Rev. Rul. 79-45

ISSUE

Whether for purposes of section 1382(f) of the Internal Revenue Code of 1954 a positive adjustment (increase in income) required under section 481(a) results in patronage earnings that are includible in the taxpayer's gross income in a taxable year after the patronage has occurred.

FACTS

The taxpayer, a cooperative within the meaning of section 1381(a)(2) of the Code, was granted permission by the Internal Revenue Service to change from the last-in, first-out (LIFO) inventory method to the first-in, first-out (FIFO) inventory method, using cost or market, whichever is lower, in 1977. This change in its method of accounting for inventories resulted in a positive adjustment. This positive adjustment represented the excess of (1) the inventory valuation at the beginning of the year of change under the new method over (2) the inventory valued at LIFO cost at the beginning of the year of change.

Because the taxpayer is a cooperative and the adjustment is related to its business done with or for its patrons, the Service required that the full amount of the positive adjustment be taken into income in the year of change. Taking the adjustment into income in that year enables the cooperative to make a one time allocation of the full amount of the adjustment to the patrons whose business with the cooperative was related to such an adjustment. This facilitates a cooperative's ability to pass through gains or losses as soon as possible to the patrons as a result of their business with the cooperative.

In passing through an amount equal to the adjustment in this situation, the cooperative during the payment period for 1977 allocated this income to the patrons whose business with the cooperative resulted in the adjustment.

Therefore, the income that the taxpayer recognized as a result of the positive adjustment was distributed on a patronage basis to the patrons of the taxpayer whose business in 1974, 1975, and 1976, the years in which the old method was used, generated the income. If the new method had been used in the years that they were patrons, they would have been entitled to a patronage dividend in an amount equal to the positive adjustment.

LAW AND ANALYSIS

The applicable sections of the Code and the Income Tax Regulations thereunder are 481 and 1.481-1, relating to adjustments required by changes in method of accounting, 1.1382-2(b)(1) relating to the allowance of a deduction to a cooperative organization to which subchapter T applies for amounts paid to patrons, and 1382(f) and 1.1382-6, relating to the treatment of earnings received after patronage has occurred.

Section 1.1382-2(b)(1) of the regulations allows as a deduction from the gross income of any cooperative organization to which part I of subchapter T applies, amounts paid to patrons during the payment period (the first day of the taxable year through the fifteenth day of the ninth month following the close of such year) as patronage dividends with respect to patronage occurring during such taxable year, but only to the extent that such amounts are paid in money, qualified written notices of allocation, or other property (other than non-qualified written notices of allocation).

Section 1382(f) of the Code concerns situations in which income is includible in a cooperative's gross income in a year subsequent to the year in which the patronage occurred that gave rise to such income. In that situation, section 1.1382-6 of the regulations provides that the patronage to which this income relates shall be considered to have occurred during the taxable year for which such income is includible in the cooperative's gross income. Thus, the distribution of such income may still receive the treatment of patronage dividends within the meaning of section 1382(b) even though the patronage to which it relates actually occurred in an earlier taxable year.

The payment of a patronage dividend that is based on income subject to the treatment of section 1382(f) of the Code necessitates a tracing of the allocation of this income to patrons that may no longer be members of the cooperative because it was their business with the cooperative that resulted in this income. In situations where this income is related to business done with patrons over an extensive period of time, the payment of a patronage dividend with respect to this income should be made in proportion, in so far as practicable, to the amount of business done by or for such patrons during the period to which such income is attributable. See section 1.1382-3(c)(3) of the regulations.

The income resulting from the positive adjustment required by section 481 of the Code was includible in the taxpayer's gross income only in the year that the taxpayer changed its inventory method. Although this income is attributable to business done with or for its patrons in prior years, such earnings were not includible in the taxpayer's gross income for the prior taxable years because the LIFO inventory method was used in those years.

HOLDING

The positive adjustment required under section 481(a) of the Code results in patronage earnings that are includible in gross income in 1977, a taxable year after the patronage occurred. Thus, for purposes of section 1382(f) of the Code, the patronage to which these earnings relate shall be considered to have occurred during 1977, the taxable year in which such earnings are includible in the gross income of the taxpayer, and therefore, the taxpayer can distribute such earnings to its 1974, 1975, and 1976 patrons during the payment period for 1977.