As indicated above, taxable income for 1958 and 1954, as determined under the cash receipts and disbursements method of accounting, was $2,000 and $4,000, respectively, and after application of the net operating loss carryback from 1955, the taxable income was reduced to zero in 1953 and to $1,000 in 1954. The taxpayer was unable to establish taxable income for these years under an accrual method of accounting; however, under section 481(b) (3) (A), increases or decreases in the tax for taxable years to which no adjustment is allocated must, nevertheless, be taken into account to the extent the tax for such years would be affected by a net operating loss determined with reference to taxable years to which adjustments are allocated. The total amount of the adjustments required under section 481(a) and attributable to the taxable years 1953 through 1957 in this example is assumed to be $10,000. The redetermination of taxable income established by the taxpayer for the taxable years 1955, 1956, and 1957 appears under the heading "Taxable income estab

1958 1957

1956.

Year

Increase in tax attributable to adjustment computed under section 481 (b) (1) ..

lished under accrual method" in the above tabulation. The tabulation assumes that the taxpayer has been able to recompute the income for those years so as to establish a net adjustment of $9,000, which leaves a balance of $1,000 unaccounted for. In accordance with the requirements of section 481(b) (2), the $1,000 amount is allocated to 1958, the taxable year of the change. The following computations are necessary in order to determine the tax attributable to the adjustments under section 481(a): Increase in tax attributable to inclusion in 1958 of the entire $10,000 adjustment Tax on income of 1958 increased by entire amount of adjustment ($100,000+$10,000).

Tax on income of 1958 without adjustment ($100,000)-

Increase in tax attributable to inclusion of entire adjustment in year of the change--

$51, 700

46,500

5, 200

Year

Since the limitation under section 481(b) (2) ($3,880) on the amount of tax attributable to the adjustments is applicable, the final tax for the taxable year of the change is computed by adding such amount to the tax for that year computed without the

inclusion of any amount attributable to the adjustments, that is, $46,500 plus $3,880, or $50,380.

[T.D. 6500, 25 F.R. 11732, Nov. 26, 1960, as amended by T.D. 6490, 25 F.R. 8374, Sept. 1, 1960]

§ 1.481-3 Adjustments attributable to pre-1954 Code years where change was not initiated by taxpayer.

If the adjustments required by section 481(a) and § 1.481-1 are attributable to a change in method of accounting which was not initiated by the taxpayer, no portion of any adjustments which is attributable to pre-1954 Code years shall be taken into account in computing taxable income. For example, if the total adjustments in the case of a change in method of accounting which is not initiated by the taxpayer amount to $10,000, of which $4,000 is attributable to pre1954 Code years, only $6,000 of the $10,000 total adjustments is required to be taken into account under section 481 in computing taxable income. The portion of the adjustments which is attributable to pre-1954 Code years is the net amount of the adjustments which would have been required if the taxpayer had changed his method of accounting in his first taxable year which began after December 31, 1953, and ended after August 16, 1954. See section 481(b) (4) (A).

[T.D. 6500, 25 F.R. 11735, Nov. 26, 1960] § 1.481-4 Adjustments attributable to pre-1954 Code years where change was initiated by taxpayer.

(a) Amount of adjustments to be taken into account. If the adjustments required by section 481 (a) and § 1.481-1 are attributable to a change in method of accounting initiated by the taxpayer, the amount of such adjustments, to the extent such amount does not exceed the net amount which would have been required if the change had been made in the first taxable year beginning after December 31, 1953, and ending after August 16, 1954, shall be taken into account by the taxpayer in computing taxable income in the manner provided in section 481(b) (4) (B) and paragraph (b) of this section. The preceding sentence shall apply only if such amount would increase taxable income for such year by more than $3,000. For example, if the total adjustments amount to $19,000, and the portion of the adjustments attributable to pre-1954 Code years is $10,000 and the balance of $9,000 is attributable to taxable years subject to the 1954 Code, the adjustments shall be taken into account as follows:

(1) The portion attributable to pre1954 Code years ($10,000) shall be taken into account in the manner provided in

section 481 (b) (4) (B) and paragraph (b) of this section, and the limitations provided in section 481(b) (1) or (2) will apply to the balance of $9,000; or

(2) If the taxpayer elects under section 481 (b) (6) to take the adjustments attributable to pre-1954 Code years into account under section 481(b) (1) or (2), the limitations provided in section 481(b) (1) or (2) will apply to the entire amount of the adjustments ($19,000).

The provisions of section 481 (b) (4), section 481(b) (6), and paragraphs (b), (c), (d), and (e) of this section shall not apply with respect to changes in methods of accounting made in taxable years beginning after December 31, 1963.

(b) Years for which amounts are to be taken into account. (1) If the amount of the adjustments determined in accordance with section 481(b) (4) (A) and paragraph (a) of this section would increase the taxable income of the taxpayer for the first taxable year to which section 481 applies by more than $3,000, the amount of such adjustments shall, except as provided in paragraphs (c), (d), (f), and (g) of this section, be taken into account

(i) One-tenth in each of the 10 taxable years beginning with the taxable year of the change, or

(ii) If the taxable year of the change was a taxable year beginning after December 31, 1953, and ending after August 16, 1954, but before January 1, 1958, and if the taxpayer makes the election under section 481 (b) (4) (B) in the manner provided in subparagraph (4) of this paragraph, one-tenth in each of the 10 taxable years beginning with the first taxable year which begins after December 31, 1957.

(2) (i) The 10-year period which begins with the taxable year of the change shall be reduced by the number of years in respect of which assessment of the tax is prevented by operation of any law or rule of law. In the case of a taxpayer whose taxable year of the change ended before January 1, 1958, and who elects to use the period provided for in subparagraph (1)(ii) of this paragraph, the 10-year period which begins with the first taxable year beginning after December 31, 1957, shall be reduced by the number of years which corresponds to the number of taxable years, beginning with the taxable year of the change in respect of which assessment of the tax

was prevented by the operation of any law or rule of law on September 2, 1958.

(ii) In the case of such a shortened period, the portion of the adjustments to be taken into account in any one taxable year within such shortened period shall be one-tenth of such adjustments, that is, the same pro rata portion which would have been taken into account in such taxable year if the 10-year period beginning with such first taxable year had not been shortened. If, for example, in a case where the 10-year period is properly used, assessment of a deficiency is prevented with respect to 1 of the 10 taxable years in which one-tenth of the adjustments would otherwise be required to be taken into account, then only ninetenths of such adjustments is to be taken into account ratably in the other 9 taxable years. Thus, if the adjustments required under section 481 (a) amount to $10,000 and assessment of a deficiency for the calendar year 1954 (the taxable year of the change) is prevented, only nine-tenths of the adjustments, $9,000, is to be taken into account in 1955 and the eight following taxable years at the rate of $1,000 a year. Similarly, if the taxpayer elects to begin the 10-year period with the taxable year 1958, only nine-tenths, or $9,000, is to be taken into account in 1958 and the eight following taxable years at the rate of $1,000 a year.

or

(3) If assessment of a deficiency is prevented with respect to a taxable year for which a prorated part would otherwise be required to be taken into account under subparagraphs (1) and (2) of this paragraph, section 481(b) (4) (B) does not reopen that year for assessment purposes.

(4) The election provided in section 481(b) (4) (B) and subparagraph (1) of this paragraph shall be made

(1) In cases where the taxpayer requests the Commissioner's permission to change his method of accounting, at the time such request is made or at such other time as the Commissioner, prior to granting the taxpayer permission to make the change, may afford the taxpayer an opportunity to make such election; or

(ii) In cases where the taxpayer changed his method of accounting without the advance approval of the Commissioner and has not made an election to return to his former method of accounting in accordance with § 1.481-6, at any time before May 21, 1959.

The election shall be in the form of a written statement to the effect that the taxpayer elects under section 481(b) (4) (B) to take the adjustments determined in accordance with section 481(b) (4) (A) into account in the 10-year period beginning with the first taxable year beginning after December 31, 1957, and that the taxpayer agrees to include one-tenth of such adjustments in taxable income for such years in the manner provided in subparagraph (2) of this paragraph. In the case of a partnership, the election shall be made by the individual partners. In the case of a taxpayer referred to in subdivision (i) of this subparagraph, the statement of election shall be filed with the Commissioner of Internal Revenue, Attention: T:R, Washington 25, D.C. In the case of a taxpayer referred to in subdivision (ii) of this subparagraph, the statement of election shall be filed with the district director with whom he filed his income tax return for the taxable year of the change.

(c) Limitation on years in which adjustments can be taken into account. The amount of any adjustments determined in accordance with section 481(b) (4) (A) and paragraph (a) of this section, to the extent not taken into account in prior taxable years under section 481(b) (4) (B) and paragraph (b) of this section, shall be taken into account as follows:

(1) In the case of an individual taxpayer, such amount shall be taken into account in the taxable year in which he dies or ceases to engage in a trade or business;

(2) In the case of a partner, his distributive share of such amount shall be taken into account in his taxable year in which the partnership terminates or in which his entire interest in such partnership is transferred or liquidated; or

(3) In the case of a corporation, such amount shall be taken into account in the taxable year in which the corporation ceases to engage in a trade or business, unless the amount is required to be taken into account by the acquiring corporation under section 381 (c) (21) and the regulations thereunder.

(d) Election under section 481(b) (6). (1) Under section 481(b) (6) a taxpayer may elect to take the adjustments determined in accordance with section 481(b) (4) (A) and paragraph (a) of this section into account in the manner provided in section 481(b) (1)

or (2) and paragraphs (a) or (b) of § 1.481-2 in lieu of taking such adjustments into account under the 10-year section allocation rule provided in

481(b) (4) (B) and paragraph (b) of this section. If a taxpayer makes the election under section 481(b) (6), such taxpayer may not take any portion of the adjustments into account under the 10year allocation rule provided in section 481 (b) (4) (B). In such cases, the entire amount of the adjustments required by section 481 (a) is to be taken into account in computing taxable income for the taxable year of the change, subject to the limitations on tax provided in section 481(b) (1) or (2). For example, if the adjustments resulting from a change in method of accounting which occurred in 1956 amount to $25,000, of which $10,000 is attributable to pre-1954 Code years, and the taxpayer elects under section 481(b) (6) to take such adjustments into account in the manner provided by section 481(b) (1) or (2), the limitations on tax provided in section 481(b) (1) or (2) shall apply to the entire $25,000 adjustments.

(2) The election under section 481(b) (6) may be made only if the taxpayer consents in writing to the assessment, within such period as may be agreed upon with the Commissioner or district director, of any deficiency for the taxable year of the change in the method of accounting which results from taking such adjustments into account in the manner so elected, even though at the time of filing such consent the assessment of such deficiency would otherwise be prevented by the operation of any law or rule of law.

(3) The election provided in section 481(b) (6) shall be made within the time prescribed by law for filing the return (including extensions of time therefor) for the taxable year of the change, or within 90 days after the date on which the Commissioner grants permission to the taxpayer to change his method of accounting, or at any time before May 21, whichever is later. The statement shall be filed with the district director with whom the taxpayer files his income tax return for the taxable year of the change and shall be attached to the return for such year or, in the case of returns previously filed, the statement shall be attached to the necessary amended return or returns.

36-051-70-19

(e) Example. The application of the provisions of this section may be illustrated by the following examples:

Example (1). X Corporation has been filing its income tax returns and keeping its books on the cash receipts and disbursements method of accounting for the calendar year. It requests, and is granted, the permission of the Commissioner, effective with the calendar year 1960, to change to an accrual method of accounting. As of January 1, 1954, the taxpayer had an opening inventory of $20,000, accounts receivable of $22,000, and accounts payable of $14,000. As of January 1, 1960, its records reflect an opening inventory of $34,000, accounts receivable of $32,000, and accounts payable of $19,000. The corporation has no other items which require adjustment under section 481 (a). The adjustments required to be made by X Corporation in 1960 under section 481 (a) amount to $47,000 ($34,000 plus $32,000 less $19,000). The amount of the adjustments which X Corporation would have been required to make if it had changed its method of accounting for the calendar year 1954 is $28,000 ($20,000 plus $22,000 less $14,000). Since such $28,000 of adjustments in respect of pre-1954 Code years would increase the taxable income for 1954 by more than $3,000, and since the adjustments are attributable to a change in method of accounting initiated by the taxpayer, such $28,000 of adjustments shall be taken into account under section 481(b) (4) (B) and paragraph (b) of § 1.481-4, unless X Corporation elects under section 481(b) (6) to have the limitations on tax provided by section 481(b) (1) or (2) apply to such adjustments. The remaining portion ($19,000) of the adjustments required by section 481(a) is to be taken into account in 1960, subject, however, to the tax limitation applicable under the 3-year allocation method of section 481(b) (1) or the new-accounting-method allocation under section 481(b)(2).

Example (2). If the facts in example (1) were the same except that as of January 1, 1960, the three adjustments are such that only $20,000 of adjustments is required to be taken into account under section 481 (a) for 1960, then the entire amount of adjustments ($20,000) is to be taken into account in the manner provided by section 481(b)(4) or section 481(b) (6) since such amount does not exceed the $28,000 of adjustments that would have been required if the taxpayer had changed its method of accounting for the calendar year 1954.

(f) Special rule for pre-1954 adjustments in case of certain decedents. Section 481(b) (5) provides a special rule in respect of the tax attributable to pre1954 adjustments in the case of a change from the cash receipts and disbursements method to an accrual method in

volving the use of inventories made on or after August 16, 1954, and before January 1, 1958, for a taxable year to which section 481 applies, by the executor or administrator of a decedent's estate in the first income tax return filed by such executor or administrator on behalf of the decedent. Such rule provides that

(1) Such a change shall be given effect in determining taxable income (other than for the purpose of computing a net operating loss carryback to any prior taxable year of the decedent); and

(2) If the adjustments required by section 481(a) in respect of taxable years to which section 481 does not apply would increase taxable income of the decedent by more than $3,000, then the tax attributable to such adjustments shall not exceed an amount equal to the tax that would have been payable on the cash receipts and disbursements method for the years for which the executor or administrator filed income tax returns on behalf of the decedent, computed for each such year as though a ratable portion of the taxable income for such year had been received in each of 10 taxable years beginning and ending on the same dates as the taxable year for which the tax is being computed.

(g) Exception for certain agreements. (1) Section 29 (d) (2) of the Technical Amendments Act of 1958 (72 Stat. 1629) provides as follows:

Sec. 29. Adjustments required by changes in method of accounting.

(d) Effective date. •

(2) Exception for certain agreements. The amendments made by subsections (a), (b) (1), and (c) shall not apply if before the date of the enactment of this Act

(A) The taxpayer applied for a change in the method of accounting in the manner provided by regulations prescribed by the Secretary of the Treasury or his delegate, and

(B) The taxpayer and the Secretary of the Treasury or his delegate agreed to the terms and conditions for making the change.

(2) The amendments made to section 481 by section 29 (other than paragraphs 2 through 5 of subsection (b)) of the Technical Amendments Act of 1958 shall not apply if, before September 2, 1958, the taxpayer applied for a change in method of accounting in the manner provided by any Federal income tax regulation and the taxpayer and the Commissioner agreed to the terms and conditions for making the change.

(3) A taxpayer who, in accordance with any provision of the Code or of any Federal income tax regulation permitting such action, elected to change his method of accounting with regard to one or more material items, such as research and experimental expenditures (section 174), soil and water conservation expenditures (section 175), last-in, firstout inventories (section 472), and exploration expenditures (section 615). and who satisfied the requirements of the regulations dealing with such elections, shall be treated for purposes of section 29(d) (2) of the Technical Amendments Act of 1958 as a taxpayer who applied for and changed his method of accounting in the manner provided by regulations and who agreed to the terms and conditions for making the change. [T.D. 6500, 25 F.R. 11735, Nov. 26, 1960] § 1.481-5

Adjustments taken into account with consent.

(a) In addition to the methods of allocation described in section 481(b), the adjustments required by section 481(a) may be taken into account in computing the tax under chapter 1 of the Code for such taxable years, in such manner and subject to such conditions as may be agreed upon between the Commissioner and the taxpayer. See section 481(c). Requests for approval of a method of allocation differing from those described in section 481(b) shall be addressed to the Commissioner of Internal Revenue, Attention: T:R, Washington 25, D.C., and shall set forth in detail the facts and circumstances upon which the taxpayer bases his request. Permission will be granted only if the taxpayer and the Commissioner agree to the terms and conditions under which the allocation is to be effected.

(b) The agreement shall be in writing and shall be signed by the Commissioner and the taxpayer. It shall set forth the items to be adjusted, the amount of the adjustments, the taxable year or years for which the adjustments are to be taken into account, and the amount of the adjustments allocable to each such year. The agreement shall be binding on the parties except upon a showing of fraud, malfeasance, or misrepresentation of a material fact. [T.D. 6500, 25 F.R. 11737, Nov. 26, 1960]