LIFO accounting methods.

Except in certain limited situations, the last-in, first-out (LIFO) inventory method may be adopted without prior IRS approval by attaching a Form 970, Application to Use LIFO Inventory Method, to a timely filed return in which the method is first used.

Once the initial election is filed, many taxpayers assume that they do not have any further election filing requirements. However, a company may need to file subsequent Forms 970 to extend the LIFO election in future years. For example, any time a new type of goods is added to a company's inventory, the company must determine whether a new LIFO election must be made or whether the new goods are covered by a previous LIFO election(s).

The need for a new LIFO election by a taxpayer can also be affected by any type of reorganizational or restructuring transactions that a company undergoes.

Many reorganizational transactions are governed by Sec. 381 (e.g., Sec. 332 liquidations, A, C, D, F and G reorganizations). Sec. 381(c) and the regulations thereunder provide that when inventories are transferred from one company to another, the acquiring company must determine which inventory method is controlling and should be used after the transfer. There is detailed guidance in the regulations on how the acquiring or surviving company determines the controlling inventory method after the transfer, and the computations necessary to combine the inventories on the date of transfer. Since the regulations determine the principal inventory accounting method and submethods to be used after the transfer, these types of transactions typically do not require the acquiring company to make a new LIFO election.

However, there are other types of restructuring transactions that may require the =mferee company to adopt LIFO inunediately after the transfer if the company desires to use the LIFO inventory method, even if LIFO had been used by the transferor. The most typical of these transactions are governed by Sec. 351 (transfer to corporation controlled by transferor), Sec. 338 (certain stock purchases treated as asset acquisitions) or Sec. 721 (nonrecognition of gain or loss on contribution to a partnership). These are instances in which accounting methods do not carry over from the transferor to the transferee entity. As such, even though the inventory transferred was accounted for under the LIFO method by the transferor, the transferee entity may need to file a Form 970 if it wants to continue using the LIFO inventory method for the acquired inventory after the transaction.

Sec. 351 Transfers

Sec. 351 generally permits the tax-free transfer of property to a corporation in exchange for stock of the corporation. These types of trasactions may be used to form a new corporation, or may be subsequent transfers of property to existing corporations. A new LIFO election must be made in the year of the transfer if the acquiring company (whether a new entity or an existing corporation) did not previously use the LIFO method for the type of goods transferred. The Sec. 351 ruies can be summarized as foflows:

*If LIFO inventory is transferred to a new company, the new company must file A Form 970 if it desires to adopt LIFO.

*If LIFO inventory is transferred to an existing company, and the company is not using the LIFO method, a Form 970 must be filed if the existing company desires to adopt LIFO.

*If LIFO inventory is transferred to an existing company, and the company is using the LIFO method for the same type of goods transferred, the existing company does not have to file a Form 970 if it desires to use the LIFO method.

*If LIFO inventory is transferred to an existing company, and the company is not using the LIFO method for the same type of goods transferred, the existing company must file a Form 970 if it desires to adopt LIFO for the type of goods transferred.

Sec. 721 Transfers

Sec. 721 generally perrriits the tax-free transfer of property to a partnership in exchange for an interest in the partnership. These types of transactions may be used to form a new partnership, or may be subsequent transfers of property to existing partnerships. The problems associated with a Sec. 721 transaction involving the transfer of LIFO inventry are similar to those in a Sec. 351 transaction, since accounting methods do not carry over in a Sec. 721 transaction. Therefore, the new or existing partnership that acquires LIFO inventory in a Sec. 721 transaction may have to make a new LIFO election in the year of the transfer (see the Sec. 351 rules summarized above).

Sec. 338 Transactions

If a purchasing corporation makes a Sec. 338 election, a stock purchase will essentially be treated for tax purposes as an asset acquisition. The target corporation is treated as a new corporation that purchases all of its assets as of the beginning of the day after the acquisition date. As a new corporation, the target entity must adopt all new accounting methods; there is no carryover of accounting methods from the target prior to the Sec. 338 transaction. Therefore, even though the target corporation may have been using the LIFO inventory method, the "new" target corporation must make a LIFO election after the Sec. 338 transaction if it desires to use the LIFO inventory method.

In any of the Sec. 351, 721 or 338 transactions discussed in which a new LIFO election is required, the electing entity should not blindly adopt the LIFO inventory method used by the transferor. In many mstances, the electing entity can adopt a method that greatly simplifies the LIFO inventory calculation without significantly reducing the LIFO benefits received. Careful consideration should be given to each of the submethod elections.

If a taxpayer uses the LIFO inventory method without filing the required Form 970, the IRS may terminate the taxpayer's LIFO election and include the LIFO reserve in income. For taxpayer who have used the LIFO inventory method in a previously filed tax return without the required filing of an election to use (or extend) the method, there may be an opportunity to correct this omission. Regs. Sec. 301.9100 allows taxpayers that start using the LIFO inventory method without fihng the required Form 970 to request an extension of time to make the LIFO election. Such an extension of time to make a LIFO election is at the IRS'S discretion.

Temp. Regs. Sec. 301.9100-2T provides for an automatic 12-month extension from the original deadline for making the LIFO inventory election. Under the automatic extension, the taxpayer files an original or amended return for the year that the LIFO election should have been made, labeling the return "FILED PURSUANT TO [section] 301.9100-2T", and attaching the Form 970 necessary to make the election to that return. There is no user fee for this automatic extension.

If the 12-month period for the automatic extension under Temp. Regs. Sec. 301.9100-2T has passed, the taxpayer may still be able to obtain relief with respect to the missing LIFO election. Temp. Regs. Sec. 301.9100-3T provides that requests for extensions of time to file elections win be granted by the Service if the taxpayer provides evidence, including affidavits, to establish that the taxpayer acted reasonably and in good faith, and that the granting of relief will not prejudice the interests of the government.

Filing for relief under Temp. Regs. Sec. 301.9100-3T is treated as a request for a letter ruling; therefore, a user fee of $3,650 applies to requests filed on or after Mar. 1, 1997. See Rev. Proc. 97-1 for information on required attachments and statements for letter ruling requests.