us-irs-revenue-procedures-irb-2001-10-pdf•Internal Revenue Bulletin 2001-10 (PDF rendition): IRS Revenue Procedures
Internal Revenue Bulletin 2001-10 (PDF rendition): IRS Revenue Procedures
us-irs-revenue-procedures-irb-2001-10-pdfInternal Revenue Bulletin 2001-10 (PDF rendition): IRS Revenue ProceduresGuidance
Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.
# Internal Revenue bulletin
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## HIGHLIGHTS OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
## INCOME TAX
Rev. Rul. 2001-10, page 755.
Low-income housing credit; satisfactory bond; "bond
factor" amounts for the period January through
March 2001. This ruling announces the monthly bond fac-
tor amounts to be used by taxpayers who dispose of qual-
ified low-income buildings or interests therein during the
period January through March 2001.
Rev. Rul. 2001-11, page 780.
Insurance companies; interest rate tables. Prevailing
state assumed interest rates are provided for the determi-
nation of reserves under section 807 of the Code for con-
tracts issued in 2000 and 2001. Rev. Rul. 92-19 supple-
mented in part.
### T.D. 8929, page 756.
Final regulations under section 460 of the Code provide guid-
ance on accounting for long-term contracts.
Notice 2001-19, page 784.
Comments on research credit regulations. This notice
announces that the Treasury Department and the IRS will
review the research credit final regulations in T.D. 8930
(2001-5 I.R.B. 433), and that comments are requested on
the final regulations. Upon completion of this review,
Treasury and the IRS will announce changes to the regula-
tions, if any, in the form of proposed regulations. In addition,
T.D. 8930 will be revised so that the provisions of the regu-
lations, including any changes, will be effective no earlier
than the date the review is completed. However, the provi-
sions related to internal-use computer software (including
any revisions) generally will be applicable to taxable years
beginning after December 31, 1985. Comments should be
submitted by April 2, 2001.
Rev. Proc. 2001-23, page 784.
Dollar-value LIFO; used vehicles. This procedure pro-
vides an optional LIFO inventory computation method for tax-
payers who sell used automobiles or used light-duty trucks.
The link-chain, dollar-value LIFO inventory method is
designed to simplify the dollar-value LIFO computations of
used vehicle dealers. Rev. Proc. 99-49 modified and ampli-
fied.
### Rev. Proc. 2001-24, page 788.
Change in method of accounting. This procedure allows
an insurance company to obtain automatic consent to
change its method of accounting for cash advances on com-
missions paid to its agents, from deducting cash advances
in the taxable year paid to an agent to deducting cash
advances in the taxable year earned by the agent. Rev. Proc.
99-49 modified and amplified.
Announcement 2001-23, page 791.
The Service announces supplements to Publication 575,
Pension and Annuity Income, and Publication 590, Individual
Retirement Arrangements, that take into account proposed
regulations (REG-130477-00; REG-130481-00) substan-
tially simplifying the calculation of minimum required distrib-
utions from qualified plans, IRAs, and other related retire-
ment savings vehicles.
(Continued on the next page)
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Department of the Treasury
Internal Revenue Service
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## EMPLOYEE PLANS
Announcement 2001-18, page 791.
Model amendment; minimum distributions under sec-
tion 401(a)(9).This announcement sets forth a corrected
model amendment for qualified plan sponsors to adopt if
they wish to follow the proposed regulations under section
401(a)(9) of the Code when making required minimum distri-
butions for 2001 and subsequent calendar years.
Announcement 2001-23, page 791.
The Service announces supplements to Publication 575, Pension
and Annuity Income, and Publication 590, Individual Retirement
Arrangements, that take into account proposed regulations
(REG-130477-00; REG-130481-00) substantially simplifying
the calculation of minimum required distributions from qualified
plans, IRAs, and other related retirement savings vehicles.
## ADMINISTRATIVE
Announcement 2001-19, page 791.
This announcement corrects a numerical error in Rev. Rul.
2000-56, 2000-52 I.R.B. 597, relating to the inflation-
adjusted amounts a taxpayer may lend a qualified continuing
care facility without incurring imputed interest under section
7872(g) of the Code.
Announcement 2001-24, page 793.
Election to treat trust as part of an estate. This docu-
ment changes the date of the public hearing and extends the
time for submission of outlines of oral comments on pro-
posed regulations REG-106542-98, 2001-5 I.R.B. 473.
The hearing is scheduled for April 11, 2001. Comments
must be received by March 21, 2001.
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# The IRS Mission
Provide America's taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
## Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents are consolidated semiannually into
Cumulative Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless oth-
erwise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Ser-
vice personnel in the disposition of other cases. In applying
published rulings and procedures, the effect of subsequent
legislation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same
conclusions in other cases unless the facts and circum-
stances are substantially the same.
The Bulletin is divided into four parts as follows:
### Part I .- 1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
### Part II .- Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Ad-
ministrative Rulings. Bank Secrecy Act Administrative Rul-
ings are issued by the Department of the Treasury's Office
of the Assistant Secretary (Enforcement).
### Part IV .- Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual
basis, and are published in the first Bulletin of the succeed-
ing semiannual period, respectively.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.
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## Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
### Section 42 .- Low-Income Housing Credit
Low-income housing credit; satisfac-
tory bond; "bond factor" amounts for
the period January through March
2001. This ruling announces the monthly
bond factor amounts to be used by tax-
payers who dispose of qualified low-in-
come buildings or interests therein during
the period January through March 2001.
### Rev. Rul. 2001-10
In Rev. Rul. 90-60, 1990-2 C.B. 3, the
Internal Revenue Service provided
guidance to taxpayers concerning the
general methodology used by the
Treasury Department in computing the
bond factor amounts used in calculating
the amount of bond considered satisfac-
tory by the Secretary under § 42(j)(6) of
the Internal Revenue Code. It further
announced that the Secretary would
publish in the Internal Revenue Bulletin
a table of "bond factor" amounts for dis-
positions occurring during each calen-
dar month.
Rev. Proc. 99-11, 1999-1 C.B. 275,
established a collateral program as an
alternative to providing a surety bond for
taxpayers to avoid or defer recapture of
the low-income housing tax credits under
§ 42(j)(6). Under this program, taxpayers
may establish a Treasury Direct Account
and pledge certain United States Treasury
securities to the Internal Revenue Service
as security.
This revenue ruling provides in Table 1
the bond factor amounts for calculating
the amount of bond considered satisfacto-
ry under § 42(j)(6) or the amount of
United States Treasury securities to
pledge in a Treasury Direct Account under
Rev. Proc. 99-11 for dispositions of quali-
fied low-income buildings or interests
therein during the period January through
March 2001.
Table 1 Rev. Rul. 2001-10 Monthly Bond Factor Amounts for Dispositions Expressed As a Percentage of Total Credits
Calendar Year Building Placed in Service or, if Section 42(f)(1) Election Was Made, the Succeeding Calendar Year
Month of Disposition
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Jan '01
21.53
39.56
54.68
67.46
78.28
81.29
84.62
87.92
91.31
94.99
98.92
Feb '01
21.53
39.56
54.68
67.46
78.28
81.05
84.36
87.65
91.02
94.68
98.57
Mar '01
21.53
39.56
54.68
67.46
78.28
80.81
84.11
87.38
90.73
94.37
98.24
Table 1 (cont'd) Rev. Rul. 2001-10 Monthly Bond Factor Amounts for Dispositions Expressed As a Percentage of Total Credits
Calendar Year Building Placed in Service or, if Section 42(f)(1) Election Was Made, the Succeeding Calendar Year
Month of Disposition
1998
1999
2000
2001
Jan '01
103.25
107.67
111.85
112.52
Feb '01
102.87
107.22
111.28
112.52
Mar '01
102.50
106.80
110.79
112.52
For a list of bond factor amounts applic-
able to dispositions occurring during other
calendar years, see the following revenue
rulings: Rev. Rul. 98-3, 1998-1 C.B. 248;
and Rev. Rul. 2001-2, 2001-2 I.R.B. 255.
### DRAFTING INFORMATION
The principal author of this revenue
ruling is Gregory N. Doran of the Office
of Associate Chief Counsel (Passthroughs
and Special Industries). For further infor-
mation regarding this revenue ruling, con-
tact Mr. Doran at (202) 622-3040 (not a
toll-free call).
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## Section 446 .- General Rule for Methods of Accounting
26 CFR 1.446-1: General rule for methods of
accounting.
Optional dollar-value LIFO inventory computa-
tion method for used vehicle dealers. See Rev. Proc.
2001-23, page 784.
## Section 451 .- General Rule For Taxable Year of Inclusion
26 CFR 1.451-1: General rule for taxable year of
inclusion.
Cash lent to agent by insurance company is in-
cudible in taxable income when earned. See Rev.
Proc. 2001-24, page 788.
## Section 460 .- Special Rules for Long-Term Contracts
26 CFR 1.460-0: Outline of regulations under
section 460.
T.D. 8929
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
## Accounting for Long-Term Contracts
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations describing how income
from a long-term contract must be
accounted for under section 460 of the
Internal Revenue Code, which was enact-
ed by the Tax Reform Act of 1986. A tax-
payer manufacturing or constructing
property under a long-term contract will
be affected by these regulations.
DATES: Effective Date: These regula-
tions are effective on January 11, 2001.
Applicability Date: These regulations
apply to any contract entered into on or
after January 11, 2001.
FOR FURTHER INFORMATION CON-
TACT: Leo F. Nolan II or John M.
Aramburu of the Office of Associate
Chief Counsel (Income Tax and
Accounting) at (202) 622-4960 (not a toll-
free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained
in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545-1650. Responses to this
collection of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
The estimated annual burden per
respondent and/or recordkeeper is 15 min-
utes.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS
Reports Clearance Officer,
W:CAR:MP:FP:S:O, Washington, DC
20224, and to the Office of Management
and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503.
Books or records relating to a collec-
tion of information must be retained as
long as their contents might become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
### Background
Section 460, which was enacted by sec-
tion 804 of the Tax Reform Act of 1986,
Public Law 99-514 (100 Stat. 2085,
2358-2361), generally requires a taxpayer
to determine the taxable income from a
long-term contract using the percentage-
of-completion method. Section 460 was
amended by section 10203 of the
Omnibus Budget Reconciliation Act of
1987, Public Law 100-203 (101 Stat.
1330, 1330-394); by sections 1008(c) and
5041 of the Technical and Miscellaneous
Revenue Act of 1988, Public Law
100-647 (102 Stat. 3342, 3438-3439 and
3673-3676); by sections 7621 and
7811(e) of the Omnibus Budget
Reconciliation Act of 1989, Public Law
101-239 (103 Stat. 2106, 2375-2377 and
2408-2409); by section 11812 of the
Omnibus Budget Reconciliation Act of
1990, Public Law 101-508 (104 Stat.
1388, 1388-534 to 1388-536); by sec-
tions 1702(h)(15) and 1704(t)(28) of the
Small Business Job Protection Act of
1996, Public Law 104-188 (110 Stat.
1755, 1874, 1888); and by section 1211 of
the Taxpayer Relief Act of 1997, Public
Law 105-34 (111 Stat. 788, 998-1000).
Section 460(h) directs the Secretary to
prescribe regulations to the extent neces-
sary or appropriate to carry out the pur-
pose of section 460, including regulations
to prevent a taxpayer from avoiding sec-
tion 460 by using related parties, pass-
through entities, intermediaries, options,
and other similar arrangements.
On May 5, 1999, the IRS and Treasury
Department published a notice of pro-
posed rulemaking (REG-208156-91,
1999-1 C.B. 1141 [64 F.R. 24096]) relat-
ing to section 460. Comments responding
to the notice were received, and a public
hearing was scheduled for September 14,
1999.
The IRS and Treasury Department
received eleven comment letters concern-
ing the notice of proposed rulemaking.
After considering the comments con-
tained in these letters, the IRS and
Treasury Department adopt the proposed
regulations as revised by this Treasury
decision. The comments and revisions are
discussed below.
### Explanation of Provisions
#### 1. Overview
Section 460 generally requires the
income from a long-term contract to be
determined using the percentage-of-com-
pletion method based on a cost-to-cost
comparison (PCM). However, the income
from exempt construction contracts still
may be determined using the completed-
contract method (CCM), the exempt-con-
tract percentage-of-completion method
(EPCM), or any other permissible
method. Contracts that are not long-term
contracts must be accounted for using a
permissible method of accounting other
than a long-term contract method (i.e., a
method other than the PCM, the CCM, or
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the EPCM). See section 446 and the reg-
ulations thereunder.
One commentator suggested that the
exceptions to the mandatory use of the
PCM included in the proposed regulations
be expanded to include "any portion of
the long-term manufacturing contract for
which no payment for the manufacture of
the subject matter of the contract is
required to be made before the manufac-
ture of the item is completed." The
exceptions contained in the proposed reg-
ulations were specifically provided by the
statute and the statute does not include the
suggestion made by the commentator.
Thus, the IRS and Treasury Department
did not adopt this suggestion.
#### 2. Definition of Long-Term Contract
Under section 460(f), "long-term con-
tract" generally means any contract for
the building, installation, construction
(construction), or the manufacture, of
property if the contract is not completed
within the taxable year the taxpayer enters
into the contract (contracting year).
However, a manufacturing contract is not
a long-term contract unless it involves the
manufacture of (1) a unique item of a type
that is not normally included in the fin-
ished goods inventory of the taxpayer or
(2) an item normally requiring more than
12 calendar months to complete, regard-
less of the duration of the contract.
Continuing the policy established in
Notice 89-15 (1989-1 C.B. 634), the pro-
posed regulations provide that it is not rel-
evant whether the customer has title to,
control over, or risk of loss with respect to
the property. One commentator suggested
that the final regulations should not retain
the rule that requires a contractor to
ignore title and risk-of-loss issues relative
to the applicability of section 460 because
a contractor has little freedom to restruc-
ture a contract to "construct" into a con-
tract to "sell." The IRS and Treasury
Department did not adopt this suggestion
because we believe that a contract's clas-
sification should be based on the perfor-
mance required of the taxpayer under the
contract regardless of whether that con-
tract otherwise would be classified as a
sales contract or a construction or manu-
facturing contract. Moreover, the IRS and
Treasury Department continue to believe
that the rule in the proposed regulations is
necessary to prevent a taxpayer from cir-
cumventing section 460 by structuring a
construction contract to resemble a sales
contract without changing the taxpayer's
obligations under the contract. Another
commentator asked whether a contract is
subject to section 460 if it requires the
taxpayer to manufacture or construct
property in order to fulfill its contractual
obligation but the property is never deliv-
ered to the customer (e.g., a research con-
tract for test results). Again, the IRS and
Treasury Department believe that a con-
tract's classification should depend upon
the performance required of the taxpayer
under the contract. Thus, the final regula-
tions clarify that it is irrelevant whether
title in the property manufactured or con-
structed under the contract is delivered to
the customer.
The proposed regulations provide that a
contract is not a construction contract if it
requires the taxpayer to provide land to
the customer and the estimated total allo-
cable contract costs attributable to the tax-
payer's construction activities are less
than 10 percent of the contract's total con-
tract price. One commentator asked for
clarification concerning whether the esti-
mated total allocable contract costs attrib-
utable to the taxpayer's construction
activities includes the cost of the land pro-
vided under the contract. The final regu-
lations clarify that the cost of this land is
not an allocable contract cost when the
taxpayer determines whether the cost of
its construction activities is less than 10
percent of the contract's total contract
price.
#### 3. Date Taxpayer Completes a Long-Term Contract
The proposed regulations provide that a
long-term contract is completed in the
earlier taxable year (completion year)
that: (1) the customer uses the subject
matter of the contract (other than for test-
ing) and at least 95 percent of the total
allocable contract costs attributable to the
subject matter have been incurred by the
taxpayer; or (2) the subject matter of the
contract is finally completed and accept-
ed. To the extent that the "customer-use"
rule requires a taxpayer to treat a contract
as completed before final completion and
acceptance have occurred, the proposed
regulations explicitly adopt a rule differ-
ent from that considered in Ball, Ball and
Brosamer, Inc. v. Commissioner, 964 F.2d
890 (9th Cir. 1992), aff'g T.C. Memo.
1990-454.
Some commentators argued against
having a rule that will declare a contract
completed earlier than under the finally-
completed-and-accepted standard illus-
trated in Ball. Some commentators also
argued that the customer-use rule is con-
fusing to subcontractors because it is
unclear whether a subcontractor's "cus-
tomer" is the general, or "prime," contrac-
tor or the ultimate owner of the property.
On the other hand, one commentator
asked for a bright-line standard for com-
pletion and suggested, among other possi-
bilities, that completion occur when 95
percent of the estimated costs have been
incurred.
The IRS and Treasury Department con-
tinue to believe that a contract is complete
for all practical purposes when the cus-
tomer uses the subject matter of that con-
tract and the taxpayer has only five per-
cent or less of the total allocable contract
costs remaining to be incurred. Delaying
a contract's completion beyond this point,
as the Tax Court permitted in Ball, does
not reflect the substance of the transaction
and could encourage the use of formalities
to delay a contract's completion unreason-
ably. Thus, the final regulations do not
substantively change the customer-use
rule contained in the proposed regula-
tions. However, the final regulations clar-
ify that a subcontractor's customer is the
general contractor.
Several commentators expressed con-
cern that the customer-use rule contained
in the proposed regulations will create
additional administrative burdens for tax-
payers using the PCM because they often
will have to apply the look-back method
two times, first upon customer use and
again upon final completion and accep-
tance. Though the IRS and Treasury
Department believe that the customer-use
rule results in an appropriate determina-
tion of completion, we understand these
concerns. Thus, to simplify a taxpayer's
reporting requirements under the look-
back method, the IRS and Treasury
Department have modified the look-back
regulations to require a taxpayer to delay
the first application of the look-back
method until the taxable year in which a
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long-term contract is finally completed
and accepted.
#### 4. Severing and Aggregating Contracts
The proposed regulations allow the
Commissioner, and generally require a
taxpayer, to sever and aggregate contracts
when necessary to clearly reflect income.
The proposed regulations provide the fol-
lowing criteria for determining whether
severance or aggregation is required:
independent versus interdependent pric-
ing, separate delivery or acceptance, and
the reasonable businessperson standard.
However, under the proposed regulations,
a taxpayer may not sever a contract sub-
ject to the PCM. In addition, the proposed
regulations require a taxpayer to notify
the Commissioner when severing a long-
term contract not accounted for using the
PCM and provide agreement-specific
information, including the criteria for sev-
ering or aggregating the agreement.
Some commentators criticized the "no
severance" rule for long-term contracts
subject to the PCM. The "no severance"
rule is provided in the proposed regula-
tions because the IRS and Treasury
Department believe that in most cases, a
taxpayer's use of the PCM and look-back
method will clearly reflect the taxpayer's
income from a long-term contract. To
date, the only identified reason to allow
severance of a contract subject to the
PCM related to the application of the 10-
percent method as shown in §1.460-1(j)
Example 8 of the proposed income tax
regulations. Conversely, the IRS and
Treasury Department believe that permit-
ting a taxpayer to sever a contract subject
to the PCM could allow the taxpayer to
manipulate taxable income (e.g., by sev-
ering to create a loss contract and acceler-
ate the loss) or to avoid the application of
section 460 (e.g., by "completing" the
contract during the contracting year).
Nonetheless, the IRS and Treasury
Department agree with the commentators'
concerns that to the extent severance is
necessary to clearly reflect income from a
long-term contract (e.g., due to the appli-
cation of the 10-percent method), it
should be permitted. Accordingly, the
final regulations allow a taxpayer to sever
a long-term contract if necessary to clear-
ly reflect income, but only if the taxpayer
has obtained the Commissioner's prior
written consent.
Some commentators criticized the noti-
fication requirement for severed and
aggregated contracts as being unduly bur-
densome. The IRS and Treasury
Department continue to believe that noti-
fication will help taxpayers and the IRS
consistently apply the severing and aggre-
gating rules. In recognition of the poten-
tial burden associated with the proposed
notification requirement, however, the
final regulations simplify the notification
by only requiring that a taxpayer inform
the IRS when it has severed or aggregated
agreements. Thus, the taxpayer is no
longer required to provide agreement-spe-
cific information.
One commentator suggested that the
reasonable businessperson standard be
eliminated because it is merely a subset of
independent pricing and interdependent
pricing (the pricing standards), which
should be the primary criteria for deter-
mining whether long-term contracts must
be severed or aggregated to clearly reflect
income. The IRS and Treasury
Department agree that the pricing stan-
dards and the reasonable businessperson
standard overlap, but believe that the pric-
ing standard is a subset of the reasonable
businessperson standard. Besides requir-
ing an analysis of pricing, the reasonable
businessperson standard requires an
analysis of all the facts and circumstances
of the business arrangement between the
taxpayer and the customer. Thus, because
the absence of the reasonable businessper-
son standard might change the decision to
sever or aggregate in some cases, the final
regulations retain this criterion and clarify
its distinction from the pricing standards.
#### 5. Hybrid Contracts
Under the proposed regulations, a tax-
payer generally must classify a contract
that requires the taxpayer to manufacture
personal property and to construct real
property (hybrid contract) as separate
manufacturing and construction contracts.
If at least 95 percent of the estimated allo-
cable contract costs are reasonably alloca-
ble to manufacturing (or construction)
activities, the taxpayer may classify the
contract as a manufacturing (or construc-
tion) contract.
One commentator suggested that the
final regulations allow a taxpayer to elect
to use the PCM to account for a hybrid
contract instead of requiring the taxpayer
to account for both parts separately. The
IRS and Treasury Department agree with
the commentator's request for simplifica-
tion. Accordingly, the final regulations
allow a taxpayer to elect, on a contract-
by-contract basis, to classify a hybrid con-
tract as a long-term manufacturing con-
tract subject to the PCM. In addition,
because this election effectively super-
sedes the 95-percent election that would
have applied to hybrid contracts that are
primarily manufacturing contracts, the
final regulations retain the 95-percent
election as a second election that applies
only to hybrid contracts that are primarily
construction contracts.
#### 6. Contracts of Related Parties
The proposed regulations provide that
if a related party and its customer enter
into a long-term contract subject to the
PCM, and a taxpayer performs any activ-
ity that is incident to or necessary for the
related party's long-term contract, the tax-
payer must account for the gross receipts
and costs attributable to the activity using
the PCM. However, the proposed regula-
tions contain an inventory exception for
components and subassemblies produced
by the taxpayer if the taxpayer regularly
carries these items in its finished goods
inventories and 80 percent or more of the
gross receipts from the sale of these items
typically comes from unrelated parties.
One commentator suggested that the
percentage threshold be lowered from 80
percent to 50 percent and that the excep-
tion not be limited to items regularly car-
ried in the taxpayer's finished goods
inventories. The IRS and Treasury
Department included the related party
rule, originally promulgated in Notice 89-
15, in the proposed regulations to prevent
taxpayers from establishing special-pur-
pose subsidiaries to avoid the application
of section 460. However, in recognition
that a related party that sells most units of
a manufactured item to unrelated parties
was not established for the purpose of
avoiding section 460, the IRS and
Treasury Department added the inventory
exception to the proposed regulations to
reduce the related party's accounting bur-
den. The IRS and Treasury Department
agree, however, that the inventory excep-
tion is too narrow. Accordingly, the final
regulations lower the percentage thresh-
old from "80 percent or more" to "more
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than 50 percent" and eliminate the
requirement that the components or sub-
assemblies be carried in finished goods
inventories.
#### 7. Unique Items
Section 460 applies if a taxpayer manu-
factures a unique item of a type that is not
normally included in the finished goods
inventory of the taxpayer and if the con-
tract is not completed by the close of the
contracting year. The proposed regula-
tions provide that "unique" means specif-
ically designed for the needs of a cus-
tomer. In addition, the proposed
regulations contain three safe harbors
concerning contracts to manufacture
unique items. First, an item is not unique
if the taxpayer normally completes the
item within 90 days. Second, an item is
not unique if the total allocable contract
costs attributable to customizing activities
that are incident to or necessary for the
production of the item do not exceed 5
percent of the estimated total costs alloca-
ble to the item. Third, a unique item ceas-
es to be unique no later than when the tax-
payer normally includes similar items in
its finished goods inventory. For an item
that does not satisfy one of these three
safe harbors, the determination of whether
the item is unique is based on the facts and
circumstances.
Some commentators suggested that the
final regulations contain either a 140-day
or a 180-day safe harbor instead of the 90-
day safe harbor. The IRS and Treasury
Department did not adopt these sugges-
tions because we believe that a 90-day
safe harbor appropriately limits the mean-
ing of "unique" in most cases. However,
the IRS and Treasury Department have
modified the 90-day safe harbor to clarify
that in the case of a contract to manufac-
ture multiple units of the same item, the
90-day safe harbor applies only if each
unit normally is completed within 90
days.
Some commentators suggested that the
final regulations contain either a 10-per-
cent, 15-percent, or 20-percent safe har-
bor instead of the 5-percent safe harbor.
In particular, these commentators stated
that a 5-percent safe harbor will not alle-
viate any controversy between taxpayers
and revenue agents because revenue
agents generally do not raise the issue of
unique items if the taxpayer's customiz-
ing costs do not exceed 5 percent. The
IRS and Treasury Department agree that it
is reasonable to assume that an item is not
unique if the taxpayer's customizing costs
do not exceed 10 percent. Thus, the cus-
tomization safe harbor in the final regula-
tions has been increased to 10 percent.
One commentator suggested that the
cost of a taxpayer's customizing activities
should not include the cost of any cus-
tomized equipment purchased by a tax-
payer from an unrelated party under a
"special accommodation" arrangement
with the customer that requires the tax-
payer to acquire and install that cus-
tomized equipment. The IRS and
Treasury Department did not adopt this
suggestion because such a special accom-
modation rule could enable taxpayers to
avoid section 460 by having some long-
term contract activities performed by out-
side parties.
Several commentators questioned the rel-
evance of the "basic design" concept includ-
ed in §1.460-2(e) Example 1 of the proposed
regulations. To determine whether an item
is unique, the relevant analysis is whether an
item is customized (or manufactured
according to a customer's specifications)
regardless of whether the item is customized
from a basic design. Accordingly, the final
regulations delete the reference to the tax-
payer's basic design in the example to elim-
inate any confusion.
One commentator questioned how the
safe harbor applies in the case of a con-
tract to manufacture multiple units of the
same item. The IRS and Treasury
Department believe that if significant cus-
tomization is necessary to produce an
item for a customer under the contract,
that item is specifically designed for the
needs of the customer, and thus is a
unique item, regardless of the number of
units produced for the customer under the
contract. Thus, the final regulations clar-
ify that for the purposes of applying the
10-percent safe harbor to a contract to
manufacture multiple units of the same
item, a taxpayer must allocate all cus-
tomization costs to the first unit manufac-
tured under the contract.
Some commentators suggested the
addition of a fourth safe harbor that would
exclude "income on contracts for which
progress payments have not been received
by year end." The IRS and Treasury
Department did not adopt this suggestion
because we do not believe that such a rule
bears any relationship to a determination
of the uniqueness of an item and because
such a rule is inconsistent with the statute.
#### 8. 12-Month Completion Period
The proposed regulations provide that a
manufactured item normally requires
more than 12 months to complete if its
"production period," as defined in
§1.263A-12, is reasonably expected to
exceed 12 months, determined at the end
of the contracting year. In general, the
production period for an item or unit
begins when the taxpayer incurs at least 5
percent of the estimated total allocable
contract costs, including planning and
design expenditures, allocable to the item
or unit, and the production period ends
when the item or unit is ready for ship-
ment to the taxpayer's customer.
Some commentators suggested that the
final regulations be clarified to provide
that "normal time to complete" includes
only the time of physical production
activity and not the time of any research,
development, planning, or design activity.
The IRS and Treasury Department did not
adopt this suggestion because we believe
that the definition of "production period"
under §1.263A-12(c)(3), which includes
the time required for planning and design
activity, is consistent with the allocation
of costs to extended-period long-term
contracts under §1.451-3(d)(6) and with
section 460(c)(1), which requires that
costs be allocated under the rules applica-
ble to extended-period long-term con-
tracts. In addition, if an item manufac-
tured under a long-term contract requires
a significant amount of design time to
produce, it is appropriate to include the
time needed to perform these activities
when determining that item's "normal
time to complete" because these activities
are directly attributable to that contract
and are necessary to manufacture the sub-
ject matter of the contract. However, the
final regulations clarify that a taxpayer is
not required to consider activities related
to costs that are not allocable contract
costs under section 460 (e.g., independent
research and development expenses, mar-
keting expenses) when determining the
item's normal time to complete.
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Some commentators asked how the 12-
month rule applies in the case of a con-
tract to manufacture multiple units of the
same item. The final regulations clarify,
that for the purposes of applying the 12-
month rule to this type of contract, the
time required to design and manufacture
the first unit generally does not reflect the
item's "normal time to complete." For
example, the time required to design the
first unit of an item should not be consid-
ered as time required to manufacture sub-
sequent identical units. The final regula-
tions also include an example illustrating
the determination of normal time to com-
plete an item in the case of a contract to
manufacture multiple units of the same
item.
#### 9. Percentage-of-Completion Method
The proposed regulations provide that,
under the PCM, a taxpayer generally
includes a portion of the total contract
price in income for each taxable year that
the taxpayer incurs contract costs alloca-
ble to the long-term contract. Under the
proposed regulations, total contract price
included all bonuses, awards, and incen-
tive payments if it is reasonably estimated
that they will be received, even if the all
events test has not yet been met. If, by the
end of the completion year, a taxpayer
cannot reasonably estimate whether a
contingency will be satisfied, the bonus,
award, or incentive payment is not
includible in total contract price.
Some commentators argued that a tax-
payer should not have to include contin-
gent compensation in "total contract
price" until the all events test for the item
has been satisfied. The IRS and Treasury
Department did not adopt this suggestion
because the all events test is a judicially
created test applying to taxpayers using an
accrual method. U.S. v. Anderson, 269
U.S. 422 (1926). Conversely, section 460
is a self-contained, statutorily created
accounting method that requires taxpayers
to use estimated amounts when comput-
ing taxable income under the PCM and to
use actual amounts when applying the
look-back method. In addition, using the
most accurate estimate of total contract
price and total contract costs will produce
the most accurate annual reporting of
income and costs and will minimize dis-
crepancies that could necessitate paying
look-back interest. See Tutor-Saliba
Corp. v. Commissioner, 115 T.C. No. 1
(July 17, 2000). However, in response to
comments and questions concerning the
contingent income rule, the final regula-
tions provide that contingent income is
includible in total contract price not later
than when it is included in income for
financial reporting purposes under gener-
ally accepted accounting principles.
One commentator suggested that the
final regulations incorporate the rule
under §1.451-3(a)(1) that allows a tax-
payer to account for long-term contracts
of less-than-substantial duration using a
method of accounting other than a long-
term contract method of accounting. The
IRS and Treasury Department did not
adopt this suggestion because such a rule
would be inconsistent with the statutory
definition of "long-term contract."
One commentator asked how a contrac-
tor should account for the subject matter
of a long-term contract when the customer
breaches that contract before the contrac-
tor has transferred title to the customer but
after the contractor has reported taxable
income from that contract under the PCM
(e.g., unfinished condominium unit). In
response to this comment, the final regu-
lations include new §1.460-4(b)(7),
which provides that if a long-term con-
tract is terminated before completion and,
as a result, the taxpayer retains ownership
of the property that is the subject matter of
that contract, the taxpayer must reverse
the previously reported gross income
(loss) from the transaction in the taxable
year of termination. As a result of revers-
ing its previously reported gross income
under this rule, a taxpayer generally will
have an adjusted basis in the retained
property equal to its previously deducted
allocable contract costs. The look-back
method does not apply to any terminated
contract to the extent it is subject to this
rule. The IRS and Treasury Department
request suggestions for rules that will
apply when the customer acquires owner-
ship of some, but not all, of the property
that is the subject matter of the contract.
#### 10. Cost Allocation Rules
The proposed and final regulations pro-
vide that a taxpayer generally must allo-
cate costs to a contract subject to section
460(a) in the same manner as direct and
indirect costs are capitalized to property
produced by a taxpayer under section
263A. The regulations provide excep-
tions, however, that reflect the differences
in the cost allocation rules of sections
263A and 460.
One commentator argued that the final
regulations should contain a single stan-
dard for determining when the cost of a
direct material is allocable to a long-term
contract. In response to this comment, the
final regulations contain a single standard
linked to the uniform capitalization (UNI-
CAP) rules of section 263A. The final
regulations also clarify that, among other
methods, a taxpayer dedicates direct
materials by associating them with a spe-
cific contract (e.g., by purchase order,
entry on books and records, shipping
instructions).
One commentator suggested that the
final regulations clarify that taxpayers
should not treat software development
and software implementation costs as cus-
tomization costs for the purposes of the
proposed 5-percent safe harbor. The IRS
and Treasury Department did not adopt
this suggestion because we believe that
software costs are allocable contract costs
(and thus customization costs) to the
extent they are incident to or necessary for
the manufacture of the subject matter of
the contract.
This commentator also suggested that
the final regulations clarify that taxpayers
should not treat guarantee, warranty, and
maintenance costs as customization costs
for the purposes of the proposed 5-percent
safe harbor. The IRS and Treasury
Department modified §1.460-1(d)(2) to
clarify that these types of costs are not
allocable contract costs.
#### 11. Simplified Cost-To-Cost Method
The proposed regulations generally
permit a taxpayer to elect to allocate con-
tract costs using the simplified cost-to-
cost method. Under the simplified cost-
to-cost method, a taxpayer must
determine a contract's completion factor
based upon only direct material costs;
direct labor costs; and depreciation, amor-
tization, and cost recovery allowances on
equipment and facilities directly used to
manufacture or construct property under
the contract.
One commentator suggested that the
final regulations clarify whether a taxpay-
er using the simplified cost-to-cost
method is allowed or required to include
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subcontracted costs in a contract's com-
pletion factor. In response to this com-
ment, the final regulations clarify that
subcontracted costs represent either direct
material or direct labor costs and thus
must be allocated to a contract under the
simplified cost-to-cost method when
incurred under § 1.461-4(d)(2)(ii). In
addition, a taxpayer must allocate subcon-
tracted costs for all section 460 purposes
(e.g., applying the 10-percent safe harbor
under §1.460-2(b)(2)(ii)).
#### 12. Statute of Limitations and Compound Interest on Look-Back Interest
One commentator requested guidance
concerning the statute of limitations
applicable to payments of, and claims for,
look-back interest. The final regulations
amend §1.460-6(f)(1) and (2) to clarify
the reporting requirements and add new
§1.460-6(f)(3). New §1.460-6(f)(3) pro-
vides guidance on the statute of limita-
tions applicable to the assessment and col-
lection of look-back interest owed by a
taxpayer. In addition, new §1.460-6(f)(3)
provides that a taxpayer's claim for credit
or refund of look-back interest previously
paid by or collected from the taxpayer is a
claim for credit or refund of an overpay-
ment of tax for federal income tax pur-
poses, which is subject to the section 6511
statute of limitations. In contrast, new
§1.460-6(f)(3) provides that a taxpayer's
claim for look-back interest (or interest
payable on look-back interest) that is not
attributable to an amount previously paid
by or collected from the taxpayer is a gen-
eral claim against the federal government,
which is subject to the statutes of limita-
tions found in 28 U.S.C. sections 2401
and 2501.
#### 13. Effective Date
These final regulations apply to any
contract entered into on or after January
11, 2001.
### Special Analyses
It has been determined that this
Treasury decision is not a significant reg-
ulatory 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 regula-
tions. Pursuant to section 7805(f) of the
Internal Revenue Code, this Treasury
decision was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business. It is hereby
certified that the collection of information
in this Treasury decision will not have a
significant economic impact on a substan-
tial number of small entities. The regula-
tions require a taxpayer to attach a state-
ment to its original federal income tax
return if the taxpayer severs or aggregates
a long-term contract. The statement is
needed so the Commissioner can deter-
mine whether the taxpayer properly sev-
ered or aggregated the contract. It is
uncommon for a taxpayer that has a long-
term contract to sever or aggregate that
contract. In addition, if a contract is sev-
ered or aggregated and a statement is
required, it is estimated that it will, on
average, require only 15 minutes to com-
plete.
### Drafting Information
The principal author of these regula-
tions is Leo F. Nolan II, Office of
Associate Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
### Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
#### PART 1-INCOME TAXES
Paragraph 1. The authority citation is
amended by removing the entry for
"Section 1.451-3 and 1.451-5", revising
the entry for "Section 1.460-4", and
adding the following entries in numerical
order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.451-5 also issued under 96
Stat. 324, 493 .***
Section 1.460-1 also issued under 26
U.S.C. 460(h).
Section 1.460-2 also issued under 26
U.S.C. 460(h).
Section 1.460-3 also issued under 26
U.S.C. 460(h).
Section 1.460-4 also issued under 26
U.S.C. 460(h) and 1502.
Section 1.460-5 also issued under 26
U.S.C. 460(h).
## §1.446-1 [Amended]
Par. 2. Section 1.446-1 is amended as
follows:
1\. In the second sentence of paragraph
(c)(1)(iii), the language "451" is removed
and "460" is added in its place.
2\. In the fourth sentence of paragraph
(e)(2)(ii)(a), the language "§1.451-3" is
removed and "§1.460-4" is added in its
place.
## §1.451-3 [Removed]
Par. 3. Section 1.451-3 is removed.
## §1.451-5 [Amended]
Par. 4. Section 1.451-5 is amended by
removing the language "§1.451-3" and
adding "§1.460-4" in its place in the first
sentence of paragraph (b)(3).
Par. 5. Section 1.460-0 is amended by:
1\. Revising the introductory text.
2\. Revising the entries for §§1.460-1
through 1.460-3, 1.460-4(a) through (i),
and 1.460-5.
3\. Adding an entry for §1.460-4(k).
4\. Removing the entry for §1.460-6(c)
(4)(iv).
5\. Adding an entry for §1.460-6(f)(3).
6\. Removing the entries for §§1.460-7
and 1.460-8.
The revisions and addition read as fol-
lows:
§1.460-0 Outline of regulations under
section 460.
This section lists the paragraphs con-
tained in §1.460-1 through §1.460-6.
§1.460-1 Long-term contracts.
(a) Overview.
(1) In general.
(2) Exceptions to required use of PCM.
(i) Exempt construction contract.
(ii) Qualified ship or residential construc-
tion contract.
(b) Terms.
(1) Long-term contract.
(2) Contract for the manufacture, build-
ing, installation, or construction of prop-
erty.
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(i) In general.
(1) In general.
(i) In general.
(ii) De minimis construction activities.
(2) Change in method of accounting.
(ii) Election.
(3) Allocable contract costs.
(i) [Reserved]
(7) Terminated contract.
(4) Related party.
(j) Examples.
(i) Reversal of income.
(5) Contracting year.
(ii) Adjusted basis.
(6) Completion year.
§1.460-2 Long-term manufacturing
(iii) Look-back method.
(7) Contract commencement date.
contracts.
(c) Exempt contract methods.
(8) Incurred.
(a) In general.
(1) In general.
(9) Independent research and develop-
(b) Unique.
(2) Exempt-contract percentage-of-com-
ment expenses.
(1) In general.
pletion method.
(10) Long-term contract methods of
(2) Safe harbors.
(i) In general.
accounting.
(i) Short production period.
(ii) Determination of work performed.
(c) Entering into and completing long-
(ii) Customized item.
(d) Completed-contract method.
term contracts.
(iii) Inventoried item.
(1) In general.
(1) In general.
(c) Normal time to complete.
(2) Post-completion-year income and
(2) Date contract entered into.
(1) In general.
costs.
(i) In general.
(2) Production by related parties.
(3) Gross contract price.
(ii) Options and change orders.
(d) Qualified ship contracts.
(4) Contracts with disputed claims.
(3) Date contract completed.
(e) Examples.
(i) In general.
(i) In general.
(ii) Taxpayer assured of profit or loss.
(ii) Secondary items.
§1.460-3 Long-term construction
(iii) Taxpayer unable to determine profit
(iii) Subcontracts.
contracts.
or loss.
(iv) Final completion and acceptance.
(iv) Dispute resolved.
(A) In general.
(a) In general.
(e) Percentage-of-completion/capitalized-
(B) Contingent compensation.
(b) Exempt construction contracts.
cost method.
(C) Assembly or installation.
(1) In general.
(f) Alternative minimum taxable income.
(D) Disputes.
(2) Home construction contract.
(1) In general.
(d) Allocation among activities.
(i) In general.
(2) Election to use regular completion
(1) In general.
(ii) Townhouses and rowhouses.
factors.
(2) Non-long-term contract activity.
(iii) Common improvements.
(g) Method of accounting.
(e) Severing and aggregating contracts.
(iv) Mixed use costs.
(h) Examples.
(1) In general.
(3) $10,000,000 gross receipts test.
(i) [Reserved].
(2) Facts and circumstances.
(i) In general.
* * * * *
(i) Pricing.
(ii) Single employer.
(k) Mid-contract change in taxpayer
(ii) Separate delivery or acceptance.
(iii) Attribution of gross receipts.
[Reserved].
(iii) Reasonable businessperson.
(c) Residential construction contracts.
§1.460-5 Cost allocation rules.
(3) Exceptions.
§1.460-4 Methods of accounting for
(i) Severance for PCM.
long-term contracts.
(a) Overview.
(ii) Options and change orders.
(b) Cost allocation method for contracts subject to PCM.
(4) Statement with return.
(a) Overview.
(f) Classifying contracts.
(b) Percentage-of-completion method.
(1) In general.
(1) In general.
(1) In general.
(2) Special rules.
(2) Hybrid contracts.
(2) Computations.
(i) Direct material costs.
(i) In general.
(3) Post-completion-year income.
(ii) Components and subassemblies.
(ii) Elections.
(4) Total contract price.
(iii) Simplified production methods.
(3) Method of accounting.
(i) In general.
(iv) Costs identified under cost-plus
(4) Use of estimates.
(A) Definition.
long-term contracts and federal long-
(i) Estimating length of contract.
(B) Contingent compensation.
term contracts.
(ii) Estimating allocable contract costs.
(C) Non-long-term contract activities.
(v) Interest.
(g) Special rules for activities benefitting
(ii) Estimating total contract price.
(A) In general.
long-term contracts of a related party.
(5) Completion factor.
(B) Production period.
(1) Related party use of PCM.
(i) Allocable contract costs.
(C) Application of section 263A(f).
(i) In general.
(ii) Cumulative allocable contract costs.
(vi) Research and experimental expenses.
(ii) Exception for components and sub-
(iii) Estimating total allocable contract
(vii) Service costs.
assemblies.
costs.
(A) Simplified service cost method.
(2) Total contract price.
(iv) Pre-contracting-year costs.
(1) In general.
(3) Completion factor.
(v) Post-completion-year costs.
(2) Example.
(h) Effective date.
(6) 10-percent method.
(B) Jobsite costs.
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(C) Limitation on other reasonable cost
allocation methods.
(c) Simplified cost-to-cost method for
contracts subject to the PCM.
(1) In general.
(2) Election.
(d) Cost allocation rules for exempt con-
struction contracts reported using CCM.
(1) In general.
(2) Indirect costs.
(i) Indirect costs allocable to exempt
construction contracts.
(ii) Indirect costs not allocable to exempt
construction contracts.
(3) Large homebuilders.
(e) Cost allocation rules for contracts
subject to the PCCM.
(f) Special rules applicable to costs allo-
cated under this section.
(1) Nondeductible costs.
(2) Costs incurred for non-long-term
contract activities.
(g) Method of accounting.
§1.460-6 Look-back method.
(f) * **
(3) Statutes of limitations and com-
pounding of interest on look-back inter-
est.
Par. 6. Sections 1.460-1 through
1.460-3 are revised to read as follows:
§1.460-1 Long-term contracts.
(a) Overview-(1) In general. This
section provides rules for determining
whether a contract for the manufacture,
building, installation, or construction of
property is a long-term contract under
section 460 and what activities must be
accounted for as a single long-term con-
tract. Specific rules for long-term manu-
facturing and construction contracts are
provided in §§1.460-2 and 1.460-3,
respectively. A taxpayer generally must
determine the income from a long-term
contract using the percentage-of-comple-
tion method described in §1.460-4(b)
(PCM) and the cost allocation rules
described in §1.460-5(b) or (c). In addi-
tion, after a contract subject to the PCM is
completed, a taxpayer generally must
apply the look-back method described in
§1.460-6 to determine the amount of
interest owed on any hypothetical under-
payment of tax, or earned on any hypo-
thetical overpayment of tax, attributable
to accounting for the long-term contract
under the PCM.
(2) Exceptions to required use of
PCM-(i) Exempt construction contract.
The requirement to use the PCM does not
apply to any exempt construction contract
described in §1.460-3(b). Thus, a taxpay-
er may determine the income from an
exempt construction contract using any
accounting method permitted by
§1.460-4(c) and, for contracts accounted
for using the completed-contract method
(CCM), any cost allocation method per-
mitted by §1.460-5(d). Exempt construc-
tion contracts that are not subject to the
PCM or CCM are not subject to the cost
allocation rules of §1.460-5 except for the
production-period interest rules of
§1.460-5(b)(2)(v). Exempt construction
contractors that are large homebuilders
described in §1.460-5(d)(3) must capital-
ize costs under section 263A. All other
exempt construction contractors must
account for the cost of construction using
the appropriate rules contained in other
sections of the Internal Revenue Code or
regulations.
(ii) Qualified ship or residential con-
struction contract. The requirement to
use the PCM applies only to a portion of a
qualified ship contract described in
§1.460-2(d) or residential construction
contract described in §1.460-3(c). A tax-
payer generally may determine the
income from a qualified ship contract or
residential construction contract using the
percentage-of-completion/capitalized-
cost method (PCCM) described in
§1.460-4(e), but must use a cost alloca-
tion method described in §1.460-5(b) for
the entire contract.
(b) Terms-(1) Long-term contract. A
long-term contract generally is any con-
tract for the manufacture, building, instal-
lation, or construction of property if the
contract is not completed within the con-
tracting year, as defined in paragraph
(b)(5) of this section. However, a contract
for the manufacture of property is a long-
term contract only if it also satisfies either
the unique item or 12-month requirements
described in §1.460-2. A contract for the
manufacture of personal property is a
manufacturing contract. In contrast, a
contract for the building, installation, or
construction of real property is a con-
struction contract.
(2) Contract for the manufacture,
building, installation, or construction of
property-(i) In general. A contract is a
contract for the manufacture, building,
installation, or construction of property if
the manufacture, building, installation, or
construction of property is necessary for
the taxpayer's contractual obligations to
be fulfilled and if the manufacture, build-
ing, installation, or construction of that
property has not been completed when the
parties enter into the contract. If a tax-
payer has to manufacture or construct an
item to fulfill its obligations under the
contract, the fact that the taxpayer is not
required to deliver that item to the cus-
tomer is not relevant. Whether the cus-
tomer has title to, control over, or bears
the risk of loss from, the property manu-
factured or constructed by the taxpayer
also is not relevant. Furthermore, how the
parties characterize their agreement (e.g.,
as a contract for the sale of property) is
not relevant.
(ii) De minimis construction activities.
Notwithstanding paragraph (b)(2)(i) of
this section, a contract is not a construc-
tion contract under section 460 if the con-
tract includes the provision of land by the
taxpayer and the estimated total allocable
contract costs, as defined in paragraph
(b)(3) of this section, attributable to the
taxpayer's construction activities are less
than 10 percent of the contract's total con-
tract price, as defined in
§1.460-4(b)(4)(i). For the purposes of
this paragraph (b)(2)(ii), the allocable
contract costs attributable to the taxpay-
er's construction activities do not include
the cost of the land provided to the cus-
tomer. In addition, a contract's estimated
total allocable contract costs include a
proportionate share of the estimated cost
of any common improvement that bene-
fits the subject matter of the contract if the
taxpayer is contractually obligated, or
required by law, to construct the common
improvement.
(3) Allocable contract costs. Allocable
contract costs are costs that are allocable
to a long-term contract under §1.460-5.
(4) Related party. A related party is a
person whose relationship to a taxpayer is
described in section 707(b) or 267(b),
determined without regard to section
267(f)(1)(A) and determined by replacing
"at least 80 percent" with "more than 50
percent" for the purposes of determining
the ownership of the stock of a corpora-
tion in sections 267(b)(2), (8), (10)(A),
and (12).
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(5) Contracting year. The contracting
year is the taxable year in which a tax-
payer enters into a contract as described in
paragraph (c)(2) of this section.
(6) Completion year. The completion
year is the taxable year in which a tax-
payer completes a contract as described in
paragraph (c)(3) of this section.
(7) Contract commencement date. The
contract commencement date is the date
that a taxpayer or related party first incurs
any allocable contract costs, such as
design and engineering costs, other than
expenses attributable to bidding and nego-
tiating activities. Generally, the contract
commencement date is relevant in apply-
ing §1.460-6(b)(3) (concerning the de
minimis exception to the look-back
method under section 460(b)(3)(B));
§1.460-5(b)(2)(v)(B)(1)(i) (concerning
the production period subject to interest
allocation); §1.460-2(d) (concerning
qualified ship contracts); and §1.460-3(b)
(1)(ii) (concerning the construction period
for exempt construction contracts).
(8) Incurred. Incurred has the meaning
given in §1.461-1(a)(2) (concerning the
taxable year a liability is incurred under
the accrual method of accounting),
regardless of a taxpayer's overall method
of accounting. See §1.461-4(d)(2)(ii) for
economic performance rules concerning
the PCM.
(9) Independent research and devel-
opment expenses. Independent research
and development expenses are any
expenses incurred in the performance of
research or development, except that this
term does not include any expenses that
are directly attributable to a particular
long-term contract in existence when the
expenses are incurred and this term does
not include any expenses under an
agreement to perform research or devel-
opment.
(10) Long-term contract methods of
accounting. Long-term contract methods
of accounting, which include the
PCM, the CCM, the PCCM, and the
exempt-contract percentage-of-completion
method (EPCM), are methods of account-
ing that may be used only for long-term
contracts.
(c) Entering into and completing long-
term contracts-(1) In general. To deter-
mine when a contract is entered into under
paragraph (c)(2) of this section and com-
pleted under paragraph (c)(3) of this sec-
tion, a taxpayer must consider all relevant
allocable contract costs incurred and
activities performed by itself, by related
parties on its behalf, and by the customer,
that are incident to or necessary for the
long-term contract. In addition, to deter-
mine whether a contract is completed in
the contracting year, the taxpayer may not
consider when it expects to complete the
contract.
(2) Date contract entered into-(i) In
general. A taxpayer enters into a contract
on the date that the contract binds both the
taxpayer and the customer under applica-
ble law, even if the contract is subject to
unsatisfied conditions not within the tax-
payer's control (such as obtaining financ-
ing). If a taxpayer delays entering into a
contract for a principal purpose of avoid-
ing section 460, however, the taxpayer
will be treated as having entered into a
contract not later than the contract com-
mencement date.
(ii) Options and change orders. A tax-
payer enters into a new contract on the
date that the customer exercises an option
or similar provision in a contract if that
option or similar provision must be sev-
ered from the contract under paragraph (e)
of this section. Similarly, a taxpayer
enters into a new contract on the date that
it accepts a change order or other similar
agreement if the change order or other
similar agreement must be severed from
the contract under paragraph (e) of this
section.
(3) Date contract completed-(i) In
general. A taxpayer's contract is com-
pleted upon the earlier of-
(A) Use of the subject matter of the
contract by the customer for its intended
purpose (other than for testing) and at
least 95 percent of the total allocable con-
tract costs attributable to the subject mat-
ter have been incurred by the taxpayer; or
(B) Final completion and acceptance of
the subject matter of the contract.
(ii) Secondary items. The date a con-
tract accounted for using the CCM is
completed is determined without regard to
whether one or more secondary items
have been used or finally completed and
accepted. If any secondary items are
incomplete at the end of the taxable year
in which the primary subject matter of a
contract is completed, the taxpayer must
separate the portion of the gross contract
price and the allocable contract costs
attributable to the incomplete secondary
item(s) from the completed contract and
account for them using a permissible
method of accounting. A permissible
method of accounting includes a long-
term contract method of accounting only
if a separate contract for the secondary
item(s) would be a long-term contract, as
defined in paragraph (b)(1) of this section.
(iii) Subcontracts. In the case of a sub-
contract, a subcontractor's customer is the
general contractor. Thus, the subject mat-
ter of the subcontract is the relevant sub-
ject matter under paragraph (c)(3)(i) of
this section.
(iv) Final completion and acceptance
-(A) In general. Except as otherwise
provided in this paragraph (c)(3)(iv), to
determine whether final completion and
acceptance of the subject matter of a con-
tract have occurred, a taxpayer must con-
sider all relevant facts and circumstances.
Nevertheless, a taxpayer may not delay
the completion of a contract for the prin-
cipal purpose of deferring federal income
tax.
(B) Contingent compensation. Final
completion and acceptance is determined
without regard to any contractual term
that provides for additional compensation
that is contingent on the successful per-
formance of the subject matter of the con-
tract. A taxpayer must account for all con-
tingent compensation that is not
includible in total contract price under
§1.460-4(b)(4)(i), or in gross contract
price under §1.460-4(d)(3), using a per-
missible method of accounting. For
application of the look-back method for
contracts accounted for using the PCM,
see §1.460-6(c)(1)(ii) and (2)(vi).
(C) Assembly or installation. Final
completion and acceptance is determined
without regard to whether the taxpayer
has an obligation to assist or supervise
assembly or installation of the subject
matter of the contract where the assembly
or installation is not performed by the tax-
payer or a related party. A taxpayer must
account for the gross receipts and costs
attributable to such an obligation using a
permissible method of accounting, other
than a long-term contract method.
(D) Disputes. Final completion and
acceptance is determined without regard
to whether a dispute exists at the time the
taxpayer tenders the subject matter of the
contract to the customer. For contracts
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accounted for using the CCM, see
§1.460-4(d)(4). For application of the
look-back method for contracts accounted
for using the PCM, see §1.460-6(c)(1)(ii)
and (2)(vi).
(d) Allocation among activities-(1) In
general. Long-term contract methods of
accounting apply only to the gross
receipts and costs attributable to long-
term contract activities. Gross receipts
and costs attributable to long-term con-
tract activities means amounts included in
total contract price or gross contract price,
whichever is applicable, as determined
under §1.460-4, and costs allocable to the
contract, as determined under §1.460-5.
Gross receipts and costs attributable to
non-long-term contract activities (as
defined in paragraph (d)(2) of this sec-
tion) generally must be taken into account
using a permissible method of accounting
other than a long-term contract method.
See section 446(c) and §1.446-1(c).
However, if the performance of a non-
long-term contract activity is incident to
or necessary for the manufacture, build-
ing, installation, or construction of the
subject matter of one or more of the tax-
payer's long-term contracts, the gross
receipts and costs attributable to that
activity must be allocated to the long-term
contract(s) benefitted as provided in
§§1.460-4(b)(4)(i) and 1.460-5(f)(2),
respectively. Similarly, if a single long-
term contract requires a taxpayer to per-
form a non-long-term contract activity
that is not incident to or necessary for the
manufacture, building, installation, or
construction of the subject matter of the
long-term contract, the gross receipts and
costs attributable to that non-long-term
contract activity must be separated from
the contract and accounted for using a
permissible method of accounting other
than a long-term contract method. But see
paragraph (g) of this section for related
party rules.
(2) Non-long-term contract activity.
Non-long-term contract activity means
the performance of an activity other than
manufacturing, building, installation, or
construction, such as the provision of
architectural, design, engineering, and
construction management services, and
the development or implementation of
computer software. In addition, perfor-
mance under a guaranty, warranty, or
maintenance agreement is a non-long-
term contract activity that is never inci-
dent to or necessary for the manufacture
or construction of property under a long-
term contract.
(e) Severing and aggregating
contracts-(1) In general. After applica-
tion of the allocation rules of paragraph
(d) of this section, the severing and aggre-
gating rules of this paragraph (e) may be
applied by the Commissioner or the tax-
payer as necessary to clearly reflect
income (e.g., to prevent the unreasonable
deferral (or acceleration) of income or the
premature recognition (or deferral) of
loss). Under the severing and aggregating
rules, one agreement may be treated as
two or more contracts, and two or more
agreements may be treated as one con-
tract. Except as provided in paragraph
(e)(3)(ii) of this section, a taxpayer must
determine whether to sever an agreement
or to aggregate two or more agreements
based on the facts and circumstances
known at the end of the contracting year.
(2) Facts and circumstances. Whether
an agreement should be severed, or two or
more agreements should be aggregated,
depends on the following factors:
(i) Pricing. Independent pricing of
items in an agreement is necessary for the
agreement to be severed into two or more
contracts. In the case of an agreement for
similar items, if the price to be paid for the
items is determined under different terms
or formulas (e.g., if some items are priced
under a cost-plus incentive fee arrange-
ment and later items are to be priced
under a fixed-price arrangement), then the
difference in the pricing terms or formulas
indicates that the items are independently
priced. Similarly, interdependent pricing
of items in separate agreements is neces-
sary for two or more agreements to be
aggregated into one contract. A single
price negotiation for similar items ordered
under one or more agreements indicates
that the items are interdependently priced.
(ii) Separate delivery or acceptance.
An agreement may not be severed into
two or more contracts unless it provides
for separate delivery or separate accep-
tance of items that are the subject matter
of the agreement. However, the separate
delivery or separate acceptance of items
by itself does not necessarily require an
agreement to be severed.
(iii) Reasonable businessperson. Two
or more agreements to perform manufac-
turing or construction activities may not
be aggregated into one contract unless a
reasonable businessperson would not
have entered into one of the agreements
for the terms agreed upon without also
entering into the other agreement(s).
Similarly, an agreement to perform manu-
facturing or construction activities may
not be severed into two or more contracts
if a reasonable businessperson would not
have entered into separate agreements
containing terms allocable to each severed
contract. Analyzing the reasonable busi-
nessperson standard requires an analysis
of all the facts and circumstances of the
business arrangement between the taxpay-
er and the customer. For purposes of this
paragraph (e)(2)(iii), a taxpayer's expec-
tation that the parties would enter into
another agreement, when agreeing to the
terms contained in the first agreement, is
not relevant.
(3) Exceptions-(i) Severance for
PCM. A taxpayer may not sever under
this paragraph (e) a long-term contract
that would be subject to the PCM without
obtaining the Commissioner's prior writ-
ten consent.
(ii) Options and change orders. Except
as provided in paragraph (e)(3)(i) of this
section, a taxpayer must sever an agree-
ment that increases the number of units to
be supplied to the customer, such as
through the exercise of an option or the
acceptance of a change order, if the agree-
ment provides for separate delivery or
separate acceptance of the additional
units.
(4) Statement with return. If a taxpayer
severs an agreement or aggregates two or
more agreements under this paragraph (e)
during the taxable year, the taxpayer must
attach a statement to its original federal
income tax return for that year. This state-
ment must contain the following informa-
tion-
(i) The legend NOTIFICATION OF
SEVERANCE OR AGGREGATION
UNDER SEC. 1.460-1(e);
(ii) The taxpayer's name; and
(iii) The taxpayer's employer identifi-
cation number or social security number.
(f) Classifying contracts-(1) In gener-
al. After applying the severing and aggre-
gating rules of paragraph (e) of this sec-
tion, a taxpayer must determine the
classification of a contract (e.g., as a long-
term manufacturing contract, long-term
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construction contract, non-long-term con-
tract) based on all the facts and circum-
stances known no later than the end of the
contracting year. Classification is deter-
mined on a contract-by-contract basis.
Consequently, a requirement to manufac-
ture a single unique item under a long-
term contract will subject all other items
in that contract to section 460.
(2) Hybrid contracts-(i) In general. A
long-term contract that requires a taxpay-
er to perform both manufacturing and
construction activities (hybrid contract)
generally must be classified as two con-
tracts, a manufacturing contract and a
construction contract. A taxpayer may
elect, on a contract-by-contract basis, to
classify a hybrid contract as a long-term
construction contract if at least 95 percent
of the estimated total allocable contract
costs are reasonably allocable to construc-
tion activities. In addition, a taxpayer
may elect, on a contract-by-contract basis,
to classify a hybrid contract as a long-
term manufacturing contract subject to the
PCM.
(ii) Elections. A taxpayer makes an
election under this paragraph (f)(2) by
using its method of accounting for similar
construction contracts or for manufactur-
ing contracts, whichever is applicable, to
account for a hybrid contract entered into
during the taxable year of the election on
its original federal income tax return for
the election year. If an electing taxpayer's
method is the PCM, the taxpayer also
must use the PCM to apply the look-back
method under §1.460-6 and to determine
alternative minimum taxable income
under §1.460-4(f).
(3) Method of accounting. Except as
provided in paragraph (f)(2)(ii) of this
section, a taxpayer's method of classify-
ing contracts is a method of accounting
under section 446 and, thus, may not be
changed without the Commissioner's con-
sent. If a taxpayer's method of classifying
contracts is unreasonable, that classifica-
tion method is an impermissible account-
ing method.
(4) Use of estimates-(i) Estimating
length of contract. A taxpayer must use a
reasonable estimate of the time required
to complete a contract when necessary to
classify the contract (e.g., to determine
whether the five-year completion rule for
qualified ship contracts under
§1.460-2(d), or the two-year completion
rule for exempt construction contracts
under §1.460-3(b), is satisfied, but not to
determine whether a contract is completed
within the contracting year under para-
graph (b)(1) of this section). To be con-
sidered reasonable, an estimate of the time
required to complete the contract must
include anticipated time for delay, rework,
change orders, technology or design prob-
lems, or other problems that reasonably
can be anticipated considering the nature
of the contract and prior experience. A
contract term that specifies an expected
completion or delivery date may be con-
sidered evidence that the taxpayer reason-
ably expects to complete or deliver the
subject matter of the contract on or about
the date specified, especially if the con-
tract provides bona fide penalties for fail-
ing to meet the specified date. If a tax-
payer classifies a contract based on a
reasonable estimate of completion time,
the contract will not be reclassified based
on the actual (or another reasonable esti-
mate of) completion time. A taxpayer's
estimate of completion time will not be
considered unreasonable if a contract is
not completed within the estimated time
primarily because of unforeseeable fac-
tors not within the taxpayer's control,
such as third-party litigation, extreme
weather conditions, strikes, or delays in
securing permits or licenses.
(ii) Estimating allocable contract costs.
A taxpayer must use a reasonable estimate
of total allocable contract costs when nec-
essary to classify the contract (e.g., to
determine whether a contract is a home
construction contract under
§1.460-(3)(b)(2)). If a taxpayer classifies
a contract based on a reasonable estimate
of total allocable contract costs, the con-
tract will not be reclassified based on the
actual (or another reasonable estimate of)
total allocable contract costs.
(g) Special rules for activities benefit-
ting long-term contracts of a related
party-(1) Related party use of PCM-(i)
In general. Except as provided in para-
graph (g)(1)(ii) of this section, if a related
party and its customer enter into a long-
term contract subject to the PCM, and a
taxpayer performs any activity that is inci-
dent to or necessary for the related party's
long-term contract, the taxpayer must
account for the gross receipts and costs
attributable to this activity using the
PCM, even if this activity is not otherwise
subject to section 460(a). This type of
activity may include, for example, the
performance of engineering and design
services, and the production of compo-
nents and subassemblies that are reason-
ably expected to be used in the production
of the subject matter of the related party's
contract.
(ii) Exception for components and sub-
assemblies. A taxpayer is not required to
use the PCM under this paragraph (g) to
account for a component or subassembly
that benefits a related party's long-term
contract if more than 50 percent of the
average annual gross receipts attributable
to the sale of this item for the 3-taxable-
year-period ending with the contracting
year comes from unrelated parties.
(2) Total contract price. If a taxpayer is
required to use the PCM under paragraph
(g)(1)(i) of this section, the total contract
price (as defined in §1.460-4(b)(4)(i)) is
the fair market value of the taxpayer's
activity that is incident to or necessary for
the performance of the related party's
long-term contract. The related party also
must use the fair market value of the tax-
payer's activity as the cost it incurs for the
activity. The fair market value of the tax-
payer's activity may or may not be the
same as the amount the related party pays
the taxpayer for that activity.
(3) Completion factor. To compute a
contract's completion factor (as described
in §1.460-4(b)(5)), the related party must
take into account the fair market value of
the taxpayer's activity that is incident to
or necessary for the performance of the
related party's long-term contract when
the related party incurs the liability to the
taxpayer for the activity, rather than when
the taxpayer incurs the costs to perform
the activity.
(h) Effective date-(1) In general.
Except as otherwise provided, this section
and §§1.460-2 through 1.460-5 are
applicable for contracts entered into on or
after January 11, 2001.
(2) Change in method of accounting.
Any change in a taxpayer's method of
accounting necessary to comply with this
section and §§1.460-2 through 1.460-5 is
a change in method of accounting to
which the provisions of section 446 and
the regulations thereunder apply. For the
first taxable year that includes January 11,
2001, a taxpayer is granted the consent of
the Commissioner to change its method of
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accounting to comply with the provisions
of this section and §§1.460-2 through
1.460-5 for long-term contracts entered
into on or after January 11, 2001. A tax-
payer that wants to change its method of
accounting under this paragraph (h)(2)
must follow the automatic consent proce-
dures in Rev. Proc. 99-49 (1999-52
I.R.B. 725) (see §601.601(d)(2) of this
chapter), except that the scope limitations
in section 4.02 of Rev. Proc. 99-49 do not
apply. Because a change under this para-
graph (h)(2) is made on a cut-off basis, a
section 481(a) adjustment is not permitted
or required. Moreover, the taxpayer does
not receive audit protection under section
7 of Rev. Proc. 99-49 for a change in
method of accounting under this para-
graph (h)(2). A taxpayer that wants to
change its exempt-contract method of
accounting is not granted the consent of
the Commissioner under this paragraph
(h)(2) and must file a Form 3115,
"Application for Change in Accounting
Method," to obtain consent. See Rev.
Proc. 97-27 (1997-1 C.B. 680) (see
§601.601(d)(2) of this chapter).
(i) [Reserved]
(j) Examples. The following examples
illustrate the rules of this section:
Example 1. Contract for manufacture of proper-
ty. B notifies C, an aircraft manufacturer, that it
wants to purchase an aircraft of a particular type. At
the time C receives the order, C has on hand several
partially completed aircraft of this type; however, C
does not have any completed aircraft of this type on
hand. C and B agree that B will purchase one of
these aircraft after it has been completed. C retains
title to and risk of loss with respect to the aircraft
until the sale takes place. The agreement between C
and B is a contract for the manufacture of property
under paragraph (b)(2)(i) of this section, even if
labeled as a contract for the sale of property, because
the manufacture of the aircraft is necessary for C's
obligations under the agreement to be fulfilled and
the manufacturing was not complete when B and C
entered into the agreement.
Example 2. De minimis construction activity. C,
a master developer whose taxable year ends
December 31, owns 5,000 acres of undeveloped land
with a cost basis of $5,000,000 and a fair market
value of $50,000,000. To obtain permission from
the local county government to improve this land, a
service road must be constructed on this land to ben-
efit all 5,000 acres. In 2001, C enters into a contract
to sell a 1,000-acre parcel of undeveloped land to B,
a residential developer, for its fair market value,
$10,000,000. In this contract, C agrees to construct
a service road running through the land that C is sell-
ing to B and through the 4,000 adjacent acres of
undeveloped land that C has sold or will sell to other
residential developers for its fair market value,
$40,000,000. C reasonably estimates that it will
incur allocable contract costs of $50,000 (excluding
the cost of the land) to construct this service road,
which will be owned and maintained by the county.
C must reasonably allocate the cost of the service
road among the benefitted parcels. The portion of
the estimated total allocable contract costs that C
allocates to the 1,000-acre parcel being sold to B
(based upon its fair market value) is $10,000
($50,000 x ($10,000,000 + $50,000,000)).
Construction of the service road is finished in 2002.
Because the estimated total allocable contract costs
attributable to C's construction activities, $10,000,
are less than 10 percent of the contract's total con-
tract price, $10,000,000, C's contract with B is not a
construction contract under paragraph (b)(2)(ii) of
this section. Thus, C's contract with B is not a long-
term contract under paragraph (b)(2)(i) of this sec-
tion, notwithstanding that construction of the service
road is not completed in 2001.
Example 3. Completion-customer use. In 2002,
C, whose taxable year ends December 31, enters into
a contract to construct a building for B. In
November of 2003, the building is completed in
every respect necessary for its intended use, and B
occupies the building. In early December of 2003, B
notifies C of some minor deficiencies that need to be
corrected, and C agrees to correct them in January
2004. C reasonably estimates that the cost of cor-
recting these deficiencies will be less than five per-
cent of the total allocable contract costs. C's con-
tract is complete under paragraph (c)(3)(i)(A) of this
section in 2003 because in that year, B used the
building and C had incurred at least 95 percent of the
total allocable contract costs attributable to the
building. C must use a permissible method of
accounting for any deficiency-related costs incurred
after 2003.
Example 4. Completion-customer use. In 2001,
C, whose taxable year ends December 31, agrees to
construct a shopping center, which includes an
adjoining parking lot, for B. By October 2002, C has
finished constructing the retail portion of the shop-
ping center. By December 2002, C has graded the
entire parking lot, but has paved only one-fourth of
it because inclement weather conditions prevented C
from laying asphalt on the remaining three-fourths.
In December 2002, B opens the retail portion of the
shopping center and the paved portion of the parking
lot to the general public. C reasonably estimates that
the cost of paving the remaining three-fourths of the
parking lot when weather permits will exceed five
percent of C's total allocable contract costs. Even
though B is using the subject matter of the contract,
C's contract is not completed in December 2002
under paragraph (c)(3)(i)(A) of this section because
C has not incurred at least 95 percent of the total
allocable contract costs attributable to the subject
matter.
Example 5. Completion-customer use. In 2001,
C, whose taxable year ends December 31, agrees to
manufacture 100 machines for B. By December 31,
2002, C has delivered 99 of the machines to B. C
reasonably estimates that the cost of finishing the
related work on the contract will be less than five
percent of the total allocable contract costs. C's con-
tract is not complete under paragraph (c)(3)(i)(A) of
this section in 2002 because in that year, B is not
using the subject matter of the contract (all 100
machines) for its intended purpose.
Example 6. Non-long-term contract activity. On
January 1, 2001, C, whose taxable year ends
December 31, enters into a single long-term contract
to design and manufacture a satellite and to develop
computer software enabling B to operate the satel-
lite. At the end of 2001, C has not finished manu-
facturing the satellite. Designing the satellite and
developing the computer software are non-long-term
contract activities that are incident to and necessary
for the taxpayer's manufacturing of the subject mat-
ter of a long-term contract because the satellite could
not be manufactured without the design and would
not operate without the software. Thus, under para-
graph (d)(1) of this section, C must allocate these
non-long-term contract activities to the long-term
contract and account for the gross receipts and costs
attributable to designing the satellite and developing
computer software using the PCM.
Example 7. Non-long-term contract activity. C
agrees to manufacture equipment for B under a long-
term contract. In a separate contract, C agrees to
design the equipment being manufactured for B
under the long-term contract. Under paragraph
(d)(1) of this section, C must allocate the gross
receipts and costs related to the design to the long-
term contract because designing the equipment is a
non-long-term contract activity that is incident to
and necessary for the manufacture of the subject
matter of the long-term contract.
Example 8. Severance. On January 1, 2001, C, a
construction contractor, and B, a real estate investor,
enter into an agreement requiring C to build two
office buildings in different areas of a large city. The
agreement provides that the two office buildings will
be completed by C and accepted by B in 2002 and
2003, respectively, and that C will be paid
$1,000,000 and $1,500,000 for the two office build-
ings, respectively. The agreement will provide C
with a reasonable profit from the construction of
each building. Unless C is required to use the PCM
to account for the contract, C is required to sever this
contract under paragraph (e)(2) of this section
because the buildings are independently priced, the
agreement provides for separate delivery and accep-
tance of the buildings, and, as each building will
generate a reasonable profit, a reasonable busi-
nessperson would have entered into separate agree-
ments for the terms agreed upon for each building.
Example 9. Severance. C, a large construction
contractor whose taxable year ends December 31,
accounts for its construction contracts using the
PCM and has elected to use the 10-percent method
described in §1.460-4(b)(6). In September 2001, C
enters into an agreement to construct four buildings
in four different cities. The buildings are indepen-
dently priced and the contract provides a reasonable
profit for each of the buildings. In addition, the
agreement requires C to complete one building per
year in 2002, 2003, 2004, and 2005. As of
December 31, 2001, C has incurred 25 percent of the
estimated total allocable contract costs attributable
to one of the buildings, but only five percent of the
estimated total allocable contract costs attributable
to all four buildings included in the agreement. C
does not request the Commissioner's consent to
sever this contract. Using the 10-percent method, C
does not take into account any portion of the total
contract price or any incurred allocable contract
costs attributable to this agreement in 2001. Upon
examination of C's 2001 tax return, the
Commissioner determines that C entered into one
agreement for four buildings rather than four sepa-
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rate agreements each for one building solely to take
advantage of the deferral obtained under the 10-per-
cent method. Consequently, to clearly reflect the
taxpayer's income, the Commissioner may require C
to sever the agreement into four separate contracts
under paragraph (e)(2) of this section because the
buildings are independently priced, the agreement
provides for separate delivery and acceptance of the
buildings, and a reasonable businessperson would
have entered into separate agreements for these
buildings.
Example 10. Aggregation. In 2001, C, a ship-
builder, enters into two agreements with the
Department of the Navy as the result of a single
negotiation. Each agreement obligates C to manu-
facture a submarine. Because the submarines are of
the same class, their specifications are similar.
Because C has never manufactured submarines of
this class, however, C anticipates that it will incur
substantially higher costs to manufacture the first
submarine, to be delivered in 2007, than to manu-
facture the second submarine, to be delivered in
2010. If the agreements are treated as separate con-
tracts, the first contract probably will produce a sub-
stantial loss, while the second contract probably will
produce substantial profit. Based upon these facts,
aggregation is required under paragraph (e)(2) of
this section because the submarines are interdepen-
dently priced and a reasonable businessperson would
not have entered the first agreement without also
entering into the second.
Example 11. Aggregation. In 2001, C, a manu-
facturer of aircraft and related equipment, agrees to
manufacture 10 military aircraft for foreign govern-
ment B and to deliver the aircraft by the end of 2003.
When entering into the agreement, C anticipates that
it might receive production orders from B over the
next 20 years for as many as 300 more of these air-
craft. The negotiated contract price reflects C's and
B's consideration of the expected total cost of man-
ufacturing the 10 aircraft, the risks and opportunities
associated with the agreement, and the additional
factors the parties considered relevant. The negoti-
ated price provides a profit on the sale of the 10 air-
craft even if C does not receive any additional pro-
duction orders from B. It is unlikely, however, that
C actually would have wanted to manufacture the 10
aircraft but for the expectation that it would receive
additional production orders from B. In 2003, B
accepts delivery of the 10 aircraft. At that time, B
orders an additional 20 aircraft of the same type for
delivery in 2007. When negotiating the price for the
additional 20 aircraft, C and B consider the fact that
the expected unit cost for this production run of 20
aircraft will be lower than the unit cost of the 10 air-
craft completed and accepted in 2003, but substan-
tially higher than the expected unit cost of future
production runs. Based upon these facts, aggrega-
tion is not permitted under paragraph (e)(2) of this
section. Because the parties negotiated the prices of
both agreements considering only the expected pro-
duction costs and risks for each agreement standing
alone, the terms and conditions agreed upon for the
first agreement are independent of the terms and
conditions agreed upon for the second agreement.
The fact that the agreement to manufacture 10 air-
craft provides a profit for C indicates that a reason-
able businessperson would have entered into that
agreement without entering into the agreement to
manufacture the additional 20 aircraft.
Example 12. Classification and completion. In
2001, C, whose taxable year ends December 31,
agrees to manufacture and install an industrial
machine for B. C elects under paragraph (f) of this
section to classify the agreement as a long-term
manufacturing contract and to account for it using
the PCM. The agreement requires C to deliver the
machine in August 2003 and to install and test the
machine in B's factory. In addition, the agreement
requires B to accept the machine when the tests
prove that the machine's performance will satisfy the
environmental standards set by the Environmental
Protection Agency (EPA), even if B has not obtained
the required operating permit. Because of technical
difficulties, C cannot deliver the machine until
December 2003, when B conditionally accepts
delivery. C installs the machine in December 2003
and then tests it through February 2004. B accepts
the machine in February 2004, but does not obtain
the operating permit from the EPA until January
2005. Under paragraph (c)(3)(i)(B) of this section,
C's contract is finally completed and accepted in
February 2004, even though B does not obtain the
operating permit until January 2005, because C com-
pleted all its obligations under the contract and B
accepted the machine in February 2004.
### §1.460-2 Long-term manufacturing contracts.
(a) In general. Section 460 generally
requires a taxpayer to determine the
income from a long-term manufacturing
contract using the percentage-of-comple-
tion method described in §1.460-4(b)
(PCM). A contract not completed in the
contracting year is a long-term manufac-
turing contract if it involves the manufac-
ture of personal property that is-
(1) A unique item of a type that is not
normally carried in the finished goods
inventory of the taxpayer; or
(2) An item that normally requires more
than 12 calendar months to complete
(regardless of the duration of the contract
or the time to complete a deliverable
quantity of the item).
(b) Unique-(1) In general. Unique
means designed for the needs of a specif-
ic customer. To determine whether an
item is designed for the needs of a specif-
ic customer, a taxpayer must consider the
extent to which research, development,
design, engineering, retooling, and similar
activities (customizing activities) are
required to manufacture the item and
whether the item could be sold to other
customers with little or no modification.
A contract may require the taxpayer to
manufacture more than one unit of a
unique item. If a contract requires a tax-
payer to manufacture more than one unit
of the same item, the taxpayer must deter-
mine whether that item is unique by con-
sidering the customizing activities that
would be needed to produce only the first
unit. For the purposes of this paragraph
(b), a taxpayer must consider the activities
performed on its behalf by a subcontrac-
tor.
(2) Safe harbors. Notwithstanding
paragraph (b)(1) of this section, an item is
not unique if it satisfies one or more of the
safe harbors in this paragraph (b)(2). If an
item does not satisfy one or more safe har-
bors, the determination of uniqueness will
depend on the facts and circumstances.
The safe harbors are:
(i) Short production period. An item is
not unique if it normally requires 90 days
or less to complete. In the case of a con-
tract for multiple units of an item, the item
is not unique only if it normally requires
90 days or less to complete each unit of
the item in the contract.
(ii) Customized item. An item is not
unique if the total allocable contract costs
attributable to customizing activities that
are incident to or necessary for the manu-
facture of the item do not exceed 10 per-
cent of the estimated total allocable con-
tract costs allocable to the item. In the
case of a contract for multiple units of an
item, this comparison must be performed
on the first unit of the item and the total
allocable contract costs attributable to
customizing activities that are incident to
or necessary for the manufacture of the
item must be allocated to the first unit.
(iii) Inventoried item. A unique item
ceases to be unique no later than when the
taxpayer normally includes similar items
in its finished goods inventory.
(c) Normal time to complete-(1) In
general. The amount of time normally
required to complete an item is the item's
reasonably expected production period, as
described in §1.263A-12, determined at
the end of the contracting year. Thus, in
general, the expected production period
for an item begins when a taxpayer incurs
at least five percent of the costs that
would be allocable to the item under
§1.460-5 and ends when the item is ready
to be held for sale and all reasonably
expected production activities are com-
plete. In the case of components that are
assembled or reassembled into an item or
unit at the customer's facility by the tax-
payer's employees or agents, the produc-
tion period ends when the components are
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assembled or reassembled into an opera-
ble item or unit. To the extent that sever-
al distinct activities related to the produc-
tion of the item are expected to occur
simultaneously, the period during which
these distinct activities occur is not count-
ed more than once. Furthermore, when
determining the normal time to complete
an item, a taxpayer is not required to con-
sider activities performed or costs
incurred that would not be allocable con-
tract costs under section 460 (e.g., inde-
pendent research and development
expenses (as defined in §1.460-1(b)(9))
and marketing expenses). Moreover, the
time required to design and manufacture
the first unit of an item for which the tax-
payer intends to produce multiple units
generally does not indicate the normal
time to complete the item.
(2) Production by related parties. To
determine the time normally required to
complete an item, a taxpayer must consid-
er all relevant production activities per-
formed and costs incurred by itself and by
related parties, as defined in
§1.460-1(b)(4). For example, if a taxpay-
er's item requires a component or sub-
assembly manufactured by a related party,
the taxpayer must consider the time the
related party takes to complete the com-
ponent or subassembly and, for purposes
of determining the beginning of an item's
production period, the costs incurred by
the related party that are allocable to the
component or subassembly. However, if
both requirements of the exception for
components and subassemblies under
§1.460-1(g)(1)(ii) are satisfied, a taxpay-
er does not consider the activities per-
formed or the costs incurred by a related
party when determining the normal time
to complete an item.
(d) Qualified ship contracts. A taxpay-
er may determine the income from a long-
term manufacturing contract that is a
qualified ship contract using either the
PCM or the percentage-of-completion/
capitalized-cost method (PCCM) of
accounting described in §1.460-4(e). A
qualified ship contract is any contract
entered into after February 28, 1986, to
manufacture in the United States not more
than 5 seagoing vessels if the vessels will
not be manufactured directly or indirectly
for the United States Government and if
the taxpayer reasonably expects to com-
plete the contract within 5 years of the
contract commencement date. Under
§1.460-1(e)(3)(i), a contract to produce
more than 5 vessels for which the PCM
would be required cannot be severed in
order to be classified as a qualified ship
contract.
(e) Examples. The following examples
illustrate the rules of this section:
Example 1. Unique item and classification. In
December 2001, C enters into a contract with B to
design and manufacture a new type of industrial
equipment. C reasonably expects the normal pro-
duction period for this type of equipment to be eight
months. Because the new type of industrial equip-
ment requires a substantial amount of research,
design, and engineering to produce, C determines
that the equipment is a unique item and its contract
with B is a long-term contract. After delivering the
equipment to B in September 2002, C contracts with
B to produce five additional units of that industrial
equipment with certain different specifications.
These additional units, which also are expected to
take eight months to produce, will be delivered to B
in 2003. C determines that the research, design,
engineering, retooling, and similar customizing
costs necessary to produce the five additional units
of equipment does not exceed 10 percent of the first
unit's share of estimated total allocable contract
costs. Consequently, the additional units of equip-
ment satisfy the safe harbor in paragraph (b)(2)(ii) of
this section and are not unique items. Although C's
contract with B to produce the five additional units
is not completed within the contracting year, the
contract is not a long-term contract since the addi-
tional units of equipment are not unique items and
do not normally require more than 12 months to pro-
duce. C must classify its second contract with B as
a non-long term contract, notwithstanding that it
classified the previous contract with B for a similar
item as a long-term contract, because the determina-
tion of whether a contract is a long-term contract is
made on a contract-by-contract basis. A change in
classification is not a change in method of account-
ing because the change in classification results from
a change in underlying facts.
Example 2. 12-month rule-related party. C
manufactures cranes. C purchases one of the crane's
components from R, a related party under
§1.460-1(b)(4). Less than 50 percent of R's gross
receipts attributable to the sale of this component
comes from sales to unrelated parties; thus, the
exception for components and subassemblies under
§1.460-1(g)(1)(ii) is not satisfied. Consequently, C
must consider the activities of R as R incurs costs
and performs the activities rather than as C incurs a
liability to R. The normal time period between the
time that both C and R incur five percent of the costs
allocable to the crane and the time that R completes
the component is five months. C normally requires
an additional eight months to complete production of
the crane after receiving the integral component
from R. C's crane is an item of a type that normally
requires more than 12 months to complete under
paragraph (c) of this section because the production
period from the time that both C and R incur five
percent of the costs allocable to the crane until the
time that production of the crane is complete is nor-
mally 13 months.
Example 3. 12-month rule-duration of contract.
The facts are the same as in Example 2, except that
C enters into a sales contract with B on December
31, 2001 (the last day of C's taxable year), and deliv-
ers a completed crane to B on February 1, 2002. C's
contract with B is a long-term contract under para-
graph (a)(2) of this section because the contract is
not completed in the contracting year, 2001, and the
crane is an item that normally requires more than 12
calendar months to complete (regardless of the dura-
tion of the contract).
Example 4. 12-month rule-normal time to com-
plete. The facts are the same as in Example 2, except
that C (and R) actually complete B's crane in only 10
calendar months. The contract is a long-term con-
tract because the normal time to complete a crane,
not the actual time to complete a crane, is the rele-
vant criterion for determining whether an item is
subject to paragraph (a)(2) of this section.
Example 5. Normal time to complete. C enters
into a multi-unit contract to produce four units of an
item. C does not anticipate producing any addition-
al units of the item. C expects to perform the
research, design, and development that are directly
allocable to the particular item and to produce the
first unit in the first 24 months. C reasonably
expects the production period for each of the three
remaining units will be 3 months. This contract is
not a contract that involves the manufacture of an
item that normally requires more than 12 months to
complete because the normal time to complete the
item is 3 months. However, the contract does not
satisfy the 90-day safe harbor for unique items
because the normal time to complete the first unit of
this item exceeds 90 days. Thus, the contract might
involve the manufacture of a unique item depending
on the facts and circumstances.
#### §1.460-3 Long-term construction contracts.
(a) In general. Section 460 generally
requires a taxpayer to determine the
income from a long-term construction
contract using the percentage-of-comple-
tion method described in §1.460-4(b)
(PCM). A contract not completed in the
contracting year is a long-term construc-
tion contract if it involves the building,
construction, reconstruction, or rehabilita-
tion of real property; the installation of an
integral component to real property; or the
improvement of real property (collective-
ly referred to as construction). Real prop-
erty means land, buildings, and inherently
permanent structures, as defined in
§1.263A-8(c)(3), such as roadways,
dams, and bridges. Real property does
not include vessels, offshore drilling plat-
forms, or unsevered natural products of
land. An integral component to real prop-
erty includes property not produced at the
site of the real property but intended to be
permanently affixed to the real property,
such as elevators and central heating and
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cooling systems. Thus, for example, a
contract to install an elevator in a building
is a construction contract because a build-
ing is real property, but a contract to
install an elevator in a ship is not a con-
struction contract because a ship is not
real property.
(b) Exempt construction contracts-(1)
In general. The general requirement to
use the PCM and the cost allocation rules
described in §1.460-5(b) or (c) does not
apply to any long-term construction con-
tract described in this paragraph (b)
(exempt construction contract). Exempt
construction contract means any-
(i) Home construction contract; and
(ii) Other construction contract that a
taxpayer estimates (when entering into the
contract) will be completed within 2 years
of the contract commencement date, pro-
vided the taxpayer satisfies the
$10,000,000 gross receipts test described
in paragraph (b)(3) of this section.
(2) Home construction contract-(i) In
general. A long-term construction con-
tract is a home construction contract if a
taxpayer (including a subcontractor work-
ing for a general contractor) reasonably
expects to attribute 80 percent or more of
the estimated total allocable contract costs
(including the cost of land, materials, and
services), determined as of the close of the
contracting year, to the construction of-
(A) Dwelling units, as defined in sec-
tion 168(e)(2)(A)(ii)(I), contained in
buildings containing 4 or fewer dwelling
units (including buildings with 4 or fewer
dwelling units that also have commercial
units); and
(B) Improvements to real property
directly related to, and located at the site
of, the dwelling units.
(ii) Townhouses and rowhouses. Each
townhouse or rowhouse is a separate
building.
(iii) Common improvements. A taxpay-
er includes in the cost of the dwelling
units their allocable share of the cost that
the taxpayer reasonably expects to incur
for any common improvements (e.g.,
sewers, roads, clubhouses) that benefit the
dwelling units and that the taxpayer is
contractually obligated, or required by
law, to construct within the tract or tracts
of land that contain the dwelling units.
(iv) Mixed use costs. If a contract
involves the construction of both com-
mercial units and dwelling units within
the same building, a taxpayer must allo-
cate the costs among the commercial units
and dwelling units using a reasonable
method or combination of reasonable
methods, such as specific identification,
square footage, or fair market value.
(3) $10,000,000 gross receipts test-(i)
In general. Except as otherwise provided
in paragraphs (b)(3)(ii) and (iii) of this
section, the $10,000,000 gross receipts
test is satisfied if a taxpayer's (or prede-
cessor's) average annual gross receipts for
the 3 taxable years preceding the contract-
ing year do not exceed $10,000,000, as
determined using the principles of the
gross receipts test for small resellers
under §1.263A-3(b).
(ii) Single employer. To apply the
gross receipts test, a taxpayer is not
required to aggregate the gross receipts of
persons treated as a single employer sole-
ly under section 414(m) and any regula-
tions prescribed under section 414.
(iii) Attribution of gross receipts. A
taxpayer must aggregate a proportionate
share of the construction-related gross
receipts of any person that has a five per-
cent or greater interest in the taxpayer. In
addition, a taxpayer must aggregate a pro-
portionate share of the construction-relat-
ed gross receipts of any person in which
the taxpayer has a five percent or greater
interest. For this purpose, a taxpayer must
determine ownership interests as of the
first day of the taxpayer's contracting year
and must include indirect interests in any
corporation, partnership, estate, trust, or
sole proprietorship according to principles
similar to the constructive ownership
rules under sections 1563(e), (f)(2), and
(f)(3)(A). However, a taxpayer is not
required to aggregate under this paragraph
(b)(3)(iii) any construction-related gross
receipts required to be aggregated under
paragraph (b)(3)(i) of this section.
(c) Residential construction contracts.
A taxpayer may determine the income
from a long-term construction contract
that is a residential construction contract
using either the PCM or the percentage-
of-completion/capitalized-cost method
(PCCM) of accounting described in
§1.460-4(e). A residential construction
contract is a home construction contract,
as defined in paragraph (b)(2) of this sec-
tion, except that the building or buildings
being constructed contain more than 4
dwelling units.
Par. 7. Section 1.460-4 is amended by
adding paragraphs (a) through (i) to read
as follows:
§1.460-4 Methods of accounting for
long-term contracts.
(a) Overview. This section prescribes
permissible methods of accounting for
long-term contracts. Paragraph (b) of
this section describes the percentage-of-
completion method under section 460(b)
(PCM) that a taxpayer generally must
use to determine the income from a long-
term contract. Paragraph (c) of this sec-
tion lists permissible methods of
accounting for exempt construction con-
tracts described in §1.460-3(b)(1) and
describes the exempt-contract percent-
age-of-completion method (EPCM).
Paragraph (d) of this section describes
the completed-contract method (CCM),
which is one of the permissible methods
of accounting for exempt construction
contracts. Paragraph (e) of this section
describes the percentage-of-comple-
tion/capitalized-cost method (PCCM),
which is a permissible method of
accounting for qualified ship contracts
described in §1.460-2(d) and residential
construction contracts described in
§1.460-3(c). Paragraph (f) of this sec-
tion provides rules for determining the
alternative minimum taxable income
(AMTI) from long-term contracts that
are not exempted under section 56.
Paragraph (g) of this section provides
rules concerning consistency in methods
of accounting for long-term contracts.
Paragraph (h) of this section provides
examples illustrating the principles of
this section. Paragraph (j) of this section
provides rules for taxpayers that file con-
solidated tax returns.
(b) Percentage-of-completion method
-(1) In general. Under the PCM, a tax-
payer generally must include in income
the portion of the total contract price, as
defined in paragraph (b)(4)(i) of this sec-
tion, that corresponds to the percentage of
the entire contract that the taxpayer has
completed during the taxable year. The
percentage of completion must be deter-
mined by comparing allocable contract
costs incurred with estimated total alloca-
ble contract costs. Thus, the taxpayer
includes a portion of the total contract
price in gross income as the taxpayer
incurs allocable contract costs.
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(2) Computations. To determine the
income from a long-term contract, a tax-
payer-
(i) Computes the completion factor for
the contract, which is the ratio of the
cumulative allocable contract costs that
the taxpayer has incurred through the end
of the taxable year to the estimated total
allocable contract costs that the taxpayer
reasonably expects to incur under the con-
tract;
(ii) Computes the amount of cumulative
gross receipts from the contract by multi-
plying the completion factor by the total
contract price;
(iii) Computes the amount of current-
year gross receipts, which is the differ-
ence between the amount of cumulative
gross receipts for the current taxable year
and the amount of cumulative gross
receipts for the immediately preceding
taxable year (the difference can be a posi-
tive or negative number); and
(iv) Takes both the current-year gross
receipts and the allocable contract costs
incurred during the current year into
account in computing taxable income.
(3) Post-completion-year income. If a
taxpayer has not included the total con-
tract price in gross income by the comple-
tion year, as defined in §1.460-1(b)(6),
the taxpayer must include the remaining
portion of the total contract price in gross
income for the taxable year following the
completion year. For the treatment of
post-completion costs, see paragraph
(b)(5)(v) of this section. See
§1.460-6(c)(1)(ii) for application of the
look-back method as a result of adjust-
ments to total contract price.
(4) Total contract price-(i) In
general-(A) Definition. Total contract
price means the amount that a taxpayer
reasonably expects to receive under a
long-term contract, including holdbacks,
retainages, and cost reimbursements. See
§1.460-6(c)(1)(ii) and (2)(vi) for applica-
tion of the look-back method as a result of
changes in total contract price.
(B) Contingent compensation. Any
amount related to a contingent right under
a contract, such as a bonus, award, incen-
tive payment, and amount in dispute, is
included in total contract price as soon as
the taxpayer can reasonably predict that
the amount will be earned, even if the all
events test has not yet been met. For
example, if a bonus is payable to a tax-
payer for meeting an early completion
date, the bonus is includible in total con-
tract price at the time and to the extent that
the taxpayer can reasonably predict the
achievement of the corresponding objec-
tive. Similarly, a portion of the contract
price that is in dispute is includible in total
contract price at the time and to the extent
that the taxpayer can reasonably predict
that the dispute will be resolved in the tax-
payer's favor (regardless of when the tax-
payer actually receives payment or when
the dispute is finally resolved). Total con-
tract price does not include compensation
that might be earned under any other
agreement that the taxpayer expects to
obtain from the same customer (e.g., exer-
cised option or follow-on contract) if that
other agreement is not aggregated under
§1.460-1(e). For the purposes of this
paragraph (b)(4)(i)(B), a taxpayer can rea-
sonably predict that an amount of contin-
gent income will be earned not later than
when the taxpayer includes that amount in
income for financial reporting purposes
under generally accepted accounting prin-
ciples. If a taxpayer has not included an
amount of contingent compensation in
total contract price under this paragraph
(b)(4)(i) by the taxable year following the
completion year, the taxpayer must
account for that amount of contingent
compensation using a permissible method
of accounting. If it is determined after the
taxable year following the completion
year that an amount included in total con-
tract price will not be earned, the taxpay-
er should deduct that amount in the year
of the determination.
(C) Non-long-term contract activities.
Total contract price includes an allocable
share of the gross receipts attributable to a
non-long-term contract activity, as
defined in §1.460-1(d)(2), if the activity
is incident to or necessary for the manu-
facture, building, installation, or construc-
tion of the subject matter of the long-term
contract. Total contract price also
includes amounts reimbursed for indepen-
dent research and development expenses
(as defined in §1.460-1(b)(9)), or for bid-
ding and proposal costs, under a federal or
cost-plus long-term contract (as defined in
section 460(d)), regardless of whether the
research and development, or bidding and
proposal, activities are incident to or nec-
essary for the performance of that long-
term contract.
(ii) Estimating total contract price. A
taxpayer must estimate the total contract
price based upon all the facts and circum-
stances known as of the last day of the
taxable year. For this purpose, an event
that occurs after the end of the taxable
year must be taken into account if its
occurrence was reasonably predictable
and its income was subject to reasonable
estimation as of the last day of that tax-
able year.
(5) Completion factor-(i) Allocable
contract costs. A taxpayer must use a cost
allocation method permitted under either
§1.460-5(b) or (c) to determine the
amount of cumulative allocable contract
costs and estimated total allocable con-
tract costs that are used to determine a
contract's completion factor. Allocable
contract costs include a reimbursable cost
that is allocable to the contract.
(ii) Cumulative allocable contract
costs. To determine a contract's comple-
tion factor for a taxable year, a taxpayer
must take into account the cumulative
allocable contract costs that have been
incurred, as defined in §1.460-1(b)(8),
through the end of the taxable year.
(iii) Estimating total allocable contract
costs. A taxpayer must estimate total allo-
cable contract costs for each long-term
contract based upon all the facts and cir-
cumstances known as of the last day of
the taxable year. For this purpose, an
event that occurs after the end of the tax-
able year must be taken into account if its
occurrence was reasonably predictable
and its cost was subject to reasonable esti-
mation as of the last day of that taxable
year. To be considered reasonable, an
estimate of total allocable contract costs
must include costs attributable to delay,
rework, change orders, technology or
design problems, or other problems that
reasonably can be predicted considering
the nature of the contract and prior expe-
rience. However, estimated total alloca-
ble contract costs do not include any con-
tingency allowance for costs that, as of the
end of the taxable year, are not reasonably
predicted to be incurred in the perfor-
mance of the contract. For example, esti-
mated total allocable contract costs do not
include any costs attributable to factors
not reasonably predictable at the end of
the taxable year, such as third-party litiga-
tion, extreme weather conditions, strikes,
and delays in securing required permits
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and licenses. In addition, the estimated
costs of performing other agreements that
are not aggregated with the contract under
§1.460-1(e) that the taxpayer expects to
incur with the same customer (e.g., fol-
low-on contracts) are not included in esti-
mated total allocable contract costs for the
initial contract.
(iv) Pre-contracting-year costs. If a
taxpayer reasonably expects to enter into
a long-term contract in a future taxable
year, the taxpayer must capitalize all costs
incurred prior to entering into the contract
that will be allocable to that contract (e.g.,
bidding and proposal costs). A taxpayer is
not required to compute a completion fac-
tor, or to include in gross income any
amount, related to allocable contract costs
for any taxable year ending before the
contracting year or, if applicable, the 10-
percent year defined in paragraph (b)(6)(i)
of this section. In that year, the taxpayer
is required to compute a completion factor
that includes all allocable contract costs
that have been incurred as of the end of
that taxable year (whether previously cap-
italized or deducted) and to take into
account in computing taxable income the
related gross receipts and the previously
capitalized allocable contract costs. If,
however, a taxpayer determines in a sub-
sequent year that it will not enter into the
long-term contract, the taxpayer must
account for these pre-contracting-year
costs in that year (e.g., as a deduction or
an inventoriable cost) using the appropri-
ate rules contained in other sections of the
Code or regulations.
(v) Post-completion-year costs. If a
taxpayer incurs an allocable contract cost
after the completion year, the taxpayer
must account for that cost using a permis-
sible method of accounting. See
§1.460-6(c)(1)(ii) for application of the
look-back method as a result of adjust-
ments to allocable contract costs.
(6) 10-percent method-(i) In general.
Instead of determining the income from a
long-term contract beginning with the
contracting year, a taxpayer may elect to
use the 10-percent method under section
460(b)(5). Under the 10-percent method,
a taxpayer does not include in gross
income any amount related to allocable
contract costs until the taxable year in
which the taxpayer has incurred at least
10 percent of the estimated total allocable
contract costs (10-percent year). A tax-
payer must treat costs incurred before the
10-percent year as pre-contracting-year
costs described in paragraph (b)(5)(iv) of
this section.
(ii) Election. A taxpayer makes an elec-
tion under this paragraph (b)(6) by using
the 10-percent method for all long-term
contracts entered into during the taxable
year of the election on its original federal
income tax return for the election year.
This election is a method of accounting
and, thus, applies to all long-term con-
tracts entered into during and after the
taxable year of the election. An electing
taxpayer must use the 10-percent method
to apply the look-back method under
§1.460-6 and to determine alternative
minimum taxable income under para-
graph (f) of this section. This election is
not available if a taxpayer uses the simpli-
fied cost-to-cost method described in
§1.460-5(c) to compute the completion
factor of a long-term contract.
(7) Terminated contract-(i) Reversal
of income. If a long-term contract is ter-
minated before completion and, as a
result, the taxpayer retains ownership of
the property that is the subject matter of
that contract, the taxpayer must reverse
the transaction in the taxable year of ter-
mination. To reverse the transaction, the
taxpayer reports a loss (or gain) equal to
the cumulative allocable contract costs
reported under the contract in all prior
taxable years less the cumulative gross
receipts reported under the contract in all
prior taxable years.
(ii) Adjusted basis. As a result of revers-
ing the transaction under paragraph
(b)(7)(i) of this section, a taxpayer will
have an adjusted basis in the retained prop-
erty equal to the cumulative allocable con-
tract costs reported under the contract in all
prior taxable years. However, if the tax-
payer received and retains any considera-
tion or compensation from the customer,
the taxpayer must reduce the adjusted basis
in the retained property (but not below
zero) by the fair market value of that con-
sideration or compensation. To the extent
that the amount of the consideration or
compensation described in the preceding
sentence exceeds the adjusted basis in the
retained property, the taxpayer must
include the excess in gross income for the
taxable year of termination.
(iii) Look-back method. The look-back
method does not apply to a terminated
contract that is subject to this paragraph
(b)(7).
(c) Exempt contract methods-(1) In
general. An exempt contract method
means the method of accounting that a
taxpayer must use to account for all its
long-term contracts (and any portion of a
long-term contract) that are exempt from
the requirements of section 460(a). Thus,
an exempt contract method applies to
exempt construction contracts, as defined
in §1.460-3(b); the non-PCM portion of a
qualified ship contract, as defined in
§1.460-2(d); and the non-PCM portion of
a residential construction contract, as
defined in §1.460-3(c). Permissible
exempt contract methods include the
PCM, the EPCM described in paragraph
(c)(2) of this section, the CCM described
in paragraph (d) of this section, or any
other permissible method. See section
446.
(2) Exempt-contract percentage-of-
completion method-(i) In general.
Similar to the PCM described in para-
graph (b) of this section, a taxpayer using
the EPCM generally must include in
income the portion of the total contract
price, as described in paragraph (b)(4) of
this section, that corresponds to the per-
centage of the entire contract that the tax-
payer has completed during the taxable
year. However, under the EPCM, the per-
centage of completion may be determined
as of the end of the taxable year by using
any method of cost comparison (such as
comparing direct labor costs incurred to
date to estimated total direct labor costs)
or by comparing the work performed on
the contract with the estimated total work
to be performed, rather than by using the
cost-to-cost comparison required by para-
graphs (b)(2)(i) and (5) of this section,
provided such method is used consistent-
ly and clearly reflects income. In addi-
tion, paragraph (b)(3) of this section
(regarding post-completion-year income),
paragraph (b)(6) of this section (regarding
the 10-percent method) and §1.460-6
(regarding the look-back method) do not
apply to the EPCM.
(ii) Determination of work performed.
For purposes of the EPCM, the criteria
used to compare the work performed on a
contract as of the end of the taxable year
with the estimated total work to be per-
formed must clearly reflect the earning of
income with respect to the contract. For
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example, in the case of a roadbuilder, a
standard of completion solely based on
miles of roadway completed in a case
where the terrain is substantially different
may not clearly reflect the earning of
income with respect to the contract.
(d) Completed-contract method-(1) In
general. Except as otherwise provided in
paragraph (d)(4) of this section, a taxpay-
er using the CCM to account for a long-
term contract must take into account in
the contract's completion year, as defined
in §1.460-1(b)(6), the gross contract price
and all allocable contract costs incurred
by the completion year. A taxpayer may
not treat the cost of any materials and sup-
plies that are allocated to a contract, but
actually remain on hand when the contract
is completed, as an allocable contract
cost.
(2) Post-completion-year income and
costs. If a taxpayer has not included an
item of contingent compensation (i.e.,
amounts for which the all events test has
not been satisfied) in gross contract price
under paragraph (d)(3) of this section by
the completion year, the taxpayer must
account for this item of contingent com-
pensation using a permissible method of
accounting. If a taxpayer incurs an allo-
cable contract cost after the completion
year, the taxpayer must account for that
cost using a permissible method of
accounting.
(3) Gross contract price. Gross con-
tract price includes all amounts (including
holdbacks, retainages, and reimburse-
ments) that a taxpayer is entitled by law or
contract to receive, whether or not the
amounts are due or have been paid. In
addition, gross contract price includes all
bonuses, awards, and incentive payments,
such as a bonus for meeting an early com-
pletion date, to the extent the all events
test is satisfied. If a taxpayer performs a
non-long-term contract activity, as
defined in §1.460-1(d)(2), that is incident
to or necessary for the manufacture, build-
ing, installation, or construction of the
subject matter of one or more of the tax-
payer's long-term contracts, the taxpayer
must include an allocable share of the
gross receipts attributable to that activity
in the gross contract price of the con-
tract(s) benefitted by that activity. Gross
contract price also includes amounts reim-
bursed for independent research and
development expenses (as defined in
§1.460-1(b)(9)), or bidding and proposal
costs, under a federal or cost-plus long-
term contract (as defined in section
460(d)), regardless of whether the
research and development, or bidding and
proposal, activities are incident to or nec-
essary for the performance of that long-
term contract.
(4) Contracts with disputed claims-(i)
In general. The special rules in this para-
graph (d)(4) apply to a long-term contract
accounted for using the CCM with a dis-
pute caused by a customer's requesting a
reduction of the gross contract price or the
performance of additional work under the
contract or by a taxpayer's requesting an
increase in gross contract price, or both,
on or after the date a taxpayer has ten-
dered the subject matter of the contract to
the customer.
(ii) Taxpayer assured of profit or loss.
If the disputed amount relates to a cus-
tomer's claim for either a reduction in
price or additional work and the taxpayer
is assured of either a profit or a loss on a
long-term contract regardless of the out-
come of the dispute, the gross contract
price, reduced (but not below zero) by the
amount reasonably in dispute, must be
taken into account in the completion year.
If the disputed amount relates to a taxpay-
er's claim for an increase in price and the
taxpayer is assured of either a profit or a
loss on a long-term contract regardless of
the outcome of the dispute, the gross con-
tract price must be taken into account in
the completion year. If the taxpayer is
assured a profit on the contract, all alloca-
ble contract costs incurred by the end of
the completion year are taken into account
in that year. If the taxpayer is assured a
loss on the contract, all allocable contract
costs incurred by the end of the comple-
tion year, reduced by the amount reason-
ably in dispute, are taken into account in
the completion year.
(iii) Taxpayer unable to determine prof-
it or loss. If the amount reasonably in dis-
pute affects so much of the gross contract
price or allocable contract costs that a tax-
payer cannot determine whether a profit
or loss ultimately will be realized from a
long-term contract, the taxpayer may not
take any of the gross contract price or
allocable contract costs into account in the
completion year.
(iv) Dispute resolved. Any part of the
gross contract price and any allocable
contract costs that have not been taken
into account because of the principles
described in paragraph (d)(4)(i), (ii), or
(iii) of this section must be taken into
account in the taxable year in which the
dispute is resolved. If a taxpayer per-
forms additional work under the contract
because of the dispute, the term taxable
year in which the dispute is resolved
means the taxable year the additional
work is completed, rather than the taxable
year in which the outcome of the dispute
is determined by agreement, decision, or
otherwise.
(e) Percentage-of-completion/capital-
ized-cost method. Under the PCCM, a
taxpayer must determine the income from
a long-term contract using the PCM for
the applicable percentage of the contract
and its exempt contract method, as
defined in paragraph (c) of this section,
for the remaining percentage of the con-
tract. For residential construction con-
tracts described in §1.460-3(c), the
applicable percentage is 70 percent, and
the remaining percentage is 30 percent.
For qualified ship contracts described in
§1.460-2(d), the applicable percentage is
40 percent, and the remaining percentage
is 60 percent.
(f) Alternative minimum taxable
income-(1) In general. Under section
56(a)(3), a taxpayer (not exempt from the
AMT under section 55(e)) must use the
PCM to determine its AMTI from any
long-term contract entered into on or after
March 1, 1986, that is not a home con-
struction contract, as defined in
§1.460-3(b)(2). For AMTI purposes, the
PCM must include any election under
paragraph (b)(6) of this section (concern-
ing the 10-percent method) or under
§1.460-5(c) (concerning the simplified
cost-to-cost method) that the taxpayer has
made for regular tax purposes. For
exempt construction contracts described
in §1.460-3(b)(1)(ii), a taxpayer must use
the simplified cost-to-cost method to
determine the completion factor for AMTI
purposes. Except as provided in para-
graph (f)(2) of this section, a taxpayer
must use AMTI costs and AMTI methods,
such as the depreciation method described
in section 56(a)(1), to determine the com-
pletion factor of a long-term contract
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(except a home construction contract) for
AMTI purposes.
(2) Election to use regular completion
factors. Under this paragraph (f)(2), a
taxpayer may elect for AMTI purposes to
determine the completion factors of all of
its long-term contracts using the methods
of accounting and allocable contract costs
used for regular federal income tax pur-
poses. A taxpayer makes this election by
using regular methods and regular costs to
compute the completion factors of all
long-term contracts entered into during
the taxable year of the election for AMTI
purposes on its original federal income
tax return for the election year. This elec-
tion is a method of accounting and, thus,
applies to all long-term contracts entered
into during and after the taxable year of
the election. Although a taxpayer may
elect to compute the completion factor of
its long-term contracts using regular
methods and regular costs, an election
under this paragraph (f)(2) does not elim-
inate a taxpayer's obligation to comply
with the requirements of section 55 when
computing AMTI. For example, although
a taxpayer may elect to use the deprecia-
tion methods used for regular tax purpos-
es to compute the completion factor of its
long-term contracts for AMTI purposes,
the taxpayer must use the depreciation
methods permitted by section 56 to com-
pute AMTI.
(g) Method of accounting. A taxpayer
that uses the PCM, EPCM, CCM, PCCM,
or elects the 10-percent method or special
AMTI method (or changes to another
method of accounting with the
Commissioner's consent) must apply the
method(s) consistently for all similarly
classified long-term contracts, until the
taxpayer obtains the Commissioner's con-
sent under section 446(e) to change to
another method of accounting. A taxpay-
er-initiated change in method of account-
ing will be permitted only on a cut-off
basis (i.e., for contracts entered into on or
after the year of change), and thus, a sec-
tion 481(a) adjustment will not be permit-
ted or required.
(h) Examples. The following examples
illustrate the rules of this section:
Example 1. PCM-estimating total contract price.
C, whose taxable year ends December 31, determines
the income from long-term contracts using the PCM.
On January 1, 2001, C enters into a contract to design
and manufacture a satellite (a unique item). The con-
tract provides that C will be paid $10,000,000 for
delivering the completed satellite by December 1,
2002. The contract also provides that C will receive a
$3,000,000 bonus for delivering the satellite by July
1, 2002, and an additional $4,000,000 bonus if the
satellite successfully performs its mission for five
years. C is unable to reasonably predict if the satellite
will successfully perform its mission for five years. If
on December 31, 2001, C should reasonably expect to
deliver the satellite by July 1, 2002, the estimated total
contract price is $13,000,000 ($10,000,000 unit price
\+ $3,000,000 production-related bonus). Otherwise,
the estimated total contract price is $10,000,000. In
either event, the $4,000,000 bonus is not includible in
the estimated total contract price as of December 31,
2001, because C is unable to reasonably predict that
the satellite will successfully perform its mission for
five years.
Example 2. PCM-computing income. (i) C,
whose taxable year ends December 31, determines the
income from long-term contracts using the PCM.
During 2001, C agrees to manufacture for the cus-
tomer, B, a unique item for a total contract price of
$1,000,000. Under C's contract, B is entitled to retain
10 percent of the total contract price until it accepts the
item. By the end of 2001, C has incurred $200,000 of
allocable contract costs and estimates that the total
allocable contract costs will be $800,000. By the end
of 2002, C has incurred $600,000 of allocable contract
costs and estimates that the total allocable contract
costs will be $900,000. In 2003, after completing the
contract, C determines that the actual cost to manufac-
ture the item was $750,000.
(ii) For each of the taxable years, C's income
from the contract is computed as follows:
Taxable Year
2001
2002
2003
(A) Cumulative incurred costs
$ 200,000
$ 600,000
$ 750,000
(B) Estimated total costs
800,000
900,000
750,000
(C) Completion factor: (A) + (B)
25.00%
66.67%
100.00%
(D) Total contract price
1,000,000
1,000,000
1,000,000
(E) Cumulative gross receipts: (C) x (D)
250,000
666,667
1,000,000
(F) Cumulative gross receipts (prior year):
( 0)
( 250,000)
( 666,667)
(G) Current-year gross receipts
250,000
416,667
333,333
(H) Cumulative incurred costs
200,000
600,000
750,000
(I) Cumulative incurred costs (prior year):
( 0)
( 200,000)
( 600,000)
(J) Current-year costs
200,000
400,000
150,000
(K) Gross income: (G) - (J)
$ 50,000
$ 16,667
$ 183,333
Example 3. PCM- computing income with cost
sharing. (i) C, whose taxable year ends December 31,
determines the income from long-term contracts using
the PCM. During 2001, C enters into a contract to
manufacture a unique item. The contract specifies a
target price of $1,000,000, a target cost of $600,000,
and a target profit of $400,000. C and B will share the
savings of any cost underrun (actual total incurred
cost is less than target cost) and the additional cost of
any cost overrun (actual total incurred cost is greater
than target cost) as follows: 30 percent to C and 70
percent to B. By the end of 2001, C has incurred
$200,000 of allocable contract costs and estimates
that the total allocable contract costs will be $600,000.
By the end of 2002, C has incurred $300,000 of allo-
cable contract costs and estimates that the total allo-
cable contract costs will be $400,000. In 2003, after
completing the contract, C determines that the actual
cost to manufacture the item was $700,000.
(ii) For each of the taxable years, C's income
from the contract is computed as follows (note that
the sharing of any cost underrun or cost overrun is
reflected as an adjustment to C's target price under
paragraph (b)(4)(i) of this section):
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Taxable Year
2001
2002
2003
(A) Cumulative incurred costs
$ 200,000
$ 300,000
$ 700,000
(B) Estimated total costs
600,000
400,000
700,000
(C) Completion factor: (A) + (B)
33.33%
75.00%
100.00%
(D) Target price
$ 1,000,000
$ 1,000,000
$ 1,000,000
(E) Estimated total costs
600,000
400,000
700,000
(F) Target costs
600,000
600,000
600,000
(G) Cost (underrun)/overrun: (E)-(F)
0
( 200,000)
100,000
(H) Adjustment rate
70%
70%
70%
(I) Target price adjustment
0
( 140,000)
70,000
(J) Total contract price: (D) + (I)
$ 1,000,000
$ 860,000
$ 1,070,000
(K) Cumulative gross receipts: (C) X (J)
$ 333,333
$ 645,000
$ 1,070,000
(L) Cumulative gross receipts (prior year):
( 0)
( 333,333)
( 645,000)
(M) Current-year gross receipts
333,333
311,667
425,000
(N) Cumulative incurred costs
200,000
300,000
700,000
(O) Cumulative incurred costs (prior year):
( 0)
( 200,000)
(300,000)
(P) Current-year costs
200,000
100,000
400,000
(Q) Gross income: (M)-(P)
$ 133,333
$ 211,667
$ 25,000
Example 4. PCM-10 percent method. (i) C,
whose taxable year ends December 31, deter-
mines the income from long-term contracts using
the PCM. In November 2001, C agrees to manu-
facture a unique item for $1,000,000. C reason-
ably estimates that the total allocable contract
costs will be $600,000. By December 31, 2001,
C has received $50,000 in progress payments and
incurred $40,000 of costs. C elects to use the 10
percent method effective for 2001 and all subse-
quent taxable years. During 2002, C receives
$500,000 in progress payments and incurs
$260,000 of costs. In 2003, C incurs an addition-
al $300,000 of costs, C finishes manufacturing
the item, and receives the final $450,000 pay-
ment.
(ii) For each of the taxable years, C's income
from the contract is computed as follows:
Taxable Year
2001
2002
2003
(A) Cumulative incurred costs
$ 40,000
$ 300,000
$ 600,000
(B) Estimated total costs
600,000
600,000
600,000
(C) Completion factor: (A) + (B)
6.67%
50.00%
100.00%
(D) Total contract price
1,000,000
1,000,000
1,000,000
(E) Cumulative gross receipts: (C) × (D)*
0
500,000
1,000,000
(F) Cumulative gross receipts (prior year):
( 0)
( 0)
( 500,000)
(G) Cumulative-year gross receipts
0
500,000
500,000
(H) Cumulative incurred costs
0
300,000
600,000
(I) Cumulative incurred costs (prior year):
( 0)
( 0)
( 300,000)
(J) Current-year costs
0
300,000
300,000
(K) Gross income: (G) - (J)
$ 0
$ 200,000
$ 200,000
* Unless (C) < 10 percent.
Example 5. PCM-contract terminated. C, whose
taxable year ends December 31, determines the
income from long-term contracts using the PCM.
During 2001, C buys land and begins constructing a
building that will contain 50 condominium units on
that land. C enters into a contract to sell one unit in
this condominium to B for $240,000. B gives C a
$5,000 deposit toward the purchase price. By the
end of 2001, C has incurred $50,000 of allocable
contract costs on B's unit and estimates that the total
allocable contract costs on B's unit will be $150,000.
Thus, for 2001, C reports gross receipts of $80,000
($50,000 = $150,000 x $240,000), current-year
costs of $50,000, and gross income of $30,000
($80,000 - $50,000). In 2002, after C has incurred
an additional $25,000 of allocable contract costs on
B's unit, B files for bankruptcy protection and
defaults on the contract with C, who is permitted to
keep B's $5,000 deposit as liquidated damages. In
2002, C reverses the transaction with B under para-
graph (b)(7) of this section and reports a loss of
$30,000 ($50,000 - $80,000). In addition, C obtains
an adjusted basis in the unit sold to B of $70,000
($50,000 (current-year costs deducted in 2001) -
$5,000 (B's forfeited deposit) + $25,000 (current-
year costs incurred in 2002). C may not apply the
look-back method to this contract in 2002.
Example 6. CCM-contracts with disputes from
customer claims. In 2001, C, whose taxable year
ends December 31, uses the CCM to account for
exempt construction contracts. C enters into a con-
tract to construct a bridge for B. The terms of the
contract provide for a $1,000,000 gross contract
price. C finishes the bridge in 2002 at a cost of
$950,000. When B examines the bridge, B insists
that C either repaint several girders or reduce the
contract price. The amount reasonably in dispute is
$10,000. In 2003, C and B resolve their dispute, C
repaints the girders at a cost of $6,000, and C and B
agree that the contract price is not to be reduced.
Because C is assured a profit of $40,000
($1,000,000 - $10,000 - $950,000) in 2002 even if
the dispute is resolved in B's favor, C must take this
$40,000 into account in 2002. In 2003, C will earn
an additional $4,000 profit ($1,000,000 - $956,000 -
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$40,000) from the contract with B. Thus, C must
take into account an additional $10,000 of gross con-
tract price and $6,000 of additional contract costs in
2003.
Example 7. CCM-contracts with disputes from
taxpayer claims. In 2003, C, whose taxable year
ends December 31, uses the CCM to account for
exempt construction contracts. C enters into a con-
tract to construct a building for B. The terms of the
contract provide for a $1,000,000 gross contract
price. C finishes the building in 2004 at a cost of
$1,005,000. B examines the building in 2004 and
agrees that it meets the contract's specifications;
however, at the end of 2004, C and B are unable to
agree on the merits of C's claim for an additional
$10,000 for items that C alleges are changes in con-
tract specifications and B alleges are within the
scope of the contract's original specifications. In
2005, B agrees to pay C an additional $2,000 to sat-
isfy C's claims under the contract. Because the
amount in dispute affects so much of the gross con-
tract price that C cannot determine in 2004 whether
a profit or loss will ultimately be realized, C may not
take any of the gross contract price or allocable con-
tract costs into account in 2004. C must take into
account $1,002,000 of gross contract price and
$1,005,000 of allocable contract costs in 2005.
Example 8. CCM-contracts with disputes from
taxpayer and customer claims. C, whose taxable
year ends December 31, uses the CCM to account
for exempt construction contracts. C constructs a
factory for B pursuant to a long-term contract.
Under the terms of the contract, B agrees to pay C a
total of $1,000,000 for construction of the factory. C
finishes construction of the factory in 2002 at a cost
of $1,020,000. When B takes possession of the fac-
tory and begins operations in December 2002, B is
dissatisfied with the location and workmanship of
certain heating ducts. As of the end of 2002, C con-
tends that the heating ducts are constructed in accor-
dance with contract specifications. The amount of
the gross contract price reasonably in dispute with
respect to the heating ducts is $6,000. As of this
time, C is claiming $14,000 in addition to the origi-
nal contract price for certain changes in contract
specifications which C alleges have increased his
costs. B denies that these changes have increased
C's costs. In 2003, the disputes between C and B are
resolved by performance of additional work by C at
a cost of $1,000 and by an agreement that the con-
tract price would be revised downward to $996,000.
Under these circumstances, C must include in his
gross income for 2002, $994,000 (the gross contract
price less the amount reasonably in dispute because
of B's claim, or $1,000,000 - $6,000). In 2002, C
must also take into account $1,000,000 of allocable
contract costs (costs incurred less the amounts in dis-
pute attributable to both B's and C's claims, or
$1,020,000 -$6,000 - $14,000). In 2003, C must
take into account an additional $2,000 of gross con-
tract price ($996,000 - $994,000) and $21,000 of
allocable contract costs ($1,021,000 - $1,000,000).
(i) [Reserved]
** * * *
(k) Mid-contract change in taxpayer.
[Reserved]
Par. 8. Section 1.460-5 is added to read
as follows:
§1.460-5 Cost allocation rules.
(a) Overview. This section prescribes
methods of allocating costs to long-term
contracts accounted for using the percent-
age-of-completion method described in
§1.460-4(b) (PCM), the completed-con-
tract method described in §1.460-4(d)
(CCM), or the percentage-of-comple-
tion/capitalized-cost method described in
§1.460-4(e) (PCCM). Exempt construc-
tion contracts described in §1.460-3(b)
accounted for using a method other than
the PCM or CCM are not subject to the
cost allocation rules of this section (other
than the requirement to allocate produc-
tion-period interest under paragraph
(b)(2)(v) of this section). Paragraph (b) of
this section describes the regular cost allo-
cation methods for contracts subject to the
PCM. Paragraph (c) of this section
describes an elective simplified cost allo-
cation method for contracts subject to the
PCM. Paragraph (d) of this section
describes the cost allocation methods for
exempt construction contracts reported
using the CCM. Paragraph (e) of this sec-
tion describes the cost allocation rules for
contracts subject to the PCCM. Paragraph
(f) of this section describes additional
rules applicable to the cost allocation
methods described in this section.
Paragraph (g) of this section provides
rules concerning consistency in method of
allocating costs to long-term contracts.
(b) Cost allocation method for con-
tracts subject to PCM-(1) In general.
Except as otherwise provided in para-
graph (b)(2) of this section, a taxpayer
must allocate costs to each long-term con-
tract subject to the PCM in the same man-
ner that direct and indirect costs are capi-
talized to property produced by a taxpayer
under §1.263A-1(e) through (h). Thus, a
taxpayer must allocate to each long-term
contract subject to the PCM all direct
costs and certain indirect costs properly
allocable to the long-term contract (i.e.,
all costs that directly benefit or are
incurred by reason of the performance of
the long-term contract). However, see
paragraph (c) of this section concerning
an election to allocate contract costs using
the simplified cost-to-cost method. As in
section 263A, the use of the practical
capacity concept is not permitted. See
§1.263A-2(a)(4).
(2) Special rules-(i) Direct material
costs. The costs of direct materials must
be allocated to a long-term contract when
dedicated to the contract under principles
similar to those in §1.263A-11(b)(2).
Thus, a taxpayer dedicates direct materi-
als by associating them with a specific
contract, including by purchase order,
entry on books and records, or shipping
instructions. A taxpayer maintaining
inventories under §1.471-1 must deter-
mine allocable contract costs attributable
to direct materials using its method of
accounting for those inventories (e.g.,
FIFO, LIFO, specific identification).
(ii) Components and subassemblies.
The costs of a component or subassembly
(component) produced by the taxpayer
must be allocated to a long-term contract
as the taxpayer incurs costs to produce the
component if the taxpayer reasonably
expects to incorporate the component into
the subject matter of the contract.
Similarly, the cost of a purchased compo-
nent (including a component purchased
from a related party) must be allocated to
a long-term contract as the taxpayer
incurs the cost to purchase the component
if the taxpayer reasonably expects to
incorporate the component into the sub-
ject matter of the contract. In all other
cases, the cost of a component must be
allocated to a long-term contract when the
component is dedicated, under principles
similar to those in §1.263A-11(b)(2). A
taxpayer maintaining inventories under
§1.471-1 must determine allocable con-
tract costs attributable to components
using its method of accounting for those
inventories (e.g., FIFO, LIFO, specific
identification).
(iii) Simplified production methods. A
taxpayer may not determine allocable
contract costs using the simplified pro-
duction methods described in
§1.263A-2(b) and (c).
(iv) Costs identified under cost-plus
long-term contracts and federal long-term
contracts. To the extent not otherwise
allocated to the contract under this para-
graph (b), a taxpayer must allocate any
identified costs to a cost-plus long-term
contract or federal long-term contract (as
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defined in section 460(d)). Identified cost
means any cost, including a charge repre-
senting the time-value of money, identi-
fied by the taxpayer or related person as
being attributable to the taxpayer's cost-
plus long-term contract or federal long-
term contract under the terms of the con-
tract itself or under federal, state, or local
law or regulation.
(v) Interest-(A) In general. If proper-
ty produced under a long-term contract is
designated property, as defined in
§1.263A-8(b) (without regard to the
exclusion for long-term contracts under
§1.263A-8(d)(2)(v)), a taxpayer must
allocate interest incurred during the pro-
duction period to the long-term contract in
the same manner as interest is allocated to
property produced by a taxpayer under
section 263A(f). See §§1.263A-8 to
1.263A-12 generally.
(B) Production period. Notwithstand-
ing §1.263A-12(c) and (d), for purposes
of this paragraph (b)(2)(v), the production
period of a long-term contract-
(1) Begins on the later of-
(i) The contract commencement date,
as defined in §1.460-1(b)(7); or
(ii) For a taxpayer using the accrual
method of accounting for long-term con-
tracts, the date by which 5 percent or more
of the total estimated costs, including
design and planning costs, under the con-
tract have been incurred; and
(2) Ends on the date that the contract is
completed, as defined in §1.460-1(c)(3).
(C) Application of section 263A(f). For
purposes of this paragraph (b)(2)(v), sec-
tion 263A(f)(1)(B)(iii) (regarding an esti-
mated production period exceeding 1 year
and a cost exceeding $1,000,000) must be
applied on a contract-by-contract basis;
except that, in the case of a taxpayer using
an accrual method of accounting, that sec-
tion must be applied on a property-by-
property basis.
(vi) Research and experimental expens-
es. Notwithstanding §1.263A-1(e)(3)
(ii)(P) and (iii)(B), a taxpayer must allo-
cate research and experimental expenses,
other than independent research and
development expenses (as defined in
§1.460-1(b)(9)), to its long-term con-
tracts.
(vii) Service costs-(A) Simplified ser-
vice cost method-(1) In general. To use
the simplified service cost method under
§1.263A-1(h), a taxpayer must allocate
the otherwise capitalizable mixed service
costs among its long-term contracts using
a reasonable method. For example, other-
wise capitalizable mixed service costs
may be allocated to each long-term con-
tract based on labor hours or contract
costs allocable to the contract. To be con-
sidered reasonable, an allocation method
must be applied consistently and must not
disproportionately allocate service costs
to contracts expected to be completed in
the near future.
(2) Example. The following example
illustrates the rule of this paragraph
(b)(2)(vii)(A):
Example. Simplified service cost method. During
2001, C, whose taxable year ends December 31, pro-
duces electronic equipment for inventory and enters
into long-term contracts to manufacture specialized
electronic equipment. C's method of allocating
mixed service costs to the property it produces is the
labor-based, simplified service cost method
described in §1.263A-1(h)(4). For 2001, C's total
mixed service costs are $100,000, C's section 263A
labor costs are $500,000, C's section 460 labor costs
(i.e., labor costs allocable to C's long-term contracts)
are $250,000, and C's total labor costs are
$1,000,000. To determine the amount of mixed ser-
vice costs capitalizable under section 263A for 2001,
C multiplies its total mixed service costs by its sec-
tion 263A allocation ratio (section 263A labor costs
total labor costs). Thus, C's capitalizable mixed
service costs for 2001 are $50,000 ($100,000 x
$500,000 + $1,000,000). Thereafter, C allocates its
capitalizable mixed service costs to produced prop-
erty remaining in ending inventory using its 263A
allocation method (e.g., burden rate, simplified pro-
duction). Similarly, to determine the amount of
mixed service costs that are allocable to C's long-
term contracts for 2001, C multiplies its total mixed
service costs by its section 460 allocation ratio (sec-
tion 460 labor + total labor costs). Thus, C's allo-
cable mixed service contract costs for 2001 are
$25,000 ($100,000 x $250,000 + $1,000,000).
Thereafter, C allocates its allocable mixed service
costs to its long-term contracts proportionately based
on its section 460 labor costs allocable to each long-
term contract.
(B) Jobsite costs. If an administrative,
service, or support function is performed
solely at the jobsite for a specific long-
term contract, the taxpayer may allocate
all the direct and indirect costs of that
administrative, service, or support func-
tion to that long-term contract. Similarly,
if an administrative, service, or support
function is performed at the jobsite solely
for the taxpayer's long-term contract
activities, the taxpayer may allocate all
the direct and indirect costs of that admin-
istrative, service, or support function
among all the long-term contracts per-
formed at that jobsite. For this purpose,
jobsite means a production plant or a con-
struction site.
(C) Limitation on other reasonable cost
allocation methods. A taxpayer may use
any other reasonable method of allocating
service costs, as provided in
§1.263A-1(f)(4), if, for the taxpayer's
long-term contracts considered as a
whole, the-
(1) Total amount of service costs allo-
cated to the contracts does not differ sig-
nificantly from the total amount of service
costs that would have been allocated to
the contracts under §1.263A-1(f)(2) or
(3);
(2) Service costs are not allocated dis-
proportionately to contracts expected to
be completed in the near future because of
the taxpayer's cost allocation method; and
(3) Taxpayer's cost allocation method
is applied consistently.
(c) Simplified cost-to-cost method for
contracts subject to the PCM-(1) In gen-
eral. Instead of using the cost allocation
method prescribed in paragraph (b) of this
section, a taxpayer may elect to use the
simplified cost-to-cost method, which is
authorized under section 460(b)(3)(A), to
allocate costs to a long-term contract sub-
ject to the PCM. Under the simplified
cost-to-cost method, a taxpayer deter-
mines a contract's completion factor
based upon only direct material costs;
direct labor costs; and depreciation, amor-
tization, and cost recovery allowances on
equipment and facilities directly used to
manufacture or construct the subject mat-
ter of the contract. For this purpose, the
costs associated with any manufacturing
or construction activities performed by a
subcontractor are considered either direct
material or direct labor costs, as appropri-
ate, and therefore must be allocated to the
contract under the simplified cost-to-cost
method. An electing taxpayer must use
the simplified cost-to-cost method to
apply the look-back method under
§1.460-6 and to determine alternative
minimum taxable income under §1.460-
4(f).
(2) Election. A taxpayer makes an elec-
tion under this paragraph (c) by using the
simplified cost-to-cost method for all
long-term contracts entered into during
the taxable year of the election on its orig-
inal federal income tax return for the elec-
tion year. This election is a method of
accounting and, thus, applies to all long-
term contracts entered into during and
after the taxable year of the election. This
election is not available if a taxpayer does
2001-10 I.R.B.
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not use the PCM to account for all long-
term contracts or if a taxpayer elects to
use the 10-percent method described in
§1.460-4(b)(6).
(d) Cost allocation rules for exempt
construction contracts reported using the
CCM-(1) In general. For exempt con-
struction contracts reported using the
CCM, other than contracts described in
paragraph (d)(3) of this section (concern-
ing contracts of homebuilders that do not
satisfy the $10,000,000 gross receipts test
described in §1.460-3(b)(3) or will not be
completed within two years of the con-
tract commencement date), a taxpayer
must annually allocate the cost of any
activity that is incident to or necessary for
the taxpayer's performance under a long-
term contract. A taxpayer must allocate to
each exempt construction contract all
direct costs as defined in
§1.263A-1(e)(2)(i) and all indirect costs
either as provided in §1.263A-1(e)(3) or
as provided in paragraph (d)(2) of this
section.
(2) Indirect costs-(i) Indirect costs
allocable to exempt construction con-
tracts. A taxpayer allocating costs under
this paragraph (d)(2) must allocate the fol-
lowing costs to an exempt construction
contract, other than a contract described in
paragraph (d)(3) of this section, to the
extent incurred in the performance of that
contract-
(A) Repair of equipment or facilities;
(B) Maintenance of equipment or facil-
ities;
(C) Utilities, such as heat, light, and
power, allocable to equipment or facili-
ties;
(D) Rent of equipment or facilities;
(E) Indirect labor and contract supervi-
sory wages, including basic compensa-
tion, overtime pay, vacation and holiday
pay, sick leave pay (other than payments
pursuant to a wage continuation plan
under section 105(d) as it existed prior to
its repeal in 1983), shift differential, pay-
roll taxes, and contributions to a supple-
mental unemployment benefits plan;
(F) Indirect materials and supplies;
(G) Noncapitalized tools and equip-
ment;
(H) Quality control and inspection;
(I) Taxes otherwise allowable as a
deduction under section 164, other than
state, local, and foreign income taxes, to
the extent attributable to labor, materials,
supplies, equipment, or facilities;
March 5, 2001
(J) Depreciation, amortization, and
cost-recovery allowances reported for the
taxable year for financial purposes on
equipment and facilities to the extent
allowable as deductions under chapter 1
of the Internal Revenue Code;
(K) Cost depletion;
(L) Administrative costs other than the
cost of selling or any return on capital;
(M) Compensation paid to officers
other than for incidental or occasional ser-
vices;
(N) Insurance, such as liability insur-
ance on machinery and equipment; and
(O) Interest, as required under para-
graph (b)(2)(v) of this section.
(ii) Indirect costs not allocable to
exempt construction contracts. A taxpay-
er allocating costs under this paragraph
(d)(2) is not required to allocate the fol-
lowing costs to an exempt construction
contract reported using the CCM-
(A) Marketing and selling expenses,
including bidding expenses;
(B) Advertising expenses;
(C) Other distribution expenses;
(D) General and administrative expens-
es attributable to the performance of ser-
vices that benefit the taxpayer's activities
as a whole (e.g., payroll expenses, legal
and accounting expenses);
(E) Research and experimental expens-
es (described in section 174 and the regu-
lations thereunder);
(F) Losses under section 165 and the
regulations thereunder;
(G) Percentage of depletion in excess
of cost depletion;
(H) Depreciation, amortization, and
cost recovery allowances on equipment
and facilities that have been placed in ser-
vice but are temporarily idle (for this pur-
pose, an asset is not considered to be tem-
porarily idle on non-working days, and an
asset used in construction is considered to
be idle when it is neither en route to nor
located at a job-site), and depreciation,
amortization and cost recovery
allowances under chapter 1 of the Internal
Revenue Code in excess of depreciation,
amortization, and cost recovery
allowances reported by the taxpayer in the
taxpayer's financial reports;
(I) Income taxes attributable to income
received from long-term contracts;
(J) Contributions paid to or under a
stock bonus, pension, profit-sharing, or
annuity plan or other plan deferring the
receipt of compensation whether or not
the plan qualifies under section 401(a),
and other employee benefit expenses paid
or accrued on behalf of labor, to the extent
the contributions or expenses are other-
wise allowable as deductions under chap-
ter 1 of the Internal Revenue Code. Other
employee benefit expenses include (but
are not limited to): worker's compensa-
tion; amounts deductible or for whose
payment reduction in earnings and profits
is allowed under section 404A and the
regulations thereunder; payments pur-
suant to a wage continuation plan under
section 105(d) as it existed prior to its
repeal in 1983; amounts includible in the
gross income of employees under a
method or arrangement of employer con-
tributions or compensation which has the
effect of a stock bonus, pension, profit-
sharing, or annuity plan, or other plan
deferring the receipt of compensation or
providing deferred benefits; premiums on
life and health insurance; and miscella-
neous benefits provided for employees
such as safety, medical treatment, recre-
ational and eating facilities, membership
dues, etc .;
(K) Cost attributable to strikes, rework
labor, scrap and spoilage; and
(L) Compensation paid to officers
attributable to the performance of services
that benefit the taxpayer's activities as a
whole.
(3) Large homebuilders. A taxpayer
must capitalize the costs of home con-
struction contracts under section 263A
and the regulations thereunder, unless the
contract will be completed within two
years of the contract commencement date
and the taxpayer satisfies the $10,000,000
gross receipts test described in
§1.460-3(b)(3).
(e) Cost allocation rules for contracts
subject to the PCCM. A taxpayer must
use the cost allocation rules described in
paragraph (b) of this section to determine
the costs allocable to the entire qualified
ship contract or residential construction
contract accounted for using the PCCM
and may not use the simplified cost-to-
cost method described in paragraph (c) of
this section.
(f) Special rules applicable to costs
allocated under this section-(1)
Nondeductible costs. A taxpayer may not
allocate any otherwise allocable contract
cost to a long-term contract if any section
of the Internal Revenue Code disallows a
deduction for that type of payment or
2001-10 I.R.B.
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expenditure (e.g., an illegal bribe
described in section 162(c)).
(2) Costs incurred for non-long-term
contract activities. If a taxpayer performs
a non-long-term contract activity, as
defined in §1.460-1(d)(2), that is incident
to or necessary for the manufacture, build-
ing, installation, or construction of the
subject matter of one or more of the tax-
payer's long-term contracts, the taxpayer
must allocate the costs attributable to that
activity to such contract(s).
(g) Method of accounting. A taxpayer
that adopts or elects a cost allocation
method of accounting (or changes to
another cost allocation method of
accounting with the Commissioner's con-
sent) must apply that method consistently
for all similarly classified contracts, until
the taxpayer obtains the Commissioner's
consent under section 446(e) to change to
another cost allocation method. A taxpay-
er-initiated change in cost allocation
method will be permitted only on a cut-off
basis (i.e., for contracts entered into on or
after the year of change, and thus, a sec-
tion 481(a) adjustment will not be permit-
ted or required.
Par. 9. Section 1.460-6 is amended as
follows:
1\. A sentence is added to the end of
paragraph (a)(2).
2\. The third sentence of paragraph
(b)(1) is removed.
3\. In the fourth sentence of paragraph
(b)(1), "Therefore, to the extent that the
percentage of completion method is
required to be used" is removed and "To
the extent that the percentage of comple-
tion method is required to be used under
§ 1.460-1(g)" is added in its place.
4\. The first sentence of paragraph
(c)(1)(ii)(A) is revised.
5\. In the first sentence of paragraph
(c)(1)(ii)(B), the language "no later than
the year" is removed and "in the year" is
added in its place and "§1.451-3(b)(2)" is
removed and "§1.460-1(c)(3)" is added in
its place.
6\. The last two sentences of paragraph
(c)(1)(ii)(B) are removed.
7\. In the last sentence of paragraph
(c)(1)(ii)(C)(2), the language "§5h.6" is
removed and "§301.9100-8 of this chap-
ter" is added in its place.
8\. In the fourth sentence of paragraph
(c)(2)(v)(A), the language "similarly" is
removed.
9\. The first, second, fifth, and sixth
sentences of paragraph (c)(2)(v)(A) are
removed.
10\. In the first sentence of paragraph
(c)(2)(vi)(B), the language "§1.451-3
(b)(2)(ii), (iii), (iv), and §1.451-3(d)(2),
(3), and (4)" is removed and "§1.460-4
(b)(4)(i)" is added in its place.
11\. In the second sentence of para-
graph (c)(2)(vi)(B), the language "the per-
centage of completion method and" is
removed.
12\. In the third sentence of paragraph
(c)(2)(vi)(B), the language ", for purposes
of both the percentage of completion
method and the look-back method" is
removed.
13\. In the fourth sentence of para-
graph (c)(2)(vi)(B), the language
"Similarly, a" is removed and "A" is
added in its place.
14\. In the first sentence of paragraph
(c)(2)(vi)(C), the language "§1.451-3(e)"
is removed and "§1.460-1(e)" is added in
its place.
15\. Paragraph (c)(4)(iv) is removed.
16\. In the first sentence of paragraph
(d)(4)(ii)(C), the language "within the
meaning of section 1504(a)" is removed
and ", as defined in § 1.1502-1(h)" is
added in its place.
17\. In the fourth sentence of paragraph
(e)(2), the language "within the meaning
of section 1504(a)" is removed and ", as
defined in §1.1502-1(h)" is added in its
place.
18\. In the first sentence of paragraph
(f)(1), the language "or to be refunded" is
removed and "from, or payable to, a tax-
payer" is added in its place.
19\. In the first sentence of paragraph
(f)(1), the language "and reported" is
removed.
20\. In the second sentence of para-
graph (f)(1), the language "and Form
8697 is filed by" is removed.
21\. In the second sentence of para-
graph (f)(2)(i), the language "fails to file
Form 8697 with respect to interest
required to be paid or that" is removed.
22\. In the second sentence of para-
graph (f)(2)(i), the language "a penalty
for failing to file Form 8697" is
removed and "an underpayment penalty
under section 6651, and the taxpayer
also is liable for underpayment interest
under section 6601" is added in its
place.
23\. In the third sentence of paragraph
(f)(2)(i), the language "penalty" is
removed and "subtitle F" is added in its
place.
24\. In the fourth sentence of paragraph
(f)(2)(i), the language "or a tax refund" is
added after "liability".
25\. In the first sentence of paragraph
(f)(2)(ii), the language "refunded" is
removed and "payable" is added in its
place.
26\. Paragraph (f)(3) is added.
The revisions and additions read as fol-
lows:
§1.460-6 Look-back method.
(a) * * *
(2) * * * Paragraph (j) of this section
provides guidance concerning the election
not to apply the look-back method in de
minimis cases.
* * * * *
(c) * * * (1) * * *
(ii) * * * (A) In general. Except as oth-
erwise provided in section 460(b)(6) (see
§1.460-6(j) for method of electing) or
§1.460-6(e), a taxpayer must apply the
look-back method to a long-term contract
in the completion year and in any post-
completion year for which the taxpayer
must adjust total contract price or total
allocable contract costs, or both, under the
PCM. * * *
* * * * *
(f) * * *
(3). Statue of limitations and com-
pounding of interest on look-back interest.
For guidance on the statute of limitations
applicable to the assessment and collec-
tion of look-back interest owed by a tax-
payer, see sections 6501 and 6502. A tax-
payer's claim for credit or refund of
look-back interest previously paid by or
collected from a taxpayer is a claim for
credit or refund of an overpayment of tax
and is subject to the statute of limitations
provided in section 6511. A taxpayer's
claim for look-back interest (or interest
payable on look-back interest) that is not
attributable to an amount previously paid
by or collected from a taxpayer is a gen-
eral, non-tax claim against the federal
government. For guidance on the statute
of limitations that applies to general, non-
tax claims against the federal government,
see 28 U.S.C. sections 2401 and 2501.
For guidance applicable to the compound-
ing of interest when the look-back interest
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is not paid, see sections 6601 to 6622.
* * * * *
## §§1.460-7 and 1.460-8 [Removed]
Par. 10. Sections 1.460-7 and 1.460-8
are removed.
### §1.471-10 [Amended]
Par. 11. Section 1.471-10 is amended
by removing the language "§1.451-3"
and adding "§1.460-2" in its place.
PART 602-OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 12. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 14. In §602.101, paragraph (b) is
amended by:
1\. Removing the entry for "1.451-3".
2\. The following entries are added in
numerical order to the table to read as fol-
lows:
§602.101 OMB Control numbers.
* * * * *
(b)
CFR part or section where Current OMB
identified and described control No.
* * * * *
1.460-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1545-1650 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
* * * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 20, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on Janu-
ary 10, 2001, 8:45 a.m., and published in the issue of
the Federal Register for January 11, 2001, 66 F.R.
2219)
## Section 472 .- Last-In, First-Out Inventories
26 CFR 1.472-1: Last-in, first-out inventories.
Optional dollar-value LIFO inventory computation
method for used vehicle dealers. See Rev. Proc.
2001-23, page 784.
## Section 481 .- Adjustments Required by Changes in Method of Accounting
26 CFR 1.481-1: Adjustments in general.
Method of accounting for cash advances paid to in-
surance agents is effected on a cut-off basis. See
Rev. Proc. 2001-24, page 788.
26 CFR 1.481-4: Adjustments taken into account
with consent.
Method of accounting for cash advances paid to in-
surance agents is effected on a cut-off basis. See
Rev. Proc. 2001-24, page 788.
## Section 807 .- Rules for Certain Reserves
Insurance companies; interest rate ta-
bles. Prevailing state assumed interest
rates are provided for the determination of
reserves under section 807 of the Code for
contracts issued in 2000 and 2001. Rev.
Rul. 92-19 supplemented in part.
## Rev. Rul. 2001-11
For purposes of § 807(d)(4) of the
Internal Revenue Code, for taxable years
beginning after December 31, 1999, this
ruling supplements the schedules of pre-
vailing state assumed interest rates set
forth in Rev. Rul. 92-19, 1992-1 C.B. 227.
This information is to be used by insur-
ance companies in computing their
reserves for (1) life insurance and supple-
mentary total and permanent disability
benefits, (2) individual annuities and pure
endowments, and (3) group annuities and
pure endowments. As § 807(d)(2)(B)
requires that the interest rate used to com-
pute these reserves be the greater of (1)
the applicable federal interest rate, or (2)
the prevailing state assumed interest rate,
the table of applicable federal interest
rates in Rev. Rul. 92-19 is also supple-
mented.
Following are supplements to sched-
ules A, B, C, and D to Part III of Rev.
Rul. 92-19, providing prevailing state
assumed interest rates for insurance
products with different features issued in
2000 and 2001, and a supplement to the
table in Part IV of Rev. Rul. 92-19, pro-
viding the applicable federal interest rate
under § 807(d) for 2000 and 2001. This
ruling does not supplement Parts I and II
of Rev. Rul. 92-19.
This is the ninth supplement to the
interest rates provided in Rev. Rul. 92-
19. Earlier supplements were published
in Rev. Rul. 93-58, 1993-2 C.B. 241
(interest rates for insurance products
issued in 1992 and 1993), Rev. Rul. 94-
11, 1994-1 C.B. 196 (1993 and 1994),
Rev. Rul. 95-4, 1995-1 C.B. 141 (1994
and 1995), Rev. Rul. 96-2, 1996-1 C.B.
141 (1995 and 1996), Rev. Rul. 97-2,
1997-1 C.B. 134 (1996 and 1997), Rev.
Rul. 98-2, 1998-1 C.B. 259 (1997 and
1998), Rev. Rul. 99-10, 1999-10 I.R.B.
10 (1998 and 1999), and Rev. Rul.
2000-17, 2000-13 I.R.B. 842 (1999 and
2000).
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# Part III. Prevailing State Assumed Interest Rates - Products Issued in Years After 1982 .* Schedule A STATUTORY VALUATION INTEREST RATES BASED ON THE 1980 AMENDMENTS TO THE NAIC STANDARD VALUATION LAW
A. Life insurance valuation:
Guarantee Duration
(years)
Calendar Year of Issue
2001
10 or fewer
5.00 **
More than 10
4.75 **
but not more than 20
More than 20
4.50 **
Source: Rates calculated from the monthly averages, ending June 30, 2000, of Moody's Corporate Bond Yield Average - Monthly
Average Corporates.
** As the applicable federal interest rate for 2001 of 6.00 percent exceeds this prevailing state assumed interest rate, the interest rate
to be used for this product under § 807 is 6.00 percent.
\* The terms used in the schedules in this ruling and in Part III of Rev. Rul. 92-19 are those used in the Standard Valuation Law; the
terms are defined in Rev. Rul. 92-19.
## Part III, Schedule B
# STATUTORY VALUATION INTEREST RATES BASED ON THE 1980 AMENDMENTS TO THE NAIC STANDARD VALUATION LAW
B. Single premium immediate annuities and annuity benefits involving life contingencies arising from other annuities with cash set-
tlement options and from guaranteed interest contracts with cash settlement options:
Calendar Year of Issue
Valuation Interest Rate
2000
7.00*
Source: Rates calculated from the monthly averages, ending June 30, 2000, of Moody's Corporate Bond Yield Average - Monthly
Average Corporates. The terms used in this schedule are those used in the Standard Valuation Law as defined in Rev. Rul. 92-19.
*As this prevailing state assumed interest exceeds the applicable federal interest rate for 2000 of 6.09 percent, the valuation interest
rate of 7.00 percent is to be used for this product under § 807.
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# Part III, Schedule C18 - 2000 STATUTORY VALUATION INTEREST RATES BASED ON NAIC STANDARD VALUATION LAW FOR 2000 CALENDAR YEAR BUSINESS GOVERNED BY THE 1980 AMENDMENTS
C. Valuation interest rates for other annuities and guaranteed interest contracts that are valued on an issue year basis:
Cash Settlement Options?
Future Interest Guarantee?
Guarantee Duration (years)
Valuation Interest Rate For Plan Type
A
B
C
Yes
Yes
5 or fewer
7.00
6.00*
5.50*
More than 5, but no more than 10
6.75
6.00*
5.50*
More than 10, but not more than 20
5.75*
5.25*
5.00*
More than 20
5.00*
4.50*
4.50*
Yes
No
5 or fewer
7.25
6.25
5.75*
More than 5, but not more than 10
7.00
6.25
5.75*
More than 10, but not more than 20
6.00*
5.50*
5.25*
More than 20
5.25*
4.75*
4.75*
No
Yes or No
5 or fewer
7.00
More than 5, but not
6.75
more than 10
NOT
APPLICABLE
More than 10, but not more than 20
6.25
More than 20
5.25*
Source: Rates calculated from the monthly averages, ending June 30, 2000, of Moody's Corporate Bond Yield Average - Monthly
Average Corporates.
*As the applicable federal interest rate for 2000 of 6.09 percent exceeds this prevailing state assumed interest rate, the interest rate
to be used for this product under § 807 is 6.09 percent.
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# Part III, Schedule D18 - 2000 STATUTORY VALUATION INTEREST RATES BASED ON NAIC STANDARD VALUATION LAW FOR 2000 CALENDAR YEAR BUSINESS GOVERNED BY THE 1980 AMENDMENTS
D. Valuation interest rates for other annuities and guaranteed interest contracts that are contracts with cash settlement options and
that are valued on a change in fund basis:
Cash Settlement Options?
Future Interest Guarantee?
Guarantee Duration (years)
Valuation Interest Rate For Plan Type
A
B
C
Yes
Yes
5 or fewer
7.75
7.25
5.75*
More than 5, but no more than 10
7.50
7.25
5.75*
More than 10, but not more than 20
7.00
6.75
5.50*
More than 20
6.00*
6.00*
5.00*
Yes
No
5 or fewer
8.00
7.50
6.00*
More than 5, but not more than 10
7.75
7.50
6.00*
More than 10, but not more than 20
7.25
7.00
5.75*
More than 20
6.25
6.25
5.25*
Source: Rates calculated from the monthly averages, ending June 30, 2000, of Moody's Corporate Bond Yield Average - Monthly
Average Corporates.
*As the applicable federal interest rate for 2000 of 6.09 percent exceeds this prevailing state assumed interest rate, the interest rate
to be used for this product under § 807 is 6.09 percent.
Part IV. Applicable Federal Interest Rates. TABLE OF APPLICABLE FEDERAL INTEREST RATES FOR PURPOSES OF § 807
Year
Interest Rate
2000
6.09
2001
6.00
Sources: Rev. Rul. 99-48, 1999-2 C.B. 600 for the 2000 rate and Rev. Rul. 2000-54, 2000-49 I.R.B. 566 for the 2001 rate.
## EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 92-19 is supplemented by the
addition to Part III of that ruling of pre-
vailing state assumed interest rates under
§ 807 for certain insurance products
issued in 2000 and 2001 and is further
supplemented by an addition to the table
in Part IV of Rev. Rul. 92-19 listing
applicable federal interest rates. Parts I
and II of Rev. Rul. 92-19 are not affected
by this ruling.
## DRAFTING INFORMATION
The principal author of this revenue
ruling is Ann H. Logan of the Office of
Assistant Chief Counsel (Financial
Institutions and Products). For further
information regarding this revenue ruling
contact her at (202) 622-3970 (not a toll-
free call).
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# Part III. Administrative, Procedural, and Miscellaneous
## Comments on Research Credit Regulations
### Notice 2001-19
On January 3, 2001, the Treasury
Department published final regulations
(T.D. 8930, 2001-5 I.R.B. 433) relating to
the computation of the research credit
under § 41(c) and the definition of quali-
fied research under § 41(d) in the Federal
Register (66 F.R. 280). These regulations
reflect changes to § 41 made by the Tax
Reform Act of 1986, the Revenue
Reconciliation Act of 1989, the Small
Business Job Protection Act of 1996, the
Taxpayer Relief Act of 1997, the Tax and
Trade Relief Extension Act of 1998, and
the Tax Relief Extension Act of 1999.
The Treasury Department and the
Internal Revenue Service will review
these final regulations. Comments are
requested on all aspects of the final regu-
lations with specific comments requested
on whether modifications should be made
to the documentation requirement con-
tained in § 1.41-4(d). As part of this
review, the Treasury Department and the
Service will reconsider all comments pre-
viously submitted in connection with the
finalization of T.D. 8930. Comments
should be submitted by April 2, 2001, and
sent to: CC:M&SP:RU (T.D. 8930),
room 5226, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Comments may
be hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to
CC:M&SP:RU (T.D. 8930), room 5226,
Internal Revenue Service, 1111
Constitution Avenue, NW., Washington,
DC 20044. 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/regsli
st.html. All submissions will be open to
public inspection.
Upon the completion of this review, the
Treasury Department and the Service will
announce changes to the regulations, if
any, in the form of proposed regulations.
In addition, T.D. 8930 will be revised so
that the provisions of the regulations,
including any changes to T.D. 8930, will
be effective no earlier than the date when
the completion of this review is
announced, except that the provisions
related to internal-use computer software
(including any revisions) generally will be
applicable for taxable years beginning
after December 31, 1985.
Taxpayers may continue to rely on T.D.
8930 during the pendency of this review.
For further information regarding this
notice, contact Lisa Shuman of the Office
of the Associate Chief Counsel
(Passthroughs and Special Industries) at
(202) 622-3120 (not a toll-free call).
26 CFR 601.204: Changes in accounting periods
and in methods of accounting.
(Also Part I, §§ 446, 472; 1.446-1, 1.472-1.)
## Rev. Proc. 2001-23
### SECTION 1. PURPOSE
This revenue procedure provides an
alternative last-in, first-out (LIFO) inven-
tory computation method (the Used
Vehicle Alternative LIFO Method) for
taxpayers that sell used automobiles or
used light-duty trucks ("used vehicle deal-
ers"). A used vehicle dealer may change
to or adopt the Used Vehicle Alternative
LIFO Method. Used vehicle dealers gen-
erally may obtain automatic consent to
change their method of accounting to the
Used Vehicle Alternative LIFO Method
by following the procedures in Rev. Proc.
99-49, 1999-2 C.B. 725, (or its succes-
sor) as modified by this revenue proce-
dure.
### SECTION 2. BACKGROUND
.01 Section 472(a) of the Internal
Revenue Code generally provides that
taxpayers may use the LIFO inventory
method if, among other requirements, the
change to, and use of, such method is in
accordance with such regulations as the
Secretary may prescribe as necessary in
order that the use of such method may
clearly reflect income.
.02 Section 472(b) and § 1.472-1(a) of
the Income Tax Regulations require tax-
payers using the LIFO inventory method
to treat goods remaining on hand at the
close of the taxable year as being: first,
those included in the opening inventory of
the taxable year, in the order of acquisi-
tion and to the extent thereof; and second,
those acquired during the taxable year.
Section 472(b) and § 1.472-2 require tax-
payers using the LIFO method to invento-
ry their goods at cost.
.03 Section 1.472-8(a) provides that
any taxpayer may elect to determine the
cost of its LIFO inventories under the
"dollar-value" LIFO method, provided
such method is used consistently and
clearly reflects the income of the taxpayer
in accordance with the rules of that sec-
tion.
.04 Section 1.472-8(e)(1) provides for
the use of a "link-chain" method of com-
puting the value of a dollar-value LIFO
pool if the taxpayer can demonstrate that
the use of either an index method or the
double-extension method would be
impractical or unsuitable in view of the
nature of inventory in the dollar-value
LIFO pool. Adequate records must be
maintained by the taxpayer to support the
appropriateness, accuracy, and reliability
of a link-chain method.
.05 Section 1.472-3(d) provides that
whether or not the taxpayer's application
for the adoption and use of the LIFO
inventory method should be approved,
and whether or not such method, once
adopted, may be continued, and the pro-
priety of all computations incidental to the
use of such method, will be determined by
the Commissioner in connection with the
examination of the taxpayer's income tax
returns.
.06 Section 446(e) and § 1.446-1(e)
(2)(i) provide that, except as otherwise
provided, a taxpayer must secure the con-
sent of the Commissioner before changing
a method of accounting for federal
income tax purposes. Section 1.446-1(e)
(3)(ii) authorizes the Commissioner to
prescribe administrative procedures set-
ting forth the terms and conditions
deemed necessary to permit a taxpayer to
obtain consent to change a method of
accounting in accordance with § 446(e).
### SECTION 3. SCOPE
The Used Vehicle Alternative LIFO
Method may be used to value LIFO
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inventories of used automobiles and used
light-duty trucks. For purposes of this
revenue procedure, used automobiles and
used light-duty trucks refer to previously
titled vehicles and do not include demon-
strator vehicles. Light-duty trucks, which
are also referred to as class 1, 2, or 3
trucks, are defined for purposes of this
revenue procedure as trucks with a gross
vehicle weight of 14,000 pounds or less.
## SECTION 4. THE USED VEHICLE ALTERNATIVE LIFO METHOD
.01 In general.
(1) The Used Vehicle Alternative
LIFO Method is a comprehensive link-
chain, dollar-value LIFO inventory
method encompassing several required
sub-methods and special rules that may
only be used to value LIFO inventories of
used automobiles and used light-duty
trucks. In general, a taxpayer using the
Used Vehicle Alternative LIFO Method
computes a dollar-value LIFO pool index
with reference to average base vehicle
prices reported in an official used vehicle
guide. This optional method of account-
ing for used vehicle inventories is
designed to simplify the dollar-value
LIFO computations of used vehicle deal-
ers.
(2) In the opinion of the
Commissioner, income will be clearly
reflected by utilization of the Used
Vehicle Alternative LIFO Method, pro-
vided that a taxpayer follows the sub-
methods and special rules described in
section 4.02 of this revenue procedure and
the computational methodology contained
in section 4.03. The Used Vehicle
Alternative LIFO Method includes, by
definition, all of its sub-methods.
(3) The Used Vehicle Alternative
LIFO Method will be accepted by the
Commissioner as an appropriate method
of computing a LIFO inventory index and
the use of that index to compute the value
of a dollar-value LIFO pool will be
accepted as accurate, reliable, and suit-
able. All computations under the Used
Vehicle Alternative LIFO Method, how-
ever, are subject to verification upon
examination of the used vehicle dealer's
income tax returns.
(4) A taxpayer that uses the Used
Vehicle Alternative LIFO Method for a
trade or business must use this method of
accounting to value the entire inventory of
used automobiles and used light-duty
trucks held by that trade or business. A
taxpayer also is required to file (or have
previously filed) an election to use the
LIFO inventory method, pursuant to the
requirements of § 1.472-3, that applies to
all of that inventory.
.02 Sub-methods and special rules.
(1) Use of base vehicle prices. In
general, indexes must be computed using
prices for base vehicles that best relate,
under the guidelines specified in this rev-
enue procedure, to the used vehicles actu-
ally held by the taxpayer. Base vehicle is
defined for purposes of this revenue pro-
cedure as the most relevant combination
of (a) a detailed base model description,
consisting of model line, body style, and
trim level (e.g., Honda Accord 4D Sedan
EX), and (b) an associated manufacturer's
base model code number that appears in
the official used vehicle guide utilized by
the taxpayer and relates to a used vehicle
held by the taxpayer.
(2) Use of official used vehicle
guides. For purposes of this revenue pro-
cedure, "official used vehicle guides" are
defined as those that (a) are widely recog-
nized and utilized in the used vehicle
dealer industry for business purposes in
the regions involved, and (b) are regularly
and consistently used by the taxpayer in
valuing inventory for federal income tax
purposes. Any change in the particular
used vehicle guide utilized by a taxpayer
in connection with the Used Vehicle
Alternative LIFO Method or any change
in the precise manner of its utilization
(e.g., a change in the specific guide cate-
gory that a taxpayer uses to represent
vehicles of average condition for purpos-
es of section 4.02(5)(a) of this revenue
procedure) represents a change in method
of accounting for which the taxpayer must
secure the consent of the Commissioner in
accordance with the requirements of Rev.
Proc. 97-27, 1997-1 C.B. 680 (or its suc-
cessor).
(3) LIFO pools. A taxpayer that uses
the Used Vehicle Alternative LIFO
Method must establish, for each trade or
business that sells used vehicles, a dollar-
value LIFO pool for all used automobiles
(regardless of manufacturer) and another
separate dollar-value LIFO pool for all
used light-duty trucks (regardless of man-
ufacturer). Used sport utility vehicles and
used hybrid vehicles (e.g., vans and mini-
vans) may be included initially in either
the used automobile or the used light-duty
truck dollar-value LIFO pool; however,
once a choice is made, all like vehicles
must be similarly treated in subsequent
years.
(4) Determination of the current-
year cost of vehicles in ending inventory.
Under the Used Vehicle Alternative LIFO
Method, the current-year cost of each
used vehicle in ending inventory must be
determined in accordance with this sec-
tion 4.02(4).
(a) Purchased vehicles. The cur-
rent-year cost for each used vehicle pur-
chased includes its purchase price plus
reconditioning costs, delivery charges,
and all other costs properly allocated to
that particular vehicle under the taxpay-
er's method of accounting (which
includes the taxpayer's method of
accounting for § 263A costs).
(b) Trade-in vehicles. The cur-
rent-year cost for each used vehicle
acquired via trade-in includes its "cost"
plus reconditioning costs and all other
costs properly allocated to that particular
vehicle under the taxpayer's method of
accounting (which includes the taxpayer's
method of accounting for § 263A costs).
The cost of a vehicle acquired via trade-in
must be determined by reference to the
wholesale price listing, as permitted by
Rev. Rul. 67-107, 1967-1 C.B. 115, in an
official used vehicle guide for a similarly
equipped, comparable base vehicle that
reflects the trade-in vehicle's actual
mileage and condition. The cost of a
trade-in vehicle also must include prices
reflected in the guide for installed options
and accessories, if any. The official used
vehicle guide from which prices are
drawn to determine the cost of a trade-in
vehicle must be the guide that covers the
day of acquisition of that specific vehicle.
(5) Inventory pool index guidelines.
(a) Computation of an inventory
pool index. For each inventory pool, cur-
rent-year and prior-year base vehicle
prices for each used vehicle in ending
inventory are totaled and the totals are
used to compute a current-year index for
the pool under the Used Vehicle
Alternative LIFO Method. These base
vehicle prices must be determined by ref-
erence to prices reported in an official
used vehicle guide for comparable base
vehicles of the same age and in average
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condition, unadjusted for options, acces-
sories, reconditioning costs, or other
costs. "Average condition" is defined for
purposes of this revenue procedure as the
category that best represents a vehicle in
average condition in the taxpayer's offi-
cial used vehicle guide. Thus, although
"average" prices would be used for guides
in which this category does appear, it
would be appropriate to select and use a
comparable category, e.g., "clean" prices,
in the case of other used vehicle guides in
which there is no average category.
Current-year indexes for each inventory
pool are then multiplied by prior-year
cumulative indexes for that pool to com-
pute a current-year cumulative index.
Once a current-year cumulative index is
computed for each inventory pool using
base vehicle prices, that index is then
applied to the total current-year cost (as
determined under section 4.02(4), includ-
ing options, accessories, reconditioning
costs, and other costs) of all vehicles in
the pool at the end of the taxable year in
order to determine whether an inventory
increment or decrement has occurred.
(b) Determination of comparable
base vehicle prices for index computa-
tions. Current-year base vehicle prices for
all vehicles in ending inventory must be
determined by reference to the official
used vehicle guide covering the last day
of the taxpayer's current taxable year for
the specific vehicles held in inventory.
Prior-year base vehicle prices for compa-
rable vehicles of the same age as those in
ending inventory must be determined by
reference to the official used vehicle
guide covering the last day of the taxpay-
er's preceding taxable year. (In the case
of a short taxable year, see section
4.02(5)(d) of this revenue procedure.) For
example, a calendar year 2000 taxpayer
that had a 1998 Vehicle X (a particular
model, body style and trim level) in end-
ing inventory would determine associated
base vehicle prices for its index computa-
tion as follows: the current-year base
vehicle price for this vehicle would be the
base price (without adjustment for any
options, accessories, reconditioning costs,
or other costs) for a 1998 Vehicle X in
average condition from the guide cover-
ing December 31, 2000; the associated
prior-year base vehicle price would be the
base price for a 1997 Vehicle X in average
condition (a comparable vehicle of the
same age) from the guide covering
December 31, 1999.
(c) Procedure when a prior-year
comparable base vehicle listing does not
exist. When no prior-year base vehicle
price for a comparable vehicle of the
same age as a vehicle in ending invento-
ry appears in the official used vehicle
guide covering the last day of the tax-
payer's preceding taxable year (e.g.,
Vehicle X was introduced for the first
time in the 1998 model year, and thus
there was no corresponding 1997 Vehicle
X), current-year base vehicle price must
be used as prior-year base vehicle price
in index computations. Current-year
base vehicle price must also be used as
prior-year base vehicle price in the event
that a change in wheelbase or track-
width from one year to the next has
occurred for a particular type of vehicle
without a corresponding change in the
relevant official used vehicle guide com-
bination of detailed base model descrip-
tion and associated manufacturer's base
model code number.
(d) Procedure in the case of a
short taxable year. Under the Used
Vehicle Alternative LIFO Method, all cur-
rent-year indexes must be adjusted in the
case of a short taxable year (i.e., a return
for a period of less than 12 months). This
adjustment involves adjusting the current-
year index, as computed on a full year
basis, as follows: current-year index for
short taxable year = 1 + [(current-year
index for full year - 1) x (number of
months in short year / 12)]. For example,
a calendar year taxpayer that went out of
existence on June 30, 2000, would use
official used vehicle guides covering
December 31, 1999, and December 31,
2000, in its index calculations to compute
a full year index for 2000 and then adjust
that index by the number of months actu-
ally contained in its short taxable year
(i.e., six months).
.03 Computational methodology. The
following methodology must be applied
to compute the value of each dollar-value
LIFO pool in a used vehicle dealer's end-
ing inventory under the Used Vehicle
Alternative LIFO Method:
STEP 1. Using an official used vehicle
guide, as defined in section 4.02(2) of this
revenue procedure, determine the detailed
base model description and associated
manufacturer's base model code number
combination that applies to each vehicle
in ending inventory.
STEP 2. Determine the current-year
cost of each vehicle in ending inventory in
accordance with section 4.02(4) of this
revenue procedure. Then, for each pool,
calculate the total current-year cost of all
vehicles in ending inventory.
STEP 3. For each vehicle in ending
inventory, using the related description
and code number from STEP 1, determine
current-year and prior-year base vehicle
price as indicated in section 4.02(5) of this
revenue procedure.
STEP 4. For each pool, calculate the
total current-year base vehicle price and
the total prior-year base vehicle price for
all vehicles in ending inventory by adding
the respective numbers from STEP 3.
Divide the total current-year base vehicle
price of all vehicles by the total prior-year
base vehicle price of all vehicles to deter-
mine the current-year pool index. In the
case of a short taxable year, adjust this
index as indicated in section 4.02(5)(d) of
this revenue procedure.
STEP 5. For each pool, compute the
cumulative index for the current taxable
year by multiplying the cumulative index
from the immediately preceding taxable
year by the current-year index from STEP
4. For the first taxable year in which the
Used Vehicle Alternative LIFO Method is
used, the cumulative index for the imme-
diately preceding taxable year is 1.00.
STEP 6. For each pool, calculate end-
ing inventory at base-year cost by divid-
ing total current-year cost from STEP 2 by
the cumulative index from STEP 5.
STEP 7. For each pool, determine
whether there is an inventory increment or
decrement by comparing ending invento-
ry at base-year cost for the current year
from STEP 6 to beginning inventory at
base-year cost (from STEP 6 of the prior-
year calculation), or, for the first taxable
year in which this method is used, to
beginning inventory (as determined under
section 5.02(3) of this revenue procedure,
if applicable). If ending inventory at
base-year cost is greater, there is an incre-
ment. Multiply this increment by the
cumulative index from STEP 5 to calcu-
late the LIFO value of the increment (i.e.,
the layer of increment). Alternatively, if
ending inventory at base-year cost is less
than beginning inventory at base-year
cost, a liquidation (also referred to as an
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inventory decrement) has occurred.
Reduce the prior-year LIFO layers of
increment in reverse chronological order
until the liquidation is fully absorbed.
STEP 8. For each pool, add together the
current year's layer of increment, if any, at
current-year cost and the remaining prior
years' layers of increment at each prior
year's historical current-year cost to com-
pute the total LIFO value of the inventory
pool.
## SECTION 5. CHANGING TO THE USED VEHICLE ALTERNATIVE LIFO METHOD
.01 In general. A change to the Used
Vehicle Alternative LIFO Method is a
change in method of accounting to which
the provisions of § 446 and the regula-
tions thereunder apply.
.02 Automatic change to the Used
Vehicle Alternative LIFO Method.
Except as provided in section 5.03(2) of
this revenue procedure (which applies
only to certain taxpayers that use the
Inventory Price Index Computation
(IPIC) method), a used vehicle dealer
that wants to change to the Used Vehicle
Alternative LIFO Method must follow
the automatic change in accounting
method provisions in Rev. Proc. 99-49
(or its successor), with the following
modifications:
(1) the scope limitations in section
4.02 of Rev. Proc. 99-49 do not apply,
provided the change is made for the first
or second taxable year ending on or after
December 31, 2000, unless the taxpayer's
method of valuing its LIFO inventories of
used automobiles or used light-duty
trucks is an issue pending within the
meaning of section 6.01(6) of Rev. Proc.
2000-38, 2000-40 I.R.B. 310. If the tax-
payer 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 Form
3115, Application for Change in
Accounting Method, to the examining
agent, appeals officer, or counsel for the
government, as appropriate, at the same
time that it files the copy of the Form
3115 with the national office;
(2) a change to the Used Vehicle
Alternative LIFO Method under the pro-
visions of Rev. Proc. 99-49 must be
effected on a cut-off method, which
requires that the value of the taxpayer's
used automobile and used light-duty
truck inventory at the beginning of the
year of change must be the same as the
value of that inventory at the end of the
preceding taxable year, plus cost restora-
tions, if any, required pursuant to section
5.04(5) of this revenue procedure.
However, if the taxpayer has previously
improperly accounted for a bulk bargain
purchase, the taxpayer, as part of a
change to the Used Vehicle Alternative
LIFO Method, must first change its
method of accounting to comply with
Hamilton Industries, Inc. v. Commis-
sioner, 97 T.C. 120 (1991), and compute
a § 481(a) adjustment for that part of the
change (see Announcement 91-173,
1991-47 I.R.B. 29);
(3) in effecting a change to the Used
Vehicle Alternative LIFO Method under
Rev. Proc. 99-49, any LIFO inventory
cost increments previously determined
and the value of those increments must be
retained. Instead of using the earliest tax-
able year for which the taxpayer adopted
LIFO as the base year, the year of change
must be used as the new base year in
determining the value of all existing LIFO
cost increments for the year of change and
later taxable years. (The cumulative index
at the beginning of the year of change will
be 1.00.) The base-year cost of all LIFO
cost increments at the beginning of the
year of change must be restated in terms
of new base-year costs, using the year of
change as the new base year, and the
indexes for previously determined inven-
tory increments must be recomputed
accordingly. The new base-year cost of a
pool is equal to the total current-year cost
of all the vehicles in the pool;
(4) when filing Form 3115, taxpayers
are reminded to complete all applicable
parts of the form, including Part I of
Schedule B, and, in lieu of the label
required by section 6.02(3) of Rev. Proc.
99-49, are instructed to write "Filed under
Rev. Proc. 2001-23" at the top of the
form; and,
(5) taxpayers must comply with the
additional conditions stated in section
5.04 of this revenue procedure.
.03 Procedure for IPIC taxpayers with
used vehicles as well as other goods in
inventory.
(1) Automatic change. A used vehi-
cle dealer using the IPIC method that also
has parts and accessories, new automo-
biles, or new light-duty trucks in invento-
ry may incorporate a change, using a cut-
off method, from IPIC to another accept-
able LIFO method for these other goods
into the change to the Used Vehicle
Alternative LIFO Method for used auto-
mobiles and used light-duty trucks made
pursuant to this revenue procedure under
the provisions of Rev. Proc. 99-49. When
changing from IPIC to a dollar-value
LIFO method for parts and accessories,
new automobiles, or new light-duty
trucks, a separate inventory pool must be
established for each of these types of
inventory.
(2) Nonautomatic change. A used
vehicle dealer that uses the IPIC method
and has in inventory goods other than
used automobiles, used light-duty trucks,
parts and accessories, new automobiles,
and new light-duty trucks must change to
the Used Vehicle Alternative LIFO
Method under the provisions of Rev. Proc.
97-27 (or its successor). When making
the change to the Used Vehicle
Alternative LIFO Method, the taxpayer
must (a) effect the change using the cut-
off method described in section 5.02(2) of
this revenue procedure, (b) use the year of
change as the new base year, with all
LIFO inventory cost increments previous-
ly determined and the value of those
increments retained, as described in sec-
tion 5.02(3) of this revenue procedure, (c)
attach to its Form 3115 a schedule setting
forth the classes of goods for which it had
elected to use the LIFO method and was
using IPIC, as well as the accounting
method changes that are being made for
each class of goods, and (d) comply with
the conditions stated in section 5.04 of
this revenue procedure.
.04 Conditions of change. A used vehi-
cle dealer that changes to the Used
Vehicle Alternative LIFO Method must
comply with the following conditions:
(1) the used vehicle dealer must
comply with the requirements incident to
the adoption and use of the LIFO invento-
ry method provided in § 1.472-2, includ-
ing the requirement to keep its books and
records for the year of change and for later
taxable years on the LIFO inventory
method and use the LIFO inventory
method for all reports, including consoli-
dated financial statements, if any, and
statements for credit purposes, in confor-
mity with the provisions of § 1.472-2(e);
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(2) the used vehicle dealer must
maintain and retain complete records of
index computations under the Used
Vehicle Alternative LIFO Method, includ-
ing relevant used vehicle guides, and
complete records of the current-year cost
of vehicles held in ending inventory for
each open year, including purchase
invoices for each vehicle purchased and
used vehicle guides used to cost trade-ins
consistent with the requirements of
§ 1.472-8(d);
(3) the used vehicle dealer must
combine and/or separate its dollar-value
LIFO pool(s) in accordance with
§ 1.472-8(g)(2) to conform with the pool-
ing requirements of section 4.02(3) of this
revenue procedure, including any pool(s)
resulting from section 5.04(4) of this rev-
enue procedure;
(4) the used vehicle dealer must con-
vert from a specific-goods LIFO method,
if applicable, to the Used Vehicle
Alternative LIFO Method in accordance
with § 1.472-8(f)(2); and,
(5) the used vehicle dealer must
elect to adopt or extend LIFO, and com-
ply with the cost restoration provisions
of § 472(d) and § 1.472-3 (see also Rev.
Rul. 76-282, 1976-2 C.B. 137), for any
used automobiles or used light-duty
trucks to which a LIFO election did not
previously apply but that are required to
be included in dollar-value LIFO pools
under the Used Vehicle Alternative LIFO
Method.
## SECTION 6. ELECTING LIFO AND ADOPTING THE USED VEHICLE ALTERNATIVE LIFO METHOD
.01 In general. If a used vehicle deal-
er is required to make an election to
adopt or extend LIFO in connection with
adoption of the Used Vehicle Alternative
LIFO Method, the used vehicle dealer
must complete and file a statement of
election of the LIFO inventory method
on Form 970, Application to Use LIFO
Inventory Method. The use of the Used
Vehicle Alternative LIFO Method should
be clearly indicated on the Form 970, or
in an attachment thereto, and a reference
should be made to this revenue proce-
dure.
.02 Conditions. (1) The five year limi-
tation on re-election of LIFO provided in
section 10.01(2) of the APPENDIX of
Rev. Proc. 99-49 will be waived for
affected taxpayers desiring to elect the
Used Vehicle Alternative LIFO Method
pursuant to this revenue procedure.
(2) A taxpayer electing LIFO and
adopting the Used Vehicle Alternative
LIFO Method must comply with the con-
ditions stated in section 5.04 of this rev-
enue procedure.
## SECTION 7. INQUIRIES
Inquiries regarding this revenue proce-
dure may be addressed to the
Commissioner of Internal Revenue,
Attention: CC:ITA:7, 1111 Constitution
Avenue, N.W., Washington, D.C. 20224.
## SECTION 8. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 99-49 is modified and
amplified to include this automatic
change in section 10 of the APPENDIX.
The APPENDIX of Rev. Proc. 99-49 is
modified to provide that the automatic
accounting method change provided in
section 10.02, which relates to a change in
the method of determining the cost of
used vehicles purchased or taken as a
trade-in, does not apply to taxpayers that
have adopted or changed to the Used
Vehicle Alternative LIFO Method.
## SECTION 9. EFFECTIVE DATE
This revenue procedure is effective for
taxable years ending on or after December
31, 2000.
## DRAFTING INFORMATION
The principal author of this revenue
procedure is Alan J. Tomsic of the Office
of Associate Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue procedure, contact
Mr. Tomsic at (202) 622-4970 (not a toll-
free call).
26 CFR 601.204: Changes in accounting periods
and in methods of accounting.
(Also Part 1 , §§ 446, 451, 481; 1.446-1, 1.451-1,
1.481-1, 1.481-4.)
Rev. Proc. 2001-24
SECTION 1. PURPOSE
This revenue procedure provides the
procedures by which an insurance compa-
ny ("Company") may obtain automatic
consent to change its method of account-
ing for cash advances on commissions
("cash advances") paid to its agents from
deducting a cash advance in the taxable
year paid to the agent to deducting a cash
advance in the taxable year earned by the
agent ("earned cash advance"). This rev-
enue procedure applies only to cash
advances that qualify as loans under this
revenue procedure.
## SECTION 2. BACKGROUND
.01 Change in method of accounting
defined. Section 1.446-1(e)(2)(ii)(a) of
the Income Tax Regulations provides that
a change in method of accounting
includes a change in the overall plan of
accounting for gross income or deduc-
tions, or a change in the treatment of any
material item. A material item is any item
that involves the proper time for the inclu-
sion of the item in income or the taking of
the item as a deduction.
.02 Securing permission to make a
method change. Sections 446(e) and
1.446-1(e) state that, except as otherwise
provided, a taxpayer must secure the con-
sent of the Commissioner before changing
a method of accounting for federal
income tax purposes. Section
1.446-1(e)(3)(i) requires that, in order to
obtain the Commissioner's consent to
change a method of accounting, a taxpay-
er must file a Form 3115, Application for
Change in Accounting Method, during the
taxable year in which the taxpayer wants
to make the proposed change. Rev. Proc.
99-49, 1999-2 C.B. 725 provides the pro-
cedures by which taxpayers may obtain
automatic consent to change certain spec-
ified methods of accounting by the filing
of a Form 3115 within the time specified
for the filing of a tax return for the year of
change.
.03 Terms and conditions of a method
change. Section 1.446-1(e)(3)(ii) autho-
rizes the Commissioner to prescribe
administrative procedures setting forth the
limitations, terms, and conditions deemed
necessary to permit a taxpayer to obtain
consent to change a method of accounting
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in accordance with §446(e). The terms
and conditions the Commissioner may
prescribe include the year of change,
whether the change is to be made with a
§481(a) adjustment or on a cut-off basis,
and the §481(a) adjustment period.
## SECTION 3. SCOPE
This revenue procedure applies to cash
advances paid by the Company to an
agent if (and only if) all four of the fol-
lowing conditions are met: (1) the agree-
ment between the Company and the agent
states that the cash advance is a "loan";
(2) the Company charges adequate inter-
est on the cash advance during the period
it is outstanding; (3) the agent is personal-
ly liable for the repayment of the cash
advance and payment of any accrued but
unpaid interest (that is, the Company's
source of repayment is not limited to the
agent's earned cash advances); and (4) the
Company treats the cash advance as a
loan for all federal tax purposes including
employment tax purposes.
## SECTION 4. CHANGE IN ACCOUNTING METHOD
.01 In general. Any change in a
Company's method of accounting pur-
suant to this revenue procedure is a
change in method of accounting to which
the provisions of §§446 and 481 and the
regulations thereunder apply.
.02 Automatic change for taxpayers
within the scope of this revenue proce-
dure. A Company changing its method of
accounting for cash advances meeting the
requirements of Section 3 for the first or
second taxable year beginning after
December 31, 1999 ("year of change")
pursuant to the provisions of this revenue
procedure must follow the automatic
change in accounting method provisions
of Rev. Proc. 99-49 (or its successor) with
the following modifications:
(1) To both copies of its Form 3115,
the Company must attach a statement that
complies with the provisions of Section
4.03 of this revenue procedure.
(2) The scope limitations in section
4.02 of Rev. Proc. 99-49 do not apply.
However, if the Company is under exam-
ination, before an appeals office, or before
a federal court regarding any income tax
issue, the Company must provide a copy
of the Form 3115 to the examining agent,
appeals officer, or counsel for the govern-
ment, as appropriate, at the same time that
it files the copy of the Form 3115 with the
National Office.
(3) This change is effected on a "cut-
off"' basis in the year of change, as specified
in section 2.06 of Rev. Proc. 99-49. Thus, a
§481(a) adjustment is neither required nor
permitted. If the Company previously
changed its method of accounting for cash
advances from "loans" to "earned cash
advances" and that change resulted in a
§481(a) adjustment that has not been fully
included in the Company's taxable income,
the Company must include the remaining
§481(a) adjustment in taxable income in the
year of change. Similarly, if the Company
previously changed its method of account-
ing for cash advances from "loans" to
"earned cash advances" and that change
resulted in a §481(a) adjustment that has not
been fully included in the agent's reported
income, the Company must include the
remaining §481(a) adjustment on the
agent's applicable Form 1099-MISC,
Miscellaneous Income, or Form W-2, Wage
and Tax Statement, for the year of change.
.03 Statement. The statement referred
to in section 4.02 of this revenue proce-
dure should be identified at the top as fol-
lows: "CHANGE IN METHOD OF
ACCOUNTING UNDER REV. PROC.
2001-24" The statement must include:
(1) a paragraph stating that the
Company is changing its method of account-
ing for cash advances that meet the require-
ments of section 3 of this Rev. Proc.
2001-24, effective for the year of change
and all subsequent tax years, from deducting
the cash advances in the taxable year paid to
an agent to deducting the cash advances in
the taxable year earned by the agent.
(2) a paragraph stating that for the
year of change and all subsequent years,
the Company will treat cash advances as
earned cash advances when the Company
incurs a liability to the agent arising from
the underlying transaction (e.g., when the
Company receives a premium payment
from the policy holder who purchased the
policy from the agent).
(3) a paragraph stating that for the
year of change and all subsequent years,
the Company will treat earned cash
advances as wages subject to federal
employment taxes in the case of an
employee agent or as compensation in the
case of an independent contractor agent.
For this purpose, earned cash advances do
not include commissions retained by the
Company to recoup cash advances (or
interest thereon) that were reported by the
Company as earned by the agent in a prior
calendar year under the Company's for-
mer method of accounting for cash
advances.
(4) a paragraph stating that the
Company agrees to all the terms and con-
ditions of this Rev. Proc. 2001-24 and
Rev. Proc. 99-49.
(5) the signature by, or on behalf of,
the Company making the election by an
individual with the authority to bind the
Company in these matters. Thus, an offi-
cer must sign on behalf of a corporation, a
general partner must sign on behalf of a
state law partnership, a member-manager
must sign on behalf of a limited liability
company, a trustee must sign on behalf of
a trust, and an individual must sign on
behalf of a sole proprietorship. If the
Company is a member of a consolidated
group, the statement submitted on behalf
of the Company must be signed by a duly
authorized officer of the common parent.
See section 6.02(4) of Rev. Proc. 99-49.
.04 Consent. Pursuant to
§1.446-1(e)(2)(i), the consent of the
Commissioner is hereby granted to any
Company within the scope of this revenue
procedure to change its method of
accounting for cash advances, provided
the Company complies with all the applic-
able provisions of this revenue procedure
and, to the extent applicable, Rev. Proc.
99-49. Further, agents of a Company
changing its method of accounting pur-
suant to this revenue procedure are grant-
ed consent to change their method of
accounting to report cash advances meet-
ing the requirements of Section 3 in the
year earned rather than in the year paid, so
long as their change in method of
accounting is consistent with the
Company's reporting. No separate filing
is required by an agent.
## SECTION 5. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 99-49 is modified and
amplified to include this automatic
change in section 5A of the APPENDIX.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective for
taxable years beginning after December
31, 1999.
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## SECTION 7. PAPERWORK REDUCTION ACT
The collection of information contained
in this revenue procedure has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545-1736.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
OMB control number.
The collection of information in this rev-
enue procedure is in section 4. This infor-
mation is required to notify the IRS that the
Company is changing its method of
accounting for cash advances that meet the
requirements of section 3 of this Rev. Proc.
2001-24 under the required terms and con-
ditions. This information will be used to
update the IRS's records. The collection of
information is required to obtain or retain
benefits. The likely respondents are busi-
ness or other for-profit institutions and
small businesses or organizations.
The estimated total annual reporting
burden is 1,318 hours.
The estimated annual burden per
respondent is 15 minutes.
The estimated number of respondents
5,270.
The estimated annual frequency of
responses is once.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
## DRAFTING INFORMATION
The principal author of this revenue
procedure is Leo F. Nolan II of the Office
of Associate Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue procedure, contact
Mr. Nolan at (202) 622-4960 (not a toll-
free call).
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## Part IV. Items of General Interest
### Model Amendment for Retirement Plans for Proposed Regulations Under Section 401(a)(9)
#### Announcement 2001-18
Proposed regulations under § 401(a)(9)
of the Internal Revenue Code, relating to
required minimum distributions from
retirement plans, were published in the
Federal Register on January 17, 2001 (the
2001 Proposed Regulations). The 2001
Proposed Regulations are proposed to be
effective for distributions for calendar
years beginning on or after January 1,
2002. The preamble to the 2001 Proposed
Regulations states that taxpayers may rely
on regulations under § 401(a)(9) that were
proposed in 1987 (the 1987 Proposed
Regulations) or on the 2001 Proposed
Regulations "[f]or determining required
minimum distributions for calendar year
2001." For this purpose, distributions for
calendar year 2001 do not include a distri-
bution that is required to be made by April
1, 2001, for calendar year 2000, such as
for an IRA owner or retired qualified plan
participant who attains age 70 1/2 in 2000.
To determine the amount of such a distri-
bution (as in the case of other distribu-
tions for calendar years prior to 2001),
taxpayers may rely on the 1987 Proposed
Regulations.
The preamble to the 2001 Proposed
Regulations contains a model amendment
for qualified plan sponsors to adopt if they
wish to follow the 2001 Proposed
Regulations in making distributions for
2001 and subsequent calendar years. The
first sentence of the model amendment, as
published in the Federal Register on
January 17, 2001, referred to distributions
made in calendar years beginning on or
after January 1, 2000, but was intended to
refer instead to distributions made for cal-
endar years beginning on or after
January 1, 2001. A correction notice is
being submitted to the Office of the
Federal Register. The 2001 Proposed
Regulations (REG-130477-00 and
REG-130481-00), as corrected, will be
published in Internal Revenue Bulletin
2001-11 dated March 12, 2001. The cor-
rect model amendment reads as follows:
Model Amendment
"With respect to distributions under the
Plan made for calendar years beginning
on or after January 1, 2001 (ALTERNA-
TIVELY, SPECIFY A LATER CALEN-
DAR YEAR FOR WHICH THE
AMENDMENT IS TO BE INITIALLY
EFFECTIVE), the Plan will apply the
minimum distribution requirements of
section 401(a)(9) of the Internal Revenue
Code in accordance with the regulations
under section 401(a)(9) that were pro-
posed on January 17, 2001, notwithstand-
ing any provision of the Plan to the con-
trary. This amendment shall continue in
effect until the end of the last calendar
year beginning before the effective date of
final regulations under section 401(a)(9)
or such other date as may be specified in
guidance published by the Internal
Revenue Service."
Qualified plan sponsors that wish to
follow the 2001 Proposed Regulations in
making distributions for 2001 and sub-
sequent calendar years should adopt the
corrected model amendment as set forth
above in lieu of the model amendment as
published in the preamble to the 2001
Proposed Regulations in the Federal
Register on January 17, 2001. A plan
sponsor that adopted the model amend-
ment as published in the Federal
Register on January 17, 2001, should
amend its plan to substitute the correct-
ed model amendment set forth above for
the model amendment that was previ-
ously adopted.
### CPI Adjustment for Below- Market Loans for 2001; Correction
### Announcement 2001-19
As published, Rev. Rul. 2000-56,
2000-52 I.R.B. 597, which lists the infla-
tion-adjusted amounts that a taxpayer
may lend to a qualified continuing care
facility without incurring imputed inter-
est
under
§ 7872(g) of the Internal Revenue Code
for years 1987- 2001, contained a numer-
ical error. Table 1 of Rev. Rul. 2000-56
incorrectly lists the year 2001 inflation-
adjusted limit under § 7872(g)(2) as
$144,111. Section 7872(g)(5)(A) of the
Code requires any increase in the dollar
amount of this inflation adjustment to be
rounded to the nearest multiple of $100.
Accordingly, the corrected year 2001
inflation-adjusted limit under § 7872
(g)(2) contained in Table 1 of Rev. Rul.
2000-56 is $144,100.
The principal author of this announce-
ment is Courtney Shepardson of the
Office of Associate Chief Counsel
(Financial Institutions and Products). For
further information regarding this
announcement, contact Ms. Shepardson at
(202) 622-3940 (not a toll-free call).
# New Simplified Rules for Minimum Required Distributions
## Announcement 2001-23
The Service announces supplements to
Publication 575, Pension and Annuity
Income, and Publication 590, Individual
Retirement Arrangements, that take
into account proposed regulations
(REG-130477-00; REG-130481-00)
substantially simplifying the calculation
of minimum required distributions from
qualified plans, IRAs, and other related
retirement savings vehicles.
## Supplement to Publication 575, Pension and Annuity Income
## New Simplified Rules for Minimum Required Distributions
After Publication 575 was printed, the
IRS issued new rules that simplify how
minimum required distributions will be
figured after 2001. For 2001, the mini-
mum required distribution can be figured
using either these new rules or the old
rules explained in Publication 575,
Pension and Annuity Income. For most
people, the new simplified rules will
result in lower minimum required distrib-
utions.
If you are age 70 1/2 or older and par-
ticipate in a qualified retirement plan or if
you are the beneficiary of such a plan, you
may be subject to an additional tax if the
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amount distributed annually by the plan is
less than the minimum required distribu-
tion for the year. This additional tax
applies to distributions from qualified
employee plans, qualified employee
annuity plans, section 457 deferred com-
pensation plans, tax-sheltered annuity
plans, and individual retirement arrange-
ments (IRAs). The additional tax is dis-
cussed in Publication 575 beginning on
page 30.
If your required beginning date is April
1, 2001 (either because you attained age
70 1/2 or retired in 2000), and you are tak-
ing your minimum required distribution
for 2000 by April 1, 2001, do not use the
new rules for figuring the distribution for
2000. Instead, use the old rules in
Publication 575. Use the new rules for fig-
uring the required distribution for 2001
that must be made by the end of 2001.
For detailed information about the new
rules, see the proposed regulations pub-
lished in the Federal Register on January
17, 2001, 66 F.R. 3928, and Announce-
ment 2001-18 in this Bulletin. The cor-
rected version of the proposed regulations
will be in Internal Revenue Bulletin
2001-11 dated March 12, 2001.
Distributions during the employee's life-
time. Under the new rules, minimum
required distributions during your lifetime
are based on a distribution period that can
be determined using a single table and your
age. The distribution period is not affected
by your beneficiary's age unless your sole
beneficiary is your spouse who is more
than 10 years younger than you are. In that
case you can use a different table.
To figure the minimum required distri-
bution for 2001, divide your account bal-
ance at the end of 2000 by the distribution
period from the table. You can use the
tables in Publication 590, Individual
Retirement Arrangements (IRAs), to
determine the distribution period. This is
the "applicable divisor" listed next to your
age (as of your birthday in 2001) in the
Table for Determining Applicable Divisor
for MDIB (Minimum Distribution
Incidental Benefit) on page 80 of
Publication 590, unless your sole benefi-
ciary is your spouse who is more than 10
years younger than you are. In that case,
use the number at the intersection of the
ages of you and your spouse (as of your
birthdays in 2001) in Table II (Joint and
Last Survivor Expectancy) beginning on
page 76 of Publication 590. These rules
also apply for figuring the minimum
required distribution for 2001 for an
employee who dies in 2001 after his or
her required beginning date.
Distributions after the employee's
death. Under the new rules, if the desig-
nated beneficiary of the employee is an
individual, such as the employee's spouse
or child, minimum required distributions
for years after the year of the employee's
death are generally based on a distribution
period that can be determined using the
beneficiary's single life expectancy. This
rule applies whether or not the death
occurred before the employee's required
beginning date. If the employee's benefi-
ciary is not an individual (for example, if
the beneficiary is the employee's estate),
the rule for determining minimum
required distributions for years after the
employee's death depends on whether or
not the death occurred before the employ-
ee's required beginning date.
If the employee's designated benefi-
ciary is an individual. To figure the mini-
mum required distribution for 2001,
divide the account balance at the end of
2000 by the distribution period. You can
use Table I (Single Life Expectancy) in
Publication 590 to determine the distribu-
tion period, as follows.
· Spouse as sole designated beneficiary.
The distribution period is the divisor list-
ed in the table next to the spouse's age
(as of the spouse's birthday in 2001). If
the employee died before the year in
which he or she attained age 70 1/2, dis-
tributions to the spouse need not begin
until the year in which the employee
would have attained age 70 1/2.
· Other designated beneficiary. The distri-
bution period is the divisor listed in the
table next to the beneficiary's age (as of
his or her birthday in the year following
the year of the employee's death), reduced
by one for each elapsed year since the
year following the employee's death.
If the employee's designated benefi-
ciary is not an individual. Determine the
minimum required distribution for 2001
as follows.
· Death on or after the required begin-
ning date. Divide the account balance
at the end of 2000 by the distribution
period from Table I (Single Life
Expectancy) on page 75 of Publication
590\. The distribution period is the divi-
sor listed next to the employee's age (as
of his or her birthday in the year of
death), reduced by one for each elapsed
year since the year of death.
· Death before the required beginning
date. The 5-year rule continues to apply.
Under this rule, the entire account must
be distributed by the end of the fifth
year following the year of the employ-
ee's death. No distribution is required
for a year before that fifth year. This
rule may also be elected by a beneficia-
ry who is an individual.
Supplement to Publication 590,
Individual Retirement Arrangements
(IRAs)
## New Simplified Rules for Minimum Required Distributions
After Publication 590 was printed, the
IRS issued new rules that simplify how
minimum required distributions will be fig-
ured after 2001. For 2001, you can figure
the minimum required distribution using
either these new rules or the old rules
explained in Publication 590, Individual
Retirement Arrangements (IRAs). For most
people, the new simplified rules will result
in lower minimum required distributions.
If you are age 70 1/2 or older and own a
traditional IRA or if you are the beneficiary
of an IRA, you may be subject to an addi-
tional tax if you do not take annual distribu-
tions from the IRA of at least the minimum
required distribution for the year. This is dis-
cussed in Publication 590 beginning on
page 21, under When Must I Withdraw IRA
Assets? (Required Distributions).
If you attained age 70 1/2 in 2000 and
are taking your minimum required distrib-
ution for 2000 by April 1, 2001, do not use
the new rules for figuring the distribution
for 2000. Instead, use the old rules in
Publication 590. Use the new rules for fig-
uring the required distribution for 2001
that must be made by the end of 2001.
For detailed information about the new
rules, see the proposed regulations pub-
lished in the Federal Register on January
17, 2001, 66 F.R. 3928, and Announce-
ment 2001-18 in this Bulletin. The cor-
rected version of the proposed regulations
will be in Internal Revenue Bulletin
2001-11 dated March 12, 2001.
Distributions during the owner's life-
time. Under the new rules, minimum
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required distributions during your lifetime
are based on a distribution period that can
be determined using a single table and your
age. The distribution period is not affected
by your beneficiary's age unless your sole
beneficiary is your spouse who is more
than 10 years younger than you are. In that
case, you can use a different table.
To figure the minimum required distrib-
ution for 2001, divide your account balance
at the end of 2000 by the distribution peri-
od from the table. This is the "applicable
divisor" listed next to your age (as of your
birthday in 2001) in the Table for
Determining Applicable Divisor for MDIB
(Minimum Distribution Incidental Benefit)
on page 80 of Publication 590, unless your
sole beneficiary is your spouse who is more
than 10 years younger than you are. In that
case, use the number at the intersection of
the ages of you and your spouse (as of your
birthdays in 2001) in Table II (Joint and
Last Survivor Expectancy) beginning on
page 76 of Publication 590. These rules also
apply for figuring the minimum required
distribution for 2001 for an owner who dies
in 2001 after his or her required beginning
date.
Distributions after the owner's death.
Under the new rules, if the designated
beneficiary of the owner is an individual,
such as the owner's spouse or child, min-
imum required distributions for years
after the year of the owner's death gener-
ally are based on a distribution period that
can be determined using the beneficiary's
single life expectancy. This rule applies
whether or not the death occurred before
the owner's required beginning date. If
the owner's beneficiary is not an individ-
ual (for example, if the beneficiary is the
owner's estate), the rule for determining
minimum required distributions for years
after the owner's death depends on
whether or not the death occurred before
the owner's required beginning date.
If the owner's designated beneficiary
is an individual. To figure the minimum
required distribution for 2001, divide the
account balance at the end of 2000 by the
distribution period from Table I (Single
Life Expectancy) on page 75 of
Publication 590. Determine the distribu-
tion period as follows.
· Spouse as sole designated beneficiary.
The distribution period is the divisor
listed in the table next to the spouse's
age (as of the spouse's birthday in
2001). If the owner died before the year
in which he or she attained age 70 1/2,
distributions to the spouse need not
begin until the year in which the owner
would have attained age 70 1/2.
· Other designated beneficiary. The dis-
tribution period is the divisor listed in the
table next to the beneficiary's age (as of
his or her birthday in the year following
the year of the owner's death), reduced
by one for each elapsed year since the
year following the owner's death.
If the owner's beneficiary is not an
individual. Determine the minimum
required distribution for 2001 as follows.
· Death on or after the required begin-
ning date. Divide the account balance
at the end of 2000 by the distribution
period from Table I (Single Life
Expectancy) on page 75 of Publication
590. The distribution period is the divi-
sor listed next to the owner's age (as of
his or her birthday in the year of death),
reduced by one for each elapsed year
since the year of death.
· Death before the required beginning
date. The 5-year rule continues to apply.
Under this rule, the entire account must
be distributed by the end of the fifth
year following the year of the owner's
death. No distribution is required for a
year before that fifth year. This rule
may also be elected by a beneficiary
who is an individual.
## Election to Treat Trust as Part of an Estate; Hearing
### Announcement 2001-24
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Change of date of public hear-
ing; extension of time to submit outlines
of oral comments.
SUMMARY: This document changes the
date of the public hearing on the proposed
regulations (REG-106542-98, 2001-5
I.R.B. 473) that relate to an election to
have certain revocable trusts treated and
taxed as part of an estate. It also extends
the time to submit outlines of oral com-
ments for the hearing.
DATES: The public hearing will be held
April 11, 2001, beginning at 10 a.m.
Additional outlines of oral comments
must be received by March 21, 2001.
ADDRESSES: The public hearing will be
held in the Auditorium, Internal Revenue
Building, 1111 Constitution Avenue, NW.,
Washington, DC. Send submissions to:
Regulations Unit CC (REG-106542-98),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions
may be hand delivered between the hours
of 8 a.m. and 5 p.m. to: Regulations Unit
CC (REG-106542-98), Courier's Desk,
Internal Revenue Service, 1111
Constitution Avenue NW., Washington
DC. Alternatively, taxpayers may submit
outlines of oral comments electronically
directly to the IRS Internet site at
http://www.irs.gov/tax_regs/reglist.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Faith
Colson, (202) 622-3060; concerning sub-
missions, LaNita Van Dyke, (202) 622-
7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
## Background
A notice of proposed rulemaking and
notice of public hearing, appearing in the
Federal Register on Monday, December
18, 2000 (65 F.R. 79015), announced that
a public hearing on the proposed regula-
tions relating to an election to have certain
revocable trusts treated and taxed as part
of an estate would be held on February 21,
2001, in the IRS Auditorium, Internal
Revenue Building 1111 Constitution
Avenue, NW., Washington, DC.
Subsequently, the date of the public hear-
ing has changed to April 11, 2001, at 10
a.m. in the IRS Auditorium. Outlines of
oral comments must be received by
March 21, 2001.
Cynthia Grigsby,
Chief, Regulations Unit,
Office of Special Counsel
(Modernization & Strategic Planning).
(Filed by the Office of the Federal Register on Feb-
ruary 7, 2001, 8:45 a.m., and published in the issue
of the Federal Register for February 8, 2001, 66 F.R.
9535)
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# Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as "rulings")
that have an effect on previous rulings
use the following defined terms to de-
scribe the effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguished describes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it ap-
# Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A-Individual.
Acq .- Acquiescence.
B-Individual.
BE-Beneficiary.
BK-Bank.
B.T.A .- Board of Tax Appeals.
C-Individual.
C.B .- Cumulative Bulletin.
CFR-Code of Federal Regulations.
CI-City.
GE-Grantee.
COOP-Cooperative.
GP-General Partner.
Ct.D .- Court Decision.
GR-Grantor.
TFE-Transferee.
TFR-Transferor.
T.I.R .- Technical Information Release.
TP-Taxpayer.
TR-Trust.
TT-Trustee.
U.S.C .- United States Code.
E-Estate.
EE-Employee.
plies to both A and B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
P-Parent Corporation.
PHC-Personal Holding Company.
PO-Possession of the U.S.
PR-Partner.
PRS-Partnership.
PTE-Prohibited Transaction Exemption.
Pub. L .- Public Law.
REIT-Real Estate Investment Trust.
Rev. Proc .- Revenue Procedure.
Rev. Rul .- Revenue Ruling.
S-Subsidiary.
S.P.R .- Statements of Procedural Rules.
Stat .- Statutes at Large.
T-Target Corporation.
T.C .- Tax Court.
T.D .- Treasury Decision.
CY-County.
D-Decedent.
DC-Dummy Corporation.
DE-Donee.
Del. Order-Delegation Order.
DISC-Domestic International Sales Corporation.
DR-Donor.
M-Minor.
Nonacq .- Nonacquiescence.
X-Corporation.
O-Organization.
Y-Corporation.
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E.O .- Executive Order.
ER-Employer.
ERISA-Employee Retirement Income Security
Act.
EX-Executor.
F-Fiduciary.
FC-Foreign Country.
FICA-Federal Insurance Contributions Act.
FISC-Foreign International Sales Company.
FPH-Foreign Personal Holding Company.
F.R .- Federal Register.
FUTA-Federal Unemployment Tax Act.
FX-Foreign Corporation.
G.C.M .- Chief Counsel's Memorandum.
IC-Insurance Company.
I.R.B .- Internal Revenue Bulletin.
LE-Lessee.
LP-Limited Partner.
LR-Lessor.
<!-- PageBreak -->
## Numerical Finding List1
Bulletins 2001-1 through 2001-9
Announcements:
2001-1, 2001-2 I.R.B. 277
2001-2, 2001-2 I.R.B. 277
2001-3, 2001-2 I.R.B. 278
2001-4, 2001-2 I.R.B. 286
2001-5, 2001-2 I.R.B. 286
2001-6, 2001-3 I.R.B. 357
2001-7, 2001-3 I.R.B. 357
2001-8, 2001-3 I.R.B. 357
2001-9, 2001-3 I.R.B. 357
2001-10, 2001-4 I.R.B. 431
2001-11, 2001-4 I.R.B. 432
2001-12, 2001-6 I.R.B. 526
2001-13, 2001-9 I.R.B. 752
2001-14, 2001-7 I.R.B. 648
2001-15, 2001-8 I.R.B. 715
2001-16, 2001-8 I.R.B. 715
2001-17, 2001-8 I.R.B. 716
2001-20, 2001-8 I.R.B. 716
2001-21, 2001-9 I.R.B. 752
### Notices:
2001-1, 2001-2 I.R.B. 261
2001-2, 2001-2 I.R.B. 265
2001-3, 2001-2 I.R.B. 267
2001-4, 2001-2 I.R.B. 267
2001-5, 2001-3 I.R.B. 327
2001-6, 2001-3 I.R.B. 327
2001-7, 2001-4 I.R.B. 374
2001-8, 2001-4 I.R.B. 374
2001-9, 2001-4 I.R.B. 375
2001-10, 2001-5 I.R.B. 459
2001-11, 2001-5 I.R.B. 464
2001-12, 2001-3 I.R.B. 328
2001-13, 2001-6 I.R.B. 514
2001-14, 2001-6 I.R.B. 516
2001-15, 2001-7 I.R.B. 589
2001-16, 2001-9 I.R.B. 730
2001-17, 2001-9 I.R.B. 730
2001-18, 2001-9 I.R.B. 731
### Proposed Regulations:
REG-209461-79, 2001-8, I.R.B. 712
REG-246256-96, 2001-8, I.R.B. 713
REG-251701-96, 2001-4, I.R.B. 396
REG-106542-98, 2001-5, I.R.B. 473
REG-121928-98, 2001-6, I.R.B. 520
REG-103320-00, 2001-8, I.R.B. 714
REG-104683-00, 2001-4, I.R.B. 407
REG-106702-00, 2001-4, I.R.B. 424
REG-106791-00, 2001-6, I.R.B. 521
REG-107176-00, 2001-4, I.R.B. 428
REG-107566-00, 2001-3, I.R.B. 346
REG-114082-00, 2001-7, I.R.B. 629
REG-114083-00, 2001-7, I.R.B. 630
REG-114084-00, 2001-7, I.R.B. 633
REG-116468-00, 2001-6, I.R.B. 522
REG-119352-00, 2001-6, I.R.B. 525
### Railroad Retirement Quarterly Rates:
2001-2, I.R.B. 258
Revenue Procedures:
2001-1, 2001-1 I.R.B. 1
2001-2, 2001-1 I.R.B. 79
2001-3, 2001-1 I.R.B. 111
2001-4, 2001-1 I.R.B. 121
2001-5, 2001-1 I.R.B. 164
2001-6, 2001-1 I.R.B. 194
2001-7, 2001-1 I.R.B. 236
2001-8, 2001-1 I.R.B. 239
2001-9, 2001-3 I.R.B. 328
2001-10, 2001-2 I.R.B. 272
2001-11, 2001-2 I.R.B. 275
2001-12, 2001-3 I.R.B. 335
2001-13, 2001-3 I.R.B. 337
2001-14, 2001-3 I.R.B. 343
2001-15, 2001-5 I.R.B. 465
2001-16, 2001-4 I.R.B. 376
2001-17, 2001-7 I.R.B. 589
2001-18, 2001-8 I.R.B. 708
2001-19, 2001-9 I.R.B. 732
2001-20, 2001-9 I.R.B. 738
2001-21, 2001-9 I.R.B. 742
2001-22, 2001-9 I.R.B. 745
### Revenue Rulings:
2001-1, 2001-9 I.R.B. 726
2001-2, 2001-2 I.R.B. 255
2001-3, 2001-3 I.R.B. 319
2001-4, 2001-3 I.R.B. 295
2001-5, 2001-5 I.R.B. 451
2001-6, 2001-6 I.R.B. 491
2001-7, 2001-7 I.R.B. 541
2001-8, 2001-9 I.R.B. 726
2001-9, 2001-8 I.R.B. 652
### Treasury Decisions:
8910, 2001-2 I.R.B. 258
8911, 2001-3 I.R.B. 321
8912, 2001-5 I.R.B. 452
8913, 2001-3 I.R.B. 300
8914, 2001-8 I.R.B. 653
8915, 2001-4 I.R.B. 359
8916, 2001-4 I.R.B. 360
8917, 2001-7 I.R.B. 538
8918, 2001-4 I.R.B. 372
8919, 2001-6 I.R.B. 505
8920, 2001-8 I.R.B. 654
8921, 2001-7 I.R.B. 532
8922, 2001-6 I.R.B. 508
8923, 2001-6 I.R.B. 485
8924, 2001-6 I.R.B. 489
8925, 2001-6 I.R.B. 496
8926, 2001-6 I.R.B. 492
8928, 2001-8 I.R.B. 685
8930, 2001-5 I.R.B. 433
8931, 2001-7 I.R.B. 542
8935, 2001-8 I.R.B. 702
8936, 2001-9 I.R.B. 720
1 A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2000-27 through
2000-52 is in Internal Revenue Bulletin 2001-1,
dated January 2, 2001.
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Finding List of Current Actions on Previously Published Items1
Revenue Procedures-continued: 99-18 Modified and superseded by
Treasury Decisions: 8889 Corrected by
Bulletins 2001-1 through 2001-9
Rev. Proc. 2001-21, 2001-9 I.R.B. 742 99-47
Ann. 2001-14, 2001-2 I.R.B. 286
Announcement:
Superseded by
98-99
Rev. Proc. 2001-16, 2001-4 I.R.B. 376
Modified by
99-49
Ann. 2001-9, 2001-3 I.R.B. 357
Modified and amplified by
99-79
Rev. Proc. 2001-10, 2001-2 I.R.B. 272
Superseded by
Rev. Rul. 2001-8, 2001-9 I.R.B. 762
Ann. 2001-3, 2001-2 I.R.B. 278
2000-1
2000-97
Superseded by
Corrected by
Rev. Proc. 2001-1, 2001-1 I.R.B. 1
Ann. 2001-7, 2001-3 I.R.B. 357
2000-2
Cumulative Bulletin:
Superseded by
1998-2
Rev. Proc. 2001-2, 2001-1 I.R.B. 79
Corrected by
2000-3
Ann. 2001-5, 2001-2 I.R.B. 286
Superseded by
Rev. Proc. 2001-3, 2001-1 I.R.B. 111
Notices:
2000-4
98-39
Superseded by
Modified by
Rev. Proc. 2001-4, 2001-1 I.R.B. 121
Notice 2001-9, 2001-4 I.R.B. 375
2000-5
98-40
Superseded by
Modified by
Rev. Proc. 2001-5, 2001-1 I.R.B. 164
Notice 2001-9, 2001-4 I.R.B. 375
2000-6
99-53
Superseded by
Modified and superseded by
Rev. Proc. 2001-6, 2001-1 I.R.B. 194
Notice 2001-7, 2001-4 I.R.B. 374
2000-7
2000-21
Superseded by
Superseded by
Rev. Proc. 2001-7, 2001-1 I.R.B. 236
Notice 2001-1, 2001-2 I.R.B. 261
2000-8
2000-22
Superseded by
Modified and superseded by
Rev. Proc. 2001-8, 2001-1 I.R.B. 239
Notice 2001-8, 2001-4 I.R.B. 374
2000-16
2000-43
Modified and superseded by
Extended by
Rev. Proc. 2001-17, 2001-7 I.R.B. 589
Notice 2001-13, 2001-6 I.R.B. 514
2000-22
Proposed Regulations:
Modified and superseded by Rev. Proc. 2001-10, 2001-2 I.R.B. 272
EE-130-86
Partially withdrawn by
2001-13
REG-209461-79, 2001-8 I.R.B. 712
Clarified by Notice 2001-12, 2001-3 I.R.B. 328
REG-116733-98
Withdrawn by
Revenue Rulings:
Ann. 2001-11, 2001-4 I.R.B. 432
64-328
Revenue Procedures:
Modified by Notice 2001-10, 2001-5 I.R.B. 459
83-87
Superseded by
66-110
Rev. Proc. 2001-15, 2001-5 I.R.B. 465 90-18
Modified by Notice 2001-10, 2001-5 I.R.B. 459
Amplified and superseded by
85-30
Rev. Proc. 2001-18, 2001-8 I.R.B. 708 92-19
Clarified by Rev. Rul. 2001-8, 2001-9 I.R.B. 762
Superseded by
88-95
Rev. Proc. 2001-15, 2001-5 I.R.B. 465
Clarified by Rev. Rul. 2001-8, 2001-9 I.R.B. 762
96-17
Modified by
Rev. Proc. 2001-9, 2001-3 I.R.B. 328
1 A cumulative list of current actions on previously
published items in Internal Revenue Bulletins
2000-27 through 2000-52 is in Internal Revenue
Bulletin 2001-1, dated January 2, 2001.
<!-- PageFooter="March 5, 2001" -->
<!-- PageFooter="2001-10 I.R.B." -->
<!-- PageBreak -->
# INDEX Internal Revenue Bulletins 2001-1 through 2001-9
The abbreviation and number in paren-
thesis following the index entry refer to
the specific item; numbers in roman and
italic type following the paranthesis
refer to the Internal Revenue Bulletin in
which the item may be found and the
page number on which it appears.
Key to Abbreviations:
Ann
CD
Announcement
Court Decision
DO
Delegation Order
EO
Executive Order
PL
Public Law
PTE
Prohibited Transaction
Exemption
RP
RR
Revenue Procedure
Revenue Ruling
SPR
Statement of Procedural
Rules
TC
Tax Convention
TD
Treasury Decision
TDO
Treasury Department Order
## EMPLOYEE PLANS
Advance letter rulings and determination
letters, areas which will not be issued
from:
Associates Chief Counsel & Division
Counsel/Associate Chief Counsel
(TE/GE) (RP 3) 1, 111
Associate Chief Counsel International
(RP 7) 1, 236
Cafeteria plans, tax treatment of (TD
8921) 7, 532; (REG-209461-79) 8,
712
Defined benefit pension plan, transfer of
excess assets (REG-116468-00) 6, 522
Determination letters, issuing procedures
(RP 6) 1, 194
Employee Plans Compliance Resolution
System (EPCRS), update (RP 2001-17)
7,589
Employee stock ownership plans,
deductibility of redemption proceeds
(RR 6) 6, 491
Full funding limitations:
Weighted average interest rate for:
December 2000 (Notice 3) 2, 267
January 2001 (Notice 15) 7, 589
# EMPLOYEE PLANS- Cont.
Group health plans:
Continuation coverage requirements
(TD 8928) 8, 685
HIPAA nondiscrimination:
Bona fide wellness programs
(REG-114084-00) 7, 633
Certain grandfathered church plans,
exception (REG-114083-00) 7, 630
Eligibility not limited by certain
health factors (TD 8931) 7, 452;
(REG-114082-00) 7, 629
GUST remedial amendment period, M&P
plans and volume submitter plans (Ann
12) 6, 526
Letter rulings:
Determination letters, and information
letters issued by Associates Chief
Counsel (RP 1) 1, 1
Information letters, etc. (RP 4) 1, 121
Life insurance contracts, "split-dollar"
arrangements (Notice 10) 5, 459
Nondiscrimination rules, governmental
and church plans, relief from (Notice 9)
4,375
Proposed Regulations:
26 CFR 1.125-1 Q&A-8, amended;
1.125-2 Q&A-6(a), amended;
1.125-2 Q&A-6(b), (c), and (d), with-
drawn; 1.125-2 Q&A-6(e), redignat-
ed as (b); tax treatment of cafeteria
plans (REG-209461-79) 8, 712
26 CFR 1.420-1, added; defined bene-
fit pension plan, transfer of excess
assets (REG-116468-00) 6, 522
26 CFR 54.9802-1, amended; group
health plans, HIPAA nondiscrimina-
tion requirements, eligibility not lim-
ited by certain health factors
(REG-114082-00) 7, 629
26 CFR 54.9802-1(f), amended; group
health plans, HIPAA nondiscrimina-
tion requirements, bona fide well-
ness programs (REG-114084-00) 7,
633
26 CFR 54.9802-2, added; group
health plans, HIPAA nondiscrimina-
tion requirements for certain grand-
fathered church plans, exception
(REG-114083-00) 7, 630
Regulations:
26 CFR 1.125-4, amended; 1.125-4T,
removed; tax treatment of cafeteria
plans (TD 8921) 7, 532
# EMPLOYEE PLANS- Cont.
26 CFR 54.4980B-0 through -8,
amended; 54.4980B-9, -10, added;
group health plans, continuation
coverage requirements (TD 8928) 8,
685
26 CFR 54.9802-1, added; 54.9802-1T,
removed; group health plans, HIPAA
nondiscrimination requirements, eli-
gibility not limited by certain health
factors (TD 8931) 7, 452
Technical advice to:
Directors and chiefs, appeals offices,
from Associates Chief Counsel
& Division Counsel/Associate
Chief Counsel (TE/GE) (RP 2) 1,
79
IRS employees (RP 5) 1, 164
User fees, request for letter rulings (RP 8)
1, 239
# EMPLOYMENT TAX
Electronic filing, Form 940 (RP 9) 3, 328
Forms:
940, electronic filing (RP 9) 3, 328
W-2, new code (Ann 7) 3, 357
Indian tribal governments under FUTA,
treatment of (Ann 16) 8, 715
Proposed Regulations:
26 CFR 31.6302-1, amended;
31.6302(c)-3, amended; removal of
Federal Reserve banks as federal
depositaries (REG-107176-00) 4,
428
Railroad retirement, rate determination,
quarterly, January 1, 2001, 2, 258
Regulations:
26 CFR 31.6053-1,-4, amended; tips,
tip reporting, employer established
electronic systems (TD 8910) 2,
258
Statutory stock options (Notice 14) 6, 516
Tips:
Tips reporting:
Employer-designed tip reporting,
food and beverage industry
(EmTRAC) programs (Notice 1)
2, 261
Employer established electronic sys-
tems (TD 8910) 2, 258
Voluntary tip reporting agreements
proformas (TRDA and TRAC)
(Ann 1) 2, 277
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<!-- PageFooter="March 5, 2001" -->
<!-- PageBreak -->
# ESTATE TAX
Charitable deductions, guaranteed annuity
and unitrust interest (TD 8923) 6, 485
Generation-skipping transfer tax and
retention of exempt status (TD 8912) 5,
452
Proposed Regulations:
26 CFR 1.641(b)-3, amended;
1.642(c)-1, revised; 1.645-1, added;
1.671-4, amended; 1.6072-1,
amended; 301.6109-1, amended;
election to treat trust as part of an
estate (REG-106542-98) 5, 473
Regulations:
26 CFR 20.2055-2, amended; charita-
ble deductions, guaranteed annuity
and unitrust interest (TD 8923) 6,
485
26 CFR 26.2601-1, amended; genera-
tion-skipping transfer issues (TD
8912) 5, 452
Trusts, election to treat trust as part of an
estate (REG-106542-98) 5, 472
# EXCISE TAX
Air transportation, mileage awards (Notice
6) 3, 327
Excess benefit transactions (TD 8920) 8,
654; (REG-246256-96) 8, 713
Proposed Regulations:
26 CFR 53.4958-0 through -8, added;
excise taxes on excess benefit trans-
actions (REG-246256-96) 8, 713
Regulations:
26 CFR 53.4958-0T through -8T,
added; 53.4963-1, amended;
301.6213-1, amended; 301.6501(e)
-1, amended; 301.6501 (n)-1,
amended; 301.7422-1, amended;
301.7454-2, amended; 301.7611-1,
amended; 602.101, amended; excise
taxes on excess benefit transactions
(TD 8920) 8, 654
## EXEMPT ORGANIZA- TIONS
Advance letter rulings and determination
letters, areas which will not be issued
from Associates Chief Counsel &
Division Counsel/Associate Chief
Counsel (TE/GE) (RP 3) 1, 111
Excise taxes on excess benefit transactions
(TD 8920) 8, 654; (REG-246256-96) 8,
713
# EXEMPT ORGANIZA- TIONS-Cont.
Indian tribal governments treated as
states, list (RP 15) 5, 465
Letter rulings, information letters, etc.
(RP 4) 1, 121
Plain language publications and voluntary
compliance programs (Ann 14) 7, 648
Proposed Regulations:
26 CFR 53.4958-0 through -8, added;
excise taxes on excess benefit trans-
actions (REG-246256-96) 8, 713
Regulations:
26 CFR 53.4958-0T through -8T,
added; 53.4963-1, amended;
301.6213-1, amended; 301.6501
(e)-1, amended; 301.6501(n)-1,
amended; 301.7422-1, amended;
301.7454-2, amended; 301.7611-1,
amended; 602.101, amended; excise
taxes on excess benefit transactions
(TD 8920) 8, 654
Revocations (Ann 20) 8, 716
Technical advice to :
Directors and chiefs, appeals offices,
from Associates Chief Counsel &
Division Counsel/Associate Chief
Counsel (TE/GE) (RP 2) 1, 79
IRS employees (RP 5) 1, 164
User fees, request for letter rulings (RP 8)
1, 239
Withholding, Voluntary Compliance on
Alien Withholding Program (VCAP)
(RP 20) 9, 738
# GIFT TAX
Charitable deductions, transfers to chari-
table lead trust (TD 8923) 6, 485
Regulations:
26 CFR 25.2522(c)-3, amended; chari-
table deductions, lifetime charitable
lead trust (TD 8923) 6, 485
# INCOME TAX
Advance letter rulings and determination
letters, areas which will not be issued
from:
Associates Chief Counsel & Division
Counsel/Associate Chief Counsel
(TE/GE) (RP 3) 1, 111
Associate Chief Counsel International
(RP 7) 1, 236
Aircraft maintenance costs (RR 4) 3, 295
Appeals, extension of test of mediation
# INCOME TAX-Cont.
procedure (Ann 9) 3, 357
Archer MSA (Ann 21) 9, 752
Attorney's fees, recovery of (TD 8922) 6,
508; (REG-121928-98) 6, 520
Automobile owners and lessees, determi-
nation of correct tax liability, 2001
inflation adjustment (RP 19) 9, 732
Case Resolution Pilot Program, extension
(Notice 13) 6, 514
Charitable deductions, transfers to chari-
table lead trust (TD 8923) 6, 485
Contribution in aid of construction
(CIAC), regulated public utilities, water
or sewerage disposal (TD 8936) 9, 720
Corporations:
Assumed liabilities (TD 8924) 6, 489;
(REG-106791-00) 6, 521
Consolidated groups, tentative carry-
back adjustments (TD 8919) 6, 505;
(REG-119352-00) 6, 525
Distributions of stock or securities in
connection with an acquisition:
Purchase of 50% or greater interest
in the corporation making the
distribution or being distributed
(REG-107566-00) 3, 346
Withdrawal of REG-116733-98
(Ann 11) 4, 432
Recognition of gain on certain distribu-
tions of stock or securities (TD 8913)
3, 300
Tax shelter:
Contingent liability (Notice 17) 9, 730
Intermediary transactions (Notice
16) 9, 730
Cost-of-living adjustments for inflation,
2001 (RP 13) 3, 337; clarified (Notice
12) 3, 328
Credits:
Deemed-paid credit computations
(REG-104683-00) 4, 407
Foreign tax credit limitations:
Affiliated groups and interest expense
allocations (TD 8916) 4, 360
Income subject to separate limita-
tions (REG-104683-00) 4, 407
Increasing research activities, defini-
tion of qualified research (TD 8930)
5,433
Low-income housing credit:
Satisfactory bond; "bond factor"
amounts for the period October
through December 2000 (RR 2) 2,
255
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<!-- PageFooter="2001-10 I.R.B." -->
<!-- PageBreak -->
# INCOME TAX-Cont.
# INCOME TAX-Cont.
# INCOME TAX-Cont.
Research credit (Notice 2) 2, 265
Cumulative Bulletin 1998-2, numerical
finding list, finding list of current
actions on previously published items
and index; corrections (Ann 5) 2, 286
Debt substitution, election to treat as real-
ization event (RP 21) 9, 742
Disclosure of returns or return informa-
tion to designee of taxpayer (TD 8935)
8, 702; (REG-103320-00) 8, 714
Earnings and profits adjustments, exercise
of stock option (RR 1) 9, 726
Electing small business trusts; ESBT:
Qualifications and treatments (REG-
251701-96) 4, 396
Tiered structures (TD 8915) 4, 359
Electronic filing; magnetic media, Form
W-4, Employee's Withholding Allow-
ance Certificate, specifications (RP 16)
4,376
Employee stock ownership plans, deduc-
tibility of redemption proceeds (RR 6)
6,491
Federal tax deposits, removal of Federal
Reserve banks as depositaries (TD 8918)
4, 372; (REG-107176-00) 4, 428
Financial asset securitization investment
trusts (FASITs) (RP 12) 3, 335
Forms:
W-2, new code (Ann 7) 3, 357
W-4, Employee's Withholding Allow-
ance Certificate, specifications (RP
6) 4, 376
W-9, Request for Taxpayer
Identification Number and
Certification (Ann 15) 8, 715
1042S, specifications for filing magnet-
ically or electronically (Ann 3) 2,
278
1120, Schedule N, Foreign Operations
of U.S. Corporations (Ann 13) 9, 752
8875, Taxable REIT Subsidiary
Election, revised (Ann 17) 8, 716
Hyperinflationary currency, definition of
(TD 8914) 8, 653
Information reporting:
Discharges of indebtedness (Notice 8)
4,374
Payments to attorneys (Notice 7) 4, 374
Payments of qualified tuition and pay-
ments of interest on qualified educa-
tion loans, magnetic media filing
requirements (Ann 10) 4, 431
Interest:
Investment:
Federal short-term, mid-term, and
long-term rates for:
January 2001 (RR 3) 3, 319
February 2001 (RR 7) 7, 541
Inventory:
Floor stocks payments (RR 8) 9, 726
LIFO:
Price indexes, department stores for:
November 2000 (RR 5) 5, 451
December 2000 (RR 9) 8, 652
Last known address (RP 18) 8, 708
Letter rulings, determination letters, and
information letters issued by Associates
Chief Counsel (RP 1) 1, 1
Life insurance contracts, "split-dollar"
arrangements (Notice 10) 5, 459
Methods of accounting, inventories, small
taxpayers (RP 10) 2, 272
Partnerships:
Corporate partner's stock, partnership
termination (REG-106702-00) 4,
424
Final short-year tax return, determina-
tion of basis (Notice 5) 3, 327
Mergers and divisions (TD 8925) 6,
496
Pre-filing agreement program (RP 22) 9,
745
Presidentially declared disaster and com-
bat zone, tax related deadlines (TD
8911) 3, 321
Proposed Regulations:
26 CFR 1.301-1, amended; liabilities
assumed in certain corporate transac-
tions (REG-106791-00) 6, 521
26 CFR 1.355-0, amended; 1.355-7,
added; recognition of gain on certain
distributions of stock or securities in
connection with an acquisition
(REG-107566-00) 3, 346
26 CFR 1.444-4, added; 1.641(c)-0,
-1, added; 1.1361-0, -1, amended;
1.1362-6, -7, amended; 1.1377-1,
-3, amended; electing small business
trusts (REG-251701-96) 4, 396
26 CFR 1.705-1, amended; 1.705-2,
added; basis adjustments upon the
sale of a corporate partner's stock
(REG-106702-00) 4, 424
26 CFR 1.902-0, -1, amended; 1.904-0,
-4, -5, -6, amended; 1.904-5,
revised; 1.904(b)-1, -2, revised;
1.904(b)-3, -4, removed; 1.904(j)-1,
added; application of section 904 to
income subject to separate limitations
and computations of deemed paid
credit under section 902
(REG-104683-00) 4, 407
26 CFR 1.1502-78, amended; corpo-
rations, consolidated groups, tenta-
tive carryback adjustments
(REG-119352-00) 6, 525
26 CFR 1.6302-1, -2, amended;
31.6302-1, amended; 31.6302(c)-3,
amended; removal of Federal Reserve
banks as federal depositaries
(REG-107176-00) 4, 428
26 CFR 301.6103(c)-1, added; disclo-
sure of return and return infor-
mation to designee of taxpayer
(REG-103320-00) 8, 714
26 CFR 301.7430-0, removed;
301.7430-7, added; attorney's fees,
recovery of (REG-121928-98) 6, 520
Publications:
547, Casualties, Disasters, and Thefts,
revised (Ann 6) 3, 357
551, Basis of Assets, revised 2000 (Ann
2) 2, 277
583, Starting a Businesss and Keeping
Records, revised (Ann 8) 3, 357
1245, Specifications for Filing Forms
W-4, Employee's Withholding
Allowance Certificate, magnetically
or electronically (RP 6) 4, 376
Qualified zone academy bonds, limitation
for 2001 (RP 14) 3, 343
Real estate mortgage investment conduits
(REMICs), safe harbor (RP 12) 3, 335
Regulations:
26 CFR 1.41-0, -1, -4, revised;
1.41-2, amended; 1.41-3, redesig-
nated as 1.41-3A; 1.41-3, added;
1.41-5, redesignated as 1.41-4A,
amended; 1.41-6, redesignated as
1.41-5, amended; 1.41-7, redesig-
nated as 1.41-5A, amended; 1.41-8,
redesignated as 1.41-6, amended;
1.41-9, redesignated as 1.41-7;
1.41-8, added; 1.41-0A through
-8A, removed; 1.41-0A, added;
1.218-0, removed; 1.482-7, amend-
ed; credit for increasing research
activities (TD 8930) 5, 433
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<!-- PageFooter="March 5, 2001" -->
<!-- PageBreak -->
# INCOME TAX-Cont.
# INCOME TAX-Cont.
# INCOME TAX-Cont.
26 CFR 1.118-2, added; contribution in
aid of construction (CIAC), regulat-
ed public utilities, water or sewerage
disposal (TD 8936) 9, 720
26 CFR 1.170A-6, amended; lifetime
charitable lead trust (TD 8923) 6, 485
26 CFR 1.301-1, amended; 1.301-1T,
added; assumed liabilities (TD
8924) 6, 489
26 CFR 1.355-0, amended; 1.355-6,
revised; recognition of gain on cer-
tain distributions of stock or securi-
ties (TD 8913) 3, 300
26 CFR 1.444-4T, added; ESBT, elect-
ing small business trusts, tiered
structures (TD 8915) 4, 359
26 CFR 1.467-0, -1, amended; 1.467-2,
added; 1.467-3, revised; rental agree-
ments involving payments of
$2,000,000 or less (TD 8917) 7, 538
26 CFR 1.643(a)-8, added; 1.664-1, -2,
-3, amended; charitable remainder
trusts, deemed sale, trust distributions,
abusive transactions (TD 8926) 6, 492
26 CFR 1.708-1, amended; 1.752-1,
-5, amended; partnership mergers
and divisions (TD 8925) 6, 496
26 CFR 1.861-9, -11, -14, added;
1.861-9T, -11T, -14T, revised;
1.902-1, amended; 1.904-0, -4, -5,
amended; application of section
904 to income subject to separate
limitations and section 864(e) affil-
iated group expense allocation and
apportionment rules (TD 8916) 4,
360
26 CFR 1.894-1, amended; 1.894-1T,
removed; guidance regarding claims
for certain income tax convention
benefits (Ann 4) 2, 286
26 CFR 1.988-1, revised; hyperinfla-
tionary currency (TD 8914) 8, 653
26 CFR 1.1502-78T, added; corpora-
tions, consolidated groups, tentative
carryback adjustments (TD 8919) 6,
505
26 CFR 301.6103(c)-1, removed;
301.6103(c)-1T, added; disclosure of
returns or return information to
designee of taxpayer (TD 8935) 8, 702
26 CFR 301.6302-1T, added; removal
of Federal Reserve banks as deposi-
taries (TD 8918) 4, 372
26 CFR 301.7430-7T, added; attorney's
fees, recovery of (TD 8922) 6, 508
26 CFR 301.7508-1, added; 301.7508
A-1, added; for combat zone service
or Presidentially declared disasters,
tax related deadlines (TD 8911) 3,
321
Rental agreements (TD 8917) 7, 538
Substantial understatement penalty, ade-
quate disclosure (RP 11) 2, 275
Tax convention, claims for benefits (Ann 4)
2, 286
Tax shelters, leasing transactions, excep-
tions (Notice 18) 9, 731
Technical advice to directors and chiefs,
appeals offices, from Associates Chief
Counsel and Division Counsel/
Associate Chief Counsel (TE/GE) (RP
2) 1, 79
Trusts:
Charitable remainder trusts, deemed
sale, trust distributions, abusive
transactions (TD 8926) 6, 492
Election to treat trust as part of an
estate (REG-106542-98) 5, 472
Withholdings:
Payments to financial institutions in
U.S. possessions (Notice 11) 5, 464
Qualified intermediary agreements,
clarifications (Notice 4) 2, 267
Voluntary Compliance on Alien
Withholding Program (VCAP) (RP
20) 9, 738
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<!-- PageFooter="2001-10 I.R.B." -->
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but must be followed up with a written cancellation within 10 days).
Important: Please include this completed order form with your payment.
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# INTERNAL REVENUE BULLETIN
The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue
Bulletin is sold on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the
Superintendent of Documents when their subscriptions must be renewed.
# CUMULATIVE BULLETINS
The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-
ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the
Superintendent of Documents.
# ACCESS THE INTERNAL REVENUE BULLETIN ON THE INTERNET
You may view the Internal Revenue Bulletin on the Internet at www.irs.gov. Select Tax Info for Business at the bottom of the
page. Then select Internal Revenue Bulletins.
# INTERNAL REVENUE BULLETINS ON CD-ROM
Internal Revenue Bulletins are available annually as part of Publication 1796 (Tax Products CD-ROM). The CD-ROM can be
purchased from National Technical Information Service (NTIS) on the Internet at www.irs.gov/cdorders (discount for online orders)
or by calling 1-877-233-6767. The first release is available in mid-December and the final release is available in late January.
# HOW TO ORDER
Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,
detach entire page, and mail to the Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA 15250-7954. Please allow two
to six weeks, plus mailing time, for delivery.
# WE WELCOME COMMENTS ABOUT THE INTERNAL REVENUE BULLETIN
If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page
(www.irs.gov) or write to the IRS Bulletin Unit, W:CAR:MP:FP, Washington, DC 20224.
## Internal Revenue Service Washington, DC 20224
Official Business
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