Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-82

1972-1 C.B. 134

Sec. 446
Sec. 471
Sec. 481

IRS Headnote

Section 481 adjustment attributable to pre-1954 Code years resulting from a Service-initiated change in the taxpayer's inventory method for a year subsequent to a year in which the taxpayer voluntarily changed his inventory valuation method.

Full Text

Rev. Rul. 72-82

Advice has been requested as to the adjustment required under section 481 of the Internal Revenue Code of 1954 as a result of changes in a taxpayer's method of valuing inventories under the circumstances described below.

The taxpayer is a domestic corporation that manufactures a product that is used by other manufacturers. Since the taxpayer's incorporation in 1940 it has consistently valued its inventory at cost or market, whichever is lower, on a first-in, first-out (FIFO) basis. The taxpayer files its return on the basis of a calendar year.

During the period 1940 through 1962, the taxpayer erroneously applied the lower of cost or market method by valuing its ending inventory each year at an amount (lower than cost) equal to 50 percent of the proper "market" value of such inventory under section 1.471-4 of the Income Tax Regulations. In 1963, without obtaining the advance approval of the Commissioner, the taxpayer began to value its ending inventory at an amount, still erroneous, equal to 90 percent of its proper "market" value. For that taxable year, the taxpayer also increased the value of its beginning inventory consistent with the new valuation method, but took into income for that year the total positive adjustment required by section 481(a) of the Code to offset the duplication of costs resulting from the increase in beginning inventory value.

Upon examination of the taxpayer's income tax return for taxable year 1968, the Service changed the taxpayer's inventory method to require the use of the proper "market" value in applying the lower of cost or market method under section 1.471-4 of the regulations. The changes in the taxpayer's treatment of valuing inventories were changes in a method of accounting within the meaning of section 1.446-1(e)(2)(ii)(c) of the regulations.

Section 481(a) of the Code provides that, in computing a taxpayer's taxable income for any taxable year, if such computation is under a method of accounting different from the method under which the taxpayer's taxable income for the preceding taxable year was computed, then there shall be taken into account those adjustments that are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted, except that there shall not be taken into account any adjustment in respect of any taxable year to which section 481 of the Code does not apply unless the change is initiated by the taxpayer.

Section 446(e) of the Code and the regulations thereunder require a taxpayer who wishes to change his method of valuing his inventories to secure the consent of the Commissioner before computing his income under the new method, regardless of whether or not the old method is proper. See section 1.446-1(e)(2)(i) of the regulations. However, section 1.481-1(c)(5) of the regulations provides, in effect, that for purposes of section 481 of the Code a change initiated by the taxpayer includes not only a change that he originates by securing the consent of the Commissioner, but also a change made without the advance approval of the Commissioner.

Thus, the taxpayer's change in its method of valuing inventories in 1963 was a change initiated by the taxpayer. Therefore, the taxpayer properly took into account for its taxable year 1963 the total positive adjustment required by section 481(a) of the Code, without eliminating therefrom the portion of such adjustment attributable to 1953 and prior years.

The change in the taxpayer's inventory method required by the Service in 1968 was not initiated by the taxpayer. Thus, the portion of the section 481 adjustment for that taxable year that is attributable to pre-1954 Code years must be eliminated.

Accordingly, the amount attributable to pre-1954 Code years to be eliminated from the positive section 481 adjustment required as a result of the 1968 change in inventory method is the excess of the value of the taxpayer's ending inventory on December 31, 1953, determined under the method the taxpayer was required to change to in 1968, over the value of such inventory determined under the method the taxpayer voluntarily changed to in 1963.