Rev. Proc. 74-21

Section 1. Purpose.

The purpose of this Revenue Procedure is to set forth the procedures to be used by the Internal Revenue Service in granting consent to taxpayers to change to the full absorption method of inventory costing as required by section 1.471-11(e)(1)(i) of the Income Tax Regulations when such taxpayers have elected to use the last-in, first-out (LIFO) inventory method under section 472 of the Internal Revenue Code of 1954.

Sec. 2. Scope.

The scope of this Revenue Procedure is limited to those taxpayers described in section 1 of this Revenue Procedure who wish to employ the cut-off method as authorized in section 1.471-11(e)(3)(ii)(B) of the regulations in changing to the full absorption method of inventory costing. Under the cut-off method the full absorption method is only applied in costing layers of inventory acquired during all taxable years beginning with the year for which the change is made, and thus does not apply to layers of inventory acquired in prior taxable years.

Sec. 3. Background.

.01 Section 1.472-4 of the regulations provides that a taxpayer may not change to the LIFO method of taking inventories unless, at the time he files his application for adoption of such method, he agrees to such adjustments incident to the change to or from such method, or incident to the use of such method, in the inventories of prior taxable years or otherwise, as the district director upon the examination of the taxpayer's returns may deem necessary in order that the true income of the taxpayer will be clearly reflected for the years involved.

.02 Section 1.471-11(e)(1)(i) of the regulations provides, in part, that a taxpayer not using the full absorption method of inventory costing, as prescribed in section 1.471-11(a), must change to that method.

.03 Section 1.471-11(e)(1)(ii) of the regulations provides that if a taxpayer elects to change to the full absorption method of inventory costing during the transition period provided therein, he may elect on Form 3115 to change to such full absorption method of inventory costing, and in so doing, employ the transition procedures and adopt any of the transition methods prescribed in subparagraph (e)(3). Such election shall be made during the first 180 days of any taxable year beginning on or after September 19, 1973, and before September 19, 1975, (i.e., the "transition period") and the change in inventory costing method shall be made for the taxable year in which the election is made.

.04 Section 1.471-11(e)(3)(ii) of the regulations provides, in part, that a taxpayer who uses the LIFO method of inventory identification may either employ the special transition rules described in section 1.471-11(e)(3)(i) (accordingly, all LIFO layers must be revalued under the full adsorption method and the section 481 of the Code adjustment must be computed for all items in all layers in inventory, but no pre-1954 inventory balances shall be taken into account as adjustments under section 481) or employ a cut-off method described in section 1.471-11(e)(3)(ii)(B) whereby the full absorption method is applied in costing layers of inventory acquired during all taxable years beginning with the year for which an election is made under paragraph (e)(1)(ii).

Sec. 4. Application.

.01 The transition rules set forth in section 1.471-11(e)(3)(ii)(B) of the regulations, relating to the use of the cut-off method for taxpayers using the LIFO method, were intended to relieve such taxpayers from the substantial administrative difficulties of having to recompute all items in all layers of inventory that had been acquired in prior taxable years. Such transition rules were not intended to permit taxpayers to avoid an adjustment resulting from a change to the full absorption method of inventory costing by first electing to use the LIFO inventory method, followed by an election within the "transition period" to use the cut-off method in effecting the change to the full absorption method. Accordingly, the Commissioner will not consent to the use of the cut-off method under section 1.471-11(e)(3)(ii)(B) for any taxpayer who has elected to change to the LIFO method under section 472 of the Code with respect to a taxable year ending on or after September 19, 1973, the beginning of the "transition period" referred to in section 1.471-11(e)(1)(ii). In the case of such a taxpayer the Commissioner will consent to using the transition method described in section 1.471-11(e)(3)(ii)(A), and the taxpayer thus will be required to revalue all inventories subject to the LIFO election under the full absorption method.

.02 Any taxpayer described in section 4.01 of this Revenue Procedure who declines to use the transition method described in section 1.471-11(e)(3)(ii)(A) of the regulations will be deemed to have violated the requirements of section 1.472-4 and thus may not be permitted to change to the LIFO inventory method.

.03 Any taxpayer described in section 4.01 of this Revenue Procedure who uses the transition method described in section 1.471-11(e)(3)(ii)(A) of the regulations will not be prevented, solely by reason of his LIFO election, from electing a transition year which is the same year or a later year than the year in which the LIFO election is made. For example, if a calendar year taxpayer elects to use the LIFO inventory method in 1973 or 1974, he is still permitted to elect to change to the full absorption method in either 1974 or 1975, provided he elects the transition method under section 1.471-11(e)(3)(ii)(A) and thus spreads the resulting adjustment under section 481(a) of the Code over a period of up to 10 taxable years.

.04 Any taxpayer who has elected to use the LIFO method for taxable years ending prior to September 19, 1973, may elect the cut-off method under section 1.471-11(e)(3)(ii)(B) of the regulations provided the election to use the full absorption method of inventory costing is made during the transition period referred to in section 1.471-11(e)(1)(ii).

¹ Also released as Technical Information Release No. 1296, dated July 17, 1974.