Rev. Proc. 79-23

Section 1. Purpose.

The Internal Revenue Service has received numerous inquiries regarding the types of situations that warrant the disallowance or termination of a last-in, first-out (LIFO) election under section 472 of the Internal Revenue Code of 1954. As a result, the Service has identified certain situations that may warrant the disallowance or termination of a LIFO election. In addition, certain situations have been identified that do not warrant a disallowance or termination of a LIFO election. The purpose of the Revenue Procedure is to set forth these situations in an attempt to resolve some of the inquiries that have been received.

Sec. 2. Background.

Section 472(a) of the Code provides, in part, that a taxpayer may use the LIFO method described in section 472(b) in inventorying the goods specified in an application to use such method filed at such time and in such manner as the Secretary may prescribe.

Section 472(b) of the Code provides that in inventorying the goods specified in the application in section 472(a), the taxpayer shall:

(1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in order of acquisition) to the extent thereof; and second, those acquired in the taxable year;

(2) Inventory them at cost; and,

(3) Treat those included in the opening inventory of the taxable year in which method is first used as having been acquired at the same time and determine their cost by the average cost method.

Section 472(c) of the Code provides that subsection (a) shall apply only if the taxpayer establishes to the satisfaction of the Secretary that the taxpayer has used no procedure other than that specified in paragraphs (1) and (3) of subsection (b) in inventorying such goods to ascertain the income, profit, or loss of the first taxable year for which the method described in subsection (b) is to be used, for the purpose of a report or statement covering such taxable year --

(1) to shareholders, partners, or other proprietors, or to beneficiaries, or,

(2) for credit purposes.

Section 472(d) of the Code provides that in determining income for the taxable year preceding the taxable year for which the LIFO method is first used, the closing inventory of such preceding year shall be valued at cost.

Section 472(e) of the Code provides, in part, that if a taxpayer having complied with section 472(a) uses the method described in section 472(b) for any taxable year, then such method shall be used in all subsequent years unless the Secretary determines that the taxpayer has used for any such subsequent taxable year some procedure other than LIFO to ascertain the income, profit, or loss of such subsequent taxable year for the purpose of a report or statement covering such taxable year (A) to shareholders, partners, or other proprietors, or beneficiaries, or (B) for credit purposes; and requires a change to a method different from that prescribed in subsection (b) beginning with such subsequent taxable year or any taxable year thereafter.

Section 1.472-3(d) of the regulations 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 propriety 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.

Sec. 3. Application.

.01 Based upon the above sections of the Code and the applicable regulations thereunder, the situations set forth below will warrant the disallowance or termination of a LIFO election. However, termination in these situations is not automatic due to the discretionary authority in section 472(e)(2) of the Code and the underlying regulations.

(a) A violation of the conformity requirements contained in section 472(c) or (e) of the Code unless otherwise provided in Sec. 3.02 or other revenue rulings or revenue procedures;

(b) Failure by the taxpayer to properly elect the LIFO method, including a failure to make the necessary adjustment required by section 472(d) of the Code. With respect to this provision, see Rev. Proc. 76-6, 1976-1 C.B. 545, Rev. Proc. 76-28, 1976-2 C.B. 645, Rev. Rul. 76-282, 1976-2 C.B. 137, and Rev. Rul. 78-262, 1978-2 C.B. 170;

(c) Failure by the taxpayer to value its LIFO inventory at cost for federal income tax purposes, for the year preceding the year of the LIFO election, the year of the LIFO election, and all subsequent taxable years. However, in determining cost for the year of the LIFO election and any subsequent year, the failure to include (or exclude) an item of cost, such as in accordance with the full absorption inventory rules of section 1.471-11 of the regulations, will not warrant disallowance or termination.

(d) Failure by the taxpayer to maintain adequate books and records with respect to its LIFO inventory and all computations incident thereto.

.02 The following situations have been identified as not warranting the disallowance or termination of a LIFO election.

(a) Computational errors made by the taxpayer in computing the value of its LIFO inventory and other computational errors made incident to the LIFO election;

(b) Selection by the taxpayer of a fewer or greater number of inventory pools than those determined by an examining agent;

(c) The taxpayer's use of the Bureau of Labor Statistics price indices for valuing its LIFO inventories for federal income tax purposes even though the taxpayer does not qualify as a department store within the meaning of Rev. Rul. 23, 1953-1 C.B. 34. In this regard, see Rev. Rul. 75-181, 1975-1 C.B. 150;

(d) The taxpayer improperly including (or excluding) a specific item in a particular inventory pool;

(e) Differences in the level of costing of the taxpayer's inventories between the taxpayer's financial statements and its federal income tax return, including adjustments in prior years arising from examination by the Internal Revenue Service that have not been reflected in the taxpayer's financial statements and differences attributable to financial restatements that have not been reflected in the taxpayer's federal income tax returns. See for example Rev. Rul. 76-379, 1976-2 C.B. 138, Rev. Rul. 76-531, 1976-2 C.B. 140, and Rev. Rul. 77-408, 1977-2 C.B. 184.

The above situations have been cited so that Internal Revenue Agents and taxpayers may have guidance as to what types of situations do not warrant the disallowance or termination of a LIFO election.

Sec. 4. Inquiries.

Inquiries regarding this Revenue Procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, Attention: T:C:C, 1111 Constitution Avenue, N.W., Washington, D.C. 20224.