘limited entrepreneur’’ under section 

461(k)(4). The Treasury Department and 

the IRS have determined that such 

guidance is outside the scope of these 

final regulations, which are to 

implement the changes made by section 

13102 of the TCJA. 

The Treasury Department and the IRS 

remain aware of the increased relevance 

of the definition of tax shelter under 

section 448(d)(3) after enactment of the 

TCJA and the practical concerns 

regarding the determination of tax 

shelter status for the taxable year. To 

ameliorate these practical concerns, 

these final regulations modify the 

syndicate election provided in proposed 

§ 1.448–2(b)(2)(iii)(B) to provide 

additional relief by making the election 

an annual election. The Treasury 

Department and the IRS have 

determined that an annual election 

appropriately balances the statutory 

language with the consistency 

requirement for use of a method of 

accounting under section 446(a) and 

§ 1.446–1. A cash method taxpayer that 

is generally profitable year-to-year may 

experience an unforeseen taxable loss 

for an anomalous year but return to its 

profitable position in subsequent years. 

If the taxpayer allocated more than 35 

percent of the taxable loss to limited 

partners or limited entrepreneurs, the 

taxpayer would be required to change 

from the cash method to another 

method for the anomalous year in 

accordance with section 448(a)(3). 

However, that taxpayer would otherwise 

not be prohibited under section 

448(a)(3) to use the cash method in the 

next profitable taxable year. An annual 

election under § 1.448–2(b)(2)(iii)(B) 

allows a taxpayer to elect in the loss 

year to use the allocated taxable income 

or loss of the immediately preceding 

taxable year to determine whether the 

taxpayer is a syndicate under section 

448(d)(3) for the current taxable year. 

The Treasury Department and the IRS 

have determined that permitting 

taxpayers to continue to use the cash 

method, as well as other methods 

impacted by a determination under 

section 448(d)(3), in such situations is 

consistent with the requirements under 

section 446(a). 

This election applies for all 

provisions of the Code that specifically 

refer to section 448(a)(3) to define tax 

shelter, such as the small business 

exemptions under sections 163(j)(3), 

263A(i)(1), 460(e)(1)(B) and 471(c)(1). A 

taxpayer is required to file a statement 

with the original timely filed Federal 

income tax return, with extensions, to 

affirmatively make this election under 

§ 1.448–2(b)(2)(iii)(B) for such taxable 

year. The election is valid only for the 

taxable year for which it is made, and 

once made, cannot be revoked. The 

Treasury Department and the IRS intend 

to issue procedural guidance to address 

the revocation of an election made 

under proposed § 1.448–2(b)(2)(iii)(B) as 

a result of the application of the final 

regulations. 

Other commenters noted for some 

taxpayers who took advantage of the 

small business exception in section 

448(b)(3) to change to the cash method, 

the change in method of accounting 

resulted in a negative section 481(a) 

adjustment, which triggered an 

allocated loss and made the taxpayer a 

tax shelter under section 448(a)(3). As a 

result, the taxpayers became ineligible 

to use the cash method for the year in 

which the negative section 481(a) 

adjustment was recognized but may be 

otherwise eligible to use the cash 

method for future years. Under 

proposed § 1.448–2(g)(3), these 

taxpayers would be ineligible for the 

automatic change procedures to make a 

subsequent change back to the cash 

method once they are no longer tax 

shelters within a five-year period. The 

commenters recommend relief for 

taxpayers with this situation. 

The commenters propose an 

exception to the tax shelter rules for a 

taxpayer that satisfies the Section 448 

Gross Receipts Test if a negative section 

481(a) adjustment from a change in 

method of accounting under the small 

business taxpayer exemptions (for 

example, sections 263A(i), 471(c), 

448(b)) results in the taxpayer being 

considered a tax shelter under section 

448(d)(3) and proposed § 1.448– 

2(b)(2)(iii). These final regulations do 

not adopt this suggestion. As described 

in the Preamble to the proposed 

regulations, the Treasury Department 

and the IRS have determined that no 

exception was provided in the TCJA to 

limit the definition of tax shelter in 

section 448(d)(3) for taxpayers making 

method changes related to the small 

business taxpayer exemptions. 

However, the Treasury Department and 

the IRS expect that the annual election 

under § 1.448–2(b)(2)(iii)(B), described 

earlier, will provide relief for many 

taxpayers in this situation. 

Additionally, the Treasury 

Department and the IRS have 

reconsidered the 5-year restriction on 

automatic method changes in light of 

these comments. Section 446(a), 

unmodified by the TCJA, provides that 

taxable income shall be computed under 

the method of accounting on the basis 

of which the taxpayer regularly 

computes his income in keeping his 

books. A taxpayer that changes its 

method of accounting for the same item 

with regular frequency (for example, 

annually or every other taxable year) is 

not adhering to the consistency 

requirement of section 446. The 

consistency requirement of section 

446(a) is distinct from the authority 

granted the Commissioner under section 

446(b) to determine whether the method 

of accounting used by a taxpayer clearly 

reflects income. See e.g., Advertisers 

Exchange, Inc. v. Commissioner, 25 T.C. 

1086, 1092 (1956) (‘‘Consistency is the 

key and is required regardless of the 

method or system of accounting used.’’) 

(citations omitted); Huntington 

Securities Corporation v. Busey, 112 

F.2d 368, 370 (1940) (‘‘. . . whatever 

method the taxpayer adopts must be 

consistent from year to year unless the 

Commissioner authorizes a change.’’) 

The Treasury Department and the IRS 

are aware that the 5-year restriction in 

proposed § 1.448–2(g)(3) could be 

burdensome for a small business 

taxpayer that was required to change 

from the cash method as a result of 


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section 448(a)(3) or not meeting the 

Section 448 Gross Receipts Test in a 

taxable year but that becomes eligible to 

use the cash method under section 448 

in the subsequent taxable year. 

Proposed § 1.448–2(g)(3) would have 

required this small business taxpayer to 

request consent to change back to the 

cash method using the non-automatic 

change procedures in Revenue 

Procedure 2015–13 (or successor). These 

final regulations remove the 5-year 

restriction on making automatic method 

changes for certain situations. 

Sections 263A(i)(3), 448(d)(7), 

460(e)(2)(B) and 471(c)(4) provide that 

certain changes in method of accounting 

for the small business exemptions are 

made with the consent of the Secretary. 

A taxpayer must follow the applicable 

administrative procedures related to a 

change in method of accounting 

notwithstanding the deemed consent of 

the Secretary. See, e.g., Capital One 

Financial Corporation and Subsidiaries 

v. Commissioner of Internal Revenue, 

130 T.C. 147, 157 (2008) (‘‘a taxpayer 

forced to change its method of 

accounting under section 448 must still 

file a Form 3115 with its return’’). The 

Treasury Department and the IRS intend 

to provide procedural rules relating to 

changes in method of accounting to 

implement the final regulations using 

the automatic method change 

procedures of Revenue Procedure 2015– 

13. Those procedural rules will address 

whether a waiver of the 5-year overall 

method eligibility rule in section 

5.01(1)(e) of Revenue Procedure 2015– 

13 is appropriate for small business 

taxpayers that were required to change 

from the cash method in one taxable 

year but are not subsequently limited by 

section 448. 

The Treasury Department and the IRS 

have determined that taxpayers that are 

voluntarily changing (that is, not 

required by section 448 to no longer use 

the cash method) between overall 

methods are distinguishable from 

taxpayers that are required to change 

from the cash method to another 

method because they no longer meet the 

Section 448(c) Gross Receipts Test or 

become a tax shelter under section 

448(d)(3). The procedural guidance is 

expected to address both fact patterns. 

Additionally, the Treasury Department 

and the IRS intend for the procedural 

guidance to address similar fact patterns 

for taxpayers making changes related to 

the regulations under sections 263A(i), 

460(e)(1)(B) and 471(c), as discussed in 

this Summary of Comments and 

Explanation of Revisions. 

3. Section 471 Small Business 

Taxpayer Exemptions 

A. Inventory Treated as Non-Incidental 

Materials and Supplies 

The preamble to the proposed 

regulations notes that the Treasury 

Department and the IRS interpret the 

statutory language of section 

471(c)(1)(B) to mean that the property 

excepted from section 471(a) by that 

provision continues to be inventory 

property even though the general 

inventory rules under section 471(a) are 

not required to be applied to that 

property. Section 471(c)(1)(B) provides 

that a qualifying taxpayer’s ‘‘method of 

accounting for inventory for such 

taxable year’’ (emphasis added) will not 

be treated as failing to clearly reflect 

income if the method ‘‘treats inventory 

as non-incidental materials and 

supplies’’ (emphasis added). The 

Treasury Department and the IRS read 

the repeated use of the word 

‘‘inventory’’ to mean that Congress 

intended that inventory property 

remains inventory property while 

relieving taxpayers from the general 

inventory rules of section 471(a). To 

reduce confusion about the nature of 

property treated as non-incidental 

materials and supplies under section 

471(c)(1)(B)(i), these final regulations 

refer to the method under that provision 

of the Code as the ‘‘section 471(c) NIMS 

inventory method.’’ 

The Treasury Department and the IRS 

interpret section 471(c)(1)(B)(i) as 

providing three distinct benefits for 

taxpayers. First, the provision 

significantly expanded the types of 

taxpayers permitted to treat their 

inventory as non-incidental materials 

and supplies. Under prior 

administrative guidance, as discussed 

later in section 3.A.i of this Summary of 

Comments and Explanation of 

Revisions, taxpayers with gross receipts 

of no more than $1 million and 

taxpayers in certain industries 

(generally not producers or resellers) 

with gross receipts of no more than $10 

million were permitted to treat their 

inventory as non-incidental materials 

and supplies. Section 471(c) greatly 

expanded the availability of this method 

of accounting to taxpayers in all types 

of trades or businesses, including 

producers and resellers, by reference to 

the increased cap on gross receipts 

under the Section 448(c) Gross Receipts 

Test. Second, treating inventory as nonincidental materials and supplies under 

§ 1.471–1(b)(5) provides simplification 

and burden reduction for taxpayers by 

requiring only certain costs to be 

capitalized to inventory. For example, a 

taxpayer using the section 471(c) NIMS 

inventory method does not capitalize 

direct labor costs or any indirect costs 

to inventory costs. See discussion of 

direct labor costs later in section 3.A.iii 

of this Summary of Comments and 

Explanation of Revisions. Simplification 

does not indicate that the nature of the 

property was changed by the TCJA, or 

that the intent of Congress was to 

provide immediate expensing of 

inventory costs. Thirdly, taxpayers, 

other than a tax shelter under section 

448(a)(3), treating inventory as nonincidental materials and supplies under 

§ 1.471–1(b)(5) are eligible to use the 

overall cash method of accounting for 

purchases and sales of merchandise, 

rather than being required to use an 

accrual method. See § 1.446–1(a)(4)(i). 

i. Definition of the Term ‘‘Used or 

Consumed’’ 

The preamble to the proposed 

regulations provides that the Treasury 

Department and IRS interpret section 

471(c)(1)(B)(i) as generally codifying the 

administrative guidance existing at the 

time of its enactment (that is, Revenue 

Procedure 2001–10 (2001–2 IRB 272) 

and Revenue Procedure 2002–28 (2002– 

18 IRB 815)) and making that method 

available to significantly more 

taxpayers. Accordingly, the proposed 

regulations provided that items of 

inventory treated as materials and 

supplies under section 471(c) are used 

or consumed in the taxable year in 

which the taxpayer provides the item to 

a customer, and the cost of such item is 

recovered in that taxable year or the 

taxable year in which the taxpayer pays 

for or incurs such cost, whichever is 

later. 

Comments were received on the 

definition of ‘‘used or consumed’’ in 

proposed § 1.471–1(b)(4)(i) as it relates 

to producers. A commenter asserted that 

the meaning of the term ‘‘used or 

consumed’’ for a producer using the 

section 471(c) NIMS inventory supplies 

method should be consistent with the 

meaning of the term ‘‘used or 

consumed’’ in § 1.162–3. The 

commenter states that a producer’s raw 

materials are ‘‘used or consumed’’ when 

the raw materials enter the taxpayer’s 

production process. The commenter 

states that under section 471(c)(1)(B)(i) 

and § 1.162–3(a)(1), only section 263A 

would limit a producer’s ability to 

recover the cost of its raw materials 

when the raw materials are first used in 

the production process, and the final 

regulations should be modified to 

provide that a producer does not wait 

until the finished product is provided to 

a customer to recover the costs of its raw 

materials. In addition, the commenter 

states that the policy considerations 


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258 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

underlying this provision were to 

provide small business taxpayers with 

simplification, and the definition of 

‘‘used or consumed’’ for producers in 

proposed § 1.471–1(b)(4)(i) does not 

result in simplification. 

The Treasury Department and IRS 

decline to change the definition of used 

or consumed for a producer in these 

final regulations. As discussed 

previously, the Treasury Department 

and the IRS interpret section 

471(c)(1)(B)(i) as generally codifying the 

administrative guidance existing at the 

time of enactment of TCJA (that is, 

Revenue Procedure 2001–10 and 

Revenue Procedure 2002–28) and 

making it applicable to significantly 

more taxpayers, in addition to the other 

benefits discussed in section 3.A of this 

Summary of Comments and Explanation 

of Revisions. The commenter’s 

recommendation that the term ‘‘used or 

consumed’’ for a producer should be 

treated as occurring when the raw 

material is used or consumed in the 

taxpayer’s production process would 

allow a producer to recover production 

costs earlier than was previously 

allowed under the administrative 

guidance of Revenue Procedure 2001–10 

and Revenue Procedure 2002–28. 

Additionally, the commenter’s 

recommendation suggests that the term 

‘‘used or consumed’’ should be 

interpreted literally by looking to actual 

use or consumption by the taxpayer. 

However, under such an interpretation 

a reseller, unlike a producer, would not 

be able to recover any inventory costs as 

a reseller does not acquire raw materials 

for use in a production process nor does 

it use or consume finished inventory; 

rather a reseller acquires and resells 

finished inventory, unchanged, to 

customers. The Treasury Department 

and the IRS have determined that the 

statute and legislative history do not 

support a reading of the provision that 

would provide such a disparity in the 

recovery of inventory costs between 

producers and resellers. 

In addition, the commenter’s 

argument interprets the words 

‘‘inventory treated as non-incidental 

materials and supplies’’ to mean that the 

components used to produce the 

finished goods inventory, rather than 

the finished goods inventory itself, are 

treated as materials and supplies. The 

interpretation advocated by the 

commenter would result in producers 

being permitted to recover the cost 

inputs of their units of inventory in the 

same manner as they recover the costs 

of their materials and supplies (that is, 

when the cost input is used or 

consumed in producing the unit of 

inventory). The Treasury Department 

and the IRS do not believe Congress 

intended to break down the traditional 

definition of the word ‘‘inventory,’’ 

particularly since that position benefits 

only a certain group of taxpayers 

(producers). The Treasury Department 

and the IRS determined that the 

definition for used or consumed should 

provide an equitable rule for the timing 

of the recovery of the inventory between 

producers and resellers. Accordingly, 

these final regulations adopt the 

proposed regulations without change. 

ii. De Minimis Safe Harbor Under 

§ 1.263(a)–1(f) 

Several comments were received 

regarding the applicability of the de 

minimis safe harbor under § 1.263(a)– 

1(f) (de minimis safe harbor) to 

inventory treated as non-incidental 

materials and supplies. The commenters 

assert that the final regulations should 

permit a taxpayer that uses the section 

471(c) NIMS inventory method to use 

the de minimis safe harbor for its 

inventory treated as non-incidental 

materials and supplies. The commenters 

point to footnote 465 of the Bluebook, 

which described the law, both before 

and after TCJA, as generally permitting 

deduction of the cost of non-incidental 

materials and supplies in the taxable 

year in which they are first used or are 

consumed in the taxpayer’s operations 

in accordance with § 1.162–3(a)(1). 

Furthermore, under § 1.162–3(a)(1), a 

taxpayer may also be able to elect to 

deduct such non-incidental materials 

and supplies in the taxable year the 

amount is paid under the de minimis 

safe harbor election under § 1.263(a)– 

1(f). General Explanation of Public Law 

115–97, at 113 fn. 465. 

The Treasury Department and the IRS 

were aware of footnote 465 in the 

Bluebook when drafting the proposed 

regulations, but have a different 

understanding of the rule for ‘‘inventory 

treated as non-incidental materials and 

supplies’’ under Section 471(c)(1)(B)(i) 

as explained in section 3.A.i of this 

Summary of Comments and Explanation 

of Revisions. The Treasury Department 

and the IRS interpret section 

471(c)(1)(B)(i) as generally codifying the 

administrative procedures that 

established the non-incidental materials 

and supplies method for inventoriable 

items, and prior pronouncements of 

§§ 1.162–3 and 1.263(a)–1(f) that these 

regulations do not apply to inventory 

property, including inventory property 

treated as non-incidental materials and 

supplies. See, e.g., Tangible Property 

Regulations—Frequently Asked 

Questions, available at https://

www.irs.gov/businesses/smallbusinesses-self-employed/tangibleproperty-final-regulations#Ademinimis. 

A commenter states that the de 

minimis safe harbor was created after 

Revenue Procedure 2001–10 and 

Revenue Procedure 2002–28 were 

released, and therefore, did not address 

the issue of the applicability of the de 

minimis safe harbor. The Treasury 

Department and the IRS agree with the 

timeline described by the commenter. 

However, as discussed in the 

immediately preceding paragraph, the 

IRS’ position on the de minimis safe 

harbor has been addressed in a prior 

pronouncement. As described 

previously in section 3.A of this 

Summary of Comments and Explanation 

of Revisions, inventory treated as nonincidental materials and supplies 

retains its character as inventory 

property. The de minimis safe harbor, 

which is a regulatory election rather 

than a statutory one, does not apply to 

inventory. Section 1.263(a)–1(f)(2)(i). 

Finally, the Treasury Department and 

the IRS note that for amounts paid to 

qualify for the de minimis safe harbor, 

the amounts must have been expensed 

on the taxpayer’s applicable financial 

statement or books and records, as 

applicable. Sections 1.263(a)– 

1(f)(1)(i)(B) and (ii)(B). This applicable 

financial statement or books and records 

expensing requirement under 

§ 1.263(a)–1(f) would be an impediment 

to the application of the de minimis safe 

harbor under the section 471(c) NIMS 

inventory method for taxpayers who 

maintain records of their inventory in 

their applicable financial statement or 

books and records, even if the section 

471(c) NIMS inventory method 

permitted the use of the de minimis safe 

harbor method. In addition, there is no 

need for the separate de minimis safe 

harbor because small business taxpayers 

may use the inventory method provided 

in section 471(c)(1)(B) which generally 

provides that a taxpayer who expenses 

inventory costs in its applicable 

financial statement or books and records 

may generally expense that cost for 

Federal income tax purposes. For 

example, a small business taxpayer that 

expenses the cost of ‘‘freight-in’’ in its 

books and records and wants to expense 

the item for Federal income tax 

purposes may generally do so using the 

non-AFS section 471(c) inventory 

method, as permitted by section 

471(c)(1)(B)(ii) and discussed later in 

section 3.C.ii of this Summary of 

Comments and Explanation of 

Revisions. 

iii. Direct Labor 

Proposed § 1.471–1(b)(4)(ii) provides 

that inventory costs includible in the 


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section 471(c) NIMS inventory method 

are the direct costs of the property 

produced or property acquired for 

resale. However, an inventory cost does 

not include a cost for which a deduction 

would be disallowed or that is not 

otherwise recoverable, in whole or in 

part, but for § 1.471–1(b)(4), under 

another provision of the Code. 

Some comments were received on the 

types of direct costs required to be 

included as an inventory cost under the 

section 471(c) NIMS inventory method. 

These commenters recommended the 

final regulations exclude direct labor 

costs from the definition of an inventory 

cost under proposed § 1.471–1(b)(4)(ii). 

The commenters reasoned that the 

preamble to the proposed regulation 

indicated that section 471(c)(1)(B)(i) was 

generally a codification of Revenue 

Procedure 2001–10 and Revenue 

Procedure 2002–28. However, the 

commenters point out that this 

administrative guidance did not provide 

for direct labor or overhead costs to be 

included in the non-incidental materials 

and supplies method. 

One commenter asserted that 

inventory treated as non-incidental 

materials and supplies are not inventory 

property but are to be characterized as 

a material and supply. The commenter 

discussed Example 1, in Section III.D of 

Notice 88–86 (1988–2 CB 401) to 

determine the treatment of nonincidental materials and supplies prior 

to the enactment of section 263A. 

Example 1 involves an architect 

providing design services that include 

blueprints and drawings and deals with 

the provision of de minimis amounts of 

property by a service provider. This 

commenter cites to Notice 88–86 to 

provide, by analogy, that inventory 

treated as non-incidental materials and 

supplies under section 471(c)(1)(B)(i) 

should not include direct labor costs. 

The Treasury Department and the IRS 

disagree with the application by analogy 

to Example 1 in Section III.D of Notice 

88–86. That example illustrates that an 

individual providing services, such as 

an architect, is not a producer despite 

providing a de minimis amount of 

property to the client as part of the 

provision of services. As discussed in 

section 3.A of this Summary of 

Comments and Explanation of 

Revisions, the Treasury Department and 

the IRS believe that inventory property 

treated as non-incidental materials and 

supplies retains its character as 

inventory property, and so Example 1 is 

inapposite. 

The Treasury Department and the IRS 

acknowledge that there was uncertainty 

under Revenue Procedure 2001–10 and 

Revenue Procedure 2002–28 as to 

whether direct labor and overhead costs 

were required to be capitalized under 

the non-incidental materials and 

supplies method permitted by those 

revenue procedures. The Treasury 

Department and the IRS are also aware 

that tracking of direct labor costs may be 

burdensome, and in some cases, 

difficult to do for many small 

businesses. The Treasury Department 

and the IRS agree with the commenters’ 

request that direct labor costs be 

excluded from the inventory costs 

required to be included in inventory 

treated as non-incidental materials and 

supplies. As a result, these final 

regulations provide that inventory costs 

includible in the section 471(c) NIMS 

inventory method are direct material 

costs of the property produced or the 

costs of property acquired for resale. 

B. Treatment of Inventory by Taxpayers 

With an Applicable Financial Statement 

(AFS) 

Under proposed § 1.471–1(b)(5), a 

taxpayer other than a tax shelter, that 

has an AFS and that meets the Section 

448(c) Gross Receipts Test is not 

required to take an inventory under 

section 471(a), and may choose to treat 

its inventory as reflected in its AFS. 

Proposed § 1.471–1(b)(5)(ii) defines AFS 

by reference to section 451(b)(3) and the 

accompanying regulations, which 

included the additional AFS rules 

provided in proposed § 1.451–3(h). 

In section 4.C.i of the preamble to the 

proposed regulations, the Treasury 

Department and the IRS requested 

comments on a proposed consistency 

rule for a taxpayer with an AFS that has 

a financial accounting year that differs 

from the taxpayer’s taxable year, and on 

other issues related to the application of 

proposed § 1.451–3(h) to the AFS 

section 471(c) inventory method. The 

Treasury Department and the IRS 

proposed to require a taxpayer with an 

AFS that uses the AFS section 471(c) 

inventory method to consistently apply 

the same mismatched reportable period 

method of accounting provided in 

proposed § 1.451–3(h)(4) for its AFS 

section 471(c) inventory method of 

accounting that is used for section 451 

purposes. No comments were received 

on the consistency rule or other issues 

related to the application of proposed 

§ 1.451–3(h) to the AFS section 471(c) 

inventory method. 

These final regulations adopt this 

consistency rule. The Treasury 

Department and the IRS have 

determined that a taxpayer using an 

accrual method with an AFS that has a 

mismatched reporting period with its 

taxable year should apply the same 

mismatched reportable period method 

of accounting for revenue recognition 

purposes and inventory purposes 

because there is better matching of 

income and cost of goods sold by 

applying the same reportable period 

method. 

C. Treatment of Inventory by Taxpayers 

Without an AFS 

Under proposed § 1.471–1(b)(6), a 

taxpayer, other than a tax shelter, that 

does not have an AFS and that meets 

the Section 448(c) Gross Receipts Test is 

not required to take an inventory under 

section 471(a), and may choose to use 

the non-AFS section 471(c) inventory 

method to account for its inventory. The 

non-AFS section 471(c) inventory 

method is the method of accounting for 

inventory reflected in the taxpayer’s 

books and records that are prepared in 

accordance with the taxpayer’s 

accounting procedures and that 

properly reflect the taxpayer’s business 

activities for non-tax purposes. For 

example, a books and records method 

that determines ending inventory and 

cost of goods sold that properly reflects 

the taxpayer’s business activities for 

non-Federal income tax purposes is to 

be used under the taxpayer’s non-AFS 

section 471(c) inventory method. 

(i) Definition of Books and Records 

Some comments were received on the 

non-AFS section 471(c) inventory 

method and the standard used in 

proposed § 1.471–1(b)(6) for ‘‘books and 

records.’’ One commenter reasoned that 

the purpose of section 471(c)(1)(B)(ii) 

was to provide simplification, and the 

reliance on the definition of books and 

records used in case law is too complex, 

creates audit risks, and uncertainties as 

to what books and records means. The 

commenter recommended using a 

standard in which ‘‘books and records’’ 

is a flexible term and something the 

taxpayer and his accounting 

professional can agree on that is 

consistent from year to year. For 

example, the commenter suggests that 

any financial statement reporting of 

inventory that is consistently applied be 

acceptable as books and records. 

Some comments discuss the issue of 

work papers and physical counts of 

inventory, and whether either should be 

used if a taxpayer is expensing these 

items for books and records purposes. 

The commenters asserted that even 

though a taxpayer takes a physical count 

of inventory, the taxpayer should be 

allowed to expense the inventory for 

Federal income tax purposes if the 

inventory is expensed on its books and 

records. 

The Treasury Department and the IRS 

decline to change the definition of the 


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260 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

term ‘‘books and records’’ in these final 

regulations, and the rules continue to 

generally include both work papers and 

physical counts of inventory. The term 

books and records is used elsewhere in 

the Code and regulations, and there is 

no indication in the statute or legislative 

history to section 471(c)(1)(B)(ii) that a 

different definition is intended from the 

general usage of this term used 

elsewhere in the Code. Consequently, 

these final regulations use the wellestablished definition of books and 

records of a taxpayer, which includes 

the totality of the taxpayer’s documents 

and electronically-stored data. See, for 

example, United States v. Euge, 444 

U.S. 707 (1980). See also Digby v. 

Commissioner, 103 T.C. 441 (1994), and 

§ 1.6001–1(a). 

Certain commenters requested that 

the final regulations provide additional 

clarification on the significance of the 

taking of a physical count of inventory 

under the non-AFS section 471(c) 

inventory method. For example, 

commenters requested that Example 1 

in proposed § 1.471–1(b)(6)(iii) be 

modified to provide that the physical 

count is ignored if the taxpayer does not 

provide inventory information to a 

creditor. These final regulations provide 

additional examples, including 

variations on Example 1, to clarify the 

relevance of a physical count of 

inventory under the non-AFS section 

471(c) inventory method. For example, 

a taxpayer that takes a physical count of 

inventory for reordering purposes but 

does not allocate cost to such inventory 

is not required to use the physical count 

for the non-AFS section 471(c) 

inventory method, regardless of whether 

the information is otherwise used for an 

internal report purpose or provided to 

an external third party, such as a 

creditor. Alternatively, a taxpayer that 

takes an end-of-year physical count and 

uses this information in its accounting 

procedures to allocate costs to inventory 

is required to use this inventory 

information for the non-AFS section 

471(c) inventory method regardless of 

whether the taxpayer makes reconciling 

entries to expense these costs in its 

financial statements. Thus, the 

examples in these final regulations 

clarify the principle that a taxpayer may 

not ignore its regular accounting 

procedures or portions of its books and 

records under the non-AFS section 

471(c) inventory method. 

(ii) Inventory Costs 

The proposed regulations defined 

‘‘inventory costs’’ for the non-AFS 

section 471(c) inventory method 

generally as costs that the taxpayer 

capitalizes to property produced or 

property acquired for resale in its books 

and records. Certain commenters 

requested that the final regulations 

clarify how a taxpayer treats costs to 

acquire or produce tangible property 

that the taxpayer does not capitalize in 

its books and records because the 

proposed regulations did not 

specifically address these costs. 

These final regulations clarify in 

§ 1.471–1(b)(6)(i) that costs that are 

generally required to be capitalized to 

inventory under section 471(a) but that 

the taxpayer is not capitalizing in its 

books and records are not required to be 

capitalized to inventory. The Treasury 

Department and the IRS have also 

determined that, under this method, 

such costs are not treated as amounts 

paid to acquire or produce tangible 

property under § 1.263(a)–2, and 

therefore, are generally deductible when 

they are paid or incurred if such costs 

may be otherwise deducted or recovered 

notwithstanding § 1.471–1(b)(4) under 

another provision of the Code and 

Regulations. Additionally, these final 

regulations clarify that costs capitalized 

for the non-AFS section 471(c) 

inventory method are those costs that 

related to the production or resale of the 

inventory to which they are capitalized 

in the taxpayer’s books and records. 

Similar clarifications have been made in 

§ 1.471–1(b)(5) regarding the AFS 

section 471(c) inventory method. 

Applicability Dates 

These final regulations are applicable 

for taxable years beginning on or after 

January 5, 2021. However, a taxpayer 

may apply these regulations for a 

taxable year beginning after December 

31, 2017, and before January 5, 2021, 

provided that if the taxpayer applies any 

aspect of these final regulations under a 

particular Code provision, the taxpayer 

must follow all the applicable rules 

contained in these regulations that 

relate to that Code provision for such 

taxable year and all subsequent taxable 

years, and must follow the 

administrative procedures for filing a 

change in method of accounting in 

accordance with § 1.446–1(e)(3)(ii). For 

example, a taxpayer that wants to apply 

§ 1.263A–1(j) to be exempt from 

capitalizing costs under section 263A 

must apply § 1.448–2 to determine 

whether it is eligible for the exemption. 

The same taxpayer must apply § 1.448– 

2 to determine whether it is eligible to 

apply § 1.471–1(b) to be exempt from 

the general inventory rules under 

section 471(a). However, it may choose 

not to apply § 1.471–1(b) even though it 

chooses to apply § 1.263A–1(j) and 

§ 1.448–2. 

Alternatively, a taxpayer may rely on 

the proposed regulations for a taxable 

year beginning after December 31, 2017 

and before January 5, 2021, provided 

that if the taxpayer applies any aspect 

of the proposed regulations under a 

particular Code provision, the taxpayer 

must follow all of the applicable rules 

contained in the proposed regulations 

that relate to that Code provision for 

such taxable year, and follow the 

administrative procedures for filing a 

change in method of accounting in 

accordance with § 1.446–1(e)(3)(ii). 

Statement of Availability of IRS 

Documents 

The IRS notices, revenue rulings, and 

revenue procedures cited in this 

preamble are published in the Internal 

Revenue Bulletin (or Cumulative 

Bulletin) and are available from the 

Superintendent of Documents, U.S. 

Government Publishing Office, 

Washington, DC 20402, or by visiting 

the IRS website at http://www.irs.gov. 

Special Analyses 

This regulation is not subject to 

review under section 6(b) of Executive 

Order 12866 pursuant to the 

Memorandum of Agreement (April 11, 

2018) between the Treasury Department 

and the Office of Management and 

Budget regarding review of tax 

regulations. 

I. Paperwork Reduction Act 

Section 1.448–2(b)(2)(iii)(B) imposes a 

collection of information for an election 

to use prior year’s allocated taxable 

income or loss to determine whether a 

partnership or other entity (other than a 

C corporation) is a ‘‘syndicate’’ for 

purposes of section 448(d)(3) for the 

current tax year. The election is made 

by attaching a statement to the 

taxpayer’s original Federal income tax 

return (including extensions) for the 

taxable year that the election is made. 

The election is an annual election and, 

if made for a taxable year, cannot be 

revoked. The collection of information 

is voluntary for purposes of obtaining a 

benefit under the proposed regulations. 

The likely respondents are businesses or 

other for-profit institutions, and small 

businesses or organizations. 

Estimated total annual reporting 

burden: 224,165 hours. 

Estimated average annual burden 

hours per respondent: 1 hour. 

Estimated number of respondents: 

224,165. 

Estimated annual frequency of 

responses: Once. 

Other than the election statement, 

these regulations do not impose any 

additional information collection 


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Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 261 

requirements in the form of reporting, 

recordkeeping requirements or thirdparty disclosure statements. However, 

because the exemptions in sections 

263A, 448, 460 and 471 are methods of 

accounting under the statute, taxpayers 

are required to request the consent of 

the Commissioner for a change in 

method of accounting under section 

446(e) to implement the statutory 

exemptions. The IRS expects that these 

taxpayers will request this consent by 

filing Form 3115, Application for 

Change in Accounting Method. 

Taxpayers may request these changes 

using reduced filing requirements by 

completing only certain parts of Form 

3115. See Revenue Procedure 2018–40 

(2018–34 IRB 320). Revenue Procedure 

2018–40 provides procedures for a 

taxpayer to make a change in method of 

accounting using the automatic change 

procedures of Revenue Procedure 2015– 

13 (2015–5 IRB 419) in order to use the 

exemptions provided in sections 263A, 

460 and/or 471. See also the revenue 

procedure accompanying these 

regulations for similar method change 

procedures to make a change in method 

of accounting to comply with these final 

regulations. 

For purposes of the Paperwork 

Reduction Act of 1995 (44 U.S.C. 

3507(c)) (PRA), the reporting burden 

associated with the collection of 

information for the election statement 

and Form 3115 will be reflected in the 

PRA submission associated with the 

income tax returns under the OMB 

control number 1545–0074 (in the case 

of individual filers of Form 3115) and 

1545–0123 (in the case of business filers 

of Form 3115). 

In 2018, the IRS released and invited 

comment on a draft of Form 3115 in 

order to give members of the public the 

opportunity to benefit from certain 

specific provisions made to the Code. 

The IRS received no comments on the 

forms during the comment period. 

Consequently, the IRS made the forms 

available in January 2019 for use by the 

public. The IRS notes that Form 3115 

applies to changes of accounting 

methods generally and is therefore 

broader than sections 263A, 448, 460 

and 471. 

As discussed earlier, the reporting 

burdens associated with the proposed 

regulations are included in the 

aggregated burden estimates for OMB 

control numbers 1545–0074 (in the case 

of individual filers of Form 3115), 1545– 

0123 (in the case of business filers of 

Form 3115 subject to Revenue 

Procedure 2019–43 and business filers 

that make the election under proposed 

§ 1.448–2(b)(2)(iii)(B)). The overall 

burden estimates associated with these 

OMB control numbers are aggregate 

amounts related to the entire package of 

forms associated with the applicable 

OMB control number and will include, 

but not isolate, the estimated burden of 

the tax forms that will be created or 

revised as a result of the information 

collections in these regulations. These 

numbers are therefore not specific to the 

burden imposed by these regulations. 

The burdens have been reported for 

other income tax regulations that rely on 

the same information collections and 

the Treasury Department and the IRS 

urge readers to recognize that these 

numbers are duplicates and to guard 

against overcounting the burdens 

imposed by tax provisions prior to the 

TCJA. No burden estimates specific to 

the forms affected by the regulations are 

currently available. For the OMB control 

numbers discussed in the preceding 

paragraphs, the Treasury Department 

and the IRS estimate PRA burdens on a 

taxpayer-type basis rather than a 

provision-specific basis. Those 

estimates capture both changes made by 

the TCJA and those that arise out of 

discretionary authority exercised in the 

final regulations and other regulations 

that affect the compliance burden for 

that form. 

II. Regulatory Flexibility Act 

The Regulatory Flexibility Act (5 

U.S.C. 601 et seq.) (RFA) imposes 

certain requirements with respect to 

federal rules that are subject to the 

notice and comment requirements of 

section 553(b) of the Administrative 

Procedure Act (5 U.S.C. 551 et seq.) and 

that are likely to have a significant 

economic impact on a substantial 

number of small entities. Unless an 

agency determines that a proposal is not 

likely to have a significant economic 

impact on a substantial number of small 

entities, section 603 of the RFA requires 

the agency to present an initial 

regulatory flexibility analysis (IRFA) of 

the proposed rules. At the proposed rule 

stage, the Treasury Department and the 

IRS had not determined whether the 

proposed rules, when finalized, would 

likely have a significant economic 

impact on a substantial number of small 

entities. The determination of whether 

the voluntary exemptions under 

sections 263A, 448, 460, and 471, and 

the regulations providing guidance with 

respect to such exemptions, will have a 

significant economic impact on a 

substantial number of small entities 

requires further study. However, 

because there is a possibility of 

significant economic impact on a 

substantial number of small entities, an 

IRFA was provided at the proposed rule 

stage. In accordance with section 604 of 

the RFA, following is the final 

regulatory flexibility analysis. 

1. Reasons for and Objectives of the 

Rule 

As discussed earlier in the preamble, 

these regulations largely implement 

voluntary exemptions that relieve small 

business taxpayers from otherwise 

applicable restrictions and requirements 

under sections 263A, 448, 460, and 471. 

Section 448 provides a general 

restriction for C corporations and 

partnerships with C corporation 

partners from using the cash method of 

accounting, and sections 263A, 460 and 

471 impose specific rules on uniform 

capitalization of direct and indirect 

production costs, the percentage of 

completion method for long-term 

contracts, and accounting for inventory 

costs, respectively. Section 13102 of 

TCJA provided new statutory 

exemptions from certain of these rules 

and expanded the scope of existing 

statutory exemptions from certain of 

these rules to reduce compliance 

burdens for small taxpayers. The 

regulations clarify the exemption 

qualification requirements and provide 

guidance with respect to the applicable 

methods of accounting should a 

taxpayer choose to apply one or more 

exemptions. 

The objective of the regulations is to 

provide clarity and certainty for small 

business taxpayers implementing the 

exemptions. Under the Code, small 

business taxpayers were able to 

implement these provisions for taxable 

years beginning after December 31, 2017 

(or, in the case of section 460, for 

contracts entered into after December 

31, 2017) even in the absence of these 

regulations. Thus, the Treasury 

Department and the IRS expect that, at 

the time these regulations are published, 

many small business taxpayers may 

have already implemented some aspects 

of the regulations. 

2. Significant Issues Raised by the 

Public Comments in Response to the 

IRFA and Comments Filed by the Chief 

Counsel for Advocacy of the Small 

Business Administration 

No public comments were received in 

response to the IRFA. Additionally, no 

comments were filed by the Chief 

Counsel for Advocacy of the Small 

Business Administration in response to 

the proposed regulations. 

3. Affected Small Entities 

The voluntary exemptions under 

sections 263A, 448, 460 and 471 

generally apply to taxpayers that meet 

the $25 million (adjusted for inflation) 

gross receipts test in section 448(c) and 


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262 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

are otherwise subject to general rules 

under sections 263A, 448, 460, or 471. 

A. Section 263A 

The Treasury Department and the IRS 

expect that the addition of section 

263A(i) will expand the number of 

small business taxpayers exempted from 

the requirement to capitalize costs, 

including interest, under section 263A. 

Under section 263A(i), taxpayers (other 

than tax shelters) that meet the $25 

million (adjusted for inflation) gross 

receipts test in section 448(c) can 

choose to deduct certain costs that are 

otherwise required to be capitalized to 

the basis of property. Section 263A 

applies to taxpayers that are producers, 

resellers, and taxpayers with selfconstructed assets. The Treasury 

Department and the IRS estimate that 

there are between 3,200,000 and 

3,575,000 respondents with gross 

receipts of not more than $25 million 

(adjusted for inflation) that have 

inventories. The Treasury Department 

and the IRS estimate that of these 

taxpayers there are between 28,900 and 

38,900 respondents with gross receipts 

of not more than $25 million (adjusted 

for inflation) that are eligible to change 

their method of accounting to no longer 

capitalize costs under section 263A. 

These estimates come from information 

collected on: Form 1125–A, Cost of 

Goods Sold, and attached to Form 1120, 

U.S. Corporation Income Tax Return, 

Form 1065, U.S. Return of Partnership 

Income or Form 1120–S, U.S. Income 

Tax Return for an S Corporation, on 

which the taxpayer also indicated it had 

additional section 263A costs. The 

Treasury Department and the IRS do not 

have readily available data to measure 

the prevalence of entities with selfconstructed assets. In addition, these 

data also do not include other business 

entities, such as a business reported on 

Schedule C, Profit or Loss Form 

Business, of an individual’s Form 1040, 

U.S. Individual Income Tax Return. 

Under section 263A, as modified by 

the TCJA, small business entities that 

qualified for Section 263A small reseller 

exception will no longer be able to use 

this exception. The Treasury 

Department and the IRS estimate that 

nearly all taxpayers that qualified for 

the small reseller exception will qualify 

for the small business taxpayer 

exemption under section 263A(i) since 

the small reseller exception utilized a 

$10 million gross receipts test. The 

Treasury Department and the IRS 

estimate that there are between 28,900 

and 38,900 respondents with gross 

receipts of not more than $25 million 

that are eligible for the exemption under 

section 263A(i). These estimates come 

from information collected on: Form 

1125–A, Cost of Goods Sold, and 

attached to Form 1120, U.S. Corporation 

Income Tax Return, Form 1065, U.S. 

Return of Partnership Income or Form 

1120–S, U.S. Income Tax Return for an 

S Corporation on which the taxpayer 

also indicated it had additional section 

263A costs. These data provide an 

upper bound for the number of 

taxpayers affected by the repeal of the 

small reseller exception and enactment 

of section 263A(i) because the data 

includes taxpayers that were not 

previously eligible for the small reseller 

exception, such as producers and 

taxpayers with gross receipts of more 

than $10 million. 

The regulations modify the $50 

million gross receipts test in § 1.263A– 

1(d)(3)(ii)(B)(1) by using the Section 448 

Gross Receipts Test. The $50 million 

gross receipts amount is used by 

taxpayers to determine whether they are 

eligible to treat negative adjustments as 

additional section 263A costs for 

purposes of the simplified production 

method (SPM) under section 263A. The 

Treasury Department and the IRS do not 

have readily available data to measure 

the prevalence of entities using the 

SPM. 

Section 1.263A–9 modifies the 

current regulation to increase the 

eligibility threshold to $25 million for 

the election permitting taxpayers to use 

the highest applicable Federal rate as a 

substitute for the weighted average 

interest rate when tracing debt for 

purposes of capitalizing interest under 

section 263A(f). The Treasury 

Department and the IRS estimate that 

there are between 28,900 and 38,900 

respondents with gross receipts of not 

more than $25 million that are eligible 

to make this election. These estimates 

come from information collected on: 

Form 1125–A, Cost of Goods Sold, 

attached to Form 1120, U.S. Corporation 

Income Tax Return, Form 1065, U.S. 

Return of Partnership Income or Form 

1120–S, U.S. Income Tax Return for an 

S Corporation, on which the taxpayer 

also indicated it had additional section 

263A costs. The Treasury Department 

and the IRS expect that many taxpayers 

eligible to make the election for 

purposes of section 263A(f) will instead 

elect the small business exemption 

under section 263A(i). Additionally, 

taxpayers who chose to apply section 

263A even though they qualify for the 

small business exemption under section 

263A(i) may not have interest expense 

required to be capitalized under section 

263A(f). As a result, although these data 

do not include taxpayers with selfconstructed assets that are eligible for 

the election, the Treasury Department 

and the IRS estimate that this data 

provides an upper bound for the 

number of eligible taxpayers. 

B. Section 448 

The Treasury Department and the IRS 

expect that the changes to section 448(c) 

by the TCJA will expand the number of 

taxpayers permitted to use the cash 

method. Section 448(a) provides that C 

corporations, partnerships with C 

corporations as partners, and tax 

shelters are not permitted to use the 

cash method of accounting; however 

section 448(c), as amended by the TCJA, 

provides that C corporations or 

partnerships with C corporations as 

partners, other than tax shelters, are not 

restricted from using the cash method if 

their average annual gross receipts are 

$25 million (adjusted for inflation) or 

less. Prior to the amendments made by 

the TCJA, the applicable gross receipts 

threshold was $5 million. Section 448 

does not apply to S corporations, 

partnerships without a C corporation 

partner, or any other business entities 

(including sole proprietorships reported 

on an individual’s Form 1040). The 

Treasury Department and the IRS 

estimate that there are between 587,000 

and 605,000 respondents with gross 

receipts of not more than $5 million 

presently using an accrual method, and 

between 70,000 and 76,500 respondents 

with gross receipts of more than $5 

million but not more than $25 million 

that are permitted to use to the cash 

method. These estimates come from 

information collected on Form 1120, 

U.S. Corporation Income Tax Return, 

Form 1065, U.S. Return of Partnership 

Income and Form 1120–S, U.S. Income 

Tax Return for an S Corporation. 

Under the regulations, taxpayers that 

would meet the gross receipts test of 

section 448(c) and seem to be eligible to 

use the cash method but for the 

definition of ‘‘syndicate’’ under section 

448(d)(3), may elect to use the allocated 

taxable income or loss of the 

immediately preceding taxable year to 

determine whether the taxpayer is a 

‘‘syndicate’’ for purposes of section 

448(d)(3) for the current taxable year. 

The Treasury Department and IRS 

estimate that 224,165 respondents may 

potentially make this election. This 

estimate comes from information 

collected on the Form 1065, U.S. Return 

of Partnership Income and Form 1120– 

S, U.S. Income Tax Return for an S 

Corporation., and the Form 1125–A, 

Cost of Goods Sold, attached to the 

Forms 1065 and 1120–S. The Treasury 

Department and the IRS estimate that 

these data provide an upper bound for 

the number of eligible taxpayers because 


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not all taxpayers eligible to make the 

election will choose to do so. 

C. Section 460 

The Treasury Department and the IRS 

expect that the modification of section 

460(e)(1)(B) by the TCJA will expand 

the number of taxpayers exempted from 

the requirement to apply the percentageof-completion method to long-term 

construction contracts. Under section 

460(e)(1)(B), as modified by the TCJA, 

taxpayers (other than tax shelters) that 

meet the $25 million (adjusted for 

inflation) gross receipts test in section 

448(c) are not required to use PCM to 

account for income from a long-term 

construction contract expected to be 

completed in two years. Prior to the 

modification of section 460(e)(1)(B) by 

the TCJA, a separate $10 million dollar 

gross receipts test applied. The Treasury 

Department and the IRS estimate that 

there are between 15,400 and 19,500 

respondents with gross receipts of 

between $10 million and $25 million 

who are eligible to change their method 

of accounting to apply the modified 

exemption. This estimate comes from 

information collected on the Form 1120, 

U.S. Corporation Income Tax Return, 

Form 1065, U.S. Return of Partnership 

Income and Form 1120–S, U.S. Income 

Tax Return for an S Corporation in 

which the taxpayer indicated its 

principal business activity was 

construction (NAICS codes beginning 

with 23). These data available do not 

distinguish between long-term contracts 

and other contracts, and also do not 

include other business entities that do 

not file Form 1120, U.S. Corporation 

Income Tax Return, Form 1065, U.S. 

Return of Partnership Income, and Form 

1120–S, U.S. Income Tax Return for an 

S Corporation, such as a business 

reported on Schedule C, Profit or Loss 

from Business, of an individual’s Form 

1040, U.S. Individual Income Tax 

Return. 

D. Section 471 

The Treasury Department and the IRS 

expect that the addition of section 

471(c) will expand the number of 

taxpayers exempted from the 

requirement to take inventories under 

section 471(a). Under section 471(c), 

taxpayers (other than tax shelters) that 

meet the $25 million (adjusted for 

inflation) gross receipts test in section 

448(c) can choose to apply certain 

simplified inventory methods rather 

than those otherwise required by section 

471(a). The Treasury Department and 

the IRS estimate that there are between 

3,200,000 and 3,575,000 respondents 

with gross receipts of not more than $25 

million that are exempted from the 

requirement to take inventories, and 

will treat their inventory either as nonincidental materials and supplies, or 

conform their inventory method to the 

method reflected in their AFS, or if they 

do not have an AFS, in their books and 

records. This estimate comes from data 

collected on the Form 1125–A, Cost of 

Goods Sold. Within that set of 

taxpayers, the Treasury Department and 

the IRS estimate that there are between 

10,500 and 11,500 respondents that may 

choose to conform their method of 

accounting for inventories to their 

method for inventory reflected in their 

AFS. This estimate comes from IRScollected data on taxpayers that filed the 

Form 1125–A, Cost of Goods Sold, in 

addition to a Schedule M3, Net Income 

(Loss) Reconciliation for Corporations 

With Total Assets of $10 Million or 

More, that indicated they had an AFS. 

These data provide a lower bound 

because they do not include other 

business entities, such as a business 

reported on Schedule C, Profit or Loss 

from Business, of an individual’s Form 

1040, U.S. Individual Income Tax 

Return, that are not required to file the 

Form 1125–A, Cost of Goods Sold. 

4. Projected Reporting, Recordkeeping, 

Other Compliance Requirements, and 

Costs 

The Treasury Department and the IRS 

have not performed an analysis with 

respect to the projected reporting, 

recordkeeping, and other compliance 

requirements associated with the 

statutory exemptions under sections 

263A, 448, 460, and 471 and the final 

regulations implementing these 

exemptions. The taxpayer may expend 

time to read and understand the final 

regulations. The cost to comply with 

these regulations are reflected in modest 

reporting activities. Taxpayers needing 

to make method changes pursuant to 

these regulations will be required to file 

a Form 3115. The Treasury Department 

and the IRS are minimizing the cost to 

comply with the regulations by 

providing administrative procedures 

that allow taxpayers to make multiple 

changes in method of accounting related 

to the statutory exemptions under 

sections 263A, 448, 460, and 471 for the 

same tax year on a single Form 3115, 

instead of filing a separate Form 3115 

for each exemption. Although there is a 

nominal implementation cost, the 

Treasury Department and the IRS 

anticipate that the statutory exemptions 

and the final regulations implementing 

these exemptions will reduce overall the 

reporting, recordkeeping, and other 

compliance requirements of affected 

taxpayers relative to the requirements 

that exist under the general rules in 

sections 263A, 448, 460, and 471. For 

example, a taxpayer that applies section 

471(c)(1)(B)(i) to treat inventory as nonincidental materials and supplies will 

only need to capitalize the direct 

material cost of producing inventory 

instead of also having to capitalize the 

direct labor and indirect costs of 

producing inventory under the general 

rules of section 471(a). Additionally, a 

taxpayer that applies section 

471(c)(1)(B)(ii) can follow the inventory 

method used in its applicable financial 

statement, or its books and records if it 

does not have an applicable financial 

statement, in lieu of keeping a separate 

inventory method under the general 

rules of section 471(a). 

5. Steps Taken To Minimize the 

Economic Impact on Small Entities 

As discussed earlier in the preamble, 

section 448 provides a general 

restriction for C corporations, 

partnerships with C corporation 

partners, and tax shelters from using the 

cash method of accounting, and sections 

263A, 460 and 471 impose specific rules 

on uniform capitalization of direct and 

indirect production costs, the 

percentage of completion method for 

long-term contracts, and accounting for 

inventory costs, respectively. Section 

13102 of TCJA provided new statutory 

exemptions and expanded the scope of 

existing statutory exemptions from these 

rules to reduce compliance burdens for 

small taxpayers (for example, reducing 

the burdens associated with applying 

complex accrual rules under section 451 

and 461, maintaining inventories, 

identifying and tracking costs that are 

allocable to property produced or 

acquired for resale, identifying and 

tracking costs that are allocable to longterm contracts, applying the look-back 

method under section 460, etc.). For 

example, a small business taxpayer with 

average gross receipts of $20 million 

may pay an accountant an annual fee of 

approximately $2,375 to perform a 25 

hour analysis to determine the section 

263A costs that are capitalized to 

inventory produced during the year. If 

this taxpayer chooses to apply the 

exemption under section 263A and 

these regulations, it will no longer need 

to pay an accountant for the annual 

section 263A analysis. 

The regulations implementing these 

exemptions are completely voluntary 

because small business taxpayers may 

continue using an accrual method of 

accounting, and applying the general 

rules under sections 263A, 460 and 471 

if they so choose. Thus, the exemptions 

increase the flexibility small business 

taxpayers have regarding their 

accounting methods relative to other 


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264 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

businesses. The regulations provide 

clarity and certainty for small business 

taxpayers implementing the 

exemptions. 

As described in more detail earlier in 

the preamble, the Treasury Department 

and the IRS considered a number of 

alternatives under the final regulations. 

For example, in providing rules related 

to inventory exemption in section 

471(c)(1)(B)(i), which permits the 

taxpayer to treat its inventory as nonincidental materials and supplies, the 

Treasury Department and the IRS 

considered whether inventoriable costs 

should be recovered by (i) using an 

approach similar to the approach set 

forth under Revenue Procedure 2001–10 

(2001–2 IRB 272) and Revenue 

Procedure 2002–28 (2002–28 IRB 815), 

which provided that inventory treated 

as non-incidental materials and supplies 

was ‘‘used and consumed,’’ and thus 

recovered through costs of goods sold by 

a cash basis taxpayer, when the 

inventory items were provided to a 

customer, or when the taxpayer paid for 

the items, whichever was later, or (ii) 

using an alternative approach that 

treated inventory as ‘‘used and 

consumed’’ and thus recovered through 

costs of goods sold by the taxpayer, in 

a taxable year prior to the year in which 

the inventory item is provided to the 

customer (for example, in the taxable 

year in which an inventory item is 

acquired or produced). The alternative 

approach described in (ii) would 

produce a savings equal the amount of 

the cost recovery multiplied by an 

applicable discount rate (determined 

based on the number of years the cost 

of goods sold recovery would be 

accelerated under this alternative). The 

Treasury Department and the IRS 

interpret section 471(c)(1)(B)(i) and its 

legislative history generally as codifying 

the rules provided in the administrative 

guidance existing at the time TCJA was 

enacted. Based on this interpretation, 

the Treasury Department and the IRS 

have determined that section 471(c) 

materials and supplies are ‘‘used and 

consumed’’ in the taxable year the 

taxpayer provides the goods to a 

customer, and are recovered through 

costs of goods sold in that year or the 

taxable year in which the cost of the 

goods is paid or incurred (in accordance 

with the taxpayer’s method of 

accounting), whichever is later. The 

Treasury Department and the IRS do not 

believe this approach creates or imposes 

undue burdens on taxpayers. 

III. Section 7805(f) 

Pursuant to section 7805(f) of the 

Code, the notice of proposed rulemaking 

preceding this Treasury Decision was 

submitted to the Chief Counsel of the 

Office of Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

IV. Executive Order 13132: Federalism 

Executive Order 13132 (entitled 

‘‘Federalism’’) prohibits an agency from 

publishing any rule that has federalism 

implications if the rule either imposes 

substantial, direct compliance costs on 

state and local governments, and is not 

required by statute, or preempts state 

law, unless the agency meets the 

consultation and funding requirements 

of section 6 of the Executive Order. This 

final rule does not have federalism 

implications and does not impose 

substantial, direct compliance costs on 

state and local governments or preempt 

state law within the meaning of the 

Executive Order. 

Drafting Information 

The principal author of these 

regulations is Anna Gleysteen, IRS 

Office of the Associate Chief Counsel 

(Income Tax and Accounting). However, 

other personnel from the Treasury 

Department and the IRS participated in 

their development. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Amendments to the Regulations 

Accordingly, 26 CFR part 1 is 

amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

■ Par. 2. Section 1.263A–0 is amended 

by: 

■ 1. Revising the entry in the table of 

contents for § 1.263A–1(b)(1). 

■ 2. Redesignating the entries in the 

table of contents for § 1.263A–1(j), (k), 

and (l) as the entries for § 1.263A–1(k), 

(l), and (m). 

■ 3. Adding a new entry in the table of 

contents for § 1.263A–1(j). 

■ 4. Revising the newly designated 

entries for § 1.263A–1(k), (l), and adding 

an entry for (m)(6). 

■ 5. Revising the entries in the table of 

contents for § 1.263A–3(a)(2)(ii). 

■ 6. Adding entries for § 1.263A–3(a)(5) 

and revising the entry for § 1.263A–3(b). 

■ 7. Redesignating the entries in the 

table of contents for § 1.263A–4(a)(3) 

and (4) as the entries for § 1.263A– 

4(a)(4) and (5). 

■ 8. Adding in the table of contents a 

new entry for § 1.263A–4(a)(3). 

■ 9. Revising the entry in the table of 

contents for § 1.263A–4(d) introductory 

text. 

■ 10. Redesignating the entry in the 

table of contents for § 1.263A–4(d)(5) as 

the entry for § 1.263A–4(d)(7). 

■ 11. Adding in the table of contents a 

new entry for § 1.263A–4(d)(5). 

■ 12. Adding an entry in the table of 

contents for § 1.263A–4(d)(6). 

■ 13. Adding an entry in the table of 

contents for § 1.263A–4(e)(5). 

■ 14. Revising the entry in the table of 

contents for § 1.263A–4(f) introductory 

text. 

■ 15. Adding an entry in the table of 

contents for § 1.263A–4(g). 

■ 16. Revising the entry in the table of 

contents for § 1.263A–7(a)(4). 

The revisions and additions read as 

follows: 

§ 1.263A–0 Outline of regulations under 

section 263A. 

* * * * * 

§ 1.263A–1 Uniform Capitalization of Costs. 

* * * * * 

(b) * * * 

(1) Small business taxpayers. 

* * * * * 

(j) Exemption for certain small business 

taxpayers. 

(1) In general. 

(2) Application of the section 448(c) gross 

receipts test. 

(i) In general. 

(ii) Gross receipts of individuals, etc. 

(iii) Partners and S corporation 

shareholders. 

(iv) Examples. 

(A) Example 1 

(B) Example 2 

(3) Change in method of accounting. 

(i) In general. 

(ii) Prior section 263A method change. 

(k) Special rules 

(1) Costs provided by a related person. 

(i) In general 

(ii) Exceptions 

(2) Optional capitalization of period costs. 

(i) In general. 

(ii) Period costs eligible for capitalization. 

(3) Trade or business application 

(4) Transfers with a principal purpose of 

tax avoidance. [Reserved] 

(l) Change in method of accounting. 

(1) In general. 

(2) Scope limitations. 

(3) Audit protection. 

(4) Section 481(a) adjustment. 

(5) Time for requesting change. 

(m) * * * 

(6) Exemption for certain small business 

taxpayers. 

§ 1.263A–3 Rules Relating to Property 

Acquired for Resale. 

(a) * * * 

(2) * * * 

(ii) Exemption for small business 

taxpayers. 

* * * * * 

(5) De minimis production activities. 


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(i) In general. 

(ii) Definition of gross receipts to 

determine de minimis production activities. 

(iii) Example. 

(b) [Reserved]. 

* * * * * 

§ 1.263A–4 Rules for Property Produced in 

a Farming Business. 

(a) * * * 

(3) Exemption for certain small business 

taxpayers. 

* * * * * 

(d) Election not to have section 263A apply 

under section 263A(d)(3). 

* * * * * 

(5) Revocation of section 263A(d)(3) 

election to permit exemption under section 

263A(i). 

(6) Change from applying exemption under 

section 263A(i) to making a section 

263A(d)(3) election. 

* * * * * 

(e) * * * 

(5) Special temporary rule for citrus plants 

lost by reason of casualty. 

(f) Change in method of accounting. 

* * * * * 

(g) Effective date. 

(1) In general. 

(2) Changes made by Tax Cuts and Jobs Act 

(Pub. L. 115–97). 

§ 1.263A–7 Changing a method of 

accounting under section 263A. 

(a) * * * 

(4) Applicability dates. 

(i) In general. 

(ii) Changes made by Tax Cuts and Jobs Act 

(Pub. L. 115–97). 

* * * * * 

■ Par. 3. Section 1.263A–1 is amended 

by: 

■ 1. Revising paragraph (a)(2) subject 

heading. 

■ 2. In paragraph (a)(2)(i), revising the 

second sentence and adding a new third 

sentence. 

■ 3. Revising paragraph (b)(1). 

■ 4. In the second sentence of paragraph 

(d)(3)(ii)(B)(1), the language ‘‘§ 1.263A– 

3(b)’’ is removed and the language 

‘‘§ 1.263A–1(j)’’is added in its place. 

■ 5. Redesignating paragraphs (j) 

through (l) as paragraphs (k) through 

(m). 

■ 6. Adding a new paragraph (j). 

■ 7. In newly-redesignated paragraph 

(m), adding paragraph (m)(6). 

The revisions and addition read as 

follows: 

§ 1.263A–1 Uniform capitalization of costs. 

(a) * * * 

(2) Applicability dates. (i) * * * In 

the case of property that is inventory in 

the hands of the taxpayer, however, 

these sections are applicable for taxable 

years beginning after December 31, 

1993. The small business taxpayer 

exception described in paragraph (b)(1) 

of this section and set forth in paragraph 

(j) of this section is applicable for 

taxable years beginning after December 

31, 2017. * * * 

* * * * * 

(b) * * * (1) Small business 

taxpayers. For taxable years beginning 

after December 31, 2017, see section 

263A(i) and paragraph (j) of this section 

for an exemption for certain small 

business taxpayers from the 

requirements of section 263A. 

* * * * * 

(j) Exemption for certain small 

business taxpayers—(1) In general. A 

taxpayer, other than a tax shelter 

prohibited from using the cash receipts 

and disbursements method of 

accounting under section 448(a)(3), that 

meets the gross receipts test under 

section 448(c) and § 1.448–2(c) (section 

448(c) gross receipts test) for any taxable 

year (small business taxpayer) is not 

required to capitalize costs under 

section 263A to any real or tangible 

personal property produced, and any 

real or personal property described in 

section 1221(a)(1) acquired for resale, 

during that taxable year. This section 

448(c) gross receipts test applies even if 

the taxpayer is not otherwise subject to 

section 448(a). 

(2) Application of the section 448(c) 

gross receipts test—(i) In general. In the 

case of any taxpayer that is not a 

corporation or a partnership, and except 

as provided in paragraphs (j)(2)(ii) and 

(iii) of this section, the section 448(c) 

gross receipts test is applied in the same 

manner as if each trade or business of 

the taxpayer were a corporation or 

partnership. 

(ii) Gross receipts of individuals, etc. 

Except when the aggregation rules of 

section 448(c)(2) apply, the gross 

receipts of a taxpayer other than a 

corporation or partnership are the 

amount derived from all trades or 

businesses of such taxpayer. Amounts 

not related to a trade or business are 

excluded from the gross receipts of the 

taxpayer. For example, an individual 

taxpayer’s gross receipts do not include 

inherently personal amounts, such as 

personal injury awards or settlements 

with respect to an injury of the 

individual taxpayer, disability benefits, 

Social Security benefits received by the 

taxpayer during the taxable year, and 

wages received as an employee that are 

reported on Form W–2. 

(iii) Partners and S corporation 

shareholders. Except when the 

aggregation rules of section 448(c)(2) 

apply, each partner in a partnership 

includes a share of the partnership’s 

gross receipts in proportion to such 

partner’s distributive share, as 

determined under section 704, of items 

of gross income that were taken into 

account by the partnership under 

section 703. Similarly, a shareholder of 

an S corporation includes such 

shareholder’s pro rata share of S 

corporation gross receipts taken into 

account by the S corporation under 

section 1363(b). 

(iv) Examples. The operation of this 

paragraph (j) is illustrated by the 

following examples: 

(A) Example 1. Taxpayer A is an 

individual who operates two separate 

and distinct trades or business that are 

reported on Schedule C, Profit or Loss 

from Business, of A’s Federal income 

tax return. For 2020, one trade or 

business has annual average gross 

receipts of $5 million, and the other 

trade or business has average annual 

gross receipts of $35 million. Under 

paragraph (j)(2)(ii) of this section, for 

2020, neither of A’s trades or businesses 

meets the gross receipts test of 

paragraph (j)(2) of this section ($5 

million + $35 million = $40 million, 

which is greater than the inflationadjusted gross receipts test amount for 

2020, which is $26 million). 

(B) Example 2. Taxpayer B is an 

individual who operates three separate 

and distinct trades or business that are 

reported on Schedule C of B’s Federal 

income tax return. For 2020, Business X 

is a retail store with average annual 

gross receipts of $15 million, Business 

Y is a dance studio with average annual 

gross receipts of $6 million, and 

Business Z is a car repair shop with 

average annual gross receipts of $12 

million. Under paragraph (j)(2)(ii) of this 

section, B’s gross receipts are the 

combined amount derived from all three 

of B’s trades or businesses. Therefore, 

for 2020, X, Y and Z do not meet the 

gross receipts test of paragraph (j)(2)(i) 

of this section ($15 million + $6 million 

+ $12 million = $33 million, which is 

greater than the inflation-adjusted gross 

receipts test amount for 2020, which is 

$26 million). 

(3) Change in method of accounting— 

(i) In general. A change from applying 

the small business taxpayer exemption 

under paragraph (j) of this section to not 

applying the exemption under this 

paragraph (j), or vice versa, is a change 

in method of accounting under section 

446(e) and § 1.446–1(e). A taxpayer 

changing its method of accounting 

under paragraph (j) of this section may 

do so only with the consent of the 

Commissioner as required under section 

446(e) and § 1.446–1. In the case of any 

taxpayer required by this section to 

change its method of accounting for any 

taxable year, the change shall be treated 

as a change initiated by the taxpayer. 

For rules relating to the clear reflection 


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266 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

of income and the pattern of consistent 

treatment of an item, see section 446 

and § 1.446–1. The amount of the net 

section 481(a) adjustment and the 

adjustment period necessary to 

implement a change in method of 

accounting required under this section 

are determined under § 1.446–1(e) and 

the applicable administrative 

procedures to obtain the 

Commissioner’s consent to change a 

method of accounting as published in 

the Internal Revenue Bulletin (see 

Revenue Procedure 2015–13 (2015–5 

IRB 419) (or successor) (see also 

§ 601.601(d)(2) of this chapter). 

(ii) Automatic consent for certain 

method changes. Certain changes in 

method of accounting made under 

paragraph (j) of this section may be 

made under the procedures to obtain the 

automatic consent of the Commissioner 

to change a method of accounting. See 

Revenue Procedure 2015–13 (2015–5 

IRB 419) (or successor) (see also 

§ 601.601(d)(2) of this chapter)). In 

certain situations, special terms and 

conditions may apply. 

* * * * * 

(m) * * * 

(6) Exemption for certain small 

business taxpayers. The second and 

third sentence in paragraph (a)(2)(i), 

paragraphs (b)(1) and (j) of this section 

apply to taxable years beginning on or 

after January 5, 2021. However, for a 

taxable year beginning after December 

31, 2017, and before January 5, 2021, a 

taxpayer may apply the paragraphs 

described in the first sentence of this 

paragraph (m)(6), provided that the 

taxpayer follows all the applicable rules 

contained in the regulations under 

section 263A for such taxable year and 

all subsequent taxable years. 

■ Par. 4. Section 1.263A–2 is amended 

by: 

■ 1. Adding a sentence at the end of 

paragraph (a) introductory text. 

■ 2. Revising paragraph (a)(1)(ii)(C). 

■ 3. Revising paragraph (g) subject 

heading. 

■ 4. Adding paragraph (g)(4). 

The additions and revisions read as 

follows: 

§ 1.263A–2 Rules relating to property 

produced by the taxpayer. 

(a) * * * For taxable years beginning 

after December 31, 2017, see § 1.263A– 

1(j) for an exception in the case of a 

small business taxpayer that meets the 

gross receipts test of section 448(c) and 

§ 1.448–2(c). 

(1) * * * 

(ii) * * * 

(C) Home construction contracts. 

Section 263A applies to a home 

construction contract unless that 

contract will be completed within two 

years of the contract commencement 

date, and, for contracts entered into after 

December 31, 2017, in taxable years 

ending after December 31, 2017, the 

taxpayer meets the gross receipts test of 

section 448(c) and § 1.448–2(c) for the 

taxable year in which such contract is 

entered into. Except as otherwise 

provided in this paragraph (a)(1)(ii)(C), 

section 263A applies to such a contract 

even if the contractor is not considered 

the owner of the property produced 

under the contract under Federal 

income tax principles. 

* * * * * 

(g) Applicability dates.* * * 

(4) The rules set forth in the last 

sentence of the introductory text of 

paragraph (a) of this section and in 

paragraph (a)(1)(ii)(C) of this section 

apply for taxable years beginning on or 

after January 5, 2021. However, for a 

taxable year beginning after December 

31, 2017, and before January 5, 2021, a 

taxpayer may apply the paragraphs 

described in the first sentence of this 

paragraph (g)(4), provided that the 

taxpayer follows all the applicable rules 

contained in the regulations under 

section 263A for such taxable year and 

all subsequent taxable years. 

■ Par. 5. Section 1.263A–3 is amended: 

■ 1. In paragraph (a)(1), by revising the 

second sentence. 

■ 2. By revising paragraphs (a)(2)(ii) and 

(iii). 

■ 4. In paragraph (a)(3), by removing the 

language ‘‘small reseller’’ and adding in 

its place the language ‘‘small business 

taxpayer’’. 

■ 5. In paragraph (a)(4)(ii), removing the 

language ‘‘(within the meaning of 

paragraph (a)(2)(iii) of this section)’’ and 

adding in its place the language 

‘‘(within the meaning of paragraph (a)(5) 

of this section)’’. 

■ 6. By adding paragraph (a)(5). 

■ 7. By removing and reserving 

paragraph (b). 

■ 8. By revising paragraph (f). 

The revisions and additions read as 

follows: 

§ 1.263A–3 Rules relating to property 

acquired for resale. 

(a) * * * (1) * * * However, for 

taxable years beginning after December 

31, 2017, a small business taxpayer, as 

defined in § 1.263A–1(j), is not required 

to apply section 263A in that taxable 

year. * * * 

(2) * * * 

(ii) Exemption for certain small 

business taxpayers. For taxable years 

beginning after December 31, 2017, see 

§ 1.263A–1(j) for an exception in the 

case of a small business taxpayer that 

meets the gross receipts test of section 

448(c) and § 1.448–2(c). 

(iii) De minimis production activities. 

See paragraph (a)(5) of this section for 

rules relating to an exception for 

resellers with de minimis production 

activities. 

* * * * * 

(5) De minimis production activities— 

(i) In general. In determining whether a 

taxpayer’s production activities are de 

minimis, all facts and circumstances 

must be considered. For example, the 

taxpayer must consider the volume of 

the production activities in its trade or 

business. Production activities are 

presumed de minimis if— 

(A) The gross receipts from the sale of 

the property produced by the reseller 

are less than 10 percent of the total gross 

receipts of the trade or business; and 

(B) The labor costs allocable to the 

trade or business’s production activities 

are less than 10 percent of the reseller’s 

total labor costs allocable to its trade or 

business. 

(ii) Definition of gross receipts to 

determine de minimis production 

activities. Gross receipts has the same 

definition as for purposes of the gross 

receipts test under § 1.448–2(c), except 

that gross receipts are measured at the 

trade-or-business level rather than at the 

single-employer level. 

(iii) Example: Reseller with de 

minimis production activities. Taxpayer 

N is in the retail grocery business. In 

2019, N’s average annual gross receipts 

for the three previous taxable years are 

greater than the gross receipts test of 

section 448(c). Thus, N is not exempt 

from the requirement to capitalize costs 

under section 263A. N’s grocery stores 

typically contain bakeries where 

customers may purchase baked goods 

produced by N. N produces no other 

goods in its retail grocery business. N’s 

gross receipts from its bakeries are 5 

percent of the entire grocery business. 

N’s labor costs from its bakeries are 3 

percent of its total labor costs allocable 

to the entire grocery business. Because 

both ratios are less than 10 percent, N’s 

production activities are de minimis. 

Further, because N’s production 

activities are incident to its resale 

activities, N may use the simplified 

resale method, as provided in paragraph 

(a)(4)(ii) of this section. 

* * * * * 

(f) Applicability dates. (1) Paragraphs 

(d)(3)(i)(C)(3), (d)(3)(i)(D)(3), and 

(d)(3)(i)(E)(3) of this section apply for 

taxable years ending on or after January 

13, 2014. 

(2) The rules set forth in the second 

sentence of paragraph (a)(1) of this 

section, paragraphs (a)(2)(ii) and (iii) of 


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this section, the third sentence of 

paragraph (a)(3) of this section, and 

paragraphs (a)(4)(ii) and (a)(5) of this 

section apply for taxable years 

beginning on or after January 5, 2021 . 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the paragraphs described in the first 

sentence of this paragraph (f)(2), 

provided the taxpayer follows all the 

applicable rules contained in the 

regulations under section 263A for such 

taxable year and all subsequent taxable 

years. 

■ Par. 6. Section 1.263A–4 is amended: 

■ 1. In paragraph (a)(1), by revising the 

last sentence. 

■ 2. In paragraph (a)(2)(ii)(A)(1), by 

removing the language ‘‘section 464(c)’’ 

and adding in its place the language 

with ‘‘section 461(k)’’. 

■ 3. By redesignating paragraphs (a)(3) 

and (4) as paragraphs (a)(4) and (5) 

respectively. 

■ 4. By adding new paragraph (a)(3). 

■ 5. By revising the paragraph (d) 

subject heading. 

■ 6. In paragraph (d)(1), by revising the 

last sentence and adding a new sentence 

at the end of the paragraph. 

■ 7. In paragraph (d)(3)(i), by removing 

the last sentence. 

■ 8. By revising paragraph (d)(3)(ii). 

■ 9. By redesignating paragraph (d)(5) as 

paragraph (d)(7). 

■ 10. By adding new paragraphs (d)(5) 

and (6) 

■ 11. By adding paragraph (e)(5). 

■ 12. By redesignating paragraph (f) as 

paragraph (g). 

■ 13. By adding new paragraph (f). 

■ 14. By revising the subject headings of 

newly-redesignated paragraphs (g) and 

(g)(1), and by revising newly-designated 

paragraph (g)(2). 

The revisions and additions read as 

follows: 

§ 1.263A–4 Rules for property produced in 

a farming business. 

(a) * * * (1) * * * Except as 

provided in paragraphs (a)(2), (a)(3), and 

(e) of this section, taxpayers must 

capitalize the costs of producing all 

plants and animals unless the election 

described in paragraph (d) of this 

section is made. 

* * * * * 

(3) Exemption for certain small 

business taxpayers. For taxable years 

beginning after December 31, 2017, see 

§ 1.263A–1(j) for an exception in the 

case of a small business taxpayer that 

meets the gross receipts test of section 

448(c) and § 1.448–2(c). 

* * * * * 

(d) Election not to have section 263A 

apply under section 263A(d)(3)—(1) 

* * * Except as provided in paragraph 

(d)(5) and (6) of this section, the election 

is a method of accounting under section 

446. An election made under section 

263A(d)(3) and this paragraph (d) is 

revocable only with the consent of the 

Commissioner. 

* * * * * 

(3) * * * 

(ii) Nonautomatic election. Except as 

provided in paragraphs (d)(5) and (6) of 

this section, a taxpayer that does not 

make the election under this paragraph 

(d) as provided in paragraph (d)(3)(i) of 

this section must obtain the consent of 

the Commissioner to make the election 

by filing a Form 3115, Application for 

Change in Method of Accounting, in 

accordance with § 1.446–1(e)(3). 

* * * * * 

(5) Revocation of section 263A(d)(3) 

election to permit exemption under 

section 263A(i). A taxpayer that elected 

under section 263A(d)(3) and paragraph 

(d)(3) of this section not to have section 

263A apply to any plant produced in a 

farming business that wants to revoke 

its section 263A(d)(3) election, and in 

the same taxable year, apply the small 

business taxpayer exemption under 

section 263A(i) and § 1.263A–1(j) may 

revoke the election in accordance with 

the applicable administrative guidance 

as published in the Internal Revenue 

Bulletin (see § 601.601(d)(2)(ii)(b) of this 

chapter). A revocation of the taxpayer’s 

section 263A(d)(3) election under this 

paragraph (d)(5) is not a change in 

method of accounting under sections 

446 and 481 and §§ 1.446–1 and 1.481– 

1 through 1.481–5. 

(6) Change from applying exemption 

under section 263A(i) to making a 

section 263A(d)(3) election. A taxpayer 

whose method of accounting is to not 

capitalize costs under section 263A 

based on the exemption under section 

263A(i), that becomes ineligible to use 

the exemption under section 263A(i), 

and is eligible and wants to elect under 

section 263A(d)(3) for this same taxable 

year to not capitalize costs under 

section 263A for any plant produced in 

the taxpayer’s farming business, must 

make the election in accordance with 

the applicable administrative guidance 

as published in the Internal Revenue 

Bulletin (see § 601.601(d)(2)(ii)(b) of this 

chapter). An election under section 

263A(d)(3) made in accordance with 

this paragraph (d)(6) is not a change in 

method of accounting under sections 

446 and 481 and §§ 1.446–1 and 1.481– 

1 through 1.481–5. 

* * * * * 

(e) * * * 

(5) Special temporary rule for citrus 

plants lost by reason of casualty. 

Section 263A(d)(2)(A) provides that if 

plants bearing an edible crop for human 

consumption were lost or damaged 

while in the hands of the taxpayer by 

reason of freezing temperatures, disease, 

drought, pests, or casualty, section 263A 

does not apply to any costs of the 

taxpayer of replanting plants bearing the 

same type of crop (whether on the same 

parcel of land on which such lost or 

damaged plants were located or any 

other parcel of land of the same acreage 

in the United States). The rules of this 

paragraph (e)(5) apply to certain costs 

that are paid or incurred after December 

22, 2017, and on or before December 22, 

2027, to replant citrus plants after the 

loss or damage of citrus plants. 

Notwithstanding paragraph (e)(2) of this 

section, in the case of replanting citrus 

plants after the loss or damage of citrus 

plants by reason of freezing 

temperatures, disease, drought, pests, or 

casualty, section 263A does not apply to 

replanting costs paid or incurred by a 

taxpayer other than the owner described 

in section 263A(d)(2)(A) if— 

(i) The owner described in section 

263A(d)(2)(A) has an equity interest of 

not less than 50 percent in the replanted 

citrus plants at all times during the 

taxable year in which such amounts 

were paid or incurred and the taxpayer 

holds any part of the remaining equity 

interest; or 

(ii) The taxpayer acquired the entirety 

of the equity interest in the land of that 

owner described in section 

263A(d)(2)(A) and on which land the 

lost or damaged citrus plants were 

located at the time of such loss or 

damage, and the replanting is on such 

land. 

(f) Change in method of accounting. 

Except as provided in paragraphs (d)(5) 

and (6) of this section, any change in a 

taxpayer’s method of accounting 

necessary to comply with this section is 

a change in method of accounting to 

which the provisions of sections 446 

and 481 and § 1.446–1 through 1.446–7 

and § 1.481–1 through § 1.481–3 apply. 

(g) Applicability dates—(1) In general. 

* * * 

(2) Changes made by Tax Cuts and 

Jobs Act (Pub. L. 115–97). Paragraphs 

(a)(3), (d)(5), (d)(6), and (e)(5) of this 

section apply for taxable years 

beginning on or after January 5, 2021. 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the paragraphs described in the first 

sentence of this paragraph (g)(2), 

provided that the taxpayer follows all 

the applicable rules contained in the 

regulations under section 263A for such 

taxable year and all subsequent taxable 

years. 


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■ Par. 7. § 1.263A–7 is amended: 

■ 1. By revising paragraph (a)(3)(i). 

■ 2. By redesignating paragraph (a)(4) as 

paragraph (a)(4)(i). 

■ 3. By adding a paragraph (a)(4) subject 

heading. 

■ 4. By revising the newly-designated 

paragraph (a)(4)(i) subject heading. 

■ 5. By adding paragraph (a)(4)(ii). 

■ 6. In paragraph (b)(1), by removing the 

language ‘‘Rev. Proc. 97–27 (1997–21 

I.R.B.10)’’ and adding in its place the 

language ‘‘Revenue Procedure 2015–13 

(2015–5 IRB 419)’’. 

■ 7. In paragraph (b)(2)(ii), by removing 

the language ‘‘Rev. Proc. 2002–9 (2002– 

1 C.B. 327) and Rev. Proc. 97–27 (1991– 

1 C.B. 680)’’ and adding the language 

‘‘Revenue Procedure 2015–13, 2015–5 

IRB 419 (or successor)’’ in its place. 

The revisions and additions read as 

follows: 

§ 1.263A–7 Changing a method of 

accounting under section 263A. 

(a) * * * 

(3) * * * 

(i) For taxable years beginning after 

December 31, 2017, resellers of real or 

personal property or producers of real or 

tangible personal property whose 

average annual gross receipts for the 

immediately preceding 3-taxable-year 

period, or lesser period if the taxpayer 

was not in existence for the three 

preceding taxable years, annualized as 

required, exceed the gross receipts test 

of section 448(c) and the accompanying 

regulations where the taxpayer was not 

subject to section 263A in the prior 

taxable year; 

* * * * * 

(4) Applicability dates—(i) In 

general.* * * 

(ii) Changes made by Tax Cuts and 

Jobs Act (Pub. L. 115–97). Paragraph 

(a)(3)(i) of this section applies to taxable 

years beginning on or after January 5, 

2021. However, for a taxable year 

beginning after December 31, 2017, and 

before January 5, 2021, a taxpayer may 

apply the paragraph described in the 

first sentence of this paragraph (a)(4)(ii), 

provided that the taxpayer follows all 

the applicable rules contained in the 

regulations under section 263A for such 

taxable year and all subsequent taxable 

years. 

* * * * * 

■ Par. 8. Section 1.263A–8 is amended 

by adding a sentence to the end of 

paragraph (a)(1) to read as follows: 

§ 1.263A–8 Requirement to capitalize 

interest. 

(a) * * * (1) * * * However, a 

taxpayer, other than a tax shelter 

prohibited from using the cash receipts 

and disbursements method of 

accounting under section 448(a)(3), that 

meets the gross receipts test of section 

448(c) for the taxable year is not 

required to capitalize costs, including 

interest, under section 263A. See 

§ 1.263A–1(j). 

* * * * * 

■ Par. 9. Section 1.263A–9 is amended 

by adding a sentence to the end of 

paragraph (e)(2) to read as follows: 

§ 1.263A–9 The avoided cost method. 

* * * * * 

(e) * * * 

(2) * * *A taxpayer is an eligible 

taxpayer for a taxable year for purposes 

of this paragraph (e) if the taxpayer is a 

small business taxpayer, as defined in 

§ 1.263A–1(j). 

* * * * * 

■ Par. 10. Section 1.263A–15 is 

amended by adding paragraph (a)(4) to 

read as follows: 

§ 1.263A–15 Effective dates, transitional 

rules, and anti-abuse rule. 

(a) * * * 

(4) The last sentence of each of 

§ 1.263A–8(a)(1) and § 1.263A–9(e)(2) 

apply to taxable years beginning on or 

after January 5, 2021. However, for a 

taxable year beginning after December 

31, 2017, and before January 5, 2021, a 

taxpayer may apply the last sentence of 

each of § 1.263A–8(a)(1) and § 1.263A– 

9(e)(2), provided that the taxpayer 

follows all the applicable rules 

contained in the regulations under 

section 263A for such taxable year and 

all subsequent taxable years. 

* * * * * 

■ Par. 11. Section 1.381(c)(5)–1 is 

amended: 

■ 1. In paragraph (a)(6), by designating 

Examples 1 and 2 as paragraphs (a)(6)(i) 

and (ii), respectively. 

■ 2. In newly-designated paragraphs 

(a)(6)(i) and (ii), by redesignating the 

paragraphs in the first column as the 

paragraphs in the second column: 

Old paragraphs New paragraphs 

(a)(6)(i)(i) and (ii) ....... (a)(6)(i)(A) and (B) 

(a)(6)(ii)(i) and (ii) ...... (a)(6)(ii)(A) and (B) 

■ 3. In newly designated paragraphs 

(a)(6)(ii)(A) and (B), by removing the 

language ‘‘small reseller’’ and adding in 

its place the language ‘‘small business 

taxpayer’’ everywhere it appears. 

■ 4. By adding a sentence to the end of 

paragraph (f). 

The addition reads as follows: 

§ 1.381(c)(5)–1 Inventory method. 

* * * * * 

(f) * * * The designations of 

paragraphs (a)(6)(ii)(A) and (B) of this 

section and removal of the term ‘‘small 

reseller’’ and replacement with the term 

‘‘small business taxpayer’’ apply to 

taxable years beginning on or after 

January 5, 2021. 

■ Par. 12. § 1.446–1 is amended: 

■ 1. In paragraph (a)(4)(i), by revising 

the first sentence. 

■ 2. By revising paragraph (c)(2)(i). 

■ 3. By adding paragraph (c)(3). 

The revisions and additions read as 

follows: 

§ 1.446–1 General rule for methods of 

accounting. 

(a) * * * 

(4) * * * 

(i) Except in the case of a taxpayer 

qualifying as a small business taxpayer 

for the taxable year under section 

471(c), in all cases in which the 

production, purchase or sale of 

merchandise of any kind is an incomeproducing factor, merchandise on hand 

(including finished goods, work in 

progress, raw materials, and supplies) at 

the beginning and end of the year shall 

be taken into account in computing the 

taxable income of the year. * * * 

* * * * * 

(c) * * * 

(2) * * * 

(i) In any case in which it is necessary 

to use an inventory, the accrual method 

of accounting must be used with regard 

to purchases and sales unless: 

(A) The taxpayer qualifies as a small 

business taxpayer for the taxable year 

under section 471(c), or 

(B) Otherwise authorized under 

paragraph (c)(2)(ii) of this section. 

* * * * * 

(3) Applicability date. The first 

sentence of paragraph (a)(4)(i) of this 

section and paragraph (c)(2)(i) of this 

section apply to taxable years beginning 

on or after January 5, 2021. However, for 

a taxable year beginning after December 

31, 2017, and before January 5, 2021, a 

taxpayer may apply the rules provided 

in the first sentence of this paragraph 

(c)(3), provided that the taxpayer 

follows all the applicable rules 

contained in the regulations under 

section 446 for such taxable year and all 

subsequent taxable years. 

* * * * * 

■ Par. 13. Section 1.448–1 is amended 

by adding new first and second 

sentences to paragraphs (g)(1) and (h)(1) 

to read as follows: 

§ 1.448–1 Limitation on the use of the cash 

receipts and disbursements method of 

accounting. 

* * * * * 

(g) * * * (1) * * * The rules 

provided in paragraph (g) of this section 


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apply to taxable years beginning before 

January 1, 2018. See § 1.448–2 for rules 

relating to taxable years beginning after 

December 31, 2017. * * * 

* * * * * 

(h) * * * (1) * * * The rules 

provided in paragraph (h) of this section 

apply to taxable years beginning before 

January 1, 2018. See § 1.448–2 for rules 

relating to taxable years beginning after 

December 31, 2017. * * * 

* * * * * 

§ 1.448–2 [Redesignated as § 1.448–3] 

■ Par. 14. Section 1.448–2 is 

redesignated as § 1.448–3. 

■ Par. 15. A new § 1.448–2 is added to 

read as follows: 

§ 1.448–2 Limitation on the use of the cash 

receipts and disbursements method of 

accounting for taxable years beginning 

after December 31, 2017. 

(a) Limitation on method of 

accounting—(1) In general. The rules of 

this section relate to the limitation on 

the use of the cash receipts and 

disbursements method of accounting 

(cash method) by certain taxpayers 

applicable for taxable years beginning 

after December 31, 2017. For rules 

applicable to taxable years beginning 

before January 1, 2018, see §§ 1.448–1 

and 1.448–1T. 

(2) Limitation rule. Except as 

otherwise provided in this section, the 

computation of taxable income using 

the cash method is prohibited in the 

case of a: 

(i) C corporation; 

(ii) Partnership with a C corporation 

as a partner, or a partnership that had 

a C corporation as a partner at any time 

during the partnership’s taxable year 

beginning after December 31, 1986; or 

(iii) Tax shelter. 

(3) Treatment of combination 

methods—(i) In general. For purposes of 

this section, the use of a method of 

accounting that records some, but not 

all, items on the cash method is 

considered the use of the cash method. 

Thus, a C corporation that uses a 

combination of accounting methods 

including the use of the cash method is 

subject to this section. 

(ii) Example. The following example 

illustrates the operation of this 

paragraph (a)(3). In 2020, A is a C 

corporation with average annual gross 

receipts for the prior three taxable years 

of greater than $30 million, is not a tax 

shelter under section 448(a)(3) and does 

not qualify as a qualified personal 

service corporation, as defined in 

paragraph (e) of this section. For the last 

20 years, A used an accrual method for 

items of income and expenses related to 

purchases and sales of inventory, and 

the cash method for items related to its 

provision of services. A is using a 

combination of accounting methods that 

include the cash method. Thus, A is 

subject to section 448. A is prohibited 

from using the cash method for any item 

for 2020 and is required to change to a 

permissible method. 

(b) Definitions. For purposes of this 

section— 

(1) C corporation—(i) In general. The 

term C corporation means any 

corporation that is not an S corporation 

(as defined in section 1361(a)(1)). For 

example, a regulated investment 

company (as defined in section 851) or 

a real estate investment trust (as defined 

in section 856) is a C corporation for 

purposes of this section. In addition, a 

trust subject to tax under section 511(b) 

is treated, for purposes of this section, 

as a C corporation, but only with respect 

to the portion of its activities that 

constitute an unrelated trade or 

business. Similarly, for purposes of this 

section, a corporation that is exempt 

from Federal income taxes under 

section 501(a) is treated as a C 

corporation only with respect to the 

portion of its activities that constitute an 

unrelated trade or business. Moreover, 

for purposes of determining whether a 

partnership has a C corporation as a 

partner, any partnership described in 

paragraph (a)(2)(ii) of this section is 

treated as a C corporation. Thus, if 

partnership ABC has a partner that is a 

partnership with a C corporation, then, 

for purposes of this section, partnership 

ABC is treated as a partnership with a 

C corporation partner. 

(ii) [Reserved] 

(2) Tax shelter—(i) In general. The 

term tax shelter means any— 

(A) Enterprise, other than a C 

corporation, if at any time, including 

taxable years beginning before January 

1, 1987, interests in such enterprise 

have been offered for sale in any 

offering required to be registered with 

any Federal or state agency having the 

authority to regulate the offering of 

securities for sale; 

(B) Syndicate, within the meaning of 

paragraph (b)(2)(iii) of this section; or 

(C) Tax shelter, within the meaning of 

section 6662(d)(2)(C). 

(ii) Requirement of registration. For 

purposes of paragraph (b)(2)(i)(A) of this 

section, an offering is required to be 

registered with a Federal or state agency 

if, under the applicable Federal or state 

law, failure to register the offering 

would result in a violation of the 

applicable Federal or state law. This 

rule applies regardless of whether the 

offering is in fact registered. In addition, 

an offering is required to be registered 

with a Federal or state agency if, under 

the applicable Federal or state law, 

failure to file a notice of exemption from 

registration would result in a violation 

of the applicable Federal or state law, 

regardless of whether the notice is in 

fact filed. However, an S corporation is 

not treated as a tax shelter for purposes 

of section 448(d)(3) or this section 

merely by reason of being required to 

file a notice of exemption from 

registration with a state agency 

described in section 461(i)(3)(A), but 

only if all corporations offering 

securities for sale in the state must file 

such a notice in order to be exempt from 

such registration. 

(iii) Syndicate—(A) In general. For 

purposes of paragraph (b)(2)(i)(B) of this 

section, the term syndicate means a 

partnership or other entity (other than a 

C corporation) if more than 35 percent 

of the losses of such entity during the 

taxable year (for taxable years beginning 

after December 31, 1986) are allocated to 

limited partners or limited 

entrepreneurs. For purposes of this 

paragraph (b)(2)(iii), the term limited 

entrepreneur has the same meaning 

given such term in section 461(k)(4). In 

addition, in determining whether an 

interest in a partnership is held by a 

limited partner, or an interest in an 

entity or enterprise is held by a limited 

entrepreneur, section 461(k)(2) applies 

in the case of the trade or business of 

farming (as defined in paragraph (d)(2) 

of this section), and section 

1256(e)(3)(C) applies in all other cases. 

Moreover, for purposes of paragraph 

(b)(2) of this section, the losses of a 

partnership, entity, or enterprise 

(entities) means the excess of the 

deductions allowable to the entities over 

the amount of income recognized by 

such entities under the entities’ method 

of accounting used for Federal income 

tax purposes (determined without 

regard to this section). For this purpose, 

gains or losses from the sale of capital 

assets or assets described in section 

1221(a)(2) are not taken into account. 

(B) Irrevocable annual election to test 

the allocation of losses from prior 

taxable year—(1) In general. For 

purposes of paragraph (b)(2)(iii)(A) of 

this section, to determine if more than 

35 percent of the losses of a venture are 

allocated to limited partners or limited 

entrepreneurs, entities may elect to use 

the allocations made in the immediately 

preceding taxable year instead of using 

the current taxable year’s allocation. An 

election under this paragraph 

(b)(2)(iii)(B) applies only to the taxable 

year for which the election is made. 

Except as otherwise provided in 

guidance published in the Internal 

Revenue Bulletin (see § 601.601(d)(2) of 

this chapter), a taxpayer that makes an 


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election under this paragraph 

(b)(2)(iii)(B) must apply this election for 

other provisions of the Code that 

specifically apply the definition of tax 

shelter in section 448(a)(3). 

(2) Time and manner of making 

election. A taxpayer makes this election 

for the taxable year by attaching a 

statement to its timely filed original 

Federal income tax return (including 

extensions) for such taxable year. The 

statement must state that the taxpayer is 

making the election under § 1.448– 

2(b)(2)(iii)(B). In the case of an S 

corporation or partnership, the election 

is made by the S corporation or the 

partnership and not by the shareholders 

or partners. An election under this 

paragraph (b)(2)(iii)(B) may not be made 

by the taxpayer in any other manner. 

For example, the election cannot be 

made through a request under section 

446(e) to change the taxpayer’s method 

of accounting. A taxpayer may not 

revoke an election under this paragraph 

(b)(2)(iii)(B). 

(3) Administrative guidance. The IRS 

may publish procedural guidance in the 

Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter) that 

provides alternative procedures for 

complying with paragraph 

(b)(2)(iii)(B)(2) of this section. 

(C) Examples. The following 

examples illustrate the rules of 

paragraph (b)(2)(iii) of this section. For 

purposes of the examples, the term 

‘‘losses’’ has the meaning stated in 

paragraph (b)(2)(iii)(A) of this section. 

(1) Example 1. Taxpayer B is a 

calendar year limited partnership, with 

no active management from its limited 

partner. For 2019, B is profitable and 

has no losses to allocate to its limited 

partner. For 2020, B is not profitable 

and allocates 60 percent of its losses to 

its general partner and 40 percent of its 

losses to its limited partner. For 2021, 

B is not profitable and allocates 50 

percent of its losses to its general 

partner and 50 percent of its losses to its 

limited partner. For taxable year 2020, 

B makes an election under paragraph 

(b)(2)(iii)(B) of this section to use its 

prior year allocated amounts. 

Accordingly, for 2020, B is not a 

syndicate because B was profitable for 

2019 and did not allocate any losses to 

its limited partner in 2019. For 2021, B 

is a syndicate because B allocated 50 

percent of its 2021 losses to its limited 

partner under paragraph (b)(2)(ii)(3)(A) 

of this section. Even if B made an 

election under paragraph (b)(2)(iii)(B) of 

this section to use prior year allocated 

amounts, B is a syndicate for 2021 

because B allocated 40 percent of its 

2020 losses to its limited partner in 

2020. Because B is a syndicate under 

paragraph (b)(2)(iii)(A) of this section 

for 2021, B is a tax shelter prohibited 

from using the cash method for taxable 

year 2021 under paragraph (b)(2)(i)(B) of 

this section. 

(2) Example (2). Same facts as 

Example (1) in paragraph (b)(2)(iii)(C)(1) 

of this section, except for 2021, B is 

profitable and has no losses to allocate 

to its limited partner. For 2020, B makes 

an election under paragraph (b)(2)(iii)(B) 

of this section to use its prior year 

allocated amounts. Accordingly, for 

2020, B is not a syndicate because it did 

not any allocate any losses to its limited 

partner in 2019. For 2021, B chooses not 

to make the election under paragraph 

(b)(2)(iii)(B) of this section. For 2021, B 

is not a syndicate because it does not 

have any 2021 losses to allocate to a 

limited partner. For taxable years 2019, 

2020 and 2021, B is not a syndicate 

under paragraph (b)(2)(iii)(A) of this 

section and is not prohibited from using 

the cash method for taxable years 2019, 

2020 or 2021 under paragraph 

(b)(2)(i)(B) of this section. 

(iv) Presumed tax avoidance. For 

purposes of (b)(2)(i)(C) of this section, 

marketed arrangements in which 

persons carrying on farming activities 

using the services of a common 

managerial or administrative service 

will be presumed to have the principal 

purpose of tax avoidance if such 

persons use borrowed funds to prepay a 

substantial portion of their farming 

expenses. Payments for farm supplies 

that will not be used or consumed until 

a taxable year subsequent to the taxable 

year of payment are an example of one 

type of such prepayment. 

(v) Taxable year tax shelter must 

change accounting method. A tax 

shelter must change from the cash 

method for the taxable year that it 

becomes a tax shelter, as determined 

under paragraph (b)(2) of this section. 

(vi) Determination of loss amount. For 

purposes of section 448(d)(3), the 

amount of losses to be allocated under 

section 1256(e)(3)(B) is calculated 

without regard to section 163(j). 

(c) Exception for entities with gross 

receipts not in excess of the amount 

provided in section 448(c)—(1) In 

general. Except in the case of a tax 

shelter, this section does not apply to 

any C corporation or partnership with a 

C corporation as a partner for any 

taxable year if such corporation or 

partnership (or any predecessor thereof) 

meets the gross receipts test of 

paragraph (c)(2) of this section. 

(2) Gross receipts test—(i) In general. 

A corporation meets the gross receipts 

test of this paragraph (c)(2) if the 

average annual gross receipts of such 

corporation for the 3 taxable years (or, 

if shorter, the taxable years during 

which such corporation was in 

existence, annualized as required) 

ending with such prior taxable year 

does not exceed the gross receipts test 

amount provided in paragraph (c)(2)(v) 

of this section (section 448(c) gross 

receipts test). In the case of a C 

corporation exempt from Federal 

income taxes under section 501(a), or a 

trust subject to tax under section 511(b) 

that is treated as a C corporation under 

paragraph (b)(1) of this section, only 

gross receipts from the activities of such 

corporation or trust that constitute 

unrelated trades or businesses are taken 

into account in determining whether the 

gross receipts test is satisfied. A 

partnership with a C corporation as a 

partner meets the gross receipts test of 

paragraph (c)(2) of this section if the 

average annual gross receipts of such 

partnership for the 3 taxable years (or, 

if shorter, the taxable years during 

which such partnership was in 

existence annualized as required) 

ending with such prior year does not 

exceed the gross receipts test amount of 

paragraph (c)(2)(v) of this section. 

Except as provided in paragraph 

(c)(2)(ii) of this section, the gross 

receipts of the corporate partner are not 

taken into account in determining 

whether a partnership meets the gross 

receipts test of paragraph (c)(2) of this 

section. 

(ii) Aggregation of gross receipts. The 

aggregation rules in § 1.448–1T(f)(2)(ii) 

apply for purposes of aggregating gross 

receipts for purposes of this section. 

(iii) Treatment of short taxable year. 

The short taxable year rules in § 1.448– 

1T(f)(2)(iii) apply for purposes of this 

section. 

(iv) Determination of gross receipts. 

The determination of gross receipts 

rules in § 1.448–1T(f)(2)(iv) apply for 

purposes of this section. 

(v) Gross receipts test amount—(A) In 

general. For purposes of paragraph (c) of 

this section, the term gross receipts test 

amount means $25,000,000, adjusted 

annually for inflation in the manner 

provided in section 448(c)(4). The 

inflation adjusted gross receipts test 

amount is published annually in 

guidance published in the Internal 

Revenue Bulletin (see § 601.601(d)(2)(ii) 

of this chapter). 

(B) Example. Taxpayer A, a C 

corporation, is a plumbing contractor 

that installs plumbing fixtures in 

customers’ homes or businesses. A’s 

gross receipts for the 2017–2019 taxable 

years are $20 million, $16 million, and 

$30 million, respectively. A’s average 

annual gross receipts for the three 

taxable-year period preceding the 2020 

taxable year is $22 million (($20 million 


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+ $16 million + $30 million)/3) = $22 

million. A may use the cash method for 

its trade or business for the 2020 taxable 

year because its average annual gross 

receipts for the preceding three taxable 

years is not more than the gross receipts 

test amount of paragraph (c)(2)(vi) of 

this section, which is $26 million for 

2020. 

(d) Exception for farming 

businesses—(1) In general. Except in the 

case of a tax shelter, this section does 

not apply to any farming business. A 

taxpayer engaged in a farming business 

and a separate non-farming business is 

not prohibited by this section from 

using the cash method with respect to 

the farming business, even though the 

taxpayer may be prohibited by this 

section from using the cash method 

with respect to the non-farming 

business. 

(2) Farming business—(i) In general. 

For purposes of paragraph (d) of this 

section, the term farming business 

means— 

(A) The trade or business of farming 

as defined in section 263A(e)(4) 

(including the operation of a nursery or 

sod farm, or the raising or harvesting of 

trees bearing fruit, nuts or other crops, 

or ornamental trees), 

(B) The raising, harvesting, or growing 

of trees described in section 263A(c)(5) 

(relating to trees raised, harvested, or 

grown by the taxpayer other than trees 

described in paragraph (d)(2)(i)(A) of 

this section), 

(C) The raising of timber, or 

(D) Processing activities which are 

normally incident to the growing, 

raising, or harvesting of agricultural 

products. 

(ii) Example. Assume a taxpayer is in 

the business of growing fruits and 

vegetables. When the fruits and 

vegetables are ready to be harvested, the 

taxpayer picks, washes, inspects, and 

packages the fruits and vegetables for 

sale. Such activities are normally 

incident to the raising of these crops by 

farmers. The taxpayer will be 

considered to be in the business of 

farming with respect to the growing of 

fruits and vegetables, and the processing 

activities incident to the harvest. 

(iii) Processing activities excluded 

from farming businesses—(A) In 

general. For purposes of this section, a 

farming business does not include the 

processing of commodities or products 

beyond those activities normally 

incident to the growing, raising, or 

harvesting of such products. 

(B) Examples. (1) Example 1. Assume 

that a C corporation taxpayer is in the 

business of growing and harvesting 

wheat and other grains. The taxpayer 

processes the harvested grains to 

produce breads, cereals, and similar 

food products which it sells to 

customers in the course of its business. 

Although the taxpayer is in the farming 

business with respect to the growing 

and harvesting of grain, the taxpayer is 

not in the farming business with respect 

to the processing of such grains to 

produce breads, cereals, and similar 

food products which the taxpayer sells 

to customers. 

(2) Example 2. Assume that a taxpayer 

is in the business of raising livestock. 

The taxpayer uses the livestock in a 

meat processing operation in which the 

livestock are slaughtered, processed, 

and packaged or canned for sale to 

customers. Although the taxpayer is in 

the farming business with respect to the 

raising of livestock, the taxpayer is not 

in the farming business with respect to 

the meat processing operation. 

(e) Exception for qualified personal 

service corporation. The rules in 

§ 1.448–1T(e) relating to the exception 

for qualified personal service 

corporations apply for taxable years 

beginning after December 31, 2017. 

(f) Effect of section 448 on other 

provisions. Except as provided in 

paragraph (b)(2)(iii)(B) of this section, 

nothing in section 448 shall have any 

effect on the application of any other 

provision of law that would otherwise 

limit the use of the cash method, and no 

inference shall be drawn from section 

448 with respect to the application of 

any such provision. For example, 

nothing in section 448 affects the 

requirement of section 447 that certain 

corporations must use an accrual 

method of accounting in computing 

taxable income from farming, or the 

requirement of § 1.446–1(c)(2) that, in 

general, an accrual method be used with 

regard to purchases and sales of 

inventory. Similarly, nothing in section 

448 affects the authority of the 

Commissioner under section 446(b) to 

require the use of an accounting method 

that clearly reflects income, or the 

requirement under section 446(e) that a 

taxpayer secure the consent of the 

Commissioner before changing its 

method of accounting. For example, a 

taxpayer using the cash method may be 

required to change to an accrual method 

of accounting under section 446(b) 

because such method clearly reflects the 

taxpayer’s income, even though the 

taxpayer is not prohibited by section 

448 from using the cash method. 

Similarly, a taxpayer using an accrual 

method of accounting that is not 

prohibited by section 448 from using the 

cash method may not change to the cash 

method unless the taxpayer secures the 

consent of the Commissioner under 

section 446(e). 

(g) Treatment of accounting method 

change and rules for section 481(a) 

adjustment—(1) In general. Any 

taxpayer to whom section 448 applies 

must change its method of accounting in 

accordance with the provisions of this 

paragraph (g). In the case of any 

taxpayer required by this section to 

change its method of accounting, the 

change shall be treated as a change 

initiated by the taxpayer to compute the 

adjustment required under section 481. 

A taxpayer must change to an overall 

accrual method of accounting for the 

first taxable year the taxpayer is subject 

to this section or a subsequent taxable 

year in which the taxpayer is newly 

subject to this section after previously 

making a change in method of 

accounting that complies with section 

448 (mandatory section 448 year). A 

taxpayer may have more than one 

mandatory section 448 year. For 

example, a taxpayer may exceed the 

gross receipts test of section 448(c) in 

non-consecutive taxable years. If the 

taxpayer complies with the provisions 

of paragraph (g)(3) of this section for its 

mandatory section 448 year, the change 

shall be treated as made with the 

consent of the Commissioner. The 

change shall be implemented pursuant 

to the applicable administrative 

procedures to obtain the automatic 

consent of the Commissioner to change 

a method of accounting under section 

446(e) as published in the Internal 

Revenue Bulletin (see Revenue 

Procedure 2015–13 (2015–5 IRB 419) (or 

successor) (see also § 601.601(d)(2) of 

this chapter)). This paragraph (g) applies 

only to a taxpayer who changes from the 

cash method as required by this section. 

This paragraph (g) does not apply to a 

change in method of accounting 

required by any Code section (or 

applicable regulation) other than this 

section. 

(2) Section 481(a) adjustment. The 

amount of the net section 481(a) 

adjustment and the adjustment period 

necessary to implement a change in 

method of accounting required under 

this section are determined under 

§ 1.446–1(e) and the applicable 

administrative procedures to obtain the 

Commissioner’s consent to change a 

method of accounting as published in 

the Internal Revenue Bulletin (see 

Revenue Procedure 2015–13 (2015–5 

IRB 419) (or successor) (see also 

§ 601.601(d)(2) of this chapter). 

(h) Applicability dates. The rules of 

this section apply for taxable years 

beginning on or after January 5, 2021. 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the rules provided in this section 


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provided that the taxpayer follows all 

the applicable rules contained in the 

regulations under section 448 for such 

taxable year and all subsequent taxable 

years. 

■ Par. 16. Newly-redesignated § 1.448–3 

is amended by revising paragraphs (a)(2) 

and (h) to read as follows: 

§ 1.448–3 Nonaccrual of certain amounts 

by service providers. 

(a) * * * 

(2) The taxpayer meets the gross 

receipts test of section 448(c) and 

§ 1.448–1T(f)(2) (in the case of taxable 

years beginning before January 1, 2018), 

or § 1.448–2(c) (in the case of taxable 

years beginning after December 31, 

2017) for all prior taxable years. 

* * * * * 

(h) Applicability dates. (1) Except as 

provided in paragraph (h)(2) of this 

section, this section is applicable for 

taxable years ending on or after August 

31, 2006. 

(2) The rules of paragraph (a)(2) of 

this section apply for taxable years 

beginning on or after January 5, 2021. 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the paragraph described in the first 

sentence of this paragraph (h)(2), 

provided that the taxpayer follows all 

the applicable rules contained in the 

regulations under section 448 for such 

taxable year and all subsequent taxable 

years. 

■ Par. 17. Section 1.460–0 is amended 

by: 

■ 1. Adding an entry for § 1.460–1(h)(3). 

■ 2. Revising the entries for § 1.460– 

3(b)(3), § 1.460–3(b)(3)(i) and (ii), and 

adding entries for § 1.460–3(b)(3)(ii)(A), 

(B), (C) and (D). 

■ 3. Removing the entry for § 1.460– 

3(b)(3)(iii). 

■ 4. Adding entries for § 1.460–3(d), 

§ 1.460–4(i), and § 1.460–6(k). 

The additions and revisions read as 

follows: 

§ 1.460–0 Outline of regulations under 

section 460. 

* * * * * 

§ 1.460–1 Long-term contracts. 

* * * * * 

(h) * * * 

(3) Changes made by Tax Cuts and Jobs Act 

(Pub. L. 115–97). 

* * * * * 

§ 1.460–3 Long-term construction contracts. 

* * * * * 

(b) * * * 

(3) Gross receipts test of section 448(c) 

(i) In general 

(ii) Application of gross receipts test 

(A) In general 

(B) Gross receipts of individuals, etc. 

(C) Partners and S corporation 

shareholders 

(D) Examples 

(1) Example 1. 

(2) Example 2. 

(iii) Method of accounting. 

* * * * * 

(d) Applicability dates. 

§ 1.460–4 Methods of Accounting for longterm contracts. 

* * * * * 

(i) Applicability date. 

* * * * * 

§ 1.460–6 Look-back method. 

* * * * * 

(k) Applicability date. 

■ Par. 18. Section 1.460–1 is amended 

by adding three sentences to the end of 

paragraph (f)(3) and adding paragraph 

(h)(3) to read as follows: 

§ 1.460–1 Long-term contracts. 

* * * * * 

(f) * * * 

(3) * * * A taxpayer may adopt any 

permissible method of accounting for 

each classification of contract. Such 

adoption is not a change in method of 

accounting under section 446 and the 

accompanying regulations. For example, 

a taxpayer that has had only contracts 

classified as nonexempt long-term 

contracts and has used the PCM for 

these contracts may adopt an exempt 

contract method in the taxable year it 

first enters into an exempt long-term 

contract. 

* * * * * 

(h) * * * 

(3) Changes made by Tax Cuts and 

Jobs Act (Pub. L. 115–97). Paragraph 

(f)(3) of this section, and § 1.460–5(d)(1) 

and (d)(3), apply for contracts entered 

into in taxable years beginning on or 

after January 5, 2021. However, for 

contracts entered into after December 

31, 2017, in a taxable year ending after 

December 31, 2017, and before January 

5, 2021, a taxpayer may apply paragraph 

(f)(3) of this section, and § 1.460–5(d)(1) 

and (d)(3), provided that the taxpayer 

also applies the applicable rules 

contained in the regulations under 

section 460 for such taxable year and all 

subsequent taxable years. 

* * * * * 

■ Par. 19. Section 1.460–3 is amended 

by revising paragraphs (b)(1)(ii) and 

(b)(3), and adding paragraph (d) to read 

as follows: 

§ 1.460–3 Long-term construction 

contracts. 

* * * * * 

(b) * * * 

(1) * * * 

(ii) Other construction contract, 

entered into after December 31, 2017, in 

a taxable year ending after December 31, 

2017, by a taxpayer, other than a tax 

shelter prohibited from using the cash 

receipts and disbursements method of 

accounting (cash method) under section 

448(a)(3), who estimates at the time 

such contract is entered into that such 

contract will be completed within the 2- 

year period beginning on the contract 

commencement date, and who meets 

the gross receipts test described in 

paragraph (b)(3) of this section for the 

taxable year in which such contract is 

entered into. 

* * * * * 

(3) Gross receipts test—(i) In general. 

A taxpayer, other than a tax shelter 

prohibited from using the cash method 

under section 448(a)(3), meets the gross 

receipts test of this paragraph (b)(3) if it 

meets the gross receipts test of section 

448(c) and § 1.448–2(c)(2). This gross 

receipts test applies even if the taxpayer 

is not otherwise subject to section 

448(a). 

(ii) Application of gross receipts test— 

(A) In general. In the case of any 

taxpayer that is not a corporation or a 

partnership, and except as provided in 

paragraphs (b)(3)(ii)(B) and (C) of this 

section, the gross receipts test of section 

448(c) and the accompanying 

regulations are applied in the same 

manner as if each trade or business of 

such taxpayer were a corporation or 

partnership. 

(B) Gross receipts of individuals, etc. 

Except when the aggregation rules of 

section 448(c)(2) apply, the gross 

receipts of a taxpayer other than a 

corporation or partnership are the 

amount derived from all trades or 

businesses of such taxpayer. Amounts 

not related to a trade or business are 

excluded from the gross receipts of the 

taxpayer. For example, an individual 

taxpayer’s gross receipts do not include 

inherently personal amounts, such as 

personal injury awards or settlements 

with respect to an injury of the 

individual taxpayer, disability benefits, 

Social Security benefits received by the 

taxpayer during the taxable year, and 

wages received as an employee that are 

reported on Form W–2. 

(C) Partners and S corporation 

shareholders. Except when the 

aggregation rules of section 448(c)(2) 

apply, each partner in a partnership 

includes a share of partnership gross 

receipts in proportion to such partner’s 

distributive share (as determined under 

section 704) of items of gross income 

that were taken into account by the 

partnership under section 703. 

Similarly, a shareholder includes the 

pro rata share of S corporation gross 


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receipts taken into account by the S 

corporation under section 1363(b). 

(D) Example. The operation of this 

paragraph (b)(3) is illustrated by the 

following examples: 

(1) Example 1. Taxpayer A is an 

individual who operates two separate 

and distinct trades or business that are 

reported on Schedule C, Profit or Loss 

from Business, of A’s Federal income 

tax return. For 2020, one trade or 

business has annual average gross 

receipts of $5 million, and the other 

trade or business has average annual 

gross receipts of $35 million. Under 

paragraph (b)(3)(ii)(B) of this section, for 

2020, neither of A’s trades or businesses 

meets the gross receipts test of 

paragraph (b)(3) of this section ($5 

million + $35 million = $40 million, 

which is greater than the inflationadjusted gross receipts test amount for 

2020, which is $26 million). 

(2) Example 2. Taxpayer B is an 

individual who operates three separate 

and distinct trades or business that are 

reported on Schedule C of B’s Federal 

income tax return. For 2020, Business X 

is a retail store with average annual 

gross receipts of $15 million, Business 

Y is a dance studio with average annual 

gross receipts of $6 million, and 

Business Z is a car repair shop with 

average annual gross receipts of $12 

million. Under paragraph (b)(3)(ii)(B) of 

this section, B’s gross receipts are the 

combined amount derived from all three 

of B’s trades or businesses. Therefore, 

for 2020, X, Y and Z do not meet the 

gross receipts test of paragraph (b)(3)(i) 

of this section ($15 million + $6 million 

+ $12 million = $33 million, which is 

greater than the inflation-adjusted gross 

receipts test amount for 2020, which is 

$26 million). 

(iii) Method of accounting. A change 

in the method of accounting used for 

exempt construction contracts described 

in paragraph (b)(1)(ii) of this section is 

a change in method of accounting under 

section 446 and the accompanying 

regulations. For rules distinguishing a 

change in method from adoption of a 

method, see § 1.460–1(f)(3). A taxpayer 

changing its method of accounting must 

obtain the consent of the Commissioner 

in accordance with § 1.446–1(e)(3). For 

rules relating to the clear reflection of 

income and the pattern of consistent 

treatment of an item, see section 446 

and § 1.446–1. A change in method of 

accounting shall be implemented 

pursuant to the applicable 

administrative procedures to obtain the 

consent of the Commissioner to change 

a method of accounting under section 

446(e) as published in the Internal 

Revenue Bulletin (IRB) (see Revenue 

Procedure 2015–13 (2015–5 IRB 419) (or 

successor) (see § 601.601(d)(2) of this 

chapter)). A taxpayer that uses the 

percentage of completion method for 

exempt contracts described in paragraph 

(b)(1)(ii) of this section that wants to 

change to another exempt contract 

method is to use the applicable 

administrative procedures to obtain the 

automatic consent of the Commissioner 

to change such method under section 

446(e) as published in the IRB. A 

taxpayer-initiated change in method of 

accounting will be permitted only on a 

cut-off basis, and thus, a section 481(a) 

adjustment will not be permitted or 

required. See § 1.460–4(g). 

* * * * * 

(d) Applicability Dates. Paragraphs 

(b)(1)(ii) and (b)(3) of this section apply, 

for contracts entered into in taxable 

years beginning on or after January 5, 

2021. However, for contracts entered 

into after December 31, 2017, in a 

taxable year ending after December 31, 

2017, and before January 5, 2021, a 

taxpayer may apply the paragraphs 

described in the first sentence of this 

paragraph (d), provided that the 

taxpayer follows all the applicable rules 

contained in the regulations under 

section 460 for such taxable year and all 

subsequent taxable years. 

■ Par. 20. Section 1.460–4 is amended 

by revising the first sentence of 

paragraph (f)(1) and adding paragraph 

(i) to read as follows: 

§ 1.460–4 Methods of Accounting for longterm contracts. 

* * * * * 

(f) * * * (1) * * * Under section 

56(a)(3), a taxpayer subject to the AMT 

must use the PCM to determine its 

AMTI from any long-term contract 

entered into on or after March 1, 1986, 

that is not a home construction contract, 

as defined in § 1.460–3(b)(2). * * * 

* * * * * 

(i) Applicability date. Paragraph (f)(1) 

of this section applies to taxable years 

beginning on or after January 5, 2021. 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the paragraph described in the first 

sentence of this paragraph (i), provided 

that the taxpayer follows all the 

applicable rules contained in the 

regulations under section 460 for such 

taxable year and all subsequent taxable 

years. 

* * * * * 

■ Par. 21. Section 1.460–5 is amended: 

■ 1. In paragraph (d)(1), by removing the 

language ‘‘(concerning contracts of 

homebuilders that do not satisfy the 

$10,000,000 gross receipts test described 

in § 1.460–3(b)(3) or will not be 

completed within two years of the 

contract commencement date)’’. 

■ 2. By revising paragraph (d)(3). 

The revision reads as follows: 

§ 1.460–5 Cost allocation rules. 

* * * * * 

(d) * * * 

(3) Large homebuilders. A taxpayer 

must capitalize the costs of home 

construction contracts under section 

263A, unless the taxpayer estimates, 

when entering into the contract, that it 

will be completed within two years of 

the contract commencement date, and 

the taxpayer satisfies the gross receipts 

test of section 448(c) described in 

§ 1.460–3(b)(3) for the taxable year in 

which the contract is entered into. 

* * * * * 

■ Par. 22. Section 1.460–6 is amended: 

■ 1. In paragraph (b)(2) introductory 

text, by removing the language ‘‘section 

460(e)(4)’’ and adding in its place the 

language ‘‘section 460(e)(3)’’. 

■ 2. By revising the first and last 

sentences of paragraph (b)(2)(ii). 

■ 3. By designating the undesignated 

text after paragraph (b)(3)(ii) as 

paragraph (b)(3)(iii). 

■ 4. In newly designated paragraph 

(b)(3)(iii), by adding a sentence to the 

end of the paragraph. 

■ 5. In paragraph (c)(1)(i), by revising 

the fifth sentence. 

■ 6. In paragraph (c)(2)(i), by revising 

the third sentence. 

■ 7. In paragraph (c)(2)(iv), by revising 

the first sentence. 

■ 8. In paragraph (c)(3)(ii), by revising 

the first sentence. 

■ 9. In paragraph (c)(3)(vi), by revising 

the first sentence. 

■ 10. In paragraph (d)(2)(i), by removing 

the language ‘‘whether or not the 

taxpayer would have been subject to the 

alternative minimum tax’’ and adding in 

its place the language ‘‘for taxpayers 

subject to the alternative minimum tax 

without regard to whether tentative 

minimum tax exceeds regular tax for the 

redetermination year’’. 

■ 11. By revising paragraph (d)(4)(i)(A). 

■ 12. By designating paragraph (h)(8)(ii) 

Example 7 as paragraph (h)(8)(iii). 

■ 13. By revising newly designated 

paragraph (h)(8)(iii). 

■ 14. By adding paragraph (k). 

The revisions and additions read as 

follows: 

§ 1.460–6 Look-back method. 

* * * * * 

(b) * * * 

(2) * * * 

(ii) is not a home construction 

contract but is estimated to be 

completed within a 2-year period by a 

taxpayer, other than a tax shelter 


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prohibited from using the cash receipts 

and disbursements method of 

accounting under section 448(a)(3), who 

meets the gross receipts test of section 

448(c) and § 1.460–3(b)(3) for the 

taxable year in which such contract is 

entered into. * * * The look-back 

method, however, applies to the 

alternative minimum taxable income 

from a contract of this type, for those 

taxpayers subject to the AMT in taxable 

years prior to the filing taxable year in 

which the look-back method is required, 

unless the contract is exempt from 

required use of the percentage of 

completion method under section 

56(a)(3). 

(3) * * * 

(iii) * * * For contracts entered into 

after December 31, 2017, in a taxable 

year ending after December 31, 2017, a 

taxpayer’s gross receipts are determined 

in the manner required by regulations 

under section 448(c). 

* * * * * 

(c) * * * 

(1) * * * 

(i) * * * Based on this reapplication, 

the taxpayer determines the amount of 

taxable income (and, when applicable, 

alternative minimum taxable income 

and modified taxable income under 

section 59A(c)) that would have been 

reported for each year prior to the filing 

year that is affected by contracts 

completed or adjusted in the filing year 

if the actual, rather than estimated, total 

contract price and costs had been used 

in applying the percentage of 

completion method to these contracts, 

and to any other contracts completed or 

adjusted in a year preceding the filing 

year. * * * 

* * * * * 

(2) * * * (i) * * * The taxpayer then 

must determine the amount of taxable 

income (and, when applicable, 

alternative minimum taxable income 

and modified taxable income under 

section 59A(c)) that would have been 

reported for each affected tax year 

preceding the filing year if the 

percentage of completion method had 

been applied on the basis of actual 

contract price and contract costs in 

reporting income from all contracts 

completed or adjusted in the filing year 

and in any preceding year. * * * 

* * * * * 

(iv) * * * In general, because income 

under the percentage of completion 

method is generally reported as costs are 

incurred, the taxable income and, when 

applicable, alternative minimum taxable 

income and modified taxable income 

under section 59A(c), are recomputed 

only for each year in which allocable 

contract costs were incurred. * * * 

* * * * * 

(3) * * * 

(ii) * * * Under the method 

described in this paragraph (c)(3) (actual 

method), a taxpayer first must 

determine what its regular and, when 

applicable, its alternative minimum tax 

and base erosion minimum tax liability 

would have been for each 

redetermination year if the amounts of 

contract income allocated in Step One 

for all contracts completed or adjusted 

in the filing year and in any prior year 

were substituted for the amounts of 

contract income reported under the 

percentage of completion method on the 

taxpayer’s original return (or as 

subsequently adjusted on examination, 

or by amended return). * * * 

* * * * * 

(vi) * * * For purposes of Step Two, 

the income tax liability must be 

redetermined by taking into account all 

applicable additions to tax, credits, and 

net operating loss carrybacks and 

carryovers. Thus, the taxes, if any, 

imposed under sections 55 and 59A 

(relating to alternative and base erosion 

minimum tax, respectively) must be 

taken into account. * * * 

* * * * * 

(d) * * * 

(4) * * * (i) * * *(A) General rule. 

The simplified marginal impact method 

is required to be used with respect to 

income reported from domestic 

contracts by a pass-through entity that is 

either a partnership, an S corporation, 

or a trust, and that is not closely held. 

With respect to contracts described in 

the preceding sentence, the simplified 

marginal impact method is applied by 

the pass-through entity at the entity 

level. The pass-through entity 

determines the amount of any 

hypothetical underpayment or 

overpayment for a redetermination year 

using the highest rate of tax in effect for 

corporations under section 11. However, 

for redetermination years beginning 

before January 1, 2018, the pass-through 

entity uses the highest rates of tax in 

effect for corporations under section 11 

and section 55(b)(1). Further, the passthrough entity uses the highest rates of 

tax imposed on individuals under 

section 1 and section 55(b)(1) if, at all 

times during the redetermination year 

involved (that is, the year in which the 

hypothetical increase or decrease in 

income arises), more than 50 percent of 

the interests in the entity were held by 

individuals directly or through 1 or 

more pass-through entities. 

* * * * * 

(h) * * * 

(8) * * * 

(iii) Example 7. X, a calendar year C 

corporation, is engaged in the 

construction of real property under 

contracts that are completed within a 

24-month period. Its average annual 

gross receipts for the prior 3-taxableyear period does not exceed 

$25,000,000. As permitted by section 

460(e)(1)(B), X uses the completed 

contract method (CCM) for regular tax 

purposes. However, X is engaged in the 

construction of commercial real 

property and, for years beginning before 

January 1, 2018, is required to use the 

percentage of completion method (PCM) 

for alternative minimum tax (AMT) 

purposes. Assume that for 2017, 2018, 

and 2019, X has only one long-term 

contract, which is entered into in 2017 

and completed in 2019 and that in 2017 

X’s average annual gross receipts for the 

prior 3-taxable-years do not exceed 

$10,000,000. Assume further that X 

estimates gross income from the 

contract to be $2,000, total contract 

costs to be $1,000, and that the contract 

is 25 percent complete in 2017 and 70 

percent complete in 2018, and 5 percent 

complete in 2019. In 2019, the year of 

completion, gross income from the 

contract is actually $3,000, instead of 

$2,000, and costs are actually $1,000. 

Because X was required to use the PCM 

for 2017 for AMT purposes, X must 

apply the look-back method to its AMT 

reporting for that year. X has elected to 

use the simplified marginal impact 

method. For 2017, X’s income using 

estimated contract price and costs is as 

follows: 

TABLE 1 TO PARAGRAPH (h)(8)(iii) 

Estimates 2017 

Gross Income ............ $500 = ($2,000 × 

25%) 

Deductions ................ $(250) = ($1,000 × 

25%) 

Contract Income— 

PCM.

$250 

(A) When X files its federal income 

tax return for 2019, the contract 

completion year, X applies the lookback method. For 2017, X’s income 

using actual contract price and costs is 

as follows: 

TABLE 2 TO PARAGRAPH (h)(8)(iii)(A) 

Actual 2017 

Gross Income ............ $750 = ($3,000 × 

25%) 

Deductions ................ $(250) = ($1,000 × 

25%) 

Contract Income— 

PCM.

$500 


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(B) Accordingly, the reallocation of 

contract income under the look-back 

method results in an increase of income 

for AMT purposes for 2017 of $250 

($500–$250). Under the simplified 

marginal impact method, X applies the 

highest rate of tax under section 55(b)(1) 

to this increase, which produces a 

hypothetical underpayment for 2017 of 

$50 (.20 × $250). Interest is charged to 

X on this $50 underpayment from the 

due date of X’s 2017 return until the due 

date of X’s 2019 return. X, a C 

corporation, is not subject to the AMT 

in 2018. X does not compute alternative 

minimum taxable income or use the 

PCM in that year. Accordingly, lookback does not apply to 2018. 

* * * * * 

(k) Applicability date. Paragraphs 

(b)(2), (b)(2)(ii), (b)(3)(iii), (c)(1)(i), 

(c)(2)(i), (c)(2)(iv), (c)(3)(ii), (c)(3)(vi), 

(d)(2)(i), (d)(4)(i)(A), and (h)(8)(iii) of 

this section apply to taxable years 

beginning on or after January 5, 2021. 

However, for a taxable year beginning 

after December 31, 2017, and before 

January 5, 2021, a taxpayer may apply 

the paragraphs described in the first 

sentence of this paragraph (k), provided 

that the taxpayer follows all the 

applicable rules contained in the 

regulations under section 460 for such 

taxable year and all subsequent taxable 

years. Further, a taxpayer may apply 

those portions of paragraphs (b)(2)(ii) 

and (b)(3)(iii) of this section that relate 

to section 460(e)(1)(B) for contracts 

entered into after December 31, 2017, in 

a taxable year ending after December 31, 

2017, provided that the taxpayer follows 

all the applicable rules contained in the 

regulations under section 460 for such 

taxable year and all subsequent taxable 

years. 

■ Par. 23. § 1.471–1 is amended by: 

■ 1. Designating the undesignated 

paragraph as paragraph (a). 

■ 2. Adding a heading to newly 

designated paragraph (a) and revising 

the first sentence. 

■ 3. Adding paragraphs (b) and (c). 

The revision and addition read as 

follows: 

§ 1.471–1 Need for inventories. 

(a) In general. Except as provided in 

paragraph (b) of this section, in order to 

reflect taxable income correctly, 

inventories at the beginning and end of 

each taxable year are necessary in every 

case in which the production, purchase, 

or sale of merchandise is an incomeproducing factor. * * * 

(b) Exemption for certain small 

business taxpayers—(1) In general. 

Paragraph (a) of this section shall not 

apply to a taxpayer, other than a tax 

shelter prohibited from using the cash 

receipts and disbursements method of 

accounting (cash method) under section 

448(a)(3), in any taxable year if the 

taxpayer meets the gross receipts test 

described in paragraph (b)(2) of this 

section, and uses as a method of 

accounting for its inventory a method 

that is described in paragraph (b)(3) of 

this section. 

(2) Gross receipts test—(i) In general. 

A taxpayer, other than a tax shelter 

prohibited from using the cash method 

under section 448(a)(3), meets the gross 

receipts test of this paragraph (b)(2) if it 

meets the gross receipts test of section 

448(c) and § 1.448–2(c). This gross 

receipts test applies even if the taxpayer 

is not otherwise subject to section 

448(a). 

(ii) Application of the gross receipts 

test—(A) In general. In the case of any 

taxpayer that is not a corporation or 

partnership, and except as otherwise 

provided in paragraphs (b)(2)(ii)(B) and 

(C) of this section, the gross receipts test 

of section 448(c) and the accompanying 

regulations are applied in the same 

manner as each trade or business of the 

taxpayer were a corporation or 

partnership. 

(B) Gross receipts of individuals, etc. 

Except when the aggregation rules of 

section 448(c)(2) apply, the gross 

receipts of a taxpayer other than a 

corporation or partnership are the 

amount derived from all trades or 

businesses of such taxpayer. Amounts 

not related to a trade or businesses are 

excluded from the gross receipts of the 

taxpayer. For example, an individual 

taxpayer’s gross receipts do not include 

inherently personal amounts, such as: 

personal injury awards or settlements 

with respect to an injury of the 

individual taxpayer, disability benefits, 

Social Security benefits received by the 

taxpayer during the taxable year, and 

wages received as an employee that are 

reported on Form W–2. 

(C) Partners and S corporation 

shareholders—(1) In general. Except 

when the aggregation rules of section 

448(c)(2) apply, each partner in a 

partnership includes a share of the 

partnership’s gross receipts in 

proportion to such partner’s distributive 

share (as determined under section 704) 

of items of gross income that were taken 

into account by the partnership under 

section 703. Similarly, a shareholder 

includes the pro rata share of S 

corporation gross receipts taken into 

account by the S corporation under 

section 1363(b). 

(2) [Reserved] 

(D) Examples. The operation of this 

paragraph (b)(2) is illustrated by the 

following examples: 

(1) Example 1. Taxpayer A, a calendar 

year S corporation, is a reseller and 

maintains inventories. In 2017, 2018, 

and 2019, A’s gross receipts were $10 

million, $11 million, and $13 million 

respectively. A is not prohibited from 

using the cash method under section 

448(a)(3). For 2020, A meets the gross 

receipts test of paragraph (b)(2) of this 

section. 

(2) Example 2. Taxpayer B operates 

two separate and distinct trades or 

businesses that are reported on 

Schedule C, Profit or Loss from 

Business, of B’s Federal income tax 

return. For 2020, one trade or business 

has annual average gross receipts of $5 

million, and the other trade or business 

has average annual gross receipts of $35 

million. Under paragraph (b)(2)(ii)(B) of 

this section, for 2020, neither of B’s 

trades or businesses meets the gross 

receipts test of paragraph (b)(2) of this 

section ($5 million + $35 million = $40 

million, which is greater than the 

inflation-adjusted gross receipts test 

amount for 2020, which is $26 million). 

(3) Example 3. Taxpayer C is an 

individual who operates three separate 

and distinct trades or business that are 

reported on Schedule C of C’s Federal 

income tax return. For 2020, Business X 

is a retail store with average annual 

gross receipts of $15 million, Business 

Y is a dance studio with average annual 

gross receipts of $6 million, and 

Business Z is a car repair shop with 

average annual gross receipts of $12 

million. Under paragraph (b)(2)(ii)(B) of 

this section, C’s gross receipts are the 

combined amount derived from all three 

of C’s trades or businesses. Therefore, 

for 2020, X, Y and Z do not meet the 

gross receipts test of paragraph (b)(2)(i) 

of this section ($15 million + $6 million 

+ $12 million = $33 million, which is 

greater than the inflation-adjusted gross 

receipts test amount for 2020, which is 

$26 million). 

(3) Methods of accounting under the 

small business taxpayer exemption. A 

taxpayer eligible to use, and that 

chooses to use, the exemption described 

in paragraph (b) of this section may 

account for its inventory by either: 

(i) Using a method that treats its 

inventory as non-incidental materials 

and supplies (section 471(c) NIMS 

inventory method), as described in 

paragraph (b)(4) of this section; or 

(ii) Using the method for each item 

that is reflected in the taxpayer’s 

applicable financial statement (AFS) 

(AFS section 471(c) inventory method); 

or, if the taxpayer does not have an AFS 

for the taxable year, the books and 

records of the taxpayer prepared in 

accordance with the taxpayer’s 

accounting procedures, as defined in 


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paragraph (b)(6)(ii) of this section (nonAFS section 471(c) inventory method). 

(4) Inventory treated as nonincidental materials and supplies—(i) In 

general. The costs of inventory treated 

as non-incidental materials and supplies 

are recovered through cost of goods sold 

only in the taxable year in which the 

inventory is used or consumed in the 

taxpayer’s business, or in the taxable 

year in which the taxpayer pays for or 

incurs the cost of the inventory, 

whichever is later. Inventory treated as 

non-incidental materials and supplies is 

used or consumed in the taxpayer’s 

business in the taxable year in which 

the taxpayer provides the inventory to 

its customer. The costs of inventory are 

treated as non-incidental materials and 

supplies under this paragraph (b)(4) are 

not eligible for the de minimis safe 

harbor election under § 1.263(a)–1(f)(2). 

(ii) Identification and valuation of 

inventory treated as non-incidental 

materials and supplies. A taxpayer may 

determine the amount of the costs of its 

inventory treated as non-incidental 

materials and supplies that are 

recoverable through costs of goods sold 

by using either a specific identification 

method, a first-in, first-out (FIFO) 

method, or an average cost method, 

provided that method is used 

consistently. See § 1.471–2(d). A 

taxpayer that uses the section 471(c) 

NIMS inventory method may not use 

any other method described in the 

regulations under section 471, or the 

last-in, first-out (LIFO) method 

described in section 472 and the 

accompanying regulations, to either 

identify inventory treated as nonincidental materials and supplies, or to 

value that inventory treated as nonincidental materials and supplies. The 

inventory costs includible in the section 

471(c) NIMS inventory method are the 

direct material costs of the property 

produced or the costs of property 

acquired for resale. However, an 

inventory cost does not include a cost 

for which a deduction would be 

disallowed, or that is not otherwise 

recoverable but for paragraph (b)(4) of 

this section, in whole or in part, under 

a provision of the Internal Revenue 

Code. 

(iii) Allocation methods. A taxpayer 

treating its inventory as non-incidental 

materials and supplies under this 

paragraph (b)(4) may allocate the costs 

of such inventory by using specific 

identification or any other reasonable 

method. 

(iv) Example. Taxpayer D is a baker 

that reports its baking trade or business 

on Schedule C, Profit or Loss From 

Business, of the Form 1040, Individual 

Tax Return, and D’s baking business has 

average annual gross receipts for the 3- 

taxable years prior to 2019 of less than 

$100,000. D meets the gross receipts test 

of section 448(c) and is not prohibited 

from using the cash method under 

section 448(a)(3) in 2019. Therefore, D 

qualifies as a small business taxpayer 

under paragraph (b)(2) of this section. D 

uses the overall cash method, and the 

section 471(c) NIMS inventory method. 

D purchases $50 of peanut butter in 

November 2019. In December 2019, D 

uses all of the peanut butter to bake 

cookies available for immediate sale. D 

sells those peanut butter cookies to 

customers in January 2020. The peanut 

butter cookies are used or consumed 

under paragraph (b)(4)(i) of this section 

in January 2020 when the cookies are 

sold to customers, and D may recover 

the cost of the peanut butter in 2020. 

(5) AFS section 471(c) inventory 

method—(i) In general. A taxpayer that 

meets the gross receipts test described 

in paragraph (b)(2) of this section and 

that has an AFS for such taxable year 

may use the AFS section 471(c) 

inventory method described in this 

paragraph to account for its inventory 

costs for the taxable year. For purposes 

of the AFS section 471(c) inventory 

method, an inventory cost is a cost of 

production or resale that a taxpayer 

capitalizes to inventory property 

produced or property acquired for resale 

in its AFS. For purposes of the AFS 

section 471(c) inventory method, costs 

that are generally required to be 

capitalized to inventory under section 

471(a) but that the taxpayer does not 

capitalize to inventory on its AFS are 

not required to be capitalized to 

inventory. However, an inventory cost 

does not include a cost that is neither 

deductible nor otherwise recoverable 

but for paragraph (b)(5) of this section, 

in whole or in part, under a provision 

of the Internal Revenue Code (for 

example, section 162(c), (e), (f), (g), or 

274). In lieu of the inventory method 

described in section 471(a), a taxpayer 

using the AFS section 471(c) inventory 

method recovers its inventory costs in 

accordance with the inventory method 

used in its AFS. 

(ii) Definition of Applicable Financial 

Statement (AFS). The term applicable 

financial statement (AFS) is defined in 

section 451(b)(3) and the accompanying 

regulations. See § 1.451–3(a)(5). The 

rules relating to additional AFS issues 

provided in § 1.451–3(h) apply to the 

AFS section 471(c) inventory method. In 

the case of a taxpayer with a financial 

accounting year that differs from the 

taxpayer’s taxable year, the taxpayer 

must consistently use the same method 

of accounting described in § 1.451– 

3(h)(4)(i)(A) through (C) that is used for 

section 451(b) purposes to also 

determine its inventory for the taxable 

year under this paragraph (b)(5)(ii). A 

taxpayer has an AFS for the taxable year 

if all of the taxpayer’s taxable year is 

covered by an AFS. 

(iii) Timing of inventory costs. 

Notwithstanding the timing rules used 

in the taxpayer’s AFS, the amount of 

any inventoriable cost may not be 

capitalized or otherwise taken into 

account for Federal income tax purposes 

any earlier than the taxable year during 

which the amount is paid or incurred 

under the taxpayer’s overall method of 

accounting, as described in § 1.446– 

1(c)(1). For example, in the case of an 

accrual method taxpayer, inventoriable 

costs must satisfy the all events test, 

including economic performance, of 

section 461. See § 1.446–1(c)(1)(ii) and 

section 461 and the accompanying 

regulations. 

(iv) Example. H is a calendar year C 

corporation that is engaged in the trade 

or business of selling office supplies and 

providing copier repair services. H 

meets the gross receipts test of section 

448(c) and is not prohibited from using 

the cash method under section 448(a)(3) 

for 2019 or 2020. For Federal income tax 

purposes, H chooses to account for 

purchases and sales of inventory using 

an accrual method of accounting and for 

all other items using the cash method. 

For AFS purposes, H uses an overall 

accrual method of accounting. H uses 

the AFS section 471(c) inventory 

method of accounting. In H’s 2019 AFS, 

H incurred $2 million in purchases of 

office supplies held for resale and 

recovered the $2 million as cost of 

goods sold. On January 5, 2020, H 

makes payment on $1.5 million of these 

office supplies. For purposes of the AFS 

section 471(c) inventory method of 

accounting, H can recover the $2 

million of office supplies in 2019 

because the amount has been included 

in cost of goods sold in its AFS 

inventory method and section 461 has 

been satisfied. 

(6) Non-AFS section 471(c) inventory 

method—(i) In general. A taxpayer that 

meets the gross receipts test described 

in paragraph (b)(2) of this section for a 

taxable year and that does not have an 

AFS, as defined in paragraph (b)(5)(ii) of 

this section, for such taxable year may 

use the non-AFS section 471(c) 

inventory method to account for its 

inventories for the taxable year in 

accordance with this paragraph (b)(6). 

The non-AFS section 471(c) inventory 

method is the method of accounting 

used for inventory in the taxpayer’s 

books and records that properly reflect 

its business activities for non-tax 

purposes and are prepared in 


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accordance with the taxpayer’s 

accounting procedures. For purposes of 

the non-AFS section 471(c) inventory 

method, an inventory cost is a cost of 

production or resale that the taxpayer 

capitalizes to inventory property 

produced or property acquired for resale 

in its books and records, except as 

provided in paragraph (b)(6)(ii) of this 

section. Costs that are generally required 

to be capitalized to inventory under 

section 471(a), but that the taxpayer 

does not capitalize in its books and 

records are not required to be 

capitalized to inventory. However, an 

inventory cost does not include a cost 

that is neither deductible nor otherwise 

recoverable but for paragraph (b)(5) of 

this section, in whole or in part, under 

a provision of the Internal Revenue 

Code (for example, section 162(c), (e), 

(f), (g), or 274). In lieu of the inventory 

method described in section 471(a), a 

taxpayer using the non-AFS section 

471(c) inventory method recovers its 

applicable costs through its book 

inventory method of accounting. A 

taxpayer that has an AFS for such 

taxable year may not use the non-AFS 

section 471(c) inventory method. 

(ii) Timing and amounts of costs. 

Notwithstanding the timing of costs 

reflected in the taxpayer’s books and 

records, a taxpayer may not recover any 

costs that have not been paid or 

incurred under the taxpayer’s overall 

method of accounting, as described in 

§ 1.446–1(c)(1). For example, in the case 

of an accrual method taxpayer or a 

taxpayer using an accrual method for 

purchases and sales, inventory costs 

must satisfy the all events test, 

including economic performance, under 

section 461(h). See § 1.446–1(c)(1)(ii), 

and section 461 and the accompanying 

regulations. 

(iii) Examples. The following 

examples illustrate the rules of 

paragraph (b)(6) of this section. 

(A) Example 1. Taxpayer E is a C 

corporation that is engaged in the retail 

trade or business of selling beer, wine, 

and liquor. In 2019, E has average 

annual gross receipts for the prior 3- 

taxable-years of $15 million and is not 

otherwise prohibited from using the 

cash method under section 448(a)(3). E 

does not have an AFS for the 2019 

taxable year. E is eligible to use the nonAFS section 471(c) inventory method of 

accounting. E uses the overall cash 

method, and the non-AFS section 471(c) 

inventory method of accounting for 

Federal income tax purposes. In E’s 

electronic bookkeeping software, E 

treats all costs paid during the taxable 

year as presently deductible. As part of 

its regular business practice, E’s 

employees take a physical count of 

inventory on E’s selling floor and its 

warehouse on December 31, 2019, and 

E uses this physical count as part of its 

books and records for purposes of 

capitalizing and allocating costs to 

inventory. E also makes representations 

to its creditor of the cost of inventory on 

hand for specific categories of product 

it sells. E may not expense all of its costs 

paid during the 2019 taxable year 

because its books and records do not 

accurately reflect the inventory records 

used for non-tax purposes in its regular 

business activity. Instead, E must use 

the physical inventory count taken at 

the end of 2019 to determine how its 

capitalized costs are allocated and 

recovered. 

(B) Example 2. Same facts as Example 

(1) in paragraph (b)(6)(iii)(A) of this 

section but E does not use the physical 

count to capitalize and allocate costs to 

inventory and does not make any 

representations about inventory on hand 

to any creditors. Although E pays or 

incurs costs that are generally required 

to be capitalized to inventory under 

section 471(a), because such costs are 

not capitalized to inventory in E’s books 

and records, they are not required to be 

capitalized to inventory under 

paragraph (b)(6)(i) of this section. 

(C) Example 3. Same facts as Example 

(1) in paragraph (b)(6)(iii)(A) of this 

section but E does not use the physical 

count to capitalize and allocate costs to 

inventory in its electronic bookkeeping 

software and does not make any 

representations about inventory on hand 

to any external parties. E does use the 

physical count to value inventory on 

hand for internal reports to its 

shareholders. The internal reports to its 

shareholders are part of E’s books and 

records and must be taken into account 

for E’s non-AFS section 471(c) inventory 

method. E recovers its inventory costs 

consistent with its non-AFS section 

471(c) inventory method. 

(D) Example 4. Taxpayer F is a C 

corporation that is engaged in the 

manufacture of baseball bats. In 2019, F 

has average annual gross receipts for the 

prior 3-taxable-years of less than $25 

million and is not otherwise prohibited 

from using the cash method under 

section 448(a)(3). F does not have an 

AFS for the 2019 taxable year. For 

Federal income tax purposes, F uses the 

overall cash method of accounting, and 

the non-AFS section 471(c) inventory 

method of accounting. For its books and 

records, F uses an overall accrual 

method and maintains inventories. In 

December 2019, F’s financial statements 

show $500,000 of direct and indirect 

material costs. F pays its supplier in 

January 2020. Under paragraph (b)(6)(ii) 

of this section, F recovers its direct and 

indirect material costs in 2020. 

(E) Example 5. Taxpayer G is a baker 

that reports its baking trade or business 

on Schedule C, Profit or Loss From 

Business, of the Form 1040, Individual 

Tax Return. In 2020, G’s baking business 

has average annual gross receipts for the 

prior 3-taxable years of less than 

$100,000 and is not otherwise 

prohibited from using the cash method 

under section 448(a)(3). G does not have 

an AFS for the 2020 taxable year. For 

Federal income tax purposes, G uses the 

overall cash method of accounting and 

the non-AFS section 471(c) inventory 

method. In G’s books and records for 

2020 that properly reflects its business 

activities for non-tax purposes, G 

capitalizes the cost of its cookie 

ingredients to inventory but 

immediately expenses the cost of labor 

for G’s employee who bakes the cookies. 

Under paragraphs (b)(6)(i) and (ii) of 

this section, G treats as an inventory 

cost the cost of its cookie ingredients 

and recovers such costs in accordance 

with the accounting procedures used to 

prepare its books and records, or, if 

later, when paid. Additionally, although 

the cost of direct labor is generally 

required to be capitalized to inventory 

under section 471(a), because such cost 

is not capitalized to inventory in G’s 

books and records, it is not required to 

be capitalized to inventory under 

paragraph (b)(6)(i) of this section. 

Further, because such direct labor cost 

is generally deductible under section 

162, and not otherwise required to be 

capitalized under section 263(a), G may 

deduct the cost of labor in the year G 

pays that expense. 

(F) Example 6. Taxpayer H is a 

partnership engaged in the resale of 

beer, wine, and liquor. In 2020, H has 

average annual gross receipts for the 

prior 3-taxable-years of less than $25 

million and is not otherwise prohibited 

from using the cash method under 

section 448(a)(3). H does not have an 

AFS for the 2020 taxable year. For 

Federal income tax purposes, H uses the 

overall cash method of accounting, and 

the non-AFS section 471(c) inventory 

method of accounting. For its books and 

records, H uses the overall cash method. 

As part of its regular business practice, 

H’s employees take regular physical 

counts of the inventory on the shop 

floor and in the storeroom, however H’s 

method of accounting for inventory for 

its books and records does not allocate 

costs between ending inventory and cost 

of goods sold, and instead expenses the 

cost of the inventory in the year it was 

paid for. Prior to December 2020, H 

acquires and pays for $500,000 of beer, 

wine, and liquor. In addition, on 


jbell on DSKJLSW7X2PROD with RULES
278 Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations 

December 1, 2020, H acquires $50,000 

in beer and wine, and pays for this beer 

and wine on December 20, 2020. H may 

recover as deductions in 2020 the 

$550,000 of inventory costs. 

(G) Example 7. Taxpayer J is a 

partnership engaged in the resale of 

beer, wine, and liquor. In 2020, J has 

average annual gross receipts for the 

prior 3-taxable-years of less than $25 

million and is not otherwise prohibited 

from using the cash method under 

section 448(a)(3). J does not have an 

AFS for the 2020 taxable year. For 

Federal income tax purposes, J uses the 

overall cash method of accounting, and 

the non-AFS section 471(c) inventory 

method of accounting. For its books and 

records, J uses the overall cash method. 

J maintains a point-of-sale computer 

system that tracks acquisition costs and 

inventory levels of the beer, wine, and 

liquor. The ledger is periodically 

reconciled with physical counts 

performed by J’s employees. J must use 

the physical inventory count and ledger 

to determine its ending inventory. J 

includes in cost of goods sold for 2020 

those inventory costs that are not 

properly allocated to ending inventory. 

(7) Effect of section 471(c) on other 

provisions. Nothing in section 471(c) 

shall have any effect on the application 

of any other provision of law that would 

otherwise apply, and no inference shall 

be drawn from section 471(c) with 

respect to the application of any such 

provision. For example, an accrual 

method taxpayer that includes 

inventory costs in its AFS is required to 

satisfy section 461 before such cost can 

be included in cost of goods sold for the 

taxable year. Similarly, nothing in 

section 471(c) affects the requirement 

under section 446(e) that a taxpayer 

secure the consent of the Commissioner 

before changing its method of 

accounting. If an item of income or 

expense is not treated consistently from 

year to year, that treatment may not 

clearly reflect income, notwithstanding 

the application of this section. Finally, 

nothing in section 471(c) permits the 

deduction or recovery of any cost that 

a taxpayer is otherwise precluded from 

deducting or recovering under any other 

provision in the Code or Regulations. 

(8) Method of accounting—(i) In 

general. A change in the method of 

treating inventory under this paragraph 

(b) is a change in method of accounting 

under sections 446 and 481 and the 

accompanying regulations. A taxpayer 

changing its method of accounting 

under paragraph (b) of this section may 

do so only with the consent of the 

Commissioner as required under section 

446(e) and § 1.446–1. For example, a 

taxpayer using the AFS section 471(c) 

inventory method or non-AFS section 

471(c) inventory method that wants to 

change its method of accounting for 

inventory in its AFS, or its books and 

records, respectively, is required to 

secure the consent of the Commissioner 

before using this new method for 

Federal income tax purposes. However, 

a change from having an AFS to not 

having an AFS, or vice versa, without a 

change in the underlying method for 

inventory for financial reporting 

purposes that affects Federal income tax 

is not a change in method of accounting 

for such inventory under section 446(e). 

In the case of any taxpayer required by 

this section to change its method of 

accounting for any taxable year, the 

change shall be treated as a change 

initiated by the taxpayer. For rules 

relating to the clear reflection of income 

and the pattern of consistent treatment 

of an item, see section 446 and § 1.446– 

1. The amount of the net section 481(a) 

adjustment and the adjustment period 

necessary to implement a change in 

method of accounting required under 

this section are determined under 

§ 1.446–1(e) and the applicable 

administrative procedures to obtain the 

Commissioner’s consent to change a 

method of accounting as published in 

the Internal Revenue Bulletin (see 

Revenue Procedure 2015–13 (2015–5 

IRB 419) (or successor) (see also 

§ 601.601(d)(2) of this chapter). 

(ii) Automatic consent for certain 

method changes. Certain changes in 

method of accounting made under 

paragraph (b) of this section may be 

made under the procedures to obtain the 

automatic consent of the Commissioner 

to change a method of accounting. See 

Revenue Procedure 2015–13 (2015–5 

IRB 419) (or successor) (see 

§ 601.601(d)(2) of this chapter)). In 

certain situations, special terms and 

conditions may apply. 

(c) Applicability dates. This section 

applies for taxable years beginning on or 

after January 5, 2021. However, for a 

taxable year beginning after December 

31, 2017, and before January 5, 2021, a 

taxpayer may apply this section 

provided that the taxpayer follows all 

the applicable rules contained in this 

section for such taxable year and all 

subsequent taxable years. 

Douglas W. O’Donnell, 

Acting Deputy Commissioner for Services and 

Enforcement. 

Approved: December 18, 2020. 

David J. Kautter, 

Assistant Secretary of the Treasury (Tax 

Policy). 

[FR Doc. 2020–28888 Filed 12–31–20; 8:45 am] 

BILLING CODE P 


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