Dollar-Value LIFO Regulations;
Inventory Price Index Computation Method

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [TD 8976] RIN 1545-
AX20

TITLE: Dollar-Value LIFO Regulations; Inventory Price Index
Computation Method

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations under section 472
of the Internal Revenue Code that relate to accounting for
inventories under the last-in, first-out (LIFO) method. The final
regulations provide guidance regarding methods of valuing dollar-
value LIFO pools and affect persons who elect to use the dollar-
value LIFO and inventory price index computation (IPIC) methods or
who receive dollar-value LIFO inventories in certain nonrecognition
transactions.

DATES: Effective Date: These regulations are effective on December
31, 2001. Applicability Date: For dates of applicability, see
§§1.472-8(e)(3)(v) and 1.472- 8(h)(4).

FOR FURTHER INFORMATION CONTACT: Leo F. Nolan II at (202) 622-4970
(not a toll-free call).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information in this final rule have been reviewed
and, pending receipt and evaluation of public comments, approved by
the Office of Management and Budget (OMB) under 44 U.S.C. 3507 and
assigned control number 1545-1767. The collections of information in
this regulation are in §1.472-8(e)(3)(iii)(B)(3) and (e)(3)
(iv). To elect the IPIC method, a taxpayer must file Form 970,
"Application to Use LIFO Inventory Method." This information is
required to inform the Commissioner regarding the taxpayer's
elections under the IPIC method. This information will be used to
determine whether the taxpayer is properly accounting for its
dollar-value pools under the IPIC method. The collections of
information are required if the taxpayer wants to obtain the tax
benefits of the LIFO method. The likely respondents are business or
other for-profit institutions, and/or small businesses or
organizations. An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless it
displays a valid control number assigned by the Office of Management
and Budget.

The reporting burden contained in §1.472-8(e)(3)(iii)(B)(3) and
(e)(3)(iv) is reflected in the burden of Form 970.

Comments on the collections of information should be sent 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, with copies to the Internal Revenue
Service , Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S,
Washington, DC 20224..

Books or records relating to a collection of information must be
retained as long as their contents may become material 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 472 of the Internal Revenue Code (Code) permits a taxpayer
to account for inventories using a last-in, first-out (LIFO) method
of accounting. Section 472(f) directs the Secretary to prescribe
regulations that permit the use of suitable published governmental
price indexes for purposes of the LIFO method. The IRS and Treasury
Department prescribed the inventory price index computation (IPIC)
method in §1.472- 8(e)(3) (TD 7814, 47 FR 11271, 1982-1 C.B.
84) (the current regulations), under the authority contained in
sections 472 and 7805. A taxpayer using the IPIC method must base
its inventory price indexes on the consumer price indexes or
producer price indexes published by the United States Bureau of
Labor Statistics (BLS). The IPIC method was intended to simplify the
use of the dollar-value LIFO method, so that the LIFO method could
be used by more taxpayers and so that taxpayers already using the
dollar-value LIFO method would have a simpler alternative method of
computing an index for their dollar-value pool.

On May 19, 2000, the IRS and Treasury Department published a notice
of proposed rulemaking (REG-107644-98, 65 FR 31841, 2000-23 I.R.B.
1229) (the proposed regulations) intended to simplify and clarify
certain aspects of the IPIC method. In addition, the proposed
regulations provided rules for computing the LIFO value of a dollar-
value pool when a taxpayer receives LIFO inventories in certain
nonrecognition transactions. Comments responding to the notice were
received, and a public hearing was held on September 15, 2000.

The IRS and Treasury Department received 16 comment letters
concerning the proposed regulations. After considering the comments
contained 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 and Summary of Comments

1. Overview

Under the last-in, first-out (LIFO) method, inventory on hand at the
end of the year is treated as consisting of "layers," first of
inventory on hand at the beginning of the year (in the order of
acquisition), and then of any inventory acquired during the current
year. Section 1.472-8 permits a taxpayer to use the dollar-value
LIFO method, which accounts for all items in an inventory "pool"
(dollar-value pool) in terms of dollars of cost rather than in terms
of quantities and prices of specific goods. Specifically, the
taxpayer annually determines the existence of an increase
(increment) or decrease (liquidation) in a dollar-value pool by
comparing inventory quantities measured in terms of equivalent-value
dollars (base-year cost). The current-year cost of beginning and
ending inventory is converted into base-year cost using an inflation
index, which is the ratio of the dollar-value pool's total current-
year cost to its total base-year cost. By subtracting the base-year
cost of the dollar-value pool at the beginning of the taxable year
from the base-year cost of the dollar-value pool at the end of the
taxable year, the taxpayer determines the amount of any resulting
increment or liquidation. Finally, the taxpayer computes the LIFO
value of an increment (layer) by multiplying that increment's base-
year cost by an inflation index.

The current regulations provide an alternative method for a taxpayer
to determine an inflation index. Under the inventory price index
computation (IPIC) method, the taxpayer computes an inventory price
index (IPI) based on the consumer price indexes (CPI) or producer
price indexes (PPI) published monthly by the United States Bureau of
Labor Statistics (BLS) in the "CPI Detailed Report" and "PPI
Detailed Report," respectively. See also To facilitate a taxpayer's
use of the IPIC method, the final regulations use new, more-
descriptive terms for some IPIC method concepts. For example, pool
index has been replaced with IPI, appropriate index has been
replaced with category inflation index, and index category has been
replaced with BLS index category. Within this preamble, the
discussion of the current and proposed regulations uses both old and
new terms, and the discussion of the final regulations generally
uses the new terms.

2. Inventory Price Index - 20 percent reduction

The current regulations state that "[a]n inventory price index
computed [under the IPIC method] shall be a stated percentage of the
percent change in the selected consumer or producer price index or
indexes for a specific category or categories of goods." For this
purpose, "stated percentage" means "100 percent" in the case of an
eligible small business, as defined in section 474 (i.e., average
annual gross receipts for the three preceding taxable years do not
exceed $5,000,000), and "80 percent" in all other cases. The
proposed regulations retained this 20 percent reduction for large
taxpayers.

Several commentators objected to the continuing requirement that
large taxpayers reduce the IPI by 20 percent. Some of these
commentators opined that the IPIC method is effectively a safe
harbor method that significantly simplifies the LIFO computation and
reduces IRS and taxpayer controversy; however, the 20 percent
reduction is a major deterrent to its use by large taxpayers. Others
argued that the CPI and PPI are representative of true inflation
and, therefore, the 20 percent reduction decreases the accuracy of
the IPIC method. Other commentators recommended that the stated
percentage not be decreased by 20 percent until the taxpayer's gross
receipts exceed $10,000,000. In their view, a taxpayer's gross
receipts are likely to exceed $5,000,000 by the time the taxpayer's
business is profitable enough to benefit by changing to the LIFO
method.

The 20 percent reduction contained in the current regulations
represents a balance between two competing tax policies --
simplification and prevention of adverse selection. The IPIC method
was developed originally to simplify the LIFO rules so that small
businesses that could not compute an internal inflation index could
use the LIFO method. Nonetheless, availability of the method was
provided to all taxpayers because it was believed to be too
difficult to define the class of taxpayers for which the LIFO rules
were unduly burdensome and inappropriate to prevent large taxpayers
from using the simplified method. Allowing all taxpayers to use the
CPI or PPI regardless of the rate of inflation they actually
experienced, however, provided an opportunity for adverse selection
whereby a sophisticated taxpayer would adopt the IPIC method only
when the inflation reflected in the CPI or PPI exceeded the
taxpayer's internal rate of inflation. The 20 percent reduction of
the IPI was incorporated into the current regulations to reduce this
potential for adverse selection.

The IRS and Treasury Department now believe that the benefits of
simplification (and reduced controversy) obtained from the IPIC
method outweigh the need to prevent adverse selection. Consequently,
the final regulations eliminate the requirement to reduce the IPI by
20 percent. All taxpayers electing to use the IPIC method may use
100 percent of the IPI to compute the LIFO value of a dollar-value
pool.

3. Use of 10 Percent Categories and BLS Weights

The current regulations provide rules for assigning the items in a
dollar-value pool to the applicable categories listed in the "CPI
Detailed Report" or the "PPI Detailed Report" for which the BLS
publishes corresponding cumulative price indexes (BLS categories and
BLS price indexes, respectively) for purposes of computing the IPI
for a dollar-value pool. In very simple terms, taxpayers use a
process of elimination to assign all the items in a dollar-value
pool to BLS categories that include at least 10 percent of the total
inventory value (10 percent BLS categories) and then use the
corresponding BLS weights to compute a weighted-average appropriate
index for the items assigned to those 10 percent BLS categories.

The proposed regulations eliminate the requirements to use the 10
percent BLS categories and BLS weights to compute an appropriate
index because it was believed that these requirements did not
provide the intended simplicity but rather added. unnecessary
complexity to the IPIC method. Instead, the proposed regulations
require the taxpayer to assign items in a dollar-value pool to the
most-detailed BLS categories listed in the "CPI Detailed Report" or
the "PPI Detailed Report," whichever is applicable, and to weight
the BLS price indexes based on the relative current-year cost of the
items assigned to those BLS categories.

Several commentators objected to the elimination of the requirement
to use the 10 percent BLS categories and BLS weights to compute an
appropriate index. They suggested that this regime does in fact
provide simplification for some taxpayers and consequently should be
retained as an option, particularly for retail grocers that would
have to incur substantial administrative costs to have the items
contained in their dollar-value pools assigned to numerous, most-
detailed BLS categories. Other commentators supported the
elimination of the requirement to use BLS weights, arguing that this
will reduce both the complexity of the IPIC method and the potential
for distortion caused by the use of the BLS weights. However, these
commentators generally recommended retention of the 10 percent
categories or, alternatively, modification of the proposed rule to
permit a taxpayer to assign items in a dollar-value pool to less-
detailed BLS categories (e.g., using 6-digit or 4-digit commodity
codes in the PPI). Another commentator suggested lowering the
testing threshold from 10 percent to 8 percent.

The IRS and Treasury Department now understand that the requirement
to use 10 percent BLS categories and BLS weights provides simplicity
for some taxpayers but complexity for others. Accordingly, the final
regulations retain the 10 percent BLS. categories and BLS weights as
an elective method (10 percent method) of determining the category
inflation index of a 10 percent BLS category. The final regulations
clarify, however, that to determine whether a BLS category may be
selected under the 10 percent method, a taxpayer must compare the
current-year cost of the items in that category to the total
current-year cost of the items in the dollar-value pool, not to the
total current-year cost of the items in the taxpayer's entire
inventory.

4. Weighted Harmonic Mean for Computing Inventory Price Index

A pool index computed using the dollar-value LIFO method should
reflect a weighted average of the inflation rates of the items
contained in the ending inventory of the dollar-value pool. The
current regulations state that the appropriate indexes are weighted
according to the relative current-year costs of the items in each
selected BLS category. However, the regulations do not state how a
taxpayer computes a weighted average of the appropriate indexes
using the amount of relative current-year costs in each selected BLS
category. An example of IPIC weighting methodology is found in Rev.
Proc. 84-57 (1984-2 C.B. 496), which shows the computation of an IPI
based on a weighted arithmetic mean of the appropriate indexes.
(Weighted Arithmetic Mean = [Sum of (Weight x Appropriate Index)] /
Sum of Weights). In addition, an example found in Rev. Proc. 98-49
(1998-2 C.B. 321) uses a weighted arithmetic mean to compute a
weighted-average percent change for a selected BLS category.

The proposed regulations provide that the pool index must be
computed using a weighted harmonic mean, instead of a weighted
arithmetic mean, based on the relative. current-year costs in the
dollar-value pool. (Weighted Harmonic Mean = Sum of Weights / Sum of
(Weight / Appropriate Index)).

Using a weighted arithmetic mean of the category inflation indexes
of the BLS categories represented in a dollar-value pool is not a
mathematically correct method of computing the IPI for the pool when
the corresponding weights are the relative current-year costs at the
end of the taxable year. If a taxpayer's dollar-value pool has the
same quantity of two items with identical base-year costs, the IPI
should reflect the inflation rates of the two items equally.
However, a weighted arithmetic mean of the category inflation
indexes will assign more weight to the inflation rate of the item
that has the higher current-year cost. Thus, the mean will be skewed
in favor of BLS categories that experience higher rates of
inflation, and the IPI will be overstated. This result also will
occur when the items in the dollar-value pool experience deflation
because too much weight will be assigned to the BLS categories that
experience less deflation.

Several commentators objected to the mandatory use of the weighted
harmonic mean when computing an IPI. Acknowledging that an IPI based
on a weighted harmonic mean is mathematically correct, these
commentators stated that the inaccuracy built into a weighted
arithmetic mean is offset (in the case of larger taxpayers) by the
20 percent reduction of the "stated percentage." Thus, they
recommended that taxpayers be permitted to continue computing IPIs
based on a weighted arithmetic mean rather than be required to incur
additional administrative costs to begin computing IPIs based on a
weighted harmonic mean.

The IRS and Treasury Department did not adopt these suggestions
because a weighted arithmetic mean based on relative current-year
costs at the end of the period is not mathematically correct and the
conversion from a weighted arithmetic mean to a weighted harmonic
mean is not unduly burdensome. To assist taxpayers that need to
change to a weighted harmonic mean, the final regulations include
the formula for, and examples of, computing a weighted harmonic
mean.

On the other hand, the use of a weighted arithmetic mean is
mathematically correct when computing a weighted-average category
inflation index based on relative costs at the beginning of the
taxable year. The published BLS weights applicable for a taxable
year are essentially based on relative costs at the beginning of the
period. Therefore, whenever it is necessary to compute the category
inflation index of a 10 percent BLS category using BLS weights,
taxpayers must compute a weighted arithmetic mean. When computing
the IPI for a dollar-value pool, however, even taxpayers electing to
use the 10 percent method must use the weighted harmonic mean based
on the current-year cost of the items assigned to each 10 percent
BLS category.

5. Selecting an Appropriate Month

The current regulations state that a taxpayer not using the retail
method must select price indexes "as of the month or months" most
appropriate to its method of determining current-year cost
(appropriate month), or make a one-time binding election of an
appropriate representative month (representative month). In the case
of a retailer using the retail method, the appropriate month is the
last month of the retailer's taxable year. The IRS has ruled that a
month is a representative month if a nexus exists. between the
selected month, the taxpayer's method of determining current-year
cost, and the taxpayer's historic experience of inventory purchases.
Rev. Rul. 89-29 (1989-1 C.B. 168). In practice, many taxpayers have
been confused about the meaning of "month or months most appropriate
to the taxpayer's method of determining current-year cost."

The proposed regulations clarify that for each dollar-value pool, a
taxpayer not using the retail method either must annually select an
appropriate month or must make an election to use a representative
month. The principles of Rev. Rul. 89-29, which have been
incorporated into the final regulations, continue to apply for the
purpose of determining whether a particular month is appropriate or
representative. Several commentators stated that taxpayers should be
permitted to use two IPIs for each taxable year (dual indexes), so
that they will not be denied the right to use the earliest
acquisitions method of determining current-year costs. These
commentators suggest that a taxpayer whose accounting system
determines the current-year cost of ending inventory using a first-
in, first-out (FIFO) method (i.e., most recent purchases) could
compute an IPI based on indexes selected from the CPI or PPI
applicable to a month late in the taxable year to deflate the
current-year cost of items in ending inventory for the purpose of
determining whether an increment or liquidation has occurred during
the taxable year. If there is an increment, the taxpayer would
compute a second IPI based on indexes selected from the CPI or PPI
applicable to a month early in the taxable year to inflate the base-
year cost of the increment to its LIFO value based on its "pricing
election" (i.e., earliest acquisitions).

The IRS and Treasury Department did not adopt this suggestion for
several reasons. First, the IPIC method and the earliest
acquisitions method are not mutually exclusive. In fact, the current
and proposed IPIC regulations clearly permit an electing taxpayer to
use any method of determining current-year cost permitted under
§1.472- 8(e)(2)(ii), including the earliest acquisitions
method. A dual index IPIC method is not needed to ensure that an
electing taxpayer will be able to use the earliest acquisitions
method. However, the earliest acquisitions method is available under
the IPIC method only to a taxpayer that actually computes the
current-year cost of its ending inventory using the earliest
acquisitions method because use of a dual index is inconsistent with
the IPIC method's concept of an appropriate month. The appropriate
month concept requires a taxpayer to select a month that correlates
with its actual method of computing current-year cost and its
experience with inventory purchases. As explained in Rev. Rul.
89-29, "[t]he timing of the index (and the month selected) must
relate to the timing of the determination of current-year cost,
otherwise distortion would occur." The determination of an
appropriate month is not a choice between equally acceptable methods
of determining current-year cost, but depends on the taxpayer's
actual method of determining current-year cost and actual purchases.
Thus, a taxpayer using a calendar tax year may select January as the
appropriate month only if items represented in the ending inventory
were purchased in January and the taxpayer determines the current-
year cost of the ending inventory based on the cost of those January
purchases..

Moreover, though a dual index IPIC method would eliminate the
requirement to determine the actual earliest acquisitions cost of
the items in a dollar-value pool, the method would not simplify a
taxpayer's use of the dollar-value LIFO method. A dual index IPIC
method will require an electing taxpayer to compute (and the IRS to
examine) twice as many category inflation indexes because the
taxpayer would need BLS price indexes that reflect its inflation
experience under the most recent purchases method as well as under
the earliest acquisitions method. Similarly, a dual index IPIC
method would require a taxpayer to select twice as many appropriate
or representative months for each taxable year. Not only does the
requirement to select two appropriate months increase the complexity
of the IPIC method, it also decreases the accuracy of the method as
some accuracy is lost as a result of determining the appropriate
month for the entire pool rather than for each inventory item or
each BLS category. In summary, the IPIC method was intended to
simplify the dollar-value LIFO method, primarily so it could be used
by taxpayers that were otherwise unable to use the method. The IPIC
method was neither intended nor designed to serve as a surrogate for
determining the earliest acquisitions cost of the items in a dollar-
value pool. The prohibition on the use of dual indexes in connection
with the IPIC method, however, does not necessarily mean that the
use of dual indexes will be prohibited in the context of other LIFO
methods.

Several commentators objected to the rule that requires a taxpayer
using both the retail method and LIFO method to use the last month
of the taxable year as its appropriate month. In their view, a month
in the middle of the year would be more. representative because the
retail method produces an average cost for a group of goods based on
purchases for an entire year.

The IRS and Treasury Department did not adopt this suggestion
because they believe that the appropriate month for a taxpayer using
the retail method is the last month of the taxable year. Section
1.471-8 generally requires that a taxpayer adjust retail selling
prices of the goods on hand at the end of the year to cost based on
the ratio of goods available for sale at cost to goods available for
sale at retail (the cost complement percentage). While this ratio
may reflect an average cost complement percentage for the year, it
is applied to retail selling prices of the goods on hand at the end
of the taxable year rather than the average retail selling price of
these goods during the year. Consequently, the approximate cost
determined under the retail method is not necessarily equal to the
average cost of the inventory. One commentator suggested that the
final regulations should include factors for determining an
appropriate month. Other commentators requested an example showing
how to determine an appropriate month when a short taxable year
follows the first taxable year that a taxpayer uses the IPIC method.
In response to these comments, the final regulations incorporate the
guidance on an appropriate representative month (including three of
the examples) found in Rev. Rul. 89-29.

6. Calculation of a Category Inflation Index

The proposed regulations generally provide that in the case of a
taxpayer using the double-extension IPIC method, the inflation index
for a selected BLS category is equal to the quotient of the BLS
price index for the appropriate or representative month of the
current taxable year and the month preceding the first day of the
base year. In the case of a taxpayer using the link-chain IPIC
method, the inflation index for a selected BLS category is equal to
the BLS price index for the appropriate or representative month of
the current taxable year divided by the appropriate or
representative month used for the immediately preceding taxable
year. However, if the first taxable year the taxpayer uses the IPIC
method also is the first taxable year the taxpayer uses the dollar-
value LIFO method, the inflation index is equal to the quotient of
the published cumulative index for the appropriate or representative
month for the current taxable year divided by the published
cumulative index for the month immediately preceding the first day
of the taxable year.

Several commentators argued that the prescribed calculation for the
first taxable year a taxpayer uses both the dollar-value LIFO and
IPIC methods is likely to overstate or understate inflation if the
taxpayer has opening inventories, unless the opening inventories
were purchased during the last month of the preceding taxable year.
To address this concern, the commentators suggested that a taxpayer
be permitted to compare the BLS price index for the appropriate
month of the first LIFO taxable year with the BLS price index for
the appropriate month of the taxpayer's last non-LIFO taxable year.
Another commentator suggested that the denominator in this formula
should be the BLS price index that reflects prices during the last
inventory turn of the immediately preceding taxable year.

The IRS and Treasury Department agree with the commentators'
concerns. In addition, the IRS and Treasury Department recognize
that the same problem exists under the proposed regulations as a
result of the requirement to use the month preceding the first day
of the base year to compute an appropriate index under the double-
extension IPIC method. Accordingly, the final regulations generally
provide that a category inflation index should be computed with
reference to the BLS price indexes for an appropriate month of the
year preceding its LIFO election (in the case of the double-
extension IPIC method) or of the preceding year (in the case of the
link-chain IPIC method). In addition, the final regulations
incorporate the general guidance of Rev. Proc. 98-49 concerning the
computation of a category inflation index when a selected BLS
category is revised for the taxable year.

7. Scope of an IPIC Method Election

The current regulations generally require a taxpayer using the IPIC
method to use that method to account for all items accounted for
using the LIFO method (LIFO inventory items). The current
regulations also prohibit the use of the IPIC method by a taxpayer
that is eligible to use BLS price indexes prepared for the purpose
of valuing the LIFO inventory items of a specific industry. For
example, a taxpayer eligible to use the BLS retail price indexes
published in "Department Store Inventory Price Indexes" (DSIP
indexes) may not use the IPIC method.

The proposed regulations liberalize the eligibility restrictions
applicable to the IPIC method in two respects. First, a taxpayer
must use the IPIC method for all items accounted for under the
dollar-value LIFO method, but not for all items accounted for under
the LIFO method. Second, a taxpayer eligible to use DSIP indexes may
elect to use the IPIC method for all its LIFO inventory items or for
those LIFO inventory items that do not fall within any of the 23
major groups listed in "Department Store Inventory Price Indexes."

Several commentators objected to the proposed general requirement
that an electing taxpayer use the IPIC method for all its LIFO
inventory items. In their view, section 446(d) permits a taxpayer to
elect the IPIC method for each trade or business. The requirement to
use the IPIC method for all LIFO inventory items, as originally
promulgated, was designed to prevent adverse selection. The IRS and
Treasury Department understand, however, that taxpayers often have
valid business reasons for using the IPIC method in some businesses
but not in others. For example, a taxpayer may have difficulty using
the double-extension method in one of its trades or businesses but
not in another. Accordingly, the final regulations permit a taxpayer
to limit its IPIC election to one or more specific trades or
businesses.

8. Selection of "CPI Detailed Report" or "PPI Detailed Report"

The current regulations state that a retailer may select price
indexes from the "CPI Detailed Report" or the "PPI Detailed Report,"
but if equally appropriate price indexes may be selected from
either, a retailer using the retail method must select from the "CPI
Detailed Report," and a retailer not using the retail method must
select from the "PPI Detailed Report."

The proposed regulations eliminate the requirement that retailers
determine whether the "CPI Detailed Report" and "PPI Detailed
Report" contain equally appropriate price indexes. Instead, the
proposed regulations require retailers using the retail method to
select price indexes from the "CPI Detailed Report" and require all
other taxpayers using the IPIC method to select price indexes from
the "PPI Detailed Report."

Several commentators suggested that the IRS and Treasury Department
permit all retailers using the IPIC method to select price indexes
from either the "CPI Detailed Report" or the "PPI Detailed Report."
These commentators argue that many retailers selecting price indexes
from the CPI do not use the retail method and would be forced to
change. This change would be particularly burdensome because the
categories listed in the "PPI Detailed Report" are far more detailed
(and less correlated) than those listed in the "CPI Detailed
Report." In addition, these commentators argue that the proposed
rule fails to recognize that the PPI does not necessarily reflect
cost for retailers not using the retail method because the majority
of retailers purchase their goods from wholesalers not producers.
Finally, the commentators expressed concern that the proposed rule
would preclude retailers that use the retail method at their stores
and a cost method at their warehouses from using the price indexes
listed in the "CPI Detailed Report" when retail price information is
not ascertained or readily available for goods in warehouses.

The IRS and Treasury Department generally agree with the
commentators' concerns. Accordingly, the final regulations permit
all retailers using the IPIC method to assign items in dollar-value
pools to the BLS categories listed in either the "CPI Detailed
Report" or the "PPI Detailed Report," whichever is selected.

9. BLS Category for Work-in-Process.

The proposed regulations provide that manufacturers and processors
must assign all work-in-process (WIP) items in a dollar-value pool
to the most-detailed index categories that include the finished
goods into which the WIP item will be manufactured or processed. For
this purpose, finished good means any good that is in a salable
state.

Several commentators objected to the proposed requirement that a
taxpayer compute a separate inflation index for a WIP item that is
in a salable state but not regularly sold by the taxpayer.

The IRS and Treasury Department agree with the commentators'
objection to the extent that the taxpayer's WIP items are merely
salable. Accordingly, the final regulations provide that a taxpayer
is not required to compute a separate category inflation index for a
salable WIP item, unless the taxpayer regularly sells that WIP item.

10. Relocation and Clarification of Special Pooling Rules

The current regulations provide special, elective pooling rules for
retailers, wholesalers, jobbers, and distributors that use the IPIC
method. These taxpayers are permitted to establish a dollar-value
pool for any group of goods included in one of the 11 general
categories of consumer goods described in the "CPI Detailed Report."
In addition, Rev. Proc. 84-57 provides that inventory pools may be
established for any group of goods included within one of the 15
general categories of producer goods described in Table 6 of the
"PPI Detailed Report." Finally, the regulations provide that dollar-
value pools that comprise less than 5 percent of inventory value may
be combined to form a single miscellaneous dollar-value pool. If the
resulting. miscellaneous dollar-value pool itself comprises less
than 5 percent of inventory value, that pool may be combined with
the largest dollar-value pool.

The proposed regulations retain the special, elective pooling rules
for inventory items accounted for under the IPIC method contained in
the current regulations and incorporate the special, elective
pooling rules contained in Rev. Proc. 84-57. Several commentators
asked whether taxpayers must apply the 5 percent rules to a dollar-
value pool annually and, if so, how they are to account for dollar-
value pools that no longer satisfy the 5 percent threshold. One
commentator suggested that the IRS and Treasury Department make
these 5 percent rules optional, state whether these rules are
methods of accounting, and require taxpayers to apply the principles
of §1.472-8(g)(2) when changing dollar-value pools because of
these 5 percent rules. Another commentator recommended that
taxpayers be permitted to include inventories not accounted for
under the LIFO method in "inventory value" when determining whether
the 5 percent rules apply.

The IRS and Treasury Department believe that both of the 5 percent
rules for dollar-value pools have been, and remain, optional. Under
the current and proposed regulations, a taxpayer may, but is not
required to, combine two or more specific dollar-value pools into a
single miscellaneous dollar-value pool when the cost of each
specific dollar-value pool does not exceed 5 percent of the total
cost of the taxpayer's LIFO inventory. In addition, a taxpayer may,
but is not required to, combine the single miscellaneous dollar-
value pool and the largest specific dollar-value pool when cost of
the miscellaneous dollar-value pool does not exceed 5 percent of the
total cost of the. taxpayer's LIFO inventory. Furthermore, the IRS
and Treasury Department believe that both of the 5 percent rules are
methods of accounting within the broader IPIC pooling method, so a
taxpayer may not change to, or cease using, either of the 5 percent
rules without obtaining the Commissioner's prior consent. In
addition, any change in pooling required by the taxpayer's proper
use of the 5 percent rule(s) is a change in method of accounting.
Thus, the final regulations require a taxpayer in these
circumstances to combine and separate its dollar-value pools in
accordance with §1.472-8(g). Moreover, the final regulations
require a taxpayer to determine whether to separate or combine the 5
percent pools every third taxable year based on current-year data
rather than on average data.

11. New Base Year for IPIC Method Changes

The current regulations require a taxpayer that changes to the IPIC
method from another dollar-value LIFO method to treat the year of
change as the base year in determining the LIFO value of the dollar-
value pool(s) for the year of change and later taxable years. The
taxpayer is required to restate the base-year cost of the existing
increments in terms of new base-year cost, which also requires the
restatement of the IPI of each of the layers. This procedure is
referred to alternatively as updating the base year or establishing
a new base year.

One commentator suggested eliminating the reference to
§1.472-8(f)(2) in the case of a voluntary change from the
specific goods LIFO method to the dollar-value LIFO method because
taxpayers and tax practitioners have long questioned how to
implement this change without updating the base year. The final
regulations adopt this. suggestion and require a taxpayer changing
from the specific goods LIFO method to the IPIC method to establish
a new base year. Although guidance addressing taxpayers changing
from the specific goods LIFO method to a dollar-value LIFO method
other than the IPIC method is outside the scope of these
regulations, the IRS and Treasury Department are considering whether
to issue additional guidance to address the commentator's concerns
regarding changes from the specific goods method to a dollar-value
LIFO method.

The proposed regulations clarify that the base-year-updating
procedure is mandatory for voluntary changes to the IPIC method.
However, the proposed regulations authorized examining agents to
require a change to the IPIC method in circumstances where the
taxpayer's prior method does not clearly reflect income and to
implement the change using a cutoff method in circumstances where
the taxpayer's books and records lacked the information necessary to
compute a section 481(a) adjustment. The latter provision was
intended to provide examining agents with an alternative to LIFO
termination in appropriate circumstances.

One commentator objected to giving examining agents the authority to
require a taxpayer using a LIFO method to change to the double-
extension IPIC method even when the taxpayer produces records that
will allow the agent to calculate the effect of changing to a
correct method other than the IPIC method. This commentator
requested "clear-cut" published guidance on the types of records
that taxpayers using a LIFO method must retain and the length of
time that they must retain them. In addition, because of the
administrative burden associated with record retention
(particularly. those records needed for LIFO methods not used by the
taxpayer), this commentator requested that the IRS and Treasury
Department create a shortcut procedure, similar to the three-year
transition rule under §1.263A-7(c)(2)(iv), to calculate the
effect of changing the taxpayer's LIFO method. Finally, this
commentator suggested that the IRS and Treasury Department, as a
matter of fairness, permit a taxpayer to recompute each year's layer
using the IPI for that year.

Several commentators urged the IRS and Treasury Department to
withdraw the involuntary change provisions entirely or,
alternatively, to modify them to give examining agents discretion to
impose a change to the double-extension IPIC method with or without
establishing a new base year. One of these commentators also urged
the IRS and Treasury Department to give these examining agents
discretion to impose a change to either the double-extension IPIC
method or the link-chain IPIC method. In response to these comments,
the final regulations provide that an examining agent may change a
taxpayer from a LIFO method that does not clearly reflect income to
the IPIC method. If the agent decides to change the taxpayer to the
IPIC method, and the taxpayer does not provide sufficient
information from its books and records to compute an adjustment
under section 481, the agent may implement the change using the
simplified transition method. Under the simplified transition
method, the agent makes certain assumptions regarding the
composition of ending inventory in prior taxable years and
recomputes the LIFO value of each dollar-value pool as of the
beginning of the year of change using the IPIC method. The section
481(a) adjustment arising from the accounting method change is equal
to the difference between that recomputed LIFO value and the LIFO
value of the dollar-value pool determined under the taxpayer's
former method. The IRS and Treasury Department are considering other
simplified methods of computing a section 481(a) adjustment arising
from a change from one LIFO method to another and may publish
additional guidance in the future. The suggestion regarding the
issuance of guidance on a taxpayer's record keeping requirement is
beyond the scope of this project, but will be considered for
possible future guidance.

12. Inventories Received in Certain Nonrecognition Transactions

An election to use the dollar-value LIFO method for LIFO inventories
received in a nonrecognition transaction to which section 381 does
not apply (non-section 381 transfer) may not continue the LIFO
reserve of the transferor. If the mix of goods in the inventory
changes significantly after the transfer, the mechanics of the
dollar-value LIFO method may produce an artificial increment in the
year the inventories are received that effectively eliminates the
LIFO reserve established by the transferor. This artificial
increment occurs because the base-year cost of new items are
reconstructed to the transferee's base year (i.e., the year it
elects LIFO) and not to the transferor's base year. When a
transferee elects the LIFO and IPIC methods for LIFO inventories
received in a non-section 381 transfer, the transferee will have an
artificial increment in the year the inventories are received even
without a significant change in the mix of goods in its ending
inventory. The IPIC method invariably produces an increment because
the difference between the current-year cost and the carryover basis
of the transferred inventories (i.e., the base-year cost) reflects
more than one year's inflation and the IPI used to convert the
current-year cost of the dollar-value pool at the end of the taxable
year to base-year cost will reflect only one year's inflation.

To prevent the recapture of a transferor's LIFO reserve in a non-
section 381 transfer, the proposed regulations require the
transferee to update its base-year cost if a transferee uses the
dollar-value LIFO method for inventories received in a non-section
381 transfer and the transferor accounted for those inventories
using the dollar-value LIFO method as follows. First, the
transferee's base year for the inventories received from the
transferor is the year of transfer. Second, the transferee's base-
year cost for the inventories received from the transferor is equal
to the transferor's current-year cost for those inventories.
Finally, if the transferee owned inventories prior to the transfer,
the new base-year cost of those inventories will be equal to their
current-year cost. The proposed regulations do not affect either the
ability of a newly formed transferee to elect new accounting methods
or the holdings of Rev. Rul. 70-564 (1970- 2 C.B. 109) and Rev. Rul.
70-565 (1970-2 C.B. 110). However, the proposed regulations do not
apply to a non-section 381 transfer if its principal purpose is to
avail the transferee of a method of accounting that is unavailable
to the transferor (or is unavailable to the transferor without the
Commissioner's consent).

One commentator asserted that when a taxpayer described in Rev. Rul.
70-564 (i.e., no beginning LIFO inventories) applies the proposed
rule to transferred inventories, the resulting IPI of the collapsed
base-year layer will not equal 1. Because this result may cause some
confusion, the commentator suggested including an example in the
final regulations. The final regulations include an example.
demonstrating the computation of increments and liquidations after a
new base year is established.

Several commentators asserted that the proposed rule may result in
the creation of an artificial increment or liquidation when a
transferee and transferor use different methods of determining
current-year costs. Thus, the regulations should be changed to
permit a transferee to establish (or reconstruct) the new base-year
cost of the transferred inventories equal to the transferor's first-
in, first-out cost for the year immediately preceding the year of
transfer, or alternatively, if the final regulations continue to
require the use of the transferor's current-year cost and current-
year cost method, the regulations should be changed to provide that
the period for measuring inflation for the base year is between the
appropriate month for determining base-year cost and the appropriate
month for determining current-year cost. In addition, one
commentator suggested that the final regulations be changed to
clarify that "beginning inventory, if any" refers only to inventory
that the transferee actually owned before the nonrecognition
transaction.

The IRS and Treasury Department agree with these commentator's
concerns.

Accordingly, the final regulations permit the transferee to compute
the base-year cost of transferred inventories using its current-year
cost and its method of determining current-year cost. The final
regulations also clarify the meaning of beginning inventory. Another
commentator contended that the holding of Rev. Rul. 70-564 is
incorrect and, thus, the average cost rule of section 472(b)(3)
should not be applied to inventories received by a transferee
without an existing LIFO election in a non-section 381 transfer. In
addition, this commentator noted that the holding of Rev. Rul.
70-564 is inconsistent with §1.1502-13 (concerning intercompany
transactions), which generally provides that an intercompany
transaction may not change the timing of the recognition of income
or deductions. This commentator suggested that the holding of Rev.
Rul. 70-565, which provides for a carryover of a transferor's LIFO
layer history in a section 351 transfer to a transferee with an
existing LIFO election, should be applied in all non-section 381
transfers.

The IRS and Treasury Department believe this comment is outside the
scope of these final regulations. However, in response to this
comment, the IRS and Treasury Department are reconsidering whether
to continue to require different results upon the transfer of LIFO
inventories in a non-section 381 transfer (as currently required by
Rev. Rul. 70-564 and Rev. Rul. 70-565 ) depending upon whether the
transferee has an existing LIFO election.

13. Effective Date of Final Regulations

The proposed regulations provide that proposed
§§1.472-8(b)(4), (c)(2), and (e)(3) will apply to taxable
years beginning on or after the date they are published in the
Federal Register as final regulations. In addition, the proposed
regulations provide that proposed §1.472-8(h) will apply to
transfers occurring on or after the date it is published in the
Federal Register as a final regulation. One commentator suggested
that taxpayers be permitted, but not required, to apply
§§1.472-8(b)(4), (c)(2), and (e)(3) for taxable years
ending on or after the date the regulations are published in the
Federal Register as final regulations. This commentator also
suggested that taxpayers be permitted to apply §1.472-8(h) to
transfers occurring during the taxable year ending on or after the
date the regulations are published in the Federal Register as final
regulations. In addition, several commentators suggested that the
transition period for an automatic change in method of accounting to
comply with §§1.472-8(b)(4), (c)(2), and (e)(3) be
extended to include the second taxable year ending on or after the
date the regulations are published in the Federal Register as final
regulations.

The IRS and Treasury Department agree with these suggestions.
However, in order to ensure that taxpayers may implement these
changes for taxable years ending December 31, 2001, as requested by
the commentators, the final regulations are effective for taxable
years ending on or after December 31, 2001.

Effect on Other Documents

Rev. Proc. 84-57, Rev. Rul. 89-29, and Rev. Proc. 98-49 are obsolete
on January 9, 2002.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory 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 regulations. Pursuant
to section 7805(f) of the Code, the proposed regulations preceding
this Treasury decision was submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on their
impact on small business. It is hereby certified that the
collections. of information in this Treasury decision will not have
a significant economic impact on a substantial number of small
entities. First, only taxpayers that adopt, or change to, the IPIC
method will be affected by the collections of information. Second,
relatively few small entities are expected to adopt, or change to,
the IPIC method. Third, the burden of the collections of information
is not significant. Therefore, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not
required.

Drafting Information

The principal author of these regulations is Leo F. Nolan II of the
Office of Associate Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and Treasury Department
participated in their development. List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

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 for part 1 is amended by adding
an entry in numerical order to read in part as follows: Authority:
26 U.S.C. 7805 * * * §1.472-8 also issued under 26 U.S.C. 472.
* * *.

Par. 2. Section 1.472-8 is amended as follows:

1. Paragraph (b)(4) is added.

2. The text of paragraph (c) following the paragraph heading is
redesignated as paragraph (c)(1) and a paragraph heading for newly
designated (c)(1) is added.

3. Paragraph (c)(2) is added.

4. Paragraph (e)(3) and (h) are revised.

5. The undesignated paragraph following paragraph (h) is removed.

The revisions and additions read as follows: §1.472-8 Dollar-
value method of pricing LIFO inventories.

* * * * *

(b) * * *

(4) IPIC method pools. A manufacturer or processor that elects to
use the inventory price index computation method described in
paragraph (e)(3) of this section (IPIC method) for a trade or
business may elect to establish dollar-value pools for those items
accounted for using the IPIC method based on the 2-digit commodity
codes (i.e., major commodity groups) in Table 6 (Producer price
indexes and percent changes for commodity groupings and individual
items, not seasonally adjusted) of the "PPI Detailed Report"
published monthly by the United States Bureau of Labor Statistics
(available from New Orders, Superintendent of Documents, P.O. Box
371954, Pittsburgh, PA 15250-7954). A taxpayer electing to establish
dollar-value pools under this paragraph (b)(4) may combine IPIC
pools that comprise less than 5 percent of the total current-year
cost of all dollar-value pools to form a single miscellaneous IPIC
pool. A taxpayer electing to establish dollar-value pools under this
paragraph (b)(4) may combine a miscellaneous IPIC pool that
comprises less than 5 percent of the total current-year cost of all
dollar-value pools with the largest IPIC pool. Each of these 5
percent rules is a method of accounting. A taxpayer may not change
to, or cease using, either 5 percent rule without obtaining the
Commissioner's prior consent. Whether a specific IPIC pool or the
miscellaneous IPIC pool satisfies the applicable 5 percent rule must
be determined in the year of adoption or year of change (whichever
is applicable) and redetermined every third taxable year. Any change
in pooling required or permitted as a result of a 5 percent rule is
a change in method of accounting. A taxpayer must secure the consent
of the Commissioner pursuant to §1.446-1(e) before combining or
separating pools and must combine or separate its IPIC pools in
accordance with paragraph (g)(2) of this section.

(c) * * *

(1) In general. * * *

(2) IPIC method pools. A retailer that elects to use the inventory
price index computation method described in paragraph (e)(3) of this
section (IPIC method) for a trade or business may elect to establish
dollar-value pools for those items accounted for using the IPIC
method based on either the general expenditure categories (i.e.,
major groups) in Table 3 (Consumer Price Index for all Urban
Consumers (CPI-U): U.S. city average, detailed expenditure
categories) of the "CPI Detailed Report" or the digit commodity
codes (i.e., major commodity groups) in Table 6 (Producer price
indexes and percent changes for commodity groupings and individual
items, not seasonally adjusted) of the "PPI Detailed Report." A
wholesaler, jobber, or distributor. that elects to use the IPIC
method for a trade or business may elect to establish dollar-value
pools for any group of goods accounted for using the IPIC method and
included within one of the 2-digit commodity codes (i.e., major
commodity groups) in Table 6 (Producer price indexes and percent
changes for commodity groupings and individual items, not seasonally
adjusted) of the "PPI Detailed Report." The "CPI Detailed Report"
and the "PPI Detailed Report" are published monthly by the United
States Bureau of Labor Statistics (BLS) (available from New Orders,
Superintendent of Documents, P.O. Box 371954, Pittsburgh, PA
15250-7954). A taxpayer electing to establish dollar-value pools
under this paragraph (c)(2) may combine IPIC pools that comprise
less than 5 percent of the total current-year cost of all dollar-
value pools to form a single miscellaneous IPIC pool. A taxpayer
electing to establish pools under this paragraph (c)(2) may combine
a miscellaneous IPIC pool that comprises less than 5 percent of the
total current-year cost of all dollar-value pools with the largest
IPIC pool. Each of these 5 percent rules is a method of accounting.
Thus, a taxpayer may not change to, or cease using, either 5 percent
rule without obtaining the Commissioner's prior consent. Whether a
specific IPIC pool or the miscellaneous IPIC pool satisfies the
applicable 5 percent rule must be determined in the year of adoption
or year of change (whichever is applicable) and redetermined every
third taxable year. Any change in pooling required or permitted
under a 5 percent rule is a change in method of accounting. A
taxpayer must secure the consent of the Commissioner pursuant to
section 1.446-1(e) before combining or separating pools and must
combine or separate its IPIC pools in accordance with paragraph (g)
(2) of this section.

* * * * *

(e) * * *

(3) Inventory price index computation (IPIC) method--

(i) In general. The inventory price index computation method
provided by this paragraph (e)(3) (IPIC method) is an elective
method of determining the LIFO value of a dollar-value pool using
consumer or producer price indexes published by the United States
Bureau of Labor Statistics (BLS). A taxpayer using the IPIC method
must compute a separate inventory price index (IPI) for each dollar-
value pool. This IPI is used to convert the total current-year cost
of the items in a dollar-value pool to base-year cost in order to
determine whether there is an increment or liquidation in terms of
base-year cost and, if there is an increment, to determine the LIFO
inventory value of the current year's layer of increment (layer).
Using one IPI to compute the base-year cost of a dollar-value pool
for the current taxable year and using a different IPI to compute
the LIFO inventory value of the current taxable year's layer is not
permitted under the IPIC method. The IPIC method will be accepted by
the Commissioner as an appropriate method of computing an index, and
the use of that index to compute the LIFO value of a dollar-value
pool will be accepted as accurate, reliable, and suitable. The
appropriateness of a taxpayer's computation of an IPI, which
includes all the steps described in paragraph (e)(3)(iii) of this
section, will be determined in connection with an examination of the
taxpayer's federal income tax return. A taxpayer using the IPIC
method may elect to establish dollar-value pools according to the
special rules in paragraphs (b)(4) and (c)(2) of this section or the
general rules in paragraphs (b) and (c) of this section. Taxpayers
eligible to use the IPIC method are described in paragraph (e)(3)
(ii) of this section. The manner in which an IPI is computed is
described in paragraph (e)(3)(iii) of this section. Rules relating
to the adoption of, or change to, the IPIC method are in paragraph
(e)(3)(iv) of this section.

(ii) Eligibility. Any taxpayer electing to use the dollar-value LIFO
method may elect to use the IPIC method. Except as provided in this
paragraph (e)(3)(ii) or in other published guidance, a taxpayer that
elects to use the IPIC method for a specific trade or business must
use that method to account for all items of dollar-value LIFO
inventory. A taxpayer that uses the retail price indexes computed by
the BLS and published in "Department Store Inventory Price Indexes"
(available from the BLS by calling (202) 606-6325 and entering
document code 2415) may elect to use the IPIC method for items that
do not fall within any of the major groups listed in "Department
Store Inventory Price Indexes." (iii) Computation of an inventory
price index--(A) In general. The computation of an IPI for a dollar-
value pool requires the following four steps, which are described in
more detail in this paragraph (e)(3)(iii): First, selection of a BLS
table and an appropriate month; second, assignment of items in a
dollar-value pool to BLS categories (selected BLS categories);
third, computation of category inflation indexes for selected BLS
categories; and fourth, computation of the IPI. A taxpayer may
compute the IPI for each dollar-value pool using either the double-
extension method (double-extension IPIC method) or the link-chain
method (link-chain IPIC method), without regard to whether the use
of a double-extension method is impractical or unsuitable. The use
of either the double-extension IPIC method or the link-chain IPIC
method is a method of accounting, and the adopted method must be
applied consistently to all dollar-value pools within a trade or
business accounted for under the IPIC method. A taxpayer that wants
to change from the double-extension IPIC method to the link-chain
IPIC method, or vice versa, must secure the consent of the
Commissioner under §1.446-1(e). This change must be made with a
new base year as described in paragraph (e)(3)(iv)(B)(1).

(b) Selection of BLS table and appropriate month--

(1) In general. Under the IPIC method, an IPI is computed using the
consumer or producer price indexes for certain categories (BLS price
indexes and BLS categories, respectively) listed in the selected BLS
table of the "CPI Detailed Report" or the "PPI Detailed Report" for
the appropriate month.

(2) BLS table selection. Manufacturers, processors, wholesalers,
jobbers, and distributors must select BLS price indexes from Table 6
(Producer price indexes and percent changes for commodity groupings
and individual items, not seasonally adjusted) of the "PPI Detailed
Report", unless the taxpayer can demonstrate that selecting BLS
price indexes from another table of the "PPI Detailed Report" is
more appropriate. Retailers may select BLS price indexes from either
Table 3 (Consumer Price Index for all Urban Consumers (CPI-U): U.S.
city average, detailed expenditure categories) of the "CPI Detailed
Report" or from Table 6 (or another more appropriate table) of the
"PPI Detailed Report." The selection of a BLS table is a method of
accounting and must be used for the taxable year of adoption and all
subsequent years, unless the taxpayer obtains the Commissioner's
consent under §1.446-1(e) to change its table selection. A
taxpayer that changes its BLS table must establish a new base year
in the year of change as described in paragraph (e)(3)(iv)(B) of
this section.

(3) Appropriate month. In the case of a retailer using the retail
method, the appropriate month is the last month of the retailer's
taxable year. In the case of all other taxpayers, the appropriate
month is the month most consistent with the method used to determine
the current-year cost of the dollar-value pool under paragraph (e)
(2)(ii) of this section and the taxpayer's history of inventory
production or purchases during the taxable year. A taxpayer not
using the retail method may annually select an appropriate month for
each dollar-value pool or make an election on Form 970, "Application
to Use LIFO Inventory Method," to use a representative appropriate
month (representative month). An election to use a representative
month is a method of accounting and the month elected must be used
for the taxable year of the election and all subsequent taxable
years, unless the taxpayer obtains the Commissioner's consent under
§1.446-1(e) to change or revoke its election.

(4) Examples. The following examples illustrate the rules of this
paragraph (e)(3)(iii)(B)(3): Example 1. Determining an appropriate
month. A wholesaler of seasonal goods timely files a Form 970,
"Application to Use LIFO Inventory Method," for the taxable year
ending December 31, 2001. The taxpayer indicates elections to use
the dollar-value LIFO method, to determine the current-year cost
using the earliest acquisitions method in accordance with paragraph
(e)(2)(ii)(b) of this section, and to use the IPIC method under
paragraph (e)(3) of this section. Although the taxpayer purchases
inventory items regularly throughout the year, the items purchased
vary according to the seasons. The seasonal items on hand at
December 31, 2001, are purchased between October and December. Thus,
based on the taxpayer's use of the earliest. acquisitions method of
determining current-year cost and its experience with inventory
purchases, the appropriate month for the items represented in the
ending inventory at December 31, 2001, is October.

Example 2. Electing a representative month. A retailer not using the
retail method timely files a Form 970, "Application to Use LIFO
Inventory Method," for the taxable year ending December 31, 2001.
The taxpayer indicates elections to use the dollar-value LIFO
method, the most recent purchases method of determining current-year
cost under paragraph (e)(2)(ii)(a) of this section, the IPIC method
under paragraph (e)(3) of this section, and December as its
representative month under paragraph (e)(3)(iii)(B)(3) of this
section. The items in the taxpayer's ending inventory are purchased
fairly uniformly throughout the year, with the first purchases
normally occurring in January and the last purchases normally
occurring in December. The taxpayer's election to use December as
its representative month is permissible because the taxpayer elected
to use the most recent purchases method and the taxpayer's last
purchases of the taxable year normally occur during December, the
last month of the taxpayer's taxable year.

Example 3. Changing representative month. The facts are the same as
in Example 2, except the taxpayer files a Form 3115, "Application
for Change in Accounting Method," requesting permission to change to
the earliest acquisitions method of determining current-year cost in
accordance with paragraph (e)(2)(ii)(b) of this section and to
change its representative month from December to January beginning
with the taxable year ending December 31, 2003. If the Commissioner
consents to the taxpayer's request to change to the earliest
acquisitions method, December will no longer be a permissible
representative month for this taxpayer because of the absence of a
nexus between the earliest acquisitions method, the month of
December (the last month of the taxpayer's taxable year), and the
taxpayer's experience with inventory purchases during the year.
Thus, the Commissioner will permit the taxpayer to change its
representative month to January, the first month of the taxpayer's
taxable year.

Example 4. Changing representative month. The facts are the same as
in Example 2. In 2002, the taxpayer changes its annual accounting
period to a taxable year ending June 30, which requires the taxpayer
to file a return for the short taxable year beginning January 1,
2002, and ending June 30, 2002. As a result, December is no longer a
permissible representative month because of the absence of a nexus
between the most recent purchases method, the month of December, and
the taxpayer's experience with inventory purchases during the year.
The taxpayer should file a Form 3115 requesting permission to change
its representative month from December to June beginning with the
short taxable year ending June 30, 2002. Because the taxpayer's last
purchases of the taxable year now will occur in June, the.
Commissioner will consent to the taxpayer's request to change its
representative month to June.

Example 5. Changing representative month. The facts are the same as
in Example 2, except that the taxpayer elects to use January as its
representative month. The taxpayer timely files a Form 3115
requesting permission to change its representative month from
January to December beginning with the taxable year ending December
31, 2003. January is not a permissible representative month because
of the absence of a nexus between the most recent purchases method,
the taxpayer's history of inventory purchases, and the month of
January, the first month in the taxpayer's taxable year. Because
December is a permissible representative month, the Commissioner
will permit the taxpayer to change its representative month to
December.

(c) Assignment of inventory items to BLS categories--

(1) In general. Except as provided in paragraph (e)(3)(iii)(C)(2) of
this section, a taxpayer must assign each item in a dollar-value
pool to the most-detailed BLS category of the selected BLS table
that contains that item. For example, in Table 6 of the "PPI
Detailed Report" for a given month, the commodity codes for the
various BLS categories run from 2 to 8 digits, with the least-
detailed BLS categories having a 2-digit code and the most-detailed
BLS categories usually (but not always) having an 8-digit code. For
purposes of assigning items to the most-detailed BLS category,
manufacturers and processors must assign each raw material item to
the most-detailed PPI category that includes that raw material and
must assign each finished good item to the most-detailed PPI
category that includes that finished good. In addition,
manufacturers and processors must assign each work-in-process (WIP)
item to the most-detailed PPI category that includes the finished
good into which the item will be manufactured or processed. For this
purpose, finished good means a salable item that the taxpayer
regularly sells. For example, a gasoline-engine manufacturer that
also manufactures the pistons used in those engines and regularly
sells some of the pistons (e.g., to retailers of replacement parts)
must assign both finished pistons that have not been affixed to an
engine block and piston WIP items to the most-detailed PPI category
that includes pistons. Finished pistons that have been affixed to an
engine block must be assigned to the most-detailed PPI category that
includes gasoline engines. In contrast, if sales of these pistons
occur infrequently, the taxpayer must assign both finished pistons
and piston WIP items to the most-detailed PPI category that includes
gasoline engines.

(2) 10 percent method. Instead of assigning each item in a dollar-
value pool to the most-detailed BLS categories, as described in
paragraph (e)(3)(iii)(C)(1) of this section, a taxpayer may elect to
use the 10 percent method described in this paragraph (e)(3)(iii)(C)
(2). Under the 10 percent method, items are assigned to BLS
categories using a three-step procedure. First, when the current-
year cost of a specific item is 10 percent or more of the total
current-year cost of the dollar-value pool, the taxpayer must assign
that item to the most-detailed BLS category that includes that item
(10 percent BLS category). Any other item that is includible in that
10 percent BLS category (other than an item that qualifies for its
own 10 percent BLS category under the preceding sentence) must be
assigned to that 10 percent BLS category. Second, if one or more
items have not been assigned to BLS categories in the first step,
the taxpayer must investigate successively less-detailed BLS
categories and assign the unassigned item(s) to the first BLS
category that contains unassigned items whose current-year cost, in
the aggregate, is 10 percent or more of the total current-year cost
of the dollar-value pool (also, 10 percent BLS categories). This
step must be repeated until all the. items in the dollar-value pool
have been included in an appropriate 10 percent BLS category, the
current-year cost of the unassigned items, in the aggregate, is less
than 10 percent of the total current-year cost of the dollar-value
pool, or the taxpayer determines that a single BLS category is not
appropriate for the aggregate of the unassigned items. Third, if
items in a dollar-value pool have not been assigned to a 10 percent
BLS category because the current-year cost of those items, in the
aggregate, is less than 10 percent of the total current-year cost of
the dollar-value pool, the taxpayer must assign those items to the
most-detailed BLS category that includes all those items (also, a 10
percent category). On the other hand, if items in a dollar-value
pool have not been assigned to a 10 percent BLS category because the
taxpayer determines that a single BLS category is not appropriate
for the aggregate of those items, the taxpayer must assign each of
those items to a single miscellaneous BLS category created by the
taxpayer (also, a 10 percent category). In no event may a taxpayer
assign items in a dollar-value pool to a BLS category that is less
detailed than either the major groups of consumer goods described in
Table 3 of the monthly "CPI Detailed Report" or the major commodity
groups of producer goods described in Table 6 of the monthly "PPI
Detailed Report." Principles similar to those described in paragraph
(e)(3)(iii)(C)(1) apply for purposes of assigning raw material,
work-in-process, and finished good items to the most-detailed BLS
category under the 10 percent method.

(3) Change in method of accounting. The 10 percent method of
assigning items in a dollar-value pool to BLS categories is a method
of accounting. In addition, a taxpayer's selection of a BLS category
for a specific item is a method of accounting. However, the
assignment of items to different BLS categories solely as a result
of the application of the 10 percent method is a change in
underlying facts and not a change in method of accounting. Likewise,
the selection of a new BLS category for a specific item as a result
of a revision to a BLS table is a change in underlying facts and not
a change in method of accounting. A taxpayer that wants to change
its method of selecting BLS categories (i.e., to or from the 10-
percent method) or of selecting a BLS category for a specific item
must secure the Commissioner's consent in accordance with
§1.446-1(e). A taxpayer that voluntarily changes its method of
selecting BLS categories or of selecting a BLS category for a
specific item must establish a new base year in the year of change
as described in paragraph (e)(3)(iv)(B) of this section.

(d) Computation of a category inflation index--

(1) In general. As described in more detail in this paragraph (e)(3)
(iii)(D), a category inflation index reflects the inflation that
occurs in the BLS price indexes for a selected BLS category (or, if
applicable, 10 percent BLS category) during the relevant measurement
period.

(2) BLS price indexes. The BLS price indexes are the cumulative
indexes published in the selected BLS table for the appropriate
month. A taxpayer may elect to use either preliminary or final BLS
price indexes for the appropriate month, provided that the selected
BLS price indexes are used consistently. However, a taxpayer that
elects to use final BLS price indexes for the appropriate month must
use preliminary BLS price indexes for any taxable year for which the
taxpayer files its original federal income tax return before the BLS
publishes final BLS price indexes for the appropriate month. If a
BLS price index for a most-detailed or 10 percent BLS category is
not. otherwise available for the appropriate or representative month
(but not because the BLS categories in the BLS table have been
revised), the taxpayer must use the BLS price index for the next
most-detailed BLS category that includes the specific item(s) in the
most-detailed or 10 percent BLS category. If a BLS price index is
not otherwise available for the appropriate or representative month
because the BLS categories in the BLS table have been revised, the
rules of paragraph (e)(3)(iii)(D)(4) of this section apply.

(3) Category inflation index.

(i) In general. Except as provided in paragraph

(e)(3)(iii)(D)(4) of this section (concerning compound category
inflation indexes) or

(e)(3)(iii)(D)(5) of this section (concerning category inflation
indexes for certain 10 percent BLS categories), a category inflation
index for a selected BLS category (or, if applicable, 10 percent BLS
category) is computed under the rules of this paragraph (e)(3)(iii)
(D)(3).

(ii) Double-extension IPIC method. In the case of a taxpayer using
the double-extension IPIC method, the category inflation index for a
BLS category is the quotient of the BLS price index for the
appropriate or representative month of the current year divided by
the BLS price index for the appropriate month of the taxable year
preceding the base year (base month). However, if the taxpayer did
not have an opening inventory in the year that its election to use
the dollar-value LIFO method and double- extension IPIC method
became effective, the category inflation index for a BLS category is
the quotient of the BLS price index for the appropriate or
representative month of the current year divided by the BLS price
index for the month immediately preceding the month of the
taxpayer's first inventory production or purchase.

(iii) Link-chain IPIC method. In the case of a taxpayer using the
link-chain IPIC method, the category inflation index for a BLS
category is the quotient of the BLS price index for the appropriate
or representative month of the current year divided by the BLS price
index for the appropriate month used for the immediately preceding
taxable year. However, if the taxpayer did not have an opening
inventory in the year that its election to use the dollar-value LIFO
method and link-chain IPIC method became effective, the category
inflation index for a BLS category for the year of election is the
quotient of the BLS price index for the appropriate or
representative month of the current year divided by the BLS price
index for the month immediately preceding the month of the
taxpayer's first inventory production or purchase.

(iv) Special rules concerning representative months. A taxpayer
electing to use a representative month under paragraph (e)(3)(iii)
(B)(3) of this section must use an appropriate month, rather than
the representative month, to determine category inflation indexes in
the circumstances described in this paragraph (e)(3)(iii)(D)(3)(iv)
and in other similar circumstances. For example, in the case of a
short taxable year, the category inflation index should reflect the
inflation that occurs from the base month (in the case of the
double-extension IPIC method), or the appropriate or representative
month used for the preceding taxable year (in the case of the link-
chain IPIC method), and the appropriate month for the short taxable
year. Similarly, if a taxpayer using the link-chain IPIC method is
granted consent to change both its method of determining the
current-year cost of a dollar-value pool and its representative
month, the category inflation index for the year of change should
reflect the inflation that occurs between the old representative
month used for the preceding taxable year and the new representative
month used for the year of change.

(4) Compound category inflation index for revised BLS categories or
price indexes--

(i) In general. Periodically, the BLS revises a BLS table to add one
or more new BLS categories, eliminate one or more previously
reported BLS categories, or reset the base-year BLS price index of
one or more BLS categories. If the BLS has revised the applicable
BLS table for a taxable year, a taxpayer must compute the category
inflation index for each BLS category for which the taxpayer cannot
compute a category inflation index in accordance with paragraph (e)
(3)(iii)(D)(3) of this section (affected BLS category) using a
reasonable method, provided the method is used consistently for all
affected BLS categories within a particular taxable year. For
example, if the BLS revised the CPI by adding new BLS categories as
of January 2001 and eliminating some previously reported BLS
categories as of December 2000, January 2002 would be the first
month for which it would be possible to compute a category inflation
index for a 12-month period using the BLS price indexes for any
affected category. The compound category inflation index described
in paragraph (e)(3)(iii)(D)(4)(ii) of this section is a reasonable
method of computing the category inflation index for an affected BLS
category.

(ii) Computation of compound category inflation index. When the
applicable BLS table is revised as described in paragraph (e)(3)
(iii)(D)(4)(i) of this section, a. taxpayer may use the procedure
described in this paragraph (e)(3)(iii)(D)(4)(ii) to compute a
compound category inflation index for each affected BLS category
represented in the taxpayer's ending inventory. For this purpose, a
compound category inflation index is the product of the category
inflation index for the "first portion" multiplied by the
corresponding category inflation index for the "second portion." The
category inflation index for the first portion must reflect the
inflation that occurs between the end of the base month (in the case
of the double-extension IPIC method), or the preceding year's
appropriate or representative month (in the case of the link-chain
IPIC method), and the end of the last month covered by the unrevised
BLS table based on the old BLS category. The corresponding category
inflation index for the second portion must reflect the inflation
that occurs between the beginning of the first month covered by the
revised BLS table based on the new BLS category and the end of the
current year's appropriate or representative month. First, using the
revised BLS table for the current-year's appropriate or
representative month, the taxpayer assigns items in the dollar-value
pool using its method of assigning items to BLS categories as
described in paragraph (e)(3)(iii)(C) of this section. Second, for
each affected BLS category represented in the ending inventory, the
taxpayer computes the category inflation index for the second
portion using this formula: [ A / B ], where A equals the BLS price
index for the current year's appropriate or representative month and
B equals the BLS price index for the last month covered by the
unrevised BLS table (as published for the first month of the revised
BLS table). Third, using the unrevised BLS table for the base month
(in the case of the double extension IPIC. method) or the preceding
year's appropriate or representative month (in the case of the link-
chain IPIC method), the taxpayer assigns each of the items in the
dollar-value pool using its method of assigning items to BLS
categories. Fourth, for each affected BLS category represented in
the ending inventory, the taxpayer computes the category inflation
index for the first portion using this formula: [ C / D ], where C
equals the BLS price index for the last month covered by the
unrevised BLS table (as published for the last month of the
unrevised BLS table) and D equals the BLS price index for the base
month (in the case of the double-extension IPIC method) or the
preceding year's appropriate or representative month (in the case of
the link-chain IPIC method). Fifth, for each affected BLS category
represented in the ending inventory, the taxpayer computes the
compound category inflation index using this formula: [ X * Y ],
where X equals the category inflation index for the second portion,
and Y equals the corresponding category inflation index for the
first portion. For the purpose of computing the compound category
inflation index for each affected BLS category, the corresponding
category inflation index for the first portion is the category
inflation index for the unrevised BLS category that includes the
specific inventory item(s) included in the revised BLS category. If
items included in a single revised BLS category had been included in
separate BLS categories before the revision of the BLS table, the
corresponding category inflation index for the first portion is the
weighted harmonic mean of the category inflation indexes for these
unrevised BLS categories. See paragraph (e)(3)(iii)(E)(1) of this
section for a formula of the weighted harmonic mean. When computing
this weighted-average category inflation index, a taxpayer must use.
the current-year costs (or in the case of a retailer using the
retail method, the retail selling prices) in ending inventory as the
weights.

(iii) New base year. A taxpayer may establish a new base year in the
year following the taxable year for which the taxpayer computed a
compound category inflation index under this paragraph (e)(3)(iii)
(D)(4) for one or more affected BLS categories in a dollar-value
pool. See paragraph (e)(3)(iv)(B) of this section for the procedures
and computations incident to establishing a new base year.

(iv) Examples. The following examples illustrate the rules of this
paragraph (e)(3)(iii)(D)(4):

Example 1. BLS categories eliminated.

(i) A retailer, whose taxable year ends January 31, elected to
account for its inventories using the dollar-value LIFO method and
double-extension IPIC method (based on the CPI), beginning with the
taxable year ending January 31, 1997. The taxpayer does not use the
retail method, but elected to use January as its representative
month. On January 31, 1999, the taxpayer's only dollar-value pool
contains only two items -- lemons and peaches. The total current-
year cost of these items is as follows: lemons, $40, and peaches,
$30.

(ii) The CPI was revised in October of 1998 to eliminate the "Citrus
fruits" subcategory of "Other fresh fruits." In addition, the base-
year BLS price index for "Other fresh fruits" was reset to 100.00 as
of October 1, 1998. In relevant part, the January 1999 CPI permits
the assignment of both lemons and peaches to "Other fresh fruits."
The January 1999 BLS price indexes for "Citrus fruits" and "Other
fresh fruits" are 96.6 and 105.6, respectively. In relevant part,
the September 1998 CPI permits the assignment of lemons to "Citrus
fruits" and peaches to "Other fresh fruits." The September 1998 BLS
price indexes for "Citrus fruits" and "Other fresh fruits" are 194.9
and 294.9, respectively, and the January 1997 BLS price indexes for
"Citrus fruits" and "Other fresh fruits" are 190.2 and 290.2,
respectively.

(iii) Because the BLS eliminated the category, "Citrus fruits," as
of October 1998, it did not publish a BLS price index for that
category in the January 1999 CPI. Thus, the taxpayer cannot compute
a category inflation index for "Citrus fruits" under the normal
procedures, but may compute a compound category inflation index for
that affected BLS category using the procedures described in
paragraph (e)(3)(iii)(D)(4)(ii) of this section.

(iv) The taxpayer computes a compound category inflation index for
the two BLS categories that formerly included lemons and peaches.
The taxpayer first assigns lemons and peaches to "Other fresh
fruits," the most-detailed index in the January 1999 CPI, and then
computes the category inflation index for the second portion as
follows:

                               Jan. 1999 index /
                               Sept. 1998 index
                               (as published in     Category
 Item       1999 Category      Oct 1998             inflation
                                                    index

Lemons &
Peaches     Other fruits       105.6 / 100.0        1.0560



(v) The taxpayer assigns the lemons and peaches to the most-detailed
BLS categories in the January 1998 CPI as follows: lemons to "Citrus
fruits" and peaches to "Other fresh fruits." Then, the taxpayer
computes the category inflation index for the first portion as
follows:


                             Sept. 1998 index
                             (as published in     Category
                             Sept. 1998) /        inflation
Item       1998 Category     Jan. 1997            index

Lemons     Citrus fruits     194.9 / 190.2        1.0247
Peaches    Other fresh       294.9 / 290.2        1.0162
           Fruits


(vi) Because lemons and peaches, which are included together in the
revised "Other fresh fruits" category, had been included in separate
BLS categories before the BLS table was revised, the taxpayer must
compute a single corresponding category inflation index for the
affected BLS categories for the first portion. This corresponding
category inflation index is the weighted harmonic mean of the
separate corresponding category inflation indexes for the first
portion using the cost of the items in ending inventory as the
weights. The taxpayer computes the corresponding category inflation
index for "Other fresh fruits" for the first portion as follows:


            (I)              (II)
            Weight           Category      (III)
Item        (Cost of item)   Index         Quotent (I)/(II)

Lemons      $40.00           $1.0247       $39.04
Peaches     $30.00           $1.0162       $29.52
Total       $70.00                         $68.56


(VI)        (V) Sum of       (VI)
(IV) Sum of (Weight /        Weighted Harmonic
Weights     Category         Mean of Other Fresh
            Inflation Index) Fruits:
                             (IV) / (V)

$70.00      $68.56           1.0210





(vii) Finally, the taxpayer computes the compound category inflation
index for Other fresh fruits as follows:

         (I)                 (II)          (III)
         Category Inflation  Index         Compound
         Category Inflation  First         Category
         Index               Portion)      Inflation Index:
Item     (Second Portion)                  (I) * (II)


Other    1.0560              1.0210        1.0782
fresh fruits



(viii) The taxpayer may establish a new base year for the taxable
year ending January 31, 2000.

Example 2. BLS categories separated.

(i) The facts are the same as in Example 1, except prior to October
1998, both lemons and peaches were assigned to "Other fresh fruits"
and in the October 1998 CPI, the BLS created a new category, "Citrus
fruits," for citrus fruits, such as lemons. Moreover, the BLS reset
the base-year BLS price index for "Other fresh fruits" to 100.0 as
of October 1, 1998. As a result of these changes, the taxpayer may
no longer assign lemons to "Other fresh fruits."

(ii) Because "Citrus fruits" is new as of October 1998, the BLS did
not publish a BLS price index for this BLS category in the January
1999 CPI. Thus, because the taxpayer cannot compute a category
inflation index for "Citrus fruits" under the normal procedures, the
taxpayer may compute a compound category inflation index for the
affected BLS category using the procedures described in paragraph
(e)(3)(iii)(D)(4)(ii) of this section.

(iii) Based on the January 1999 CPI, the taxpayer assigns lemons to
"Citrus fruits" and peaches to "Other fresh fruits." Then, the
taxpayer computes a compound. category inflation index for each of
the two BLS categories. The computation of the category inflation
index for the second portion is as follows:

                           Jan. 1999 index /
                           Sept. 1998 index        Category
                           (as published in        Inflation
Item       1999 Category   Oct. 1998)              Index

Lemons     Citrus fruits   96.6 / 100              0.9660
Peaches    Other fresh     105.6 / 100             1.0560
           fruits


(iv) Then, the taxpayer computes the category inflation index for
the first portion as follows:


                              Sept. 1998 index
                              (as published in
                              Sept. 1998)        Category
Item        1998 Category     / Jan. 1997        Inflation Index

Lemons &
Peaches     Other fresh       294.9 / 290.2      1.0162
            fruits



(v) Finally, the taxpayer computes the compound category inflation
index for "Citrus fruits" and "Other fresh fruits":

            (I)                 (II)                  (III)
            Category Inflation  Category Inflation    Compound
Item        Index               Index                 Category Inflation
            (Second Portion)    (First Portion)       Index: (I) * (II)



Citrus      0.9660              1.0162                0.9816
fruits

Other       1.0560              1.0162                1.0731
fresh fruits



(vi) The taxpayer may establish a new base year for the taxable year
ending January 31, 2000.

(5) 10 percent method.

(i) Applicability. A taxpayer that elects to use the 10 percent
method described in paragraph (e)(3)(iii)(C)(2) of this section must
compute a category inflation index for a less-detailed 10 percent
BLS category as provided in this paragraph (e)(3)(iii)(D)(5). A
less-detailed 10 percent category is a BLS category that--

(A) subsumes two or more BLS categories;.

(b) does not have a single assigned item whose current-year cost is
10 percent or more of the current-year cost of all the items in the
dollar-value pool;

(C) has at least one item in at least one of the subsumed BLS
categories; and

(D) has at least one subsumed BLS category that either does not have
any assigned items or is a separate 10 percent BLS category.

(ii) Determination of category inflation index. If the rules of this
paragraph (e)(3)(iii)(D)(5) apply, the category inflation index for
the less-detailed 10 percent BLS category is equal to the weighted
arithmetic mean of the category inflation index (or, compound
category inflation index, if applicable) for each of the subsumed
BLS categories that have been assigned at least one item from the
taxpayer's dollar-value pool (excluding any item that is properly
assigned to a separate 10 percent BLS category). [Weighted
Arithmetic Mean = Sum of (Weight x Category Inflation Index)] / Sum
of Weights]. The appropriate weight for each of the most-detailed
BLS categories referenced in the preceding sentence is the
corresponding BLS weight. Currently, in January of each year, the
BLS publishes the BLS weights determined for December of the
preceding year. In the case of a taxpayer using the double-extension
IPIC method, the BLS weights for December of the taxable year
preceding the base year are to be used for all taxable years. In the
case of a taxpayer using the link-chain IPIC method, the BLS weights
for December of a given calendar year are to be used for taxable
years that end during the 12-month period that begins on July 1 of
the following calendar year. However, if the BLS weights are not
published for all of the most-detailed BLS categories referenced
above, the taxpayer may use the current-year cost. (or in the case
of a retailer using the retail method, the retail selling prices) of
all items assigned to a specific most-detailed BLS category as the
appropriate weight for that category, but must compute a weighted
harmonic mean. See paragraph (e)(3)(iii)(E)(1) of this section for a
formula of the weighted harmonic mean.

(e) Computation of Inventory Price Index (IPI)--(1) Double-extension
IPIC method. Under the double-extension IPIC method, the IPI for a
dollar-value pool is the weighted harmonic mean of the category
inflation indexes (or, if applicable, compound category inflation
indexes) determined under paragraph (e)(3)(iii)(D) of this section
for each selected BLS category (or, if applicable 10 percent BLS
category) represented in the taxpayer's dollar-value pool at the end
of the taxable year. The formula for computing the weighted harmonic
mean of the category inflation indexes is: [ Sum of Weights / Sum of
(Weight / Category Inflation Index) ]. The weights to be used when
computing this weighted harmonic mean are the current-year costs
(or, in the case of a retailer using the retail method, the retail
selling prices) in each selected BLS category represented in the
dollar-value pool at the end of the taxable year.

(2) Link-chain IPIC method. Under the link-chain IPIC method, the
IPI for a dollar-value pool is the product of the weighted harmonic
mean of the category inflation indexes (or, if applicable, the
compound category inflation indexes) determined under paragraph (e)
(3)(iii)(D) of this section for each selected BLS category (or, if
applicable, 10 percent BLS category) represented in the taxpayer's
dollar-value pool at the end of the taxable year multiplied by the
IPI for the immediately preceding taxable year. The formula for
computing the weighted harmonic mean of the category inflation
indexes is:. [ Sum of Weights / Sum of (Weight / Category Inflation
Index) ]. The weights to be used when computing this weighted
harmonic mean are the current-year costs (or, in the case of a
retailer using the retail method, the retail selling prices) in each
selected BLS category represented in the dollar-value pool at the
end of the taxable year.

(3) Examples. The following examples illustrate the rules of this
paragraph (e)(3)(iii)(E): Example 1. Double-extension method.

(i) Introduction. R is a retail furniture merchant that does not use
the retail method. For the taxable year ending December 31, 2000, R
used the first-in, first-out method of identifying inventory and
valued its inventory at cost. The total cost of R's inventory on
December 31, 2000, was $850,000. R elected to use the dollar-value
LIFO and double-extension IPIC methods for its taxable year ending
December 31, 2001. R does not elect to use the 10 percent method
described in paragraph (e)(3)(iii)(C)(2) of this section. R
determines the current-year cost of the items using the actual cost
of the most recently purchased goods. R elected to pool its
inventory based on the major groups in Table 6 of the monthly "PPI
Detailed Report" in accordance with the special IPIC pooling rules
of paragraph (b)(4) of this section. All items in R's inventories
fall within the 2-digit commodity code in Table 6 of the monthly
"PPI Detailed Report" for "furniture and household durables."
Therefore, R will maintain a single dollar-value pool.

(ii) Select a BLS table and appropriate month for 2001. R determines
that the appropriate month for 2001 is October. R also determines
that the appropriate month for 2000 would have been December if R
had used the IPIC method for that year.

(iii) Assign inventory items to BLS categories for 2001. For 2001, R
assigns all items in the dollar-value pool to the most-detailed BLS
categories listed in Table 6 of the October 2001 "PPI Detailed
Report" that contain those items. The BLS categories and the
current-year cost of the items assigned to them are summarized as
follows:

Commodity Code        Category                Current-Year Cost
12120101              Living Room Table       $111,924.00
12120211              Dining Room Table       $159,578.00
12120216              Dining Room Chairs      $98,639.00
12130101              Upholstered Sofas       $332,488.00
12130111              Upholstered Chairs      $218,751.00

Total                                         $921,380.00

(iv) Compute category inflation indexes for 2001. Because R elected
to use the double-extension IPIC method and did not elect the 10
percent method, the category inflation indexes are computed in
accordance with paragraph (e)(3)(iii)(D)(3)(ii) of this section (BLS
price indexes for October 2001 divided by BLS price indexes for
December 2000). R computes the category inflation indexes for 2001
as follows:

                     (I)          (II)        (III)
                     Oct. 2001    Dec. 2000   Category Inflation
Category             Index        Index       Index:
                                              (I) / (II)

Living Room Table    172.4        169.2       1.018913
Dining Room Table    171.9        168.1       1.022606
Dining Room Chairs   172.8        169.7       1.018268
Upholstered Sofas    142.2        140.9       1.009226
Upholstered Chairs   134.1        132.5       1.012075




(v) Compute IPI for 2001. R must compute the IPI for 2001, which is
the weighted harmonic mean of the category inflation indexes for
2001. The formula for the weighted harmonic mean provided in
paragraph (e)(3)(iii)(E)(1) of this section is [ Sum of Weights /
Sum of (Weight / Category Inflation Index) ]. The IPI for 2001 is
computed as follows:

                                       (II)         (III)
                       (I)       Category Inflation Quotient
Category             Weight             Index       (I) / (II)


Living Room Table    $111,924.00        1.018913     $109,846.47
Dining Room Table    $159,578.00        1.022606     $156,050.33
Dining Room Chairs   $98,639.00         1.018268     $96,869.39
Upholstered Sofas   $332,488.00         1.009226     $329,448.51
Upholstered Chairs  $218,751.00         1.012075     $216,141.10
Total	            $921,380.00                      $908,355.80



                  (V)                        (VI)
(IV)              Sum of (Weight /           Inventory Price Index:
Sum of Weights    Category Inflation         (IV) / (V)
                  Index)

$921,380.00       $908,355.80                1.01433821



(vi) Determine the LIFO value of the dollar-value pool for 2001. For
2001, R determines the total base-year cost of its ending inventory
by dividing the total current-year cost of the items in the dollar-
value pool by the IPI for 2001. The total base-year cost of R's
ending inventory is $908,355.80 ($921,380 / 1.01433821). Comparing
the base-year cost of the ending inventory to the base-year cost of
the beginning inventory, R determines that the base-year cost of the
2001 increment is $58,355.80 ($908,355.80 - $850,000.00). R
multiplies the base-year cost of the 2001 increment by the IPI for
2001 and determines that the LIFO value of the 2001 layer is
$59,192.52 ($58,355.80 * 1.01433821). Thus, the LIFO value of R's
total inventory at the end of 2001 is $909,192.52 ($850,000.00
(opening inventory) + $59,192.52 (2001 layer)).

(vii) Select a BLS table and appropriate month for 2002. For 2002, R
must compute a new IPI under the double-extension IPIC method to
determine the LIFO value of its dollar-value pool. R determines that
the appropriate month for 2002 is November.

(viii) Assign inventory items to BLS categories for 2002. For 2002,
R assigns all items in the dollar-value pool to the most-detailed
BLS categories listed in Table 6 of the November 2002 "PPI Detailed
Report" that contain those items. The BLS categories and the
current-year cost of the items assigned to them are summarized as
follows:

Commodity Code   Category               Current-Year Cost
12120103         Living Room Desks      $125,008.00
12120211         Dining Room Table      $136,216.00
12120216         Dining Room Chairs     $113,569.00
12130101         Upholstered Sofas      $343,900.00
12130111         Upholstered Chairs     $233,050.00
Total	                                $951,743.00





                                                    (III)
                    (I)            (II)        Category Inflation
                    Nov. 2002      Dec. 2000        Index
 Category           Index          Index            (I) / (II)


Living Room Desks   172.6          160.3            1.076731
Dining Room Table   174.8          168.1            1.039857
Dining Room Chairs  177.0          169.7            1.043017
Upholstered Sofas   144.9          140.9            1.028389
Upholstered Chairs  136.6          132.5            1.030943



(ix) Compute category inflation indexes for 2002. Because R uses the
double-extension IPIC method and did not elect the 10 percent
method, the category inflation indexes are computed in accordance
with paragraph (e)(3)(iii)(D)(3)(ii) of this section (BLS price
indexes for November 2002 divided by BLS price indexes for December
2000). R computes the category inflation indexes for 2002 as
follows:

                                (II)        (III)
                    (I)         Category    Inflation Quotient:
Category            Weight      Index       (I) / (II)
Living Room Desks   $125,008.00 1.076731    $116,099.56
Dining Room Table   $136,216.00 1.039857    $130,994.93
Dining Room Chairs  $113,569.00 1.043017    $108,885.09
Upholstered Sofas   $343,900.00 1.028389    $334,406.53
Upholstered Chairs  $233,050.00 1.030943    $226,055.17
Total               $951,743.00             $916,441.28


                  (V)                        (VI)
(IV)              Sum of (Weight /           Inventory Price Index:
Sum of Weights    Category Inflation Index)  (IV) / (V)
$951,743.00       $916,441.28                1.03852044



(x) Compute IPI for 2002. R must compute the IPI for 2002, which is
the weighted harmonic mean [Sum of Weights / Sum of (Weight /
Category Inflation. Index)] of the category inflation indexes for
2002. The IPI for 2002 is computed as follows:

Category Weight Index (I) / (II)
(I) Category Inflation Quotient:

(II) (III)

Living Room Desks     $125,008.00     1.076731       $116,099.56

Dining Room Table     136,216.00      1.039857       130,994.93

Dining Room Chairs    113,569.00      1.043017       108,885.09

Upholstered Sofas     343,900.00      1.028389       334,406.53

Upholstered Chairs    233,050.00      1.030943       226,055.17

Total                $951,743.00                    $916,441.28

(IV) Sum of (Weight / Inventory Price Index:
Sum of Weights Category Inflation Index) (IV) / (V)

(V) (VI)

$951,743.00   $916,441.28   1.03852044

(xi) Determine the LIFO value of the pool for 2002. For 2002, R
determines the total base-year cost of its ending inventory by
dividing the total current-year cost of the items in the dollar-
value pool by the IPI for 2002. The total base-year cost of the
ending inventory is $916,441.28 ($951,743.00 / 1.03852044).
Comparing the base-year cost of the ending inventory to the base-
year cost of the beginning inventory, R determines that the base-
year cost of the 2002 increment is $8,085.48 ($916,441.28 -$
908,355.80). R multiplies the base-year cost of the 2002 increment
by the IPI for 2002 and determines that the LIFO value of the 2002
layer is $8,396.94 ($8,085.48 * 1.03852044). Thus, the LIFO value of
R's total inventory at the end of 2002 is $917,589.46 ($850,000.00
(opening inventory) + $59,192.52 (2001 layer) + $8,396.94 (2002
layer)).

Example 2. Link-chain method.

(i) Introduction. The facts are the same as Example 1, except that R
uses the link-chain IPIC method. The double-extension IPIC method
and the link-chain IPIC method yield the same results for the first
taxable year in which the dollar-value LIFO and IPIC methods are
used. Therefore, this example illustrates only how R will compute
the IPI for, and determine the LIFO value of, its dollar-value pool
for 2002.

(ii) Select a BLS table and appropriate month for 2002. R determines
that the appropriate month for 2002 is November.

(iii) Assign inventory items to BLS categories for 2002. For 2002, R
assigns all items in the dollar-value pool to the most-detailed BLS
categories listed in Table 6 of. the November 2002 "PPI Detailed
Report" that contain those items. The BLS categories and the
current-year cost of the items assigned to them are summarized as
follows:

Commodity Code          Category             Current-Year Cost
12120103 Living Room    Desks                $125,008.00
12120211 Dining Room    Table                $136,216.00
12120216 Dining Room    Chairs               $113,569.00
12130101 Upholstered    Sofas                $343,900.00
12130111 Upholstered    Chairs               $233,050.00
Total                                        $951,743.00

(iv) Compute category inflation indexes for 2002. Because R uses the
link-chain IPIC method and did not elect the 10 percent method, the
category inflation indexes are computed in accordance with paragraph
(e)(3)(iii)(D)(3)(iii) of this section (BLS price indexes for
November 2002 divided by BLS price indexes for October 2001). R
computes the category inflation indexes for 2002 as follows:

                                                (III)
                    (I)        (II)             Category Inflation
                    Nov. 2002  Oct. 2001        Index:
Category            Index      Index            (I) / (II)
Living Room Desks   172.6      162.0            1.065432
Dining Room Table   174.8      171.9            1.016870
Dining Room Chairs  177.0      172.8            1.024306
Upholstered Sofas   144.9      142.2            1.018987
Upholstered Chairs  136.6      134.1            1.018643

(v) Compute IPI for 2002. As provided in paragraph (e)(3)(iii)(E)(2)
of this section, R must compute the IPI for 2002 by multiplying the
weighted harmonic mean of the category inflation indexes for 2002 by
the IPI for 2001. The IPI for 2002 is computed as follows:

                                  (II)       (III)
                    (I)           Category   Inflation Quotient
Category            Weight        Index      (I) / (II)
Living Room Desks   $125,008.00   1.065432   $117,330.81
Dining Room Table   $136,216.00   1.016870   $133,956.16
Dining Room Chairs  $113,569.00   1.024306   $110,874.09
Upholstered Sofas   $343,900.00   1.018987   $337,492.04
Upholstered Chairs  $233,050.00   1.018643   $228,784.77
Total               $951,743.00              $928,437.87


(vi) Determine the LIFO value of the pool for 2002. R determines the
total base-year cost of its ending inventory by dividing the total
current-year cost of the items in the dollar-value pool by the IPI
for 2002. The total base-year cost of the ending inventory is
$915,313.91 ($951,743.00 / 1.03979956). Comparing the base-year cost
of the ending inventory to the base-year cost of the beginning
inventory, R determines that the base-year cost of the 2002 layer is
$6,958.11 ($915,313.91 - $908,355.80). R multiplies the base-year
cost of the 2002 layer by the IPI for 2002 and determines that the
LIFO value of the 2002 layer is $7,235.04 ($6,958.11 * 1.03979956).
Thus, the LIFO value of R's total inventory at the end of 2002 is
$916,427.56 ($850,000.00 (opening inventory) + $59,192.52 (2001
layer) + $7,235.04 (2002 layer)).

(iv) Adoption or change of method--(A) Adoption or change to IPIC
method. The use of an inventory price index computed under the IPIC
method is a method of accounting. A taxpayer permitted to adopt the
dollar-value LIFO method without first securing the Commissioner's
consent also may adopt the IPIC method without first securing the
Commissioner's consent. The IPIC method may be adopted and used,.
however, only if the taxpayer provides the following information on
a Form 970, "Application to Use LIFO Inventory Method," or in
another manner as may be acceptable to the Commissioner: A complete
list of dollar-value pools (including a description of the items in
each dollar-value pool); the BLS table (i.e., CPI or PPI) selected
for each dollar-value pool; the representative month, if applicable,
elected for each dollar-value pool; the BLS categories to which the
items in each dollar-value pool will be assigned; the method of
assigning items to BLS categories (e.g., the 10 percent method) for
each dollar-value pool; and the method of computing the IPI (i.e.,
double-extension IPIC method or link-chain IPIC method) for each
dollar-value pool. In the case of a taxpayer permitted to adopt the
IPIC method without requesting the Commissioner's consent, the Form
970 must be attached to the taxpayer's income tax return for the
taxable year of adoption. In all other cases, a taxpayer may change
to the IPIC method only after securing the Commissioner's consent as
provided in §1.446-1(e). In these latter cases, the Form 970
containing the information described in this paragraph (e)(3)(iv)(A)
must be attached to a Form 3115, "Application for Change in
Accounting Method," filed as required by §1.446-1(e). A
taxpayer that simultaneously changes to the dollar-value LIFO and
IPIC methods from another LIFO method must apply the rules of
paragraph (f)(2) of this section before applying the rules of
paragraph (e)(3)(iv)(B)(1) of this section. To satisfy the
requirements of §1.472-2(h), taxpayers must maintain adequate
books and records, including those concerning the use of the IPIC
method and necessary computations. Notwithstanding the rules in
paragraph (e)(1) of this section, a taxpayer that adopts, or changes
to, the link-chain. IPIC method is not required to demonstrate that
the use of any other method of determining the LIFO value of a
dollar-value pool is impractical.

(b) New base year--(1) Voluntary change--

(i) In general. In the case of a taxpayer using a non-IPIC method to
determine the LIFO value of inventory, the layers previously
determined under that method, if any, and the LIFO values of those
layers are retained if the taxpayer voluntarily changes to the IPIC
method. Instead of using the earliest taxable year for which the
taxpayer adopted the LIFO method for any items in the dollar-value
pool, the year of change is used as the new base year for the
purpose of determining the amount of increments and liquidations, if
any, for the year of change and subsequent taxable years. The base-
year cost of the layers in a dollar-value pool at the beginning of
the year of change must be restated in terms of new base-year cost
using the year of change as the new base year and, if applicable,
the indexes for the previously determined layers must be recomputed
accordingly. The recomputed indexes will be used to determine the
LIFO value of subsequent liquidations. For purposes of computing an
IPI under paragraph (e)(3)(iii)(E) of this section, the IPI for the
immediately preceding year is 1.00. The new total base-year cost of
the items in a dollar-value pool for the purpose of determining
future increments and liquidations is equal to the total current-
year cost of the items in the dollar-value pool (determined using
the taxpayer's method of determining the total current-year cost of
the items in the dollar-value pool under paragraph (e)(2)(ii) of
this section). A taxpayer must allocate this new total base-year
cost to each layer based on the ratio of the old base-year cost of
the layer to the old total base-year cost of the dollar-value. pool.

(ii) Example. The following example illustrates the rules of this
paragraph (e)(3)(iv)(B)(1): Example.

(i) In 1990, X elected to use a dollar-value LIFO method (other than
the IPIC method) for its single dollar-value pool. X is granted
permission to change to the link-chain IPIC method, beginning with
the taxable year ending December 31, 2001. X will continue using a
single dollar-value pool. X's beginning inventory as of January 1,
2001, computed using its former inventory method, is as follows:

               (I)              (II)           (III)
               Base-Year        Inflation      LIFO Value:
Layer          Cost             Index          (I) * (II)
Base layer     $135,000         1.00           $135,000
1991 layer     $20,000          1.43           $28,600
1994 layer     $60,000          1.55           $93,000
1995 layer     $13,000          1.59           $20,670
1997 layer     $2,000           1.61           $3,220
Total          $230,000                        $280,490



(ii) Under X's method of determining the current-year cost of items
in a dollar-value pool, the current-year cost of the beginning
inventory is $391,000. Thus, X's new base-year cost as of January 1,
2001, is $391,000. X allocates this new base-year cost to each layer
based on the ratio of old base-year cost of the layer to the total
old base-year cost of the dollar-value pool. To recompute the
inflation indexes for each of its layers, X divides the LIFO value
of each layer by the new base-year cost attributable to the layer.
The new base-year cost, recomputed inflation indexes, and LIFO value
of X's layers as of January 1, 2001, are as follows:

            (I)       (II)        (III)
            Base-Year Inflation   LIFO Value:
Layer       Cost      Index       (I) * (II)
Base layer  $229,500  $0.588235   $135,000
1991 layer  $34,000   $0.841176   $28,600
1994 layer  $102,000  $0.911765   $93,000
1995 layer  $22,100   $0.935294   $20,670
1997 layer  $3,400    $0.947059   $3,220
Total       $391,000              $280,490





(iii) In 2001, the current-year cost of X's ending inventory is
$430,139. The. weighted harmonic mean of the category inflation
indexes applicable to X's ending inventory is 1.075347, and in
accordance with paragraph (e)(3)(iv)(B)(1)(i) of this section, the
inflation index for the immediately preceding taxable year is 1.00.
Thus, X's IPI for 2001 is 1.075347 (1.00 * 1.075347). The total
base-year cost of X's ending inventory is $400,000 ($430,139 /
1.075347). The base-year cost, IPI, and LIFO value of X's layers as
of December 31, 2001, are as follows:

            (I)        (II)             (III)
            Base-Year  Inventory Price	LIFO Value:
Layer       Cost       Index            (I) * (II)
Base layer  $229,500   0.588235         $135,000
1991 layer  $34,000    0.841176         $28,600
1994 layer  $102,000   0.911765         $93,000
1995 layer  $22,100    0.935294         $20,670
1997 layer  $3,400     0.947059         $3,220
2001 layer  $9,000     1.075347         $9,678
Total       $400,000                    $290,168



(iv) In 2002, the current-year cost of X's ending inventory is
$418,000. The weighted harmonic mean of the category inflation
indexes applicable to X's ending inventory is 1.02292562, and the
IPI for the immediately preceding year is 1.075347. Thus, X's IPI
for 2001 is 1.10 (1.075347 * 1.02292562). The total base-year cost
of X's ending inventory is $380,000 ($418,000 / 1.10), which results
in a liquidation of $20,000 ($400,000 - $380,000) in terms of base-
year cost. This liquidation eliminates the 2001 layer ($9,000 base-
year cost), the 1997 layer ($3,400 base-year cost), and part of the
1995 layer ($7,600 base-year cost). The base-year cost, indexes, and
LIFO value of X's layers as of December 31, 2002, are as follows:

            (I)         (II)             (III)
            Base-Year   Inventory Price  LIFO Value:
Layer       Cost        Index            (I) * (II)
Base layer  $229,500    0.588235         $135,000
1991 layer  $34,000     0.841176         $28,600
1994 layer  $102,000    0.911765         $93,000
1995 layer  $14,500     0.935294         $13,562
Total       $380,000                     $270,162


(2) Involuntary change--

(i) In general. If a taxpayer uses a non-IPIC method to compute the
LIFO value of a dollar-value pool, and if the Commissioner
determines that the taxpayer's method does not clearly reflect
income, the Commissioner may require. the taxpayer to change to the
IPIC method. If the Commissioner requires a taxpayer to change to
the IPIC method, and the taxpayer does not provide sufficient
information from its books and records to compute an adjustment
under section 481, the Commissioner may implement the change using
the simplified transition method described in paragraph (e)(3)(iv)
(B)(2)(ii) of this section.

(ii) Simplified Transition Method. Under the simplified transition
method, the Commissioner will recompute the LIFO value of each
dollar-value pool as of the beginning of the year of change using
the double-extension IPIC method or the link-chain IPIC method. The
adjustment under section 481 is equal to the difference between the
recomputed LIFO value and the LIFO value of the pool determined
under the taxpayer's former method. The Commissioner will compute an
IPI using the double- extension IPIC method or link-chain IPIC
method for each taxable year in which the LIFO method was used by
the taxpayer based on the assumptions that the ending inventory of
the pool in each taxable year was comprised of items that fall into
the same BLS categories as the items in the ending inventory of the
year of change and that the relative weights of those BLS categories
in all prior years were the same as the relative weights of those
BLS categories in the ending inventory of the year of change. The
base-year cost of the items in a dollar-value pool at the end of a
taxable year will be determined by dividing the IPI computed for the
taxable year into the current-year cost of the items in that pool
determined in accordance with paragraph (e)(2)(ii) of this section.
If the comparison of the base-year cost of the beginning and ending
inventory produces a current-year increment, the base-year cost of
that increment will be. multiplied by the IPI computed for that
taxable year to determine the LIFO value of that layer.

(iii) Example. The following example illustrates the rules of this
paragraph (e)(3)(iv)(B)(2)(ii). Example.

(i) Z began using a dollar-value LIFO method other than the IPIC
method in the taxable year ending December 31, 1998, and maintains a
single dollar-value pool. Z's beginning inventory as of January 1,
2000, computed using its method of accounting, was as follows:

                    (I)            (II)         (III)
                    Base-Year      Inflation    LIFO Value:
Layer               Cost           Index        (I) * (II)
Base layer          $105,000       1.00         $105,000
1998 layer          $3,000         1.40         $4,200
Total               $108,000                    $109,200


(ii) Upon examining Z's federal income tax return for the taxable
year ending December 31, 2000, the examining agent determines that
Z's dollar-value LIFO method does not clearly reflect income. The
examining agent chooses to change Z to the double-extension IPIC
method for 2000 and implements the change using the simplified
transition method as follows. First, the inventory in Z's dollar-
value pool at the end of 2000 is assigned to the most-detailed
categories in the CPI or PPI, whichever is appropriate. Assume that
80 percent of the current-year cost of Z's inventory as of December
31, 2000, is assigned to Category 1, 10 percent is assigned to
Category 2, and 10 percent is assigned to Category 3. Assume further
that the current-year cost of the inventory in Z's dollar-value pool
at the end of 1998 and 1999 was $133,000 and $145,000, respectively.

(iii) The category inflation indexes for 1998 computed under the
double-extension IPIC method are 1.17 for Category 1, 1.26 for
Category 2, and 1.19 for Category 3. The weights to be used in
computing the IPI for 1998 are $106,400 ($133,000 * 80 percent) for
Category 1, $13,300 ($133,000 * 10 percent) for Category 2, and
$13,300 ($133,000 * 10 percent) for Category 3. The IPI for 1998 is
computed as follows:



                  (I)          (II)               (III)
Category          Weight       Category Inflation Quotient:
                               Index              (I) / (II)
1                $106,400      1.17               $90,940
2                 $13,300      1.26               $10,556
3                 $13,300      1.19               $11,176
Total            $133,000                        $112,672



(IV)         (V)                         (VI)
Sum of       Sum of (Weight /            Inventory Price Index:
Weights      Category Inflation Index)   (IV) / (V )
$133,000     $112,672                    1.180417




(iv) The base-year cost of the inventory in Z's pool at the end of
1998 is $112,672 ($133,000 / 1.180417), and the base-year cost of
the 1998 increment is $7,672 ($112,672 - $105,000). The LIFO value
of the 1998 layer is $9,056 ($7,672 * 1.180417).

(v) The category inflation indexes for 1999 computed under the
double-extension IPIC method were 1.21 for Category 1, 1.29 for
Category 2 and 1.23 for Category 3. The weights to be used in
computing the IPI for 1999 are $116,000 ($145,000 * 80 percent) for
Category 1, $14,500 ($145,000 * 10 percent) for Category 2, and
$14,500 ($145,000 * 10 percent) for Category 3. The IPI for 1999 is
computed as follows:

                                                         (III)
                     (I)            (II)                 Quotient:
Category             Weight         Category Inflation
                                    Index                (I) / (II)
 1                   $116,000       1.21                 $95,868
 2                     14,500       1.29                 11,240
 3                     14,500       1.23                 11,789
 Total               $145,000                            $118,897


                   (V)                               (VI)
(IV)               Sum of (Weight /           Inventory Price Index:
Sum of Weights     Category Inflation Index)         (IV) / (V)
$145,000           $118,897                          1.219543




(vi) The base-year cost of the inventory in Z's pool at the end of
1999 is $118,897 ($145,000 / 1.219543), and the base-year cost of
the 1999 layer is $6,225 ($118,897 - $112,672). The LIFO value of
the 1999 layer is $7,592 ($6,225 * 1.219543).

(vii) The LIFO value of Z's dollar-value pool at the end of 1999
computed under the double-extension IPIC method is as follows:

               (I)       (II)               (III)
               Base-Year  Inventory Price   LIFO Value:
Layer          Cost       Index             (I) * (II)
Base layer     $105,000   1.000000          $105,000
1998 layer       $7,672   1.180417          $9,056
1999 layer       $6,225   1.219542          $7,592
Total          $118,897                     $121,648



(viii) The section 481(a) adjustment is equal to the difference
between the LIFO value of the inventory at the beginning of 2000
computed under Z's former method of accounting and recomputed by the
examining agent under the double-extension IPIC method, or $12,448
($121,648 - $109,200).

(ix) Finally, the examining agent will recompute Z's taxable income
for 2000 and succeeding taxable years using the double-extension
IPIC method.

(v) Effective date--(A) In general. The rules of this paragraph (e)
(3) and paragraphs (b)(4) and (c)(2) of this section are applicable
for taxable years ending on or after December 31, 2001.

(b) Change in method of accounting. Any change in a taxpayer's
method of accounting necessary to comply with this paragraph (e)(3)
or with paragraphs (b)(4) or (c)(2) of this section is a change in
method of accounting to which the provisions of section 446 and the
regulations thereunder apply. For the first or second taxable year
ending on or after December 31, 2001, a taxpayer is granted the
consent of the Commissioner to change its method of accounting to a
method required or permitted by this paragraph (e)(3) and paragraphs
(b)(4) and (c)(2) of this section. A taxpayer that wants to change
its method of accounting under this paragraph (e)(3)(v) must follow
the. automatic consent procedures in Rev. Proc. 2002-9 (2002-3
I.R.B. xxx) (see §601.601(d)(2) of this chapter). However, the
scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply,
and the five-year limitation on the readoption of the LIFO method
under section 10.01(2) of the Appendix is waived. In addition, if
the taxpayer's method of accounting for its LIFO inventories is an
issue under consideration at the time the application is filed with
the national office, the audit protection of section 7 of Rev. Proc.
2002-9 does not apply. If a taxpayer changing its method of
accounting under this paragraph (e)(3)(v)(B) 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
application to the examining agent(s), appeals officer or counsel
for the government, as appropriate, at the same time it files the
application with the national office. Any change under this
paragraph (e)(3)(v)(B) must be made using a cut-off method and new
base year as required by paragraph (e)(3)(iv)(B)(1) of this section.
Because a change under this paragraph (e)(3)(v)(B) is made using a
cut-off method, a section 481(a) adjustment is not permitted.
However, a taxpayer changing its method of accounting under this
paragraph (e)(3)(v)(B) must comply with the requirements of section
10.06(3) of the APPENDIX of Rev. Proc. 2002-9 (concerning bargain
purchases).

(h) LIFO inventories received in certain nonrecognition
transactions--(1) In general. Except as provided in paragraph (h)(3)
of this section, if inventory items accounted for under the LIFO
method are received in a transaction described in paragraph (h)(2)
of this section, then, for the purpose of determining future
increments and liquidations, the transferee must use the year of
transfer as the base year and must use its current-year cost
(computed under the transferee's method of accounting) of those
items as their new base-year cost. If the transferee had opening
inventories in the year of transfer, then, for the purpose of
determining future increments and liquidations, the transferee must
use its current-year cost (computed under the transferee's method of
accounting) of those inventories as their new base-year cost. For
this purpose, "opening inventory" refers to all items owned by the
transferee before the transfer for which the transferee uses, or
elects to use, the LIFO method. The total new base-year cost of the
transferee's inventory as of the beginning of the year of transfer
is equal to the new base-year cost of the inventory received from
the transferor and the new base-year cost of the transferee's
opening inventory. The index (or, the cumulative index in the case
of the link-chain method) for the year immediately preceding the
year of transfer is 1.00. The base-year cost of any layers in the
dollar-value pool, as determined after the transfer, must be
recomputed accordingly. See paragraph (e)(3)(iv)(B)(1) of this
section for an example of this computation.

(2) Transactions to which this paragraph (h) applies. The rules in
this paragraph

(h) apply to a transaction in which--

(i) The transferee determines its basis in the inventories, in whole
or in part, by reference to the basis of the inventories in the
hands of the transferor;

(ii) The transferor used the dollar-value LIFO method to account for
the transferred inventories;.

(iii) The transferee uses the dollar-value LIFO method to account
for the inventories in the year of the transfer; and (iv) The
transaction is not described in section 381(a).

(3) Anti-avoidance rule. The rules in this paragraph (h) do not
apply to a transaction entered into with the principal purpose to
avail the transferee of a method of accounting that would be
unavailable to the transferor (or would be unavailable to the
transferor without securing consent from the Commissioner). In
determining the principal purpose of a transfer, consideration will
be given to all of the facts and circumstances. However, a transfer
is deemed made with the principal purpose to avail the transferee of
a method of accounting that would be unavailable to the transferor
without securing consent from the Commissioner if the transferor
acquired inventory in a bargain purchase within the five taxable
years preceding the year of the transfer and used a dollar-value
LIFO method to account for that inventory that did not treat the
bargain purchase inventory and physically identical inventory
acquired at market prices as separate items. Inventory is deemed
acquired in a bargain purchase if the actual cost of the inventory
(or, if appropriate, the allocated cost of the inventory) was less
than or equal to 50 percent of the replacement cost of physically
identical inventory. Inventory is not considered acquired in a
bargain purchase if the actual cost of the inventory (or, if
appropriate, the allocated cost of the inventory) was greater than
or equal to 75 percent of the replacement cost of physically
identical inventory.

(4) Effective date. The rules of this paragraph (h) are applicable
for transfers that occur during a taxable year ending on or after
December 31, 2001. PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK
REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as
follows: Authority: 26 U.S.C. 7805.

Par. 4. In §602.101, the table in paragraph (b) is amended by
revising the entry for 1.472-8 to read as follows:

§602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where Current OMB
identified and described control No.

* * * * *

CFR part or section where                       Current OMB
identified and described                        control No.

* * * * *

1.472-8 .........................................
545-0028 ........................................
1545-0042 .......................................
1545-1767

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue.
Approved: December 21, 2001
Mark Weinberger
Assistant Secretary of the Treasury.

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