[Federal Register Volume 65, Number 98 (Friday, May 19, 2000)]
[Proposed Rules]
[Pages 31841-31853]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-12174]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-107644-98]
RIN 1545-AX20


Dollar-Value LIFO Regulations; Inventory Price Index Computation 
Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations under section 472 
of the Internal Revenue Code that relate to accounting for inventories 
under the last-in, first-out (LIFO) method. The proposed regulations 
provide guidance regarding methods of valuing dollar-value LIFO pools 
and affect persons who elect to use the dollar-value LIFO and inventory 
price index computation (IPIC) methods. This document also provides 
notice of a public hearing on these proposed regulations.

DATES: Written and electronic comments must be received by August 17, 
2000. Requests to speak (with outlines of oral comments) at a public 
hearing scheduled for September 15, 2000, at 10 a.m., must be received 
by August 25, 2000.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-107644-98), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 5 p.m. to:
    CC:DOM:CORP:R (REG-107644-98), Courier's Desk, Internal Revenue 
Service, 1111 Constitution Avenue, NW., Washington, DC.
    Alternatively, taxpayers may submit comments electronically via the 
Internet by selecting the ``Tax Regs'' option on the IRS Home Page, or 
by submitting comments directly to the IRS Internet site at http://www.irs.ustreas.gov/tax_regs/regslist.html. The public hearing will be 
held in room 4718, Internal Revenue Building, 1111 Constitution Avenue, 
NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jeffery G. Mitchell, (202)622-4970; concerning submissions of comments, 
the hearing, and/or to be placed on the building access list to attend 
the hearing, Guy Traynor of the Regulations Unit at (202) 622-7180 (not 
toll-free calls).

SUPPLEMENTARY INFORMATION:   

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) that relate to the last-in, first-out 
(LIFO) inventory accounting method under section 472 of the Internal 
Revenue Code (Code). The LIFO method of accounting for goods treats 
inventories on hand at the end of the year as consisting first of 
inventory on hand at the beginning of the year and then of inventories 
acquired during the year.
    Under Sec. 1.472-8, a taxpayer is permitted to use the dollar-value 
LIFO method of accounting for inventories, which accounts for 
inventories in terms of dollars of cost rather than specific goods. The 
dollar-value LIFO method measures increases or decreases in inventory 
quantities by comparing the total cost of the quantity of goods on hand 
at the beginning and end of the taxable year in terms of equivalent-
value dollars, i.e., base-year cost. The current-year dollar cost of 
beginning and ending inventory may be converted into a base-year dollar 
cost using price indexes. Then, the quantity of base-year cost in 
beginning and ending inventory can be compared and the increase 
(increment) or decrease (liquidation) can be measured.
    Section 472(f) directs the Secretary to prescribe regulations that 
permit the use of suitable published governmental price indexes for 
purposes of the LIFO method. The IRS and Treasury Department prescribed 
the inventory price index computation (IPIC) method in Sec. 1.472-
8(e)(3) (TD 7814, 47 FR 11271, 1982-1 C.B. 84), pursuant to authority 
contained in sections 472 and 7805. Under the IPIC method, inventory 
price indexes are computed with reference to consumer or producer price 
indexes published by the United States Bureau of Labor Statistics 
(BLS). The IPIC method was intended to simplify the use of the dollar-
value LIFO method so that the LIFO method could be used by more 
taxpayers and would be easier to use by taxpayers already using the 
dollar-value LIFO method.

Explanation of Provisions

    This document contains proposed amendments to the IPIC method 
provided in Sec. 1.472-8(e)(3) of computing the LIFO value of a dollar-
value inventory pool that are intended to simplify and clarify certain 
aspects of the IPIC method as well as to modify the computational 
methodology so that the IPIC method produces a more accurate and 
suitable inventory price index. In addition, the proposed regulations 
provide rules for computing the LIFO value of a dollar-value pool when 
a taxpayer receives LIFO inventories in certain nonrecognition 
transactions.

1. Elimination of Requirement To Use 10 Percent Categories and BLS 
Weights

    Section 1.472-8(e)(3)(iii) of the regulations provides detailed 
rules for assigning inventory items to index categories published by 
the BLS in the ``CPI Detailed Report'' or the ``PPI Detailed Report'' 
for purposes of computing an inventory price index. Items are first 
assigned to the most detailed index category listed in the appropriate 
table of the ``CPI Detailed Report'' or the ``PPI Detailed Report'' 
that contains those items. If the total current-year cost of the items 
in a single detailed index category equals or exceeds 10 percent of the 
total inventory value, the taxpayer must use the published index for 
that selected index category for all items that are included in that 
detailed index category. If the total current-year cost of items in a

[[Page 31842]]

single detailed index category is less than 10 percent of the total 
inventory value, the taxpayer must investigate successively less 
detailed index categories until it reaches an index category that meets 
the 10 percent threshold. The taxpayer, however, may only use the 
published index for a less detailed selected index category if it has 
at least one item that would have been included in each of the most 
detailed index categories subsumed by the selected category. For 
example, a taxpayer may only use the published index for the ``Fresh 
fruits'' category from the ``CPI Detailed Report'' if its inventory 
includes at least one apple, banana, orange, citrus fruit other than 
orange, and other fresh fruit. If the taxpayer's inventory does not 
contain at least one item in each of the most detailed index categories 
within the selected index category, the taxpayer must compute an 
appropriate index for the selected index category. An appropriate index 
for the selected index category is a weighted average of the published 
indexes for the most detailed index categories that include at least 
one of the taxpayer's inventory items. The weights to be used in 
computing the appropriate index are the BLS weights listed for the 
detailed index categories. In computing an index for a pool, however, a 
taxpayer must weight the appropriate indexes for the selected index 
categories comprising the pool according to the taxpayer's actual 
inventory weights for those selected index categories.
    The proposed regulations eliminate the requirement to use 10 
percent categories and BLS weights to determine an appropriate index 
for two reasons. First, the weight assigned to an index category by the 
BLS may vary dramatically from the taxpayer's actual inventory weight 
for that category. Consequently, the index computed for those items 
using BLS weights will not accurately reflect the taxpayer's inflation 
experience. Second, the requirement to use 10 percent categories and 
BLS weights was intended to simplify the index computation procedure 
for those taxpayers that did not keep detailed inventory records. In 
practice, however, this requirement adds complexity to the index 
computation for most taxpayers. Moreover, even the most detailed BLS 
index categories are fairly broad and, with current inventory 
recordkeeping procedures and practices, most taxpayers have 
sufficiently detailed books and records to classify their inventory 
items according to the most detailed BLS index categories.
    The proposed regulations require a taxpayer to classify its 
inventory items into the most detailed index category listed in the 
``CPI Detailed Report'' or the ``PPI Detailed Report.'' For purposes of 
computing a weighted average pool index, the weight assigned to each 
selected index category will be the relative current-year cost of the 
items in that category. The IRS and Treasury Department request written 
comments regarding rules for excluding index categories that contain 
items with a de minimis amount of relative current-year cost from the 
pool index computation.

2. Weighted Harmonic Mean for Computing Pool Index

    A pool index computed using the dollar-value LIFO method should 
reflect a weighted average of the inflation rates of the items 
contained in the ending inventory. Under LIFO methods that compute an 
internal index, the index computation procedure automatically produces 
an appropriately weighted pool index. However, when a taxpayer computes 
a LIFO inventory pool index using externally generated inflation rates, 
the taxpayer must weight the inflation rates to compute an appropriate 
composite index for the pool.
    Section 1.472-8(e)(3)(iii)(B) states that the appropriate indexes 
are weighted according to the relative current-year costs of the items 
in each selected index category. However, the regulations do not set 
forth how to compute a weighted average of the appropriate indexes 
using the amount of relative current-year costs in each selected index 
category. The IRS provided an example of IPIC weighting methodology in 
Rev. Proc. 84-57 (1984-2 C.B. 496). The example computes a weighted 
average pool index based on a weighted arithmetic mean of the 
appropriate indexes. (Weighted Arithmetic Mean = [Sum of (Weight  x  
Appropriate Index)]/Sum of Weights). The example provided in Rev. Proc. 
98-49 (1998-37 I.R.B. 9), also used a weighted arithmetic mean to 
compute a weighted average percent change for a selected index 
category.
    The IRS and Treasury Department have determined that a weighted 
arithmetic mean is mathematically inappropriate for averaging inflation 
indexes based on current-year costs. The mathematically correct method 
of averaging inflation indexes using relative current-year costs is a 
weighted harmonic mean. (Weighted Harmonic Mean = Sum of Weights/Sum of 
[Weight/Appropriate Index]). Therefore, the proposed regulations make 
the weighted harmonic mean the only acceptable method of computing a 
weighted average pool index using relative current-year costs of items 
in ending inventory.

3. Double-Extension or Link-Chain Method of Index Computation

    The current regulations do not indicate whether the inventory price 
index should be computed using a link-chain or double-extension 
methodology. Section 1.472-8(e)(3)(ii) merely states that ``[a]n 
inventory price index computed [under the IPIC method] shall be a 
stated percentage of the percent change in the selected consumer or 
producer price index or indexes for a specific category or categories 
of goods.''
    In practice, some taxpayers have used a link-chain methodology, and 
others a double-extension methodology. The proposed regulations 
specifically permit either method. The proposed regulations also 
explain how to compute an index under each method and provide examples.

4. Selecting Indexes as of an Appropriate Month

    Section 1.472-8(e)(3)(iii)(C) states that a taxpayer not using the 
retail inventory method must select indexes ``as of the month or 
months'' most appropriate to its method of determining current-year 
cost, or make a one-time binding election of an appropriate 
representative month. The IRS has ruled that a month is an appropriate 
representative month if there is a nexus between the selected month, 
the taxpayer's method of determining current-year cost, and the 
taxpayers' historical experience of inventory purchases. Rev. Rul. 89-
29 (1989-1 C.B. 168). In practice, there has been confusion about the 
meaning of the phrase ``month or months most appropriate to the 
taxpayer's method of determining current-year cost.''
    The proposed regulations clarify that, for each dollar-value pool, 
a taxpayer should either annually determine the month most appropriate 
to its method of determining the current-year cost of the pool 
(appropriate month) or make a one-time election of a representative 
appropriate month (representative month) for the pool. The principles 
of Rev. Rul. 89-29 continue to apply for purposes of determining 
whether a particular month is appropriate or representative. An 
appropriate index is computed by comparing the published cumulative 
index for the appropriate or representative month to the published 
cumulative index for the appropriate or representative month used for 
the immediately preceding year (in the case of a taxpayer using the 
link-chain IPIC method) or the published cumulative index for the month 
preceding the first

[[Page 31843]]

day of the base year (in the case of a taxpayer using the double-
extension IPIC method). The proposed regulations also clarify that a 
taxpayer electing to use a representative month must use an appropriate 
month, rather than the representative month, to compute an appropriate 
index in certain circumstances, such as a short taxable year.

5. Taxpayers Eligible To Use ``Department Store Inventory Price 
Indexes''

    The current regulations prohibit the use of the IPIC method by a 
taxpayer that is eligible to use inventory price indexes prepared by 
the BLS for the purpose of valuing the LIFO inventories of a specific 
industry. Specifically, Sec. 1.472-8(e)(3)(i) provides that a taxpayer 
eligible to use the retail price indexes prepared by the BLS and 
published in ``Department Store Inventory Price Indexes'' may not use 
the IPIC method.
    Some retailers may carry goods traditionally carried by department 
stores and other goods that are not traditionally carried by department 
stores. Such taxpayers may qualify as department stores, but 
``Department Store Inventory Price Indexes'' may not provide indexes 
that are applicable for some of the taxpayers' departments. Whenever 
one or more departments of a department store do not fit into any one 
of the 23 major groups established by the BLS or into the special 
combinations listed in Rev. Proc. 86-46 (1986-2 C.B. 739), the taxpayer 
may use either an index that represents an average for the whole of the 
remainder of the LIFO inventory or the store total index published by 
the BLS. However, the express terms of the current regulations prohibit 
taxpayers eligible to value their LIFO inventories using ``Department 
Store Inventory Price Indexes'' from using the IPIC method to compute 
an index for any dollar-value pool.
    The proposed regulations eliminate the eligibility restrictions 
applicable to the IPIC method. Generally, any taxpayer may adopt the 
IPIC method as long as it uses that method for all goods accounted for 
under the dollar-value LIFO method. However, a taxpayer eligible to use 
``Department Store Inventory Price Indexes'' may elect to use those 
indexes for LIFO inventory items that fall within any of the 23 major 
groups listed in ``Department Store Inventory Price Indexes'' and the 
IPIC method for the remainder of its LIFO inventory items, or may elect 
to use the IPIC method for all of its LIFO inventories. The proposed 
regulations do not, however, affect the ability of an eligible taxpayer 
to use ``Department Store Inventory Price Indexes'' to value its LIFO 
inventories in accordance with Sec. 1.472-1(k) and Rev. Proc. 86-46.

6. Selection From ``CPI Detailed Report'' or ``PPI Detailed Report''

    Section 1.472-8(e)(3)(iii)(C) states that a retailer may select 
indexes from the ``CPI Detailed Report'' or the ``PPI Detailed 
Report,'' but if equally appropriate indexes may be selected from 
either, a retailer using the retail inventory method must select from 
the ``CPI Detailed Report'' and a retailer not using the retail 
inventory method must select from the ``PPI Detailed Report.''
    The proposed regulations eliminate the need for a retailer to 
determine whether the ``CPI Detailed Report'' and ``PPI Detailed 
Report'' contain equally appropriate indexes. The proposed regulations 
require retailers using the retail inventory method to select indexes 
from the ``CPI Detailed Report.'' All other taxpayers must select 
indexes from the ``PPI Detailed Report.''

7. Elimination of Requirement To Convert Published Indexes Into Retail 
Price Indexes or Cost Price Indexes

    Section 1.472-8(e)(3)(iii)(C) provides that if a retailer using the 
retail inventory method selects an index from the ``PPI Detailed 
Report,'' the selected index must be converted into a retail price 
index, and that if a retailer not using the retail inventory method 
selects an index from the ``CPI Detailed Report,'' the selected index 
must be converted into a cost price index. The regulations further 
provide that manufacturers, processors, wholesalers, jobbers, and 
distributors must convert selected indexes into cost price indexes.
    This conversion requirement in the current regulations was intended 
to more accurately represent the taxpayer's inflation experience 
relative to the selected price index. However, due to the inability of 
many taxpayers to determine gross profit percentages at the detailed 
index category level and the fact that gross profit percentages for 
many taxpayers are relatively constant, this conversion requirement may 
not actually increase the accuracy of the indexes used in the inventory 
price index computation. The IRS and Treasury Department have concluded 
that the administrative burden of converting published indexes into 
retail price or cost price indexes outweighs any benefits of increased 
accuracy from the procedure. Thus, the proposed regulations eliminate 
the requirement to convert published price indexes into either retail 
price indexes or cost price indexes.

8. Relocation and Clarification of Special Pooling Rules

    Section 1.472-8(e)(3)(iv) provides special, elective pooling rules 
for retailers, wholesalers, jobbers, and distributors that use the IPIC 
method. Such taxpayers are permitted to establish an inventory pool for 
any group of goods included in one of the eleven general categories of 
consumer goods described in the ``CPI Detailed Report.'' Although 
wholesalers, jobbers and distributors are allowed to pool goods 
according to categories found in the ``CPI Detailed Report,'' they must 
select indexes from the ``PPI Detailed Report'' pursuant to Sec. 1.472-
8(e)(3)(iii)(C). The current regulations provide no special, elective 
pooling rules for manufacturers that use the IPIC method. However, Rev. 
Proc. 84-57 provides that an inventory pool or pools may be established 
for any group of goods included within one of the 15 general categories 
of producer goods described in Table 6 of the ``PPI Detailed Report.''
    The proposed regulations provide special, elective pooling rules 
for LIFO inventories accounted for under the IPIC method. Specifically, 
retailers using the retail inventory method may establish an inventory 
pool for any group of goods accounted for under the IPIC method 
included within one of the general expenditure categories (i.e., major 
groups) in Table 3 of the ``CPI Detailed Report.'' Retailers not using 
the retail method, wholesalers, jobbers, distributors, processors, and 
manufacturers may establish an inventory pool for any group of goods 
accounted for under the IPIC method included within one of the 2-digit 
commodity codes (i.e., major commodity groups) in Table 6 of the ``PPI 
Detailed Report.'' The special, elective pooling rules provided in the 
proposed regulations correspond with the pooling rules found in section 
474(b) so that a taxpayer may change from the simplified dollar-value 
LIFO method of section 474 to the IPIC method without changing its 
pooling structure. In addition, the special, elective pooling rules for 
taxpayers using the IPIC method are relocated with the general pooling 
rules applicable to all taxpayers in Sec. 1.472-8(b) and (c).

9. Clarification of the Definition of ``Eligible Small Business''

    Section 1.472-8(e)(3)(ii) permits an eligible small business, as 
defined under section 474(b) of the Internal Revenue

[[Page 31844]]

Code of 1954, to compute an inventory price index for its pool(s) using 
100 percent of the percent change in the selected indexes. All other 
taxpayers must compute an inventory price index for their pools using 
80 percent of the percent change in the selected indexes. At the time 
the regulations were published, section 474(b) defined an eligible 
small business as a taxpayer with average annual gross receipts that 
did not exceed $2,000,000 for the 3-taxable-year period ending with the 
taxable year.
    Section 474 was amended by the Tax Reform Act of 1986. Public Law 
99-514, 100 Stat. 2348. An eligible small business is now defined by 
section 474(c) as a taxpayer with average annual gross receipts that do 
not exceed $5,000,000 for the 3 preceding taxable years. The proposed 
regulations clarify that the IPIC method definition of ``eligible small 
business'' mirrors the definition in current section 474.

10. New Base Year for IPIC Method Changes

    Section 1.472-8(e)(vi) requires a taxpayer that changes to the IPIC 
method from another dollar-value LIFO method to treat the year of 
change as the base year in determining the LIFO value of the inventory 
pool(s) for the year of change and later taxable years. The taxpayer is 
also required to restate indexes of existing layers of increment in 
terms of new base-year cost. This procedure is generally known as 
updating the base year.
    The proposed regulations clarify that the base year updating 
procedure applies in the case of a voluntary change to the IPIC method, 
but is discretionary in the case of an involuntary change to the IPIC 
method. If an examining agent determines that a taxpayer's dollar-value 
LIFO method does not clearly reflect income, the agent may require the 
taxpayer to change to the double-extension IPIC method on a cut-off 
basis with or without an updated base year. If the examining agent 
chooses not to update the base year, the examining agent will ascertain 
the amount of any increment in terms of base-year cost for the year of 
change by comparing the total base-year cost of the beginning inventory 
determined under the taxpayer's dollar-value LIFO method and the total 
base-year cost of the ending inventory determined under the double-
extension IPIC method. Any increment so determined will be valued using 
the index computed under the double-extension IPIC method.

11. Inventories Received in a Nonrecognition Transaction

    Under current law, the treatment of LIFO inventories received in a 
nonrecognition transaction depends upon whether the transaction 
qualifies as a corporate reorganization to which section 381 applies. 
Section 381(c)(5) provides that inventory accounting methods generally 
carry over, uninterrupted, to a transferee in a transaction described 
in section 381(a).
    However, inventory accounting methods generally do not carry over 
to a transferee in other nonrecognition transactions such as transfers 
to a controlled corporation under section 351, divisive ``D'' 
reorganizations under section 368(a)(1)(D), or contributions to a 
partnership under section 721 (non-section 381 transfers). Textile 
Apron Company, Inc. v. Commissioner, 21 T.C. 146 (1953), acq., 1954-1 
C.B. 7. But see Sec. 1.263A-7(c)(4); 1.1502-17. If a transferee that 
has never owned inventories or that has accounted for inventories using 
a method other than LIFO wants to use the LIFO method to account for 
inventories received in a non-section 381 transfer, it must elect the 
LIFO method for the year of transfer. The inventories received in the 
transfer are treated as opening inventory and their cost is determined 
using the average cost method as provided in section 472(b)(3). Rev. 
Rul. 70-564 (1970-2 C.B. 109). A transferee that previously elected to 
use the LIFO method may account for the LIFO inventories received in a 
non-section 381 transfer using its preexisting LIFO method. The LIFO 
layers of the transferor retain the transferor's original acquisition 
dates and costs and are integrated into the transferee's existing LIFO 
layers. Commissioner v. Joseph E. Seagram & Sons, Inc., 394 F.2d 738 
(1968), rev'g, 46 T.C. 698 (1966); Rev. Rul. 70-565 (1970-2 C.B. 110).
    An election to use the dollar-value LIFO method for LIFO 
inventories received in a non-section 381 transfer, however, may not 
continue the LIFO reserve of the transferor. If the mix of goods in the 
inventory changes significantly after the transfer, the mechanics of 
the dollar-value LIFO method may produce an increment in the first 
taxable year that effectively eliminates the LIFO reserve established 
by the transferor. This occurs because the transferee's base year is 
the year in which it elects LIFO.
    A taxpayer using the dollar-value LIFO method determines whether 
there is an increase or decrease in the quantity of inventory by 
comparing the base-year cost of the ending inventory to the base-year 
cost of the beginning inventory. When inventory is received in a non-
section 381 transfer, the transferee's basis is determined by reference 
to the transferor's basis in the inventory. The transferee's base-year 
cost, however, is not determined by reference to the transferor's base-
year cost. The transferee's base-year cost of inventory received in a 
non-section 381 transfer is equal to the transferee's cost of the 
inventory, which is generally the carryover basis of the inventory. 
Since the transferor's basis was established by reference to the actual 
cost of the goods in years prior to the transfer, the carryover basis 
of the inventory may be considerably lower than what it would cost to 
purchase or produce the goods in the current year. If a new item enters 
the transferee's inventory, Sec. 1.472-8(e)(2)(iii) only permits the 
transferee to reconstruct the base-year unit cost of that item back to 
the year in which it elected LIFO. If the transferee elected LIFO in 
the year in which the non-section 381 transfer occurred, the base-year 
unit cost of the new item will not be comparable to the base-year unit 
cost of the items that were received in the transfer and comprised the 
opening inventory. The disparity in the base-year unit costs may 
produce an increment in terms of base-year cost that would not have 
occurred but for the low base-year unit cost of the inventory received 
in the transfer.
    While the current regulations contain a provision requiring a 
taxpayer that changes to the IPIC method from another LIFO method to 
treat the year of change as the base year in determining the LIFO value 
of the inventory pool(s) for the year of change and later taxable 
years, the provision does not apply to an initial adoption of LIFO by a 
transferee. When a transferee elects the LIFO and IPIC methods for LIFO 
inventories received in a non-section 381 transfer, the transferee will 
have an increment in the year in which the inventories are received 
even without a significant change in the mix of goods in the 
transferee's ending inventory. The IPIC method invariably produces an 
increment because the index used to convert the current-year cost of 
the ending inventory to base-year cost will reflect only one year of 
inflation while the difference between the current-year cost and the 
carryover basis of the opening inventory reflects more than one year of 
inflation.
    The IRS and Treasury Department have determined that recapture of 
the LIFO reserve established by the transferor's use of the dollar-
value LIFO method solely by virtue of the mechanical application of the 
dollar-

[[Page 31845]]

value LIFO method after a non-section 381 transfer is inappropriate, 
given the business continuity principles governing the tax treatment of 
the underlying transaction. Accordingly, the proposed regulations 
provide that if a transferee uses the dollar-value LIFO method for 
inventories that were received in a nonrecognition transaction to which 
section 381 does not apply and that were accounted for using the 
dollar-value LIFO method by the transferor, the transferee must use the 
year of transfer as the base year and the transferor's current-year 
cost of the inventory received as the new base-year cost of such 
inventory for purposes of determining future increments and 
liquidations. The proposed regulations do not affect a newly formed 
transferee's ability to elect new accounting methods or the holdings of 
Rev. Rul. 70-564 and Rev. Rul. 70-565. However, the new base year rule 
does not apply to a non-section 381 transaction if the transaction was 
made with the principal purpose of availing the transferee of a method 
of accounting that would be unavailable to the transferor (or would be 
unavailable without securing consent from the Commissioner). In 
determining the principal purpose of a transfer, consideration will be 
given to all of the facts and circumstances. However, if a transferor 
acquired inventory in a bargain purchase within the five taxable years 
preceding the year of the transfer and accounted for that inventory 
using a dollar-value LIFO method that did not treat the bargain 
purchase inventory and physically identical inventory acquired at 
market prices as separate items, the transfer will be deemed made with 
the principal purpose of availing the transferee of a method of 
accounting that would be unavailable to the transferor (or would be 
unavailable without securing consent from the Commissioner).

Proposed Effective Date

    These regulations are proposed to be effective for taxable years 
beginning on or after the date they are published in the Federal 
Register as final regulations.

Effect on Other Documents

    Rev. Proc. 84-57 will become obsolete as of the date these 
regulations are published in the Federal Register as final regulations. 
In addition, Rev. Proc. 98-49 is modified with respect to the 
requirements to use 10 percent categories and BLS weights, to compute a 
weighted average using a weighted arithmetic mean, and to convert 
selected indexes to cost, as of the date these regulations are 
published in the Federal Register as final regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) and electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for September 15, 2000, at 10 
a.m., in room 4718, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures, 
visitors must enter at the 10th Street entrance, located between 
Constitution and Pennsylvania Avenues, NW. In addition, all visitors 
must present photo identification to enter the building. Because of 
access restrictions, visitors will not be admitted beyond the immediate 
entrance area more than 15 minutes before the hearing starts. For 
information about having your name placed on the building access list 
to attend the hearing, see the FOR FURTHER INFORMATION CONTACT section 
of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit written or electronic comments by August 17, 2000 and submit an 
outline of the topics to be discussed and the time to be devoted to 
each topic (a signed original and eight (8) copies) by August 25, 2000.
    A period of 10 minutes will be allocated to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.
    Drafting information. The principal author of these regulations is 
Jeffery G. Mitchell of the Office of Assistant Chief Counsel (Income 
Tax and Accounting). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Sec. 1.472-8 also issued under 26 U.S.C. 472. * * *
    Par. 2. Section 1.472-8 is amended as follows:
    1. Paragraph (b)(4) is added.
    2. The text of paragraph (c) following the paragraph heading is 
redesignated as paragraph (c)(1) and a paragraph heading for newly 
designated paragraph (c)(1) is added.
    3. Paragraph (c)(2) is added.
    4. Paragraphs (e)(3) and (h) are revised.
    The revisions and additions read as follows:


Sec. 1.472-8  Dollar-value method of pricing LIFO inventories.

* * * * *
    (b) * * *
    (4) Inventory price index pools. A manufacturer or processor that 
elects to use the inventory price index computation method described in 
paragraph (e)(3) of this section to value its dollar-value pools may 
establish an inventory pool for any group of goods included within one 
of the 2-digit commodity codes (i.e., major commodity groups) in Table 
6 (Producer price indexes for commodity groups, subgroups, product 
classes, and individual items) of the ``PPI Detailed Report'' published 
by the United States Bureau of Labor Statistics (Available from New 
Orders, Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 
15250-7954). Inventory pools that comprise less than 5 percent of the 
total inventory value may be combined to form a single miscellaneous 
inventory pool. If the resulting miscellaneous inventory pool

[[Page 31846]]

itself comprises less than 5 percent of the total inventory value, that 
pool may be combined only with the largest inventory pool.
    (c) * * * (1) In general. * * *
    (2) Inventory price index pools. A retailer using the retail 
inventory method that elects to use the inventory price index 
computation method described in paragraph (e)(3) of this section (the 
IPIC method) may establish an inventory pool for any group of goods 
accounted for under the IPIC method included within one of the general 
expenditure categories (i.e., major groups) in Table 3 (Consumer Price 
Index for all Urban Consumers (CPI-U): U.S. city average, detailed 
expenditure categories) of the ``CPI Detailed Report'' published by the 
United States Bureau of Labor Statistics (Available from New Orders, 
Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 15250-
7954). A retailer not using the retail inventory method, wholesaler, 
jobber, or distributor electing to use the IPIC method may establish an 
inventory pool for any group of goods accounted for under the IPIC 
method included within one of the 2-digit commodity codes (i.e., major 
commodity groups) in Table 6 (Producer price indexes for commodity 
groups, subgroups, product classes, and individual items) of the ``PPI 
Detailed Report'' published by the United States Bureau of Labor 
Statistics. Inventory pools that comprise less than 5 percent of the 
total inventory value may be combined to form a single miscellaneous 
inventory pool. If the resulting miscellaneous inventory pool itself 
comprises less than 5 percent of the total inventory value, that pool 
may be combined only with the largest inventory pool.
* * * * *
    (e) * * *
    (3) Inventory price index computation method--(i) In general. The 
inventory price index computation method provided by this paragraph 
(e)(3) (the IPIC method) is a method of determining the LIFO value of a 
dollar-value inventory pool with reference to indexes published by the 
United States Bureau of Labor Statistics (BLS). An inventory price 
index computed using the IPIC method will be accepted by the 
Commissioner as an appropriate method of computing an index, and the 
use of that inventory price index to compute the LIFO value of a 
dollar-value inventory pool will be accepted as accurate, reliable, and 
suitable. The appropriateness of a taxpayer's computation of an 
inventory price index, including the selection of the consumer or 
producer price indexes and the propriety of all computations incidental 
to the use of those consumer or producer price indexes, will be 
determined in connection with the examination of the taxpayer's income 
tax return. A taxpayer using the IPIC method may elect to establish 
inventory pools in accordance with the special rules in paragraphs 
(b)(4) and (c)(2) of this section or the general rules for establishing 
inventory pools in paragraphs (b) and (c) of this section. Taxpayers 
eligible to use the IPIC method are described in paragraph (e)(3)(ii) 
of this section. The manner in which an inventory price index is 
computed using the IPIC method is described in paragraph (e)(3)(iii) of 
this section. Rules relating to the adoption of, or change to, the IPIC 
method are in paragraph (e)(3)(iv) of this section.
    (ii) Eligibility. Any taxpayer electing to use the dollar-value 
LIFO method may elect to compute an inventory price index in accordance 
with the IPIC method. Except as provided in this paragraph (e)(3)(ii), 
a taxpayer using the IPIC method must use that method in determining 
the value of all goods for which the taxpayer has elected to use the 
dollar-value LIFO method. A taxpayer that uses the retail price indexes 
prepared by the BLS and published in ``Department Store Inventory Price 
Indexes'' (Available from the BLS by calling (202) 606-6325 and 
entering document code 2415) may elect to use the IPIC method for 
inventory items that do not fall within any of the major groups listed 
in ``Department Store Inventory Price Indexes.''
    (iii) Computation of an inventory price index--(A) In general. An 
inventory price index computed using the IPIC method is used to convert 
the current-year cost of the inventory in a dollar-value inventory pool 
to base-year cost for purposes of determining whether an increment or 
liquidation in terms of base-year cost exists and to value the 
increment, if any, at current-year cost. A taxpayer must compute a 
separate inventory price index for each dollar-value inventory pool. 
The computation of an index for each pool involves the following four 
steps which are described in more detail in this paragraph (e)(3)(iii): 
First, selection of a BLS table and an appropriate month, second, 
selection of an index category, third computation of an appropriate 
index for each selected index category, and fourth, computation of a 
pool index. A taxpayer may compute an inventory price index for each 
dollar-value inventory pool under the IPIC method using a double-
extension method (the double-extension IPIC method) or a link-chain 
method (the link-chain IPIC method) without regard to whether the use 
of a double-extension method is impractical or unsuitable. See 
paragraphs (e)(3)(iii)(D) and (E) of this section. The use of the 
double-extension IPIC method or the link-chain IPIC method is a method 
of accounting, and whichever method is adopted must be applied 
consistently to all of the taxpayer's dollar-value inventory pools 
accounted for using the IPIC method.
    (B) Selection of a BLS table and appropriate month--(1) In general. 
An inventory price index computed using the IPIC method is computed 
with reference to the consumer or producer price indexes for specific 
categories of inventory items listed in the ``CPI Detailed Report'' or 
``PPI Detailed Report'' published by the BLS for the appropriate month. 
A taxpayer may elect to use either the preliminary or final indexes 
published by the BLS for the appropriate month provided that the chosen 
indexes are used consistently from year to year. A taxpayer that elects 
to use final indexes must use preliminary indexes for the appropriate 
month for any taxable year in which it files its original federal 
income tax return before the BLS publishes final indexes.
    (2) BLS table selection. Manufac-     turers, processors, 
wholesalers, jobbers, distributors, and retailers not using the retail 
inventory method must select indexes from Table 6 (Producer price 
indexes for commodity groups, subgroups, product classes, and 
individual items) of the ``PPI Detailed Report,'' unless the taxpayer 
can demonstrate that the selection of an index from another table of 
the ``PPI Detailed Report'' would be more appropriate. Retailers using 
the retail inventory method must select indexes from Table 3 (Consumer 
Price Index for all Urban Consumers (CPI-U): U.S. city average, 
detailed expenditure categories) of the ``CPI Detailed Report.''
    (3) Appropriate month. In the case of a retailer using the retail 
inventory method, the appropriate month is the last month of the 
retailer's taxable year. In the case of all other taxpayers, the 
appropriate month is a month most appropriate to the taxpayer's method 
of determining the current-year cost of each dollar-value inventory 
pool under paragraph (e)(2)(ii) of this section. A taxpayer not using 
the retail inventory method may annually select an appropriate month 
for each dollar-value inventory pool or make an election of a 
representative appropriate month (representative month). An election of 
a representative month is a method of

[[Page 31847]]

accounting and must be used for the taxable year of the election and 
all subsequent taxable years, unless the taxpayer obtains the consent 
of the Commissioner as provided in Sec. 1.446-1(e) to change or revoke 
its election. The election of a representative month must be clearly 
set forth on Form 970. See paragraph (e)(3)(iv)(A) of this section.
    (C) Selection of an index category--(1) In general. The inventory 
items in each dollar-value pool should be classified according to the 
most detailed listings in the appropriate tables of the ``CPI Detailed 
Report'' or the ``PPI Detailed Report.'' The selection of a consumer or 
producer price index category for a specific item to compute an 
inventory price index under the IPIC method is a method of accounting. 
However, the selection of a new consumer or producer price index 
category for a specific item as a result of revisions to the ``CPI 
Detailed Report'' or the ``PPI Detailed Report'' is a change in 
underlying facts and not a change in method of accounting. Change in 
method of accounting rules relating to changes in selected indexes are 
in paragraph (e)(3)(iv) of this section.
    (2) Index selection from the PPI Detailed Report. Manufacturers, 
processors, wholesalers, jobbers, distributors, and retailers not using 
the retail inventory method must classify their inventory items 
according to the detailed listings in the appropriate table(s) of the 
``PPI Detailed Report.'' Each specific inventory item in the taxpayer's 
inventory must be assigned to the most detailed index category listed 
in the appropriate tables (as determined under paragraph 
(e)(3)(iii)(B)(2) of this section) of the ``PPI Detailed Report'' that 
includes that specific inventory item. Manufacturers and processors 
must assign each raw material inventory item to the most detailed index 
category that includes that raw material and each finished good 
inventory item to the most detailed index category that includes that 
finished good. Manufacturers and processors must assign work-in-process 
inventory items to the most detailed index category that includes the 
finished good into which the item will be manufactured or processed. 
For this purpose, the term finished good means a good that is in a 
saleable state. For example, a gasoline engine manufacturer that also 
produces pistons for the engines must assign finished pistons that have 
not yet been affixed to an engine block and the piston work-in-process 
items to the most detailed index category that includes pistons. 
Finished pistons that have been affixed to an engine block must be 
assigned to the most detailed index category that includes the engine.
    (3) Index selection from the CPI Detailed Report. Retailers using 
the retail inventory method must classify their inventory items 
according to the detailed listings in the appropriate tables of the 
``CPI Detailed Report.'' Each specific inventory item in the taxpayer's 
inventory must be placed in the most detailed index category listed in 
the appropriate table (as determined under paragraph (e)(3)(iii)(B)(2) 
of this section) of the ``CPI Detailed Report'' that includes that 
specific inventory item.
    (D) Computation of an appropriate index--(1) Double-extension IPIC 
method. In the case of a taxpayer using the double-extension IPIC 
method, an appropriate index for a selected index category is the 
percent change in the published cumulative indexes for that category 
for the index period between the appropriate or representative month of 
the current taxable year (determined under paragraph (e)(3)(iii)(B)(3) 
of this section) and the month preceding the first day of the base year 
(the base month). The percent change in the published indexes is equal 
to the quotient of the published cumulative index for the appropriate 
or representative month of the current year divided by the published 
cumulative index for the base month.
    (2) Link-chain IPIC method. In the case of a taxpayer using the 
link-chain IPIC method, an appropriate index for a selected index 
category is the percent change in the published cumulative indexes for 
that category during the index period between the appropriate or 
representative month of the current taxable year (determined under 
paragraph (e)(3)(iii)(B)(3) of this section) and the appropriate or 
representative month used for the immediately preceding taxable year. 
The percent change in the published indexes is equal to the quotient of 
the published cumulative index for the appropriate or representative 
month of the current year divided by the published cumulative index for 
the appropriate or representative month used for the immediately 
preceding year (or, for the month immediately preceding the first day 
of the taxable year, if such year is the first taxable year in which 
the taxpayer uses dollar-value LIFO).
    (3) Limitation on index period. A taxpayer electing to use a 
representative month under paragraph (e)(3)(iii)(B)(3) of this section 
must use an appropriate month, rather than the representative month, to 
determine the index period in the circumstances described in this 
paragraph (e)(3)(iii)(D)(3) and other similar circumstances. For 
example, if the first taxable year in which the taxpayer uses the IPIC 
method is also the first taxable year in which the taxpayer uses the 
dollar-value LIFO method, the index period is the period between the 
month immediately preceding the first day of the taxable year and an 
appropriate month for that taxable year. Likewise, in the case of a 
short taxable year, the index period ordinarily is the period between 
the base month (double-extension IPIC method) or the appropriate or 
representative month used for the preceding taxable year (link-chain 
IPIC method) and the appropriate month for the short taxable year. 
Similarly, if a taxpayer using the link-chain IPIC method is granted 
consent to change its method of determining the current-year cost of a 
dollar-value pool and its representative month, the index period is the 
period between the old representative month used for the preceding 
taxable year and the new representative month for the year of change.
    (E) Computation of a pool index--(1) Weighted average pool index. 
To compute an inventory price index for a dollar-value pool, a taxpayer 
must compute a weighted average pool index. A weighted average pool 
index is a weighted harmonic mean of the appropriate indexes 
(determined under paragraph (e)(3)(iii)(D) of this section) for each 
selected index category represented in the taxpayer's ending inventory. 
The formula for computing a weighted harmonic mean is: Sum of weights/
Sum of (Weight/Appropriate Index). The costs to be used in computing a 
weighted harmonic mean are the relative amount of current-year costs 
(or, in the case of a retailer using the retail inventory method, the 
relative retail selling prices) in each index category represented in 
the ending inventory of the pool.
    (2) Double-extension IPIC method. Under the double-extension IPIC 
method, an inventory price index computed for each pool is 1.0 plus a 
stated percentage of the increase since the base date in the weighted 
average pool index determined under paragraph (e)(3)(iii)(E)(1) of this 
section. In the case of an eligible small business as defined in 
section 474, the stated percentage is 100%. In the case of all other 
taxpayers, the stated percentage is 80%. Thus, the inventory price 
index for an eligible small business is equal to the weighted average 
pool index determined under paragraph (e)(3)(iii)(E)(1) of this 
section. The inventory price index for all other taxpayers is computed 
using the

[[Page 31848]]

following formula: 1 + [ 0.8 * (weighted average pool index - 1)].
    (3) Link-chain IPIC method. Under the link-chain IPIC method, an 
inventory price index for each pool is 1.0 plus a stated percentage of 
the increase since the base date in a cumulative index. In the case of 
an eligible small business as defined in section 474, the stated 
percentage is 100%. In the case of all other taxpayers, the stated 
percentage is 80%. The cumulative index for each taxable year is the 
product of the weighted average pool index determined under paragraph 
(e)(3)(iii)(E)(1) of this section multiplied by the cumulative index 
for the immediately preceding taxable year. The cumulative index for 
the taxable year is computed using the following formula: (weighted 
average pool index * preceding year's Cumulative Index). The inventory 
price index for a taxable year of an eligible small business is equal 
to the cumulative index for the taxable year. The inventory price index 
for a taxable year of all other taxpayers is computed using the 
following formula: 1 + [0.8 * (Cumulative Index for the taxable year - 
1)].
    (F) Examples. The following examples illustrate the rules of this 
paragraph (e)(3)(iii):

    Example 1. Double-extension Method.
    (i) Introduction. R is a retail furniture merchant with more 
than $5,000,000 in average annual gross receipts for all relevant 
years. For the taxable year ending December 31, 1996, R used the 
first-in, first-out method of identifying inventory and valued its 
inventory at cost. R's inventory on December 31, 1996, had a cost of 
$850,000.00. R elected to use the dollar-value LIFO and double-
extension IPIC methods for its taxable year ending December 31, 
1997. R determines the current-year cost of inventory items by 
reference to the actual cost of the goods most recently purchased. R 
elected to pool its inventory in accordance with the special IPIC 
pooling rules of paragraph (b)(4) of this section. R does not use 
the retail inventory method. All of R's inventory items fall within 
the 2-digit commodity code in Table 6 (Producer price indexes for 
commodity groups, subgroups, product classes, and individual items) 
of the ``PPI Detailed Report'' for ``furniture and household 
durables.'' Therefore, R will maintain a single inventory pool.
    (ii) Select a BLS table and appropriate month for the 1997 
taxable year. R determines that the appropriate month for the 
taxable year ending December 31, 1997, is October. Because R is a 
retailer not using the retail inventory method, R must select 
indexes from the ``PPI Detailed Report.'' The indexes in Table 6 of 
the ``PPI Detailed Report'' are appropriate for R's inventory.
    (iii) Select index categories for the 1997 taxable year. R's 
inventory items can be classified into five detailed categories 
listed in Table 6 of the ``PPI Detailed Report'' published for 
October, 1997. The categories and current-year cost of items in 
those categories can be summarized as follows:

----------------------------------------------------------------------------------------------------------------
                   Commodity code                                     Category                 Current-year cost
----------------------------------------------------------------------------------------------------------------
12120101............................................  Living Room Table......................        $111,924.00
12120211............................................  Dining Room table......................         159,578.00
12120216............................................  Dining Room chairs.....................          98,639.00
12130101............................................  Upholstered Sofas......................         332,488.00
12130111............................................  Upholstered Chairs.....................         218,751.00
                                                                                              ------------------
                                                                                                      921,380.00
----------------------------------------------------------------------------------------------------------------

    (IV) Compute appropriate indexes for the 1997 taxable year. 
Because R elected to use the double-extension IPIC method, R will 
compute appropriate indexes in accordance with paragraph 
(e)(3)(iii)(D)(1) of this section (published cumulative index for 
October, 1997 divided by published cumulative index for December, 
1996). R computes the appropriate indexes as follows:

----------------------------------------------------------------------------------------------------------------
                        Category                           Oct. '97 index     Dec. '96 index   Appropriate index
----------------------------------------------------------------------------------------------------------------
Living Room Table......................................              172.4              169.2           1.018913
Dining Room Table......................................              171.9              168.1           1.022606
Dining Room Chairs.....................................              172.8              169.7           1.018268
Upholstered Sofas......................................              142.2              140.9           1.009226
Upholstered Chairs.....................................              134.1              132.5           1.012075
----------------------------------------------------------------------------------------------------------------

    (v) Compute a weighted average pool index for the 1997 taxable 
year. R must first compute a weighted average pool index using the 
formula set forth in paragraph (e)(3)(iii)(E)(1) of this section 
(Sum of weights/Sum of [Weight/Appropriate Index]). The weighted 
average pool index is computed as follows:

----------------------------------------------------------------------------------------------------------------
                        Category                               Weight       Appropriate index       Quotient
----------------------------------------------------------------------------------------------------------------
Living Room Table......................................        $111,924.00           1.018913        $109,846.47
Dining Room Table......................................         159,578.00           1.022606         156,050.33
Dining Room Chairs.....................................          98,639.00           1.018268          96,869.39
Upholstered Sofas......................................         332,488.00           1.009226         329,448.51
Upholstered Chairs.....................................         218,751.00           1.012075         216,141.10
                                                        --------------------------------------------------------
      Total............................................         921,380.00  .................        $908,355.80
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                             Sum of (weight/       Weighted average pool
     Sum of weights         appropriate index)             index
------------------------------------------------------------------------
         $921,380.00              $908,355.80               1.0143382
------------------------------------------------------------------------

    (vi) Compute an inventory price index for the 1997 taxable year. 
R computes an inventory price index for the pool using the formula 
set forth in paragraph (e)(3)(iii)(E)(2) of this section. The 
inventory price index is 1.0114710 (1 + [0.8 * (1.0143382 -1)]).
    (vii) Determine the LIFO value of the pool for the 1997 taxable 
year. R determines the total base-year cost of its ending inventory 
by dividing the total current-year cost of the inventory items in 
the pool by the inventory price index. The total base-year cost of 
R's ending inventory is $910,930.71 ($921,380/1.011471). R compares 
the ending inventory at base-year cost to the beginning inventory at 
base-year cost and determines that the amount of the layer of 
increment for the taxable year in terms of base-year cost is

[[Page 31849]]

$60,930.71 ($910,930.71-$850,000.00). R multiplies the base-year 
cost of the increment by the inventory price index computed for the 
taxable year and determines that the LIFO value of the increment is 
$61,629.65 ($60,930.71 * 1.011471). Thus, the LIFO value of R's 
inventory at the end of the 1997 taxable year is $911,629.65 
($850,000 opening inventory + $61,629.65 increment).
    (viii) Select a BLS table and appropriate month for the 1998 
taxable year. For the 1998 taxable year, R must compute a new 
inventory price index under the double-extension IPIC method to 
determine the LIFO value of its dollar-value pool. R determines that 
the appropriate month for the taxable year ending December 31, 1998, 
is November.
    (ix) Select index categories for the 1998 taxable year. The 
inventory items contained in R's ending inventory can be classified 
into five detailed categories listed in Table 6 of the ``PPI 
Detailed Report'' published for November, 1998. The categories and 
current-year cost of items in those categories can be summarized as 
follows:

------------------------------------------------------------------------
     Commodity code              Category            Current-year cost
------------------------------------------------------------------------
            12120103        Living Room Desks             $125,008.00
            12120211        Dining Room Table              136,216.00
            12120216             Dining Room Chairs        113,569.00
            12130101        Upholstered Sofas              343,900.00
            12130111             Upholstered Chairs        233,050.00
                                                 -----------------------
                                                           951,743.00
------------------------------------------------------------------------

    (x) Compute appropriate indexes for the 1998 taxable year. 
Because R uses the double-extension IPIC method, R will compute an 
appropriate index in accordance with paragraph (e)(3)(iii)(D)(1) of 
this section (published cumulative index for November, 1998 divided 
by published cumulative index for December, 1996). R computes the 
appropriate indexes as follows:

----------------------------------------------------------------------------------------------------------------
                        Category                           Nov. '98 index     Dec. '96 index   Appropriate index
----------------------------------------------------------------------------------------------------------------
Living Room Desks......................................              172.6              160.3           1.076731
Dining Room Table......................................              174.8              168.1           1.039857
Dining Room Chairs.....................................              177.0              169.7           1.043017
Upholstered Sofas......................................              144.9              140.9           1.028389
Upholstered Chairs.....................................              136.6              132.5           1.030943
----------------------------------------------------------------------------------------------------------------

    (xi) Compute a pool index for the 1998 taxable year. R must 
first compute a weighted average pool index using the formula set 
forth in paragraph (e)(3)(iii)(E)(1) of this section (Sum of 
weights/(Sum of [Weight/Appropriate Index])). The weighted average 
pool index is computed as follows:

----------------------------------------------------------------------------------------------------------------
               Category                         Weight             Appropriate index             Quotient
----------------------------------------------------------------------------------------------------------------
Living Room Desks....................              $125,008.00                 1.076731              $116,099.56
Dining Room Table....................               136,216.00                 1.039857               130,994.93
Dining Room Chairs...................               113,569.00                 1.043017               108,885.09
Upholstered Sofas....................               343,900.00                 1.028389               334,406.53
Upholstered Chairs...................               233,050.00                 1.030943               226,055.17
                                      --------------------------------------------------------------------------
      Total..........................               951,743.00  .......................               916,441.28
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                             Sum of (weight/       Weighted average pool
     Sum of weights         appropriate index)             index
------------------------------------------------------------------------
         $951,743.00              $916,441.28               1.0385204
------------------------------------------------------------------------

    (xii) Compute an inventory price index for the 1997 taxable 
year. R computes the inventory price index for the pool using the 
formula set forth in paragraph (e)(3)(iii)(E)(2) of this section. 
The inventory price index is 1.0308163 (1 + [0.8 * (1.0385204 -1)]).
    (xiii) Determine the LIFO value of the pool for the 1998 taxable 
year. R determines the total base-year cost of its ending inventory 
by dividing the total current-year cost of the inventory items in 
the pool by the pool index. The total base-year cost of the ending 
inventory is $923,290.60 ($951,743.00/1.0308163). R compares the 
ending inventory at base-year cost to the beginning inventory at 
base-year cost and determines that the amount of the layer of 
increment for the taxable year in terms of base-year cost is 
$12,359.89 ($923,290.60 -$910,930.71). R multiplies the base-year 
cost of the increment by the pool index computed for the taxable 
year and determines that the LIFO value of the increment is 
$12,740.78 ($12,359.89 * 1.0308163). Thus, the LIFO value of R's 
inventory at the end of the 1997 taxable year is $924,370.43 
($850,000.00 base year layer + $61,629.65 1997 layer + $12,740.78 
1998 layer).
    Example 2. Link-chain Method. (i) Introduction. The facts are 
the same as Example 1, except that R uses the link-chain IPIC 
method. The double-extension IPIC method and the link-chain IPIC 
method yield the same results for the first taxable year in which 
the IPIC method is used. Therefore, this example only illustrates 
how R would compute an inventory price index and determine the LIFO 
value of its dollar-value pool for the 1998 taxable year.
    (ii) Select a BLS table and appropriate month for the 1998 
taxable year. R determines that the appropriate index month for the 
taxable year ending December 31, 1998, is November.
    (iii) Select index categories for the 1998 taxable year. R's 
inventory items can be classified into five detailed categories 
listed in Table 6 of the ``PPI Detailed Report'' published for 
November, 1998. The categories and current-year cost of items in 
those categories can be summarized as follows:

----------------------------------------------------------------------------------------------------------------
                   Commodity code                                     Category                 Current-year cost
----------------------------------------------------------------------------------------------------------------
12120103............................................  Living Room Desks......................        $125,008.00
12120211............................................  Dining Room Table......................         136,216.00

[[Page 31850]]

 
12120216............................................  Dining Room Chairs.....................         113,569.00
12130101............................................  Upholstered Sofas......................         343,900.00
12130111............................................  Upholstered Chairs.....................         233,050.00
                                                                                              ------------------
                                                                                                      951,743.00
----------------------------------------------------------------------------------------------------------------

    (iv) Compute appropriate indexes for the 1998 taxable year. 
Because R uses the link-chain IPIC method, R will compute an 
appropriate index in accordance with paragraph (e)(3)(iii)(D)(2) of 
this section (published cumulative index for the November, 1998 
divided by published cumulative index for the October, 1997). R 
computes the appropriate indexes as follows:

----------------------------------------------------------------------------------------------------------------
                        Category                           Nov. '98 index     Oct. '97 index   Appropriate index
----------------------------------------------------------------------------------------------------------------
Living Room Desks......................................              172.6              162.0           1.065432
Dining Room Table......................................              174.8              171.9           1.016870
Dining Room Chairs.....................................              177.0              172.8           1.024306
Upholstered Sofas......................................              144.9              142.2           1.018987
Upholstered Chairs.....................................              136.6              134.1           1.018643
----------------------------------------------------------------------------------------------------------------

    (v) Compute a pool index for the 1998 taxable year. R must first 
compute a weighted average pool index using the formula set forth in 
paragraph (e)(3)(iii)(E)(1) of this section (Sum of weights/Sum of 
[Weight/Appropriate Index]). The weighted average pool index is 
computed as follows:

----------------------------------------------------------------------------------------------------------------
                        Category                               Weight       Appropriate index       Quotient
----------------------------------------------------------------------------------------------------------------
Living Room Desks......................................        $125,008.00           1.065432        $117,330.81
Dining Room Table......................................         136,216.00           1.016870         133,956.16
Dining Room Chairs.....................................         113,569.00           1.024306         110,874.09
Upholstered Sofas......................................         343,900.00           1.018987         337,492.04
Upholstered Chairs.....................................         233,050.00           1.018643         228,784.77
                                                        --------------------------------------------------------
      Total............................................         951,743.00  .................         928,437.87
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                             Sum of (weight/       Weighted average pool
     Sum of weights         appropriate index)             index
------------------------------------------------------------------------
         $951,743.00              $928,437.87               1.0251014
------------------------------------------------------------------------

    (vi) Compute an inventory price index for the 1997 taxable year. 
R computes the inventory price index in accordance with paragraph 
(e)(3)(iii)(E)(3) of this section. R multiplies the weighted average 
pool index by the prior year's cumulative index to get the 
cumulative index for the taxable year. Because 1997 was the first 
year in which R used the link-chain IPIC method, the prior year's 
cumulative index is equal to the 1997 weighted average pool index. 
The cumulative index for 1998 is 1.0397995 (1.0143382 * 1.0251014). 
R computes the inventory price index using the formula set forth in 
paragraph (e)(3)(iii)(E)(3) of this section. The inventory price 
index is 1.0318396 (1 + [0.80 * (1.0397995 -1)]).
    (vii) Determine the LIFO value of the pool for the 1998 taxable 
year. R determines the total base-year cost of its ending inventory 
by dividing the total current-year cost of the inventory items in 
the pool by the inventory price index. The total base-year cost of 
the ending inventory is $922,374.95 ($951,743.00/1.0318396). R 
compares the ending inventory at base-year cost to the beginning 
inventory at base-year cost and determines that the amount of the 
layer of increment for the taxable year in terms of base-year cost 
is $11,444.24 ($922,374.95 -$910,930.71). R multiplies the base-year 
cost of the increment by the pool index computed for the taxable 
year and determines that the LIFO value of the increment is 
$11,808.62 ($11,444.24 * 1.0318396). Thus, the LIFO value of R's 
inventory at the end of the 1998 taxable year is $923,438.27 
($850,000 base year layer + $61,629.65 1997 layer + $11,808.62 1998 
layer).

    (iv) Adoption or change of method--(A) Adoption or change to IPIC 
method. The use of an inventory price index computed using the IPIC 
method is a method of accounting. A taxpayer permitted to adopt the 
dollar-value LIFO method without first securing the consent of the 
Commissioner may also adopt the IPIC method incident to that adoption 
without first securing the consent of the Commissioner. The IPIC method 
may be adopted and used only if the taxpayer indicates on a Form 970, 
``Application to Use LIFO Inventory Method,'' or in such other manner 
as may be acceptable to the Commissioner, a listing of each dollar-
value inventory pool, the type of goods included in each pool, the 
consumer or producer price index or indexes selected for each pool, 
whether the taxpayer will use the double-extension IPIC method or the 
link-chain IPIC method of computing an inventory price index, and if 
the taxpayer makes a one-time binding election of an appropriate 
representative month, the representative month. In the case of a 
taxpayer permitted to adopt the IPIC method without requesting the 
Commissioner's consent, the Form 970 shall be attached to the 
taxpayer's income tax return for the taxable year of that adoption. In 
all other cases, a taxpayer may change to the IPIC method prescribed by 
this paragraph only after first securing the consent of the 
Commissioner as provided in Sec. 1.446-1(e). In such cases, the Form 
970 containing the information described above must be attached to a 
Form 3115, ``Application for Change in Accounting Method,'' filed in 
accordance with Sec. 1.446-1(e). Taxpayers must maintain adequate books 
and records in order to satisfy the requirements of Sec. 1.472-2(h), 
including adequate books and records of the use and computations of the 
IPIC method. Notwithstanding the rules in paragraph (e)(1) of this 
section, a taxpayer that adopts or changes to the use of an inventory 
price index computed using the IPIC method is not required to 
demonstrate that the use of any other method of computing the LIFO 
value of a dollar-value inventory pool is impractical.
    (B) Change in selected index. The selection of a consumer or 
producer price index category for a specific item

[[Page 31851]]

to compute an appropriate index under paragraph (e)(3)(iii)(B) of this 
section is a method of accounting. A taxpayer desiring to change the 
selection of such a consumer or producer price index must secure the 
consent of the Commissioner as provided in Sec. 1.446-1(e).
    (C) New base year--(1) Voluntary change--(i) In general. In the 
case of a taxpayer using a method other than the IPIC method to 
determine the LIFO value of a dollar-value inventory pool, any layers 
of inventory increments previously determined by that method and the 
LIFO value of those layers are retained if the taxpayer voluntarily 
changes to the use of the IPIC method. In the case of a taxpayer 
changing the selection of an index category for an inventory item, any 
layers of inventory increments previously determined and the LIFO value 
of those layers are retained. Instead of using the earliest taxable 
year for which the taxpayer adopted the LIFO method for any items in 
the pool, the year of change is used as the new base year in 
determining the LIFO value of the inventory pool for the year of change 
and later taxable years. The cumulative index as of the first day of 
the year of change (the base date) is 1.00. The base-year costs of 
layers of increment in the pool at the beginning of the year of change 
must be restated in terms of new base-year cost, using the year of 
change as the new base year, and the indexes for previously determined 
inventory increments must be recomputed accordingly. The new base-year 
cost of a pool is equal to the total current-year cost of all the items 
in the pool as determined pursuant to the taxpayer's established method 
of determining the total current-year cost of items making up the pool 
under paragraph (e)(2)(ii) of this section. See paragraph (f)(2) of 
this section for rules relating to a change to the dollar-value method 
from another method of pricing LIFO inventories.
    (ii) Example. The following example illustrates the rules of this 
paragraph (e)(3)(iv)(C)(1):

    Example. (i) X began using a dollar-value LIFO method other than 
the IPIC method in 1990 and maintains a single dollar-value pool. X 
is granted permission to change to the IPIC method, beginning with 
the taxable year ending December 31, 2000. X will continue to use a 
single dollar-value pool under the IPIC method. X's beginning 
inventory as of January 1, 2000, computed using its former method, 
is as follows:

----------------------------------------------------------------------------------------------------------------
                                                          Base-year costs         Index            LIFO value
----------------------------------------------------------------------------------------------------------------
Base layer.............................................           $135,000               1.00           $135,000
1991 layer.............................................             20,000               1.43             28,600
1994 layer.............................................             60,000               1.55             93,000
1995 layer.............................................             13,000               1.59             20,670
1997 layer.............................................              2,000               1.61              3,220
                                                        --------------------------------------------------------
      Totals...........................................            230,000  .................            280,490
----------------------------------------------------------------------------------------------------------------

    (ii) Under X's method of determining the current-year cost of 
items, the current-year cost of the beginning inventory is $391,000. 
Thus, X's new base-year cost as of January 1, 2000 is $391,000. X 
allocates this new base-year cost to each LIFO layer based on the 
ratio of old base-year cost of the layer to the total old base-year 
cost of the pool. To recompute the indexes for each of its LIFO 
layers, X divides the LIFO value of each layer by the new base-year 
cost attributable to the layer. The new base-year costs, recomputed 
indexes, and LIFO value of X's inventory are as follows:


----------------------------------------------------------------------------------------------------------------
                                                          Base-year costs         Index            LIFO value
----------------------------------------------------------------------------------------------------------------
Base layer.............................................           $229,500           0.588235           $135,000
1991 layer.............................................             34,000           0.841176             28,600
1994 layer.............................................            102,000           0.911765             93,000
1995 layer.............................................             22,100           0.935294             20,670
1997 layer.............................................              3,400           0.947059              3,220
                                                        --------------------------------------------------------
      Totals...........................................            391,000  .................            280,490
----------------------------------------------------------------------------------------------------------------

    (2) Involuntary change--(i) In general. If a taxpayer uses a method 
of accounting other than the IPIC method to determine the LIFO value of 
a dollar-value inventory pool and the Commissioner determines that the 
method does not clearly reflect income, the Commissioner may require 
the taxpayer to change to the IPIC method. If a taxpayer is unable to 
provide a sufficient basis, including information from its books and 
records, to compute an adjustment under section 481, and the 
Commissioner requires the taxpayer to change to the IPIC method, the 
Commissioner will require the taxpayer to change to the double-
extension IPIC method and implement the change on a cut-off basis 
without a new base year. Under the cut-off basis without a new base 
year, the Commissioner will determine the amount of any increment in 
terms of base-year cost for the year of change by comparing the total 
base-year cost of the beginning inventory under the taxpayer's method 
and the total base-year cost of the ending inventory under the double-
extension IPIC method described in this paragraph (e)(3) and value any 
increment so determined using the inventory price index computed under 
the double-extension IPIC method.
    (ii) Example. The following example illustrates the rules of this 
paragraph (e)(3)(iv)(C)(2):

    Example. (i) Y began using a dollar-value LIFO method other than 
the IPIC method in 1994 and maintains a single dollar-value pool. 
Under Y's method of determining the current-year cost of items, the 
current-year cost of Y's ending inventory for the 2000 taxable year 
is $348,160. Y's beginning inventory as of January 1, 2000, computed 
using its method, is as follows:

----------------------------------------------------------------------------------------------------------------
                                                          Base-year costs         Index            LIFO value
----------------------------------------------------------------------------------------------------------------
Base layer.............................................           $105,000               1.00           $105,000
1995 layer.............................................              3,000               1.70              5,100
1996 layer.............................................              5,500               2.00             11,000

[[Page 31852]]

 
1997 layer.............................................              2,900               2.50              7,250
1998 layer.............................................              1,400               2.85              3,990
                                                        --------------------------------------------------------
      Totals...........................................            117,800  .................            132,340
----------------------------------------------------------------------------------------------------------------

    (ii) Upon examination, it is determined that Y's dollar-value 
LIFO method does not clearly reflect income. If Y is unable to 
provide the examining agent with a sufficient basis to compute a 
section 481 adjustment arising from a change to a dollar-value LIFO 
method that does clearly reflect income, and the examining agent 
chooses to change Y to the IPIC method, the change will be 
implemented as follows. First, the examining agent will compute an 
inventory price index under the double-extension IPIC method in 
accordance with this paragraph (e)(3). For purposes of this example, 
assume that the inventory price index computed under the double-
extension IPIC method is 1.438793. Second, the examining agent will 
divide the current-year cost of Y's ending inventory by the 
inventory price index to determine the base-year cost of Y's 
inventory under the double-extension IPIC method. The base-year cost 
is $241,980.60 ($348,160/1.438793). Third, the examining agent will 
compare the base-year cost of the ending inventory determined under 
the double-extension IPIC method to the base-year cost of the 
beginning inventory determined under Y's method of accounting to 
determine the amount of any increment. The increment at base-year 
cost for the 2000 taxable year is $124,180.60 ($241,980.60 
-$117,800.00). Fourth, the examining agent will value the increment 
by multiplying the base-year cost of the increment by the inventory 
price index. The LIFO value of the increment is $178,670.18 
($241,980.60 * 1.438793). Finally, the examining agent will reduce 
Y's cost of goods sold and increases Y's gross income for the 2000 
taxable year by the increase in the LIFO value of the 2000 ending 
inventory, or $178,670.18.

    (v) Effective date--(A) In general. The rules of this paragraph 
(e)(3) and paragraphs (b)(4) and (c)(2) of this section are applicable 
for taxable years beginning on or after the date these regulations are 
published in the Federal Register as final regulations.
    (B) Change in method of accounting. Any change in a taxpayer's 
method of accounting necessary to comply with this paragraph (e)(3) or 
paragraphs (b)(4) or (c)(2) of this section is a change in method of 
accounting to which the provisions of section 446 and the regulations 
thereunder apply. For the first taxable year beginning on or after the 
date these regulations are published in the Federal Register as final 
regulations, a taxpayer is granted the consent of the Commissioner to 
change its method of accounting to a method required or permitted by 
this paragraph (e)(3) and paragraphs (b)(4) and (c)(2) of this section. 
A taxpayer that wants to change its method of accounting under this 
paragraph (e)(3)(v) must follow the automatic consent procedures in 
Rev. Proc. 99-49 (1999-52 I.R.B. 725) (see Sec. 601.601(d)(2) of this 
chapter). However, the scope limitations in section 4.02 of Rev. Proc. 
99-49 do not apply. In addition, if the taxpayer's method of accounting 
for its LIFO inventories is an issue under consideration at the time 
the application is filed with the national office, the audit protection 
of section 7 of Rev. Proc. 99-49 does not apply. If a taxpayer changing 
its method of accounting under this paragraph (e)(3)(v)(B) is under 
examination, before an appeals office, or before a federal court with 
respect to any income tax issue, the taxpayer must provide a copy of 
the application to the examining agent(s), appeals officer or counsel 
for the government, as appropriate, at the same time it files the 
application with the national office. A change under this paragraph 
(e)(3)(v)(B) must be made using a cut-off basis and new base year in 
accordance with paragraph (e)(3)(iv)(C)(1) of this section. Because a 
change under this paragraph (e)(3)(v)(B) is made on a cut-off basis, a 
section 481(a) adjustment is not required. However, a taxpayer changing 
its method of accounting under this paragraph (e)(3)(v)(B) must comply 
with the requirements of section 10.04(3) of the APPENDIX of Rev. Proc. 
99-49 (concerning bargain purchases).
* * * * *
    (h) Inventories received in certain nonrecognition transactions--
(1) In general. Except as provided in paragraph (h)(3) of this section, 
if inventories are received in a transaction described in paragraph 
(h)(2) of this section, then for purposes of determining future 
increments and liquidations the transferee must use the year of the 
transfer as the base year and the current-year cost (determined under 
the transferor's method of accounting) of the inventories received as 
the new base-year cost of such inventories. Likewise, the transferee 
must use the current-year cost (determined under the transferee's 
method of accounting) of its beginning inventory, if any, as the new 
base-year cost of the beginning inventory for purposes of determining 
future increments and liquidations. The total new base-year cost of the 
transferee's beginning inventory is equal to the new base-year cost of 
the inventories received and the new base-year cost of the beginning 
inventory. The cumulative index as of the first day of the year in 
which the inventory is received (the base date) is 1.00. The base-year 
costs of any layers of increment in the pool, as determined after the 
transfer, must be restated in terms of new base-year costs and the 
indexes for all such layers must be restated in terms of the new base 
year index. See paragraph (e)(3)(iv)(C)(1) of this section for an 
example of this computation.
    (2) Transactions to which this paragraph (h) applies. A transaction 
is described in this paragraph (h) if--
    (i) The transferee determines its basis in the inventories, in 
whole or in part, by reference to the basis of the inventories in the 
hands of the transferor;
    (ii) The transferor used the dollar-value LIFO method to account 
for the transferred inventories;
    (iii) The transferee uses the dollar-value LIFO method to account 
for the inventories in the year of the transfer; and
    (iv) The transaction is not described in section 381(a).
    (3) Anti-avoidance rule. The rule in paragraph (h)(1) of this 
section will not apply to a transaction entered into with the principal 
purpose to avail the transferee of a method of accounting that would be 
unavailable to the transferor (or would be unavailable to the 
transferor without securing consent from the Commissioner). In 
determining the principal purpose of a transfer, consideration will be 
given to all of the facts and circumstances. However, a transfer is 
deemed made with the principal purpose to avail the transferee of a 
method of accounting that would be unavailable to the transferor 
without securing consent from the Commissioner if the transferor 
acquired inventory in a bargain purchase within the five taxable years 
preceding the year of the transfer and used a dollar-value LIFO method 
to account for that inventory that did not treat the bargain purchase 
inventory and physically identical inventory acquired at market prices 
as separate items. Inventory is deemed acquired in a bargain purchase

[[Page 31853]]

if the actual cost of the inventory (or, if appropriate, the allocated 
cost of the inventory) was less than or equal to 50 percent of the 
replacement cost of physically identical inventory. Inventory is not 
considered acquired in a bargain purchase if the actual cost of the 
inventory (or, if appropriate, the allocated cost of the inventory) was 
greater than or equal to 75 percent of the replacement cost of 
physically identical inventory.
    (4) Effective date. The rules of this paragraph (h) are applicable 
for transfers on or after the date these regulations are published in 
the Federal Register as final regulations.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-12174 Filed 5-18-00; 8:45 am]
BILLING CODE 4830-01-U