Internal Revenue Bulletin 2021-3 (PDF rendition): IRS Revenue Procedures

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Bulletin No. 2021–3
January 19, 2021
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
ADMINISTRATIVE, EMPLOYMENT TAX
Notice 2021-7, page 482.
Notice 2021-7 provides temporary relief in response to the
ongoing COVID-19 pandemic for employers using the auto-
mobile lease valuation rule to value an employee’s personal
use of an employer-provided automobile for purposes of in-
come inclusion, employment tax, and reporting purposes. If
certain requirements are met, employers that are using the
automobile lease valuation rule may instead use the vehicle
cents-per-mile valuation rule to determine the value of an em-
ployee’s personal use of an employer-provided automobile
beginning as of March 13, 2020. For 2021, employers may
revert to the automobile lease valuation rule or continue us-
ing the vehicle cents-per-mile valuation rule provided certain
requirements are met.
EMPLOYEE PLANS, INCOME TAX
T.D. 9932, page 345.
Section 162(m)(1) of the Internal Revenue Code generally
limits to $1,000,000 the allowable deduction for a taxable
year for applicable employee remuneration paid by any pub-
licly held corporation with respect to a covered employee.
The final regulations provide guidance on the application of
§162(m), as amended by section 13601 of Tax Cuts and
Jobs Act (the Act). The Act made significant amendments
to §162(m), and provided a transition rule applicable to cer-
tain outstanding arrangements (commonly referred to as
the grandfather rule). The final regulations provide guidance
on the amendments made by the Act to the definitions of
publicly held corporation, covered employee, and applicable
employee remuneration. Additionally, the final regulations
provide guidance on the operation of the grandfather rule,
including when a contract will be considered materially mod-
ified so that it is no longer grandfathered.
ESTATE TAX
REG-114615-16, page 489.
This guidance contains proposed regulations to establish a
new user fee for authorized persons who wish to request
the issuance of IRS Letter 627, also referred to as an estate
tax closing letter. Pursuant to the guidelines in OMB Circular
A-25, the IRS has calculated its cost of providing the estate
tax closing letter to be $67. REG-114615-16.
INCOME TAX
Notice 2021-2, page 478.
This notice provides the optional 2021 standard mileage
rates for taxpayers to use in computing the deductible costs
of operating an automobile for business, charitable, medi-
cal, or moving expense purposes. This notice also provides
the amount taxpayers must use in calculating reductions
to basis for depreciation taken under the business stan-
dard mileage rate, and the maximum standard automobile
cost that may be used in computing the allowance under
a fixed and variable rate plan. Additionally, this notice pro-
vides the maximum fair market value of employer-provided
automobiles first made available to employees for personal
use in calendar year 2021 for which employers may use
the fleet-average valuation rule in § 1.61-21(d)(5)(v) of the
Income Tax Regulations or the vehicle cents-per-mile valua-
tion rule in § 1.61-21(e).
Notice 2021-5, page 479.
Beginning of Construction for Sections 45 and 48; Extension
of Continuity Safe Harbor for Offshore Projects and Federal
Land Projects. The notice extends the Continuity Safe Harbor
applicable to the production tax credit for renewable energy
facilities under section 45 and the investment tax credit for
energy property under section 48 for Offshore and Federal
Finding Lists begin on page ii.

Land Projects. Specifically, the notice provides that if a qual-
ified facility or an energy property construction project is an
Offshore or Federal Land Project, the Continuity Safe Harbor
is satisfied if a taxpayer places the qualified facility or energy
property that is the subject of the project into service by
the end of a calendar year that is no more than 10 calendar
years after the calendar year during which construction of
the project began.
Rev. Proc. 2021-9, page 485.
This revenue procedure provides a safe harbor that allows a
trade or business that manages or operates a qualified resi-
dential living facility to be treated as a real property trade or
business solely for purposes of qualifying as an electing real
property trade or business under section 163(j)(7)(B) of the
Internal Revenue Code.
T.D. 9939, page 376.
These final regulations provide guidance under section 274
of the Internal Revenue Code (Code) regarding certain amend-
ments made to section 274 by the Tax Cuts and Jobs Act of
2017 (TCJA). These final regulations address the elimination
of the deduction under section 274 for expenses related to
certain transportation and commuting benefits provided by
employers to their employees. The final regulations provide
guidance to determine the amount of such expenses that
is nondeductible and apply certain exceptions under sec-
tion 274(e) that may allow such expenses to be deductible.
These final regulations affect taxpayers who pay or incur
such expenses.
T.D. 9941, page 396.
This Treasury Decision provides final rules regarding the
timing of income inclusion for accrual method taxpayers
with an applicable financial statement, and the treatment
of advance payments resulting from the 2017 enactment
of the Tax Cuts and Jobs Act (TCJA). The Treasury Decision
provides general rules on the timing of income inclusion,
including key definitions and guidance on calculating the
amount of the inclusion. The Treasury Decision also pro-
vides rules regarding cost offsets that apply in certain con-
texts.
T.D. 9942, page 450.
This document contains final regulations to implement leg-
islative changes to sections 263A, 448, 460, and 471 of
the Internal Revenue Code (Code) that simplify the appli-
cation of those tax accounting provisions for certain busi-
nesses having average annual gross receipts that do not
exceed $25 million, adjusted for inflation. This document
also contains final regulations regarding certain special ac-
counting rules for long-term contracts under section 460
to implement legislative changes applicable to corporate
taxpayers. The final regulations generally affect taxpayers
with average annual gross receipts of not more than $25
million (adjusted for inflation).

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing of-
ficial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of inter-
nal management are not published; however, statements of
internal practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service
on the application of the law to the pivotal facts stated in
the revenue ruling. In those based on positions taken in rul-
ings to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature are
deleted to prevent unwarranted invasions of privacy and to
comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative
Rulings. Bank Secrecy Act Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
January 19, 2021 Bulletin No. 2021–3

Part I
26 CFR 1.162-33: Certain employee remuneration
in excess of $1,000,000 not deductible for taxable
years beginning after December 31, 2017.
T.D. 9932
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Certain Employee
Remuneration in Excess of
$1,000,000 under Internal
Revenue Code Section
162(m)
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document sets forth
final regulations under section 162(m) of
the Internal Revenue Code (Code), which
for Federal income tax purposes limits the
deduction for certain employee remuner-
ation in excess of $1,000,000. These final
regulations implement the amendments
made to section 162(m) by the Tax Cuts
and Jobs Act and finalize the proposed
regulations published on December 20,
2019. These final regulations affect pub-
licly held corporations.
DATES: Effective Date: These regula-
tions are effective on December 30, 2020.
Applicability Dates: For dates of applica-
bility, see §1.162-33(h).
FOR FURTHER INFORMATION
CONTACT: Ilya Enkishev at (202) 317-
5600 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document amends the Income
Tax Regulations (“Treasury regulations”
(26 CFR part 1) under section 162(m)).
Section 162(m)(1) disallows a deduction
by any publicly held corporation for ap-
plicable employee remuneration paid or
otherwise deductible with respect to any
covered employee to the extent that such
remuneration for the taxable year exceeds
$1,000,000. Section 162(m) was added to
the Code by section 13211(a) of the Om-
nibus Budget Reconciliation Act of 1993,
Public Law 103-66. Proposed regulations
under section 162(m) were published
in the Federal Register on December
20, 1993 (58 FR 66310) (1993 proposed
regulations). On December 2, 1994, the
Department of the Treasury (Treasury
Department) and the Internal Revenue
Service (IRS) issued amendments to
the proposed regulations (59 FR 61884)
(1994 proposed regulations). On Decem-
ber 20, 1995, the Treasury Department
and the IRS issued final regulations under
section 162(m) (TD 8650) (60 FR 65534)
(1995 regulations).
Section 162(m) was amended by sec-
tion 13601 of the Tax Cuts and Jobs Act
(TCJA) (Pub. L. 115-97, 131 Stat. 2054,
2155 (2017)). Section 13601 of TCJA
amended the definitions of covered em-
ployee, publicly held corporation, and
applicable employee remuneration in sec-
tion 162(m). Section 13601 also provid-
ed a transition rule applicable to certain
outstanding compensatory arrangements
(commonly referred to as the grandfather
rule). On August 21, 2018, the Treasury
Department and the IRS released No-
tice 2018-68 (2018-36 I.R.B. 418), which
provides guidance on certain issues under
section 162(m).
On December 20, 2019, the Treasury
Department and the IRS published pro-
posed regulations (REG-122180-18) re-
lating to the amendments TCJA made to
section 162(m) in the Federal Register
(84 FR 70356) (the proposed regulations).
The changes to section 162(m) made by
section 13601 of TCJA and the initial
guidance provided by Notice 2018-68 are
described in detail in the preamble to the
proposed regulations.
A public hearing was held on March 9,
2020. The Treasury Department and the
IRS also received written comments with
respect to the proposed regulations. All
written comments received in response
to the proposed regulations are available
at www.regulations.gov or upon request.
After full consideration of the comments
received on the proposed regulations and
the testimony heard at the public hearing,
this Treasury decision adopts the proposed
regulations with modifications in response
to certain comments and testimony, as de-
scribed in the Summary of Comments and
Explanation of Revisions section. Com-
ments outside of the scope of the proposed
regulations generally are not addressed in
this preamble but may be considered in
connection with future guidance projects.
Summary of Comments and
Explanation of Revisions
I. Overview
Section 13601 of TCJA significant-
ly amended section 162(m). Consistent
with the proposed regulations, these final
regulations add a section to the Treasury
regulations to reflect these amendments.
Amended section 162(m) applies to tax-
able years beginning after December 31,
2017, except to the extent transition and
grandfather rules described in section VI
of this preamble apply. Because the 1995
regulations continue to apply to deduc-
tions related to amounts of remuneration
to which the grandfather rule applies, the
1995 regulations are retained as a separate
section in the Treasury regulations under
section 162(m).
These final regulations retain the basic
approach and structure of the proposed
regulations, with certain revisions (in-
cluding revised examples). This Summa-
ry of Comments and Explanation of Re-
visions discusses those revisions, as well
as comments received in response to the
proposed regulations.
II. Publicly Held Corporation
A. In General
As amended by TCJA, section 162(m)
(2) defines the term “publicly held corpo-
ration” as any corporation that is an issuer
(as defined in section 3 of the Securities
Exchange Act of 1934 (Exchange Act))
of securities that are required to be reg-
Bulletin No. 2021–3 345 January 19, 2021

istered under section 12 of the Exchange
Act, or that is required to file reports un-
der section 15(d) of the Exchange Act.
These final regulations adopt the rule in
the proposed regulations providing that,
for ease of administration, a corporation
is a publicly held corporation if, as of the
last day of its taxable year, its securities
are required to be registered under section
12 of the Exchange Act or it is required
to file reports under section 15(d) of the
Exchange Act.
These final regulations also adopt the
rules set forth in the proposed regulations
for determining whether a publicly trad-
ed partnership, a corporation that owns an
entity that is disregarded as an entity sep-
arate from its owner within the meaning
of §301.7701-2(c)(2)(i), or an S corpo-
ration (including an S corporation parent
of a qualified subchapter S subsidiary (as
defined in section 1361(b)(3)(B)) (QSub)
is a publicly held corporation as defined
in section 162(m)(2). Consistent with the
proposed rules, these final regulations
also provide that a real estate investment
trust (REIT), as defined in section 856(a),
that owns a qualified real estate invest-
ment trust subsidiary as defined in section
856(i)(2) (QRS), is a publicly held corpo-
ration if the QRS issues securities required
to be registered under section 12(b) of the
Exchange Act, or is required to file reports
under section 15(d) of the Exchange Act.
B. Affiliated Groups
These final regulations adopt the rules
set forth in the 1995 regulations and the
proposed regulations providing that the
term “publicly held corporation” includes
an affiliated group of corporations (affil-
iated group), as defined in section 1504
(determined without regard to section
1504(b)), that includes one or more pub-
licly held corporations, and that a subsid-
iary corporation that meets the definition
of publicly held corporation is separately
subject to section 162(m). These final reg-
ulations also adopt the rules set forth in
the proposed regulations providing that an
affiliated group includes a parent corpora-
tion that is privately held if one or more
of its subsidiary corporations is a public-
ly held corporation, and that an affiliated
group may include more than one public-
ly held corporation as defined in section
162(m)(2).
In response to the proposed regula-
tions, a commenter suggested that an af-
filiated group with more than one publicly
held corporation should have only one set
of covered employees for the affiliated
group (instead of one set of covered em-
ployees for each separate publicly held
corporation that is a member of the affili-
ated group). These final regulations do not
adopt this suggestion because each corpo-
ration in an affiliated group is a separate
taxpayer and section 162(m)(3) provides
that each taxpayer that is a publicly held
corporation has its own set of covered
employees. Instead, as provided in the
1995 regulations and in the proposed reg-
ulations, these final regulations provide
that, in an affiliated group, each corpora-
tion that is a publicly held corporation is
separately subject to section 162(m) and,
therefore, has its own set of covered em-
ployees.
These final regulations adopt the rules
set forth in the 1995 regulations and the
proposed regulations addressing situations
in which a covered employee of a publicly
held corporation that is a member of an af-
filiated group performs services for anoth-
er member of the affiliated group. These fi-
nal regulations provide that compensation
1
paid by all members of the affiliated group
is aggregated and that any amount disal-
lowed as a deduction by section 162(m) is
prorated among the payor corporations in
proportion to the amount of compensation
paid to the covered employee by each cor-
poration in the taxable year. For situations
in which a covered employee is paid com-
pensation during a taxable year by more
than one publicly held corporation that
are members of the same affiliated group,
these final regulations adopt the rules set
forth in the proposed regulations provid-
ing that the amount of the deduction that
is disallowed for compensation paid to a
covered employee is determined separate-
ly with respect to each payor corporation
that is a publicly held corporation. These
final regulations clarify that compensation
paid by a member of an affiliated group
that is not a publicly held corporation to
an employee who is a covered employee
of two or more other members of the affil-
iated group is prorated for purposes of the
determining the deduction disallowance
among the members that are publicly held
corporations of which the employee is a
covered employee.
C. Foreign Private Issuers
Pursuant to the amended definition
of publicly held corporation in section
162(m)(2), the proposed regulations pro-
vide that a foreign private issuer
2
(FPI) is
a publicly held corporation if it is required
to register securities under section 12 of
the Exchange Act or file reports under
section 15(d) of the Exchange Act. The
legislative history to TCJA indicates that
Congress intended section 162(m) to ap-
ply to FPIs.
3
In response to Notice 2018-68, com-
menters suggested that the proposed reg-
ulations provide that section 162(m) does
not apply to FPIs because FPIs are not
required to disclose compensation of their
officers on an individual basis under the
Exchange Act, unless similar disclosure
is required by their home country.
4
The
commenters asserted that determining
compensation on an individual basis (in
order to determine the three most highly
compensated executive officers) would
require the FPIs to expend significant
time and money in adopting the necessary
1
For simplicity, where possible, these final regulations use the term “compensation” instead of “applicable employee remuneration.” These terms have the same meaning in these final reg-
ulations.
2
The term “foreign private issuer” is defined in 21 CFR 240.3b-4(c).
3
The legislative history to TCJA provides that the amendment to the definition of publicly held corporation under section 162(m) “extends the applicability of section 162(m) to include ... all
foreign companies publicly traded through ADRs.” House Conf. Rpt. 115-466, 489 (2017). The Blue Book similarly states that “the provision extends the applicability of section 162(m) to
include all foreign companies publicly traded through ADRs.” Staff of the Joint Committee on Taxation, General Explanation of Public Law 115-97 (Blue Book), at 261 (December 20, 2018).
4
Before TCJA, the IRS ruled in several private letter rulings that section 162(m), as in effect at that time, did not apply to FPIs because FPIs are not required to disclose compensation of
their officers on an individual basis under the Exchange Act, and, therefore, did not have covered employees. A private letter ruling may be relied upon only by the taxpayer to whom the
ruling was issued and does not constitute generally applicable guidance. See section 11.02 of Revenue Procedure 2020-1, 2020-01 I.R.B. 144. TCJA amended section 162(m) to provide that
a requirement to disclose compensation is not determinative of whether an officer is a covered employee.
January 19, 2021 346 Bulletin No. 2021–3

Bulletin No. 2021–3 347 January 19, 2021
internal procedures to make the determi-
nation consistent with Exchange Act re-
quirements that are inapplicable to them.
The proposed regulations do not adopt
these suggestions.
However, the preamble to the pro-
posed regulations requested comments as
to whether a safe harbor exemption from
the definition of a publicly held corpora-
tion under section 162(m) was appropriate
for FPIs that are not required to disclose
compensation of their officers on an indi-
vidual basis in their home countries and,
if so, how such a safe harbor could be
designed. In response to this request for
comments a commenter suggested that
these final regulations should exempt any
FPI from the definition of publicly held
corporation, unless the FPI is required to
disclose compensation of its officers on
an individual basis in its home country.
Another commenter suggested that these
final regulations should exclude FPIs from
the definition of publicly held corporation
because determining compensation on an
individual basis (in order to determine the
three most highly compensated executive
officers) requires extensive calculations
consistent with executive compensation
disclosure rules under the Exchange Act
that are not applicable to FPIs. The com-
menters did not provide any analysis in
support of a safe harbor rule or address
how a safe harbor could be designed and
administered. These final regulations do
not adopt these suggestions because the
scope of the exemption suggested for FPIs
from the definition of publicly held cor-
poration is inconsistent with the statutory
language and the legislative history. Rath-
er, these final regulations adopt the rules
set forth in the proposed regulations pro-
viding that a FPI is a publicly held corpo-
ration if it is required to register securities
under section 12 of the Exchange Act or
file reports under section 15(d) of the Ex-
change Act.
III. Covered Employee
A. In General
As amended by TCJA, section 162(m)
(3) defines the term “covered employee”
as an employee of the taxpayer if (1) the
employee is the principal executive officer
(PEO) or principal financial officer (PFO)
of the taxpayer at any time during the tax-
able year, or was an individual acting in
such a capacity, (2) the total compensa-
tion of the employee for the taxable year
is required to be reported to shareholders
under the Exchange Act by reason of the
employee being among the three highest
compensated officers for the taxable year
(other than the PEO and PFO), or (3)
the individual was a covered employee
of the taxpayer (or any predecessor) for
any preceding taxable year beginning af-
ter December 31, 2016. TCJA also added
flush language to provide that a covered
employee includes any employee of the
taxpayer whose total compensation for the
taxable year places the individual among
the three highest compensated officers for
the taxable year (other than any individual
who is the PEO or PFO of the taxpayer at
any time during the taxable year, or was
an individual acting in such a capacity)
even if the compensation of the officer is
not required to be reported to shareholders
under the Exchange Act.
These final regulations adopt the rules
set forth in the proposed regulations pro-
viding that a covered employee for any
taxable year means any employee of the
publicly held corporation who is among
the three highest compensated executive
officers for the taxable year, regardless of
whether the executive officer is serving
as an executive officer at the end of the
publicly held corporation’s taxable year,
and regardless of whether the executive
officer’s compensation is subject to dis-
closure for the publicly held corporation’s
last completed fiscal year under the appli-
cable SEC rules. The determination that
an officer is a covered employee because
the officer is one of the three highest com-
pensated executive officers, even if the
officer’s compensation is not required to
be disclosed under the SEC rules, is based
on the flush language to section 162(m)
(3), the legislative history,
5
and the SEC
executive compensation disclosure rules.
6

These final regulations also adopt the rule
in the proposed regulations providing that
the amount of compensation used to iden-
tify the three most highly compensated
executive officers is determined pursuant
to the executive compensation disclosure
rules under the Exchange Act, substitut-
ing the publicly held corporation’s taxable
year for references to the corporation’s
fiscal year for purposes of applying the
disclosure rules under the Exchange Act.
In response to the proposed regula-
tions, a commenter suggested that, with
respect to the three highest compensated
executive officers (other than the PEO
and PFO), the term “covered employee”
should include only executive officers
whose compensation is required to be
disclosed pursuant to the SEC executive
compensation disclosure rules. These final
regulations do not adopt this suggestion
because it is inconsistent with the flush
language of section 162(m)(3) providing
that, even if the compensation of an exec-
utive officer is not required to be reported
to shareholders under the Exchange Act,
the officer is a covered employee if the of-
ficer’s total compensation for the taxable
year, determined in accordance with the
SEC disclosure rules, places the officer
among the three highest compensated of-
ficers for the taxable year (other than the
PEO and PFO).
Section 162(m)(3)(C) provides that the
term “covered employee” includes any
employee who was a covered employee of
any predecessor of the publicly held cor-
poration for any preceding taxable year
beginning after December 31, 2016. The
proposed regulations provide rules for
determining the predecessor of a public-
ly held corporation for various corporate
transactions. With respect to asset acqui-
sitions, the proposed regulations provide
that, if an acquiror corporation acquires at
least 80% of the operating assets (deter-
mined by fair market value on the date of
acquisition) of a publicly held target cor-
poration, then the target corporation is a
predecessor of the acquiror corporation. A
commenter suggested that these final reg-
ulations clarify that the operating assets
refer to gross operating assets instead of
net operating assets. These final regula-
tions adopt this suggestion.
The proposed regulations also provide
rules for determining the covered employ-
5
See House Conf. Rpt. 115-466, 489 (2017).
6
17 CFR 229.402(a)(3) (Item 402 of Regulation S-K).

January 19, 2021 348 Bulletin No. 2021–3
ees of an owner of a disregarded entity,
and an S corporation that owns a QSub.
No comments were received with respect
to these provisions of the proposed regula-
tions. Accordingly, these final regulations
adopt the rules set forth in the proposed
regulations and, consistent with those
rules, provide additional rules for purpos-
es of determining the covered employees
of a REIT that owns a QRS.
B. Covered Employees Limited to
Executive Officers
Under the definition of covered em-
ployee in section 162(m)(3) as amended
by TCJA, a PEO and PFO are covered em-
ployees by virtue of holding those positions
or acting in those capacities. The three
highest compensated officers (other than
the PEO or PFO) are covered employees
by reason of their compensation. Pursuant
to section 162(m)(3)(B), the three highest
compensated officers are determined based
on the methods by which these officers are
identified for purposes of the executive
compensation disclosure rules under the
Exchange Act. With respect to the three
highest compensated officers for a taxable
year, consistent with the disclosure rules
under the Exchange Act, the proposed reg-
ulations provide that only an executive of-
ficer, as defined in 17 CFR 240.3b-7 (Rule
3b-7), may qualify as a covered employee.
In relevant part, Rule 3b-7 provides that
“[e]xecutive officers of subsidiaries may be
deemed executive officers of the registrant
if they perform...policy making functions
for the registrant.” A commenter suggested
that these final regulations provide that an
executive officer of a subsidiary may be a
covered employee of the publicly held cor-
poration that is the registrant only if the of-
ficer is also an officer of that publicly held
corporation. These final regulations do not
adopt this suggestion because it is inconsis-
tent with Rule 3b-7.
C. Covered Employees after Separation
from Service
Section 162(m)(3)(C), as amended by
TCJA, provides that a covered employee
includes “a covered employee of the tax-
payer (or any predecessor) for any preced-
ing taxable year beginning after Decem-
ber 31, 2016.” The legislative history to
TCJA provides that:
if an individual is a covered employee
with respect to a corporation for a tax-
able year beginning after December 31,
2016, the individual remains a covered
employee for all future years. Thus, an
individual remains a covered employee
with respect to compensation other-
wise deductible for subsequent years,
including for years during which the in-
dividual is no longer employed by the
corporation and years after the individ-
ual has died.
(House Conf. Rpt. 115-466, 489 (2017)).
The Blue Book reiterated the legislative
history in explaining the amended defini-
tion of covered employee. See Blue Book
at page 260.
Consistent with section 162(m)(3)(C),
as amended by TCJA, and the legislative
history, the proposed regulations provide
that a covered employee identified for
taxable years beginning after Decem-
ber 31, 2016, will continue to be a cov-
ered employee for all subsequent taxable
years, including years during which the
individual is no longer employed by the
corporation and years after the individu-
al has died. A commenter suggested that,
based on the statutory text of both section
162(m) and section 4960, which was en-
acted by TCJA, Congress intended the
term “employee” in section 162(m) to be
limited to a current employee. The com-
menter pointed out that section 4960(c)
(2) provides, in relevant part, that “the
term ‘covered employee’ means any em-
ployee (including any former employee)”
and noted that the words “including any
former employee” are absent from the
definition of covered employee in section
162(m)(3). The commenter reasoned that,
because Congress enacted section 4960
and amended the definition of covered
employee in section 162(m) in the same
legislation (TCJA), the absence of these
words limits the definition of covered em-
ployee to a current employee for purposes
of section 162(m).
The Treasury Department and the IRS
have concluded that the better analysis is
that Congress intended to apply both sec-
tion 162(m) and section 4960 to current
and former employees. Congress may ac-
complish the same objective in two sep-
arate legislative provisions without using
identical statutory language. As explained
in section III. D of the preamble to the
proposed regulations, the reference to
an employee in section 162(m) provides
no indication that the term “employee”
is limited to a current employee, since a
reference in the Code to an “employee”
has frequently been interpreted in regula-
tions as a reference to both a current and
a former employee.
7
In addition, as pre-
viously noted, the legislative history to
section 162(m) makes clear that Congress
intended the term “covered employee” to
include a former employee.
8
Accordingly,
these final regulations adopt the proposed
regulations without change.
IV. Applicable Employee Remuneration
A. In General
Section 162(m)(4)(A) defines the term
“applicable employee remuneration”
with respect to any covered employee
for any taxable year as the aggregate
amount allowable as a deduction for the
taxable year (determined without regard
to section 162(m)) for remuneration for
services performed by such employee
(whether or not during the taxable year).
Section 162(m)(4)(F) provides that re-
muneration shall not fail to be applicable
employee remuneration merely because
it is includible in the income of, or paid
to, a person other than the covered em-
ployee, including after the death of the
covered employee. For simplicity, the
proposed regulations and these final reg-
ulations use the term “compensation”
instead of “applicable employee remu-
neration” wherever possible. Like the
proposed regulations, these final regula-
tions provide that compensation means
the aggregate amount allowable as a de-
7
See section III. D of the preamble to the proposed regulations. For example, under §1.105-11(c)(3)(iii), the nondiscrimination rules of section 105(h)(3) apply to former employees even
though the Code uses only the term “employees.”
8
House Conf. Rpt. 115-466, supra, at 489.

Bulletin No. 2021–3 349 January 19, 2021
duction under chapter 1 of the Code for
the taxable year (determined without re-
gard to section 162(m)) for remuneration
for services performed by a covered em-
ployee, whether or not the services were
performed during the taxable year, and
that compensation includes an amount
that is includible in the income of, or
paid to, a person other than the covered
employee, including after the death of the
covered employee
B. Compensation Paid by a Partnership to
a Covered Employee
Section 162(m)(1) provides that “[i]
n the case of any publicly held corpora-
tion, no deduction shall be allowed under
this chapter for applicable employee re-
muneration with respect to any covered
employee.” As explained in section IV.
B of the preamble to the proposed reg-
ulations, this statutory provision serves
as the basis for the rule in the proposed
regulations that a publicly held corpora-
tion that holds a partnership interest must
take into account its distributive share of
the partnership’s deduction for compen-
sation paid to the publicly held corpora-
tion’s covered employee and aggregate
that distributive share with the corpora-
tion’s otherwise allowable deduction for
compensation paid directly to that em-
ployee in applying the deduction limita-
tion under section 162(m).
In response to this provision of the pro-
posed regulations, commenters suggested
that remuneration paid by a partnership is
not compensation for purposes of section
162(m) because the partnership is neither
a publicly held corporation nor a member
of an affiliated group. Section 162(m) does
not limit the application of section 162(m)
in that manner. Rather, section 162(m) ap-
plies to all compensation, which includes
“all amounts allowable as a deduction...
for remuneration for services performed
by such employee (whether or not during
the taxable year).” While the comments
suggest a reading of section 162(m)(1)
that services must be performed in the
employee’s capacity as an employee and
must be performed for the publicly held
corporation, neither of these requirements
appear in the statute. In addition, adoption
of the commenters’ suggestion could lead
to the use of partnerships as a method of
avoiding application of section 162(m), a
result that the Treasury Department and
IRS conclude is not intended by the stat-
ute.
Commenters also suggested that re-
muneration paid by a partnership should
be compensation for purposes of section
162(m) only if the publicly held corpora-
tion has an 80% or greater interest in the
partnership because the definition of an
affiliated group requires 80% ownership
by vote and value among the members
of the affiliated group. The Treasury De-
partment and the IRS did not adopt this
rule because the analogy to the affiliated
group proffered by the commenters does
not take into account that the tax treat-
ment of a partner in a partnership differs
from the tax treatment of a corporation
that owns stock in another corporation.
Although a consolidated group of cor-
porations may obtain a tax result similar
to a deduction flow through, a subsidi-
ary’s compensation deduction does not
flow through to the parent corporation
in a non-consolidated group of corpora-
tions. In contrast, when a publicly held
corporation is a partner in a partnership,
a share of the partnership’s items of in-
come, gain, loss, and deduction general-
ly is allocated to the publicly held cor-
poration in accordance with partnership
agreement, subject to section 704. Fur-
thermore, that allocation may occur re-
gardless of the level of ownership by the
publicly held corporation.
These final regulations adopt the provi-
sions of the proposed regulations and pro-
vide that a publicly held corporation must
take into account its distributive share of a
partnership’s deduction for compensation
paid to the publicly held corporation’s
covered employee in determining the
amount allowable to the corporation as a
deduction for compensation under section
162(m). Consistent with an example in
the proposed regulations and incorporated
into these final regulations, these final reg-
ulations clarify that the publicly held cor-
poration’s distributive share of the part-
nership’s deduction for compensation paid
by the partnership to a covered employee
in connection with the performance of ser-
vices includes the partnership’s deduction
for a payment to the covered employee for
services under section 707(a) or section
707(c).
In response to a commenter’s request
for clarification on the application of the
rule that a publicly held corporation must
take into account its distributive share of
a partnership’s compensation payment to
the publicly held corporation’s covered
employee, the Treasury Department and
the IRS confirm that these final regula-
tions address only application of the sec-
tion 162(m) compensation deduction lim-
itation to the publicly held corporation’s
distributive share of the payment. The
commenter also noted that this partner-
ship rule results in a different application
of section 162(m) depending on whether
a publicly held corporation’s covered em-
ployee receives compensation for services
from a partnership in which the publicly
held corporation is a partner or from a
corporate subsidiary of the partnership.
Assuming the partnership is respected
for U.S. Federal income tax purposes,
section 162(m) generally would not ap-
ply to compensation paid to a publicly
held corporation’s covered employee by a
corporate subsidiary of a partnership for
services performed as an employee of the
subsidiary because, in this circumstance,
the corporate subsidiary would not be a
member of the publicly held corporation’s
affiliated group.
In recognition of the prior lack of clar-
ity in this area, the proposed regulations
provide a special applicability date for this
rule, as well as limited transition relief ap-
plicable to arrangements in which a pub-
licly held corporation holds a partnership
interest. Specifically, to ensure that com-
pensation agreements were not formed
or otherwise structured to circumvent the
rule regarding partnerships after publica-
tion of the proposed regulations and prior
to the publication of these final regula-
tions, the proposed regulations set forth a
special applicability date that would apply
the rule to any deduction for compensa-
tion paid by a partnership that is otherwise
allowable for a taxable year ending on or
after December 20, 2019 (the publication
date of the proposed regulations), but
would not apply the rule to compensation
paid pursuant to a written binding contract
in effect on December 20, 2019 that is not
materially modified after that date.
Commenters requested additional
transition relief for this rule. A comment-
er suggested a transition relief period of

January 19, 2021 350 Bulletin No. 2021–3
7 years from the date of publication of
these final regulations.
9
Other comment-
ers suggested that transition relief should
apply for taxable years beginning before
the publication of these final regulations.
In the alternative, these commenters sug-
gested transition relief for compensation
arrangements in effect on December 22,
2017 (the date of TJCA enactment), re-
gardless of whether the partnership is ob-
ligated to pay the amount of compensation
under applicable law, which would pro-
vide for more expansive transition relief
than set forth in the proposed regulations.
As the preamble to the proposed reg-
ulations explains, the transition relief for
this definition of compensation must be
designed to ensure that compensation
agreements are not formed or otherwise
structured to circumvent the proposed
rules after publication of the proposed
regulations and prior to the publication of
these final regulations. In consideration of
commenters’ requests for additional tran-
sition relief, these final regulations modify
the applicability date of the definition of
compensation under §1.162-33(c)(3)(ii)
to provide additional limited transition
relief. Under these final regulations, the
definition of compensation under §1.162-
33(c)(3)(ii) includes an amount equal
to a publicly held corporation’s distrib-
utive share of a partnership’s deduction
for compensation expense attributable
to the compensation paid by the partner-
ship after December 18, 2020, the date on
which these final regulations were made
publicly available on the IRS website at
http://www.irs.gov. Because the date that
these final regulations are made publicly
available is prior to the date that they are
published in the Federal Register, using
the earlier date for the expiration of the
additional transition relief is appropriate
to ensure that compensation is not paid
to circumvent these final regulations. In
addition, these final regulations continue
to provide that this aspect of the definition
of compensation does not apply to com-
pensation paid after December 30, 2020
if the compensation is paid pursuant to a
written binding contract that is in effect on
December 20, 2019, and that is not mate-
rially modified after that date.
C. Compensation for Services in a
Capacity other than as a Common Law
Employee
The proposed regulations provide that
compensation subject to section 162(m)
includes remuneration for services per-
formed by a covered employee in any
capacity, including as a common law em-
ployee, a director, or an independent con-
tractor. As explained in section IV. C of the
preamble to the proposed regulations, this
rule is based on the lack of a specific lim-
itation in the statutory language regarding
the capacity in which the covered employ-
ee must perform the services for which re-
muneration is paid, and it is supported by
the legislative history to the enactment of
section 162(m) in 1993
10
and the preamble
to the 1993 proposed regulations.
11
In response to the proposed regula-
tions, commenters suggested that, based
on the language of section 162(m)(4)(A),
compensation subject to section 162(m)
should include only compensation for
services performed by a covered employ-
ee as an employee of the publicly held
corporation. The commenters reasoned
that, because section 162(m)(4)(A) uses
the phrase “for remuneration for services
performed by such employee” (emphasis
added) in defining compensation subject
to section 162(m), only compensation for
services provided as an employee is sub-
ject to section 162(m).
12
While the statute may be read in the
manner suggested by the commenters,
there is nothing in the language that
compels this reading, nor does the legis-
lative history to the enactment of section
162(m) suggest that compensation sub-
ject to section 162(m) was intended to
include only compensation for services
as an employee. Section 162(m)(4)(A),
which was not amended by TCJA, pro-
vides that “the term ‘applicable employee
remuneration’ means, with respect to any
covered employee for any taxable year,
the aggregate amount allowable as a de-
duction under this chapter for such taxable
year...for remuneration for services per-
formed by such employee (whether or not
during the taxable year).” The legislative
history provides that section 162(m) “ap-
plies to all compensation...regardless of
whether the compensation is for services
as a covered employee and regardless of
when the compensation was earned.”
13

Consistent with this legislative history, the
1995 regulations defined the term com-
pensation as “the aggregate amount allow-
able as a deduction...for remuneration for
services performed by a covered employ-
ee, whether or not the services were per-
formed during the taxable year.”
14
Thus,
9
This commenter also suggested a transition relief period of 10 years for taxpayers that, prior to the IRS first announcing the no-rule position on this issue in Revenue Procedure 2010-3,
received private letter rulings providing that section 162(m) did not limit the deduction of the publicly held corporation for compensation paid to a covered employee by a partnership in which
the publicly held corporation held a partnership interest. The IRS announced the no-rule position in 2010 in section 5.06 of Revenue Procedure 2010-3, 2010-1 I.R.B. 110, which provided that
“[w]hether the deduction limit under § 162(m) applies to compensation attributable to services performed for a related partnership” was an area under study in which rulings or determination
letters will not be issued until the IRS resolves the issue through publication of a revenue ruling, revenue procedure, regulations, or otherwise.
10
The legislative history to the enactment of section 162(m) provides that:

Unless specifically excluded, the deduction limitation applies to all remuneration for services, including cash and the cash value of all remuneration (including benefits) paid in a medi-
um other than cash. If an individual is a covered employee for a taxable year, the deduction limitation applies to all compensation not explicitly excluded from the deduction limitation,
regardless of whether the compensation is for services as a covered employee and regardless of when the compensation was earned.

House Conf. Rpt. 103-213, 585 (1993).
11
The preamble to the 1993 proposed regulations provides that, “[t]he deduction limit of section 162(m) applies to any compensation that could otherwise be deducted in a taxable year, except
for enumerated types of payments set forth in section 162(m)(4)” (58 FR 66310, 66310).
12
In suggesting that the statute should be read to exclude payments for services performed as an independent contractor from compensation subject to section 162(m), commenters point to
a private letter ruling issued in 1997 (PLR 9745002). In the letter ruling, based on the facts presented, the IRS ruled that, for purposes of section 162(m), compensation excludes consulting
fees for services performed by a covered employee as an independent contractor. A private letter ruling may be relied upon only by the taxpayer to whom the ruling was issued and does not
constitute generally applicable guidance. See section 11.02 of Revenue Procedure 2020-1, 2020-01 I.R.B. 144.
13
House Conf. Rpt. 103-213, 585 (1993).
14
Section 1.162-27(c)(3)(i). The preamble to the 1993 proposed regulations reiterates this principle, as quoted earlier.

Bulletin No. 2021–3 351 January 19, 2021
neither the statute nor the 1995 regula-
tions specifically limit the compensation
subject to section 162(m) to remuneration
paid to the covered employee for services
as an employee.
Commenters also suggested that sec-
tion 162(m) does not apply to compensa-
tion for services as an independent con-
tractor because by excluding from the
definition of compensation payments that
may be made only to an employee, sec-
tion 162(m)(4)(C) indicates that compen-
sation subject to section 162(m) is lim-
ited to compensation for services as an
employee. Section 162(m)(4)(C) excludes
from the definition of compensation: “(i)
any payment referred to in so much of sec-
tion 3121(a)(5) as precedes subparagraph
(E) thereof, and (ii) any benefit provided
to or on behalf of an employee if at the
time such benefit is provided it is reason-
able to believe that the employee will be
able to exclude such benefit from gross
income under this chapter.”
Section 162(m)(4)(i), by cross-ref-
erencing sections 3121(a)(5)(A)-(D),
generally excludes from compensation
contributions by an employer on an em-
ployee’s behalf to certain types of quali-
fied retirement plans and payments from
those types of plans to the employee.
Thus, contributions to these arrangements
for which an employer would otherwise
have a deduction available will not be
treated as compensation and the deduc-
tion will not be limited by section 162(m).
Section 162(m)(4)(C)(ii) serves a similar
function by excluding from compensation
(and thus not limiting the compensation
deduction) certain employee benefits that
would be excludible from the employee’s
income. These exclusions of benefit pay-
ments from the definition of “applicable
employee remuneration” reflect only that
an individual must be an active employ-
ee of the publicly held corporation (or
a predecessor) at some point in order to
become a covered employee, and that the
individual typically would participate in
these types of employee benefit arrange-
ments as an employee (often continuing
participation that started before the indi-
vidual became a covered employee).
Importantly, the TCJA amendments
to section 162(m) changed the context
in which the question as to whether
non-employee compensation is subject
to the deduction limitation is analyzed.
Prior to TCJA, the section 162(m) de-
duction limitation could be avoided by
ensuring that any compensation in excess
of $1,000,000 paid to a covered employee
qualified as performance-based compen-
sation or was paid to the covered employ-
ee after separation from service or after
termination of the individual’s status as a
covered employee. For example, if a PEO
ceased serving as PEO or as an executive
officer but continued as an employee of
the publicly held corporation for later tax-
able years, the former PEO could be com-
pensated without taking into account the
potential for a limitation on the deduction
due to section 162(m).
The TCJA amendment of section
162(m) eliminates the exclusion from
the deduction limitation for compensa-
tion paid after the individual is no longer
a covered employee. Under the amended
section 162(m) rules, once an individu-
al is identified as a covered employee,
the individual continues to be a covered
employee, and all compensation paid to
that individual is subject to the deduction
limitation, even after the individual is no
longer employed by the publicly held cor-
poration. As explained in the legislative
history, this result was intended.
15
The commenters’ suggestion that sec-
tion 162(m) does not apply to compen-
sation for services as an independent
contractor would lead to uncertainty and
administrative burdens for both the tax-
payer and the IRS, as well as to the poten-
tial for abusive arrangements structured to
avoid the application of section 162(m) to
covered employees who have terminated
employment (or who have purportedly
terminated employment). Given that the
amendments to section 162(m) no longer
limit the deduction disallowance to taxable
years in which a covered employee is em-
ployed on the last day of the taxable year,
and the lack of statutory language or legis-
lative history specifically indicating an in-
tent to restrict the deduction limitation to
compensation earned by the individual in
the capacity as an employee, the Treasury
Department and the IRS have determined
that the more appropriate construction of
the statutory language defining “applica-
ble employee remuneration” is to include
all compensation paid to a covered em-
ployee regardless of the capacity in which
the covered employee performed services
to earn that compensation.
V. Privately Held Corporations that
Become Publicly Held
These final regulations adopt the rules
set forth in the proposed regulations pro-
viding that, in the case of a privately held
corporation that becomes a publicly held
corporation, section 162(m) limits the de-
duction for any compensation that is oth-
erwise deductible for the taxable year end-
ing on or after the date that the corporation
becomes a publicly held corporation, and
that a corporation is considered to become
publicly held on the date that its registra-
tion statement becomes effective under
the Securities Act or the Exchange Act.
These final regulations also adopt the
transition relief set forth in the proposed
regulations providing that a privately held
corporation that becomes a publicly held
corporation on or before December 20,
2019, generally may rely on the transition
rules provided in §1.162-27(f)(1) and (2)
of the 1995 regulations.
16
In response to
a question from a commenter, these fi-
nal regulations clarify that a subsidiary
that is a member of an affiliated group
may rely on transition relief provided in
§1.162-27(f)(4) of the 1995 regulations if
it becomes a separate publicly held corpo-
ration (for example, in a spin-off transac-
tion) on or before December 20, 2019.
Consistent with comments received
prior to issuance of the proposed regula-
tions, a commenter suggested that these fi-
nal regulations should continue to provide
transition relief similar to that provided in
§1.162-27(f)(1) and (2) of the 1995 reg-
ulations for privately held corporations
that become publicly held after Decem-
ber 20, 2019. Those sections of the 1995
regulations were formulated based on the
15
House Conf. Rpt. 115-466, 489 (2017).
16
Specifically, a privately held corporation that becomes a publicly held corporation before December 20, 2019, may rely on the transition rules provided in §1.162-27(f)(1) until the earliest
of the events described in §1.162-27(f)(2). As provided in the 1995 regulations, a corporation that is a member of an affiliated group that includes a publicly held corporation is considered
publicly held and, thus, may not rely on the transition relief provided in §1.162-27(f)(1).

January 19, 2021 352 Bulletin No. 2021–3
legislative history to the enactment of
section 162(m) and were intended to per-
mit a transition period to meet the share-
holder approval requirement for qualified
performance-based compensation so that
the resulting compensation would not be
subject to the deduction limitation under
section 162(m). TCJA eliminated the ex-
clusion from the definition of compen-
sation for qualified performance-based
compensation. Thus, a transition period
to accommodate a shareholder approval
process is no longer needed. There is no
indication in the language of the amended
section 162(m) or the legislative history to
the amendments that the transition period
was intended be extended even though the
original basis for its adoption no longer
exists. Accordingly, the suggestion is not
adopted in these final regulations.
VI. Grandfather Rule
A. In General
Section 13601(e) of TCJA generally
provides that the amendments to section
162(m) apply to taxable years beginning
after December 31, 2017. However, it fur-
ther provides that those amendments do
not apply to compensation that is payable
pursuant to a written binding contract that
was in effect on November 2, 2017, and
that was not modified in any material re-
spect on or after that date (the grandfather
rule).
As discussed in section VI. A of the
preamble to the proposed regulations,
the text of section 13601(e) of TJCA is
almost identical to the text of pre-TCJA
section 162(m)(4)(D), which provided a
transition rule in connection with the en-
actment of section 162(m) in 1993 (the
1993 grandfather rule). Under the 1993
grandfather rule, section 162(m) did not
apply to compensation payable under a
written binding contract that was in ef-
fect on February 17, 1993, and that was
not modified thereafter in any material re-
spect before the compensation was paid.
Section 1.162-27(h) provides guidance on
the definitions of written binding contract
and material modification for purposes of
applying the 1993 grandfather rule. The
proposed regulations adopt those defini-
tions for purposes of the grandfather rule
under section 13601(e) of TCJA. These
final regulations adopt the provisions of
the proposed regulations and retain these
definitions, including that compensation is
payable under a written binding contract
that was in effect on November 2, 2017,
only to the extent that the corporation is
obligated under applicable law to pay the
compensation if the employee performs
services or satisfies the applicable vesting
conditions. Section 162(m), as amended,
applies to any amount of compensation
that exceeds the amount that applicable
law obligates the corporation to pay under
a written binding contract that was in ef-
fect on November 2, 2017.
In response to the proposed regula-
tions, a commenter requested that these
final regulations adopt a safe harbor based
on Generally Acceptable Accounting
Principles (GAAP). The same suggestion
had been made prior to issuance of the
proposed regulations, and section VI. A
of the preamble to the proposed regula-
tions describes a number of issues with a
GAAP safe harbor and asks for comments
on how and whether these issues could be
addressed. The commenter did not address
any of these issues related to the formula-
tion and application of a GAAP safe har-
bor. Accordingly, these final regulations
do not adopt a GAAP safe harbor rule.
Another commenter suggested a safe
harbor that would grandfather an amount
of compensation paid pursuant to a com-
pensation arrangement that satisfied three
requirements on or before November 2,
2017: (1) the arrangement was memorial-
ized in some form of media (for example,
presentation slides or spreadsheet); (2)
the arrangement was communicated to its
participants (for example, disseminated in
hard copy, electronically, or via presen-
tation format); and (3) participants in the
arrangement had a reasonable expectation
that they were eligible to receive compen-
sation pursuant to the arrangement. This
suggested safe harbor would require an
intensive facts and circumstances anal-
ysis and raise administrability issues
about how to determine the participants’
expectations regarding the compensation
arrangement and whether those expecta-
tions were reasonable. Furthermore, the
suggested safe harbor arguably is incon-
sistent with the statutory language that
grandfathers an amount of compensation
only if the corporation was obligated to
pay it under applicable law pursuant to a
written binding contract in effect on No-
vember 2, 2017, and not, for example, if
an employee merely had a reasonable ex-
pectation of payment (without regard to
the corporation’s obligation under appli-
cable law). For these reasons, these final
regulations do not adopt this safe harbor.
B. Compensation Subject to Negative
Discretion
These final regulations adopt the rule
set forth in the proposed regulations pro-
viding that a provision in a compensation
agreement that purports to provide the
employer with the discretion to reduce or
eliminate a compensation payment (nega-
tive discretion) is taken into account only
to the extent the corporation has the right
to exercise the negative discretion under
applicable law (for example, applicable
state contract law). If a compensation
arrangement allows the corporation to
exercise negative discretion, compensa-
tion payable under the arrangement is not
grandfathered to the extent the corpora-
tion is not obligated to pay it under appli-
cable law.
In response to the proposed regu-
lations, a commenter suggested that
negative discretion provisions should
be disregarded in determining whether
compensation is grandfathered because
numerous performance-based compensa-
tion arrangements provide corporations
with such discretion. However, the prac-
tice of including negative discretion pro-
visions in compensation arrangements is
based on a well-known and longstand-
ing regulatory provision, and Congress
could have provided for a grandfather
rule that addressed performance-based
compensation arrangements that include
a negative discretion provision, but it did
not. Instead, the grandfather rule refers
only to compensation paid pursuant to a
legally binding contract in effect on the
transition date. Thus, whether a perfor-
mance-based compensation arrangement
that includes a negative discretion provi-
sion is a legally binding contract is deter-
mined based on applicable law.
Another commenter suggested that
a corporation should be deemed not to
have a right to exercise negative discre-
tion if the terms of the agreement provide

Bulletin No. 2021–3 353 January 19, 2021
that the corporation may not exercise this
discretion if doing so would result in the
payment of compensation that would
not be deductible by reason of section
162(m). Whether a compensation agree-
ment that includes a negative discretion
provision of this sort would be a written
binding contract that permitted the exer-
cise of the negative discretion after the
amendments to section 162(m) or rather
obligated the employer to pay the com-
pensation because the section 162(m)
amendments negated the employer’s
ability to exercise the negative discretion
must be determined based on applicable
law. Accordingly, these final regulations
do not provide a separate standard for
purposes of applying the grandfather rule
to compensation agreements that include
this type of negative discretion provision
(or any other type of negative discretion
provision).
C. Recovery of Compensation
The proposed regulations provide
that, if the corporation is obligated or
has discretion to recover compensation
paid in a taxable year only upon the fu-
ture occurrence of a condition that is
objectively outside of the corporation’s
control, then the corporation’s right to
recovery is disregarded for purposes of
determining the grandfathered amount
for the taxable year. The proposed regu-
lations also provide that, if the condition
occurs, then only the amount the corpora-
tion is obligated to pay under applicable
law remains grandfathered, taking into
account the occurrence of the condition.
After further consideration, the Treasury
Department and the IRS recognize that
the corporation’s right to recover com-
pensation is a contractual right that is
separate from the corporation’s binding
obligation under the contract (as of No-
vember 2, 2017) to pay the compensa-
tion. Accordingly, these final regulations
provide that the corporation’s right to
recover compensation does not affect the
determination of the amount of compen-
sation the corporation has a written bind-
ing contract to pay under applicable law
as of November 2, 2017, whether or not
the corporation exercises its discretion to
recover any compensation in the event
the condition arises in the future.
D. Account and Nonaccount Balance
Plans
The proposed regulations include ex-
amples illustrating the application of the
grandfather rule to account and nonac-
count balance nonqualified deferred com-
pensation (NQDC) plans. In response to
comments, these final regulations clarify
the application of the grandfather rule to
compensation payable under these plans
by providing detailed rules and thus elimi-
nate the need to retain certain examples in
these final regulations. Specifically, with
respect to an account balance plan, these
final regulations provide that the grandfa-
thered amount under an account balance
plan is the amount that the corporation is
obligated to pay pursuant to the terms of
the plan as of November 2, 2017, as de-
termined under applicable law. If the cor-
poration is obligated to pay the employee
the account balance that is credited with
earnings and losses and has no right to ter-
minate or materially amend the contract,
then the grandfathered amount would be
the account balance as of November 2,
2017, plus any additional contributions
and earnings and losses that the corpora-
tion is obligated to credit under the plan,
through the date of payment. These final
regulations provide an analogous rule for
nonaccount balance plans.
If the terms of the account balance
plan that is a written binding contract as
of November 2, 2017, provide that the
corporation may terminate the plan and
distribute the account balance to the em-
ployee, then the grandfathered amount is
the account balance determined as if the
corporation had terminated the plan on
November 2, 2017, or, if later, the ear-
liest possible date the plan could be ter-
minated (termination date). Furthermore,
whether additional contributions and
earnings and losses credited to the ac-
count balance after the termination date,
through the earliest possible date the ac-
count balance could have been distrib-
uted to the employee, are grandfathered
depends on whether the terms of the plan
require the corporation to make those
contributions or credit those earnings and
losses through the earliest possible date
the account balance could be distributed
if it were terminated as of the termination
date. These final regulations provide an
analogous rule for nonaccount balance
plans.
If the terms of the account balance plan
provide that the corporation may not ter-
minate the contract, but may discontinue
future contributions to the account bal-
ance and distribute the account balance
in accordance with the terms of the plan,
then the grandfathered amount is the ac-
count balance determined as if the corpo-
ration had exercised the right to discon-
tinue contributions on November 2, 2017
or, if later, the earliest permissible date the
corporation could exercise that right in ac-
cordance with the terms of the plan (the
freeze date). Furthermore, if the plan re-
quired the crediting of earnings and loss-
es on the account balance after the freeze
date through the payment date, then those
earnings and losses credited to the grand-
fathered account balance are also grand-
fathered. These final regulations provide
an analogous rule for nonaccount balance
plans.
Alternatively, whether the terms of
the account balance plan provide that the
corporation may terminate the plan or,
instead, may discontinue future contribu-
tions, the corporation may elect to treat the
account balance as of the termination date
(or freeze date, if applicable) as the grand-
fathered amount regardless of when the
amount is paid and regardless of whether
it has been credited with earnings or losses
prior to payment. These final regulations
provide an analogous rule for nonaccount
balance plans. These final regulations
adopt this alternative grandfather rule
that disregards earnings and losses in or-
der to minimize the administrative burden
of tracking the earnings, losses and new
contributions (if made) on an account bal-
ance plan or the increase or decrease in a
nonaccount balance benefit after Novem-
ber 2, 2017. With respect to an account
balance plan, the Treasury Department
and IRS understand that this grandfather
rule may result in contributions made af-
ter November 2, 2017, not being subject
to the section 162(m) limitation if the
contributions offset losses; however, the
Treasury Department and IRS concluded
that under many common arrangements
the continuous separate tracking of earn-
ings, losses, and contributions on the No-
vember 2, 2017, account balance through
the payment date would be burdensome to

January 19, 2021 354 Bulletin No. 2021–3
administer while having a limited, if any,
impact on the available deduction.
E. Ordering Rule for Payments
Consisting of Grandfathered and Non-
Grandfathered Amounts Deductible for
Taxable Years Ending Prior to December
20, 2019
These final regulations adopt the or-
dering rule set forth in the proposed reg-
ulations for identifying the grandfathered
amount when payment under a grandfa-
thered arrangement is made in a series of
payments. Pursuant to the ordering rule,
the grandfathered amount is allocated to
the first otherwise deductible payment
paid under the arrangement. If the grand-
fathered amount exceeds the payment,
then the excess is allocated to the next
otherwise deductible payment paid under
the arrangement. This process is repeated
until the entire grandfathered amount has
been paid.
For example, assume an employer
maintains a nonaccount balance NQDC
plan (payable as an annuity) as of Novem-
ber 2, 2017, and that the grandfathered
amount is $2,000,000. Further assume
that additional benefits accrue under the
plan after November 2, 2017, with the
result that the employee’s benefit is pay-
able as an annual annuity of $1,500,000
commencing at the employee’s retirement
for the employee’s life. Under these final
regulations, the entire $1,500,000 paid in
the first year is grandfathered. In the sec-
ond year, only $500,000 of the $1,500,000
payment is grandfathered; the remaining
$1,000,000 paid in the second year is not
grandfathered. For subsequent taxable
years, none of the $1,500,000 payments
are grandfathered.
A commenter suggested that for pay-
ments otherwise deductible for taxable
years ending prior to the date the proposed
regulations were published (December 20,
2019), it would be a reasonable good faith
interpretation of the statute if the grandfa-
thered amount were allocated to the last
otherwise deductible payment or to each
payment on a pro rata basis. The Trea-
sury Department and the IRS agree and
these final regulations permit the grandfa-
thered amount to be allocated to the last
otherwise deductible payment or to each
payment on a pro rata basis for taxable
years ending before December 20, 2019.
However, these final regulations provide
that the ordering rule requiring the grand-
fathered amount to be allocated to the first
otherwise deductible payment paid under
the arrangement must be used for taxable
years ending on or after December 20,
2019, regardless of the method used to
allocate the grandfathered amount for tax-
able years ending prior to that date.
F. Grandfathered Amount Limited to a
Particular Plan or Arrangement
These final regulations provide that the
grandfathered amount payable under a
plan or arrangement applies solely to the
amounts paid under that plan or arrange-
ment. Regardless of whether all of the
grandfathered amount is paid to the em-
ployee, no portion of that grandfathered
amount may be treated as a grandfathered
amount under any other separate plan or
arrangement in which the employee is a
participant. If, for example, all or a por-
tion of a grandfathered amount is forfeited
because the employee died before being
paid the entire amount, then any unpaid
portion of the grandfathered amount may
not be applied as a grandfathered amount
to payments under any other separate plan
or arrangement in which the employee
participated.
G. Material Modification
1. In General
These final regulations adopt the rules
set forth in the proposed regulations re-
lated to material modifications. A mate-
rial modification occurs when a contract
is amended to increase the amount of
compensation payable to the employee.
If a written binding contract is material-
ly modified, it is treated as a new contract
entered into as of the date of the material
modification. Accordingly, if a contract
is materially modified, amounts received
by an employee under the contract before
the material modification are not affected,
but amounts received after the material
modification are treated as paid pursuant
to a new contract, rather than as grandfa-
thered. The adoption of a supplemental
contract or agreement that provides for
increased compensation, or the payment
of additional compensation, results in a
material modification if the facts and cir-
cumstances demonstrate that the compen-
sation under the supplement is paid on the
basis of substantially the same elements
or conditions as the compensation that
is otherwise paid pursuant to the written
binding contract.
If a written binding contract in effect on
November 2, 2017, is subsequently mod-
ified to defer the payment of compensa-
tion, any compensation paid or to be paid
that is in excess of the amount that was
originally payable to the employee under
the contract will not be treated as resulting
in a material modification if the addition-
al amount is based on either a reasonable
rate of interest or a predetermined actual
investment (whether or not assets associ-
ated with the original amount are actual-
ly invested therein) such that the amount
payable by the employer at the later date
will be based on the rate of interest or the
actual rate of return on the investment
(including any decrease, as well as any
increase, in the value of the investment).
However, the additional amount paid will
not be treated as a grandfathered amount.
Additionally, a modification of the con-
tract after November 2, 2017, to offer an
additional or substitute a predetermined
actual investment as an investment alter-
native under the arrangement is not a ma-
terial modification.
A commenter suggested that these final
regulations provide that the deferral of a
grandfathered amount after November 2,
2017, but prior to September 10, 2018 (the
publication date of Notice 2018-68), is not
a material modification even if the earn-
ings on the deferred amount are not based
on either a reasonable rate of interest or a
predetermined actual investment because
taxpayers were not aware prior to the
publication of the notice that this deferral
would constitute a material modification.
The grandfather rule described in section
13601(e) of TCJA and its legislative histo-
ry, including the definition and the result-
ing impact of a material modification, is
almost identical to the statutory language
and legislative history to the grandfather
rule provided when section 162(m) was
enacted in 1993. The 1995 final regula-
tions interpreting the original grandfather
rule in the 1993 legislation provided that a
deferral of payment of compensation will

Bulletin No. 2021–3 355 January 19, 2021
not be treated as a material modification
if any additional amount paid were deter-
mined based on a reasonable rate of inter-
est or one or more predetermined actual
investments, and there is no indication in
the grandfather rule in section 13601 of
TCJA or its legislative history of an in-
tent to adopt a different grandfather rule.
17

Therefore, these final regulations do not
adopt the commenter’s suggestion.
2. Extension of an Exercise Period for a
Non-Statutory Stock Option
Commenters asked if extending the
exercise period for a non-statutory stock
option
18
is a material modification. The
grandfather rule in the proposed regula-
tions provides that compensation attribut-
able to the exercise of an option is grand-
fathered only if, as of November 2, 2017,
pursuant to terms of the option and under
applicable law, the employer is obligated
to transfer the option’s underlying shares
of stock to the employee upon exercise of
the option.
The Treasury Department and the IRS
recognize that, for bona fide business rea-
sons, an employer may want to extend
an exercise period of a stock option or a
stock appreciation right (SAR). This often
occurs when a stock option or SAR grant
agreement provides that the exercise pe-
riod will terminate immediately or within
a short period following the employee’s
separation from service, but the employer
later decides to waive that termination or
otherwise extend the exercise period for
some period of time upon the employee’s
separation from service. These concerns
led to treating certain extensions of stock
options or SARs as not being material
modifications in the regulations under
section 409A. For the same reasons, these
final regulations incorporate the section
409A regulatory provisions and provide
that, if compensation attributable to the
exercise of a non-statutory stock option or
a SAR is grandfathered and the exercise
period of the option or SAR is extended,
then all compensation attributable to the
exercise of the option or the SAR is grand-
fathered if the extension complies with
§1.409A-1(b)(5)(v)(C)(1).
19
VII. Coordination with Section 409A
Section 409A addresses NQDC ar-
rangements and sets forth certain require-
ments that must be met to avoid current in-
come inclusion, a 20% additional income
tax on the amount includible in income
per section 409A(a)(1)(B)(i)(II), and a
second additional income tax based on the
tax benefit received due to the deferral per
section 409A(a)(1)(B)(i)(I). Recogniz-
ing that the TCJA amendments to section
162(m) required coordination with the
section 409A rules in certain circumstanc-
es, the preamble to the proposed regula-
tions provided that certain modifications
would be made to the regulations under
section 409A and that taxpayers may rely
on the preamble until this guidance is is-
sued. Commenters suggested additional
modifications to the rules and regulations
under section 409A to provide further co-
ordination between sections 162(m) and
409A. Until guidance under section 409A
is issued, taxpayers may continue to rely
on the preamble to the proposed regula-
tions. The Treasury Department and the
IRS will continue to consider whether
additional guidance under section 409A is
appropriate.
VIII. Applicability Dates
A. General Applicability Date
Generally, these final regulations apply
to taxable years beginning on or after De-
cember 30, 2020. However, taxpayers may
choose to apply these final regulations to a
taxable year beginning after December 31,
2017, provided the taxpayer applies these
final regulations in their entirety and in a
consistent manner to that taxable year and
all subsequent taxable years. See section
7805(b)(7). Like the proposed regulations,
these final regulations generally do not ex-
pand the definition of “covered employee”
as provided in Notice 2018-68 and do not
narrow the application of the definition of
“written binding contract” as provided in
Notice 2018-68. With respect to the limit-
ed number of changes that do affect these
definitions, a special applicability date
has been provided as described in section
VIII. B of this preamble. Accordingly, tax-
payers may not rely on Notice 2018-68 for
taxable years ending on or after December
20, 2019, the publication date of the pro-
posed regulations.
B. Special Applicability Dates
These final regulations include special
applicability dates covering certain as-
pects of the following provisions of these
final regulations:
1. Definition of covered employee.
2. Definition of predecessor of a pub-
licly held corporation.
3. Definition of compensation.
4. Application of section 162(m) to a
deduction for compensation otherwise
deductible for a taxable year ending on or
after a privately held corporation becomes
a publicly held corporation.
5. Definitions of written binding con-
tract and material modification.
First, the definition of covered employ-
ee applies to taxable years ending on or
after September 10, 2018, the publication
date of Notice 2018-68, which provid-
ed guidance on the definition of covered
employee. Notice 2018-68 also provided
that the Treasury Department and the IRS
anticipate that the guidance in the notice
will be incorporated into future regula-
tions that, with respect to the issues ad-
dressed in the notice, will apply to any
taxable year ending on or after September
10, 2018. These final regulations adopt the
definition of covered employee in Notice
2018-68 as anticipated, and according-
17
Section 1.162-27(h)(iii)(B) provides that if the contract is modified to defer the payment of compensation, any compensation paid in excess of the amount that was originally payable to
the employee under the contract will not be treated as a material modification if the additional amount is based on either a reasonable rate of interest or one or more predetermined actual
investments (whether or not assets associated with the amount originally owed are actually invested therein) such that the amount payable by the employer at the later date will be based on
the actual rate of return of the specific investment (including any decrease as well as any increase in the value of the investment).
18
A non-statutory stock option is an option other than an incentive stock option described in section 422 or a stock option granted under an employee stock purchase plan described in section
423.
19
Section 1.409A-1(b)(5)(v)(C)(1) describes the following requirements for an extension: (1) at the time of the extension, the exercise price is greater than the underlying stock’s fair market
value and (2) the exercise period is extended to a date no later than the earlier of the latest date upon which the stock right could have expired by its original terms or the 10
th
anniversary of
the original date of grant.

January 19, 2021 356 Bulletin No. 2021–3
ly the definition of covered employee in
these final regulations applies to taxable
years ending on or after September 10,
2018. The Treasury Department and the
IRS recognize, however, that the rules
under §1.162-33(c)(2)(i)(B), related to a
corporation whose fiscal year and taxable
year do not end on the same date, were
not addressed in Notice 2018-68 but were
discussed initially in the proposed regula-
tions. Accordingly, these final regulations
provide that, for a corporation the fiscal
and taxable years of which do not end on
the same date, the rule requiring the de-
termination of the three most highly com-
pensated executive officers to be made
pursuant to the rules under the Exchange
Act applies to taxable years ending on or
after December 20, 2019.
Second, the provisions defining a pre-
decessor corporation of a publicly held
corporation apply to corporate transac-
tions that occur on or after December 30,
2020. These final regulations also include
a special applicability date for corpora-
tions that change from being a publicly
held corporation to a privately held cor-
poration, and, later, back to a publicly
held corporation on or after December 30,
2020.
If a corporate transaction occurs before
December 30, 2020, then taxpayers may
apply either the definition of predecessor
of a publicly held corporation in §1.162-
33(c)(2)(ii) of these final regulations or a
reasonable good faith interpretation of the
term “predecessor” in section 162(m)(3)
(C) with respect to such transaction. How-
ever, with respect to any of the following
corporate transactions occurring after De-
cember 20, 2019, and before December
30, 2020, excluding target corporations
from the definition of the term “prede-
cessor” is not a reasonable good faith in-
terpretation of the statute: (1) a publicly
held target corporation the stock or assets
of which are acquired by another publicly
held corporation in a transaction to which
section 381(a) applies, and (2) a publicly
held target corporation, at least 80% of the
total voting power of the stock of which,
and at least 80% of the total value of the
stock of which, are acquired by a publicly
held acquiring corporation (including an
affiliated group). No inference is intended
regarding whether the treatment of a target
corporation as other than a “predecessor”
in any other situation is a reasonable good
faith interpretation of the statute.
Third, as discussed in section IV. B.
of this preamble, these final regulations
modify the proposed applicability date
for the definition of compensation under
§1.162-33(c)(3)(ii). Under these final
regulations, the definition of compensa-
tion under §1.162-33(c)(3)(ii) includes an
amount equal to the publicly held corpora-
tion’s distributive share of a partnership’s
deduction for compensation expense only
if the deduction is attributable to compen-
sation paid by the partnership after De-
cember 18, 2020 (the date that these final
regulations were made publicly available
on the IRS website at http://www.irs.gov).
However, these final regulations contin-
ue to provide a transition rule so that this
aspect of the definition of compensation
related to the distributive share of a part-
nership’s deduction for compensation ex-
pense does not apply to compensation paid
after December 30, 2020 if the compensa-
tion is paid pursuant to a written binding
contract that is in effect on December 20,
2019, and that is not materially modified
after that date.
Fourth, the guidance on the appli-
cability of section 162(m)(1) to the de-
duction for any compensation otherwise
deductible for a taxable year ending on
or after the date when a corporation be-
comes a publicly held corporation ap-
plies to corporations that become pub-
licly held after December 20, 2019. A
corporation that was not a publicly held
corporation and then becomes a publicly
held corporation on or before December
20, 2019, may rely on the transition re-
lief provided in §1.162-27(f)(1) until the
earliest of the events provided in §1.162-
27(f)(2). Furthermore, a subsidiary cor-
poration that is a member of an affiliated
group (as defined in §1.162-27(c)(1)(ii))
may rely on the transition relief provided
in §1.162-27(f)(4) if it becomes a sepa-
rate publicly held corporation (whether in
a spin-off transaction or otherwise) on or
before December 20, 2019.
Fifth, the definitions of written binding
contract and material modification in these
final regulations apply to taxable years
ending on or after September 10, 2018, the
publication date of Notice 2018-68, which
provided guidance defining these terms.
Notice 2018-68 also provided that the
Treasury Department and IRS anticipated
that the guidance in the notice would be
incorporated into future regulations that,
with respect to the issues addressed in the
notice, would apply to any taxable year
ending on or after September 10, 2018.
Because these final regulations adopt the
definitions of the terms “written binding
contract” and “material modification”
that were included in Notice 2018-68, the
guidance on these definitions in these final
regulations applies to taxable years ending
on or after September 10, 2018.
Effect on Other Documents
Section 4.01(13) of Revenue Procedure
2020-3, 2020-1 I.R.B. 131 (providing that
“[w]hether the deduction limit under §
162(m) applies to compensation attribut-
able to services performed for a related
partnership” is an area in which rulings
or determination letters will not ordinarily
be issued) is obsolete as of December 30,
2020.
Statement of Availability of IRS
Documents
The IRS Notices, Revenue Rulings,
and Revenue Procedures cited in this doc-
ument are published in the Internal Reve-
nue Bulletin (or Cumulative Bulletin) and
are available from the Superintendent of
Documents, U.S. Government Publish-
ing Office, Washington, DC 20402, or by
visiting the IRS website at http://www.irs.
gov.
Special Analyses
I. Regulatory Planning and Review
This regulation is not subject to review
under section 6(b) of Executive Order
12866 pursuant to the Memorandum of
Agreement (April 11, 2018) between the
Department of the Treasury and the Office
of Management and Budget regarding re-
view of tax regulations.
II. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibil-
ity Act (RFA) (5 U.S.C. chapter 6), it is
hereby certified that these final regulations
would not have a significant economic

Bulletin No. 2021–3 357 January 19, 2021
impact on a substantial number of small
entities. This certification is based on the
fact that section 162(m)(1) applies only
to publicly held corporations (for exam-
ple, corporations that list securities on a
national securities exchange and are rare-
ly small entities) and only impacts those
publicly held corporations that compen-
sate certain executive officers in excess of
$1 million in a taxable year. Pursuant to
section 7805(f), the proposed regulations
preceding these final regulations were
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on its impact on small busi-
ness, and no comments were received.
III. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 (UMRA) requires
that agencies assess anticipated costs and
benefits and take certain actions before is-
suing a final rule that includes any Federal
mandate that may result in expenditures
in any one year by a state, local, or trib-
al government, in the aggregate, or by the
private section, of $100 million in 1995
dollars, update annually for inflation. This
rule does not include any Federal mandate
that may result in expenditures by state,
local, or tribal governments, or by the pri-
vate section in excess of that threshold.
IV. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive order. This final rule does
not have federalism implications and does
not impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive order.
Drafting Information
The principal author of these regula-
tions is Ilya Enkishev, Office of Associ-
ate Chief Counsel (Employee Benefits,
Exempt Organizations, and Employment
Taxes). However, other personnel from
the Treasury Department and the IRS par-
ticipated in the development of these reg-
ulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.162-27 is amended
by revising the section heading and para-
graphs (a) and (j)(1) to read as follows:
§1.162-27 Certain employee
remuneration in excess of $1,000,000 not
deductible for taxable years beginning on
or after January 1, 1994, and for taxable
years beginning prior to January 1, 2018.
(a) Scope. This section provides rules
for the application of the $1 million de-
duction limitation under section 162(m)
(1) for taxable years beginning on or af-
ter January 1, 1994, and beginning prior
to January 1, 2018, and, as provided in
paragraph (j) of this section, for taxable
years beginning after December 31, 2017.
For rules concerning the applicability of
section 162(m)(1) to taxable years be-
ginning after December 31, 2017, see
§1.162-33. Paragraph (b) of this section
provides the general rule limiting deduc-
tions under section 162(m)(1). Paragraph
(c) of this section provides definitions of
generally applicable terms. Paragraph (d)
of this section provides an exception from
the deduction limitation for compensation
payable on a commission basis. Paragraph
(e) of this section provides an exception
for qualified performance-based compen-
sation. Paragraphs (f) and (g) of this sec-
tion provide special rules for corporations
that become publicly held corporations
and payments that are subject to section
280G, respectively. Paragraph (h) of this
section provides transition rules, includ-
ing the rules for contracts that are grand-
fathered and not subject to section 162(m)
(1). Paragraph (j) of this section contains
the effective date provisions, which also
specify when these rules apply to the de-
duction for compensation otherwise de-
ductible in a taxable year beginning after
December 31, 2017. For rules concern-
ing the deductibility of compensation for
services that are not covered by section
162(m)(1) and this section, see section
162(a)(1) and §1.162-7. This section is not
determinative as to whether compensation
meets the requirements of section 162(a)
(1). For rules concerning the deduction
limitation under section 162(m)(6) appli-
cable to certain health insurance provid-
ers, see §1.162-31.
*****
(j) * * *
(1) In general. Section 162(m) and this
section apply to the deduction for com-
pensation that is otherwise deductible by
the corporation in taxable years beginning
on or after January 1, 1994, and beginning
prior to January 1, 2018. Section 162(m)
and this section also apply to compensa-
tion that is a grandfathered amount (as
defined in §1.162-33(g)) at the time it is
paid to the covered employee or otherwise
deductible. For examples of the applica-
tion of the rules of this section to grandfa-
thered amounts paid during or otherwise
deductible for taxable years beginning af-
ter December 31, 2017, see §1.162-33(g).
*****
Par. 3. Section 1.162-33 is added to
read as follows:
§1.162-33 Certain employee
remuneration in excess of $1,000,000 not
deductible for taxable years beginning
after December 31, 2017.
(a) Scope. This section provides rules
for the application of the $1 million de-
duction limitation under section 162(m)
(1) for taxable years beginning after De-
cember 31, 2017. For rules concerning the
applicability of section 162(m)(1) to tax-
able years beginning on or after January
1, 1994, and prior to January 1, 2018, see
§1.162-27. Paragraph (b) of this section
provides the general rule limiting deduc-
tions under section 162(m)(1). Paragraph

January 19, 2021 358 Bulletin No. 2021–3
(c) of this section provides definitions of
generally applicable terms. Paragraph
(d) of this section provides rules for de-
termining when a corporation becomes
a publicly held corporation. Paragraph
(e) of this section provides rules for pay-
ments that are subject to section 280G
(golden parachute payments). Paragraph
(f) of this section provides a special rule
for coordination with section 4985 (stock
compensation of insiders in expatriated
corporations). Paragraph (g) of this sec-
tion provides transition rules addressing
the amendments made by Public Law
115-97, including the rules for contracts
that are grandfathered. Paragraph (h) of
this section sets forth the effective date
provisions. For rules concerning the de-
ductibility of compensation for services
that are not covered by section 162(m)
(1) and this section, see section 162(a)(1)
and §1.162-7. This section is not determi-
native as to whether compensation meets
the requirements of section 162(a)(1). For
rules concerning the deduction limita-
tion under section 162(m)(6) applicable
to certain health insurance providers, see
§1.162-31. For purposes of this section,
references to an amount being paid to an
employee refer to the event that otherwise
would result in the availability of a deduc-
tion to the employer with respect to such
amount, whether that results from an actu-
al payment in cash, transfer of property, or
other event.
(b) Limitation on deduction. Section
162(m)(1) precludes a deduction under
chapter 1 of the Internal Revenue Code
by any publicly held corporation for com-
pensation paid to any covered employee
to the extent that the compensation for the
taxable year exceeds $1,000,000.
(c) Definitions—(1) Publicly held cor-
poration—(i) General rule. A publicly
held corporation means any corporation
that issues securities required to be reg-
istered under section 12 of the Exchange
Act or that is required to file reports under
section 15(d) of the Exchange Act. In ad-
dition, a publicly held corporation means
any S corporation (as defined in section
1361(a)(1)) that issues securities that are
required to be registered under section
12(b) of the Exchange Act, or that is re-
quired to file reports under section 15(d)
of the Exchange Act. For purposes of this
section, whether a corporation is publicly
held is determined based solely on wheth-
er, as of the last day of its taxable year,
the securities issued by the corporation are
required to be registered under section 12
of the Exchange Act or the corporation is
required to file reports under section 15(d)
of the Exchange Act. Whether registra-
tion under the Exchange Act is required
by rules other than those of the Exchange
Act is irrelevant to this determination. A
publicly traded partnership that is treated
as a corporation under section 7704 (or
otherwise) is a publicly held corporation
if, as of the last day of its taxable year, its
securities are required to be registered un-
der section 12 of the Exchange Act or it is
required to file reports under section 15(d)
of the Exchange Act.
(ii) Affiliated groups—(A) In gener-
al. A publicly held corporation includes
an affiliated group of corporations (affil-
iated group), as defined in section 1504
(determined without regard to section
1504(b)), that includes one or more pub-
licly held corporations (as defined in
paragraph (c)(1)(i) of this section). In the
case of an affiliated group that includes
two or more publicly held corporations as
defined in paragraph (c)(1)(i) of this sec-
tion, each member of the affiliated group
that is a publicly held corporation as de-
fined in paragraph (c)(1)(i) of this section
is separately subject to this section, and,
due to having at least one member that
is a publicly held corporation, the affil-
iated group as a whole is subject to this
section. Thus, for example, assume that
a publicly held corporation (as defined
in paragraph (c)(1)(i) of this section) is
a wholly-owned subsidiary of another
publicly held corporation (as defined in
paragraph (c)(1)(i) of this section), which
is a wholly-owned subsidiary of a pri-
vately held corporation. In this case, the
two subsidiaries are separately subject to
this section, and all three corporations
are members of an affiliated group that is
subject to this section. If an individual is
a covered employee of both subsidiaries,
each subsidiary has its own $1 million
deduction limitation with respect to that
covered employee. Furthermore, each
subsidiary has its own set of covered em-
ployees as defined in paragraphs (c)(2)(i)
through (iv) of this section (although the
same individual may be a covered em-
ployee of both subsidiaries).
(B) Proration of amount disallowed as
a deduction. If, in a taxable year, a cov-
ered employee (as defined in paragraphs
(c)(2)(i) through (v) of this section) of
one member of an affiliated group is paid
compensation by more than one member
of the affiliated group, compensation paid
by each member of the affiliated group is
aggregated with compensation paid to the
covered employee by all other members
of the affiliated group (excluding com-
pensation paid by any other publicly held
corporation in the affiliated group, as de-
fined in paragraph (c)(1)(i) of this section,
of which the individual is also a covered
employee as defined in paragraphs (c)(2)
(i) through (v) of this section). In the event
that, in a taxable year, a covered employee
(as defined in paragraphs (c)(2)(i) through
(v) of this section) is paid compensation
by more than one publicly held corpora-
tion in an affiliated group and is also a
covered employee of more than one pub-
licly held payor corporation (as defined in
paragraph (c)(1)(i) of this section) in the
affiliated group, the amount disallowed as
a deduction is determined separately with
respect to each publicly held corporation
of which the individual is a covered em-
ployee. Any amount disallowed as a de-
duction by this section must be prorated
among the payor corporations (excluding
any other publicly held payor corporation
of which the individual is also a covered
employee) in proportion to the amount
of compensation paid to the covered em-
ployee (as defined in paragraphs (c)(2)(i)
through (v) of this section) by each such
corporation in the taxable year. For pur-
poses of this paragraph (c)(1)(ii)(B), the
amount of compensation treated as paid by
a payor corporation that is not a publicly
held corporation (as defined in paragraph
(c)(1)(i) of this section) is determined by
prorating the amount actually paid by that
payor corporation in proportion to the to-
tal amount paid by all of the publicly held
corporations of which the individual is
a covered employee (as defined in para-
graph (c)(2)(i) through (v) of this section).
This process is repeated for each publicly
held payor corporation of which the indi-
vidual is a covered employee.
(iii) Disregarded entities. For purposes
of paragraph (c)(1) of this section, a pub-
licly held corporation includes a corpora-
tion that owns an entity that is disregarded

Bulletin No. 2021–3 359 January 19, 2021
as an entity separate from its owner within
the meaning of §301.7701-2(c)(2)(i) of
this chapter if the disregarded entity issues
securities required to be registered under
section 12(b) of the Exchange Act, or is
required to file reports under section 15(d)
of the Exchange Act.
(iv) Qualified subchapter S subsidiar-
ies. For purposes of paragraph (c)(1) of
this section, a publicly held corporation
includes an S corporation that owns a
qualified subchapter S subsidiary as de-
fined in section 1361(b)(3)(B) (QSub) if
the QSub issues securities required to be
registered under section 12(b) of the Ex-
change Act, or is required to file reports
under section 15(d) of the Exchange Act.
(v) Qualified real estate investment
trust subsidiaries. For purposes of para-
graph (c)(1) of this section, a publicly
held corporation includes a real estate in-
vestment trust as defined in section 856(a)
that owns a qualified real estate invest-
ment trust subsidiary as defined in section
856(i)(2) (QRS), if the QRS issues securi-
ties required to be registered under section
12(b) of the Exchange Act or is required
to file reports under section 15(d) of the
Exchange Act.
(vi) Examples. The following exam-
ples illustrate the provisions of this para-
graph (c)(1). For each example, assume
that no corporation is a predecessor of a
publicly held corporation within the mean-
ing of paragraph (c)(2)(ii) of this section.
Furthermore, for each example, unless
provided otherwise, a reference to a pub-
licly held corporation means a publicly
held corporation as defined in paragraph
(c)(1)(i) of this section. Additionally, for
each example, assume that the corporation
is a calendar-year taxpayer and has a fiscal
year ending December 31 for reporting
purposes under the Exchange Act. The ex-
amples in this paragraph (c)(1)(vi) are not
intended to provide guidance on the legal
requirements of the Securities Act and Ex-
change Act and the rules thereunder (17
CFR part 240).
(A) Example 1 (Corporation required to file re-
ports under section 15(d) of the Exchange Act)—(1)
Facts. Corporation Z plans to issue debt securities in
a public offering registered under the Securities Act.
Corporation Z is not required to file reports under
section 15(d) of the Exchange Act for any other class
of securities and does not have another class of secu-
rities required to be registered under section 12 of the
Exchange Act. On April 1, 2021, the SEC declares
effective the Securities Act registration statement for
Corporation Z’s debt securities. As a result, Corpora-
tion Z is required to file reports under section 15(d)
of the Exchange Act, and this requirement continues
to apply as of December 31, 2021.
(2) Conclusion. Corporation Z is a publicly held
corporation for its 2021 taxable year because it is
required to file reports under section 15(d) of the
Exchange Act as of the last day of its taxable year.
(B) Example 2 (Corporation not required to file
reports under section 15(d) of the Exchange Act)—
(1) Facts. The facts are the same as in paragraph (c)
(1)(vi)(A) of this section (Example 1), except that, on
January 1, 2022, pursuant to section 15(d) of the Ex-
change Act, Corporation Z’s obligation to file reports
under section 15(d) is automatically suspended for
the fiscal year ending December 31, 2022, because
Corporation Z meets the statutory requirements for
an automatic suspension. As of December 31, 2022,
Corporation Z is not required to file reports under
section 15(d) of the Exchange Act.
(2) Conclusion. Corporation Z is not a publicly
held corporation for its 2022 taxable year because
it is not required to file reports under section 15(d)
of the Exchange Act as of as of the last day of its
taxable year.
(C) Example 3 (Corporation not required to file
reports under section 15(d) of the Exchange Act)—
(1) Facts. The facts are the same as in paragraph (c)
(1)(vi)(B) of this section (Example 2), except that, on
January 1, 2022, pursuant to section 15(d) of the Ex-
change Act, Corporation Z’s obligation to file reports
under section 15(d) is not automatically suspended
for the fiscal year ending December 31, 2022. In-
stead, on May 2, 2022, Corporation Z is eligible to
suspend its section 15(d) reporting obligation under
17 CFR 240.12h-3 (Rule 12h-3 under the Exchange
Act) and files Form 15, Certification and Notice of
Termination of Registration under Section 12(g) of
the Securities Exchange Act of 1934 or Suspension
of Duty to File Reports under Sections 13 and 15(d)
of the Securities Exchange Act of 1934, (or its suc-
cessor) to suspend its section 15(d) reporting obliga-
tion for its fiscal year ending December 31, 2022. As
of December 31, 2022, Corporation Z is not required
to file reports under section 15(d) of the Exchange
Act.
(2) Conclusion. Corporation Z is not a publicly
held corporation for its 2022 taxable year because
it is not required to file reports under section 15(d)
of the Exchange Act as of the last day of its taxable
year. If Corporation Z had not utilized Rule 12h-3
to suspend its section 15(d) reporting obligation,
Corporation Z would be a publicly held corporation
for its 2022 taxable year because it would have been
required to file reports under section 15(d) of the Ex-
change Act as of the last day of its taxable year.
(D) Example 4 (Corporation required to file re-
ports under section 15(d) of the Exchange Act)—(1)
Facts. Corporation Y is a wholly-owned subsidiary
of Corporation X, which is required to file reports
under the Exchange Act. Corporation Y issued a
class of debt securities in a public offering registered
under the Securities Act, and therefore is required to
file reports under section 15(d) of the Exchange Act
for its fiscal year ending December 31, 2020. Cor-
poration Y has no other class of securities registered
under the Exchange Act. In its Form 10-K, Annual
Report Pursuant to section 13 or section 15(d) of
the Securities Exchange Act of 1934, (or its suc-
cessor) for the 2020 fiscal year, Corporation Y may
omit Item 11, Executive Compensation (required by
Part III of Form 10-K), which requires disclosure of
compensation of certain executive officers, because
it is wholly-owned by Corporation X and the other
conditions of General Instruction I to Form 10-K are
satisfied.
(2) Conclusion. Corporation Y is a publicly held
corporation for its 2020 taxable year because it is
required to file reports under section 15(d) of the
Exchange Act as of the last day of its taxable year.
(E) Example 5 (Corporation not required to file
reports under section 15(d) of the Exchange Act and
not required to register securities under section 12 of
the Exchange Act)—(1) Facts. Corporation A has a
class of securities registered under section 12(g) of
the Exchange Act. For its 2020 taxable year, Corpo-
ration A is a publicly held corporation. On September
30, 2021, Corporation A is eligible to terminate the
registration of its securities under section 12(g) of
the Exchange Act pursuant to 17 CFR 240.12g-4(a)
(2) (Rule 12g-4(a)(2) under the Exchange Act), but
does not terminate the registration of its securities
prior to December 31, 2021. Because Corporation
A did not issue securities in a public offering regis-
tered under the Securities Act, Corporation A is not
required to file reports under section 15(d) of the Ex-
change Act.
(2) Conclusion. Corporation A is not a publicly
held corporation for its 2021 taxable year because, as
of the last day of its taxable year, the securities issued
by Corporation A are not required to be registered
under section 12 of the Exchange Act and Corpo-
ration A is not required to file reports under section
15(d) of the Exchange Act.
(F) Example 6 (Corporation required to file re-
ports under section 15(d) of the Exchange Act)—(1)
Facts. The facts are the same as in paragraph (c)(1)
(vi)(E) of this section (Example 5), except that Cor-
poration A previously issued a class of securities
in a public offering registered under the Securities
Act. Furthermore, on October 1, 2021, Corporation
A terminates the registration of its securities under
section 12(g) of the Exchange Act. Because Corpora-
tion A issued a class of securities in a public offering
registered under the Securities Act and is not eligi-
ble to suspend its reporting obligation under section
15(d) of the Exchange Act, as of December 31, 2021,
Corporation A is required to file reports under sec-
tion 15(d) of the Exchange Act.
(2) Conclusion. Corporation A is a publicly held
corporation for its 2021 taxable year because it is
required to file reports under section 15(d) of the
Exchange Act as of the last day of its taxable year.
(G) Example 7 (Corporation not required to file
reports under section 15(d) of the Exchange Act and
not required to register securities under section 12
of the Exchange Act)—(1) Facts. On November 1,
2021, Corporation B is an issuer with only one class
of equity securities. On November 5, 2021, Corpo-
ration B files a registration statement for its equity
securities under section 12(g) of the Exchange Act.
Corporation B’s filing of its registration statement
is voluntary because the Exchange Act does not re-
quire Corporation B to register its class of securities
under section 12(g) of the Exchange Act based on
the number and composition of its record holders.

January 19, 2021 360 Bulletin No. 2021–3
On December 1, 2021, the SEC declares effective
the Exchange Act registration statement for Cor-
poration B’s securities. As of December 31, 2021,
Corporation B continues to have its class of equity
securities registered voluntarily under section 12 of
the Exchange Act. Corporation B is not required to
file reports under section 15(d) of the Exchange Act
because it did not register any class of securities in a
public offering under the Securities Act.
(2) Conclusion. Corporation B is not a publicly
held corporation for its 2021 taxable year because,
as of the last day of that taxable year, the securities
issued by Corporation B are not required to be reg-
istered under section 12 of the Exchange Act and
Corporation B is not required to file reports under
section 15(d) of the Exchange Act.
(H) Example 8 (Corporation not required to file
reports under section 15(d) of the Exchange Act and
not required to register securities under section 12
of the Exchange Act)—(1) Facts. The facts are the
same as in paragraph (c)(1)(vi)(G) of this section
(Example 7), except that, on December 31, 2022,
because of a change in circumstances, Corporation
B must register its class of equity securities under
section 12(g) of the Exchange Act within 120 days
of December 31, 2022. On February 1, 2023, the
SEC declares effective the Exchange Act registration
statement for Corporation B’s securities.
(2) Conclusion. Corporation B is not a publicly
held corporation for its 2022 taxable year because,
as of the last day of that taxable year, Corporation B
is not required to file reports under section 15(d) of
the Exchange Act and the class of equity securities
issued by Corporation B is not yet required to be reg-
istered under section 12 of the Exchange Act.
(I) Example 9 (Securities of foreign private issu-
er in the form of ADRs traded in the over-the-counter
market)—(1) Facts. For its fiscal and taxable years
ending December 31, 2021, Corporation W is a for-
eign private issuer. Because Corporation W has not
registered an offer or sale of securities under the Se-
curities Act, it is not required to file reports under
section 15(d) of the Exchange Act. Corporation W
qualifies for an exemption from registration of its
securities under section 12(g) of the Exchange Act
pursuant to 17 CFR 240.12g3-2(b) (Rule 12g3-2(b)
under the Exchange Act). Corporation W wishes to
have its securities traded in the U.S. in the over-the-
counter market in the form of ADRs. Because Corpo-
ration W qualifies for an exemption pursuant to Rule
12g3-2(b), Corporation W is not required to register
its securities underlying the ADRs under section 12
of the Exchange Act; however, the depositary bank
is required to register the ADRs under the Securities
Act. Even though the depositary bank is required to
register the ADRs under the Securities Act, the reg-
istration of the ADRs does not result in either the
depositary bank or Corporation W being required to
file reports under section 15(d) of the Exchange Act.
On February 3, 2021, the SEC declares effective the
Securities Act registration statement for the ADRs.
On February 4, 2021, Corporation W’s ADRs begin
trading in the over-the-counter market. On Decem-
ber 31, 2021, the securities of Corporation W are
not required to be registered under section 12 of the
Exchange Act because Corporation W qualifies for
an exemption pursuant to Rule 240.12g3-2(b). Fur-
thermore, on December 31, 2021, Corporation W is
not required to file reports under section 15(d) of the
Exchange Act.
(2) Conclusion. Corporation W is not a publicly
held corporation for its 2021 taxable year because, as
of the last day of that taxable year, the securities un-
derlying the ADRs are not required to be registered
under section 12 of the Exchange Act and Corpora-
tion W is not required to file reports under section
15(d) of the Exchange Act. The result would be the
same if Corporation W had its securities traded in
the over-the-counter market other than in the form
of ADRs.
(J) Example 10 (Securities of foreign private is-
suer in the form of ADRs quoted on Over the Counter
Bulletin Board)—(1) Facts. The facts are the same as
in paragraph (c)(1)(vi)(I) of this section (Example 9),
except that Corporation W has its securities quoted
on the Over the Counter Bulletin Board (OTCBB) in
the form of ADRs. Because Corporation W qualifies
for an exemption pursuant to 17 CFR 240.12g3-2(b)
(Rule 12g3-2(b) under the Exchange Act), Corpora-
tion W is not required to register its securities un-
derlying the ADRs under section 12 of the Exchange
Act. However, the depositary bank is required to reg-
ister the ADRs under the Securities Act. In addition,
section 6530(b)(1) of the OTCBB Rules requires
that a foreign equity security may be quoted on the
OTCBB only if the security is registered with the
SEC pursuant to section 12 of the Exchange Act and
the issuer of the security is current in its reporting
obligations. To comply with the OTCBB Rules, on
February 5, 2021, Corporation W files a registration
statement for its class of securities underlying the
ADRs under section 12(g) of the Exchange Act. On
February 26, 2021, the SEC declares effective the
Exchange Act registration statement for Corporation
W’s securities. As of December 31, 2021, Corpora-
tion W is subject to the reporting obligations under
section 12 of the Exchange Act as a result of the sec-
tion 12 registration.
(2) Conclusion. Corporation W is not a publicly
held corporation for its 2021 taxable year because,
as of the last day of that taxable year, its ADRs and
the securities underlying the ADRs are not required
by the Exchange Act to be registered under section
12 and Corporation W is not required to file reports
under section 15(d) of the Exchange Act. The Securi-
ties Act requirement applicable to the bank pursuant
to the OTCBB rules is irrelevant. The result would
be the same if Corporation W had its securities trad-
ed on the OTCBB other than in the form of ADRs.
(K) Example 11 (Securities of foreign private
issuer in the form of ADRs listed on a national se-
curities exchange without a capital raising trans-
action)—(1) Facts. For its fiscal and taxable years
ending December 31, 2021, Corporation V is a for-
eign private issuer. Corporation V wishes to list its
securities on the New York Stock Exchange (NYSE)
in the form of ADRs without a capital raising trans-
action. Under the Exchange Act, Corporation V is re-
quired to register its securities underlying the ADRs
under section 12(b) of the Exchange Act. Because
the ADRs and the deposited securities are separate
securities, the depositary bank is required to regis-
ter the ADRs under the Securities Act. On February
2, 2021, the SEC declares effective Corporation V’s
registration statement under section 12(b) of the
Exchange Act in connection with the underlying se-
curities, and the depositary bank’s registration state-
ment under the Securities Act in connection with the
ADRs. On March 1, 2021, Corporation V’s securities
begin trading on the NYSE in the form of ADRs. As
of December 31, 2021, Corporation V is not required
to file reports under section 15(d) of the Exchange
Act; however, the securities underlying the ADRs
are required to be registered under section 12(b) of
the Exchange Act.
(2) Conclusion. Corporation V is a publicly held
corporation for its 2021 taxable year because, as of
the last day of that taxable year, the securities under-
lying the ADRs are required to be registered under
section 12 of the Exchange Act. The result would be
the same if Corporation V had its securities listed
on the NYSE other than in the form of ADRs. The
result also would be the same if Corporation V had
wished to raised capital during its 2021 taxable year
and been required to register the offer of securities
underlying the ADRs under the Securities Act and
to register the class of those securities under section
12(b) of the Exchange Act, and the depositary bank
was required to register the ADRs under the Secu-
rities Act.
(L) Example 12 (Foreign private issuer incor-
porates subsidiary in the United States to issue debt
securities and subsequently issues a guarantee)—(1)
Facts. For its fiscal and taxable years ending Decem-
ber 31, 2021, Corporation T is a foreign private issu-
er. Corporation T wishes to access the U.S. capital
markets. Corporation T incorporates Corporation U,
a wholly-owned subsidiary, in the U.S. to issue debt
securities. On January 15, 2021, the SEC declares
effective Corporation U’s Securities Act registration
statement. To enhance Corporation U’s credit and
the marketability of Corporation U’s debt securities,
Corporation T issues a guarantee of Corporation U’s
securities and, as required, registers the guarantee
under the Securities Act on Corporation U’s regis-
tration statement. On December 31, 2021, Corpora-
tions T and U are required to file reports under sec-
tion 15(d) of the Exchange Act.
(2) Conclusion. Corporations T and U are pub-
licly held corporations for their 2021 taxable years
because they are required to file reports under section
15(d) of the Exchange Act as of the last day of their
taxable years.
(M) Example 13 (Affiliated group comprised of
two corporations, one of which is a publicly held
corporation)—(1) Facts. Employee D, a covered
employee of Corporation N, receives compensation
from, Corporations N and O, members of an affili-
ated group. Corporation N, the parent corporation,
is a publicly held corporation. Corporation O is a
direct subsidiary of Corporation N and is a private-
ly held corporation. The total compensation paid
to Employee D from the affiliated group members
is $3,000,000 for the taxable year, of which Corpo-
ration N pays $2,100,000 and Corporation O pays
$900,000.
(2) Conclusion. Because the compensation paid
by all affiliated group members is aggregated for
purposes of section 162(m)(1), $2,000,000 of the ag-
gregate compensation paid is nondeductible. Corpo-
rations N and O each are treated as paying a ratable
portion of the nondeductible compensation. Thus,
two thirds of each corporation’s payment will be
nondeductible. Corporation N has a nondeductible

Bulletin No. 2021–3 361 January 19, 2021
compensation expense of $1,400,000 ($2,100,000
x $2,000,000/$3,000,000). Corporation O has a
nondeductible compensation expense of $600,000
($900,000 x $2,000,000/$3,000,000).
(N) Example 14 (Affiliated group comprised of
two corporations, one of which is a publicly held
corporation)—(1) Facts. The facts are the same as in
paragraph (c)(1)(vi)(M) of this section (Example 13),
except that Corporation O is a publicly held corpo-
ration, Corporation N is a privately held corporation,
and Employee D is a covered employee of Corpora-
tion O (instead of Corporation N).
(2) Conclusion. The result is the same as in para-
graph (c)(1)(vi)(M) of this section (Example 13).
Even though subsidiary Corporation O is the public-
ly held corporation, Corporations N and O still com-
prise an affiliated group. Accordingly, $2,000,000 of
the aggregate compensation paid is nondeductible,
and Corporations N and O each are treated as paying
a ratable portion of the nondeductible compensation.
(O) Example 15 (Affiliated group comprised of
two publicly held corporations)—(1) Facts. The
facts are the same as in paragraph (c)(1)(vi)(M) of
this section (Example 13), except that Corporation O
is a publicly held corporation. As in paragraph (c)(1)
(vi)(M) of this section (Example 13), Employee D is
not a covered employee of Corporation O.
(2) Conclusion. The result is the same as in para-
graph (c)(1)(vi)(M) of this section (Example 13).
Even though Corporations N and O each are publicly
held corporations, Corporations N and O comprise an
affiliated group for purposes of prorating the amount
disallowed as a deduction. Accordingly, $2,000,000
of the aggregate compensation paid is nondeductible,
and Corporations N and O each are treated as paying
a ratable portion of the nondeductible compensation.
(P) Example 16 (Affiliated group comprised of
two publicly held corporations)—(1) Facts. The
facts are the same as in paragraph (c)(1)(vi)(O) of
this section (Example 15), except that Employee D
also is a covered employee of Corporation O.
(2) Conclusion. Corporations N and O each
are publicly held corporations and separately
subject to this section, but also comprise an af-
filiated group. Because Employee D is a covered
employee of both Corporations N and O, each of
which is a separate publicly held corporation, the
determination of the amount disallowed as a de-
duction is made separately for each publicly held
corporation. Corporation N has a nondeductible
compensation expense of $1,100,000 (the excess
of $2,100,000 over $1,000,000), and Corporation
O has no nondeductible compensation expense be-
cause the amount it paid to Employee D did not
exceed $1,000,000.
(Q) Example 17 (Affiliated group comprised of
three corporations, one of which is a publicly held
corporation)—(1) Facts. Employee C, a covered
employee of publicly held parent Corporation P, re-
ceives compensation from Corporations P, Q, and R,
members of an affiliated group. Corporation Q is a
direct subsidiary of Corporation P, and Corporation
R is a direct subsidiary of Corporation Q. Corpo-
rations Q and R both are privately held. The total
compensation paid to Employee C from the affiliated
group members is $3,000,000 for the taxable year, of
which Corporation P pays $1,500,000, Corporation
Q pays $900,000, and Corporation R pays $600,000.
(2) Conclusion. Because the compensation paid
by affiliated group members is aggregated for pur-
poses of section 162(m)(1), $2,000,000 of the ag-
gregate compensation paid is nondeductible. Cor-
porations P, Q, and R each are treated as paying a
ratable portion of the nondeductible compensation.
Thus, two thirds of each corporation’s payment will
be nondeductible. The nondeductible compensation
expense for Corporation P is $1,000,000 ($1,500,000
x $2,000,000/$3,000,000); for Corporation Q is
$600,000 ($900,000 x $2,000,000/$3,000,000);
and for Corporation R is $400,000 ($600,000 x
$2,000,000/$3,000,000).
(R) Example 18 (Affiliated group comprised of
three corporations, one of which is a publicly held
corporation)—(1) Facts. The facts are the same as
in paragraph (c)(1)(vi)(Q) of this section (Example
17), except that Corporation Q is a publicly held cor-
poration and Corporation P is a privately held cor-
poration, and Employee C is a covered employee of
Corporation Q (instead of Corporation P).
(2) Conclusion. The result is the same as in
paragraph (c)(1)(vi)(Q) of this section (Example
17). Even though Corporation Q, the subsidiary, is
the publicly held corporation, Corporations P, Q,
and R comprise an affiliated group. Accordingly,
$2,000,000 of the aggregate compensation paid is
nondeductible, and Corporations P, Q, and R each
are treated as paying a ratable portion of the nonde-
ductible compensation.
(S) Example 19 (Affiliated group comprised of
three corporations, two of which are publicly held
corporations)—(1) Facts. The facts are the same as
in paragraph (c)(1)(vi)(R) of this section (Example
18), except that Corporation R also is a publicly held
corporation. As in paragraph (c)(1)(vi)(R) of this
section (Example 18), Corporation Q is a publicly
held corporation, Corporation P is a privately held
corporation, and Employee C is a covered employ-
ee of Corporation Q but not a covered employee of
Corporation R.
(2) Conclusion. The result is the same as in
paragraph (c)(1)(vi)(R) of this section (Example
18). Even though Corporation R also is a publicly
held corporation, Corporations P, Q, and R comprise
an affiliated group. Accordingly, $2,000,000 of the
aggregate compensation paid is nondeductible, and
Corporations P, Q, and R each are treated as paying
a ratable portion of the nondeductible compensation.
(T) Example 20 (Affiliated group comprised of
three publicly held corporations)—(1) Facts. The
facts are the same as in paragraph (c)(1)(vi)(Q) of
this section (Example 17), except that Corporations
Q and R also are publicly held corporations, and Em-
ployee C is a covered employee of both Corporations
P and Q but is not a covered employee of Corpora-
tion R.
(2) Conclusion. Even though Corporations P,
Q, and R each are publicly held corporations, they
comprise an affiliated group. Because Employee C
is a covered employee of both Corporations P and
Q, the determination of the amount disallowed as
a deduction is separately prorated among Corpo-
rations P and R and among Corporations Q and R.
For each separate calculation of the total amount of
the disallowed deduction and the proration of the
disallowed deduction, the amount paid by Corpo-
ration R is taken into account in proportion to the
total compensation paid by Corporations P and Q.
With respect to Corporations P and R, $875,000 of
the aggregate compensation is nondeductible (the
excess of $1,875,000 (the sum of the compensation
paid by Corporation P ($1,500,000) and the por-
tion of compensation paid by Corporation R that is
treated as allocable to Employee C being a covered
employee of Corporation P ($600,000 x $1,500,000/
($1,500,000 + $900,000) = $375,000) over the
$1,000,000 deduction limitation). Corporations P
and R each are treated as paying a ratable portion of
the nondeductible compensation. Corporation P has
a nondeductible compensation expense of $700,000
($1,500,000 x $875,000/$1,875,000), and Corpora-
tion R has a nondeductible compensation expense
of $175,000 ($375,000 x $875,000/$1,875,000).
For Corporations Q and R, $125,000 of the aggre-
gate compensation is nondeductible (the excess of
$1,125,000 (the sum of the compensation paid by
Corporation Q ($900,000) and the portion of com-
pensation paid by Corporation R that is treated as
allocable to Employee C being a covered employee
of Corporation Q ($600,000 x $900,000/($1,500,000
+ $900,000) = $225,000) over the $1,000,000 de-
duction limitation). Corporation Q has a nondeduct-
ible compensation expense of $100,000 ($900,000
x $125,000/$1,125,000), and Corporation R has a
nondeductible compensation expense of $25,000
($225,000 x $125,000/$1,125,000). The total nonde-
ductible compensation expense for Corporation R is
$200,000.
(U) Example 21 (Affiliated group comprised of
three publicly held corporations)—(1) Facts. The
facts are the same as in paragraph (c)(1)(vi)(T) of
this section (Example 20), except that Employee C
does not receive any compensation from Corporation
R.
(2) Conclusion. Even though Corporations P,
Q, and R each are publicly held corporations and
separately subject to this section, they comprise an
affiliated group. Because Employee C is a covered
employee of, and receives compensation from, both
Corporations P and Q, each of which is a separate
publicly held corporation, the determination of the
amount disallowed as a deduction is made separately
for Corporations P and Q. Corporation P has a non-
deductible compensation expense of $500,000 (the
excess of $1,500,000 over $1,000,000), and Cor-
poration Q has no nondeductible compensation ex-
pense because the amount it paid to Employee C was
below $1,000,000.
(V) Example 22 (Affiliated group comprised of
three corporations, one of which is a publicly held
corporation)—(1) Facts. The facts are the same as
in paragraph (c)(1)(vi)(Q) of this section (Example
17), except that Corporation R is a direct subsidiary
of Corporation P (and not a direct subsidiary of Cor-
poration Q).
(2) Conclusion. The result is the same as in
paragraph (c)(1)(vi)(Q) of this section (Example
17). Corporations P, Q, and R comprise an affiliat-
ed group. Accordingly, $2,000,000 of the aggregate
compensation paid is nondeductible, and Corpora-
tions P, Q, and R each are treated as paying a ratable
portion of the nondeductible compensation.
(W) Example 23 (Affiliated group comprised of
three publicly held corporations)—(1) Facts. The
facts are the same as in paragraph (c)(1)(vi)(V) of

January 19, 2021 362 Bulletin No. 2021–3
this section (Example 22), except that Corporations
Q and R also are publicly held corporations, and Em-
ployee C is a covered employee of both Corporations
P and Q but not of Corporation R.
(2) Conclusion. The result is the same as in para-
graph (c)(1)(vi)(V) of this section (Example 22).
Even though Corporations P, Q, and R each are pub-
licly held corporations, they comprise an affiliated
group. Because Employee C is a covered employee
of both Corporations P and Q, the amount disallowed
as a deduction is prorated separately among Corpo-
rations P and R and among Corporations Q and R.
(X) Example 24 (Disregarded entity)—(1) Facts.
Corporation G is privately held for its 2020 taxable
year. Entity H, a limited liability company, is whol-
ly-owned by Corporation G and is disregarded as an
entity separate from its owner under §301.7701-2(c)
(2)(i) of this chapter. As of December 31, 2020, Enti-
ty H is required to file reports under section 15(d) of
the Exchange Act.
(2) Conclusion. Because Entity H is required to
file reports under section 15(d) of the Exchange Act
and is disregarded as an entity separate from its own-
er, Corporation G is a publicly held corporation for
its 2020 taxable year. The result would be the same if
Corporation G was a REIT under section 856(a) and
Entity H was a QRS under section 856(i)(2).
(2) Covered employee—(i) Gener-
al rule. Except as provided in paragraph
(c)(2)(vi) of this section, with respect to
a publicly held corporation as defined in
paragraph (c)(1) of this section (without
regard to paragraph (c)(1)(ii) of this sec-
tion), for the publicly held corporation’s
taxable year, a covered employee means
any of the following—
(A) The principal executive officer
(PEO) or principal financial officer (PFO)
of the publicly held corporation serving at
any time during the taxable year, including
individuals acting in either such capacity.
(B) The three highest compensated
executive officers of the publicly held
corporation for the taxable year (other
than the principal executive officer or
principal financial officer, or an individ-
ual acting in such capacity), regardless
of whether the executive officer is serv-
ing at the end of the publicly held cor-
poration’s taxable year, and regardless of
whether the executive officer’s compen-
sation is subject to disclosure for the last
completed fiscal year under the executive
compensation disclosure rules under the
Exchange Act. For purposes of this para-
graph (c)(2)(i)(B), the term “executive
officer” means an executive officer as de-
fined in 17 CFR 240.3b-7. The amount of
compensation used to identify the three
most highly compensated executive of-
ficers for the taxable year is determined
pursuant to the executive compensation
disclosure rules under the Exchange Act
(using the taxable year as the fiscal year
for purposes of making the determina-
tion), regardless of whether the corpora-
tion’s fiscal year and taxable year end on
the same date.
(C) Any individual who was a covered
employee of the publicly held corporation
(or any predecessor of a publicly held cor-
poration, within the meaning of paragraph
(c)(2)(ii) of this section) for any preceding
taxable year beginning after December 31,
2016. For taxable years beginning prior to
January 1, 2018, covered employees are
identified in accordance with the rules in
§1.162-27(c)(2).
(ii) Predecessor of a publicly held cor-
poration—(A) Publicly held corporations
that become privately held. For purposes
of this paragraph (c)(2)(ii), a predecessor
of a publicly held corporation includes a
publicly held corporation that, after be-
coming a privately held corporation, again
becomes a publicly held corporation for a
taxable year ending before the 36-month
anniversary of the due date for the corpo-
ration’s U.S. Federal income tax return
(disregarding any extensions) for the last
taxable year for which the corporation
was previously publicly held.
(B) Corporate reorganizations. A pre-
decessor of a publicly held corporation
includes a publicly held corporation the
stock or assets of which are acquired in
a corporate reorganization (as defined in
section 368(a)(1)).
(C) Corporate divisions. A predecessor
of a publicly held corporation includes a
publicly held corporation that is a distrib-
uting corporation (within the meaning of
section 355(a)(1)(A)) that distributes the
stock of a controlled corporation (within
the meaning of section 355(a)(1)(A)) to its
shareholders in a distribution or exchange
qualifying under section 355(a)(1) (corpo-
rate division). The rule of this paragraph
(c)(2)(ii)(C) applies only with respect to
covered employees of the distributing
corporation who begin performing ser-
vices for the controlled corporation (or
for a corporation affiliated with the con-
trolled corporation that receives stock of
the controlled corporation in the corporate
division) within the period beginning 12
months before and ending 12 months after
the distribution.
(D) Affiliated groups. A predecessor
of a publicly held corporation includes
any other publicly held corporation that
becomes a member of its affiliated group
(as defined in paragraph (c)(1)(ii) of this
section).
(E) Asset acquisitions. If a publicly
held corporation, including one or more
members of an affiliated group as defined
in paragraph (c)(1)(ii) of this section (ac-
quiror), acquires at least 80% of the gross
operating assets (determined by fair mar-
ket value on the date of acquisition) of
another publicly held corporation (target),
then the target is a predecessor of the ac-
quiror. For an acquisition of assets that oc-
curs over time, only assets acquired within
a 12-month period are taken into account
to determine whether at least 80% of the
target’s gross operating assets were ac-
quired. However, this 12-month period is
extended to include any continuous period
that ends on, or begins on, any day during
which the acquiror has an arrangement
to purchase, directly or indirectly, assets
of the target. A shareholder’s additions to
the assets of target made as part of a plan
or arrangement to avoid the application
of this subsection to acquiror’s purchase
of target’s assets are disregarded in ap-
plying this paragraph (c)(2)(ii)(E). This
paragraph (c)(2)(ii)(E) applies only with
respect to the target’s covered employ-
ees who begin performing services for
the acquiror (or a corporation affiliated
with the acquiror) within the period be-
ginning 12 months before and ending 12
months after the date of the transaction as
defined in paragraph (c)(2)(ii)(I) of this
section (incorporating any extensions to
the 12-month period made pursuant to this
paragraph).
(F) Predecessor of a predecessor. For
purposes of this paragraph (c)(2)(ii), a
predecessor of a corporation includes each
predecessor of the corporation and the
predecessor or predecessors of any prior
predecessor or predecessors.
(G) Corporations that are not public-
ly held at the time of the transaction and
sequential transactions–(1) Predecessor
corporation is not publicly held at the
time of the transaction. This paragraph
(c)(2)(ii)(G)(1) applies if a corporation
that was previously publicly held (the
first corporation) would be a predecessor
to another corporation (the second corpo-

Bulletin No. 2021–3 363 January 19, 2021
ration) under the rules of this paragraph
(c)(2)(ii) but for the fact that the first cor-
poration is not a publicly held corpora-
tion at the time of the relevant transaction
(or transactions). If this paragraph (c)(2)
(ii)(G)(1) applies, the first corporation is
a predecessor of a publicly held corpora-
tion if the second corporation is a pub-
licly held corporation at the time of the
relevant transaction (or transactions) and
the relevant transaction (or transactions)
take place during a taxable year ending
before the 36-month anniversary of the
due date for the first corporation’s U.S.
Federal income tax return (excluding any
extensions) for the last taxable year for
which the first corporation was previous-
ly publicly held.
(2) Second corporation is not pub-
licly held at the time of the transaction.
This paragraph (c)(2)(ii)(G)(2) applies
if a corporation that is publicly held (the
first corporation) at the time of the rele-
vant transaction (or transactions) would
be a predecessor to another corporation
(the second corporation) under the rules
of this paragraph (c)(2)(ii) but for the
fact that the second corporation is not a
publicly held corporation at the time of
the relevant transaction (or transactions).
If this paragraph (c)(2)(ii)(G)(2) applies,
the first corporation is a predecessor of
a publicly held corporation if the second
corporation becomes a publicly held cor-
poration for a taxable year ending before
the 36-month anniversary of the due date
for the first corporation’s U.S. Federal
income tax return (excluding any exten-
sions) for the first corporation’s last tax-
able year in which the transaction is taken
into account.
(3) Neither corporation is publicly held
at the time of the transaction. This para-
graph (c)(2)(ii)(G)(3) applies if a corpora-
tion that was previously publicly held (the
first corporation) would be a predecessor
to another corporation (the second corpo-
ration) under the rules of this paragraph
(c)(2)(ii) but for the fact that neither the
first corporation nor the second corpora-
tion is a publicly held corporation at the
time of the relevant transaction (or trans-
actions). If this paragraph (c)(2)(ii)(G)(3)
applies, the first corporation is a predeces-
sor of a publicly held corporation if the
second corporation becomes a publicly
held corporation for a taxable year ending
before the 36-month anniversary of the
due date for the first corporation’s U.S.
Federal income tax return (excluding any
extensions) for the last taxable year for
which the first corporation was previously
publicly held.
(4) Sequential transactions. If a corpo-
ration that was previously publicly held
(the first corporation) would be a prede-
cessor to another corporation (the second
corporation) under the rules of this para-
graph (c)(2)(ii) but for the fact that the
first corporation is (or its assets are) trans-
ferred to one or more intervening corpora-
tions prior to being transferred to the sec-
ond corporation, and if each intervening
corporation would be a predecessor of a
publicly held corporation with respect to
the second corporation if the intervening
corporation or corporations were publicly
held corporations, then paragraphs (c)(2)
(ii)(G)(1) through (3) of this section also
apply without regard to the intervening
corporations.
(H) Elections under sections 336(e)
and 338. For purposes of this paragraph
(c)(2), if a corporation makes an election
to treat as an asset purchase either the sale,
exchange, or distribution of stock pursu-
ant to regulations under section 336(e)
(§§1.336-1 through 1.336-5) or the pur-
chase of stock pursuant to regulations un-
der section 338 (§§1.338-1 through 1.338-
11, 1.338(h)(10)-1, and 1.338(i)-1), the
corporation that issued the stock is treated
as the same corporation both before and
after such transaction.
(I) Date of transaction. For purposes
of this paragraph (c)(2)(ii), the date that
a transaction is treated as having occurred
is the date on which all events necessary
for the transaction to be described in the
relevant provision in this paragraph (c)(2)
(ii) have occurred.
(J) Publicly traded partnership. For
purposes of applying this paragraph (c)
(2)(ii), a publicly traded partnership is a
predecessor of a publicly held corporation
if under the same facts and circumstances
a corporation substituted for the publicly
traded partnership would be a predeces-
sor of the publicly held corporation, and
at the time of the transaction the publicly
traded partnership is treated as a publicly
held corporation as defined in paragraph
(c)(1)(i) of this section. In making this de-
termination, the rules in paragraphs (c)(2)
(ii)(A) through (I) of this section apply by
analogy to publicly traded partnerships.
(iii) Disregarded entities. If a public-
ly held corporation under paragraph (c)
(1) of this section owns an entity that is
disregarded as an entity separate from its
owner under §301.7701-2(c)(2)(i) of this
chapter, then the covered employees of the
publicly held corporation are determined
pursuant to paragraphs (c)(2)(i) and (ii)
of this section. The executive officers of
the entity that is disregarded as an entity
separate from its corporate owner under
§301.7701-2(c)(2)(i) of this chapter are
neither covered employees of the entity
nor of the publicly held corporation un-
less they meet the definition of covered
employee in paragraphs (c)(2)(i) and (ii)
of this section with respect to the publicly
held corporation, in which case they are
covered employees for its taxable year.
(iv) Qualified subchapter S subsidiar-
ies. If a publicly held corporation under
paragraph (c)(1) of this section owns an
entity that is a QSub under section 1361(b)
(3)(B), then the covered employees of the
publicly held corporation are determined
pursuant to paragraphs (c)(2)(i) and (ii)
of this section. The executive officers of
the QSub are neither covered employees
of the QSub nor of the publicly held cor-
poration unless they meet the definition of
covered employee in paragraphs (c)(2)(i)
and (ii) of this section with respect to the
publicly held corporation, in which case
they are covered employees for the tax-
able year of the publicly held corporation.
(v) Qualified real estate investment
trust subsidiaries. If a publicly held cor-
poration under paragraph (c)(1) of this
section owns an entity that is a QRS under
section 856(i)(2), then the covered em-
ployees of the publicly held corporation
are determined pursuant to paragraphs
(c)(2)(i) and (ii) of this section. The ex-
ecutive officers of the QRS are neither
covered employees of the QRS nor of
the publicly held corporation unless they
meet the definition of covered employ-
ee in paragraphs (c)(2)(i) and (ii) of this
section with respect to the publicly held
corporation, in which case they are cov-
ered employees for the taxable year of the
publicly held corporation.
(vi) Covered employee of an affiliat-
ed group. A person who is identified as
a covered employee in paragraphs (c)(2)

January 19, 2021 364 Bulletin No. 2021–3
(i) through (v) of this section for a public-
ly held corporation’s taxable year is also
a covered employee for the taxable year
of an affiliated group treated as a publicly
held corporation pursuant to paragraph (c)
(1)(ii) of this section (treatment of an af-
filiated group).
(vii) Examples. The following exam-
ples illustrate the provisions of this para-
graph (c)(2). For each example, assume
that the corporation has a taxable year
that is a calendar year and has a fiscal
year ending December 31 for reporting
purposes under the Exchange Act. Also,
for each example, unless provided other-
wise, assume that none of the employees
were covered employees for any taxable
year preceding the first taxable year set
forth in that example (since being a cov-
ered employee for a preceding taxable
year would provide a separate, indepen-
dent basis for classifying that employee
as a covered employee for a subsequent
taxable year).
(A) Example 1 (Covered employees of members
of an affiliated group)—(1) Facts. Corporations A,
B, and C are direct wholly-owned subsidiaries of
Corporation D. Corporations D and A are each pub-
licly held corporations as of December 31, 2020.
Corporations B and C are not publicly held corpo-
rations for their 2020 taxable years. Employee E
served as the PEO of Corporation D from January
1, 2020, to March 31, 2020. Employee F served as
the PEO of Corporation D from April 1, 2020, to
December 31, 2020. Employee G served as the PEO
of Corporation A for its entire 2020 taxable year.
Employee H served as the PEO of Corporation B
for its entire 2020 taxable year. Employee I served
as the PEO of Corporation C for its entire 2020 tax-
able year. From April 1, 2020, through September
30, 2020, Employee E served as an advisor (not as
a PEO) to Employee I and received compensation
from Corporation C for these services. In 2020, all
four corporations paid compensation to their re-
spective PEOs.
(2) Conclusion (Employees E and F). Because
both Employees E and F served as the PEO of Cor-
poration D during its 2020 taxable year, both Em-
ployees E and F are covered employees of Corpo-
ration D for its 2020 and subsequent taxable years.
(3) Conclusion (Employee G). Because Employ-
ee G served as the PEO of Corporation A, Employ-
ee G is a covered employee of Corporation A for its
2020 and subsequent taxable years.
(4) Conclusion (Employee H). Even though Em-
ployee H served as the PEO of Corporation B, Em-
ployee H is not a covered employee of Corporation
B for its 2020 taxable year, because Corporation B
is considered a publicly held corporation solely by
reason of being a member of an affiliated group as
defined in paragraph (c)(1)(ii) of this section.
(5) Conclusion (Employee I). Even though Em-
ployee I served as the PEO of Corporation C, Em-
ployee I is not a covered employee of Corporation
C for its 2020 taxable year, because Corporation C
is considered a publicly held corporation solely by
reason of being a member of an affiliated group as
defined in paragraph (c)(1)(ii) of this section.
(B) Example 2 (Covered employees of a publicly
held corporation)—(1) Facts. Corporation J is a pub-
licly held corporation. Corporation J is not a smaller
reporting company or emerging growth company for
purposes of reporting under the Exchange Act. For
2020, Employee K served as the sole PEO of Corpo-
ration J and Employees L and M both served as the
PFO of Corporation J at separate times during the
year. Employees N, O, and P were, respectively, the
first, second, and third highest compensated execu-
tive officers of Corporation J for 2020 other than the
PEO and PFO, and all three retired before December
31, 2020. Employees Q, R, and S were, respective-
ly, Corporation J’s fourth, fifth, and sixth highest
compensated executive officers other than the PEO
and PFO for 2020, and all three were serving as of
December 31, 2020. On March 1, 2021, Corporation
J filed its Form 10-K, Annual Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act
of 1934 with the SEC. With respect to Item 11, Exec-
utive Compensation (as required by Part III of Form
10-K, or its successor), Corporation J disclosed the
compensation of Employee K for serving as the PEO,
Employees L and M for serving as the PFO, and Em-
ployees Q, R, and S pursuant to 17 CFR 229.402(a)
(3)(iii) (Item 402 of Regulation S-K). Corporation J
also disclosed the compensation of Employees N and
O pursuant to 17 CFR 229.402(a)(3)(iv) (Item 402 of
Regulation S-K).
(2) Conclusion (Employee K). Because Employ-
ee K served as the PEO during 2020, Employee K is
a covered employee for Corporation J’s 2020 taxable
year.
(3) Conclusion (Employees L and M). Because
Employees L and M served as the PFO during 2020,
Employees L and M are covered employees for Cor-
poration J’s 2020 taxable year.
(4) Conclusion (Employees N, O, P, Q, R, and S).
Even though the executive compensation disclosure
rules under the Exchange Act require Corporation
J to disclose the compensation of Employees N, O,
Q, R, and S for 2020, Corporation J’s three highest
compensated executive officers who are covered em-
ployees for its 2020 taxable year are Employees N,
O, and P, because these are the three highest com-
pensated executive officers other than the PEO and
PFO for 2020.
(C) Example 3 (Covered employees of a small-
er reporting company)—(1) Facts. The facts are the
same as in paragraph (c)(2)(vii)(B) of this section
(Example 2), except that Corporation J is a smaller
reporting company or emerging growth company for
purposes of reporting under the Exchange Act. With
respect to Item 11, Executive Compensation, Corpo-
ration J disclosed the compensation of Employee K
for serving as the PEO, Employees Q and R pursuant
to 17 CFR 229.402(m)(2)(ii) (Item 402(m) of Regu-
lation S-K), and Employees N and O pursuant to 17
CFR 229.402(m)(2)(iii) (Item 402(m) of Regulation
S-K).
(2) Conclusion. The result is the same as in
paragraph (c)(2)(vii)(L) of this section (Example
2). For purposes of identifying a corporation’s cov-
ered employees, it is irrelevant whether the report-
ing obligation under the Exchange Act for smaller
reporting companies and emerging growth compa-
nies apply to the corporation, and it is irrelevant
whether the specific executive officers’ compensa-
tion must be disclosed pursuant to the disclosure
rules under the Exchange Act applicable to the
corporation.
(D) Example 4 (Covered employees of a pub-
licly held corporation that is not required to file a
Form 10-K)—(1) Facts. The facts are the same as in
paragraph (c)(2)(vii)(B) of this section (Example 2),
except that on February 4, 2021, Corporation J files
Form 15, Certification and Notice of Termination of
Registration under Section 12(g) of the Securities
Exchange Act of 1934 or Suspension of Duty to File
Reports under Sections 13 and 15(d) of the Securities
Exchange Act of 1934, (or its successor) to terminate
the registration of its securities. Corporation J’s duty
to file reports under Section 13(a) of the Exchange
Act is suspended upon the filing of the Form 15
and, as a result, Corporation J is not required to file
a Form 10-K and disclose the compensation of its
executive officers for 2020.
(2) Conclusion. The result is the same as in
paragraph (c)(2)(vii)(B) of this section (Example
2). Covered employees include executive officers of
a publicly held corporation even if the corporation
is not required to disclose the compensation of its
executive officers under the Exchange Act. There-
fore, Employees K, L, M, N, O, and P are covered
employees for 2020. The result would be different
if Corporation J filed Form 15 to terminate the reg-
istration of its securities prior to December 31, 2020.
In that case, Corporation J would not be a publicly
held corporation for its 2020 taxable year, and, there-
fore, Employees K, L, M, N, O, and P would not be
covered employees for Corporation J’s 2020 taxable
year.
(E) Example 5 (Covered employees of two pub-
licly held corporations after a corporate transac-
tion)—(1) Facts. Corporation T is a publicly held
corporation for its 2019 taxable year. Corporation
U is a privately held corporation for its 2019 and
2020 taxable years. On July 31, 2020, Corporation
U acquires for cash 80% of the only class of out-
standing stock of Corporation T. The affiliated group
(comprised of Corporations U and T) elects to file a
consolidated Federal income tax return. As a result
of this election, Corporation T has a short taxable
year ending on July 31, 2020. Corporation T does
not change its fiscal year for reporting purposes
under the Exchange Act to correspond to the short
taxable year. Corporation T remains a publicly held
corporation for its short taxable year ending on July
31, 2020, and its subsequent taxable year ending on
December 31, 2020, for which it files a consolidated
Federal income tax return with Corporation U. For
Corporation T’s taxable year ending July 31, 2020,
Employee V serves as the only PEO, and Employ-
ee W serves as the only PFO. Employees X, Y, and
Z are the three most highly compensated executive
officers of Corporation T for the taxable year ending
July 31, 2020, other than the PEO and PFO. As a
result of the acquisition, effective July 31, 2020, Em-
ployee V ceases to serve as the PEO of Corporation

Bulletin No. 2021–3 365 January 19, 2021
T. Instead, Employee AA starts serving as the PEO
of Corporation T on August 1, 2020. Employee V
continues to provide services for Corporation T but
never serves as PEO again (or as an individual acting
in such capacity). For Corporation T’s taxable year
ending December 31, 2020, Employee AA serves as
the only PEO, and Employee W serves as the only
PFO. Employees X, Y, and Z continue to serve as ex-
ecutive officers of Corporation T during the taxable
year ending December 31, 2020. Employees BB,
CC, and DD are the three most highly compensated
executive officers of Corporation T, other than the
PEO and PFO, for the taxable year ending December
31, 2020.
(2) Conclusion (Employee V). Because Employ-
ee V served as the PEO during Corporation T’s short
taxable year ending July 31, 2020, Employee V is a
covered employee for Corporation T’s short taxable
year ending July 31, 2020, even though Employee
V’s compensation is required to be disclosed pursu-
ant to the executive compensation disclosure rules
under the Exchange Act only for the fiscal year end-
ing December 31, 2020. Because Employee V was a
covered employee for Corporation T’s short taxable
year ending July 31, 2020, Employee V is also a cov-
ered employee for Corporation T’s short taxable year
ending December 31, 2020.
(3) Conclusion (Employee W). Because Employ-
ee W served as the PFO during Corporation T’s short
taxable years ending July 31, 2020, and December
31, 2020, Employee W is a covered employee for
both taxable years, even though Employee W’s com-
pensation is required to be disclosed pursuant to the
executive compensation disclosure rules under the
Exchange Act only for the fiscal year ending Decem-
ber 31, 2020. Because Employee W was a covered
employee for Corporation T’s short taxable year end-
ing July 31, 2020, Employee W would be a covered
employee for Corporation T’s short taxable year end-
ing December 31, 2020, even if Employee W did not
serve as the PFO during this taxable year.
(4) Conclusion (Employee AA). Because Em-
ployee AA served as the PEO during Corporation
T’s short taxable year ending December 31, 2020,
Employee AA is a covered employee for that short
taxable year.
(5) Conclusion (Employees X, Y, and Z). Employ-
ees X, Y, and Z are covered employees for Corpo-
ration T’s short taxable years ending July 31, 2020,
and December 31, 2020. Employees X, Y, and Z are
covered employees for Corporation T’s short taxable
year ending July 31, 2020, because those employees
are the three highest compensated executive officers
for that short taxable year. Because they were cov-
ered employees for Corporation T’s short taxable
year ending July 31, 2020, Employees X, Y, and Z
are covered employees for Corporation T’s short tax-
able year ending December 31, 2020 and would be
covered employees for that later short taxable year
even if their compensation would not be required to
be disclosed pursuant to the executive compensation
disclosure rules under the Exchange Act.
(6) Conclusion (Employees BB, CC, and DD).
Employees BB, CC, and DD are covered employees
for Corporation T’s short taxable year ending De-
cember 31, 2020, because those employees are the
three highest compensated executive officers for that
short taxable year.
(F) Example 6 (Predecessor of a publicly held
corporation)—(1) Facts. Corporation EE is a public-
ly held corporation for its 2021 taxable year. Corpo-
ration EE is a privately held corporation for its 2022
and 2023 taxable years. For its 2024 taxable year,
Corporation EE is a publicly held corporation.
(2) Conclusion. For its 2024 taxable year, Corpo-
ration EE is a predecessor of a publicly held corpo-
ration within the meaning of paragraph (c)(2)(ii)(A)
of this section because, after ceasing to be a publicly
held corporation, it again became a publicly held
corporation for a taxable year ending prior to April
15, 2025. Therefore, for Corporation EE’s 2024 tax-
able year, the covered employees of Corporation EE
include the covered employees of Corporation EE
for its 2021 taxable year and any additional covered
employees determined pursuant to this paragraph (c)
(2).
(G) Example 7 (Predecessor of a publicly held
corporation)—(1) Facts. The facts are the same as in
paragraph (c)(2)(vii)(F) of this section (Example 6),
except that Corporation EE remains a privately held
corporation until it becomes a publicly held corpora-
tion for its 2027 taxable year.
(2) Conclusion. Corporation EE is not a pre-
decessor of a publicly held corporation within the
meaning of paragraph (c)(2)(ii)(A) of this section
because it became a publicly held corporation for
a taxable year ending after April 15, 2025. There-
fore, any covered employee of Corporation EE for
its 2021 taxable year is not a covered employee of
Corporation EE for its 2027 taxable year due to that
individual’s status as a covered employee of Corpo-
ration EE for a preceding taxable year (beginning
after December 31, 2016) but may be a covered em-
ployee due to that individual’s status during the 2027
taxable year.
(H) Example 8 (Predecessor of a publicly held
corporation that is party to a merger)—(1) Facts.
On June 30, 2021, Corporation FF (a publicly held
corporation) merged into Corporation GG (a pub-
licly held corporation) in a transaction that qualifies
as a reorganization under section 368(a)(1)(A), with
Corporation GG as the surviving corporation. As
a result of the merger, Corporation FF has a short
taxable year ending June 30, 2021. Corporation FF
is a publicly held corporation for this short taxable
year. Corporation GG does not have a short taxable
year and is a publicly held corporation for its 2021
taxable year.
(2) Conclusion. Corporation FF is a predecessor
of a publicly held corporation within the meaning
of paragraph (c)(2)(ii)(B) of this section. Therefore,
any covered employee of Corporation FF for its short
taxable year ending June 30, 2021, is a covered em-
ployee of Corporation GG for its 2021 taxable year.
For Corporation GG’s 2021 and subsequent taxable
years, the covered employees of Corporation GG in-
clude the covered employees of Corporation FF (for
a preceding taxable year beginning after December
31, 2016) and any additional covered employees de-
termined pursuant to this paragraph (c)(2).
(I) Example 9 (Predecessor of a publicly held
corporation that is party to a merger)—(1) Facts.
The facts are the same as in paragraph (c)(2)(vii)
(H) of this section (Example 8), except that, after the
merger, Corporation GG is a privately held corpora-
tion for its 2021 taxable year.
(2) Conclusion. Because Corporation GG is a
privately held corporation for its 2021 taxable year,
it is not subject to section 162(m)(1) for this taxable
year.
(J) Example 10 (Predecessor of a publicly held
corporation that is party to a merger)—(1) Facts.
The facts are the same as in paragraph (c)(2)(vii)(I)
of this section (Example 9), except that Corporation
GG, becomes a publicly held corporation (as defined
in paragraph (c)(1)(i) of this section) on June 30,
2023, and is a publicly held corporation for its 2023
taxable year.
(2) Conclusion. Because Corporation GG be-
came a publicly held corporation for a taxable year
ending prior to April 15, 2025, Corporation FF is a
predecessor of a publicly held corporation within
the meaning of paragraph (c)(2)(ii)(G) of this sec-
tion. For Corporation GG’s 2023 and subsequent
taxable years, the covered employees of Corpora-
tion GG include the covered employees of Corpo-
ration FF (for a preceding taxable year beginning
after December 31, 2016) and any additional cov-
ered employees determined pursuant to this para-
graph (c)(2).
(K) Example 11 (Predecessor of a publicly held
corporation that is party to a merger)—(1) Facts.
The facts are the same as in paragraph (c)(2)(vii)(J)
of this section (Example 10), except that Corporation
FF is a privately held corporation for its taxable year
ending June 30, 2021, but was a publicly held corpo-
ration for its 2020 taxable year.
(2) Conclusion. Even though Corporation FF
was a privately held corporation when it merged
with Corporation GG on June 30, 2021, Corpora-
tion FF will be a predecessor corporation if Cor-
poration GG becomes a publicly held corporation
within a taxable year ending prior to April 15, 2024.
Because Corporation GG became a publicly held
corporation for its taxable year ending December
31, 2023, Corporation FF is a predecessor of a pub-
licly held corporation within the meaning of para-
graph (c)(2)(ii)(G) of this section. For Corporation
GG’s 2023 and subsequent taxable years, the cov-
ered employees of Corporation GG include the cov-
ered employees of Corporation FF (for a preceding
taxable year beginning after December 31, 2016)
and any additional covered employees determined
pursuant to this paragraph (c)(2).
(L) Example 12 (Predecessor of a publicly held
corporation that is party to a merger and subse-
quently becomes member of an affiliated group)—(1)
Facts. The facts are the same as in paragraph (c)(2)
(vii)(J) of this section (Example 10), except that, on
June 30, 2022, Corporation GG becomes a publicly
held corporation by becoming a member of an af-
filiated group (as defined in paragraph (c)(1)(ii) of
this section). Corporation II is the parent corporation
of the group and is a publicly held corporation. Em-
ployee HH was a covered employee of Corporation
FF for its taxable year ending June 30, 2021. On July
1, 2022, Employee HH becomes an employee of
Corporation II.
(2) Conclusion. By becoming a member of an
affiliated group (as defined in paragraph (c)(1)(ii)
of this section) on June 30, 2022, Corporation GG
became a publicly held corporation for a taxable
year ending prior to April 15, 2025. Therefore, Cor-
poration FF is a predecessor of a publicly held cor-

January 19, 2021 366 Bulletin No. 2021–3
poration (Corporation GG) within the meaning of
paragraph (c)(2)(ii)(G) of this section. Furthermore,
Corporation FF is also a predecessor of Corporation
II, a publicly held corporation within the meaning of
paragraph (c)(2)(ii)(G) of this section. For Corpora-
tion II’s 2022 and subsequent taxable years, Employ-
ee HH is a covered employee of the affiliated group
that includes Corporation II because Employee HH
was a covered employee of Corporation FF for its
taxable year ending June 30, 2021.
(M) Example 13 (Predecessor of a publicly held
corporation that is party to a merger and subse-
quently becomes member of an affiliated group)—
(1) Facts. The facts are the same as in paragraph (c)
(2)(vii)(L) of this section (Example 12), except that
Corporation FF was a privately held corporation for
its taxable year ending June 30, 2021, and Employee
HH was a covered employee of Corporation FF for
its taxable year ending December 31, 2020.
(2) Conclusion. Even though Corporation FF
was a privately held corporation when it merged with
Corporation GG on June 30, 2021, Corporation FF
will be a predecessor corporation if Corporation GG
becomes a publicly held corporation for a taxable
year ending prior to April 15, 2024. Because Corpo-
ration GG became a publicly held corporation for its
2022 taxable year by becoming a member of an affil-
iated group (as defined in paragraph (c)(1)(ii) of this
section), Corporation FF is a predecessor of a pub-
licly held corporation (Corporation GG) within the
meaning of paragraph (c)(2)(ii)(G) of this section.
Furthermore, Corporation FF is also a predecessor of
Corporation II, a publicly held corporation within the
meaning of paragraph (c)(2)(ii)(G) of this section.
Therefore, any covered employee of Corporation FF
for its 2020 taxable year is a covered employee of the
affiliated group that includes Corporation II for its
2022 and subsequent taxable years. For Corporation
II’s 2022 taxable year, Employee HH is a covered
employee of the affiliated group that includes Corpo-
ration II because Employee HH was a covered em-
ployee of Corporation FF for its 2020 taxable year.
(N) Example 14 (Predecessor of a publicly held
corporation that is a party to a merger)—(1) Facts.
Corporation JJ is a publicly held corporation for its
2019 taxable year and is incorporated in State KK.
On June 1, 2019, Corporation JJ formed a whol-
ly-owned subsidiary, Corporation LL. Corporation
LL is a publicly held corporation incorporated in
State MM. On June 30, 2021, Corporation JJ merged
into Corporation LL under State MM law in a trans-
action that qualifies as a reorganization under section
368(a)(1)(A), with Corporation LL as the surviving
corporation. As a result of the merger, Corporation
JJ has a short taxable year ending June 30, 2021.
Corporation JJ is a publicly held corporation for this
short taxable year.
(2) Conclusion. Corporation JJ is a predecessor
of a publicly held corporation within the meaning of
paragraph (c)(2)(ii)(B) of this section. For Corpora-
tion LL’s taxable years ending after June 30, 2021,
the covered employees of Corporation LL include
the covered employees of Corporation JJ for its short
taxable year ending June 30, 2021 (as well as pre-
ceding taxable years beginning after December 31,
2016) and any additional covered employees deter-
mined pursuant to this paragraph (c)(2).
(O) Example 15 (Predecessor of a publicly
held corporation becomes member of an affiliated
group)—(1) Facts. On June 30, 2021, Corporation
OO acquires for cash 100% of the only class of
outstanding stock of Corporation NN. The affiliat-
ed group (comprised of Corporations NN and OO)
elects to file a consolidated Federal income tax re-
turn. As a result of this election, Corporation NN
has a short taxable year ending on June 30, 2021.
Corporation NN is a publicly held corporation for its
taxable year ending June 30, 2021, and a privately
held corporation for subsequent taxable years. On
June 30, 2022, Corporation OO completely liqui-
dates Corporation NN. Corporation OO is a publicly
held corporation for its 2021 and 2022 taxable years.
(2) Conclusion. After Corporation OO acquired
Corporation NN, Corporations NN and OO comprise
an affiliated group as defined in paragraph (c)(1)(ii)
of this section. Thus, Corporation NN is a predeces-
sor of a publicly held corporation within the meaning
of paragraph (c)(2)(ii)(D) of this section. For Corpo-
ration OO’s taxable years ending after June 30, 2021,
the covered employees of Corporation OO include
the covered employees of Corporation NN for its
short taxable year ending June 30, 2021 (as well as
preceding taxable years beginning after December
31, 2016) and any additional covered employees de-
termined pursuant to this paragraph (c)(2).
(P) Example 16 (Predecessor of a publicly
held corporation becomes member of an affiliat-
ed group)—(1) Facts. The facts are the same as in
paragraph (c)(2)(vii)(O) of this section (Example
15), except that Corporation OO is a privately held
corporation on June 30, 2021, and for its 2021 and
2022 taxable years.
(2) Conclusion. Because Corporation OO is a
privately held corporation for its 2021 and 2022 tax-
able years, it is not subject to section 162(m)(1) for
these taxable years.
(Q) Example 17 (Predecessor of a publicly
held corporation becomes member of an affiliat-
ed group)—(1) Facts. The facts are the same as in
paragraph (c)(2)(vii)(P) of this section (Example 16),
except that, on October 1, 2022, the SEC declares ef-
fective Corporation OO’s Securities Act registration
statement in connection with its initial public offer-
ing, and Corporation OO is a publicly held corpora-
tion for its 2022 taxable year.
(2) Conclusion (Taxable Year Ending December
31, 2021). Because Corporation OO is a privately
held corporation for its 2021 taxable year, it is not
subject to section 162(m)(1) for this taxable year.
(3) Conclusion (Taxable Year Ending December
31, 2022). For the 2022 taxable year, Corporations
NN and OO comprise an affiliated group as defined
in paragraph (c)(1)(ii) of this section. Corporation
NN is a predecessor of a publicly held corporation
within the meaning of paragraph (c)(2)(ii)(D) and
(G) of this section because Corporation OO became
a publicly held corporation for a taxable year ending
prior to April 15, 2025. For Corporation OO’s 2022
and subsequent taxable years, the covered employees
of Corporation OO include the covered employees
of Corporation NN for its short taxable year ending
June 30, 2021 (as well as preceding taxable years be-
ginning after December 31, 2016) and any additional
covered employees determined pursuant to this para-
graph (c)(2).
(R) Example 18 (Predecessor of a publicly held
corporation and asset acquisition)—(1) Facts. Cor-
porations VV, WW, and XX are publicly held cor-
porations for their 2020 and 2021 taxable years.
Corporations VV and WW are members of an affil-
iated group. Corporation WW is a direct subsidiary
of Corporation VV. On June 30, 2021, Corporation
VV acquires for cash 40% of the gross operating as-
sets (determined by fair market value as of January
31, 2022) of Corporation XX. On January 31, 2022,
Corporation WW acquires an additional 40% of the
gross operating assets (determined by fair market
value as of January 31, 2022) of Corporation XX.
Employees EB, EC, and EA are covered employees
for Corporation XX’s 2020 taxable year. Employees
ED and EF are also covered employees for Cor-
poration XX’s 2021 taxable year. On January 15,
2021, Employee EA started performing services as
an employee of Corporation WW. On July 1, 2021,
Employee EB started performing services as an em-
ployee of Corporation WW. On February 1, 2022,
Employees EC and ED started performing services
as employees of Corporation WW. On June 30, 2023,
Employee EF started performing services as an em-
ployee of Corporation WW.
(2) Conclusion. Because an affiliated group,
comprised of Corporations VV and WW, acquired
80% of Corporation XX’s gross operating assets
(determined by fair market value) within a twelve-
month period, Corporation XX is a predecessor of
a publicly held corporation within the meaning of
paragraph (c)(2)(ii)(E) of this section. Therefore, any
covered employee of Corporation XX for its 2020
and 2021 taxable years (who started performing ser-
vices as an employee of Corporation WW within the
period beginning 12 months before and ending 12
months after the date of the January 31, 2022, ac-
quisition (determined under paragraph (c)(2)(ii)(I)
of this section) is a covered employee of Corpora-
tion WW for its 2021, 2022, and subsequent taxable
years. For Corporation WW’s 2021 and subsequent
taxable years, the covered employees of Corporation
WW include Employee EB and any additional cov-
ered employees determined pursuant to paragraph
(c)(2)(i) of this section. For Corporation WW’s 2022
and subsequent taxable years, the covered employ-
ees of Corporation WW include Employees EB,
EC, and ED, and any additional covered employ-
ees determined pursuant to this paragraph (c)(2).
Because Employee EA started performing services
as an employee of Corporation WW before January
31, 2021, Employee EA is not a covered employee
of Corporation WW for its 2021 taxable year and
subsequent taxable years by reason of paragraph (c)
(2)(ii)(E) of this section, but may be a covered em-
ployee of Corporation WW by application of other
rules in this paragraph (c)(2). Because Employee EF
started performing services as an employee of Cor-
poration WW after January 31, 2023, Employee EF
is not a covered employee of Corporation WW for its
2023 taxable year by reason of paragraph (c)(2)(ii)
(E) of this section, but may be a covered employee
of Corporation WW by application of other rules in
this paragraph (c)(2).
(S) Example 19 (Predecessor of a publicly held
corporation and asset acquisition)—(1) Facts. The
facts are the same as in paragraph (c)(2)(vii)(R) of
this section (Example 18), except that Corporations

Bulletin No. 2021–3 367 January 19, 2021
VV and WW are not publicly held corporations on
June 30, 2021, or for their 2021 taxable years.
(2) Conclusion. Because Corporations VV and
WW are not publicly held corporations for their 2021
taxable years, they are not subject to section 162(m)
(1) for their 2021 taxable years.
(T) Example 20 (Predecessor of a publicly held
corporation and asset acquisition)—(1) Facts. The
facts are the same as in paragraph (c)(2)(vii)(R) of
this section (Example 18), except that, on October 1,
2022, the SEC declares effective Corporation VV’s
Securities Act registration statement in connection
with its initial public offering, and Corporation VV is
a publicly held corporation for its 2022 taxable year.
(2) Conclusion (2021 taxable year). Because
Corporations VV and WW are not publicly held cor-
porations for their 2021 taxable years, they are not
subject to section 162(m)(1) for their 2021 taxable
years.
(3) Conclusion (2022 taxable year). Corpora-
tion XX is a predecessor of a publicly held corpo-
ration within the meaning of paragraphs (c)(2)(ii)
(E) and (G) of this section because a member of
the affiliated group comprised of Corporations VV
and WW acquired 80% of Corporation XX’s gross
operating assets (determined by fair market value)
within a twelve-month period ending on January
31, 2022, and the parent of the affiliated group,
Corporation VV, subsequently became a publicly
held corporation for a taxable year ending prior to
April 15, 2024. Therefore, any covered employee
of Corporation XX for its 2020 and 2021 taxable
years (who started performing services as an em-
ployee of Corporation WW within the period be-
ginning 12 months before and ending 12 months
after the acquisition) is a covered employee of the
affiliated group comprised of Corporations VV and
WW for its 2022 and subsequent taxable years. For
Corporation WW’s 2022 and subsequent taxable
years, the covered employees of Corporation WW
include Employees EB, EC, and ED, and any ad-
ditional covered employees determined pursuant to
this paragraph (c)(2).
(U) Example 21 (Predecessor of a publicly held
corporation and a division)—(1) Facts. Corporation
CA is a publicly held corporation for its 2021 and
2022 taxable years. On March 2, 2021, Corporation
DDD forms a wholly-owned subsidiary, Corporation
CB, and transfers assets to it. On April 1, 2022, Cor-
poration CA distributes all shares of Corporation CB
to its shareholders in a transaction described in sec-
tion 355(a)(1). On April 1, 2022, the SEC declares
effective Corporation CB’s Securities Act registra-
tion statement in connection with its initial public
offering. Corporation CB is a publicly held corpora-
tion for its 2022 taxable year. Employee EG serves
as the PFO of Corporation CA from January 1, 2022,
to March 31, 2022. On April 2, 2022, Employee EG
starts performing services as an employee of Corpo-
ration CB advising the PFO of Corporation CB. Af-
ter March 31, 2022, Employee EG ceases to provide
services for Corporation CA.
(2) Conclusion. Because the distribution of the
stock of Corporation CB is a transaction described
under section 355(a)(1), Corporation CA is a pre-
decessor of Corporation CB within the meaning
of paragraph (c)(2)(ii)(C) of this section. Because
Employee EG was a covered employee of Corpo-
ration CA for its 2022 taxable year, Employee ED
is a covered employee of Corporation CB for its
2022 taxable year. The result is the same whether
Employee EG performs services as an advisor for
Corporation CB as an employee or an independent
contractor.
(V) Example 22 (Predecessor of a publicly held
corporation and a division)—(1) Facts. The facts
are the same as in paragraph (c)(2)(vii)(U) of this
section (Example 21), except that Corporation CA
distributes 100% of the shares of Corporation CB
to Corporation CD in exchange for all of Corpora-
tion CD’s stock in Corporation CA in a transaction
described in section 355(a)(1) and Corporation CB
does not register any class of securities with the SEC.
Also, Employee EG performs services as an employ-
ee of Corporation CD instead of as an employee of
Corporation CB. Corporation CD is a privately held
corporation for its 2022 taxable year. On October 1,
2023, the SEC declares effective Corporation CD’s
Securities Act registration statement in connection
with its initial public offering. Corporation CD is a
publicly held corporation for its 2023 taxable year.
On January 1, 2028, Employee EG starts performing
services as an employee of Corporation CA. Corpo-
ration CA is a publicly held corporation for its 2028
taxable year.
(2) Conclusion (2022 taxable year). Because
Corporation CD is a privately held corporation for its
2022 taxable year, it is not subject to section 162(m)
(1) for this taxable year.
(3) Conclusion (2023 taxable year). Because
the exchange of the stock of Corporation CB for the
stock of Corporation CA is a transaction described in
section 355(a)(1), Corporations CB and CD are an
affiliated group, and Corporation CD became a pub-
licly held corporation for a taxable year ending prior
to April 15, 2026, Corporation CA is a predecessor
of Corporation CD within the meaning of paragraphs
(c)(2)(ii)(D) and (G) of this section. Employee EG
was a covered employee of Corporation CA for its
2022 taxable year, and started performing services as
an employee of Corporation CD following April 1,
2021, and before April 1, 2023. Therefore, Employee
ED is a covered employee of Corporation CD for its
2023 taxable year.
(4) Conclusion (2028 taxable year). Because
Employee EG served as the PFO of Corporation CA
from January 1, 2022, to March 31, 2022, Employee
EG was a covered employee of Corporation CA for
its 2022 taxable year. Because an individual who is a
covered employee for a taxable year remains a cov-
ered employee for all subsequent taxable years (even
after the individual has separated from service), Em-
ployee EG is a covered employee of Corporation CA
for its 2028 taxable year.
(W) Example 23 (Predecessor of a publicly held
corporation and a division)—(1) Facts. The facts are
the same as in paragraph (c)(2)(vii)(V) of this section
(Example 22), except that Employee EG starts per-
forming services as an employee of Corporation CD
on June 30, 2023, instead of on April 2, 2022, and
never performs services for Corporation CA after
June 30, 2023. Furthermore, on June 30, 2023, Em-
ployee EH, a covered employee of Corporation CB
for all of its taxable years, starts performing services
for Corporation EF as an independent contractor ad-
vising its PEO but not serving as a PEO.
(2) Conclusion (2023 taxable year). Because
the exchange of the stock of Corporation CB for the
stock of Corporation CA is a transaction described
in section 355(a)(1) and Corporation CD became a
publicly held corporation for a taxable year ending
before April 15, 2026, Corporation CA is a prede-
cessor of Corporation CD within the meaning of
paragraphs (c)(2)(ii)(D) and (G) of this section.
Even though Employee EG was a covered employ-
ee of Corporation CA for its 2022 taxable year, be-
cause Employee EG started performing services as
an employee of Corporation CD after April 1, 2023,
Employee EG is not a covered employee of Corpo-
ration CD for its 2023 taxable year under paragraph
(c)(2)(ii)(C) of this section. However, Employee EG
may be a covered employee of Corporation CD by
application of other rules in this paragraph (c)(2).
Because Employee EH was a covered employee of
Corporation CB for its 2022 taxable year, Employee
EH is a covered employee of Corporation CD for its
2023 taxable year.
(X) Example 24 (Predecessor of a publicly
held corporation and election under section 338(h)
(10))—(1) Facts. Corporation CE is the common
parent of a group of corporations filing consolidat-
ed returns that includes Corporation CF as a mem-
ber. Corporation CE wholly-owns Corporation CF,
a publicly held corporation within the meaning of
paragraph (c)(1)(i) of this section. On June 30, 2021,
Corporation CG purchases Corporation CF from
Corporation CE. Corporation CE and Corporation
CG make a timely election under section 338(h)
(10) with respect to the purchase of Corporation
CF stock. For its taxable year ending December 31,
2021, Corporation CF continues to be a publicly held
corporation within the meaning of paragraph (c)(1)
(i) of this section.
(2) Conclusion. As provided in paragraph (c)(2)
(ii)(H) of this section, Corporation CF is treated as
the same corporation after the section 338(h)(10)
transaction as before the transaction for purposes
for purposes of this paragraph (c)(2). Any covered
employee of Corporation CF for its short taxable
year ending June 30, 2021, is a covered employee of
Corporation CF for its short taxable year ending on
December 31, 2021, and subsequent taxable years.
(Y) Example 25 (Disregarded entity)–(1) Facts.
Corporation CH is a privately held corporation for its
2020 taxable year. Entity CI is a wholly-owned lim-
ited liability company and is disregarded as an enti-
ty separate from its owner, Corporation CH, under
§301.7701-2(c)(2)(i) of this chapter. As of December
31, 2020, Entity CI is required to file reports under
section 15(d) of the Exchange Act. For the 2020 tax-
able year, Employee EI is the PEO and Employee
EJ is the PFO of Corporation CH. Employees EK,
EL, and EM, are the three most highly compensat-
ed executive officers of Corporation CH (other than
Employees EI and EJ). Employee EN is the PFO of
Entity CI and does not perform any policy making
functions for Corporation CH. Entity CI has no other
executive officers.
(2) Conclusion. Because Entity CI is disregard-
ed as an entity separate from its owner, Corporation
CH, and is required to file reports under section
15(d) of the Exchange Act, Corporation CH is a
publicly held corporation under paragraph (c)(1)
(iii) of this section for its 2020 taxable year. Even

January 19, 2021 368 Bulletin No. 2021–3
though Employee EN is a PFO of Entity CI, Em-
ployee EN is not considered a PFO of Corporation
CH under paragraph (c)(2)(iii) of this section. As
PEO and PFO, Employees EI and EJ are covered
employees of Corporation CH under paragraph (c)
(2)(i) of this section. Additionally, as the three most
highly compensated executive officers of Corpo-
ration CH (other than Employees EI and EJ), Em-
ployees EK, EL, and EM also are covered employ-
ees of Corporation CH under paragraph (c)(2)(i)
of this section for Corporation CH’s 2020 taxable
year. The result would be the same if Entity CI was
not required to file reports under section 15(d) of
the Exchange Act and Corporation CH was a pub-
licly held corporation pursuant to paragraph (c)(1)
(i) instead of paragraph (c)(1)(iii) of this section.
(Z) Example 26 (Disregarded entity)—(1) Facts.
The facts are the same as in paragraph (c)(2)(vii)(Y)
of this section (Example 25), except that Employee
EN performs a policy making function for Corpora-
tion CH. If Corporation CH were subject to the SEC
executive compensation disclosure rules, then Em-
ployee EN would be treated as an executive officer
of Corporation CH pursuant to 17 CFR 240.3b-7 for
purposes of determining the three highest compen-
sated executive officers for Corporation CH’s 2020
taxable year. Employee EN is compensated more
than Employee EK, but less than Employees EL and
EM.
(2) Conclusion. Because Entity CI is disregard-
ed as an entity separate from its owner, Corporation
CH, and is required to file reports under section 15(d)
of the Exchange Act, Corporation CH is a publicly
held corporation under paragraph (c)(1)(iii) of this
section for its 2020 taxable year. As PEO and PFO,
Employees EI and EJ are covered employees of Cor-
poration CH under paragraph (c)(2)(i) of this section.
Employee EN is one of the three highest compensat-
ed executive officers for Corporation CH’s taxable
year. Because Employees EN, EL, and EM are the
three most highly compensated executive officers
of Corporation CH (other than Employees EI and
EJ), they are covered employees of Corporation CH
under paragraph (c)(2)(i) of this section for Corpo-
ration CH’s 2020 taxable year. The result would be
the same if Entity CI was not required to file reports
under section 15(d) of the Exchange Act and Corpo-
ration CH was a publicly held corporation pursuant
to paragraph (c)(1)(i) instead of paragraph (c)(1)(iii)
of this section.
(AA) Example 27 (Individual as covered employ-
ee of a publicly held corporation that includes the
affiliated group)—(1) Facts. Corporations CJ and
CK are publicly held corporations for their 2020,
2021, and 2022 taxable years. Corporation CK is a
direct subsidiary of Corporation CJ. Employee EO is
an employee, but not a covered employee (as defined
in paragraph (c)(2)(i) of this section), of Corporation
CJ for its 2020, 2021, and 2022 taxable years. From
April 1, 2020, to September 30, 2020, Employee EO
serves as the PFO of Corporation CK. Employee EO
does not perform any services for Corporation CK
for its 2021 and 2022 taxable years, however, em-
ployee EO is a covered employee (as defined in para-
graph (c)(2)(i) of this section) of Corporation CK for
its 2020, 2021, and 2022 taxable years. For the 2020
taxable year, Employee EO receives compensation
of $1,500,000 for services provided to Corporations
CJ and CK. Employee EO receives $2,000,000 from
Corporation CJ for performing services for Corpo-
ration CJ during each of its 2021 and 2022 taxable
years. On June 30, 2022, Corporation CK pays
$500,000 to Employee EO from a nonqualified de-
ferred compensation plan that complies with section
409A.
(2) Conclusion (2020 taxable year). Because
Employee EO is a covered employee of Corporation
CK and because the affiliated group (comprised of
Corporations CJ and CK) is a publicly held corpo-
ration, Employee EO is a covered employee of the
publicly held corporation that is the affiliated group
pursuant to paragraph (c)(2)(vi) of this section.
Compensation paid by Corporations CJ and CK is
aggregated for purposes of section 162(m)(1) and,
as a result, $500,000 of the aggregate compensation
paid is nondeductible. The result would be the same
if Corporation CJ was a privately held corporation
for its 2020 taxable year.
(3) Conclusion (2021 taxable year). Because
Employee EO is a covered employee of Corporation
CK pursuant to paragraph (c)(2)(i)(C) of this section
and because the affiliated group (comprised of Cor-
porations CJ and CK) is a publicly held corporation,
Employee EO is a covered employee of the publicly
held corporation that is the affiliated group pursuant
to paragraph (c)(2)(vi) of this section. Compensa-
tion paid by Corporations CJ and CK is aggregated
for purposes of section 162(m)(1) and, as a result,
$1,000,000 of the aggregate compensation paid is
nondeductible. The result would be the same if Cor-
poration CJ was a privately held corporation for its
2021 taxable year.
(4) Conclusion (2022 taxable year). Because
Employee EO is a covered employee of Corporation
CK pursuant to paragraph (c)(2)(i)(C) of this section
and because the affiliated group (comprised of Cor-
porations CJ and CK) is a publicly held corporation,
Employee EO is a covered employee of the publicly
held corporation that is the affiliated group pursuant
to paragraph (c)(2)(vi) of this section. Compensa-
tion paid by Corporations CJ and CK is aggregated
for purposes of section 162(m)(1) and, as a result,
$1,500,000 of the aggregate compensation paid is
nondeductible. The result would be the same if Cor-
poration CJ was a privately held corporation for its
2022 taxable year.
(BB) Example 28 (Individual as covered em-
ployee of a publicly held corporation that includes
the affiliated group)—(1) Facts. Corporation CL
is a publicly held corporation for its 2020 through
2023 taxable years. Corporations CM and CN are
direct subsidiaries of Corporation CL and are pri-
vately held corporations for their 2020 through
2022 taxable years. Employee EP serves as the
PFO of Corporation CL from January 1, 2020 to
December 31, 2020, when Employee EP terminates
employment from Corporation CL. On January 1,
2021, Employee EP starts performing services as an
employee of Corporation CM. In 2021, Employee
EP receives compensation from Corporation CM in
excess of $1,000,000. On April 1, 2022, Employ-
ee EP starts performing services as an employee of
Corporation CN. On September 30, 2022, Employ-
ee EP terminates employment from Corporations
CM and CN. In 2022, Employee EP receives com-
pensation from Corporations CM and CN in excess
of $1,000,000. For the 2021 and 2022 taxable years,
Employee EP does not serve as either the PEO or
PFO of Corporations CM and CN, and is not one
of the three highest compensated executive officers
(other than the PEO or PFO) of Corporations CM
and CN. On April 1, 2023, Corporation CL distrib-
utes all the shares of Corporation CM to its share-
holders in a transaction described in section 355(a)
(1). On April 1, 2023, the SEC declares effective
Corporation CM’s Securities Act registration state-
ment in connection with its initial public offering.
Corporation CM is a publicly held corporation for
its 2023 taxable year. On April 2, 2023, Employ-
ee EP starts performing services as an employee of
Corporation CM but is not an executive officer of
Corporation CM.
(2) Conclusion (2021 taxable year). Employee
EP is a covered employee of Corporation CL for the
2020 and subsequent taxable years. Because Em-
ployee EP is a covered employee of Corporation CL
and because the affiliated group (comprised of Cor-
porations CL, CM, and CN) is a publicly held cor-
poration, Employee EP is a covered employee of the
publicly held corporation that is the affiliated group
pursuant to paragraph (c)(2)(vi) of this section for
the 2020 and subsequent taxable years. Therefore,
Corporation CM’s deduction for compensation paid
to Employee EP for the 2021 taxable year is subject
to section 162(m)(1). The result would be the same if
Corporation CM was a publicly held corporation as
defined in paragraph (c)(1)(i) of this section.
(3) Conclusion (2022 taxable year). Because
Employee EP is a covered employee of Corporation
CL and because the affiliated group (comprised of
Corporations CL, CM, and CN) is a publicly held
corporation, Employee EP is a covered employee
of the publicly held corporation that is the affili-
ated group pursuant to paragraph (c)(2)(vi) of this
section. Therefore, Corporation CM’s and CN’s de-
duction for compensation paid to Employee EP for
the 2022 taxable year is subject to section 162(m)
(1). Because the compensation paid by all affiliated
group members is aggregated for purposes of section
162(m)(1), $1,000,000 of the aggregate compensa-
tion paid is nondeductible. Corporations CM and CN
are each treated as paying a ratable portion of the
nondeductible compensation. The result would be
the same if either Corporation CM or CN (or both)
was a publicly held corporation as defined in para-
graph (c)(1)(i) of this section.
(4) Conclusion (2023 taxable year). Because
the distribution of the stock of Corporation CM is a
transaction described in section 355(a)(1), Corpora-
tion CL is a predecessor of Corporation CM within
the meaning of paragraph (c)(2)(ii)(C) of this sec-
tion. However, because Employee EP started per-
forming services as an employee of Corporation CM
on January 1, 2021, and the distribution of stock of
Corporation CM did not occur until April 1, 2023,
Employee EP is not a covered employee of Corpora-
tion CM for its 2023 taxable year.
(3) Compensation—(i) In general.
For purposes of the deduction limitation
described in paragraph (b) of this sec-
tion, compensation means the aggregate
amount allowable as a deduction to the
publicly held corporation under chapter 1

Bulletin No. 2021–3 369 January 19, 2021
of the Internal Revenue Code for the tax-
able year (determined without regard to
section 162(m)(1)) for remuneration for
services performed by a covered employ-
ee in any capacity, whether or not the ser-
vices were performed during the taxable
year. Compensation includes an amount
that is includible in the income of, or paid
to, a person other than the covered em-
ployee (including a beneficiary after the
death of the covered employee) for ser-
vices performed by the covered employee.
(ii) Compensation paid by a partner-
ship. For purposes of paragraph (c)(3)(i)
of this section, compensation includes an
amount equal to a publicly held corpora-
tion’s distributive share of a partnership’s
deduction for compensation expense at-
tributable to the remuneration paid by the
partnership to a covered employee of the
publicly held corporation for services per-
formed by the covered employee, includ-
ing a payment for services under section
707(a) or under section 707(c).
(iii) Exceptions. Compensation does
not include—
(A) Remuneration covered in section
3121(a)(5)(A) through (D) (concerning
remuneration that is not treated as wag-
es for purposes of the Federal Insurance
Contributions Act);
(B) Remuneration consisting of any
benefit provided to or on behalf of an
employee if, at the time the benefit is pro-
vided, it is reasonable to believe that the
employee will be able to exclude it from
gross income; or
(C) Salary reduction contributions de-
scribed in section 3121(v)(1).
(iv) Examples. The following exam-
ples illustrate the provisions of this para-
graph (c)(3). For each example, assume
that the corporation is a calendar year tax-
payer.
(A) Example 1—(1) Facts. Corporation Z is a
publicly held corporation for its 2020 taxable year,
during which Employee A serves as the PEO of
Corporation Z and also serves on the board of di-
rectors of Corporation Z. In 2020, Corporation Z
paid $1,200,000 to Employee A plus a $50,000 fee
for serving as a director of Corporation Z. These
amounts are otherwise deductible for Corporation
Z’s 2020 taxable year.
(2) Conclusion. The $1,200,000 paid to Employ-
ee A in 2020 plus the $50,000 director’s fee paid to
Employee A in 2020 are compensation within the
meaning of this paragraph (c)(3). Therefore, Corpo-
ration Z’s $1,250,000 deduction for the 2020 taxable
year is subject to the section 162(m)(1) limit.
(B) Example 2—(1) Facts. Corporation X is a
publicly held corporation for its 2020 and all sub-
sequent taxable years. Employee B serves as the
PEO of Corporation X for its 2020 taxable year and
is a participant in the Corporation X nonqualified
retirement plan that meets the requirements of sec-
tion 409A. The plan provides for the distribution of
benefits over a three-year period beginning after a
participant separates from service. Employee B ter-
minates employment in 2021. In 2022, Employee B
receives a $75,000 fee for services as a director and
$1,500,000 as the first payment under the retirement
plan. Employee B continues to serve on the board of
directors until 2023 when Employee B dies before
receiving the retirement benefit for 2023 and before
becoming entitled to any director’s fees for 2023. In
2023 and 2024, Corporation X pays the $1,500,000
annual retirement benefits to Person C, a beneficiary
of Employee B.
(2) Conclusion (2022 Taxable Year). In 2022,
Corporation X paid Employee B $1,575,000, in-
cluding $1,500,000 under the retirement plan and
$75,000 in director’s fees. The retirement benefit
and the director’s fees are compensation within the
meaning of this paragraph (c)(3). Therefore, Corpo-
ration X’s $1,575,000 deduction for the 2022 taxable
year is subject to the section 162(m)(1) limit.
(3) Conclusion (2023 and 2024 Taxable Years).
In 2023 and 2024, Corporation X made payments to
Person C of $1,500,000 under the retirement plan.
The retirement benefits are compensation within the
meaning of this paragraph (c)(3). Therefore, Cor-
poration X’s deduction for each annual payment of
$1,500,000 for the 2023 and 2024 taxable years is
subject to the section 162(m)(1) limit.
(C) Example 3—(1) Facts. Corporation T is a
publicly held corporation for its 2021 taxable year.
Corporation S is a privately held corporation for its
2021 taxable year. On January 2, 2021, Corporations
S and T form a general partnership. Under the part-
nership agreement, Corporations S and T each have
a 50% distributive share of the partnership’s income,
gain, loss, and deductions. For the taxable year end-
ing December 31, 2021, Employee D, a covered
employee of Corporation T, performs services for
the partnership, and the partnership pays $800,000
to Employee D for these services, the deduction of
$400,000 of which is allocated to Corporation T.
Corporation T’s $400,000 distributive share of the
partnership’s deduction is reported separately to Cor-
poration T pursuant to §1.702-1(a)(8)(iii).
(2) Conclusion. Because Corporation T’s
$400,000 distributive share of the partnership’s de-
duction is attributable to the compensation paid by
the partnership for services performed by Employ-
ee D, a covered employee of Corporation T, the
$400,000 is compensation within the meaning of
this paragraph (c)(3) and Corporation T’s deduction
for this expense for its 2021 taxable year is sub-
ject to the section 162(m)(1) limit. Corporation T’s
$400,000 allocation of the partnership’s deduction is
aggregated with Corporation T’s deduction for com-
pensation paid to Employee D, if any, in determining
the amount allowable as a deduction to Corporation
T for compensation paid to Employee D for Corpo-
ration T’s 2021 taxable year. The result is the same
whether Employee D performs services for the part-
nership as a common law employee, an independent
contractor, or a partner, and whether the payment to
Employee D is a payment under section 707(a) or
section 707(c).
(4) Securities Act. The Securities Act
means the Securities Act of 1933.
(5) Exchange Act. The Exchange Act
means the Securities Exchange Act of
1934.
(6) SEC. The SEC means the United
States Securities and Exchange Commis-
sion.
(7) Foreign Private Issuer. A foreign
private issuer means an issuer as defined
in 17 CFR 240.3b-4(c).
(8) American Depositary Receipt
(ADR). An American Depositary Receipt
or ADR means a negotiable certificate that
evidences ownership of a specified num-
ber (or fraction) of a foreign private issu-
er’s securities held by a depositary (typi-
cally, a U.S. bank).
(9) Privately held corporation. A pri-
vately held corporation is a corporation
that is not a publicly held corporation as
defined in paragraph (c)(1) of this section
(without regard to paragraph (c)(1)(ii) of
this section).
(d) Corporations that become pub-
licly held—(1) In general. In the case of
a corporation that was a privately held
corporation and then becomes a publicly
held corporation, the deduction limitation
of paragraph (b) of this section applies to
any compensation that is otherwise de-
ductible for the taxable year ending on or
after the date that the corporation becomes
a publicly held corporation. A corporation
is considered to become publicly held
on the date that its registration statement
becomes effective either under the Secu-
rities Act or the Exchange Act. The rules
in this section apply to a partnership that
becomes a publicly traded partnership that
is a publicly held corporation within the
meaning of paragraph (c)(1)(i) of this sec-
tion.
(2) Example. The following exam-
ple illustrates the provision of this para-
graph (d).
(i) Facts. In 2021, Corporation E plans to issue
debt securities in a public offering registered under
the Securities Act. Corporation E is not required to
file reports under section 15(d) of the Exchange Act
with respect to any other class of securities and does
not have another class of securities required to be
registered under section 12 of the Exchange Act. On
December 18, 2021, the SEC declares effective the
Securities Act registration statement for Corporation
E’s debt securities.

January 19, 2021 370 Bulletin No. 2021–3
(ii) Conclusion. Corporation E becomes a public-
ly held corporation on December 18, 2021 because it
is then required to file reports under section 15(d) of
the Exchange Act. The deduction limitation of para-
graph (b) of this section applies to any compensa-
tion that is otherwise deductible for Corporation E’s
taxable year ending on or after December 18, 2021.
(e) Coordination with disallowed ex-
cess parachute payments under section
280G. The $1,000,000 limitation in para-
graph (b) of this section is reduced (but
not below zero) by the amount (if any)
that would have been included in the com-
pensation of the covered employee for
the taxable year but for being disallowed
by reason of section 280G. For example,
assume that during a taxable year a cor-
poration pays $1,500,000 to a covered
employee, of which $600,000 is an excess
parachute payment, as defined in section
280G(b)(1), and a deduction for that ex-
cess parachute payment is disallowed by
reason of section 280G(a). Because the
$1,000,000 limitation in paragraph (b) of
this section is reduced by the amount of
the excess parachute payment, the corpo-
ration may deduct $400,000 ($1,000,000
- $600,000), and $500,000 of the other-
wise deductible amount is nondeductible
by reason of section 162(m)(1). Thus
$1,100,000 (of the total $1,500,000 pay-
ment) is non-deductible, reflecting the dis-
allowance related to the excess parachute
payment under section 280G and the ap-
plication of section 162(m)(1).
(f) Coordination with excise tax
on specified stock compensation. The
$1,000,000 limitation in paragraph (b)
of this section is reduced (but not below
zero) by the amount (if any) of any pay-
ment (with respect to such employee) of
the tax imposed by section 4985 directly
or indirectly by the expatriated corpora-
tion (as defined in section 4985(e)(2)) or
by any member of the expanded affiliated
group (as defined in section 4985(e)(4))
that includes such corporation.
(g) Transition rules—(1) Amount of
compensation payable under a written
binding contract that was in effect on No-
vember 2, 2017—(i) General rule. This
section does not apply to the deduction
for compensation payable under a written
binding contract that was in effect on No-
vember 2, 2017, and that is not modified
in any material respect on or after that date
(a grandfathered amount). Instead, section
162(m), as in effect prior to its amendment
by Public Law 115-97, applies to limit the
deduction for that compensation. Because
§1.162-27 implemented section 162(m) as
in effect prior to its amendment by Pub-
lic Law 115-97, the rules of §1.162-27
determine the applicability of the deduc-
tion limitation under section 162(m) with
respect to the payment of a grandfathered
amount (including the potential applica-
tion of the separate grandfathering rules
contained in §1.162-27(h)). Compensa-
tion is a grandfathered amount only to the
extent that as of November 2, 2017, the
corporation was and remains obligated
under applicable law (for example, state
contract law) to pay the compensation un-
der the contract if the employee performs
services or satisfies the applicable vesting
conditions. This section applies to the de-
duction for any amount of compensation
that exceeds the grandfathered amount. If
a grandfathered amount and non-grandfa-
thered amount are otherwise deductible
for the same taxable year and, under the
rules of §1.162-27, the deduction of some
or all of the grandfathered amount may be
limited (for example, the grandfathered
amount does not satisfy the requirements
of §1.162-27(e)(2) through (5) as quali-
fied performance-based compensation),
then the grandfathered amount is aggre-
gated with the non-grandfathered amount
to determine the deduction disallowance
for the taxable year under section 162(m)
(1) (so that the deduction limit applies to
the excess of the aggregated amount over
$1 million).
(ii) Contracts that are terminable or
cancelable. If a written binding contract
is renewed after November 2, 2017, this
section (and not §1.162-27) applies to
any payments made after the renewal. A
written binding contract that is terminable
or cancelable by the corporation without
the employee’s consent after November
2, 2017, is treated as renewed as of the
earliest date that any such termination or
cancellation, if made, would be effective.
Thus, for example, if the terms of a con-
tract provide that it will be automatically
renewed or extended as of a certain date
unless either the corporation or the em-
ployee provides notice of termination of
the contract at least 30 days before that
date, the contract is treated as renewed as
of the date that termination would be ef-
fective if that notice were given. Similar-
ly, for example, if the terms of a contract
provide that the contract will be terminat-
ed or canceled as of a certain date unless
either the corporation or the employee
elects to renew within 30 days of that
date, the contract is treated as renewed by
the corporation as of that date (unless the
contract is renewed before that date, in
which case, it is treated as renewed on the
earlier date). Alternatively, if the corpora-
tion will remain legally obligated by the
terms of a contract beyond a certain date
at the sole discretion of the employee, the
contract will not be treated as renewed as
of that date if the employee exercises the
discretion to keep the corporation bound
to the contract. A contract is not treated as
terminable or cancelable if it can be termi-
nated or canceled only by terminating the
employment relationship of the employ-
ee. A contract is not treated as renewed
if upon termination or cancellation of
the contract the employment relationship
continues but would no longer be covered
by the contract. However, if the employ-
ment continues after the termination or
cancellation, payments with respect to
the post-termination or post-cancellation
employment are not made pursuant to the
contract (and, therefore, are not grandfa-
thered amounts).
(iii) Compensation payable under a
plan or arrangement. If a compensation
plan or arrangement is a written binding
contract in effect on November 2, 2017,
the deduction for the amount that the cor-
poration is obligated to pay to an employ-
ee pursuant to the plan or arrangement is
not subject to this section solely because
the employee was not eligible to partici-
pate in the plan or arrangement as of No-
vember 2, 2017, provided the employee
was employed on November 2, 2017, by
the corporation that maintained the plan
or arrangement, or the employee had the
right to participate in the plan or arrange-
ment under a written binding contract as
of that date.
(iv) Compensation subject to recovery
by corporation. If the corporation is ob-
ligated or has discretion to recover com-
pensation paid in a taxable year only upon
the future occurrence of a condition that
is objectively outside of the corporation’s
control, then the corporation’s right to
recovery is disregarded for purposes of
determining the grandfathered amount

Bulletin No. 2021–3 371 January 19, 2021
for the taxable year. Whether or not the
corporation exercises its discretion to re-
cover any compensation does not affect
the amount of compensation that the cor-
poration remains obligated to pay under
applicable law.
(v) Compensation payable from an
account balance plan—(A) In general.
Except as otherwise provided in this para-
graph (g), the grandfathered amount of
payments from an account balance plan
(as defined in §1.409A-1(c)(2)(i)(A)) that
is a written binding contract in effect as of
November 2, 2017, is the amount that the
corporation is obligated to pay pursuant to
the terms of the account balance plan in
effect as of that date, as determined under
applicable law. If under the terms of the
plan, the corporation is obligated to pay
the employee the account balance that is
credited with earnings and losses and has
no right to terminate or materially amend
the plan, then the grandfathered amount
would be the account balance as of No-
vember 2, 2017, plus any additional con-
tributions and earnings and losses that the
corporation is obligated to credit to the
account balance in accordance with the
terms of the plan as of November 2, 2017,
through the date of payment.
(B) Account balance plan providing
right to terminate. If under the terms of
the account balance plan in effect as of
November 2, 2017, the corporation may
terminate the contract and distribute the
account balance to the employee, then the
grandfathered amount would be the ac-
count balance determined as if the corpo-
ration had terminated the plan on Novem-
ber 2, 2017 or, if later, the earliest possible
date the plan could be terminated in accor-
dance with the terms of the plan (termi-
nation date). Whether additional contribu-
tions and earnings and losses credited to
the account balance after the termination
date, through the earliest possible date the
account balance could have been distrib-
uted to the employee in accordance with
the terms of the plan, are grandfathered
depends on whether the terms of the plan
require the corporation to make those
contributions or credit those earnings and
losses through that distribution date. Not-
withstanding the foregoing, the corpora-
tion may treat the account balance as of
the termination date as the grandfathered
amount regardless of when the amount is
paid and regardless of whether it has been
credited with additional contributions or
earnings or losses prior to payment.
(C) Account balance plan providing
right to discontinue future contributions.
If under the terms of the account balance
plan in effect as of November 2, 2017, the
corporation has no right to terminate the
plan, but may discontinue future contri-
butions and distribute the account balance
in accordance with the terms of the plan,
then the grandfathered amount would be
the account balance determined as if the
corporation had exercised the right to
discontinue contributions on November
2, 2017, or, if later, the earliest permis-
sible date the corporation could exercise
that right in accordance with the terms
of the plan (the freeze date). If, after the
freeze date, the plan requires the credit-
ing of earnings and losses on the account
balance through the payment date, then
the earnings and losses credited to the
grandfathered account balance would
also be grandfathered. Notwithstanding
the foregoing, the corporation may treat
the account balance as of the freeze date
as the grandfathered amount regardless of
when the amount is paid and regardless of
whether it has been credited with earnings
or losses prior to payment.
(vi) Compensation payable from a non-
account balance plan—(A) In general.
Except as otherwise provided in this para-
graph (g), the grandfathered amount of
payments from a nonaccount balance plan
(as defined in §1.409A-1(c)(2)(i)(C)) that
is a written binding contract in effect as
of November 2, 2017, is the amount that
the corporation is obligated to pay pursu-
ant to the terms of the nonaccount balance
plan in effect as of that date, as determined
under applicable law. If under the terms
of the plan, the corporation is obligated
to pay the employee the benefit under the
plan and has no right to terminate or ma-
terially amend the plan, then the grandfa-
thered amount would be the benefit under
the plan as of November 2, 2017, plus any
additional accrued benefits that the corpo-
ration is obligated to pay in accordance
with the terms of the plan as of November
2, 2017, through the date of payment.
(B) Nonaccount balance plan provid-
ing right to terminate. If under the terms
of the nonaccount balance plan in effect as
of November 2, 2017, the corporation may
terminate the plan and distribute the total
benefit to the employee, then the grandfa-
thered amount would be the present value
of the total benefit (lump sum value) deter-
mined as if the corporation had terminated
the plan on November 2, 2017 or, if later,
the earliest possible date the plan could be
terminated in accordance with the terms
of the plan (termination date). Whether an
increase or decrease in the lump sum val-
ue after the termination date, through the
earliest possible date the lump sum value
could have been distributed to the employ-
ee, is grandfathered depends on whether
the terms of the plan require the corpo-
ration to increase or decrease the lump
sum value through the distribution date.
For example, if the plan did not require
the corporation to make further service or
compensation credits, then any increase in
the lump sum value for these credits after
the termination date is not grandfathered.
Notwithstanding the foregoing, the corpo-
ration may treat the lump sum value as of
the termination date as the grandfathered
amount regardless of when the amount
is paid and regardless of whether it has
increased or decreased prior to payment.
For purposes of this paragraph (g)(1)(vi)
(B), the lump sum value is determined
based on the actuarial methods and as-
sumptions provided in the plan in effect
on November 2, 2017, if the assumptions
are reasonable, or any reasonable actuarial
assumptions if the plan does not provide
for applicable actuarial methods and as-
sumptions or the terms of the plan were
not reasonable. The determination of the
lump sum value may not take into account
the likelihood that payments will not be
made (or will be reduced) because of the
unfunded status of the plan, the risk that
the employer, the trustee, or another par-
ty will be unwilling or unable to pay, the
possibility of future plan amendments, the
possibility of a future change in the law, or
similar risks or contingencies. If the ben-
efit provided under the plan in effect on
November 2, 2017, is paid as a life annui-
ty or other form of benefit that is not a sin-
gle lump sum payment, the application of
the grandfathered amount to the payments
of the benefit is determined in accordance
with the ordering rule of paragraph (g)(1)
(viii) of this section.
(C) Nonaccount balance plan provid-
ing right to discontinue future accrual of

January 19, 2021 372 Bulletin No. 2021–3
benefits. If under the terms of the nonac-
count balance plan in effect as of Novem-
ber 2, 2017, the corporation has no right
to terminate the plan, but may discontinue
future accruals of benefits and distribute
the benefit in accordance with the terms
of the plan, then the grandfathered amount
would be the lump sum value of the to-
tal benefit (lump sum value) determined
as if the corporation had exercised the
right to discontinue the future accrual of
benefits on November 2, 2017, or, if lat-
er, the earliest permissible date the cor-
poration could exercise such right in ac-
cordance with the terms of the plan (the
freeze date). If, after the freeze date, the
plan required the corporation to increase
or decrease the lump sum value through
the payment date, then any increase to the
grandfathered lump sum would also be
grandfathered. Notwithstanding the fore-
going, the corporation may treat the lump
sum value determined as of the freeze date
as the grandfathered amount regardless of
when the amount is paid and regardless
of whether it has been increased or de-
creased prior to payment. For purposes
of this paragraph (g)(1)(vi)(C), the lump
sum value is determined based on the ac-
tuarial methods and assumptions provid-
ed in the plan in effect on November 2,
2017, if the assumptions are reasonable,
or any reasonable actuarial assumptions
if the plan does not provide for applica-
ble actuarial methods and assumptions or
the terms of the plan were not reasonable.
The determination of the lump sum value
may not take into account the likelihood
that payments will not be made (or will be
reduced) because of the unfunded status
of the plan, the risk that the employer, the
trustee, or another party will be unwilling
or unable to pay, the possibility of future
plan amendments, the possibility of a fu-
ture change in the law, or similar risks or
contingencies. If the benefit paid under
the plan in effect on November 2, 2017,
is paid as a life annuity or other form of
benefit that is not a single lump sum pay-
ment, the application of the grandfathered
amount to the payments of the benefit is
determined in accordance with the order-
ing rule of paragraph (g)(1)(viii) of this
section.
(vii) Grandfathered amount limited to
a particular plan or arrangement. The
grandfathered amount under a plan or ar-
rangement applies solely to the amounts
paid under that plan or arrangement, so
that regardless of whether all of the grand-
fathered amount is paid to the participant
(for example, regardless of whether some
or all of the grandfathered amount under
the plan is forfeited under the terms of
the plan), no portion of that grandfathered
amount may be treated as a grandfathered
amount under any other separate plan or
arrangement in which the employee is a
participant.
(viii) Ordering rule. If a portion of the
amount payable under a plan or arrange-
ment is a grandfathered amount and a por-
tion is subject to this section, and payment
under the plan or arrangement is made
in a series of payments (including pay-
ments as a life annuity), the grandfathered
amount is allocated to the first payment of
an amount under the plan or arrangement
that is otherwise deductible. If the grand-
fathered amount exceeds the initial pay-
ment, the excess is allocated to the next
payment of an amount under the plan or
arrangement that is otherwise deductible,
and this process is repeated until the entire
grandfathered amount has been paid. Not-
withstanding the foregoing, for amounts
otherwise deductible for taxable years
ending before December 20, 2019, the
grandfathered amount may be allocated to
each payment on a pro rata basis or to the
last otherwise deductible payment. If one
of these two methods was used for taxable
years ending before December 20, 2019,
then, for taxable years ending on or after
December 20, 2019, the method must be
changed to allocate any remaining grand-
fathered amount to the first payment for
the remaining payments (treating as the
first payment the first otherwise deduct-
ible amount for taxable years ending on or
after December 20, 2019).
(2) Material modifications. (i) If a writ-
ten binding contract is modified on or after
November 2, 2017, this section (and not
§1.162-27) applies to any payments made
after the modification. A material modifi-
cation occurs when the contract is amend-
ed to increase the amount of compensa-
tion payable to the employee. If a written
binding contract is materially modified, it
is treated as a new contract entered into
as of the date of the material modification.
Thus, amounts received by an employee
under the contract before a material mod-
ification are not affected, but amounts
received subsequent to the material mod-
ification are treated as paid pursuant to a
new contract, rather than as paid pursuant
to a written binding contract in effect on
November 2, 2017.
(ii) A modification of the contract
that accelerates the payment of compen-
sation is a material modification unless
the amount of compensation paid is dis-
counted to reasonably reflect the time
value of money. If the contract is mod-
ified to defer the payment of compensa-
tion, any compensation paid or to be paid
that is in excess of the amount that was
originally payable to the employee under
the contract will not be treated as result-
ing in a material modification if the ad-
ditional amount is based on applying to
the amount originally payable either a
reasonable rate of interest or the rate of
return on a predetermined actual invest-
ment as defined in §31.3121(v)(2)-1(d)(2)
(i)(B) of this chapter (whether or not as-
sets associated with the amount originally
owed are actually invested therein) such
that the amount payable by the employ-
er at the later date will be based on the
reasonable rate of interest or the actual
rate of return on the predetermined ac-
tual investment (including any decrease,
as well as any increase, in the value of
the investment). For an arrangement un-
der which the grandfathered amounts are
subject to increase or decrease based on
the performance of a predetermined actu-
al investment, the addition or substitution
of a predetermined actual investment or
reasonable interest rate as an investment
alternative for amounts deferred is not
treated as a material modification. How-
ever, a modification of a contract to defer
payment of a grandfathered amount that
results in payment of additional amounts
(such as additional earnings) does not nec-
essarily mean that the additional amounts
are grandfathered amounts; for rules
concerning the determination of grandfa-
thered amounts see paragraph (g) of this
section. Notwithstanding the foregoing,
if compensation attributable to an option
to purchase stock (other than an incentive
stock option described in section 422 or
a stock option granted under an employ-
ee stock purchase plan described in sec-
tion 423) or a stock appreciation right is
grandfathered, an extension of the exer-

Bulletin No. 2021–3 373 January 19, 2021
cise period that is extended in compliance
with §1.409A-1(b)(5)(v)(C)(1) will not
be treated as a material modification and
the amount of compensation paid upon
the exercise of the stock option or stock
appreciation right will be grandfathered.
(iii) The adoption of a supplemental
contract or agreement that provides for
increased compensation, or the payment
of additional compensation, is a material
modification of a written binding contract
if the facts and circumstances demonstrate
that the additional compensation to be
paid is based on substantially the same el-
ements or conditions as the compensation
that is otherwise paid pursuant to the writ-
ten binding contract. However, a material
modification of a written binding contract
does not include a supplemental payment
that is equal to or less than a reasonable
cost-of-living increase over the payment
made in the preceding year under that
written binding contract. In addition, the
failure, in whole or in part, to exercise
negative discretion under a contract does
not result in the material modification of
that contract (although the existence of the
negative discretion under the contract may
impact the initial determination of wheth-
er amounts under the contract are grandfa-
thered amounts).
(iv) If a grandfathered amount is sub-
ject to a substantial risk of forfeiture (as
defined in §1.409A-1(d)), then a modi-
fication of the contract that results in a
lapse of the substantial risk of forfeiture
is not considered a material modification.
Furthermore, for compensation received
pursuant to the substantial vesting of re-
stricted property, or the exercise of a stock
option or stock appreciation right that does
not provide for a deferral of compensation
(as defined in §1.409A-1(b)(5)(i) and (ii)),
a modification of a written binding con-
tract in effect on November 2, 2017, that
results in a lapse of the substantial risk of
forfeiture (as defined §1.83-3(c)) is not
considered a material modification.
(3) Examples. The following exam-
ples illustrate the provisions of this para-
graph (g). For each example, assume for
all relevant years that the corporation is
a publicly held corporation within the
meaning of paragraph (c)(1) of this sec-
tion and is a calendar year taxpayer, and
is not a “smaller reporting company” or
“emerging growth company” for purposes
of reporting under the Exchange Act. Fur-
thermore, assume that, for each example,
if any arrangement is subject to section
409A, then the arrangement complies with
section 409A, and that no arrangement is
subject to section 457A.
(i) Example 1 (Multi-year agreement for annual
salary)—(A) Facts. On October 2, 2017, Corpora-
tion X executed a three-year employment agreement
with Employee A for an annual salary of $2,000,000
beginning on January 1, 2018. Employee A serves as
the PFO of Corporation X for the 2017 through 2020
taxable years. The agreement provides for automat-
ic extensions after the three-year term for additional
one-year periods, unless the corporation exercises
its option to terminate the agreement within 30 days
before the end of the three-year term or, thereafter,
within 30 days before each anniversary date. Ter-
mination of the employment agreement does not
require the termination of Employee A’s employ-
ment with Corporation X. Under applicable law, the
agreement for annual salary constitutes a written
binding contract in effect on November 2, 2017, to
pay $2,000,000 of annual salary to Employee A for
three years through December 31, 2020.
(B) Conclusion. If this section applies, Employee
A is a covered employee for Corporation X’s 2018
through 2020 taxable years. Because the October
2, 2017, employment agreement is a written bind-
ing contract to pay Employee A an annual salary of
$2,000,000, this section does not apply (and §1.162-
27 does apply) to the deduction for Employee A’s
annual salary. Pursuant to §1.162-27(c)(2), Employ-
ee A is not a covered employee for Corporation X’s
2018 through 2020 taxable years. The deduction for
Employee A’s annual salary for the 2018 through
2020 taxable years is not subject to section 162(m)
(1). However, the employment agreement is treated
as renewed on January 1, 2021, unless it is previous-
ly terminated, and the deduction limit of this §1.162-
33 (and not §1.162-27) will apply to the deduction
for any payments made under the employment
agreement on or after that date.
(ii) Example 2 (Agreement for severance based
on annual salary and discretionary bonus)—(A)
Facts. The facts are the same as in paragraph (g)(3)(i)
of this section (Example 1), except that the employ-
ment agreement also requires Corporation X to pay
Employee A severance if Corporation X terminates
the employment relationship without cause during
the term of the agreement. The amount of severance
is equal to the sum of two times Employee A’s annual
salary plus two times Employee A’s discretionary bo-
nus (if any) paid within 24 months preceding termi-
nation. Under applicable law, the agreement for sev-
erance constitutes a written binding contract in effect
on November 2, 2017, to pay $4,000,000 (two times
Employee A’s $2,000,000 annual salary) if Corpora-
tion X terminates Employee A’s employment without
cause during the term of the agreement.
(B) Conclusion. If this section applies, Employee
A is a covered employee for Corporation X’s 2018
through 2020 taxable years. Because the October 2,
2017, employment agreement is a written binding
contract to pay Employee A $4,000,000 if Employ-
ee A is terminated without cause prior to December
31, 2020, this section does not apply (and §1.162-
27 does apply) to the deduction for $4,000,000 of
Employee A’s severance. Pursuant to §1.162-27(c)
(2), Employee A is not a covered employee for Cor-
poration X’s 2018 through 2020 taxable years. The
deduction for $4,000,000 of Employee A’s sever-
ance is not subject to section 162(m)(1). However,
the employment agreement is treated as renewed on
January 1, 2021, unless it is previously terminated,
and this §1.162-33 (and not §1.162-27) will apply
to the deduction for any payments made under the
employment agreement, including for severance, on
or after that date.
(iii) Example 3 (Effect of discretionary bonus
payment on agreement for severance based on an-
nual salary and discretionary bonus)—(A) Facts.
The facts are the same as in paragraph (g)(3)(ii) of
this section (Example 2), except that, on October
31, 2017, Corporation X paid Employee A a discre-
tionary bonus of $100,000, on May 14, 2018, Cor-
poration X paid Employee A a discretionary bonus
of $600,000, and on April 30, 2019, terminated Em-
ployee A’s employment without cause. Pursuant to
the terms of the employment agreement for sever-
ance, on May 1, 2019, Corporation X paid to Em-
ployee A a $5,400,000 severance payment (the sum
of two times the $2,000,000 annual salary, two times
the $100,000 discretionary bonus, and two times the
$600,000 discretionary bonus).
(B) Conclusion. If this section applies, Employ-
ee A is a covered employee for Corporation X’s
2019 taxable year. Because the October 2, 2017,
agreement is a written binding contract to pay Em-
ployee A $4,000,000 if Employee A is terminated
without cause prior to December 31, 2020, and
$200,000 if Corporation X terminates Employee
A’s employment without cause prior to October 31,
2019, this section does not apply (and §1.162-27
does apply) to the deduction for $4,200,000 of Em-
ployee A’s severance payment. The deduction for
$4,200,000 of Employee A’s severance payment is
not subject to section 162(m)(1). Because the Octo-
ber 2, 2017, agreement is not a written binding con-
tract to pay Employee A’s $600,000 discretionary
bonus (since, as of November 2, 2017, Corporation
X was not obligated under applicable law to make
the bonus payment), the deduction for $1,200,000
of the $5,400,000 payment is subject to this section
(and not §1.162-27).
(iv) Example 4 (Effect of adjustment to annual
salary on severance)—(A) Facts. The facts are the
same as in paragraph (g)(3)(ii) of this section (Ex-
ample 2), except that the employment agreement
provides for discretionary increases in salary and, on
January 1, 2019, Corporation X increased Employee
A’s annual salary from $2,000,000 to $2,050,000, an
increase that was less than a reasonable, cost-of-liv-
ing adjustment.
(B) Conclusion (Annual salary). If this section
applies, Employee A is a covered employee for
Corporation X’s 2018 through 2020 taxable years.
Because the October 2, 2017, agreement is a writ-
ten binding contract to pay Employee A an annual
salary of $2,000,000, this section does not apply (and
§1.162-27 does apply) to the deduction for Employ-
ee A’s annual salary unless the change in the salary
is a material modification. Even though the $50,000
increase is paid on the basis of substantially the same
elements or conditions as the salary that is otherwise

January 19, 2021 374 Bulletin No. 2021–3
paid under the contract, the $50,000 increase does
not constitute a material modification because it
is less than or equal to a reasonable cost-of-living
increase to the $2,000,000 annual salary Corpora-
tion X is required to pay under applicable law as of
November 2, 2017. However, the deduction for the
$50,000 increase is subject to this section (and not
§1.162-27).
(C) Conclusion (Severance payment). Because
the October 2, 2017, agreement is a written binding
contract to pay Employee A severance of $4,000,000,
this section would not apply (and §1.162-27 would
apply) to the deduction for this amount of severance
unless the change in the employment agreement is a
material modification. Even though the $100,000 in-
crease in severance (two times the $50,000 increase
in salary) would be paid on the basis of substantial-
ly the same elements or conditions as the severance
that would otherwise be paid pursuant to the writ-
ten binding contract, the $50,000 increase in salary
on which it is based does not constitute a material
modification of the written binding contract since it
is less than or equal to a reasonable cost-of-living
increase. However, the deduction for the $100,000
increase in severance is subject to this section (and
not §1.162-27).
(v) Example 5 (Effect of adjustment to annual
salary on severance)—(A) Facts. The facts are the
same as in paragraph (g)(3)(iv) of this section (Ex-
ample 4), except that, on January 1, 2019, Corpora-
tion X increased Employee A’s annual salary from
$2,000,000 to $3,000,000, an increase that exceeds a
reasonable, cost-of-living adjustment.
(B) Conclusion (Annual salary). If this section
applies, Employee A is a covered employee for
Corporation X’s 2018 through 2020 taxable years.
Because the October 2, 2017, agreement is a written
binding contract to pay Employee A an annual sal-
ary of $2,000,000, this section does not apply (and
§1.162-27 does apply) to the deduction for Employ-
ee A’s annual salary unless the change in the em-
ployment agreement is a material modification. The
$1,000,000 increase is a material modification of
the written binding contract because the additional
compensation is paid on the basis of substantially
the same elements or conditions as the compensa-
tion that is otherwise paid pursuant to the written
binding contract, and it exceeds a reasonable, an-
nual cost-of-living increase from the $2,000,000
annual salary for 2018 that Corporation X is re-
quired to pay under applicable law as of Novem-
ber 2, 2017. Because the written binding contract
is materially modified as of January 1, 2019, the
deduction for all annual salary paid to Employee A
in 2019 and thereafter is subject to this section (and
not §1.162-27).
(C) Conclusion (Severance payment). Because
the October 2, 2017, agreement is a written binding
contract to pay Employee A severance of $4,000,000,
this section would not apply (and §1.162-27 would
apply) to the deduction for this amount of severance
unless the change in the employment agreement is
a material modification. The additional $2,000,000
severance payment (two times the $1,000,000 in-
crease in annual salary) constitutes a material mod-
ification of the written binding contract because the
$1,000,000 increase in salary on which it is based
constitutes a material modification of the written
binding contract since it exceeds a reasonable cost-
of-living increase from the $2,000,000 annual salary
for 2018 that Corporation X is required to pay under
applicable law as of November 2, 2017. Because
the agreement is materially modified as of January
1, 2019, the deduction for any amount of severance
paid to Employee A under the agreement is subject to
this section (and not §1.162-27).
(vi) Example 6 (Elective deferral of an amount
that corporation was obligated to pay under ap-
plicable law)—(A) Facts. The facts are the same
as in paragraph (g)(3)(i) of this section (Example
1), except that, on December 15, 2018, Employ-
ee A makes a deferral election under a nonquali-
fied deferred compensation (NQDC) plan to defer
$200,000 of annual salary earned and payable in
2019. Pursuant to the NQDC plan, the $200,000,
including earnings, is to be paid in a lump sum on
the date six months following Employee A’s sep-
aration from service. The earnings are based on
the Standard & Poor’s 500 Index. Under applica-
ble law, pursuant to the written binding contract
in effect on November 2, 2017, (and absent the
deferral agreement) Corporation X would have
been obligated to pay $200,000 to Employee A in
2019, but is not obligated to pay any earnings on
the $200,000 deferred pursuant to the deferral elec-
tion Employee A makes on December 15, 2018.
Employee A separates from service on December
15, 2020. On June 15, 2021, Corporation X pays
$250,000 (the deferred $200,000 of salary plus
$50,000 in earnings).
(B) Conclusion. If this section applies, Em-
ployee A is a covered employee for Corporation
X’s 2021 taxable year. Employee A’s NQDC plan
is not a material modification of the written binding
contract in effect on November 2, 2017, because
the earnings to be paid under the NQDC plan are
based on a predetermined actual investment (as de-
fined in §31.3121(v)(2)-1(d)(2)(i)(B) of this chap-
ter). The deduction for the $50,000 of earnings to
be paid that exceed the amount originally payable
to Employee A under the written binding contract
($200,000 of salary) are subject to this section
(and not §1.162-27). This section does not apply
(and §1.162-27 does apply) to the deduction for
the $200,000 portion of the $250,000 payment that
Corporation X was obligated under applicable law
to pay as of November 2, 2017. Pursuant to §1.162-
27(c)(2), Employee A is not a covered employee
for Corporation X’s 2021 taxable year; thus, the
deduction for the $200,000 payment is not subject
to section 162(m)(1).
(vii) Example 7 (Compensation subject to dis-
cretionary recovery by corporation)—(A) Facts.
Employee B serves as the PFO of Corporation Z
for its 2017 through 2019 taxable years. On Oc-
tober 2, 2017, Corporation Z executed a bonus
agreement with Employee B that requires Corpo-
ration Z to pay Employee B a performance bonus
of $3,000,000 on May 1, 2019, if Corporation Z’s
net earnings increase by at least 10% for its 2018
taxable year based on the financial statements filed
with the SEC. The agreement does not permit Cor-
poration Z to reduce the amount of the bonus pay-
ment for any reason if the Corporation Z attains
the net earnings performance target. However, the
agreement provides that, if the bonus is paid and
subsequently the financial statements are restated
to show that the net earnings did not increase by
at least 10%, then Corporation Z may, in its dis-
cretion, recover the $3,000,000 from Employee B
within six months of the restatement. Under appli-
cable law, the agreement for the performance bonus
constitutes a written binding contract in effect on
November 2, 2017, to pay $3,000,000 to Employ-
ee B if Corporation Z’s net earnings increase by at
least 10% for its 2018 taxable year based on the
financial statements filed with the SEC. On May 1,
2019, Corporation Z pays $3,000,000 to Employee
B because its net earnings increased by at least 10%
of its 2018 taxable year.
(B) Conclusion. If this section applies, Employee
B is a covered employee for Corporation Z’s 2019
taxable year. Because the October 2, 2017, agree-
ment is a written binding contract to pay Employee
B $3,000,000 if the applicable conditions are met,
this section does not apply (and §1.162-27 does ap-
ply) to the deduction for the $3,000,000 regardless
of whether Corporation Z’s financial statements are
restated to show that its net earnings did not increase
by at least 10%, and regardless of whether Corpora-
tion Z exercises its discretion to recover the bonus
if Corporation Z’s financial statements are restated
to show that its net earnings did not increase by at
least 10%.
(viii) Example 8 (Performance bonus plan with
negative discretion)—(A) Facts. Employee E serves
as the PEO of Corporation V for the 2017 and 2018
taxable years. On February 1, 2017, Corporation V
establishes a bonus plan, under which Employee E
will receive a cash bonus of $1,500,000 if a speci-
fied performance goal is satisfied. The compensation
committee retains the right, if the performance goal
is met, to reduce the bonus payment to no less than
$400,000 if, in its judgment, other subjective factors
warrant a reduction. On November 2, 2017, under
applicable law, which takes into account the employ-
er’s ability to exercise negative discretion, the bonus
plan established on February 1, 2017, constitutes a
written binding contract to pay $400,000. On March
1, 2018, the compensation committee certifies that
the performance goal was satisfied, but exercises
its discretion to reduce the award to $500,000. On
April 1, 2018, Corporation V pays $500,000 to Em-
ployee E. The payment satisfies the requirements
of §1.162-27(e)(2) through (5) as qualified perfor-
mance-based compensation.
(B) Conclusion. If this section applies, Employ-
ee E is a covered employee for Corporation V’s
2018 taxable year. Because the February 1, 2017,
plan is a written binding contract to pay Employee
E $400,000 if the performance goal is satisfied, this
section does not apply (and §1.162-27 does apply)
to the deduction for the $400,000 portion of the
$500,000 payment. Furthermore, pursuant to para-
graph (g)(2)(iii) of this section, the failure of the
compensation committee to exercise its discretion
to reduce the award further to $400,000, instead of
$500,000, does not result in a material modification
of the contract. Pursuant to §1.162-27(e)(1), the
deduction for the $400,000 payment is not subject
to section 162(m)(1) because the payment satis-

Bulletin No. 2021–3 375 January 19, 2021
fies the requirements of §1.162-27(e)(2) through
(5) as qualified performance-based compensation.
The deduction for the remaining $100,000 of the
$500,000 payment is subject to this section (and not
§1.162-27) and therefore the status as qualified per-
formance-based compensation is irrelevant to the
application of section 162(m)(1) to this remaining
amount.
(ix) Example 9 (Equity-based compensation
with underlying grants made prior to November 2,
2017)—(A) Facts. On January 2, 2017, Corporation
T executed a 4-year employment agreement with
Employee G to serve as its PEO, and Employee G
serves as the PEO for the four-year term. Pursuant
to the employment agreement, on January 2, 2017,
Corporation T executed a grant agreement and grant-
ed to Employee G nonqualified stock options to pur-
chase 1,000 shares of Corporation T stock, stock ap-
preciation rights (SARs) on 1,000 shares, and 1,000
shares of Corporation T restricted stock. On the date
of grant, the stock options had no readily ascertain-
able fair market value as defined in §1.83-7(b), and
neither the stock options nor the SARs provided for
a deferral of compensation under § 1.409A-1(b)(5)(i)
(A) and (B). The stock options, SARs, and shares of
restricted stock are subject to a substantial risk of for-
feiture and all substantially vest on January 2, 2020.
Employee G may exercise the stock options and the
SARs at any time from January 2, 2020, through Jan-
uary 2, 2027. On January 2, 2020, Employee G exer-
cises the stock options and the SARs, and the 1,000
shares of restricted stock become substantially vest-
ed (as defined in §1.83-3(b)). The grant agreement
pursuant to which grants of the stock options, SARs,
and shares of restricted stock are made constitutes a
written binding contract under applicable law. The
compensation attributable to the stock options and
the SARs satisfy the requirements of §1.162-27(e)
(2) through (5) as qualified performance-based com-
pensation.
(B) Conclusion. If this section applies, Employ-
ee G is a covered employee for Corporation T’s
2020 taxable year. Because the January 2, 2017,
grant agreement constitutes a written binding con-
tract, this section does not apply (and §1.162-27
does apply) to the deduction for compensation re-
ceived pursuant to the exercise of the stock options
and the SARs, or the restricted stock becoming
substantially vested (as defined in §1.83-3(b)). Pur-
suant to §1.162-27(e)(1), the deduction attributable
to the stock options and the SARs is not subject to
section 162(m)(1) because the compensation sat-
isfies the requirements of §1.162-27(e)(2) through
(5) as qualified performance-based compensation.
However, the deduction attributable to the restrict-
ed stock is subject to section 162(m)(1) because
the compensation does not satisfy the requirements
of §1.162-27(e)(2) through (5) as qualified perfor-
mance-based compensation.
(x) Example 10 (Plan in which an employee
is not a participant on November 2, 2017)—(A)
Facts. On October 2, 2017, Employee H executes
an employment agreement with Corporation Y to
serve as its PFO, and begins employment with Cor-
poration Y. The employment agreement, which is a
written binding contract under applicable law, pro-
vides that if Employee H continues in his position
through April 1, 2018, Employee H will become a
participant in the NQDC plan of Corporation Y and
that Employee H’s benefit accumulated on that date
will be $3,000,000. On April 1, 2021, Employee
H receives a payment of $4,500,000 (the increase
from $3,000,000 to $4,500,000 is not a result of a
material modification as defined in paragraph (g)
(2) of this section), which is the entire benefit ac-
cumulated under the plan through the date of pay-
ment.
(B) Conclusion. If this section applies, Em-
ployee H is a covered employee for Corporation
Y’s 2021 taxable year. Even though Employee H
was not eligible to participate in the NQDC plan
on November 2, 2017, Employee H had the right
to participate in the plan under a written binding
contract as of that date. Because the amount re-
quired to be paid pursuant to the written binding
contract is $3,000,000, this section does not apply
(and §1.162-27 does apply) to the deduction for
the $3,000,000 portion of the $4,500,000. Pursuant
to §1.162-27(c)(2), Employee H is not a covered
employee of Corporation Y for the 2021 taxable
year. The deduction for the $3,000,000 portion of
the $4,500,000 is not subject to section 162(m)(1).
The deduction for the remaining $1,500,000 por-
tion of the payment is subject to this section (and
not §1.162-27).
(xi) Example 11 (Material modification of annu-
al salary)—(A) Facts. On January 2, 2017, Corpo-
ration R executed a 5-year employment agreement
with Employee I to serve as Corporation R’s PFO,
providing for an annual salary of $1,800,000. The
agreement constitutes a written binding contract
under applicable law. In 2017 and 2018, Employ-
ee I receives the salary of $1,800,000 per year. In
2019, Corporation R increases Employee I’s salary
by $40,000, which is less than a reasonable cost-
of-living increase from $1,800,000. On January 1,
2020, Corporation R increases Employee I’s sala-
ry to $2,400,000. The $560,000 increase exceeds
a reasonable, annual cost-of-living increase from
$1,840,000.
(B) Conclusion ($1,840,000 Payment in 2019). If
this section applies, Employee I is a covered employ-
ee for Corporation R’s 2018 through 2020 taxable
years. Because the January 1, 2017, agreement is a
written binding contract to pay Employee I an annual
salary of $1,800,000, this section does not apply (and
§1.162-27 does apply) to the deduction for Employ-
ee I’s annual salary unless the change in the employ-
ment agreement is a material modification. Pursuant
to §1.162-27(c)(2), Employee I is not a covered em-
ployee of Corporation R for the 2019 taxable year, so
the deduction for the $1,800,000 salary is not subject
to section 162(m)(1). Even though the $40,000 in-
crease is made on the basis of substantially the same
elements or conditions as the salary, the $40,000
increase does not constitute a material modification
of the written binding contract because the $40,000
is less than or equal to a reasonable cost-of-living
increase. However, the deduction for the $40,000 in-
crease is subject to this section (and not §1.162-27).
(C) Conclusion (Salary increase to $2,400,000
in 2020). The $560,000 increase in salary in 2020 is
a material modification of the written binding con-
tract because the additional compensation is paid on
the basis of substantially the same elements or con-
ditions as the salary, and it exceeds a reasonable,
annual cost-of-living increase from $1,840,000.
Because the written binding contract is materially
modified as of January 1, 2020, the deduction for
all salary paid to Employee I on and after January
1, 2020, is subject is subject to this section (and not
§1.162-27).
(xii) Example 12 (Additional payment not consid-
ered a material modification)—(A) Facts. The facts
are the same as in paragraph (g)(3)(xi) of this section
(Example 11), except that instead of an increase in
salary, in 2020 Employee I receives a restricted stock
grant subject to Employee I’s continued employment
for the balance of the contract.
(B) Conclusion. The restricted stock grant is not
a material modification of the written binding con-
tract because any additional compensation paid to
Employee I under the grant is not paid on the basis
of substantially the same elements and conditions as
Employee I’s salary. However, the deduction attrib-
utable to the restricted stock grant is subject to this
section (and not §1.162-27).
(h) Effective/Applicability dates—(1)
Effective date. This section is effective on
December 30, 2020.
(2) Applicability dates—(i) General
applicability date. Except as otherwise
provided in paragraph (h)(2)(ii) of this
section, this section applies to taxable
years beginning on or after December 30,
2020. Taxpayers may choose to apply this
section for taxable years beginning after
December 31, 2017, and before Decem-
ber 30, 2020 provided the taxpayer ap-
plies this section in its entirety and in a
consistent manner.
(ii) Special applicability dates—(A)
Definition of covered employee. The defi-
nition of covered employee in paragraph
(c)(2)(i) of this section applies to taxable
years ending on or after September 10,
2018. However, for a corporation whose
fiscal year and taxable year do not end on
the same date, the rule in paragraph (c)(2)
(i)(B) of this section requiring the deter-
mination of the three most highly com-
pensated executive officers to be made
pursuant to the rules under the Exchange
Act applies to taxable years ending on or
after December 20, 2019.
(B) Definition of predecessor of a
publicly held corporation—(1) Publicly
held corporations that become privately
held. The definition of predecessor of a
publicly held corporation in paragraph
(c)(2)(ii)(A) of this section applies to
any publicly held corporation that be-
comes a privately held corporation for a
taxable year beginning after December
31, 2017, and, subsequently, again be-
comes a publicly held corporation on or

January 19, 2021 376 Bulletin No. 2021–3
after December 30, 2020. The definition
of predecessor of a publicly held corpo-
ration in paragraph (c)(2)(ii)(A) of this
section does not apply to any publicly
held corporation that became a private-
ly held corporation for a taxable year
beginning before January 1, 2018, with
respect to the earlier period as a publicly
held corporation; or a publicly held cor-
poration that becomes a privately held
corporation for a taxable year beginning
after December 31, 2017, and, subse-
quently, again becomes a publicly held
corporation before December 30, 2020.
(2) Corporate transactions. The defi-
nition of predecessor of a publicly held
corporation in paragraphs (c)(2)(ii)(B)
through (H) of this section applies to cor-
porate transactions that occur (as provid-
ed in the transaction timing rule of para-
graph (c)(2)(ii)(I) of this section) on or
after December 30, 2020. With respect
to any of the following corporate trans-
actions occurring after December 20,
2019, and before December 30, 2020,
excluding target corporations from the
definition of the term “predecessor” is
not a reasonable good faith interpretation
of the statute:
(i) A publicly held target corporation
the stock or assets of which are acquired
by another publicly held corporation in
a transaction to which section 381(a) ap-
plies.
(ii) A publicly held target corporation,
at least 80% of the total voting power of
the stock of which, and at least 80% of the
total value of the stock of which, are ac-
quired by a publicly held acquiring corpo-
ration (including an affiliated group).
(C) Definition of compensation. The
definition of compensation provided in
paragraph (c)(3)(ii) of this section (relating
to distributive share of partnership deduc-
tions for compensation paid) applies to any
deduction for compensation that is paid af-
ter December 18, 2020. The definition of
compensation in paragraph (c)(3)(ii) does
not apply to compensation paid pursuant to
a written binding contract that is in effect
on December 20, 2019, and that is not ma-
terially modified after that date. For purpos-
es of this paragraph (h)(3), written binding
contract and material modification have the
same meanings as provided in paragraphs
(g)(1) and (2) of this section.
(D) Corporations that become pub-
licly held. The rule in paragraph (d) of
this section (providing that the deduction
limitation of paragraph (b) of this section
applies to a deduction for any compensa-
tion that is otherwise deductible for the
taxable year ending on or after the date
that a privately held corporation becomes
a publicly held corporation) applies to
corporations that become publicly held
after December 20, 2019. A privately held
corporation that becomes a publicly held
corporation on or before December 20,
2019, may rely on the transition rules pro-
vided in §1.162-27(f)(1) until the earliest
of the events provided in §1.162-27(f)(2).
A subsidiary that is a member of an affili-
ated group (as defined in §1.162-27(c)(1)
(ii)) may rely on transition relief provided
in §1.162-27(f)(4) if it becomes a sepa-
rate publicly held corporation (whether in
a spin-off transaction or otherwise) on or
before December 20, 2019.
(E) Transition rules. Except for the
transition rules in paragraphs (g)(1)(v)
through (vii) of this section, the transition
rules in paragraphs (g)(1) and (2) of this
section (providing that this section does
not apply to compensation payable under
a written binding contract which was in
effect on November 2, 2017, and which
is not modified in any material respect on
or after such date) apply to taxable years
ending on or after September 10, 2018.
Par. 4. Section 1.338-1 is amended by
revising paragraph (b)(2)(i) to read as fol-
lows:
§ 1.338-1 General principles; status of
old target and new target.
* * * * *
(b) * * *
(2) * * *
(i) The rules applicable to employ-
ee benefit plans (including those plans
described in sections 79, 104, 105, 106,
125, 127, 129, 132, 137, and 220), qual-
ified pension, profit-sharing, stock bonus
and annuity plans (sections 401(a) and
403(a)), simplified employee pensions
(section 408(k)), tax qualified stock op-
tion plans (sections 422 and 423), welfare
benefit funds (sections 419, 419A, 512(a)
(3), and 4976), voluntary employee bene-
fit associations (section 501(c)(9) and the
regulations thereunder (§§ 1.501(c)(9)-1
through 1.501(c)(9)-8)) and certain ex-
cessive employee remuneration (section
162(m) and the regulations thereunder (§§
1.162-27, 1.162-31, and 1.162-33));
* * * * *
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: December 11, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on De-
cember 18, 2020, 8:45 a.m., and published in the is-
sue of the Federal Register for December 30, 2020,
85 F.R. 86481)
26 CFR 1.274-13 Disallowance of deductions for
certain qualified transportation fringe expenditures;
26 CFR 1.274-14 Disallowance of deductions
for certain transportation and commuting benefit
expenditures
T.D. 9939
DEPARTMENT OF
TREASURY
Internal Revenue Service
26 CFR Part 1
Qualified Transportation
Fringe, Transportation
and Commuting Expenses
under Section 274
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final Regulations.
SUMMARY: This document contains fi-
nal regulations to implement legislative
changes to section 274 of the Internal
Revenue Code (Code) effective for tax-
able years beginning after December 31,
2017. Specifically, the final regulations
address the elimination of the deduction
under section 274 for expenses related
to certain transportation and commuting
benefits provided by employers to their
employees. The final regulations pro-

Bulletin No. 2021–3 377 January 19, 2021
vide guidance to determine the amount
of such expenses that is nondeductible
and apply certain exceptions under sec-
tion 274(e) that may allow such expenses
to be deductible. These final regulations
affect taxpayers who pay or incur such
expenses.
DATES: Effective Date: These regula-
tions are effective on December 16, 2020.
Applicability Date: These regulations ap-
ply to taxable years beginning on or af-
ter December 16, 2020. Notwithstanding
the preceding sentence, taxpayers may
choose to apply §1.274-13(b)(14)(ii) to
taxable years ending after December 31,
2019.
FOR FURTHER INFORMATION
CONTACT: Patrick Clinton of the Office
of Associate Chief Counsel (Income Tax
and Accounting), (202) 317-7005 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains final regula-
tions under section 274 of the Code that
amend the Income Tax Regulations (26
CFR part 1). In general, section 274 limits
or disallows deductions for certain expen-
ditures that otherwise would be allowable
under chapter 1 of the Code (chapter 1),
primarily under section 162(a), which al-
lows a deduction for ordinary and neces-
sary expenses paid or incurred during the
taxable year in carrying on any trade or
business.
On December 22, 2017, section 274
was amended by section 13304 of Public
Law 115-97 (131 Stat. 2054), commonly
referred to as the Tax Cuts and Jobs Act
(TCJA), to disallow a deduction for the
expense of any qualified transportation
fringe (QTF) as defined in section 132(f)
provided to an employee of the taxpayer,
effective for amounts paid or incurred af-
ter December 31, 2017.
The TCJA also added section 274(l),
which provides that no deduction is al-
lowed under chapter 1 for any expense
incurred for providing any transportation,
or any payment or reimbursement, to an
employee of the taxpayer in connection
with travel between the employee’s res-
idence and place of employment, except
as necessary for ensuring the safety of the
employee, effective for transportation and
commuting expenses paid or incurred af-
ter December 31, 2017.
On December 24, 2018, the Department
of the Treasury (Treasury Department)
and the IRS published Notice 2018-99,
2018-52 I.R.B. 1067, “Parking Expens-
es for Qualified Transportation Fringes
under § 274(a)(4) and § 512(a)(7) of the
Internal Revenue Code.” Notice 2018-99,
in part, provided interim guidance for tax-
payers to determine the amount of parking
expenses for QTFs that is nondeductible
under section 274(a)(4).
On June 23, 2020, the Treasury De-
partment and the IRS published a notice
of proposed rulemaking (REG-119307-
19) in the Federal Register (85 FR
37599) containing proposed regulations
under section 274 (proposed regulations)
to implement the TCJA’s amendments to
section 274. The proposed regulations
would add a new section at §1.274-13 to
address parking and other QTF expenses
under section 274(a)(4), including the ap-
plication of certain exceptions in section
274(e) to QTF expenses. The proposed
regulations also would add a new section
at §1.274-14 to address transportation
and commuting expenses under section
274(l).
Pending the issuance of these final reg-
ulations, taxpayers were allowed to rely
on the proposed regulations or the guid-
ance provided in Notice 2018-99 for park-
ing expenses, other QTF expenses, and
transportation and commuting expenses,
as applicable, paid or incurred in taxable
years beginning after December 31, 2017.
The Treasury Department and the IRS
received one request to speak at a public
hearing that was later withdrawn. There-
fore, no public hearing was held. The Trea-
sury Department and the IRS received 12
written and electronic comments respond-
ing to the proposed regulations. All com-
ments were considered and are available
at https://www.regulations.gov or upon
request. The comments addressing the
proposed regulations are summarized in
the Summary of Comments and Explana-
tion of Revisions section. However, com-
ments recommending statutory revisions
or addressing issues outside the scope of
these final regulations are not discussed in
this preamble.
After full consideration of the com-
ments received on the proposed regula-
tions, this Treasury decision adopts the
proposed regulations with modifications
in response to certain comments, as de-
scribed in the Summary of Comments and
Explanation of Revisions section.
Summary of Comments and
Explanation of Revisions
1. Qualified Transportation Fringes
A. In General
Section 274(a)(4), as added by the
TCJA, provides that no deduction is al-
lowed under chapter 1 for the expense of
any QTF (as defined in section 132(f)) pro-
vided by taxpayers to their employees for
expenses paid or incurred after December
31, 2017. Section 132 generally excludes
from employees’ gross income the value
of certain fringe benefits. Section 132(a)
(5) generally provides that gross income
does not include any fringe benefit that
qualifies as a QTF under section 132(f).
QTFs are defined in section 132(f)(1) to
mean any of the following provided by an
employer to an employee: (1) transporta-
tion in a commuter highway vehicle be-
tween the employee’s residence and place
of employment, (2) any transit pass, (3)
qualified parking, and (4) any qualified bi-
cycle commuting reimbursement. Section
132(f)(5)(A), (B), (C), and (F)(i) define
transit pass, commuter highway vehicle,
qualified parking, and qualified bicycle
commuting reimbursement, respective-
ly. Section 132(f)(2) provides that the
amount of QTFs provided by an employ-
er to any employee that can be excluded
from gross income under section 132(a)
(5) cannot exceed a maximum monthly
dollar amount, adjusted for inflation. The
adjusted maximum monthly excludable
amount for 2020 is $270.
The proposed regulations restated
the statutory rules under section 274(a)
(4), defined relevant terms, and provid-
ed a general rule and three simplified
methodologies to determine the amount
of nondeductible parking expenses when
a parking facility is owned or leased by
the taxpayer. Additionally, the proposed

January 19, 2021 378 Bulletin No. 2021–3
regulations included rules addressing
the deduction disallowance for expenses
related to providing employees transpor-
tation in a commuter highway vehicle
and transit pass QTFs. Finally, the pro-
posed regulations applied the applicable
exceptions in section 274(e) to all QTF
expenses.
Specifically, the proposed regulations
provided that if the taxpayer pays a third
party for its employee’s QTF, the sec-
tion 274(a)(4) disallowance is generally
calculated as the taxpayer’s total annual
cost of the QTF paid to the third party.
With regard to QTF parking expenses,
the proposed regulations provided that
if the taxpayer owns or leases all or a
portion of one or more parking facili-
ties, the section 274(a)(4) disallowance
may be calculated using a general rule or
any one of three simplified methodolo-
gies. The proposed regulations provided
taxpayers the option to apply the gener-
al rule or a simplified methodology for
each taxable year and for each parking
facility. The proposed regulations in-
cluded special rules and definitions for
allocating certain mixed parking expens-
es, aggregating parking spaces by geo-
graphic location, removing inventory/
unusable spaces from available parking
spaces, defining general public for multi-
tenant building parking facilities, disre-
garding five or fewer reserved parking
spaces if the reserved spaces are 5 per-
cent or less of total parking spaces, and
determining employee use of parking on
a typical business day. The preamble to
the proposed regulations provided that
taxpayers may use statistical sampling
with the general rule or simplified meth-
odologies if they follow the procedures
in Rev. Proc. 2011-42, 2011-37 I.R.B.
318, as corrected by Ann. 2013-46,
2013-48 I.R.B. 593.
The general rule in the proposed reg-
ulations allowed taxpayers to calculate
the disallowance based on a reasonable
interpretation of section 274(a)(4). How-
ever, the proposed regulations required
taxpayers to use the expense paid or in-
curred in providing a QTF and not its val-
ue to an employee, allocate parking ex-
penses to reserved employee spaces, and
properly apply the exception for parking
made available to the general public. The
proposed regulations allowed a special
rule for aggregating parking spaces by
geographic location to be used with the
general rule.
The proposed regulations also included
three simplified methodologies as alter-
natives to the general rule. Under the first
simplified methodology, the “qualified
parking limit methodology,” taxpayers
calculate the disallowance by multiply-
ing the total number of spaces used by
employees during the peak demand peri-
od, or, alternatively, the total number of
the taxpayer’s employees, by the section
132(f)(2) monthly per employee limita-
tion on exclusion for qualified parking
($270 for 2020), for each month in the
taxable year.
The second simplified methodology,
the “primary use methodology,” is largely
based on the method deemed reasonable
in Notice 2018-99, modified in response
to comments received on the Notice. The
proposed regulations permitted the use of
special rules for allocating certain mixed
parking expenses and aggregating park-
ing spaces by geographic location. The
proposed regulations also provided defini-
tions for employee, general public, park-
ing facility, total parking spaces, reserved
employee spaces, reserved nonemployee
spaces, primary use, and total parking ex-
penses, geographic location, inventory/
unusable spaces, available parking spaces,
peak demand period, and mixed parking
expense.
The third simplified methodology pro-
vided in the proposed regulations is the
“cost per space methodology,” which al-
lows taxpayers to calculate the disallow-
ance by multiplying the cost per parking
space by the number of available parking
spaces used by employees during the peak
demand period. The proposed regulations
provided that cost per space is calculated
by dividing total parking expenses (in-
cluding expenses for inventory/unusable
spaces) by total parking spaces (including
inventory/unusable spaces). The proposed
regulations also permitted special rules for
allocating certain mixed parking expenses
and aggregating parking spaces by geo-
graphic location to be used with the cost
per space methodology.
Finally, the proposed regulations pro-
vided that the deduction disallowance
under section 274(a)(4) does not apply
to expenditures for QTFs that meet the
requirements of section 274(e)(2), (7), or
(8), the three exceptions in section 274(e)
that are relevant for QTFs. Pursuant to
section 274(e)(2), the proposed regula-
tions provided that the disallowance under
section 274(a) does not apply to expendi-
tures for QTFs to the extent the taxpayer
properly treats the expenses as compen-
sation to the employee on the taxpayer’s
Federal income tax return as originally
filed, and as wages to the employee for
purposes of withholding under chapter 24
of the Code (chapter 24) relating to col-
lection of Federal income tax at source on
wages. The proposed regulations also pro-
vided, in accordance with section 274(e)
(7), that any taxpayer expense for trans-
portation in a commuter highway vehicle,
a transit pass, or parking that otherwise
qualifies as a QTF under section 132(f)
(1) is not subject to the deduction disal-
lowance under section 274(a) to the extent
such transportation, transit pass, or park-
ing is made available to the general pub-
lic. Finally, consistent with section 274(e)
(8), the proposed regulations provided that
any taxpayer expense for transportation
in a commuter highway vehicle, a transit
pass, or parking that otherwise qualifies as
a QTF under section 132(f)(1) that is sold
to customers in a bona fide transaction
for an adequate and full consideration in
money or money’s worth is not subject to
the deduction disallowance under section
274(a).
The final regulations substantially
adopt the proposed regulations, with cer-
tain modifications and clarifications, as
discussed in this Summary of Comments
and Explanation of Revisions. In applying
the final regulations, taxpayers may con-
tinue to use statistical sampling with the
general rule or simplified methodologies
if they follow the procedures in Rev. Proc.
2011-42, 2011-37 I.R.B. 318, as corrected
by Ann. 2013-46, 2013-48 I.R.B. 593.
B. Definitions
As described in this part 1.B., the final
regulations generally include the defi-
nitions from the proposed regulations,
modified and clarified in response to com-
ments.

Bulletin No. 2021–3 379 January 19, 2021
i. Qualified Transportation Fringe
The final regulations adopt the pro-
posed regulations’ definition for the term
“qualified transportation fringe.” The
definition is based on section 132(f)(1),
except that it does not include qualified
bicycle commuting reimbursements. Al-
though section 132(f)(1) includes quali-
fied bicycle commuting reimbursements
as a QTF, section 132(f)(8) provides that
the inclusion of qualified bicycle com-
muting reimbursements in the definition
of a QTF is suspended for taxable years
beginning after December 31, 2017, and
before January 1, 2026. Accordingly,
for such taxable years, qualified bicycle
commuting reimbursements are not ex-
cluded from an employee’s income as
a QTF. Because qualified bicycle com-
muting reimbursements are not QTFs,
deductions for qualified bicycle commut-
ing reimbursements are not disallowed
under section 274(a)(4) for taxable years
beginning after December 31, 2017 and
before January 1, 2026. Thus, the final
regulations provide that the term “qual-
ified transportation fringe” means any of
the following provided by an employer
to an employee: (1) transportation in a
commuter highway vehicle if such trans-
portation is in connection with travel be-
tween the employee’s residence and place
of employment (as described in section
132(f)(1)(A) and (f)(5)(B)), (2) any tran-
sit pass (as described in section 132(f)(1)
(B) and (f)(5)(A)), or (3) qualified park-
ing (as described in section 132(f)(1)(C)
and (f)(5)(C)).
Under section 132(f)(1)(C) and (f)
(5)(C), the term “qualified parking” in-
cludes parking provided by an employer
to an employee on or near the business
premises of the employer. A commenter
requested that the final regulations define
“parking provided to an employee” to
include only parking spaces that are re-
served or otherwise set aside exclusively
for employee use. The Treasury Depart-
ment and the IRS decline to adopt this
suggestion. Section 1.132-9, Q/A-4(d)
provides that parking is provided by an
employer to an employee if the parking
is on property that the employer owns or
leases, the employer pays for the parking,
or the employer reimburses the employee
for parking expense. Thus, the definition
of qualified parking as a QTF under sec-
tion 132(f) is not limited to parking that
is reserved or otherwise set aside exclu-
sively for employee use.
Another commenter suggested that
parking with no objective value to an
employee, such as parking in industri-
al, remote, or rural areas (that is, areas
where the general public would not pay
to park) is not a QTF and therefore, that
section 274(a)(4) should not disallow the
deduction of the expenses. The Treasury
Department and the IRS note that there is
nothing in section 132 or §1.132-9 that
supports the proposition that the value
of parking to an employee is relevant in
determining whether the parking itself
constitutes qualified parking and a QTF.
Thus, the Treasury Department and the
IRS do not agree with the commenter
that qualified parking with no objective
value to an employee is not a QTF. How-
ever, see part 1.E.iii. of this Summary of
Comments and Explanation of Revisions
section for a discussion of the applica-
bility of the section 274(e)(8) exception
to parking with no objective value to an
employee.
ii. Employee
The proposed regulations defined the
term “employee” based on definitions in
§§1.132-1(b)(2)(i) and 1.132-9(b), Q/A-
5 and Q/A-24. The term “employee” for
Federal tax purposes generally is under-
stood to refer to a common-law employ-
ee. Whether a service provider is a com-
mon-law employee generally turns on
whether the service recipient has the right
to direct and control the service provider,
not only as to the result to be accomplished
by the work but also as to the details and
means by which that result is accom-
plished. See, e.g., §31.3121(d)-1(c)(2) of
the Employment Taxes and Collection of
Income Tax at Source Regulations. The
determination does not depend on wheth-
er or how the individual is compensated,
or by which person. The regulations under
section 132 also include certain statutory
employees such as officers of corporations
in the definition of employee for purpos-
es of QTFs. No comments were received
on the proposed definition of “employee”.
Thus, the final regulations adopt this defi-
nition without modification.
iii. General Public
Commenters on Notice 2018-99 raised
concerns that, for taxpayers that lease
space in a multi-tenant building, the No-
tice did not include employees, partners,
2-percent shareholders of S corporations
(as defined in section 1372(b)), indepen-
dent contractors, clients, or customers of
unrelated tenants in the building as mem-
bers of the general public. In response to
these comments, the proposed regulations
provided that “general public” includes
employees, partners, 2-percent sharehold-
ers of S corporations (as defined in section
1372(b)), sole proprietors, independent
contractors, clients, or customers of unre-
lated tenants in multi-tenant buildings, as
well as customers, clients, or visitors of
the taxpayer, individuals delivering goods
or services to the taxpayer, students of an
educational institution, and patients of a
health care facility.
A commenter on the proposed regula-
tions raised concerns that the definition of
the term “general public” in the proposed
regulations gives tenants of multi-tenant
buildings an unfair advantage in compar-
ison to tenants in buildings with only one
tenant and suggested all tenants be treated
the same. The Treasury Department and
the IRS decline to adopt this suggestion
because any alternative would likely im-
pose an undue administrative burden on
taxpayers in a multi-tenant building to de-
termine the use of the parking facility by
numerous other tenants.
A commenter also asked why taxpayers
that own or lease space in a multi-tenant
building may include independent contrac-
tors in the definition of general public. The
Treasury Department and the IRS note that
the proposed regulations defined general
public to include independent contractors
of unrelated taxpayers in a multi-tenant
building because unlike independent con-
tractors of the taxpayer, independent con-
tractors of unrelated tenants do not have
a relationship with the taxpayer. The final
regulations continue to provide that inde-
pendent contractors of unrelated tenants
in multi-tenant buildings are included in
the general public. However, independent
contractors of the taxpayer continue to be
excluded from the general public regard-
less of whether the taxpayer owns or leases
space in a multi-tenant building.

January 19, 2021 380 Bulletin No. 2021–3
A commenter requested that a car
dealership’s parking spaces occupied by
customers’ vehicles being repaired or
serviced be excluded from the definition
of inventory/unusable spaces and instead
be included in the definition of spaces
available to the general public because
the parking spaces are used by customers
and are not available for employee park-
ing. The Treasury Department and the
IRS agree with the commenter and have
revised the definition of general public in
the final regulations accordingly. Thus,
the final regulations follow the definition
of the term general public as provided in
the proposed regulations with the clarifi-
cation that parking spaces that are used to
park vehicles owned by members of the
general public while the vehicles await
repair or service by the taxpayer also are
treated as provided to the general public.
iv. Parking Facility
The final regulations include a defi-
nition of the term “parking facility” that
follows the definition of qualified parking
in section 132(f)(5)(C) and includes one
or more indoor or outdoor garages and
other structures, as well as parking lots
and other areas where employees may
park. Commenters on Notice 2018-99
suggested that because qualified parking
as defined in section 132(f)(5)(C) and
§1.132-9(b), Q/A-4(c) does not include
any parking on or near property used by
the employee for residential purposes, in-
cluding parking for resident employees of
residential rental buildings, the definition
of “total parking spaces” in the proposed
regulations should exclude such spaces. In
response to these comments, the proposed
regulations specifically excluded parking
spaces on or near property used by the
employee for residential purposes from
the definition of parking facility. The final
regulations adopt this definition, without
modification.
v. Geographic Location
Consistent with the proposed regula-
tions, the final regulations allow the tax-
payer to aggregate the number of parking
spaces in a single geographic location to
determine the section 274(a)(4) disallow-
ance using the general rule, primary use
methodology, or cost per space methodol-
ogy.
The proposed regulations defined the
term “geographic location” as contig-
uous tracts or parcels of land owned or
leased by the taxpayer. Two or more tracts
or parcels of land are contiguous if they
share common boundaries or would share
common boundaries but for the interposi-
tion of a road, street, railroad, stream, or
similar property. Tracts or parcels of land
which touch only at a common corner are
not contiguous.
A commenter suggested that the defi-
nition of geographic location be expanded
to allow parking lots located within rea-
sonable distance (1/4 mile) of a principal
parking lot to be aggregated as part of a
single geographic location. The comment-
er explained that automotive dealers often
have overflow parking lots not designated
for any purpose available relatively close
to the business location in the event the in-
ventory levels exceed the spaces available
at the principal location.
The Treasury Department and the IRS
considered this comment and decline
to adopt it because the term “reasonable
distance” is difficult to define and, as the
commenter explained, overflow parking
facilities are typically utilized for excess
inventory vehicles, instead of parking for
the general public. The Treasury Depart-
ment and the IRS believe that expanding
the definition of geographic location to
include noncontiguous tracts or parcels of
land would introduce unnecessary com-
plexity without providing a meaningful
benefit to taxpayers. Thus, the final reg-
ulations adopt the proposed regulations’
definition of geographic location, without
modification.
vi. Total Parking Spaces
The proposed regulations defined the
term “total parking spaces” as the total
number of parking spaces, or the taxpay-
er’s portion thereof, in the parking facility.
No comments were received on this defi-
nition, and the final regulations adopt it
without modification.
vii. Reserved Employee Spaces
A commenter on Notice 2018-99 rec-
ommended that the definition of the term
“reserved employee spaces” be limited to
parking spaces actually used by employ-
ees on a typical business day. Because
section 274(a)(4) disallows the deduction
for the expense of providing a QTF to an
individual employee, the commenter rea-
soned that the taxpayer should identify the
expense for each QTF provided to each in-
dividual employee when determining the
amount that is disallowed.
After considering the comment, the
Treasury Department and the IRS, in the
proposed regulations, provided that costs
allocated to reserved employee spaces
would be disallowed regardless of actual
use of the reserved spaces. However, the
proposed regulations also included a spe-
cial rule in step 1 of the primary use meth-
odology providing that there is no disal-
lowance for reserved employee spaces if
the primary use of the available parking
spaces is to provide parking to the general
public, there are five or fewer reserved em-
ployee spaces, and the number of reserved
employee spaces is 5 percent or less of the
total parking spaces in the parking facility.
The final regulations adopt the disallow-
ance of costs allocated to reserved em-
ployee spaces and the special rule in step 1
of the primary use methodology provided
in the proposed regulations, without mod-
ification.
viii. Reserved Nonemployee Spaces
A commenter on Notice 2018-99 sug-
gested that parking spaces reserved for
drivers with disabilities be treated as “re-
served nonemployee spaces” and thus,
any related expenses not be disallowed
under section 274(a)(4). After consider-
ing the comment, the Treasury Depart-
ment and the IRS declined to include
parking spaces reserved for drivers with
disabilities from the definition of reserved
nonemployee spaces in the proposed reg-
ulations. The Treasury Department and
the IRS reasoned that unlike parking
spaces reserved for customers or visitors,
parking spaces reserved for drivers with
disabilities may be used by employees
(with disabilities), and section 274(a)
(4) would then apply to disallow the
expense. The proposed regulations also
did not include parking spaces reserved
for drivers with disabilities in “reserved
employee spaces” because they may or

Bulletin No. 2021–3 381 January 19, 2021
may not be exclusively reserved for em-
ployees. The final regulations adopt the
proposed regulations’ definitions of re-
served nonemployee spaces and reserved
employee spaces, without modification.
ix. Inventory/Unusable Spaces
The Treasury Department and the IRS
received questions and comments in re-
sponse to Notice 2018-99 on how parking
spaces reserved for, or used by, invento-
ried vehicles are to be treated for purposes
of determining the disallowance. For ex-
ample, taxpayers asked whether parking
spaces reserved exclusively for, or used
by, vehicles to be sold or leased to cus-
tomers at a car dealership or car rental
agency are treated as spaces available to
the general public.
In response to the comments and ques-
tions received, the proposed regulations
added a new definition for the term “in-
ventory/unusable spaces” that includes
parking spaces used exclusively for in-
ventoried vehicles, qualified nonpersonal
use vehicles (as described in §1.274-5(k)),
other fleet vehicles used in a taxpayer’s
trade or business, or otherwise not usable
for parking by employees.
A commenter on the proposed regu-
lations suggested that inventory spaces
should be included in the definition of
spaces available to the general public in
cases where inventory spaces may at times
be used by customers and are not avail-
able for employee parking. The Treasury
Department and the IRS note that spaces
used by customers should not be included
in inventory/unusable spaces. Therefore,
the final regulations adopt the definition
of “inventory/unusable spaces” included
in the proposed regulations, with the clar-
ification that inventory/unusable spaces
are otherwise not usable for parking by
the general public.
Inventory/unusable spaces are specif-
ically excluded from the definitions of
“available parking spaces,” discussed
later, and “reserved nonemployee spac-
es,” discussed earlier, under the primary
use methodology and primary use test in
the final regulations. The final regula-
tions exclude inventory/unusable spaces
because those spaces are not available
to employees or the general public but
are instead used exclusively for other
purposes. Inventory/unusable spaces are
included in total parking spaces under
the cost per space methodology because
taxpayers do incur costs in maintaining
the spaces.
A commenter on the proposed regula-
tions requested that a safe harbor be added
to the final regulations to determine the
number of inventory spaces at a car deal-
ership because of extreme fluctuations of
inventory over a car dealer’s tax year. The
commenter suggested that the safe harbor
should be based on an annualization of the
number of spaces occupied by inventory
vehicles at the end of the month during
the tax year with lowest inventory, or al-
ternatively, based on the average number
of spaces occupied by inventory vehicles
at the end of each month. The comment-
er further suggested that inventory per
month should be determined based on in-
ventory levels a car dealer reports to the
vehicle manufacturer on monthly financial
reporting.
The Treasury Department and the IRS
note that the proposed regulations did
not specifically describe how taxpayers
should determine the number of invento-
ry/unusable spaces in the parking facility.
Thus, the Treasury Department and the
IRS have added a rule in these final reg-
ulations providing that taxpayers may use
any reasonable methodology to determine
the number of inventory/unusable spac-
es in the parking facility. In addition, in
response to the commenter’s alternative
suggestion, the final regulations provide
that a reasonable methodology may in-
clude using the average of monthly inven-
tory counts.
x. Available Parking Spaces
The proposed regulations included a
definition of “available parking spaces” to
clarify that reserved employee spaces and
inventory/unusable spaces are not includ-
ed in determining primary use under the
primary use methodology. No comments
were received on this definition, and the
final regulations adopt it without modifi-
cation.
xi. Primary Use
The proposed regulations provided
that for purposes of the primary use test
of the primary use methodology, “prima-
ry use” means greater than 50 percent of
actual or estimated usage of the parking
spaces in the parking facility by the gen-
eral public. A commenter on the proposed
regulations suggested that the final reg-
ulations provide that primary use should
mean 30 percent or greater for healthcare
facilities, including skilled nursing and as-
sisted living healthcare facilities, because
the employees at these types of healthcare
businesses provide essential and life-sav-
ing care services to the public, especially
during the ongoing Coronavirus Disease
(COVID-19) pandemic.
After considering this comment, the
Treasury Department and the IRS have
decided to retain the primary use test as
described in the proposed regulations. The
Treasury Department and the IRS contin-
ue to believe that this primary use test is
a reasonable interpretation of the excep-
tion in section 274(e)(7) for parking made
available to the general public. Further,
this interpretation is consistent with recent
final regulations addressing the applica-
tion of the section 274(e)(7) exception to
the limitation on the deduction for meals
and entertainment expenses, which apply
the section 274(e)(7) exception to food
and beverages “primarily consumed” by
the general public, meaning greater than
50 percent of actual or reasonably esti-
mated consumption. See TD 9925, 85 FR
64026 (October 9, 2020).
The Treasury Department and the
IRS understand that the primary use of
a parking facility could be affected by
a federally declared disaster such as the
COVID-19 pandemic. Thus, as discussed
in part 1.B.xiv. of this Summary of Com-
ments and Explanation of Revisions
section, the final regulations modify the
definition of “peak demand period” to
provide flexibility for taxpayers affected
by a federally declared disaster to deter-
mine the primary use of parking spaces
used by employees during the peak de-
mand period.
xii. Total Parking Expenses
Commenters on Notice 2018-99 sug-
gested that safety-related expenses, such
as lighting, snow and ice removal, leaf re-
moval, trash removal, cleaning, and secu-
rity, should be excluded from the definition

January 19, 2021 382 Bulletin No. 2021–3
of “total parking expenses.” Commenters
reasoned that including the expenses may
encourage unsafe parking conditions and
neglect of care in maintaining the parking
facilities. Commenters on the Notice also
requested the removal of indirect costs,
such as utility costs, insurance, property
taxes, snow and ice removal, leaf remov-
al, trash removal, cleaning, parking lot
attendant expenses, and security. Multiple
commenters on the Notice also suggested
adding depreciation to total parking ex-
penses, reasoning that these are costs of
parking facilities.
After considering the comments re-
ceived, the Treasury Department and the
IRS determined that the proposed regu-
lations should include the definition of
the term “total parking expenses” from
Notice 2018-99, and the final regula-
tions adopt this definition without mod-
ification. Section 274(a)(4) disallows a
deduction for the expense of providing
a QTF, without regard to whether the
expense is required for safety reasons.
Further, QTF parking expenses include
indirect costs such as allocable salaries
for security and maintenance personnel,
property taxes, repairs and maintenance,
etc. See Joint Committee on Taxation,
General Explanation of Public Law 115-
97 (JCS-1-18), at 190, December 2018.
However, a deduction for an allowance
for depreciation is not included in total
parking expenses because it is an allow-
ance for the exhaustion, wear and tear,
and obsolescence of property, and not a
parking expense.
xiii. Mixed Parking Expense
Numerous commenters on Notice
2018-99 expressed concerns and asked
questions about how to determine the
amount of expenses allocable to a park-
ing facility if the invoice does not sepa-
rate parking facility expenses from non-
parking facility expenses. Commenters
explained that determining and allocating
expenses may impose excessive and un-
duly burdensome recordkeeping require-
ments on taxpayers and may be difficult
for taxpayers and the IRS to administer.
Commenters noted that such expenses
for parking and nonparking property may
include rent or lease payments, repairs,
maintenance, utility costs, insurance,
property taxes, interest, snow or ice re-
moval, and security. In response to the
comments, the Treasury Department and
the IRS included in the proposed regu-
lations a definition for the term “mixed
parking expense” and a special rule for
allocating certain mixed parking expens-
es. The proposed regulations defined
“mixed parking expense” as an amount
paid or incurred by a taxpayer for both
a parking facility and nonparking facility
property that a taxpayer owns or leases.
The proposed regulations provided that
mixed parking expenses may be allocat-
ed using any reasonable methodology
but provided a special rule for allocating
certain mixed costs that taxpayers could
chose to apply in conjunction with cer-
tain of the methodologies for determin-
ing disallowed parking expenses.
The final regulations adopt the defini-
tion of “mixed parking expenses” includ-
ed in the proposed regulations, as well as
the rule allowing the use of any reasonable
methodology to allocate mixed parking
expenses. However, the final regulations
make certain modifications to the allow-
ance of the special rule in the proposed
regulations for allocating certain mixed
parking expenses. The special rule for al-
locating certain mixed parking expenses
to a parking facility and the modifications
made in the final regulations is explained
in part 1.C of this Summary of Comments
and Explanation of Revisions section.
A commenter on the proposed regu-
lations suggested using property tax as-
sessments and/or acreage to determine the
amount of mixed parking expenses alloca-
ble to a parking facility. The Treasury De-
partment and the IRS note that taxpayers
may use any reasonable methodology to
allocate mixed parking expenses. Howev-
er, the Treasury Department and the IRS
decline to adopt a specific methodology as
reasonable for this purpose. The Treasury
Department and the IRS further note that
the methodology must be reasonable for
the expense being allocated. Thus, one
methodology for multiple expenses may
be used only if the methodology is reason-
able for all such expenses.
xiv. Peak Demand Period
In the proposed regulations, several
of the methodologies for determining the
section 274(a)(4) disallowance for parking
facilities require the taxpayer to determine
the total number of parking spaces used
by employees during the peak demand
period for employee parking on a typical
business day. The proposed regulations
provided that for purposes of §1.274-13,
the term “peak demand period” means
the period of time on a typical business
day when the greatest number of the tax-
payer’s employees are utilizing parking
spaces in the taxpayer’s parking facility.
If a taxpayer’s employees work in shifts,
the peak demand period would take into
account the shift during which the larg-
est number of employees park in the tax-
payer’s parking facility. However, a brief
transition period during which two shifts
overlap in their use of parking spaces, as
one shift of employees is getting ready
to leave and the next shift is reporting to
work, may be disregarded.
A commenter on the proposed regula-
tions explained that it is overly burden-
some for taxpayers at healthcare facilities
to determine how many employees are
at each location 24 hours a day, 7 days a
week and instead suggested using an aver-
age based on the primary location of each
employee and the amount of time each
employee typically works each week.
The Treasury Department and the IRS
considered the comment and have deter-
mined that the proposed rules regarding
“peak demand period” should be adopted
in the final regulations, subject to an op-
tional rule for parking facilities located in
a federally declared disaster area as dis-
cussed later in this part 1.B.xiv. of this
Summary of Comments and Explanation
of Revisions section. However, the Trea-
sury Department and the IRS note that the
definition of peak demand period allows
for flexibility based on taxpayer facts and
circumstances by allowing taxpayers to
choose a typical business day during the
taxable year and to use any reasonable
methodology to determine the total num-
ber of spaces used by employees. For ex-
ample, a taxpayer may determine the to-
tal number of spaces used by employees
based on periodic inspections or employee
surveys.
The ongoing COVID-19 pandemic
highlights that taxpayers may experience
significant variations in employee parking
during the taxable year due to a national

Bulletin No. 2021–3 383 January 19, 2021
emergency or other type of disaster. In the
preamble to the proposed regulations, the
Treasury Department and the IRS request-
ed comments on what additional rules,
if any, are needed to address significant
variations in employee parking during the
taxable year due to the COVID-19 pan-
demic. One commenter suggested that the
final regulations allow for a COVID-19
exception for employees not working at
the workplace location and thus not using
employee parking during the period of the
COVID-19 pandemic. Specifically, the
commenter requested that taxpayers be
permitted to calculate their disallowance
under one of the simplified methodologies
in §1.274-13(d)(2), and then reduce their
disallowance by a certain amount based
on the taxpayer’s “COVID relief peri-
od” and the reduction in their workforce
during that period.
Although the commenter’s example
would not be permitted under any of the
simplified methodologies in the proposed
or final regulations because taxpayers
must use one methodology for the entire
year, taxpayers may achieve a similar
result using any reasonable method un-
der the general rule. Taxpayers also may
achieve a similar result by using a month-
ly computation method such as the quali-
fied parking limit methodology or the cost
per space methodology. A taxpayer using
the cost per space methodology generally
computes the cost per space and multi-
plies it by the number of spaces used by
employees during the peak demand pe-
riod. Although the proposed regulations
did not specify whether the cost per space
must be based on one peak demand period
in the taxable year, these final regulations
clarify that the cost per space calculation
may be performed on a monthly basis.
A taxpayer using the primary use meth-
odology would be allowed a full deduction
for parking expenses (except for expenses
related to reserved employee spaces) if the
primary use of the parking facility during
the peak demand period is for the general
public. The proposed regulations defined
“peak demand period” as the period of
time on a typical business day when the
greatest number of the taxpayer’s em-
ployees are utilizing parking spaces in the
taxpayer’s parking facility. As discussed
previously in this part 1.B.xiv. of this
Summary of Comments and Explanation
of Revisions section, the final regulations
retain this general definition. However, to
provide relief to taxpayers affected by the
COVID-19 pandemic or other federally
declared disasters, the final regulations
add an optional rule in the definition of
“peak demand period” for taxpayers who
own or lease a parking facility that is lo-
cated in a federally declared disaster area,
as defined in section 165(i)(5). A taxpayer
that uses this rule may identify a typical
business day for the taxable year in which
the disaster occurred by reference to a
typical business day in that taxable year
prior to the date that the taxpayer’s oper-
ations were impacted by the federally de-
clared disaster. For example, a restaurant
that transitioned from a dine-in restaurant
to take-out service due to the COVID-19
pandemic could determine its parking
disallowance under the primary use test
based on the usage of parking on a typical
business day prior to its transition to take-
out service. Alternatively, under this rule,
a taxpayer may choose to identify a typ-
ical business day for the month(s) of the
taxable year in which the disaster occurred
by reference to a typical business day in
the same month(s) of the taxable year
immediately preceding the taxable year
in which the disaster first occurred. For
purposes of this rule, the taxable year in
which the disaster occurred is determined
without regard to whether the taxpayer
makes an election under section 165(i). In
order to allow taxpayers affected by the
COVID-19 pandemic to benefit from this
rule, the final regulations allow a taxpayer
to apply this rule to taxable years ending
after December 31, 2019. This rule is in-
tended to provide relief to both calendar
and fiscal year taxpayers, as well as tax-
payers with a seasonal business, that are
affected by a federally declared disaster.
C. Optional Rules for QTF Parking
Expenses
The proposed regulations included a
special rule for allocating certain mixed
parking expenses to reduce administra-
tive burdens for taxpayers and simplify
calculations in complying with section
274(a)(4). Specifically, the proposed reg-
ulations provided that a taxpayer may
choose to allocate 5 percent of certain
mixed parking expenses to the park-
ing facility. This special rule applies to
mixed parking expenses related to pay-
ments under a lease or rental agreement,
and payments for utilities, insurance, in-
terest and property taxes. However, the
proposed regulations provided that the
special rule for allocating certain mixed
parking expenses may only be used in
applying the primary use methodology
and cost per space methodology and may
not be used in applying the general rule
or the qualified parking limit methodol-
ogy. The proposed regulations did not
require taxpayers to use the special rule
for allocating certain mixed parking ex-
penses and provided that taxpayers may
instead use any reasonable methodology
for mixed parking expenses.
A commenter on the proposed regula-
tions requested that the final regulations
allow taxpayers to use this special rule
for applicable mixed parking expenses
when using the general rule to calculate
the disallowance of deductions for QTFs
based on a reasonable interpretation of
section 274(a)(4). In response to the com-
menter’s request, these final regulations
have extended the 5 percent optional
rule for allocating certain mixed parking
expenses to the general rule as a further
attempt to reduce administrative burdens
for taxpayers and to simplify calculations
in complying with section 274(a)(4). The
optional rule for allocating certain mixed
parking expenses in these final regulations
may therefore be used in applying the
general rule, the primary use methodolo-
gy, and the cost per space methodology.
In addition, this optional rule may be used
by taxpayers using the qualified parking
methodology, but solely for the purpose
of determining total parking expenses. As
revised, this optional rule may be used to
determine total parking expenses under
any of the parking methodologies permit-
ted in the proposed and final regulations.
Thus, the final regulations relocate this
rule from §1.274-13(c) to the definition
of total parking expenses in §1.274-13(b)
(12).
A commenter suggested that the
5 percent special rule for allocating
mixed parking expenses be expanded
to include any parking expense that is
not allocated by a service provider to a
parking facility or is not accounted for
separately on the taxpayer’s books, in-

January 19, 2021 384 Bulletin No. 2021–3
cluding expenses for maintenance, snow
and ice removal, landscape costs, secu-
rity, cleaning. The Treasury Department
and the IRS continue to believe that this
optional rule should apply only to mixed
parking expenses related to payments
under a lease or rental agreement, and
payments for utilities, insurance, inter-
est and property taxes, and therefore,
decline to adopt this comment. Howev-
er, the final regulations clarify that a tax-
payer who chooses to apply the 5 percent
optional rule is not required to apply the
rule to allocate all eligible mixed park-
ing expenses. Thus, a taxpayer may
choose to apply the 5 percent optional
rule to allocate one or more of the eligi-
ble mixed parking expenses, while using
a reasonable methodology to allocate re-
maining eligible mixed parking expens-
es. Certain types of expenses, such as
parking facility maintenance, snow and
ice removal, landscape costs, security,
and parking facility cleaning are more
likely to be separately billed and/or pri-
marily allocable to the parking facility.
Taxpayers may, however, continue to
use any reasonable methodology to allo-
cate these mixed parking expenses.
Consistent with the proposed regu-
lations, the final regulations permit tax-
payers using certain methodologies to
aggregate the number of parking spaces
in a single geographic location if they
so choose. The final regulations adopt
the proposed definition of the term “geo-
graphic location,” which is based on
tracts or parcels of land that are contig-
uous. The optional rule for aggregation
of parking spaces in a single geographic
location may be used in applying the gen-
eral rule, primary use methodology, and
cost per space methodology, but may not
be used with the qualified parking limit
methodology. The final regulations clar-
ify that a taxpayer that chooses to apply
this optional aggregation rule must treat
the aggregated parking spaces as one
parking facility for purposes of determin-
ing total parking expenses.
D. Calculation of Disallowance of QTF
Parking Expenses
Like the proposed regulations, the final
regulations provide that if a taxpayer pays
one or more third parties an amount for
its employees’ QTFs, the section 274(a)
(4) disallowance is equal to the taxpay-
er’s total annual cost for the QTFs paid
or incurred to third parties. The Treasury
Department and the IRS determined that
amounts paid to a third party for qualified
parking should be disallowed regardless
of actual employee use of the spaces be-
cause the taxpayer paid or incurred the ex-
pense for its employees’ QTFs regardless
of employee use.
If instead, the taxpayer owns or leas-
es a parking facility, the final regulations
continue to provide that a taxpayer may
use the general rule or choose any of the
following three simplified methodologies
for each parking facility to determine the
section 274(a)(4) disallowance for each
taxable year. The general rule and three
simplified methodologies are substantially
the same as those provided in the proposed
regulations, with the following modifica-
tions based on comments received.
i. General Rule
Consistent with the proposed regula-
tions, under the general rule provided in
the final regulations taxpayers may cal-
culate the disallowance based on a rea-
sonable interpretation of section 274(a)
(4), as long as the taxpayer’s methodol-
ogy does not use the value of a QTF in-
stead of its expense, fail to allocate park-
ing expense to reserved employee spaces,
or improperly apply the exception for
qualified parking made available to the
public (for example, by treating a park-
ing facility regularly used by employees
as available to the public merely because
the public has access to the parking fa-
cility).
In response to the proposed regulations,
a commenter recommended that taxpayers
be permitted to elect to use historic infor-
mation to calculate the current year disal-
lowance to reduce the compliance burden
of annually calculating the disallowance
under section 274(a)(4). For example,
the commenter suggested that the aver-
age disallowed amount for the prior two
years may be used as the disallowance
for the next five years or, alternatively, if
the primary use of the available parking
spaces is to provide parking to the gener-
al public for two out of three years, then
the taxpayer may treat the primary use of
the available parking spaces as providing
parking to the general public for the next
five years. The Treasury Department and
the IRS considered this comment and do
not believe that section 274(a)(4) permits
taxpayers to compute the amount of a
permanently disallowed deduction for a
taxable year based on the amount of the
disallowance in one or more different tax-
able years.
ii. Qualified Parking Limit Methodology
Consistent with the proposed regula-
tions, the final regulations provide that the
maximum monthly dollar amount under
section 132(f)(2), adjusted for inflation,
may be used as a simple estimate of the
taxpayer’s monthly total cost per parking
space. The adjusted maximum monthly
excludable amount for 2020 is $270 per
employee. Taxpayers using the qualified
parking limit methodology may determine
the disallowance simply by multiplying
the section 132(f)(2) monthly per employ-
ee limitation on the exclusion by the to-
tal number of spaces used by employees
during the peak demand period. Alterna-
tively, taxpayers using this methodology
may instead multiply the section 132(f)
(2) monthly per employee limitation on
the exclusion by the total number of the
taxpayer’s employees.
A commenter recommended the adop-
tion of an alternative monthly rate of $25
per parking space, instead of the maxi-
mum monthly dollar amount under section
132(f)(2), to estimate a taxpayer’s month-
ly total cost per parking space for parking
facilities located outside the city limits of
the 20 most populous cities in the Unit-
ed States. The commenter explained that
this will encourage the use of the qualified
parking limit methodology by manufac-
turers and employers with parking spac-
es in less populous areas. The Treasury
Department and the IRS decline to adopt
this comment because the commenter pro-
vided no evidence that the monthly rate of
$25 per parking space is the appropriate
cost for all parking spaces located outside
the city limits of the 20 most populous cit-
ies in the United States.
Section 274(e)(2) provides that the sec-
tion 274(a)(4) disallowance for QTFs does
not apply to the extent that a QTF is treat-
ed as compensation to an employee on

Bulletin No. 2021–3 385 January 19, 2021
the taxpayer’s return and as wages to the
employee. Under §1.274-13(e)(2)(i) of the
proposed regulations, a taxpayer using this
qualified parking limit methodology who
has monthly expenses per parking space
exceeding the section 132(f)(2) monthly
per employee limitation on the exclusion
could deduct those excess expenses with-
out regard to how much (if any) of the val-
ue of the parking space to the employee
exceeds the section 132(f)(2) monthly per
employee limitation on exclusion. How-
ever, the proposed regulations provided
that the qualified parking limit methodol-
ogy could be used only if the value of the
QTF, to the extent it exceeds the sum of
the amount paid (if any) by the employee
for the QTF and the applicable statutory
monthly limit in section 132(f)(2), is in-
cluded on the taxpayer’s Federal income
tax return as originally filed as compensa-
tion paid to the employee and as wages to
the employee for purposes of withholding
under chapter 24 (relating to collection of
Federal income tax at source on wages).
The final regulations adopt this rule from
the proposed regulations without change.
iii. Primary Use Methodology
The Treasury Department and the IRS
received numerous comments on Notice
2018-99 related to the four-step meth-
od provided in the Notice. The proposed
regulations adopted the four-step method
provided in the Notice, with revisions in
response to comments, and renamed it
the “primary use methodology.” No com-
ments were received on the primary use
methodology included in the proposed
regulations, and the final regulations
adopt the primary use methodology with-
out modification.
iv. Cost Per Space Methodology
The proposed regulations also provid-
ed a cost per space methodology, which
allows taxpayers to calculate the dis-
allowance by multiplying the cost per
space by the number of available park-
ing spaces used by employees. Taxpayers
must identify the number of total parking
spaces used by employees during the peak
demand period. Cost per space is calcu-
lated by dividing total parking expenses
(including expenses related to inventory/
unusable spaces) by total parking spaces
(including inventory/unusable spaces).
In response to the proposed regulations,
a commenter pointed out that a taxpay-
er using the cost per space methodology
calculates the disallowance of deductions
for QTF parking expenses by multiplying
the cost per space by the total number of
“available parking spaces” used by em-
ployees during the peak demand period
rather than the “total parking spaces” used
by employees. The commenter suggest-
ed that “total parking spaces” should be
used instead of “available parking spac-
es” because reserved spaces are excluded
from the definition of “available parking
spaces.” The Treasury Department and
the IRS agree with this suggestion and
modify the cost per space methodology
provided in the proposed regulations by
specifying that “total parking spaces” is
used to calculate the disallowance under
the final regulations. In addition, as dis-
cussed in part 1.B.xiv. of this Summary of
Comments and Explanation of Revisions
section, the final regulations clarify that
the cost per space calculation may be per-
formed on a monthly basis.
v. Expenses for Transportation in a
Commuter Highway Vehicle and Transit
Pass QTFs
Consistent with the proposed regula-
tions, the final regulations include rules
addressing the disallowance of deductions
for expenses for transportation in a com-
muter highway vehicle and transit pass
QTFs, as well as the applicability of cer-
tain exceptions under section 274(e). The
general rules are unchanged from those in
the proposed regulations.
E. Specific Exceptions to Section 274(a)
for QTF Expenses
Section 274(e) provides that the de-
duction disallowance under section 274(a)
does not apply to any expense described
in section 274(e). Consistent with the pro-
posed regulations, the final regulations
provide that the deduction disallowance
does not apply to expenditures for QTFs
that meet the requirements of section
274(e)(2), (7), or (8), which are the three
exceptions in section 274(e) that are rele-
vant for QTFs.
A commenter suggested that the IRS
implement a moratorium on enforce-
ment of the deduction disallowance for
the expense of QTFs during the ongoing
COVID-19 pandemic. In addition, a com-
menter requested that healthcare facilities,
including skilled nursing and assisted
living healthcare facilities, be excepted
from the section 274(a)(4) disallowance
because the employees at these types of
healthcare businesses provide essential
and life-saving care services to the public.
The Treasury Department and the IRS
note that exceptions for QTFs during the
COVID-19 pandemic or for healthcare fa-
cility taxpayers are not provided for in any
of the exceptions under section 274(e) and
therefore are not exceptions to the section
274(a)(4) disallowance that the Treasury
Department and the IRS may allow. How-
ever, as discussed in part 1.B.xiv. of this
Summary of Comments and Explanation
of Revisions section, the Treasury Depart-
ment and the IRS are modifying the defi-
nition of “peak demand period” to provide
additional flexibility for taxpayers affect-
ed by the COVID-19 pandemic or other
federally declared disaster in applying the
methodologies for determining the section
274(a)(4) disallowance for parking facil-
ities.
i. Certain QTF Expenses Treated as
Compensation under Section 274(e)(2)
Section 274(e)(2) provides an excep-
tion to section 274(a) for expenses for
goods, services, and facilities, to the ex-
tent that the expenses are treated by the
taxpayer, with respect to the recipient of
the entertainment, amusement, or rec-
reation, as compensation to its employ-
ees under chapter 1 and as wages to its
employees under chapter 24. Pursuant
to section 274(e)(2), the proposed reg-
ulations provided that the disallowance
under section 274(a) does not apply to
expenditures for QTFs to the extent the
taxpayer properly treats the expenses as
compensation to the employee on the
taxpayer’s Federal income tax return
as originally filed, and as wages to the
employee for purposes of withholding
under chapter 24 relating to collection
of Federal income tax at source on wag-
es. Because section 132(a)(5) excludes
the value of QTFs from an employee’s

January 19, 2021 386 Bulletin No. 2021–3
gross income up to the limitations on
exclusion provided by section 132(f)(2),
the proposed regulations provided that
the exception in section 274(e)(2) does
not apply to expenses paid or incurred
for QTFs the value of which (including
a purported value of zero) is excluded
from an employee’s gross income under
section 132(a)(5). The proposed regula-
tions further provided that section 274(e)
(2) applies to expenses paid or incurred
for QTFs, the value of which exceeds
the sum of the amount, if any, paid by
the employee for the fringe benefits and
any amount excluded from gross income
under section 132(a)(5), if treated as
compensation on the taxpayer’s Federal
income tax return as originally filed and
as wages to the employee for purposes of
withholding under chapter 24.
Section 1.61-21(b)(1) provides rules
for the valuation of fringe benefits and
requires that an employee must include
in gross income the amount by which the
fair market value of the fringe benefit
exceeds the sum of the amount paid for
the benefit by or on behalf of the recip-
ient and the amount, if any, specifically
excluded from gross income under the
Code. Thus, in the case of reimburse-
ments by a recipient, the amount of the
reimbursement is taken into account in
determining the amount properly inclu-
dible in the recipient’s income and does
not affect the taxpayer’s ability to use the
exception in section 274(e)(2).
To prevent taxpayers from inappro-
priately claiming a full deduction under
section 274(e)(2) by including a value that
is less than the amount required to be in-
cluded under §1.61-21, the proposed regu-
lations provided that the exception in sec-
tion 274(e)(2) does not apply to expenses
for QTFs for which the taxpayer calcu-
lates a value that is less than the amount
required to be included in gross income
under §1.61-21.
Commenters on the proposed regu-
lations under section 274 limiting de-
ductions for meals and entertainment
expenses (proposed §§1.274-11 and
1.274-12 (REG-100814-19)) asserted
that a rule disallowing the application of
section 274(e)(2) to expenses for which
an improper amount is included in com-
pensation and wages or in gross income,
as applicable, is unduly harsh given the
difficulty in determining the value of
a fringe benefit under §1.61-21 and the
possibility of good faith errors. See TD
9925, 85 FR 64026, 64031 (October 9,
2020). In addition, a commenter noted
that the “to the extent that” language in
section 274(e)(2)(A) does not support ap-
plying an “all or nothing” rule against the
taxpayer.
The Treasury Department and the
IRS agree that the “all or nothing” rule
in proposed §§ 1.274-13 and 1.274-14
may lead to unduly harsh results. There-
fore, in response to these comments, the
Treasury Department and the IRS have
revised the rules in proposed §1.274-
13(e)(2)(i) to allow a taxpayer to apply
section 274(e)(2) even if the taxpayer
includes less than the proper amount in
compensation and wages as required un-
der §1.61-21. In such a case, however,
the amount of a taxpayer’s deduction is
limited to the amount included in com-
pensation and wages, taking into account
the amount, if any, reimbursed to the tax-
payer by the employee (referred to as the
“dollar-for-dollar” methodology in this
preamble). This is consistent with the
rule provided in section 274(e)(2)(B) for
QTFs provided to specified individuals.
The final regulations also provide that
if the value of a QTF exceeds the month-
ly per employee limitations on exclusion
provided by section 132(f)(2) ($270 per
employee for 2020), so that only a portion
of the value is included in the employees’
wages, the taxpayer may apply section
274(e)(2). However, in this case, the tax-
payer must use the dollar-for-dollar meth-
odology.
ii. Expenses for Transportation in a
Commuter Highway Vehicle, Transit
Pass, or Parking Made Available to the
Public
Section 274(e)(7) provides an excep-
tion to section 274(a) for expenses for
goods, services, and facilities made avail-
able by the taxpayer to the general public.
Pursuant to section 274(e)(7), the pro-
posed regulations provided that any tax-
payer expense for transportation in a com-
muter highway vehicle, a transit pass, or
parking that otherwise qualifies as a QTF
under section 132(f)(1) is not subject to
the deduction disallowance under section
274(a) to the extent such transportation,
transit pass, or parking is made available
to the general public. No comments were
received on this provision, and the final
regulations adopt it without modification.
As described further in part 1.B.iii. of this
Summary of Comments and Explanation
of Revisions section, “general public” in-
cludes, but is not limited to, customers,
clients, visitors, individuals delivering
goods or services to the taxpayer, and pa-
tients of a health care facility. The general
public does not include employees, part-
ners, 2-percent shareholders of S corpora-
tions (as defined in section 1372(b)), sole
proprietors, or independent contractors of
the taxpayer. If a taxpayer owns or leas-
es space in a multi-tenant building, em-
ployees, partners, 2-percent shareholders
of S corporations (as defined in section
1372(b)), sole proprietors, independent
contractors or customers of unrelated ten-
ants in the building are included in the
definition of general public.
iii. Expenses for Transportation in a
Commuter Highway Vehicle, Transit
Pass, or Parking Sold to Customers
Section 274(e)(8) provides an excep-
tion to section 274(a) for expenses for
goods or services (including the use of
facilities) which are sold by the taxpayer
in a bona fide transaction for an adequate
and full consideration in money or mon-
ey’s worth. Pursuant to section 274(e)(8),
the proposed regulations provided that
any taxpayer expense for transportation
in a commuter highway vehicle, a transit
pass, or parking that otherwise qualifies
as a QTF under section 132(f)(1) that is
sold to customers in a bona fide transac-
tion for an adequate and full consideration
in money or money’s worth is not sub-
ject to the deduction disallowance under
section 274(a). The proposed regulations
also provided that for purposes of this
section, the term “customer” includes an
employee of the taxpayer who purchases
the transportation in a commuter highway
vehicle, transit pass, or parking in a bona
fide transaction for an adequate and full
consideration in money or money’s worth.
The final regulations adopt these provi-
sions.
A commenter requested guidance
in the final regulations for a situation in

Bulletin No. 2021–3 387 January 19, 2021
which employees are charged for parking
at a parking facility. If a taxpayer charges
its employees for parking at its parking
facilities in a bona fide transaction for
adequate and full consideration in mon-
ey or money’s worth, the employees are
the taxpayer’s customers for this purpose
and the exception in section 274(e)(8)
and §1.274-13(e)(2)(iii) would apply. On
the other hand, if an employee pays less
than adequate and full consideration, this
exception would not apply because the
parking was not sold to the employee for
full consideration. In this case, however,
the taxpayer may apply the exception in
section 274(e)(2) and §1.274-13(e)(2)(i)
to the extent of the reimbursement.
Another commenter suggested that the
deduction disallowance for the expense
of any QTF should not apply to expenses
for parking that has no objective value to
the taxpayer’s employees, such as parking
in industrial, remote, or rural areas (that
is, areas where the general public would
not pay to park). In response to this com-
ment, the Treasury Department and the
IRS have determined that the exception in
section 274(e)(8) and the final regulations
at §1.274-13(e)(2)(iii) should apply if in
a bona fide transaction, the adequate and
full consideration for qualified parking is
zero. The final regulations provide that to
apply the exception in such a case, the tax-
payer bears the burden of proving that the
fair market value of the qualified parking
is zero. However, a taxpayer will be treat-
ed as satisfying this burden if the qualified
parking is provided in a rural, industrial,
or remote area in which no commercial
parking is available and an individual
other than an employee ordinarily would
not pay to park. The final regulations also
provide an example illustrating the appli-
cation of this rule.
2. Transportation and Commuting
Expenses
Section 274(l)(1), as added by the
TCJA, provides that no deduction is al-
lowed under chapter 1 for any expense in-
curred for providing any transportation, or
any payment or reimbursement, to an em-
ployee of the taxpayer in connection with
travel between the employee’s residence
and place of employment, except as nec-
essary for ensuring the safety of the em-
ployee. The provision applies to expenses
paid or incurred after December 31, 2017.
Section 274(l)(2) provides that the disal-
lowance of a deduction for commuting
and transportation expenses under section
274(l) is suspended for any qualified bicy-
cle commuting reimbursement (described
in section 132(f)(5)(F)) paid or incurred
after December 31, 2017, and before Jan-
uary 1, 2026. Thus, for such period, de-
ductions for qualified bicycle commuting
reimbursements, which, also for such pe-
riod, are not excluded from an employee’s
income under section 132(f)(8), are not
disallowed under section 274(l).
Section 1.274-14 addresses the dis-
allowance of deductions under section
274(l). Section 1.274-14 of the proposed
regulations provided that travel between
the employee’s residence and place of em-
ployment includes travel that originates at
a transportation hub near the employee’s
residence or place of employment. For
example, an employee who commutes to
work by airplane from an airport near the
employee’s residence to an airport near
the employee’s place of employment is
traveling between the residence and place
of employment.
A commenter suggested that the final
regulations clarify that section 274(l) ap-
plies to commuting expenses only and
does not apply to business travel. The
commenter further requested that the con-
cept of transportation originating at a hub
near the employee’s residence or place of
employment be removed from the pro-
posed regulations because it may disal-
low business travel between two places of
employment. In addition, the comment-
er noted that it is incorrect to describe a
commute as originating at a transportation
hub because an individual’s commute will
always begin at the residence, even if the
individual first travels from the residence
to the transportation hub. Thus, the com-
menter suggested that instead of the hub
reference, the final regulations provide
that the application of section 274(l) to
travel between a residence and place of
employment is not affected by the use of
different modes of transportation on the
trip.
The Treasury Department and the IRS
agree with these suggestions. The final
regulations do not include a reference to a
transportation hub and instead explain that
travel between the employee’s residence
and place of employment is not affected
by the use of different modes of transpor-
tation, or by whether the employer pays
for all modes of transportation during the
commute. The final regulations also state
that the disallowance under section 274(l)
does not apply to business expenses under
section 162(a)(2) paid or incurred while
traveling away from home.
A commenter suggested that only the
marginal cost of commuting should be
disallowed, similar to spouse and de-
pendent travel in section 274(m)(3). The
Treasury Department and the IRS decline
to adopt this suggestion because the lan-
guage of section 274(l) broadly refers to
“any expense” incurred for the provision
of commuting to an employee. Further,
the Treasury Department and the IRS are
not aware of any evidence that Congress
intended to disallow only the marginal
cost of commuting.
A commenter requested that the final
regulations include a definition of “em-
ployee” for purposes of section 274(l). In
response to this comment, the Treasury
Department and the IRS include a defini-
tion of employee in the final regulations.
Under the final regulations, the term “em-
ployee” means an employee of the taxpay-
er as defined in section 3121(d)(1) and (2)
(that is, officers of a corporate taxpayer
and employees of the taxpayer under the
common law rules).
The proposed regulations provided a
definition for an employee’s “residence,”
referencing the definition of the term “res-
idence” in §1.121-1(b)(1). Under §1.121-
1(b)(1), whether property is used by the
taxpayer as the taxpayer’s residence
depends upon all the facts and circum-
stances. A property used by the taxpayer
as the taxpayer’s residence may include a
houseboat, a house trailer, or the house or
apartment that the taxpayer is entitled to
occupy as a tenant-stockholder in a coop-
erative housing corporation.
A commenter requested that the final
regulations limit the definition of “resi-
dence” to the residence to or from which
the employee regularly commutes, which
generally is the employee’s principal res-
idence. The Treasury Department and the
IRS decline to adopt this comment be-
cause nothing in the language of section
274(l) indicates that commuting is limit-

January 19, 2021 388 Bulletin No. 2021–3
ed to transportation from a principal res-
idence. An employee could, for example,
regularly commute from a vacation home
to the workplace. Thus, the final regula-
tions continue to define “residence” by
referencing the definition of the term
“residence” in §1.121-1(b)(1), and spe-
cifically provide that this definition may
include a residence that is not a principal
residence.
The proposed regulations also defined
the term “safety of the employee,” ref-
erencing the description of a bona fide
business-oriented security concern in
§1.132-5(m). Several commenters sug-
gested that the proposed rules for deter-
mining when transportation provided by
an employer is necessary for the safety
of the employee were too narrow and
should be expanded to apply beyond a
bona fide business-oriented security con-
cern in §1.132-5(m). These commenters
generally suggested that the final regula-
tions should instead define “safety of the
employee” by reference to §1.61-21(k)
(5). Section 1.61-21(k)(5) provides that
unsafe conditions exist if a reasonable
person would, under the facts and cir-
cumstances, consider it unsafe for the
employee to walk to or from home, or to
walk to or use public transportation at the
time of day the employee must commute.
One of the factors indicating whether it is
unsafe is the history of crime in the geo-
graphic area surrounding the employee’s
workplace or residence at the time of day
the employee must commute.
The Treasury Department and the IRS
agree with this suggestion. Accordingly,
the final regulations clarify that a transpor-
tation or commuting expense is necessary
for ensuring the safety of the employee if
unsafe conditions, as described in §1.61-
21(k)(5), exist for the employee.
To further clarify the exception, a com-
menter also suggested that examples be
included illustrating situations in which
transportation provided by an employer is
necessary for the safety of the employee.
The Treasury Department and the IRS be-
lieve that further clarification is unneces-
sary in light of the final regulations’ refer-
ence to unsafe conditions as described in
§1.61-21(k)(5).
A commenter suggested that tempo-
rary or occasional places of employment
should not be considered an employee’s
place of employment for purpose of sec-
tion 274(l). The commenter pointed to
prior guidance issued by the IRS as well
as to case law that provides that travel
to a temporary place of employment is
not treated as commuting. The Treasury
Department and the IRS agree with this
comment and have modified the final reg-
ulations to explain that temporary or oc-
casional places of employment are not an
employee’s place of employment under
section 274(l). However, the final regula-
tions provide that an employee must have
at least one regular or principal place of
business.
The Treasury Department and the IRS
have determined that the exceptions in
section 274(e) do not apply to deductions
disallowed by section 274(l), because the
statutory language in section 274 applies
the exceptions in 274(e) only to expenses
that are otherwise disallowed or limited
by section 274(a), (k), and (n). A com-
menter pointed out that although the ex-
ceptions in section 274(e) are applicable
only to expenses disallowed or limited by
section 274(a), (k), and (n), the Treasury
Department and the IRS have previously
extended the exceptions in 274(e)(2) to
expenses otherwise disallowed by other
subsections of section 274. Specifically,
the commenter noted that the exception
in section 274(e)(2) was extended to the
spouse travel disallowance in §274(m)(3),
pursuant to §1.274-2(f)(2)(iii).
The Treasury Department and the IRS
considered this comment but do not be-
lieve that the exception in section 274(e)
(2) should be extended to commuting ex-
penses disallowed by section 274(l). The
Joint Committee on Taxation’s “Blue-
book” describing the TCJA confirms that
the exception in section 274(e)(2) does
not apply to section 274(l) expenses:
The provision is intended to include
qualified transportation fringe expenses
in the exception to the deduction disal-
lowance for expenses that are treated as
compensation. Any expenses incurred
for providing any form of transportation
which are not qualified transportation
fringes (or any payment or reimburse-
ment) for commuting between the em-
ployee’s residence and place or employ-
ment, even if included in compensation,
are not eligible for this exception.
Joint Committee on Taxation, General
Explanation of Public Law 115-97 (JCS-
1-18), at 190 (December 20, 2018). Thus,
the final regulations do not apply the sec-
tion 274(e) exceptions, including section
274(e)(2), to commuting expenses disal-
lowed by section 274(l).
Applicability Date
These regulations apply to taxable
years beginning on or after December
16, 2020. Notwithstanding the preceding
sentence, taxpayers may choose to apply
§1.274-13(b)(14)(ii) of these final regula-
tions to taxable years ending after Decem-
ber 31, 2019.
Taxpayers may continue to rely on
proposed §§ 1.274-13 through 1.274-14,
which were issued in a notice of proposed
rulemaking (REG-119307-19) and pub-
lished on June 23, 2020, in the Federal
Register (85 FR 37599) or the guidance
provided in Notice 2018-99 for parking
expenses, other QTF expenses, and trans-
portation and commuting expenses, as ap-
plicable, paid or incurred in taxable years
beginning after December 31, 2017 and
before December 16, 2020.
Special Analyses
These final regulations are not subject
to review under section 6(b) of Executive
Order 12866 pursuant to the Memoran-
dum of Agreement (April 11, 2018) be-
tween the Treasury Department and the
Office of Management and Budget regard-
ing review of tax regulations.
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is here-
by certified that this final rule will not
have a significant economic impact on a
substantial number of small entities. Al-
though the rule may affect a substantial
number of small entities, the economic
impact of the regulations is not likely
to be significant. Data are not readily
available about the number of taxpay-
ers affected, but the number is likely to
be substantial for both large and small
entities because the rule may affect en-
tities that incur QTF or commuting ex-
penses. The economic impact of these
regulations is not likely to be significant,
however, because these final regulations
substantially incorporate prior guidance

Bulletin No. 2021–3 389 January 19, 2021
and otherwise clarify the application of
the TCJA changes to section 274 related
to QTF and commuting expenses. These
final regulations will assist taxpayers in
understanding the changes to section 274
and make it easier for taxpayers to com-
ply with those changes. Accordingly,
the Secretary of the Treasury’s delegate
certifies that the rule will not have a sig-
nificant economic impact on a substan-
tial number of small entities. Notwith-
standing this certification, the Treasury
Department and the IRS welcome com-
ments on the impact of these regulations
on small entities.
Pursuant to section 7805(f), these fi-
nal regulations have been submitted to
the Chief Counsel for the Office of Ad-
vocacy of the Small Business Adminis-
tration for comment on their impact on
small business. No comments on the
proposed regulations were received from
the Chief Counsel for the Office of Ad-
vocacy of the Small Business Adminis-
tration.
Effect on Other Documents
The following publications are obso-
lete as of December 16, 2020.
Notice 2018-99 (2018-52 I.R.B. 1067).
Statement of Availability of IRS
Documents
Notices cited in this preamble are pub-
lished in the Internal Revenue Bulletin (or
Cumulative Bulletin) and are available
from the Superintendent of Documents,
U.S. Government Publishing Office,
Washington, DC 20402, or by visiting the
IRS web site at http://www.irs.gov.
Drafting Information
The principal author of this final reg-
ulation is Patrick Clinton, Office of the
Associate Chief Counsel (Income Tax &
Accounting). Other personnel from the
Treasury Department and the IRS partic-
ipated in their development.
List of Subjects in 26 CFR Part 1
Income Taxes, Reporting and record-
keeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR Part 1 is amend-
ed as follows:
Part 1—INCOME TAX
Paragraph 1. The authority citation for
part 1 is amended by adding entries in for
§§1.274-13 and 1.274-14 in numerical or-
der to read in part as follows:
Authority: 26 U.S.C. 7805.
* * * * *
Section 1.274-13 also issued under 26
U.S.C. 274.
Section 1.274-14 also issued under 26
U.S.C. 274.
* * * * *
Par. 2. Section 1.274-13 is added to
read as follows:
§1.274-13 Disallowance of deductions
for certain qualified transportation
fringe expenditures.
(a) In general. Except as provided in
this section, no deduction otherwise al-
lowable under chapter 1 of the Internal
Revenue Code (Code) is allowed for any
expense of any qualified transportation
fringe as defined in paragraph (b)(1) of
this section.
(b) Definitions. The following defini-
tions apply for purposes of this section:
(1) Qualified transportation fringe.
The term qualified transportation fringe
means any of the following provided by
an employer to an employee:
(i) Transportation in a commuter high-
way vehicle if such transportation is in
connection with travel between the em-
ployee’s residence and place of employ-
ment (as described in sections 132(f)(1)
(A) and 132(f)(5)(B));
(ii) Any transit pass (as described in
sections 132(f)(1)(B) and 132(f)(5)(A));
or
(iii) Qualified parking (as described in
sections 132(f)(1)(C) and 132(f)(5)(C)).
(2) Employee. The term employee
means a common law employee or other
statutory employee, such as an officer of
a corporation, who is currently employed
by the taxpayer. See §1.132-9 Q/A-5.
Partners, 2-percent shareholders of S cor-
porations (as defined in section 1372(b)),
sole proprietors, and independent con-
tractors are not employees of the taxpayer
for purposes of this section. See §1.132-9
Q/A-24.
(3) General public. (i) In general. The
term general public includes, but is not
limited to, customers, clients, visitors, indi-
viduals delivering goods or services to the
taxpayer, students of an educational insti-
tution, and patients of a health care facility.
The term general public does not include
individuals that are employees, partners,
2-percent shareholders of S corporations
(as defined in section 1372(b)), sole propri-
etors, or independent contractors of the tax-
payer. Also, an exclusive list of guests of
a taxpayer is not the general public. Park-
ing spaces that are available to the general
public but empty are treated as provided to
the general public. Parking spaces that are
used to park vehicles owned by the gener-
al public while the vehicles await repair or
service by the taxpayer are also treated as
provided to the general public.
(ii) Multi-tenant building. If a taxpay-
er owns or leases space in a multi-tenant
building, the term general public includes
employees, partners, 2-percent sharehold-
ers of S corporations (as defined in section
1372(b)), sole proprietors, independent
contractors, clients, or customers of unre-
lated tenants in the building.
(4) Parking facility. The term parking
facility includes indoor and outdoor ga-
rages and other structures, as well as park-
ing lots and other areas, where a taxpayer
provides qualified parking (as defined in
section 132(f)(5)(C)) to one or more of its
employees. The term parking facility may
include one or more parking facilities but
does not include parking spaces on or near
property used by an employee for residen-
tial purposes.
(5) Geographic location. The term
geographic location means contiguous
tracts or parcels of land owned or leased
by the taxpayer. Two or more tracts or
parcels of land are contiguous if they
share common boundaries or would share
common boundaries but for the interposi-
tion of a road, street, railroad, stream, or
similar property. Tracts or parcels of land
which touch only at a common corner are
not contiguous.
(6) Total parking spaces. The term to-
tal parking spaces means the total number

January 19, 2021 390 Bulletin No. 2021–3
of parking spaces, or the taxpayer’s por-
tion thereof, in the parking facility.
(7) Reserved employee spaces. The
term reserved employee spaces means
the spaces in the parking facility, or the
taxpayer’s portion thereof, exclusively
reserved for the taxpayer’s employees.
Employee spaces in the parking facility,
or portion thereof, may be exclusively re-
served for employees by a variety of meth-
ods, including, but not limited to, specific
signage (for example, “Employee Parking
Only”) or a separate facility or portion of a
facility segregated by a barrier to entry or
limited by terms of access. Inventory/un-
usable spaces are not included in reserved
employee spaces.
(8) Reserved nonemployee spaces.
The term reserved nonemployee spaces
means the spaces in the parking facility,
or the taxpayer’s portion thereof, exclu-
sively reserved for nonemployees. Such
parking spaces may include, but are not
limited to, spaces reserved exclusively
for visitors, customers, partners, sole pro-
prietors, 2-percent shareholders of S cor-
porations (as defined in section 1372(b)),
vendor deliveries, and passenger loading/
unloading. Nonemployee spaces in the
parking facility, or portion thereof, may
be exclusively reserved for nonemploy-
ees by a variety of methods, including,
but not limited to, specific signage (for
example, “Customer Parking Only”) or a
separate facility, or portion of a facility,
segregated by a barrier to entry or limited
by terms of access. Inventory/unusable
spaces are not included in reserved non-
employee spaces.
(9) Inventory/unusable spaces. The
term inventory/unusable spaces means the
spaces in the parking facility, or the tax-
payer’s portion thereof, exclusively used
or reserved for inventoried vehicles, quali-
fied nonpersonal use vehicles described in
§1.274-5(k), or other fleet vehicles used in
the taxpayer’s business, or that are other-
wise not usable for parking by employees
or the general public. Examples of such
parking spaces include, but are not lim-
ited to, parking spaces for vehicles that
are intended to be sold or leased at a car
dealership or car rental agency, parking
spaces for vehicles owned by an electric
utility used exclusively to maintain elec-
tric power lines, or parking spaces occu-
pied by trash dumpsters (or similar prop-
erty). Taxpayers may use any reasonable
methodology to determine the number of
inventory/unusable spaces in the parking
facility. A reasonable methodology may
include using the average of monthly in-
ventory counts.
(10) Available parking spaces. The
term available parking spaces means the
total parking spaces, less reserved em-
ployee spaces and less inventory/unusable
spaces, that are available to employees
and the general public.
(11) Primary use. The term primary
use means greater than 50 percent of ac-
tual or estimated usage of the available
parking spaces in the parking facility.
(12) Total parking expenses—(i) In
general. The term total parking expenses
means all expenses of the taxpayer related
to total parking spaces in a parking facil-
ity including, but not limited to, repairs,
maintenance, utility costs, insurance,
property taxes, interest, snow and ice re-
moval, leaf removal, trash removal, clean-
ing, landscape costs, parking lot atten-
dant expenses, security, and rent or lease
payments or a portion of a rent or lease
payment (if not broken out separately). A
taxpayer may use any reasonable method-
ology to allocate mixed parking expenses
to a parking facility. A deduction for an
allowance for depreciation on a parking
facility owned by a taxpayer and used for
parking by the taxpayer’s employees is an
allowance for the exhaustion, wear and
tear, and obsolescence of property, and
not included in total parking expenses for
purposes of this section. Expenses paid or
incurred for nonparking facility property,
including items related to property next to
the parking facility, such as landscaping
or lighting, also are not included in total
parking expenses.
(ii) Optional rule for allocating cer-
tain mixed parking expenses. A taxpayer
may choose to allocate 5 percent of any
the following mixed parking expenses to
a parking facility: lease or rental agree-
ment expenses, property taxes, interest
expense, and expenses for utilities and
insurance.
(13) Mixed parking expense. The term
mixed parking expense means a single ex-
pense amount paid or incurred by a tax-
payer that includes both parking facility
and nonparking facility expenses for a
property that a taxpayer owns or leases.
(14) Peak demand period—(i) In gen-
eral. The term peak demand period refers
to the period of time on a typical busi-
ness day during the taxable year when
the greatest number of the taxpayer’s em-
ployees are utilizing parking spaces in the
taxpayer’s parking facility. If a taxpayer’s
employees work in shifts, the peak de-
mand period would take into account the
shift during which the largest number of
employees park in the taxpayer’s parking
facility. However, a brief transition period
during which two shifts overlap in their
use of parking spaces, as one shift of em-
ployees is getting ready to leave and the
next shift is reporting to work, may be
disregarded. Taxpayers may use any rea-
sonable methodology to determine the
total number of spaces used by employ-
ees during the peak demand period on a
typical business day. A reasonable meth-
odology may include periodic inspections
or employee surveys.
(ii) Optional rule for federally declared
disasters. If a taxpayer owns or leases a
parking facility that is located in a fed-
erally declared disaster area, as defined
in section 165(i)(5), the taxpayer may
choose to identify a typical business day
for the taxable year in which the disaster
occurred by reference to a typical business
day in that taxable year prior to the date
that the taxpayer’s operations were im-
pacted by the federally declared disaster.
Alternatively, a taxpayer may choose to
identify a typical business day during the
month(s) of the taxable year in which the
disaster occurred by reference to a typical
business day during the same month(s) of
the taxable year immediately preceding
the taxable year in which the disaster first
occurred. For purposes of applying the
optional rule for federally declared disas-
ters, the taxable year in which the disas-
ter occurs is determined without regard to
whether an election under section 165(i) is
made with respect to the disaster.
(c) Optional aggregation rule for cal-
culating total parking spaces; taxpayer
owned or leased parking facilities. For
purposes of determining total parking
spaces in calculating the disallowance of
deductions for qualified transportation
fringe parking expenses under the general
rule in paragraph (d)(2)(i) of this section,
the primary use methodology in paragraph
(d)(2)(ii)(B) of this section, or the cost per

Bulletin No. 2021–3 391 January 19, 2021
space methodology in paragraph (d)(2)(ii)
(C) of this section, a taxpayer that owns or
leases more than one parking facility in a
single geographic location may aggregate
the number of spaces in those parking fa-
cilities. For example, parking spaces at
an office park or an industrial complex in
the geographic location may be aggregat-
ed. However, a taxpayer may not aggre-
gate parking spaces in parking facilities
that are in different geographic locations.
A taxpayer that chooses to aggregate its
parking spaces under this paragraph (c)
must determine its total parking expenses,
including the allocation of mixed parking
expenses, as if the aggregated parking
spaces constitute one parking facility.
(d) Calculation of disallowance of
deductions for qualified transportation
fringe expenses—(1) Taxpayer pays a
third party for parking qualified trans-
portation fringe. If a taxpayer pays a third
party an amount for its employees’ park-
ing qualified transportation fringe, the
section 274(a)(4) disallowance generally
is calculated as the taxpayer’s total annual
cost of employee parking qualified trans-
portation fringes paid to the third party.
(2) Taxpayer provides parking quali-
fied transportation fringe at a parking fa-
cility it owns or leases. If a taxpayer owns
or leases all or a portion of one or more
parking facilities where its employees
park, the section 274(a)(4) disallowance
may be calculated using the general rule in
paragraph (d)(2)(i) of this section or any
of the simplified methodologies in para-
graph (d)(2)(ii) of this section. A taxpayer
may choose to use the general rule or any
of the following methodologies for each
taxable year and for each parking facility.
(i) General rule. A taxpayer that uses
the general rule in this paragraph (d)(2)
(i) must calculate the disallowance of de-
ductions for qualified transportation fringe
parking expenses for each employee re-
ceiving the qualified transportation fringe
based on a reasonable interpretation of
section 274(a)(4). A taxpayer that uses
the general rule in this paragraph (d)(2)
(i) may use the aggregation rule in para-
graph (c) of this section for determining
total parking spaces. An interpretation of
section 274(a)(4) is not reasonable unless
the taxpayer applies the following rules
when calculating the disallowance under
this paragraph (d)(2)(i).
(A) A taxpayer must not use value to
determine expense. A taxpayer may not
use the value of employee parking to de-
termine expenses allocable to employee
parking that is either owned or leased by
the taxpayer because section 274(a)(4)
disallows a deduction for the expense of
providing a qualified transportation fringe,
regardless of its value.
(B) A taxpayer must not deduct expens-
es related to reserved employee spaces.
A taxpayer must determine the allocable
portion of total parking expenses that re-
late to any reserved employee spaces. No
deduction is allowed for the parking ex-
penses that relate to reserved employee
spaces.
(C) A taxpayer must not improperly
apply the exception for qualified parking
made available to the public. A taxpayer
must not improperly apply the exception
in section 274(e)(7) or paragraph (e)(2)(ii)
of this section to parking facilities, for ex-
ample, by treating a parking facility regu-
larly used by employees as available to the
general public merely because the general
public has access to the parking facility.
(ii) Additional simplified methodolo-
gies. Instead of using the general rule in
paragraph (d)(2)(i) of this section for a
taxpayer owned or leased parking facility,
a taxpayer may use a simplified methodol-
ogy under paragraph (d)(2)(ii)(A), (B), or
(C) of this section.
(A) Qualified parking limit method-
ology. A taxpayer that uses the qualified
parking limit methodology in this para-
graph (d)(2)(ii)(A) must calculate the
disallowance of deductions for qualified
transportation fringe parking expenses
by multiplying the total number of spaces
used by employees during the peak de-
mand period, or the total number of tax-
payer’s employees, by the section 132(f)
(2) monthly per employee limitation on
exclusion (adjusted for inflation), for each
month in the taxable year. The result is the
amount of the taxpayer’s expenses that
are disallowed under section 274(a)(4).
In applying this methodology, a taxpayer
calculates the disallowed amount as re-
quired under this paragraph (d)(2)(ii)(A),
regardless of the actual amount of the tax-
payer’s total parking expenses. This meth-
odology may be used only if the taxpayer
includes the value of the qualified trans-
portation fringe in excess of the sum of
the amount, if any, paid by the employee
for the qualified transportation fringe and
the applicable statutory monthly limit in
section 132(f)(2) as compensation paid to
the employee under chapter 1 of the Code
(chapter 1) and as wages to the employee
for purposes of withholding under chap-
ter 24 of the Code (chapter 24), relating to
collection of Federal income tax at source
on wages. In addition, the exception to the
disallowance for amounts treated as em-
ployee compensation provided for in sec-
tion 274(e)(2) and in paragraph (e)(2)(i) of
this section cannot be applied to reduce a
section 274(a)(4) disallowance calculated
using this method. A taxpayer using this
methodology may not use the aggregation
rule in paragraph (c) of this section.
(B) Primary use methodology. A tax-
payer that uses the primary use method-
ology in this paragraph (d)(2)(ii)(B) must
use the following four-step methodology
to calculate the disallowance of deduc-
tions for qualified transportation fringe
parking expenses for each parking facility
for which the taxpayer uses the primary
use methodology. A taxpayer using this
methodology may use the aggregation
rule in paragraph (c) of this section for de-
termining total parking spaces.
(1) Step 1 - Calculate the disallowance
for reserved employee spaces. A taxpayer
must identify the total parking spaces in
the parking facility, or the taxpayer’s por-
tion thereof, exclusively reserved for the
taxpayer’s employees. The taxpayer must
then determine the percentage of reserved
employee spaces in relation to total park-
ing spaces and multiply that percentage
by the taxpayer’s total parking expenses
for the parking facility. The product is the
amount of the deduction for total parking
expenses that is disallowed under section
274(a)(4) for reserved employee spaces.
There is no disallowance for reserved em-
ployee spaces if the following conditions
are met:
(i) The primary use (as defined in para-
graphs (b)(11) and (d)(2)(ii)(B)(2) of this
section) of the available parking spaces is
to provide parking to the general public;
(ii) There are five or fewer reserved
employee spaces in the parking facility;
and
(iii) The reserved employee spaces are
5 percent or less of the total parking spac-
es.

January 19, 2021 392 Bulletin No. 2021–3
(2) Step 2 - Determine the primary use
of available parking spaces. A taxpayer
must identify the available parking spac-
es in the parking facility and determine
whether their primary use is to provide
parking to the general public. If the prima-
ry use of the available parking spaces in
the parking facility is to provide parking
to the general public, then total parking
expenses allocable to available parking
spaces at the parking facility are excepted
from the section 274(a)(4) disallowance
by the general public exception under
section 274(e)(7) and paragraph (e)(2)(ii)
of this section. Primary use of available
parking spaces is based on the number of
available parking spaces used by employ-
ees during the peak demand period.
(3) Step 3 - Calculate the allowance for
reserved nonemployee spaces. If the pri-
mary use of a taxpayer’s available park-
ing spaces is not to provide parking to the
general public, the taxpayer must identify
the number of available parking spaces
in the parking facility, or the taxpayer’s
portion thereof, exclusively reserved for
nonemployees. A taxpayer that has no re-
served nonemployee spaces may proceed
to Step 4 in paragraph (d)(2)(ii)(B)(4) of
this section. If the taxpayer has reserved
nonemployee spaces, it may determine
the percentage of reserved nonemployee
spaces in relation to remaining total park-
ing spaces and multiply that percentage
by the taxpayer’s remaining total parking
expenses. The product is the amount of
the deduction for remaining total parking
expenses that is not disallowed because
the spaces are not available for employee
parking.
(4) Step 4 - Determine remaining use
of available parking spaces and allocable
expenses. If a taxpayer completes Steps 1
- 3 in paragraph (d)(2)(ii)(B) of this sec-
tion and has any remaining total parking
expenses not specifically categorized as
deductible or nondeductible, the taxpayer
must reasonably allocate such expenses
by determining the total number of avail-
able parking spaces used by employees
during the peak demand period.
(C) Cost per space methodology. A
taxpayer using the cost per space meth-
odology in this paragraph (d)(2)(ii)
(C) must calculate the disallowance of
deductions for qualified transportation
fringe parking expenses by multiplying
the cost per space by the number of total
parking spaces used by employees during
the peak demand period. The product is
the amount of the deduction for total
parking expenses that is disallowed un-
der section 274(a)(4). A taxpayer may
calculate cost per space by dividing total
parking expenses by total parking spac-
es. This calculation may be performed
on a monthly basis. A taxpayer using this
methodology may use the aggregation
rule in paragraph (c) of this section for
determining total parking spaces.
(3) Expenses for transportation in a
commuter highway vehicle or transit pass.
If a taxpayer pays a third party an amount
for its employees’ commuter highway ve-
hicle or a transit pass qualified transporta-
tion fringe, the section 274(a)(4) disallow-
ance generally is equal to the taxpayer’s
total annual cost of employee commuter
highway vehicle or a transit pass quali-
fied transportation fringes paid to the third
party. If a taxpayer provides transportation
in a commuter highway vehicle or transit
pass qualified transportation fringes in
kind directly to its employees, the tax-
payer must calculate the disallowance of
deductions for expenses for such fringes
based on a reasonable interpretation of
section 274(a)(4). However, a taxpay-
er may not use the value of the qualified
commuter highway vehicle or transit pass
fringe to the employee to determine ex-
penses allocable to such fringe because
section 274(a)(4) disallows a deduction
for the expense of providing a qualified
transportation fringe, regardless of its val-
ue to the employee.
(e) Specific exceptions to disallowance
of deduction for qualified transportation
fringe expenses—(1) In general. The pro-
visions of section 274(a)(4) and paragraph
(a) of this section (imposing limitations
on deductions for qualified transportation
fringe expenses) are not applicable in the
case of expenditures set forth in paragraph
(e)(2) of this section. Such expenditures
are deductible to the extent allowable un-
der chapter 1 of the Code. This paragraph
(e) cannot be construed to affect wheth-
er a deduction under section 162 or 212
is allowed or allowable. The fact that an
expenditure is not covered by a specific
exception provided for in this paragraph
(e) is not determinative of whether a de-
duction for the expenditure is disallowed
under section 274(a)(4) and paragraph (a)
of this section.
(2) Exceptions to disallowance. The ex-
penditures referred to in paragraph (e)(1)
of this section are set forth in paragraphs
(e)(2)(i) through (iii) of this section.
(i) Certain qualified transportation
fringe expenses treated as compensa-
tion—(A) Expenses includible in income
of persons who are employees and are
not specified individuals. In accordance
with section 274(e)(2)(A), and except as
provided in paragraph (e)(2)(i)(C) of this
section, an expense paid or incurred by
a taxpayer for a qualified transportation
fringe, if an employee who is not a speci-
fied individual is the recipient of the qual-
ified transportation fringe, is not subject to
the disallowance of deductions provided
for in paragraph (a) of this section to the
extent that the taxpayer—
(1) Properly treats the expense relating
to the recipient of the qualified transporta-
tion fringe as compensation to an employ-
ee under chapter 1 and as wages to the
employee for purposes of chapter 24; and
(2) Treats the proper amount as com-
pensation to the employee under §1.61-21.
(B) Specified Individuals. In accor-
dance with section 274(e)(2)(B), in the
case of a specified individual (as defined
in section 274(e)(2)(B)(ii)), the disallow-
ance of deductions provided for in para-
graph (a) of this section does not apply to
an expense for a qualified transportation
fringe of the specified individual to the
extent that the amount of the expense does
not exceed the sum of—
(1) the amount treated as compensation
to the specified individual under chapter 1
and as wages to the specified individual
for purposes of chapter 24; and
(2) any amount the specified individual
reimburses the taxpayer.
(C) Expenses for which an amount is
excluded from income or is less than the
proper amount. Notwithstanding para-
graph (e)(2)(i)(A) of this section, in the
case of an expense paid or incurred by
a taxpayer for a qualified transportation
fringe for which an amount is wholly or
partially excluded from a recipient’s in-
come under subtitle A of the Code (other
than because the amount is reimbursed
by the recipient), or for which an amount
included in compensation and wages to
an employee is less than the amount re-

Bulletin No. 2021–3 393 January 19, 2021
quired to be included under §1.61-21, the
disallowance of deductions provided for
in paragraph (a) of this section does not
apply to the extent that the amount of the
expense does not exceed the sum of—
(1) the amount treated as compensa-
tion to the recipient under chapter 1 and
as wages to the recipient for purposes of
chapter 24; and
(2) any amount the recipient reimburs-
es the taxpayer.
(ii) Expenses for transportation in a
commuter highway vehicle, transit pass,
or parking made available to the public.
Under section 274(e)(7) and this para-
graph (e)(2)(ii), any expense paid or in-
curred by a taxpayer for transportation
in a commuter highway vehicle, a transit
pass, or parking that otherwise qualifies
as a qualified transportation fringe is not
subject to the disallowance of deductions
provided for in paragraph (a) of this sec-
tion to the extent that such transportation,
transit pass, or parking is made available
to the general public. With respect to park-
ing, this exception applies to the entire
amount of the taxpayer’s parking expense,
less any expenses specifically attributable
to employees (for example, expenses allo-
cable to reserved employee spaces), if the
primary use of the parking is by the gener-
al public. If the primary use of the parking
is not by the general public, this exception
applies only to the costs attributable to the
parking used by the general public.
(iii) Expenses for transportation in a
commuter highway vehicle, transit pass,
or parking sold to customers. Under sec-
tion 274(e)(8) and this paragraph (e)(2)
(iii), any expense paid or incurred by a
taxpayer for transportation in a commuter
highway vehicle, a transit pass, or park-
ing that otherwise qualifies as a qualified
transportation fringe to the extent such
transportation, transit pass, or parking is
sold to customers in a bona fide transac-
tion for an adequate and full consideration
in money or money’s worth, is not subject
to the disallowance of deductions provid-
ed for in paragraph (a) of this section. For
purposes of this paragraph (e)(2)(iii), the
term customer includes an employee of
the taxpayer who purchases transportation
in a commuter highway vehicle, a transit
pass, or parking in a bona fide transaction
for an adequate and full consideration in
money or money’s worth. If in a bona fide
transaction, the adequate and full consid-
eration for qualified parking is zero, the
exception in this paragraph (e)(2)(iii) ap-
plies even though the taxpayer does not
actually sell the parking to its employees.
To apply the exception in this case, the
taxpayer bears the burden of proving that
the fair market value of the qualified park-
ing is zero. However, solely for purposes
of this paragraph (e)(2)(iii), a taxpayer
will be treated as satisfying this burden if
the qualified parking is provided in a ru-
ral, industrial, or remote area in which no
commercial parking is available and an in-
dividual other than an employee ordinari-
ly would not pay to park in the parking
facility.
(f) Examples. The following examples
illustrate the provisions of this section
related to parking expenses for qualified
transportation fringes. For each exam-
ple, unless otherwise stated, assume the
parking expenses are otherwise deduct-
ible expenses paid or incurred during the
2020 taxable year; all or some portion of
the expenses relate to a qualified trans-
portation fringe under section 132(f); the
section 132(f)(2) monthly per employee
limitation on an employee’s exclusion is
$270; the fair market value of the qualified
parking is not $0; all taxpayers are calen-
dar-year taxpayers; and the length of the
2020 taxable year is 12 months.
(1) Example 1. Taxpayer A pays B, a third party
who owns a parking garage adjacent to A’s place of
business, $100 per month per parking space for each
of A’s 10 employees to park in B’s garage, or $12,000
for parking in 2020 (($100 x 10) x 12 = $12,000).
The $100 per month paid for each of A’s 10 employ-
ees for parking is excludible from the employees’
gross income under section 132(a)(5), and none of
the exceptions in section 274(e) or paragraph (e) of
this section are applicable. Thus, the entire $12,000
is subject to the section 274(a)(4) disallowance un-
der paragraphs (a) and (d)(1) of this section.
(2) Example 2. (i) Assume the same facts as in
paragraph (f)(1) of this section (Example 1), except
A pays B $300 per month for each parking space, or
$36,000 for parking for 2020 (($300 x 10) x 12 =
$36,000). Of the $300 per month paid for parking for
each of 10 employees, $270 is excludible under sec-
tion 132(a)(5) for 2020 and none of the exceptions
in section 274(e) or paragraph (e) of this section are
applicable to this amount. A properly treats the ex-
cess amount of $30 ($300 - $270) per employee per
month as compensation and wages. Thus, $32,400
(($270 x 10) x 12 = $32,400) is subject to the section
274(a)(4) disallowance under paragraphs (a) and (d)
(1) of this section.
(ii) The excess amount of $30 per employee per
month is not excludible under section 132(a)(5). As
a result, the exceptions in section 274(e)(2) and para-
graph (e)(2)(i) of this section are applicable to this
amount. Thus, $3,600 ($36,000 - $32,400 = $3,600)
is not subject to the section 274(a)(4) disallowance
and remains deductible.
(3) Example 3. (i) Taxpayer C leases from a third
party a parking facility that includes 200 parking
spaces at a rate of $500 per space, per month in 2020.
C’s annual lease payment for the parking spaces is
$1,200,000 ((200 x $500) x 12 = $1,200,000). The
number of available parking spaces used by C’s em-
ployees during the peak demand period is 200.
(ii) C uses the qualified parking limit method-
ology described in paragraph (d)(2)(ii)(A) of this
section to determine the disallowance under sec-
tion 274(a)(4). Under this methodology, the section
274(a)(4) disallowance is calculated by multiplying
the number of available parking spaces used by em-
ployees during the peak demand period, 200, the
section 132(f)(2) monthly per employee limitation
on exclusion, $270, and 12, the number of months
in the applicable taxable year. The amount subject to
the section 274(a)(4) disallowance is $648,000 (200
x $270 x 12 = $648,000). This amount is excludi-
ble from C’s employees’ gross incomes under sec-
tion 132(a)(5) and none of the exceptions in section
274(e) or paragraph (e) of this section are applicable
to this amount. The excess $552,000 ($1,200,000 -
$648,000) for which C is not disallowed a deduction
under 274(a)(4) is included in C’s employees’ gross
incomes because it exceeds the section 132(f)(2)
monthly per employee limitation on exclusion.
(4) Example 4. (i) Facts. Taxpayer D, a big box
retailer, owns a surface parking facility adjacent to its
store. D incurs $10,000 of total parking expenses for
its store in the 2020 taxable year. D’s parking facility
has 510 spaces that are used by its customers, em-
ployees, and its fleet vehicles. None of D’s parking
spaces are reserved. The number of available park-
ing spaces used by D’s employees during the peak
demand period is 50. Approximately 30 nonreserved
parking spaces are empty during D’s peak demand
period. D’s fleet vehicles occupy 10 parking spaces.
(ii) Methodology. D uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4).
(iii) Step 1. Because none of D’s parking spaces
are exclusively reserved for employees, there is no
amount to be specifically allocated to reserved em-
ployee spaces under paragraph (d)(2)(ii)(B)(1) of
this section.
(iv) Step 2. D’s number of available parking
spaces is the total parking spaces reduced by the
number of reserved employee spaces and inventory/
unusable spaces or 500 (510 – 0 – 10 = 500). The
number of available parking spaces used by D’s em-
ployees during the peak demand period is 50. Of the
500 available parking spaces, 450 are used to pro-
vide parking to the general public, including the 30
empty nonreserved parking spaces that are treated as
provided to the general public. The primary use of
D’s available parking spaces is to provide parking to
the general public because 90% (450 / 500 = 90%) of
the available parking spaces are used by the general
public under paragraph (d)(2)(ii)(B)(2) of this sec-
tion. Because the primary use of the available park-
ing spaces is to provide parking to the general public,
the exception in section 274(e)(7) and paragraph (e)

January 19, 2021 394 Bulletin No. 2021–3
(2)(ii) of this section applies and none of the $10,000
of total parking expenses is subject to the section
274(a)(4) disallowance.
(5) Example 5. (i) Facts. Taxpayer E, a manu-
facturer, owns a surface parking facility adjacent to
its plant. E incurs $10,000 of total parking expenses
in 2020. E’s parking facility has 500 spaces that are
used by its visitors and employees. E reserves 25 of
these spaces for nonemployee visitors. The number
of available parking spaces used by E’s employees
during the peak demand period is 400.
(ii) Methodology. E uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4).
(iii) Step 1. Because none of E’s parking spaces
are exclusively reserved for employees, there is no
amount to be specifically allocated to reserved em-
ployee spaces under paragraph (d)(2)(ii)(B)(1) of
this section.
(iv) Step 2. The primary use of E’s parking facil-
ity is not to provide parking to the general public be-
cause 80% (400 / 500 = 80%) of the available park-
ing spaces are used by its employees. Thus, expenses
allocable to those spaces are not excepted from the
section 274(a) disallowance by section 274(e)(7) and
paragraph (e)(2)(ii) of this section under the primary
use test in paragraph (d)(2)(ii)(B)(2) of this section.
(v) Step 3. Because 5% (25 / 500 = 5%) of E’s
available parking spaces are reserved nonemployee
spaces, up to $9,500 ($10,000 x 95% = $9,500) of
E’s total parking expenses are subject to the section
274(a)(4) disallowance under this step as provided
in paragraph (d)(2)(ii)(B)(3) of this section. The re-
maining $500 ($10,000 x 5% = $500) of expenses al-
locable to reserved nonemployee spaces is excepted
from the section 274(a) disallowance and continues
to be deductible.
(vi) Step 4. E must reasonably determine the em-
ployee use of the remaining parking spaces by using
the number of available parking spaces used by E’s
employees during the peak demand period and de-
termine the expenses allocable to employee parking
spaces under paragraph (d)(2)(ii)(B)(4) of this sec-
tion.
(6) Example 6. (i) Facts. Taxpayer F, a manu-
facturer, owns a surface parking facility adjacent to
its plant. F incurs $10,000 of total parking expenses
in 2020. F’s parking facility has 500 spaces that are
used by its visitors and employees. F reserves 50
spaces for management. All other employees park in
nonreserved spaces in F’s parking facility; the num-
ber of available parking spaces used by F’s employ-
ees during the peak demand period is 400. Addition-
ally, F reserves 10 spaces for nonemployee visitors.
(ii) Methodology. F uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4).
(iii) Step 1. Because F reserved 50 spaces for
management, $1,000 ((50 / 500) x $10,000 = $1,000)
is the amount of total parking expenses that is nonde-
ductible for reserved employee spaces under section
274(a)(4) and paragraphs (a) and (d)(2)(ii)(B)(1) of
this section. None of the exceptions in section 274(e)
or paragraph (e) of this section are applicable to this
amount.
(iv) Step 2. The primary use of the remainder of
F’s parking facility is not to provide parking to the
general public because 89% (400 / 450 = 89%) of
the available parking spaces in the facility are used
by its employees. Thus, expenses allocable to these
spaces are not excepted from the section 274(a)(4)
disallowance by section 274(e)(7) and paragraph (e)
(2)(ii) of this section under the primary use test in
paragraph (d)(2)(ii)(B)(2) of this section.
(v) Step 3. Because 2% (10 / 450 = 2.22%) of F’s
available parking spaces are reserved nonemployee
spaces, the $180 allocable to those spaces (($10,000
- $1,000) x 2%) is not subject to the section 274(a)(4)
disallowance and continues to be deductible under
paragraph (d)(2)(ii)(B)(3) of this section.
(vi) Step 4. F must reasonably determine the em-
ployee use of the remaining parking spaces by using
the number of available parking spaces used by F’s
employees during the peak demand period and de-
termine the expenses allocable to employee parking
spaces under paragraph (d)(2)(ii)(B)(4) of this sec-
tion.
(7) Example 7. (i) Facts. Taxpayer G, a financial
services institution, owns a multi-level parking garage
adjacent to its office building. G incurs $10,000 of
total parking expenses in 2020. G’s parking garage
has 1,000 spaces that are used by its visitors and em-
ployees. However, one floor of the parking garage is
segregated by an electronic barrier that can only be
accessed with a card provided by G to its employees.
The segregated parking floor contains 100 spaces. The
other floors of the parking garage are not used by em-
ployees for parking during the peak demand period.
(ii) Methodology. G uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4).
(iii) Step 1. Because G has 100 reserved spac-
es for employees, $1,000 ((100 / 1,000) x $10,000
= $1,000) is the amount of total parking expenses
that is nondeductible for reserved employee spaces
under section 274(a)(4) and paragraph (d)(2)(ii)(B)
(1) of this section. None of the exceptions in section
274(e) or paragraph (e) of this section are applicable
to this amount.
(iv) Step 2. The primary use of the available
parking spaces in G’s parking facility is to provide
parking to the general public because 100% (900
/ 900 = 100%) of the available parking spaces are
used by the public. Thus, expenses allocable to those
spaces, $9,000, are excepted from the section 274(a)
(4) disallowance by section 274(e)(7) and paragraph
(e)(2)(ii) of this section under the primary use test in
paragraph (d)(2)(ii)(B)(2).
(8) Example 8. (i) Facts. Taxpayer H, an ac-
counting firm, leases a parking facility adjacent to
its office building. H incurs $10,000 of total parking
expenses related to the lease payments in 2020. H’s
leased parking facility has 100 spaces that are used
by its clients and employees. None of the parking
spaces are reserved. The number of available park-
ing spaces used by H’s employees during the peak
demand period is 60.
(ii) Methodology. H uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4).
(iii) Step 1. Because none of H’s leased parking
spaces are exclusively reserved for employees, there
is no amount to be specifically allocated to reserved
employee spaces under paragraph (d)(2)(ii)(B)(1) of
this section.
(iv) Step 2. The primary use of H’s leased park-
ing facility under paragraph (d)(2)(ii)(B)(2) of this
section is not to provide parking to the general public
because 60% (60 / 100 = 60%) of the lot is used by its
employees. Thus, H may not utilize the general pub-
lic exception from the section 274(a)(4) disallow-
ance provided by section 274(e)(7) and paragraph
(e)(2)(ii) of this section.
(v) Step 3. Because none of H’s parking spaces
are exclusively reserved for nonemployees, there is
no amount to be specifically allocated to reserved
nonemployee spaces under paragraph (d)(2)(ii)(B)
(3) of this section.
(vi) Step 4. H must reasonably determine the
use of the parking spaces and the related expenses
allocable to employee parking. Because the number
of available parking spaces used by H’s employees
during the peak demand period is 60, H reasonably
determines that 60% (60 / 100 = 60%) of H’s to-
tal parking expenses or $6,000 ($10,000 x 60% =
$6,000) is subject to the section 274(a)(4) disal-
lowance under paragraph (d)(2)(ii)(B)(4) of this
section.
(9) Example 9. (i) Facts. Taxpayer I, a large man-
ufacturer, owns multiple parking facilities adjacent to
its manufacturing plant, warehouse, and office build-
ing at its complex in the city of X. All of I’s tracts or
parcels of land at its complex in city X are located in a
single geographic location. I owns parking facilities in
other cities. I incurs $50,000 of total parking expenses
related to the parking facilities at its complex in city X
in 2020. I’s parking facilities at its complex in city X
have 10,000 total parking spaces that are used by its
visitors and employees of which 500 are reserved for
management. All other spaces at parking facilities in
I’s complex in city X are nonreserved. The number of
nonreserved spaces used by I’s employees other than
management during the peak demand period at I’s
parking facilities in city X is 8,000.
(ii) Methodology. I uses the primary use meth-
odology in paragraph (d)(2)(ii)(B) of this section to
determine the amount of parking expenses that are
disallowed under section 274(a)(4). I chooses to
apply the aggregation rule in paragraph (c) of this
section to aggregate all parking facilities in the geo-
graphic location that comprises its complex in city
X. However, I may not aggregate parking facilities
in other cities with its parking facilities in city X be-
cause they are in different geographic locations.
(iii) Step 1. Because 500 spaces are reserved for
management, $2,500 ((500 / 10,000) x $50,000 =
$2,500) is the amount of total parking expenses that
is nondeductible for reserved employee spaces for
I’s parking facilities in city X under section 274(a)
(4) and paragraphs (a) and (d)(2)(ii)(B)(1) of this
section.
(iv) Step 2. The primary use of the remainder of
I’s parking facility is not to provide parking to the
general public because 84% (8,000 / 9,500 = 84%) of
the available parking spaces in the facility are used
by its employees. Thus, expenses allocable to these
spaces are not excepted from the section 274(a)(4)

Bulletin No. 2021–3 395 January 19, 2021
disallowance by section 274(e)(7) or paragraph (e)
(2)(ii) of this section under the primary use test in
paragraph (d)(2)(ii)(B)(2) of this section.
(v) Step 3. Because none of I’s parking spaces
in its parking facilities in city X are exclusively re-
served for nonemployees, there is no amount to be
specifically allocated to reserved nonemployee spac-
es under paragraph (d)(2)(ii)(B)(3) of this section.
(vi) Step 4. I must reasonably determine the use
of the remaining parking spaces and the related ex-
penses allocable to employee parking for its parking
facilities in city X. Because the number of available
parking spaces used by I’s employees during the peak
demand period in city X during an average workday
is 8,000, I reasonably determines that 84.2% (8,000
/ 9,500 = 84.2%) of I’s remaining parking expense
or $39,900 (($50,000 - $2,500) x 84% = $39,900) is
subject to the section 274(a)(4) disallowance under
paragraph (d)(2)(ii)(B)(4) of this section.
(10) Example 10. (i) Taxpayer J, a manufactur-
er, owns a parking facility and incurs the following
mixed parking expenses (along with other park-
ing expenses): property taxes, utilities, insurance,
security expenses, and snow removal expenses.
In accordance with paragraph (b)(12)(i) and (ii)
of this section, J determines its total parking ex-
penses by allocating 5% of its property tax, utili-
ties, and insurance expenses to its parking facility.
J uses a reasonable methodology to allocate to its
parking facility an applicable portion of its secu-
rity and snow removal expenses. J determines that
it incurred $100,000 of total parking expenses in
2020. J’s parking facility has 500 spaces that are
used by its visitors and employees. The number of
total parking spaces used by J’s employees during
the peak demand period is 475.
(ii) J uses the cost per space methodology de-
scribed in paragraph (d)(2)(ii)(C) of this section
to determine the amount of parking expenses that
are disallowed under section 274(a)(4). Under this
methodology, J multiplies the cost per space by the
number of total parking spaces used by J’s employ-
ees during the peak demand period. J calculates the
cost per space by dividing total parking expenses by
the number of total parking spaces ($100,000 / 500
= $200). J determines that $95,000 ($200 x 475 =
$95,000) of J’s total parking expenses is subject to
the section 274(a)(4) disallowance and none of the
exceptions in section 274(e) or paragraph (e) of this
section are applicable.
(11) Example 11. Taxpayer K operates an indus-
trial plant with a parking facility in a rural area in
which no commercial parking is available. K pro-
vides qualified parking at the plant to its employ-
ees free of charge. Further, an individual other than
an employee ordinarily would not consider paying
any amount to park in the plant’s parking facility.
Although K does not charge its employees for the
qualified parking, the exception in section 274(e)
(8) and this paragraph (e)(3)(iii) will apply to K’s
total parking expenses if in a bona fide transaction,
the adequate and full consideration for the qualified
parking is zero. In order to treat the adequate and full
consideration as zero, K bears the burden of proving
that the parking has no objective value. K is treated
as satisfying this burden because the parking is pro-
vided in a rural area in which no commercial parking
is available and in which an individual other than an
employee ordinarily would not consider paying any
amount to park in the parking facility. Therefore, the
exception in paragraph (e)(2)(iii) of this section ap-
plies to K’s total parking expenses and a deduction
for the expenses is not disallowed by reason of sec-
tion 274(a)(4).
(g) Applicability date. This section ap-
plies to taxable years beginning on or after
December 16, 2020. However, taxpayers
may choose to apply §1.274-13(b)(14)(ii)
to taxable years ending after December
31, 2019.
Par. 3. Section 1.274-14 is added to
read as follows:
§1.274-14 Disallowance of deductions
for certain transportation and
commuting benefit expenditures.
(a) General rule. Except as provided in
this section, no deduction is allowed for
any expense incurred for providing any
transportation, or any payment or reim-
bursement, to an employee of the taxpayer
in connection with travel between the em-
ployee’s residence and place of employ-
ment. The disallowance is not subject to
the exceptions provided in section 274(e).
The disallowance applies regardless of
whether the travel between the employ-
ee’s residence and place of employment
includes more than one mode of transpor-
tation, and regardless of whether the tax-
payer provides, or pays or reimburses the
employee for, all modes of transportation
used during the trip. For example, the dis-
allowance applies if an employee drives
a personal vehicle to a location where a
different mode of transportation is used
to complete the trip to the place of em-
ployment, even though the taxpayer may
not incur any expense for the portion of
travel in the employee’s personal vehicle.
The rules in section 274(l) and this section
do not apply to business expenses under
section 162(a)(2) paid or incurred while
traveling away from home. The rules in
section 274(l) and this section also do not
apply to any expenditure for any qualified
transportation fringe (as defined in sec-
tion 132(f)) provided to an employee of
the taxpayer. All qualified transportation
fringe expenses are required to be ana-
lyzed under section 274(a)(4) and §1.274-
13
(b) Exception. The disallowance for the
deduction for expenses incurred for pro-
viding any transportation or commuting
in paragraph (a) of this section does not
apply if the transportation or commuting
expense is necessary for ensuring the safe-
ty of the employee. The transportation or
commuting expense is necessary for en-
suring the safety of the employee if unsafe
conditions, as described in §1.61-21(k)
(5), exist for the employee.
(c) Definitions. The following defini-
tions apply for purposes of this section:
(1) Employee. The term employee
means an employee of the taxpayer as de-
fined in section 3121(d)(1) and (2) (that is,
officers of a corporate taxpayer and em-
ployees of the taxpayer under the common
law rules).
(2) Residence. The term residence
means a residence as defined in §1.121-
1(b)(1). An employee’s residence is not
limited to the employee’s principal resi-
dence.
(3) Place of employment. The term
place of employment means the employ-
ee’s regular or principal (if more than one
regular) place of business. An employee’s
place of employment does not include
temporary or occasional places of em-
ployment. An employee must have at least
one regular or principal place of business.
(d) Applicability date. This section ap-
plies to taxable years beginning on or after
December 16, 2020.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: December 4, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on De-
cember 15, 2020, 8:45 a.m, and published in the is-
sue of the Federal Register for December 16, 2020,
85 F.R. 81391)

January 19, 2021 396 Bulletin No. 2021–3
26 CFR 1.451-3 Timing of income inclusion for
taxpayers with an applicable financial statement
using an accrual method of accounting.; 26 CFR
1.451-8 Advance payments for goods, services, and
certain other items.
T.D. 9941
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Taxable Year of Income
Inclusion under an Accrual
Method of Accounting and
Advance Payments for
Goods, Services, and Other
Items
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations regarding the timing
of income inclusion under an accru-
al method of accounting, including
the treatment of advance payments for
goods, services, and certain other items.
The regulations reflect changes made by
the Tax Cuts and Jobs Act and affect tax-
payers that use an accrual method of ac-
counting and have an applicable finan-
cial statement. These final regulations
also affect taxpayers that use an accrual
method of accounting and receive ad-
vance payments.
DATES: Effective Date: The regulations
are effective on December 30, 2020.
Applicability Dates: For dates of applica-
bility, see §§1.451-3(m), 1.451-8(h), and
1.1275-2(l)(2).
FOR FURTHER INFORMATION CON-
TACT: Concerning any provisions in
§1.451-3 within the jurisdiction of the
Associate Chief Counsel (Income Tax
& Accounting), Jo Lynn Ricks, (202)
317-4615, Sean Dwyer, (202) 317-4853,
or Doug Kim, (202) 317-4794, and con-
cerning any provisions in §1.451-8 with-
in the jurisdiction of the Associate Chief
Counsel (Income Tax & Accounting), Jo
Lynn Ricks, (202) 317-4615, or David
Christensen, (202) 317-4861; concerning
any provisions in §1.451-3 or § 1.451-8
within the jurisdiction of the Associate
Chief Counsel (Financial Institutions &
Products), Deepan Patel, (202) 317-3423,
or Charles Culmer, (202) 317-4528 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 451(b) and (c) of the
Internal Revenue Code (Code).
On December 22, 2017, section 451(b)
and (c) were amended by section 13221
of Public Law 115-97 (131 Stat. 2054),
commonly referred to as the Tax Cuts
and Jobs Act (TCJA). Section 451(b) was
amended to provide that, for a taxpayer
using an accrual method of accounting
(accrual method taxpayer), the all events
test for an item of gross income, or por-
tion thereof, is met no later than when the
item, or portion thereof, is included in
revenue for financial accounting purpos-
es on an applicable financial statement
(AFS). Section 451(c) was amended to
provide that an accrual method taxpayer
may use the deferral method of account-
ing provided in section 451(c) for ad-
vance payments. Unless otherwise indi-
cated, all references to section 451(b) and
section 451(c) hereinafter are references
to section 451(b) and section 451(c), as
amended by the TCJA.
I. Section 451(b)
In general, section 451(a) provides that
the amount of any item of gross income is
included in gross income for the taxable
year in which it is received by the taxpay-
er, unless, under the method of account-
ing used in computing taxable income,
the amount is to be properly accounted
for as of a different period. Under §1.451-
1(a), accrual method taxpayers generally
include items of income in gross income
in the taxable year when all the events
occur that fix the right to receive the in-
come and the amount of the income can
be determined with reasonable accuracy
(all events test). All the events that fix the
right to receive income occur when (1)
the required performance takes place, (2)
payment is due, or (3) payment is made,
whichever happens first. Revenue Ruling
2003-10, 2003-1 C.B. 288; Revenue Rul-
ing 84-31, 1984-1 C.B. 127; Revenue Rul-
ing 80-308, 1980-2 C.B. 162.
Section 451(b)(1)(A) provides that,
for an accrual method taxpayer, the all
events test for an item of gross income,
or portion thereof, is met no later than
when the item, or portion thereof, is in-
cluded as revenue in an AFS (AFS In-
come Inclusion Rule).
Section 451(b)(1)(B) lists exceptions
to the AFS Income Inclusion Rule. The
AFS Income Inclusion Rule does not ap-
ply to taxpayers that do not have an AFS
for a taxable year or to any item of gross
income from a mortgage servicing con-
tract.
Section 451(b)(1)(C) codifies the all
events test, stating that the all events test is
met for any item of gross income if all the
events have occurred which fix the right
to receive such income and the amount of
such income can be determined with rea-
sonable accuracy.
Section 451(b)(2) provides that the
AFS Income Inclusion Rule does not ap-
ply for any item of gross income the rec-
ognition of which is determined using a
special method of accounting, “other than
any provision of part V of subchapter P
(except as provided in clause (ii) of para-
graph (1)(B)).”
Section 451(b)(3) defines an AFS, as
referenced in section 451(b)(1)(A)(i), by
providing a hierarchical list of financial
statements.
Section 451(b)(4) provides that for
purposes of section 451(b), in the case of
a contract which contains multiple perfor-
mance obligations, the allocation of the
transaction price to each performance ob-
ligation is equal to the amount allocated to
each performance obligation for purposes
of including such item in revenue in the
taxpayer’s AFS.
Section 451(b)(5) provides that, if the
financial results of a taxpayer are report-
ed on the AFS for a group of entities, the
group’s financial statement shall be treat-
ed as the AFS of the taxpayer.

Bulletin No. 2021–3 397 January 19, 2021
II. Section 451(c)
Section 451(c) provides special rules
for the treatment of advance payments.
Section 451(c)(1)(A) provides the general
rule requiring an accrual method taxpayer
to include an advance payment in gross in-
come in the taxable year of receipt. How-
ever, section 451(c)(1)(B) permits a tax-
payer to elect to include any portion of the
advance payment in gross income in the
taxable year following the year of receipt
to the extent income is not included in
revenue in the AFS in the year of receipt.
Section 451(c)(1)(B) generally codifies
Revenue Procedure 2004-34, 2004-22
I.R.B. 991, which provided for a similar
deferral period.
Section 451(c)(2)(A) provides the
Secretary of the Treasury or his delegate
(Secretary) with the authority to provide
the time, form and manner for making
the election under section 451(c)(1)(B),
and the categories of advance payments
for which an election can be made. Un-
der section 451(c)(2)(B), the election is
effective for the taxable year that it is first
made and for all subsequent taxable years,
unless the taxpayer receives the consent of
the Secretary to revoke the election. Sec-
tion 451(c)(3) provides that the deferral
election does not apply to advance pay-
ments received in the taxable year that the
taxpayer ceases to exist.
Section 451(c)(4)(A) defines advance
payment for purposes of section 451(c).
Under section 451(c)(4)(A), the term ad-
vance payment means any payment that
meets the following three requirements:
(1) the full inclusion of the payment in
gross income in the year of receipt is a
permissible method of accounting; (2) any
portion of the advance payment is includ-
ed in revenue in an AFS for a subsequent
tax year; and (3) the advance payment is
for goods, services, or such other items
that the Secretary has identified. Section
451(c)(4)(B) lists certain payments that
are excluded from the definition of ad-
vance payment and gives the Secretary
the authority to identify other payments to
be excluded from the definition. Section
451(c)(4)(C) provides a special definition
of the term “receipt” for purposes of the
definition of advance payment, and sec-
tion 451(c)(4)(D) states that rules simi-
lar to those for allocating the transaction
price among performance obligations in
section 451(b)(4) also apply for purposes
of section 451(c).
III. Prior Guidance
On April 12, 2018, the Department of
the Treasury (Treasury Department) and
the IRS issued Notice 2018-35, 2018-18
I.R.B. 520, providing interim guidance on
the treatment of advance payments and re-
questing suggestions for future guidance
under section 451(b) and section 451(c).
On September 27, 2018, the Treasury
Department and the IRS issued Notice
2018-80, 2018-42 I.R.B. 609, announcing
that the Treasury Department and the IRS
intend to issue proposed regulations pro-
viding that accrued market discount is not
includible in income under section 451(b).
On September 9, 2019, the Treasury
Department and the IRS published pro-
posed regulations under section 451(b)
(REG-104870-18, 84 FR 47191) (pro-
posed section 451(b) regulations) and
proposed regulations under section 451(c)
(REG-104554-18, 84 FR 47175) (pro-
posed section 451(c) regulations), referred
to collectively hereinafter as the “pro-
posed regulations.” The notices of pro-
posed rulemaking for section 451(b) and
(c) reflect consideration of the comments
received in response to Notice 2018-35.
A public hearing on the proposed reg-
ulations was held on December 10, 2019,
at which two speakers provided testimo-
ny. The Treasury Department and the IRS
received approximately ten written com-
ments responding to the proposed regula-
tions.
After the comment period for the
proposed regulations closed, the Trea-
sury Department and the IRS received a
comment letter regarding the allocation
of transaction price for contracts that in-
clude both income subject to section 451
and income subject to a special method of
accounting provision, specifically, section
460. In response to these comments, in the
Explanation of Provisions of a notice of
proposed rulemaking (REG-132766-18)
that was published on August 5, 2020 (85
FR 47508), the Treasury Department and
the IRS suggested allocation rules and
requested comments regarding the appli-
cation of section 451(b)(2) and (4) to con-
tracts with income that is accounted for in
part under proposed §1.451-3 and in part
under a special method of accounting. No
formal comments were received regarding
these suggested rules.
Comments received before these reg-
ulations were substantially developed, in-
cluding all comments received on or before
the deadline for comments on November
8, 2019, were carefully considered in de-
veloping these regulations. Copies of the
comments received are available for pub-
lic inspection at http://www.regulations.
gov or upon request. After consideration
of the comments received and the testi-
mony at the public hearing, this Treasury
decision adopts the proposed regulations
as revised in response to such comments
and testimony. The comments and the re-
visions are discussed in the Summary of
Comments and Explanation of Revisions
section of this preamble.
Summary of Comments and
Explanation of Revisions
I. Overview
This Summary of Comments and Ex-
planation of Revisions section summariz-
es the formal written comments and some
of the informal commentary, both in writ-
ing and at public events, addressing the
proposed regulations. Comments merely
summarizing or interpreting the proposed
regulations or recommending statutory
revisions generally are not discussed in
this preamble. Similarly, comments out-
side the scope of this rulemaking gener-
ally are not addressed in this Summary of
Comments and Explanation of Revisions
section.
II. Comments and Explanation of
Revisions Regarding the Proposed
Section 451(b) Regulations
A. Realization and recognition
As noted in the preamble to the pro-
posed section 451(b) regulations, footnote
872 of the Conference Report to the TCJA
states that section 451(b) was not intended
to revise the rules associated with when
an item is realized for Federal income tax
purposes and does not require the recog-
nition of income in situations where the
Federal income tax realization event has

January 19, 2021 398 Bulletin No. 2021–3
not taken place. See H.R. Rep. No. 115-
466, at 428 fn. 872 (2017) (Conf. Rep.).
As also noted in the preamble to the pro-
posed section 451(b) regulations, footnote
874 of the Conference Report provides,
by way of example, that the timing rules
of section 451(b) apply to unbilled receiv-
ables for partially performed services. Id.
at 428 fn. 874.
Commenters provided little commen-
tary on footnote 874, except to state that
it is contrary to footnote 872. Instead, the
commenters presented two views. First,
some commenters highlighted footnote
872 and cited case law to support the
claim that a realization event is, and has
always been, a prerequisite for income
recognition. These commenters acknowl-
edged, however, that the case law frames
the issue not in terms of “realization” but
rather in terms of whether a seller has a
fixed right to income under the all events
test.
Second, some commenters suggested
definitions of realization. However, these
recommended definitions differ, particu-
larly as to whether realization applies to
the provision of services. For example,
some commenters described realization
as applying to both contracts for the pro-
vision of services and contracts for the
sale of goods, and stated that realization
occurs when the taxpayer has a “fixed and
unconditional right to payment” under the
contract. One commenter reasoned that
existing judicial precedents require real-
ization without distinguishing between
whether the income is for the performance
of services or the sale of property. Another
commenter asserted that realization means
there has been a sale or disposition under
section 1001(a), suggesting that realiza-
tion applies only to the sale of property.
In sum, these commenters suggested that
the proposed section 451(b) regulations
do not give effect to footnote 872 in the
Conference Report and ask that the final
regulations either explicitly define reali-
zation or clarify when realization occurs
in certain circumstances, such as where a
taxpayer produces goods for customers or
where a taxpayer provides non-severable
services to customers.
The Treasury Department and the IRS
have considered these comments and de-
cline to define the term realization in the
final regulations. Congress did not explic-
itly define realization in the Conference
Report. Some of the suggested definitions
of realization, particularly the ones equat-
ing realization with the all events test,
would nullify the AFS Income Inclusion
Rule entirely, which is clearly contrary to
Congress’ intent. Accordingly, it is reason-
able to conclude that Congress intended a
different concept of realization that would
give full effect to the statute. Further, the
final regulations do not clarify when real-
ization occurs in specific circumstances.
Realization is a factual determination that,
while closely aligned with the all events
test, has different meanings in different
contexts.
Section 451 is a timing provision and
the amendments to section 451(b)(1)(A)
by TCJA were intended to modify the
timing of income to require an accru-
al method taxpayer with an AFS to treat
the right to income as fixed, under the all
events test, no later than the time at which
the item (or portion thereof) is taken into
account in its AFS. The statute thus re-
flects Congress’ intent to incorporate tim-
ing concepts from the financial reporting
rules in the tax timing rules for including
items in gross income. It does not seek to
answer whether the AFS income inclusion
has been realized. Accordingly, the focus
of the final regulations is on the appropri-
ate taxable year of AFS income inclusion.
B. Scope of AFS Income Inclusion Rule
1. Proposed §1.451-3(b): General rule
The general AFS Income Inclusion
Rule in the proposed section 451(b) reg-
ulations provides that, if a taxpayer in-
cludes an item of gross income, or por-
tion thereof, in revenue in the taxpayer’s
AFS, the taxpayer must include the item
in gross income under section 451(b). In
addition to commenting that the general
rule in the proposed section 451(b) reg-
ulations potentially overrides the realiza-
tion requirement, contrary to footnote 872
of the Conference Report, commenters
suggested that the rule is overbroad and
could cause taxpayers to incur a tax lia-
bility without having the money to pay the
liability.
The Treasury Department and the IRS
note that the potential to incur a tax liabil-
ity without having the money to pay the
liability is inherent in the accrual method.
However, the Treasury Department and
the IRS acknowledge that the proposed
AFS Income Inclusion Rule could exac-
erbate this situation and that the proposed
rule could result in inclusions that would
be inconsistent with footnote 872 of the
Conference Report. Accordingly, the final
regulations provide that, under the AFS
Income Inclusion Rule, the all events test
under §1.451-1(a) for any item of gross
income, or portion thereof, is met no later
than when that item, or portion thereof, is
“taken into account as AFS revenue.” In
determining when an item of gross income
is “taken into account as AFS revenue,”
AFS revenue is reduced by amounts that
the taxpayer does not have an enforce-
able right to recover if the customer were
to terminate the contract on the last day
of the taxable year. The determination of
whether the taxpayer has an enforceable
right to recover amounts of AFS revenue
is governed by the terms of the contract
and applicable Federal, state, or interna-
tional law, and includes amounts recover-
able in equity and liquidated damages.
The revised rule is designed to recon-
cile the intended preservation of the real-
ization concept, consistent with footnote
872 of the Conference Report, with the
intended scope of section 451(b), as illus-
trated in footnote 874 of the Conference
Report. The revised rule is also consistent
with concepts illustrated in Example 4 in
the Joint Committee on Taxation, General
Explanation of Public Law 115-97 (JCS-
1-18) at 163 (Dec. 20, 2018) (Blue Book).
In the example, the taxpayer enters into a
contract with a customer for a customized
piece of machinery. Under the contract,
the taxpayer will not invoice the customer
until the item is delivered to the custom-
er, the customer accepts the machinery,
and title to the machinery has transferred
to the customer. The contract specifically
provides that, if the customer withdraws
from the agreement, the taxpayer has an
enforceable right to payment as the work
is performed, even if the contract is not
completed. The taxpayer does not com-
plete the machinery in year one but in-
cludes an amount in revenue in its AFS in
year one. Example 4 concludes that, under
the AFS Income Inclusion Rule, the tax-
payer is required to recognize the amount
in year one. The revised AFS Income In-

Bulletin No. 2021–3 399 January 19, 2021
clusion Rule in the final regulations in-
corporates the key elements reflected in
Example 4.
To reduce any additional compliance
burdens, the final regulations provide an
alternative method to determine when an
item of gross income is treated as “taken
into account as AFS revenue” under the
AFS Income Inclusion Rule. Under the
“alternative AFS revenue method”, the
taxpayer does not reduce AFS revenue
by amounts that the taxpayer lacks an en-
forceable right to recover if the customer
were to terminate the contract on the last
day of the taxable year. The alternative
AFS revenue method is a method of ac-
counting that applies to all items of gross
income in the trade or business that are
subject to the AFS income inclusion rule.
Taxpayers using the alternative AFS rev-
enue method may also use the AFS cost
offset method provided in the final regu-
lations.
Under the final regulations two addi-
tional adjustments to AFS revenue are
made in determining whether an item
of gross income is treated as “taken into
account as AFS revenue.” These adjust-
ments apply both under the AFS Income
Inclusion Rule and under the alternative
AFS revenue method. First, if the trans-
action price, as defined in §1.451-3(a)
(14), was increased because a significant
financing component is deemed to exist
under the standards the taxpayer uses to
prepare its AFS, then any AFS revenue
attributable to such increase is disregard-
ed. In such situations, total AFS revenue
taken into account over the term of the
contract exceeds the stated consideration
in the contract and such excess is, for
AFS purposes, offset by a corresponding
interest expense. Because such excess is
generally not imputed income for Federal
income tax purposes and a deduction for
the AFS interest expense is generally not
imputed for Federal income tax purpos-
es, it is necessary to adjust AFS revenue
to prevent the improper acceleration, or
overreporting, of gross income. If situa-
tions arise in which imputed income and
imputed deductions are also required for
Federal income tax purposes, an adjust-
ment to AFS revenue is still appropriate
as the amount and timing of the imputed
income would be outside the scope of sec-
tion 451 and the regulations thereunder.
Second, to the extent that AFS revenue
reflects a reduction for (1) amounts that
are cost of goods sold or liabilities that are
required to be accounted for under other
provisions of the Code, such as section
461, including liabilities for allowances,
rebates, chargebacks, rewards issued in
credit card and other transactions and oth-
er reward programs, and refunds (for ex-
ample, estimated returns based on historic
practice), regardless of when any such
amount is incurred (Liability Amounts);
or (2) amounts anticipated to be in dispute
or anticipated to be uncollectable, the tax-
payer must increase AFS revenue by such
amounts. The Treasury Department and
the IRS have determined that adjustments
for such amounts are necessary to prevent
the taxpayer from effectively taking such
amounts into account for Federal income
tax purposes in a taxable year prior to the
taxable year in which they are otherwise
permitted to be taken into account under
other provisions of the Code. Additional-
ly, if AFS revenue is not adjusted for Li-
ability Amounts in the taxable year that
such amounts are otherwise permitted
to be taken into account, then a taxpayer
may obtain an improper double benefit
by taking such amounts into account to
reduce taxable income under another pro-
vision of the Code while also deferring an
equal amount of gross income to a later
year under §1.451-3. The AFS revenue
adjustments in the final regulations do not
preclude a taxpayer from accounting for
trading stamps and premium coupons un-
der §1.451-4. However, the Treasury De-
partment and the IRS are still evaluating
whether the rules in §1.451-4 should be
modified or clarified in light of certain fi-
nancial reporting changes under ASC 606.
On a separate issue relating to the
scope of the AFS Income Inclusion Rule,
taxpayers questioned, in light of the reali-
zation discussion in footnote 872, whether
the AFS Income Inclusion Rule applies to
the sale of goods. Since Example 4 of the
Blue Book involves the sale of goods, it
is reasonable to conclude that Congress
intended for the AFS Income Inclusion
Rule, as revised, to extend to contracts for
the sale of goods. Accordingly, as with the
proposed section 451(b) regulations, the
final regulations provide that the AFS In-
come Inclusion Rule applies to contracts
for the sale of goods.
2. Proposed §1.451-3(b): Cost offset for
AFS income inclusions
Proposed §1.451-3(b) does not pro-
vide for a cost offset when an amount is
included under the AFS Income Inclusion
Rule. The preamble to the proposed sec-
tion 451(b) regulations discusses reasons
for not providing a cost offset, including
the potential for income distortions and
Congressional intent that a cost offset not
be provided. The preamble to the pro-
posed section 451(b) regulations requests
comments on this issue.
Multiple commenters proposed allow-
ing an offset for the cost of goods sold
(COGS) when income is included under
the AFS Income Inclusion Rule. Com-
menters pointed out that the term “item of
gross income” generally means total sales
net of COGS. See, for example, §1.61-
3(a). Commenters also described situa-
tions where income might be distorted by
inclusions in early years of a multi-year
contract with the costs being allowed in
later years without income to offset. Com-
menters expressed concern that, in these
situations, or more generally, the AFS In-
come Inclusion Rule might operate as a
tax on gross receipts.
One commenter suggested that the stat-
ute uses the AFS as a backstop to timing
recognition of revenue because the AFS
provides a good standard by which to de-
termine when a taxpayer receives an eco-
nomic benefit. The commenter acknowl-
edged that there has been a policy interest
in achieving greater book-tax conformity
in a variety of areas. The commenter rec-
ommended that, if the final regulations use
the AFS to measure the receipt of an eco-
nomic benefit, then the final regulations
also should reflect the AFS standards that
require certain items of income be report-
ed “net” of offsetting items.
Commenters also noted that, for AFS
purposes, credit card issuers generally re-
port interchange fees net of estimated re-
ward costs and report credit card late fees
net of estimated uncollectable amounts.
Commenters explained that reward costs
and uncollectable credit card late fees “are
so closely aligned with the realization of
income that AFS standards require those
items to be presented separately in the
revenue section of the income statement
but concurrently as to timing.” One com-

January 19, 2021 400 Bulletin No. 2021–3
menter expressed concern that not reduc-
ing interchange fees by estimated reward
costs and credit card late fees by estimated
uncollectable amounts in determining the
amount of income recognized under the
AFS Income Inclusion Rule would result
in the inclusion of more income for Feder-
al income tax purposes than was reported
on the AFS.
Accordingly, commenters recommend-
ed that the final regulations provide that
the all events test and the economic per-
formance requirement under section 461
should be deemed to be met for items that
are “closely aligned” with income amounts
recognized under the AFS Income Inclu-
sion Rule. Commenters explained that
section 461 should be deemed to be met
for items such as estimated reward costs
and estimated uncollectable late fees to
the extent these items are reported on the
revenue section of the AFS as a reduction
to amounts subject to the AFS Income In-
clusion Rule. One commenter further ex-
plained that this treatment would be con-
sistent with the clear reflection of income
doctrine of section 446. Alternatively,
one commenter recommended modifying
the definition of transaction price under
proposed §1.451-3(c)(6) to reduce inter-
change fees by the amount of reward costs
that satisfy section 461 and credit card
late fees by amounts that are considered
uncollectable for AFS purposes.
The Treasury Department and the IRS
have considered these comments and have
determined that a cost offset based on
estimates of future costs would be inap-
propriate. As discussed in the preamble to
the proposed section 451(b) regulations,
allowing a cost offset based on estimated
costs would be inconsistent with sections
461, 263A, and 471, and the regulations
under those sections of the Code. In addi-
tion, a cost offset based on estimated costs
would increase the possibility of income
distortions as the costs of goods would
effectively be recovered, through income
deferral, prior to the taxable year in which
the cost was actually incurred.
However, the Treasury Department
and the IRS agree with comments sug-
gesting that taxpayers should be afforded
the flexibility of applying an offset for
costs incurred against AFS income inclu-
sions from the future sale of inventory, the
“AFS cost offset method.” Accordingly,
a taxpayer that uses the AFS cost offset
method determines the amount of gross
income includible for a year prior to the
year in which ownership of inventory
transfers to the customer by reducing the
amount of revenue it would otherwise be
required to include under the AFS Income
Inclusion Rule for the taxable year (AFS
inventory inclusion amount) by the cost
of goods related to the item of inventory
for the taxable year, the “cost of goods
in progress offset.” The net result is the
amount that is required to be included in
gross income for that year under the AFS
Income Inclusion Rule. The deferred rev-
enue, that is, the revenue that was reduced
by the cost of goods in progress offset for
a taxable year prior to the taxable year
that ownership of the item of inventory is
transferred to the customer, is generally
taken into account in the taxable year in
which ownership of the item of inventory
is transferred to the customer.
The final regulations provide that the
cost of goods in progress offset for each
item of inventory for the taxable year is
calculated as (1) the cost of goods in-
curred through the last day of the taxable
year, (2) reduced by the cumulative cost
of goods in progress offset amounts at-
tributable to the items of inventory that
were taken into account in prior taxable
years, if any. However, the cost of goods
in progress offset cannot reduce the AFS
inventory inclusion amount for the item of
inventory below zero. Further, the cost of
goods in progress offset attributable to one
item of inventory cannot reduce the AFS
inventory inclusion amount attributable
to a separate item of inventory. Any cost
of goods that were not used to offset AFS
inventory inclusion amounts because they
were subject to limitation are considered
when the taxpayer determines the cost of
goods in progress offset for that item of
inventory in a subsequent taxable year.
The cost of goods in progress offset is
determined by reference to the costs and
expenditures related to each item of in-
ventory produced or acquired for resale,
which costs have been incurred under sec-
tion 461 and have been capitalized and in-
cluded in inventory under sections 471 and
263A or any other applicable provision of
the Code at the end of the year. However,
the cost of goods in progress offset does
not reduce the costs that are capitalized
to the item of inventory produced or ac-
quired for resale by the taxpayer under the
contract. That is, while the cost of goods
in progress offset reduces the AFS inven-
tory inclusion amount, it does not affect
how and when costs are capitalized to
inventory under sections 471 and 263A
or any other applicable provision of the
Code or when those capitalized costs will
be recovered. Instead, the cost of goods
in progress offset serves only to reduce
or “offset” any AFS income inclusion
amounts for the item of inventory and
defer such amounts to the taxable year in
which ownership of the item of inventory
is transferred to the customer.
The costs of goods comprising the
cost of goods in progress offset must be
determined by applying the inventory ac-
counting methods used by the taxpayer for
Federal income tax purposes. A taxpayer
must calculate its cost of goods in prog-
ress offset by reference to all costs that the
taxpayer has permissibly capitalized and
allocated to items of inventory under its
inventory method, but may not consider
costs that are not properly capitalized un-
der such method.
In the taxable year in which ownership
of the item of inventory is transferred to
the customer, any revenue deferred by
way of a prior year cost offset is included
in gross income in the year of the transfer
along with any additional revenue that is
otherwise required to be included in gross
income under the AFS Income Inclusion
Rule for such year. Although no cost off-
set is permitted in such year, the taxpayer
would recover costs capitalized and allo-
cated to the item of inventory transferred
as cost of goods sold in such year in ac-
cordance with sections 471 and 263A or
any other applicable provision of the
Code. However, if in a taxable year prior
to the taxable year in which ownership of
the item of inventory is transferred to the
customer, either (A) the taxpayer dies or
ceases to exist in a transaction other than
a transaction to which section 381(a) ap-
plies, or (B) the taxpayer’s obligation to
the customer with respect to the item of
inventory ends other than in a transaction
to which 381(a) applies or certain section
351(a) transactions between members of
the same consolidated group, then all pay-
ments received for the item of inventory
that were not previously included in gross

Bulletin No. 2021–3 401 January 19, 2021
income as a result of the application of the
cost offset rules are required to be includ-
ed in gross income in such year.
The Treasury Department and the IRS
adopted this approach in the final regula-
tions because the AFS cost offset method
provides options for taxpayers. All tax-
payers that are required to account for
income from the sale of inventory under
the AFS income inclusion rule and that
report AFS revenue in a taxable year pri-
or to the taxable year in which ownership
of the item of inventory is transferred to
the customer will generally be required to
accelerate income inclusions under such
rule. However, taxpayers have the op-
tion of using the AFS cost offset method
to reduce the amount of income they are
required to accelerate under such rule.
The AFS cost offset allows taxpayers to
reasonably match income inclusions and
incurred cost of goods, and more clearly
reflects income.
The final regulations adopt a cost of
goods sold offset based on incurred costs
because the approach is consistent with
§1.61-3 and more objective than a cost of
goods sold offset based on projected fu-
ture costs. In addition, the AFS cost off-
set method provides a degree of parity for
sellers of goods with service providers
who deduct costs as incurred without cap-
italizing the costs to inventory. A cost off-
set based on projected future cost of goods
sold was rejected because it is inconsistent
with sections 461(h), 263A and 471, and
the regulations under those sections of
the Code. Further, Congress rejected the
deferral method for advance payments in
former §1.451-5(c), which contained a
cost of goods sold offset for estimated fu-
ture costs. See Conf. Rep. at 429 fn. 880.
The AFS cost offset method is a meth-
od of accounting that applies to all items
of income eligible for the AFS cost offset
method in the trade or business. The meth-
od applies to items at the trade or business
level so that taxpayers can choose to ap-
ply the method only to trades or business-
es where the burden of determining costs
incurred relative to the related reduction
in AFS income inclusion amount warrants
the adoption of the method. If a taxpay-
er uses the AFS cost offset method for a
trade or business it must use the method
for all eligible items in that trade or busi-
ness. Further, if a taxpayer uses the AFS
cost offset method, it must also use the
advance payment cost offset method in
§1.451-8(e). The advance payment cost
offset method is discussed later in this
preamble. Special coordination rules exist
for taxpayers that use the AFS cost offset
method and the advance payment cost off-
set method and that have income from the
sale of an item of inventory that is required
to be accounted for under both §§1.451-3
and 1.451-8 because certain payments re-
ceived for such item meet the definition
of an advance payment under §1.451-8(a)
(1). See §1.451-3(c)(1) for such coordina-
tion rules.
The AFS cost offset method reduces
the amount of income from the sale of an
item of inventory that is required to be
accelerated under the AFS Income Inclu-
sion Rule by an amount of incurred cost
of goods related to the item. However, the
offsets to interchange fees and credit card
late fees recommended by the comment-
ers are based on estimated reward costs
and uncollectable late fees rather than
incurred costs of goods. Accordingly, the
final regulations do not allow a cost offset
for interchange fees, credit card late fees,
and similar items of revenue that are sub-
ject to the AFS Income Inclusion Rule and
reported net of estimated future amounts
for AFS purposes.
3. Proposed §1.451-3(c)(4) and (c)(6)(ii):
Revenue, transaction price and increases
in consideration
Proposed §1.451-3(c)(4) provides that,
for the AFS Income Inclusion Rule, rev-
enue means all transaction price amounts
includible in gross income under section
61 of the Code. Proposed §1.451-3(c)(6)
provides that the transaction price is the
gross amount of consideration to which
a taxpayer expects to be entitled for AFS
purposes in exchange for transferring
goods, services, or other property, but not
including, among other things, “increases
in consideration” to which a taxpayer’s
entitlement is contingent on the occur-
rence or nonoccurrence of a future event
for the period in which the amount is con-
tingent.
Commenters expressed confusion
about the phrase “increases in consider-
ation” because the definition of transac-
tion price otherwise refers to “amounts”
and does not distinguish between increas-
es and decreases. Commenters asserted
that there is no reason to treat “increases”
in consideration different from other con-
sideration because all consideration is not
realized until the taxpayer has a fixed right
to payment. Commenters concluded that
any portion of the contract price subject to
a contractual contingency, for example, a
future performance, is excluded from the
transaction price until the contingency is
satisfied. In addition, one commenter not-
ed that it is unclear when there is a con-
tingent “increase” in consideration, and
taxpayers could revise the contract terms
to meet this requirement.
The Treasury Department and the IRS
agree with these comments. The term “in-
creases in consideration” was meant to
signal income items that are subject to a
condition precedent, such as bonus pay-
ments that require complete performance
before the taxpayer is entitled to the bo-
nus payment. The final regulations have
been revised to remove the reference to
“increases in consideration” entirely. The
concept is now subsumed by the general
rule that, to determine when an item of
gross income is “taken into account as
AFS revenue” under the AFS Income In-
clusion Rule, AFS revenue is reduced by
amounts that the taxpayer does not have
an enforceable right to recover if the cus-
tomer were to terminate the contract at the
end of the taxable year. If an amount is
contingent due to a condition precedent,
such as with some bonus payments, and
the taxpayer would not have an enforce-
able right to recover such amount if the
customer were to terminate the contract at
the end of the taxable year, the AFS In-
come Inclusion Rule does not require the
taxpayer to include such amount in gross
income in the current year.
4. Proposed §1.451-3(c)(6)(ii):
Rebuttable presumption
Proposed §1.451-3(c)(6)(ii) provides a
rebuttable presumption that amounts in-
cluded in revenue in an AFS are presumed
to not be contingent on the occurrence or
nonoccurrence of a future event unless,
upon examination of all the facts and
circumstances existing at the end of the
taxable year, it can be established to the
satisfaction of the Commissioner that the

January 19, 2021 402 Bulletin No. 2021–3
amount is contingent on the occurrence or
nonoccurrence of a future event.
Commenters requested that the final
regulations remove the rebuttable pre-
sumption regarding contingent consid-
eration. Commenters reasoned that the
rebuttable presumption imposes a higher
standard of proof upon taxpayers than is
ordinarily required to establish that con-
sideration is contingent. Additionally,
commenters noted that basing the pre-
sumption on the treatment of the consid-
eration for financial reporting purposes
is not sensible because the financial ac-
counting rules do not make the conclusion
dependent on whether the consideration is
or is not contingent on the occurrence or
non-occurrence of a future event. Rather,
under the Financial Accounting Standards
Board (FASB) and International Account-
ing Standards Board,
Accounting Standards Codification
(ASC) Topic 606 and International Fi-
nancial Reporting Standards (IFRS) 15,
Revenue from Contracts with Customers
(collectively, ASC 606), the recognition
of contingent consideration is based on a
determination of the likely outcome of the
contingency. Accordingly, commenters
recommended that the final regulations
eliminate the presumption in favor of non-
contingency.
As noted earlier, the final regulations
have been revised to remove the reference
to “contingent consideration” entirely.
The concept is now subsumed by the gen-
eral rule that, to determine when an item
of gross income is “taken into account as
AFS revenue” under the AFS Income In-
clusion Rule, AFS revenue is reduced by
amounts that the taxpayer does not have
an enforceable right to recover if the cus-
tomer terminates the contract at the end
of the taxable year. Given this change,
the final regulations remove the rebut-
table presumption that a taxpayer has an
enforceable right to amounts included in
AFS revenue.
5. Proposed §1.451-3(c)(6)(ii):
Enforceable right to payment
Commenters requested that the final
regulations clarify or remove the rule in
proposed §1.451-3(c)(6)(ii) that treats
amounts for which the taxpayer has an
“enforceable right to payment” for perfor-
mance completed to date as not contingent
on the occurrence or nonoccurrence of a
future event. First, commenters reasoned
that the rule is ambiguous, resulting in
controversies with exam. Second, com-
menters asserted that, assuming the phrase
“enforceable right to payment” is based on
the financial statement rules in ASC 606,
this standard effectively overrides the tax
realization requirement requiring a fixed,
unconditional right to payment. Further,
commenters reasoned that the rule is in-
consistent with the exception for increases
in consideration to which a taxpayer’s en-
titlement is contingent on the occurrence
or nonoccurrence of a future event.
The Treasury Department and the IRS
agree with these comments. As discussed
earlier, the final regulations modify the
general AFS Income Inclusion Rule by re-
ducing the AFS revenue that is accelerated
and included in gross income. Under the
AFS Income Inclusion Rule, to determine
when the item of gross income is “taken
into account as AFS revenue,” AFS reve-
nue is reduced by amounts that the taxpay-
er does not have an “enforceable right” to
recover if the customer were to terminate
the contract on the last day of the taxable
year. The term “enforceable right” is spe-
cifically defined in §1.451-3(a)(9) as any
right that a taxpayer has under the terms
of a contract or under applicable federal,
state, or international law, including rights
to amounts recoverable in equity or liqui-
dated damages.
6. Proposed §1.451-3(c)(6)(iii):
Reductions for amounts subject to section
461 and disputed income
Proposed §1.451-3(c)(6)(iii) provides
that the “transaction price” does not in-
clude reductions for amounts subject to
section 461, including amounts anticipat-
ed to be in dispute, returns, and rewards
issued in credit card transactions. One
commenter recommended that the final
regulations clarify that rewards issued
in credit card transactions are subject to
section 461 and do not reduce original
issue discount (OID) income in any cir-
cumstance, regardless of the structure of
the credit card program. The commenter
requested this clarification because tax-
payers have taken different positions on
the treatment of these rewards while the
IRS has taken the position that rewards do
not reduce OID income. The commenter
stated that the better approach is to treat
these rewards as liabilities under section
461. The commenter further explained
that treating these rewards as amounts
subject to section 461 in all circumstanc-
es would create uniformity among credit
card issuers, reduce controversy between
taxpayers and the IRS, and ease the com-
pliance burden on taxpayers by eliminat-
ing the need for a facts and circumstances
analysis of each credit card program. The
Treasury Department and the IRS agree
with the commenter and have modified
the final regulations in §1.451-3(b)(2)(i)
(A)(1) to clarify that rewards issued in a
credit card transaction are items subject to
section 461.
Commenters also questioned whether
the AFS Income Inclusion Rule modifies
the treatment of income amounts subject
to an actual dispute or a clerical error
(disputed income amounts). The AFS In-
come Inclusion Rule does not modify the
treatment of disputed income amounts.
The principles set forth in Revenue Rul-
ing 2003-10, 2003-1 C.B. 288, continue
to apply. For example, an accrual method
taxpayer does not accrue gross income in
the taxable year of sale if, during the year
of sale, the customer disputes its liability
to the taxpayer. In addition, if an accrual
method taxpayer overbills a customer due
to a clerical mistake, and the customer dis-
putes the liability in the subsequent tax-
able year, the taxpayer must accrue gross
income in the taxable year of sale for the
correct amount. Lastly, if a taxpayer ships
excess quantities of goods and the cus-
tomer does not dispute the shipment and
agrees to pay for the excess quantities of
goods, the taxpayer accrues gross income
in the amount of the agreed payment in the
taxable year of the sale.
In response to these comments, the fi-
nal regulations clarify that, under the AFS
Income Inclusion Rule, to the extent that
AFS revenue was reduced for amounts
anticipated to be in dispute or anticipat-
ed to be uncollectable, AFS revenue is
increased by such amounts. Accordingly,
although ASC 606 reduces the transaction
price for anticipated disputes to determine
the amount of revenue to include on an
AFS, see ASC 606-10-32-6, AFS revenue
is increased for amounts anticipated to be

Bulletin No. 2021–3 403 January 19, 2021
in dispute or anticipated to be uncollect-
able, because those amounts are included
in gross income until they are actually dis-
puted.
C. Proposed §1.451-3(c)(5): Special
method of accounting
Proposed §1.451-3(c)(5) provides a
non-exhaustive list of examples of special
methods of accounting to which the AFS
Income Inclusion Rule generally does
not apply. Commenters requested that
the final regulations include the methods
of accounting for notional principal con-
tracts under §1.446-3 and the timing rules
for stripped bonds under section 1286 as
examples of special methods of account-
ing. The Treasury Department and the IRS
adopt these comments in the final regula-
tions and have added additional special
methods for clarification purposes. The
list of special methods of accounting re-
mains non-exhaustive.
D. Proposed §1.451-3(d): Exceptions to
the AFS Income Inclusion Rule
Proposed §1.451-3(d) describes the
exceptions to the AFS Income Inclusion
Rule. The proposed rule clarifies that the
AFS Income Inclusion Rule does not ap-
ply unless all of the taxpayer’s entire tax-
able year is covered by an AFS. In addi-
tion, the AFS Income Inclusion Rule does
not cover items of income in connection
with a mortgage servicing contract. A
commenter requested that an exception
be added for any amount that has not yet
been realized for Federal income tax pur-
poses. As discussed earlier, the Treasury
Department and the IRS decline to adopt
this suggestion because providing rules on
realization is beyond the scope of these fi-
nal regulations.
E. Proposed §1.451-3(g): Contracts with
multiple performance obligations
1. Proposed §1.451-3(g): Allocation
of transaction price to contracts with
multiple performance obligations subject
to section 451(b)
Proposed §1.451-3(g) provides that if
a taxpayer’s contract with a customer has
multiple performance obligations subject
to section 451(b), transaction price is allo-
cated to performance obligations as trans-
action price is allocated to performance
obligations in the taxpayer’s AFS.
The final regulations clarify that each
performance obligation yields an item
of gross income that must be accounted
for separately under the AFS Income In-
clusion Rule. When a contract contains
multiple performance obligations, to de-
termine the amount of gross income al-
located to each performance obligation,
the transaction price determined under the
taxpayer’s applicable accounting princi-
ples, is allocated to each corresponding
item of gross income in accordance with
how the transaction price is allocated to
each performance obligation for AFS pur-
poses. If the accounting standards used to
prepare the AFS identify a single perfor-
mance obligation that yields more than
one corresponding item of gross income,
the portion of the transaction price amount
that is allocated to the single performance
obligation for AFS purposes must be fur-
ther allocated among the corresponding
items of gross income using any reason-
able method.
The final regulations simplify the defi-
nition of transaction price. The final reg-
ulations define the term transaction price
to mean the total amount of consideration
to which a taxpayer is, or expects to be,
entitled from all performance obligations
under a contract. The transaction price is
determined under the standards the tax-
payer uses to prepare its AFS. Accord-
ingly, adjustments to the transaction price
that were reflected in the transaction price
definition in the proposed regulations
have, to the extent relevant under these
final regulations, been moved to operative
rules to ensure clarity. See §1.451-3(b)(2)
and (d)(3).
In addition, the final regulations clar-
ify how the transaction price should be
allocated to the extent the transaction
price includes a reduction for liabilities,
amounts anticipated to be in dispute or
anticipated to be uncollectable, or a signif-
icant financing component that is deemed
to exist under the standards the taxpayer
uses to prepare its AFS. The final regu-
lations clarify that the taxpayer must de-
termine the specific performance obliga-
tion to which such reduction relates and
increase the transaction price allocable to
the corresponding item of gross income
by the amount of the reduction (specific
identification approach). If it is impracti-
cable from the taxpayer’s records to use
the specific identification approach, the fi-
nal regulations allow taxpayers to use any
reasonable method to allocate the amount
to the items of gross income in the con-
tract. The final regulations also provide
that a pro-rata allocation of this amount
across all items of gross income under the
contract based on the relative transaction
price amounts allocated to the items for
AFS purposes is a reasonable method.
Similarly, the final regulations clarify
how the transaction price should be allo-
cated if the transaction price was increased
because a significant financing component
is deemed to exist under the standards the
taxpayer uses to prepare its AFS. In this
situation, the taxpayer must determine the
specific performance obligation to which
such amount relates and decrease the
transaction price amount allocable to the
corresponding item of gross income by
such amount (the “specific identification
approach”). If it is impracticable from the
taxpayer’s records to use the specific iden-
tification approach, the taxpayer may use
any reasonable method to allocate such
amount to the items of gross income in
the contract. The final regulations provide
that a pro-rata allocation of such amount
across all items of gross income under the
contract based on the relative transaction
price amounts allocated to the items for
AFS purposes is a reasonable method.
2. Proposed §1.451-3(g): Contracts with
income subject to §1.451-3 and income
subject to a special method of accounting
In the proposed regulations, the Trea-
sury Department and the IRS requested
comments on the allocation of the trans-
action price for contracts that include
both income subject to section 451 and
income subject to a special method of ac-
counting provision, specifically, section
460. A commenter to the proposed regu-
lations suggested that the allocation pro-
visions under section 460 and the regula-
tions thereunder, and not section 451(b)
(4), should control the amount of gross
income from a long-term contract that
is accounted for under section 460. The
commenter noted that using this approach

January 19, 2021 404 Bulletin No. 2021–3
is appropriate in light of section 451(b)
(2), which reflects Congress’s intent to
not disturb the treatment of amounts for
which the taxpayer uses a special method
of accounting.
The Treasury Department and the IRS
believe that a rule is necessary to address
the application of section 451(b)(2) and
(4) to contracts with income that is ac-
counted for in part under §1.451-3 and in
part under a special method of accounting
and suggested rules for public comment in
the preamble of a separate notice of pro-
posed rulemaking published in the Federal
Register on August 5, 2020 (85 FR 47508).
The suggested rules provided that if an ac-
crual method taxpayer with an AFS has a
contract with a customer that includes one
or more items of gross income subject to
a special method of accounting (as de-
fined in proposed §1.451-3(c)(5)) and one
or more items of gross income subject to
section 451, the allocation rules under sec-
tion 451(b)(4) do not apply to determine
the amount of each item of gross income
that is accounted for under the special
method of accounting provision. Rather,
the taxpayer first allocates the transaction
price to the item(s) of gross income sub-
ject to a special method of accounting (as
determined under the special method of
accounting). The remainder of the trans-
action price, the “residual amount”, is
then allocated to the items of gross income
that are subject to §1.451-3. To the extent
the contract contains more than one item
of gross income that is subject to section
451, the residual amount would be allocat-
ed to each such item in proportion to the
amounts allocated to the corresponding
performance obligations for AFS purpos-
es. The Treasury Department and the IRS
requested comments on these suggested
allocation rules. However, no formal com-
ments were received regarding these sug-
gested rules.
The final regulations largely adopt the
rules suggested in the preamble to the sep-
arate notice of proposed rulemaking pub-
lished in the Federal Register on August
5, 2020 (85 FR 47508). Accordingly, the
final regulations provide that the transac-
tion price allocation rule in §1.451-3(d)(1)
does not apply to determine the amount of
each item of gross income that is subject
to a special method of accounting. Rather,
the final regulations provide that the trans-
action price is first allocated to items of
gross income subject to a special method
of accounting, as determined under the
special method of accounting. For this
purpose, a special method of accounting
has the meaning set forth in §1.451-3(a)
(13), except as otherwise provided in
guidance published in the Internal Reve-
nue Bulletin (see §601.601(d)).
To determine the transaction price allo-
cated to items of gross income subject to
a special method of accounting, the tax-
payer must first adjust the AFS transaction
price by the amounts described in the final
paragraph of part II.B.1 of this Summary
of Comments and Explanation of Revi-
sions. Accordingly, if the AFS transaction
price includes a reduction for cost of goods
sold, liabilities, amounts expected to be in
dispute or anticipated to be uncollectible,
or a significant financing component that
exists under the standards the taxpayer
uses to prepare its AFS, the taxpayer must
increase the transaction price amount by
the amount of such reduction. If the AFS
transaction price has been increased be-
cause a significant financing component
exists under the standards the taxpayer
uses to prepare its AFS, the taxpayer must
decrease the transaction price amount by
the amount of such increase.
After the taxpayer makes the adjust-
ments to the transaction price described
earlier, the taxpayer first allocates such
amount to the item(s) of gross income
subject to a special method of account-
ing, and then allocates the remainder
(residual amount) to the item(s) of gross
income that are subject to §1.451-3. If the
contract, contains more than one item of
gross income that is subject to §1.451-3,
the taxpayer allocates the residual amount
to these items in proportion to the amounts
allocated to the corresponding perfor-
mance obligations for AFS purposes or as
otherwise provided in guidance published
in the Internal Revenue Bulletin (see
§601.601(d)).
F. Proposed §1.451-3(i): Special ordering
rule for certain items of income for debt
instruments.
Under proposed §1.451-3(i), if a fee is
not treated by a taxpayer as discount or as
an adjustment to the yield of a debt instru-
ment over the life of the instrument (such
as points) in its AFS, and the fee otherwise
would be treated as creating or increasing
OID for Federal income tax purposes
(specified fee), then the rules in the pro-
posed regulations under section 451(b)
apply before the rules in sections 1271
through 1275 and the corresponding regu-
lations. Proposed §1.451-3(i)(2) provides
three examples of specified fees: credit
card late fees, credit card cash advance
fees, and interchange fees (specified credit
card fees). Interchange fees are sometimes
labeled merchant discount in certain pri-
vate label credit card transactions.
Commenters requested that the final
regulations provide that promotional dis-
count, which also is sometimes labeled
merchant discount, is not a specified fee.
Promotional discount arises when a cred-
it card issuer charges a fee to a merchant
as compensation for accepting a below
market interest rate on a credit card
balance during a promotional period.
Commenters explained that promotional
discount is generally included in income
over a promotional or similar period on
a taxpayer’s AFS and, despite possible
alternative labeling, is, in substance, an
adjustment to the yield of a debt instru-
ment for AFS purposes. The Treasury
Department and the IRS agree that any
fee that adjusts the yield of a debt instru-
ment for AFS purposes over the life of
the instrument or another period should
not be a specified fee. Therefore, the fi-
nal regulations do not include the phrase
“over the life of the instrument” in the
definition of a specified fee but add the
phrase “spread over a period of time” to
clarify the definition. Thus, a fee that ad-
justs the yield of a debt instrument over
a promotional or similar period for AFS
purposes, such as promotional discount,
is not a specified fee under the final reg-
ulations.
One commenter agreed that section
451(b) was not intended to affect the ap-
plication of the general OID timing rules
to OID other than for certain fees that are
not treated as discount for AFS purposes,
including the specified credit card fees.
Accordingly, the commenter agreed with
the rules in proposed §1.451-3(i) and the
inclusion of the general OID timing rules
as a special method of accounting. Except
as provided in the preceding paragraph,
the definition of specified fees in the pro-

Bulletin No. 2021–3 405 January 19, 2021
posed regulations is adopted in the final
regulations.
G. Proposed §1.451-3(k): Cumulative
rule for multi-year contracts
The proposed regulations provide that
for a multi-year contract, a taxpayer must
take into account the cumulative amounts
included in income in prior taxable years
on the contract in order to determine the
amount to be included for the taxable
years remaining in the contract. The pro-
posed regulations contain two examples
that illustrate this rule.
The final regulations clarify that if the
item of gross income from a multi-year
contract is from the sale of an item of
inventory and the taxpayer uses the AFS
cost offset method, the taxpayer must first
determine the “AFS inventory inclusion
amount” for the taxable year. The taxpay-
er determines the AFS inventory inclusion
amount for the taxable year by first taking
the greater of: (1) the cumulative amount
of revenue from the item of inventory that
satisfies the all events test under §1.451-
1(a) through the last day of the taxable
year, less the portion of any advance pay-
ment received that is deferred to a subse-
quent taxable year under §1.451-8, if ap-
plicable, or (2) the cumulative amount of
revenue from the item of inventory that is
treated as taken into account as AFS rev-
enue through the last day of the taxable
year and identifies the larger of the two
amounts or if the two amounts are equal,
the equal amount. The taxpayer then re-
duces such amount by the prior year AFS
inventory inclusion amount for that item
of inventory, if any, to determine the AFS
inventory inclusion amount for the current
taxable year. Lastly, the taxpayer reduces
the AFS inventory inclusion amount for
the taxable year by the cost of goods in
progress offset for the taxable year (which
generally equals the costs of goods in
progress for the item of inventory as of
the end of the year less the portion of such
costs that were taken into account as a cost
of goods in progress offset for a prior tax-
able year). This net amount is the amount
required to be included in gross income in
the taxable year. However, in the taxable
year in which ownership of the item of in-
ventory is transferred to the customer, the
taxpayer performs the same “greater of”
computation noted earlier, but rather than
subtract the prior year AFS inventory in-
clusion amount for the item of inventory
(which is gross of cost offsets) from the
result of the “greater of” computation, the
taxpayer subtracts all prior year gross in-
come inclusions for the item of inventory
from the result of the “greater of” compu-
tation. This net amount is the amount re-
quired to be included in gross income in
the taxable year of ownership transfer. The
effect of this computation is that any reve-
nue reduced by a cost offset in a prior year
is included in gross in the taxable year in
which ownership of the item of inventory
is transferred to the customer. Although
no cost offset is permitted in such year,
the taxpayer would recover costs capital-
ized and allocated to the item of inventory
transferred as cost of goods sold in such
year in accordance with sections 471 and
263A or any other applicable provision of
the Code.
In the case of any other item of gross
income from a multi-year contract, the
taxpayer first compares the cumulative
amount of the item of gross income that
satisfies the all events test under §1.451-
1(a) through the last day of the taxable
year with the cumulative amount of rev-
enue from the item of gross income that
is treated as taken into account as AFS
revenue through the last day of the tax-
able year and identifies the larger of the
two amounts (or, if the two amounts are
equal, the equal amount). The taxpayer
then reduces such amount by all prior year
inclusion amounts attributable to the item
of gross income, if any, to determine the
amount required to be included in gross
income in the current taxable year. Special
coordination rules for applying §1.451-8
are also provided to the extent certain pay-
ments received under a multi-year con-
tract are advance payments. The analysis
in the examples is updated to reflect the
clarifications to the rule.
H. Proposed §1.1275-2(l): OID rule for
income item subject to section 451(b)
Under proposed §1.1275-2(l), notwith-
standing any other rule in sections 1271
through 1275 and §§1.1271-1 through
1.1275-7, if, and to the extent, a taxpay-
er’s item of income for a debt instrument
is subject to the timing rules in proposed
§1.451-3(i) (including credit card late
fees, credit card cash advance fees, or
interchange fees), then the taxpayer does
not take the item into account to determine
whether the debt instrument has any OID.
As a result, the taxpayer does not treat the
item as creating or increasing any OID on
the debt instrument. Commenters agree
with these rules and note that these rules
confirm that the current treatment of items
other than specified fees will not be af-
fected by section 451(b). The commenters
also note that removing specified fees, in-
cluding specified credit card fees, from the
calculation of OID will permit taxpayers
to apply only the rules of section 451(b)
to these fees, without also having to apply
the OID rules, thereby reducing taxpay-
er compliance burdens. Accordingly, the
Treasury Department and the IRS adopt
the rules in proposed §1.1275-2(l) in the
final regulations.
I. Other comments
1. Burial plots and interment rights
Commenters request clarification on
the treatment of income from contracts
with customers for the sale of burial plots
or interment rights, on a pre-need basis
(pre-need contracts). The terms of the pre-
need contracts typically require the cus-
tomer to make an initial down payment
and pay the balance of the sales price
over several years. If the purchaser can-
cels or fails to perform under the contract
before the entire purchase price is paid,
commenters represent that, under every
state law, the taxpayer’s sole remedy is
to keep all or a portion of the installment
payments previously received from the
customer as liquidated damages. Com-
menters highlighted that there may be an
extended period of time between the date
the pre-need contract is executed and the
date the taxpayer collects the full sales
price from the customer.
Commenters represented that ASC 606
requires the entire transaction price from
a pre-need contract, net of costs, to be in-
cluded in revenue in the year in which the
parties execute the contract. However, for
Federal income tax purposes, commenters
requested that the final regulations clari-
fy that taxpayers with pre-need contracts
should not include the unpaid balance

January 19, 2021 406 Bulletin No. 2021–3
of the transaction price in income in the
taxable year the contract is executed un-
der the AFS Income Inclusion Rule. In
commenters’ view, the sale of a burial plot
should not be treated as a completed sale
for tax purposes until the entire sales price
of the burial plot is paid by the customer
and ownership rights in the burial plot are
transferred. Further, the taxpayer does not
have an enforceable right to payment for
the entire transaction price of the plot if
the customer cancels or fails to perform
under the contract.
Commenters concluded that these tax-
payers should be entitled to recover any
allocable cost basis in the burial plot be-
fore including in gross income any of the
installment payments received from the
customer. Commenters viewed the sale
of a burial plot as the sale of an interest
in real property and assert that the basis
recovery rules of sections 1016 and 1001
apply to prepayments for burial plots. Un-
der this approach, prepayments for the
purchase price of a burial plot before the
sale of the plot first decrease the taxpay-
er’s basis in the burial plot. See §1.1016-
2(a). When the prepayments exceed the
taxpayer’s basis in the burial plot, the
taxpayer recognizes the excess amount as
gain. See §1.1001-1(c)(1). Accordingly,
commenters requested that the final reg-
ulations clarify the application of sections
1001 and 1016 to the sale of pre-need
burial plots.
Commenters also requested clarifica-
tion on the income recognition treatment
of pre-need contracts with customers for
the sale of interment rights. Commenters
noted that the ASC 606 treatment for pre-
need contracts for the sale of interment
rights resemble the treatment for pre-need
contracts for the sale of burial rights.
Commenters viewed the receipt of any
installment payments prior to the transfer
of those rights and prior to the payment
of the entire transaction price to be con-
trolled by sections 1001 and 1016, rather
than by sections 451 and 471. Under this
rationale, a taxpayer’s treatment of the
down payment and the installment pay-
ments from pre-need contracts in its AFS
should not determine the timing of income
for tax purposes. Instead, commenters
suggested that the amounts received be-
fore the transfer of the interment rights
should be viewed as a return of capital and
a reduction in the taxpayer’s basis in the
interment space.
The IRS and the Treasury Department
agree that the sale of burial plots and in-
terment rights are governed by sections
1001 and 1016 but consider the determi-
nation of whether a sale has occurred to be
a factual issue. If a sale has occurred under
the facts and circumstances, any income
resulting from the sale is realized under
section 1001 and the right to the income is
fixed, therefore the AFS Income Inclusion
Rule does not result in the acceleration of
AFS revenue. If the sale has not occurred,
and the right to the future payments is
extinguished if the customer cancels the
contract, the AFS Income Inclusion Rule
does not require acceleration because
there is no enforceable right to the future
payments if the contract is cancelled by
the customer provided that the taxpayer
is not using the alternative AFS revenue
method in §1.451-3(b)(2)(ii).
2. Book percentage-of-completion
method (Book PCM)
One commenter expressed interest in a
Book PCM option as a special method of
accounting that taxpayers with contracts
accounted for using an over-time method
of accounting for revenue under ASC 606
could elect to include the full amount of
revenue reported on its AFS without re-
gard to any offset or exception provided in
these regulations, but with an offset for the
allocable costs reported on its AFS, with
some potential tax adjustments. Under
ASC 606, the over-time method, where
taxpayers recognize revenue over time (as
opposed to at a point in time) is used for
the following contracts where control over
promised goods or services is transferred
over time: (1) where the customer controls
the asset as it is created or enhanced by the
entity’s performance under the contract;
(2) where the customer receives and con-
sumes the benefits of the entity’s perfor-
mance as it performs under the contract;
or (3) where the entity’s performance cre-
ates or enhances an asset that has no al-
ternative use to the entity, and the entity
has the right to receive payment for work
performed to date and expects to fulfill the
contract as promised. An entity using an
“over-time method” recognizes revenue
using either: (1) an output method, which
measures the value of the goods and ser-
vices transferred to date to the customer
(for example, units produced); or (2) an
input method, which recognizes revenue
based on the entity’s efforts or inputs (for
example, labor hours expended, costs in-
curred) as compared to the expected total
costs to satisfy the performance obliga-
tion.
Other commenters expressed con-
cern about allowing a Book PCM option.
Some commenters suggested that limiting
a Book PCM option to only taxpayers that
must report revenue on a particular over-
time basis, such as an input cost-incurred
method, could create more complexity,
not less. Other commenters suggested
that, while a Book PCM option might
achieve some book-tax conformity, they
would still want the opportunity to take
advantage of tax rules that provide more
beneficial timing than available under
Book PCM, such as additional first year
depreciation. The Treasury Department
and the IRS will continue studying the fea-
sibility and efficacy of an optional Book
PCM approach. At this time, however, the
Treasury Department and the IRS decline
to adopt the Book PCM option set forth
by commenters because of the concerns
raised regarding the complexity and the
desire by some taxpayers to obtain more
beneficial timing under tax rules when us-
ing a Book PCM method.
3. AFS Issues
No formal comments were received re-
garding the definition of AFS in proposed
§1.451-3(c)(1). Accordingly, the defini-
tion of AFS remains largely unchanged
in these final regulations. See §1.451-3(a)
(5). One commenter questioned the stat-
utory language in section 451(b) regard-
ing financial statements prepared using
international financial reporting standards
(IFRS). Specifically, section 451(b)(3)(B)
provides that a financial statement made
on the basis of IFRS is an AFS for sec-
tion 451(b) if the financial statement is
filed with a foreign government agency
that is equivalent to the United States Se-
curities and Exchange Commission (SEC)
and has financial reporting standards not
less stringent than the standards imposed
by the SEC. Proposed §1.451-3(c)(1)(iii)
(A) and the final regulations §1.451-3(a)

Bulletin No. 2021–3 407 January 19, 2021
(5)(ii)(A) mirror the statutory language.
The commenter questioned whether the
requirement in section 451(b)(3)(B) that
the financial reporting standards of a for-
eign agency or government be not less
stringent than the standards required by
the SEC, refers solely to reporting stan-
dards related to revenue or if it also refers
to reporting standards for other items that
are not related to revenue. The statutory
language does not distinguish the report-
ing standards between revenue and other
items that are not related to revenue. Ad-
ditionally, Revenue Procedure 2004-34,
which was the model for the definition
of AFS in section 451(b)(3), did not have
similar language. Accordingly, based on
the plain language of the statute, if the
financial reporting standard for any item
is less stringent than SEC reporting stan-
dards, even if that standard does not relate
to revenue reporting, the statement will
not be an AFS under proposed §1.451-3(c)
(1)(iii)(A) or §1.451-3(a)(5)(ii)(A) of the
final regulations. However, the financial
reporting standards relativity requirement
does not prevent the IFRS financial state-
ments from qualifying as an AFS under
proposed §1.451-3(c)(1)(iii)(B) or (C) or
§1.451-3(a)(5)(ii)(B) or (C) of the final
regulations.
No formal comments were received
regarding the AFS issues addressed in
proposed §1.451-3(h)(1). Accordingly,
the rules regarding an AFS that covers a
group of entities (consolidated AFS rules)
and mismatched reporting periods remain
largely unchanged in these final regula-
tions. However, the Treasury Department
and the IRS are aware of questions regard-
ing the application of certain aspects of the
consolidated AFS rules. Under proposed
§1.451-3(h)(1)(i), if a taxpayer’s results
are reported on the AFS for a group of
entities, the taxpayer’s AFS is the group’s
AFS. Proposed §1.451-3(h)(3) provides
that if a group’s AFS does not separate-
ly state items, the portion of the revenue
allocable to the taxpayer is determined by
relying on the source documents that were
used to create the group’s AFS.
Under the proposed regulations, it was
unclear whether the portion of the AFS
revenue allocable to the taxpayer includes
amounts that are subsequently eliminated
in the group’s AFS (consolidated AFS).
Accordingly, the final regulations clarify
that, if the consolidated AFS does not sep-
arately state items, the portion of the AFS
revenue allocable to the taxpayer is deter-
mined by relying on the taxpayer’s sepa-
rate source documents used to create the
consolidated AFS and includes amounts
that are subsequently eliminated in the
consolidated AFS.
III. Comments and revisions regarding
§1.451-8
A. Proposed §1.451-8(b)(1)(i): Definition
of advance payment
1. Prepayments for pre-need burial plots
Under section 451(c)(4)(A), the term
advance payment means any payment that
meets the following three requirements:
(1) the full inclusion of the payment in
gross income in the year of receipt is a
permissible method of accounting; (2) any
portion of the advance payment is includ-
ed in revenue in an AFS for a subsequent
tax year; and (3) the advance payment is
for goods, services, or such other items
that the Secretary has identified. Proposed
§1.451-8(b)(1)(i) largely mirrors the defi-
nition of an advance payment in section
4.01 of Revenue Procedure 2004-34,
which expands upon the goods, services,
and other items for which a payment can
qualify as an advance payment.
One commenter requested that the Sec-
retary exercise the authority to broaden
the definition of advance payment to in-
clude prepayments for the sale of an in-
terest in real property, including pre-need
burial plots. If the comment is adopted,
prepayments for pre-need burial plots
would be eligible for the one-year deferral
of income.
Commenters agreed that taxpayers in
the death care industry uniformly treat the
entire amount of the sales price for pre-
need burial plots as income on an AFS in
the year the pre-need contract is executed.
To qualify as an advance payment, a por-
tion of the prepayment must be included
in revenue by the taxpayer in an AFS for
a subsequent taxable year. Section 451(c)
(4)(A)(ii). Since prepayments for pre-
need burial plots cannot meet this require-
ment, these prepayments cannot qualify
as advance payments. For this reason, the
Treasury Department and the IRS decline
to adopt this comment in the final regula-
tions.
No other requests were received to ex-
pand the definition of advance payment.
Accordingly, the list of items that are in-
cluded in the definition of advance pay-
ment under proposed §1.451-8(b)(1)(i) is
unchanged.
2. Amount of payment included in AFS
revenue in a subsequent year
Under section 451(c)(4)(A) and pro-
posed §1.451-8(a)(1)(i), for a payment
to qualify as an advance payment, a por-
tion of the payment must be included in
revenue in an AFS for a subsequent tax
year. The final regulations clarify that to
determine the amount of the payment that
is taken into account as AFS revenue, the
taxpayer must adjust AFS revenue for any
amounts described in §1.451-3(b)(2)(i)
(A), (C), and (D). As a result, to the extent
that AFS revenue in the taxable year of re-
ceipt reflects, for example, a reduction for
liabilities that are required to be accounted
for under provisions such as section 461
or amounts anticipated to be in dispute,
AFS revenue in the taxable year of receipt
must be increased by such amounts.
The final regulations make similar
clarifying changes to the deferral method
for taxpayers with an AFS in §1.451-8(c).
Under §1.451-8(c), a taxpayer that uses
the deferral method must include all or a
portion of the advance payment in gross
income in the taxable year of receipt to
the extent “taken into account as AFS rev-
enue” as of the end of the taxable year of
receipt, and include the remaining portion
of the advance payment in gross income in
the following taxable year. To determine
the extent that an advance payment is treat-
ed as “taken into account as AFS revenue”
as of the end of the taxable year of receipt,
the taxpayer must adjust AFS revenue by
the amounts described in §1.451-3(b)(2)
(i)(A), (C), and (D). Accordingly, to the
extent that AFS revenue reflects a reduc-
tion for liabilities that are accounted for
under other provisions of the Code such
as section 461 or amounts anticipated to
be in dispute, AFS revenue is increased by
such amounts. Further, if the transaction
price, as defined in §1.451-3(a)(14), was
increased because a significant financing
component is deemed to exist under the

January 19, 2021 408 Bulletin No. 2021–3
standards the taxpayer uses to prepare its
AFS, then any AFS revenue attributable to
such increase is disregarded.
B. Proposed §1.451-8(b)(1)(ii)(H):
Specified Good Exception
Proposed §1.451-8(b)(1)(ii) lists ex-
ceptions to the definition of an advance
payment. Specifically, proposed §1.451-
8(b)(1)(ii)(H) provides that an advance
payment does not include a payment re-
ceived in a taxable year earlier than the
taxable year immediately preceding the
taxable year of the contractual deliv-
ery date for a specified good. Proposed
§1.451-8(b)(8) defines the “contractual
delivery date” as the month and year of
delivery listed in the written contract to
the transaction. A “specified good” is
defined in proposed §1.451-8(b)(9) as
a good for which: (1) the taxpayer does
not have the goods of a substantially
similar kind and in a sufficient quantity
at the end of the taxable year the upfront
payment is received; and (2) the taxpay-
er recognizes all of the revenue from the
sale of the good in its AFS in the year of
delivery. If the prepayment satisfies the
specified good exception, the prepay-
ment is analyzed under section 451(b)
and §1.451-1.
1. Contractual delivery date requirement
Some commenters generally request-
ed that the Treasury Department and the
IRS re-examine the contractual delivery
date requirement. One commenter re-
quested that the definition of contractu-
al delivery date be broadened to include
contracts where the delivery date can
be reasonably determined based on all
the facts and circumstances as provided
in the contract. Another commenter re-
quested that the exception be modified to
cover any contract for the sale or produc-
tion of goods where, based on all of the
facts and circumstances, it is reasonably
certain that the taxpayer’s performance
to which the advance payment relates
will in fact take place. The same com-
menter also suggested that if the defini-
tion of the contractual delivery date was
broadened, the requirement regarding the
period of time between when an advance
payment is received and the delivery date
for a specified good could be modified to
require that the expected delivery date
occur more than 24 months after the ad-
vance payment is received.
The Treasury Department and the IRS
decline to adopt the comments to broad-
en the definition of contractual delivery
date in the final regulations because the
suggested approaches would decrease ad-
ministrability and increase uncertainty for
taxpayers and the potential for litigation.
Therefore, the definition of contractual
delivery date in the final regulations con-
tinues to be limited to situations where the
written contract provides the month and
year of delivery for the goods.
In addition, because the Treasury De-
partment and the IRS are not broaden-
ing the definition of contractual delivery
date, it is not necessary to limit the spec-
ified good exception to situations where
there is more than 24 months between the
date the advance payment is received and
the contractual delivery date. The rec-
ommended rule is more restrictive than
the rule in the proposed regulation which
requires the payment to be received in a
taxable year earlier than the taxable year
immediately preceding the taxable year
of the contractual delivery date. Accord-
ingly, the Treasury Department and the
IRS decline to adopt this recommenda-
tion.
2. Requirement that AFS revenue must be
recognized in the year of delivery
One commenter questioned why the
specified good exception in the proposed
section 451(c) regulations is restricted to
situations where all the revenue from the
sale of the good is recognized in the tax-
payer’s AFS in the year of delivery. The
commenter requested that the exception
be expanded to include situations where
the taxpayer recognizes the revenue for
Federal income tax purposes no later than
the time when the revenue related to the
production of the goods is recognized for
financial accounting purposes. As a result,
taxpayers using the over-time method to
report revenue under ASC 606 could be
eligible for the exception.
Payments that qualify for the specified
good exception are subject to the general
accrual method of accounting rules under
section 451(a) and (b), including the all
events test under section 451(b)(1)(C)
and §1.451-1(a) and the existing case
law that addresses the all events test. The
specified good exception was narrowly
crafted to allow a taxpayer meeting the
requirements to evaluate its treatment of
qualifying payments under the all events
test under section 451(b)(1)(C) and
§1.451-1(a) and the existing case law that
addresses the all events test. Taxpayers
that meet the specified good exception
criteria, unlike those taxpayers that use
the over-time method to report revenue
from the sale of goods under ASC 606,
are generally not required to test the pay-
ment for inclusion under the AFS income
inclusion rule in section 451(b)(1)(A), as
the payment is not taken into account as
AFS revenue until the specified good is
delivered to the customer, and is only re-
quired to analyze the payment for inclu-
sion under the all events test in section
451(b)(1)(C). Additionally, taxpayers
that use the over-time method under ASC
606 generally incur production costs as
AFS revenue is recognized and can there-
fore benefit from the advance payment
cost offset method under §1.451-8(e).
However, taxpayers that use the point-in-
time method to report revenue from the
sale of goods under ASC 606 and that
meet the rest of the specified good ex-
ception criteria generally don’t incur pro-
duction costs until closer to the delivery
date and may not be able to benefit from
the advance payment cost offset method
under §1.451-8(e). For these reasons, the
Treasury Department and the IRS decline
to expand the specified good exception to
situations where taxpayers are using the
over-time method to report revenue un-
der ASC 606.
For this reason, the Treasury Depart-
ment and the IRS do not adopt this com-
ment. Therefore, the definition of specified
good in the final regulations retains the re-
quirement that the taxpayer recognizes all
of the revenue from the sale of the good in
its AFS in the year of delivery.
3. Integral services
A commenter requested that the defi-
nition of “specified good” in proposed
§1.451-8(b)(8) be expanded to include
“integral services” furnished for the
good. However, the commenter provided

Bulletin No. 2021–3 409 January 19, 2021
no definition of integral services, a term
which could be broadly construed result-
ing in audit controversies. Moreover, the
Conference Report expresses Congress’
intent for section 451(c) to override former
§1.451-5, which defined an advance pay-
ment to include prepayments for services
that were integral to the sale or disposition
of goods. See H.R. Rep. No. 115-466, at
429 fn. 880 (2017) (Conf. Rep.). For these
reasons, the Treasury Department and the
IRS decline to accept this comment.
4. Reasonable estimate of unused net
operating loss (NOL)
One commenter requested that, if cer-
tain proposed changes to the specified
good exception are not adopted, the Trea-
sury Department and the IRS should in-
clude an exclusion to the definition of “ad-
vance payment” for prepayments where
the taxpayer reasonably estimates, based
on the facts at the time the agreement is
entered into, that it will have a NOL that
remains unused for the 5-year period after
the year the prepayments received are in-
cluded in the taxpayer’s taxable income.
The requested rule would be difficult to
administer because it requires a taxpayer
to estimate that it will have an NOL that
remains unused for a 5-year period after
the advance payments are included in
gross income. Accordingly, the Treasury
Department and the IRS decline to adopt
this comment in the final regulations.
5. Tax consequences of meeting the
specified good exception
Several commenters provided exam-
ples in which payments that qualify for
the specified good exception in proposed
§1.451-8(a)(1)(ii)(H) are deferred and in-
cluded in gross income when the payment
is recognized as revenue in the taxpayer’s
AFS in the year the good is delivered. As
mentioned in part III.B.2 of this Summa-
ry of Comments and Explanation of Re-
visions and for additional clarification,
payments that qualify for the specified
good exception are subject to the general
accrual method of accounting rules under
section 451(a) and (b), including the all
events test under section 451(b)(1)(C) and
§1.451-1 and the existing case law that ad-
dresses the all events test.
6. Method to treat prepayments satisfying
the specified good exception as advance
payments
One commenter asked that the spec-
ified good exception be made optional,
particularly if meeting the specified good
exception does not result in deferral of the
prepayment to match the book timing of
the payment. The commenter noted that
some taxpayers may prefer the section
451(c) regime, especially if there is some
uncertainty whether the contract meets the
specified good exception. Further, some
taxpayers that had the choice of a longer
deferral under §1.451-5 or a one-year de-
ferral under Revenue Procedure 2004-34
still chose the 1-year deferral.
The Treasury Department and the IRS
agree with this comment. Accordingly, the
final regulations allow taxpayers to treat
all prepayments that satisfy the specified
good exception as advance payments sub-
ject to section 451(c), the “specified good
section 451(c) method.” See §1.451-8(f).
The requested election provides flexibility
for taxpayers. If the taxpayer does not use
the specified good section 451(c) method,
payments satisfying the specified good
exception are not eligible for the deferral
method provided in section 451(c) and
§1.451-8 but are subject to section 451(b)
and §1.451-1(a). If the taxpayer uses the
specified good section 451(c) method, the
prepayment is generally deferred for one
year; however, if a taxpayer also uses the
advance payment cost offset method un-
der §1.451-8(e) to account for such pre-
payments, a portion of the prepayment
may be deferred until the year in which
ownership of the good is transferred to the
customer.
The specified good section 451(c)
method is a method of accounting. The
method applies to all payments that satisfy
the specified good exception that are re-
ceived by each trade or business that uses
the method. The use of this method results
in the adoption of, or a change in, a meth-
od of accounting under section 446. See
§1.451-8(g).
C. Proposed §1.451-8(c)(2)(i)(B):
Acceleration of Advance Payments
Under proposed §1.451-8(c)(2)(i)(B),
a taxpayer that uses the deferral method
generally includes an advance payment in
gross income when it satisfies its obliga-
tion for the advance payment. Example 11
of proposed §1.451-8(c)(8)(xi) provides
an example of a travel agent that received
commission income when it purchased
and delivered the ticket to the customer
but did not include the commission in rev-
enue in its AFS until the following year.
The example concludes that the commis-
sion is not an advance payment because it
was not earned by the taxpayer in a subse-
quent taxable year.
Example 11 incorrectly concludes that
the payment for the commission is not an
advance payment. The payment for the
commission income is an advance pay-
ment because it meets the definition of an
advance payment under section 451(c)(4),
including the requirement that a portion of
the payment is included in the taxpayer’s
revenue in an AFS for a subsequent taxable
year. However, the commission income is
included in income in the year of receipt
because the taxpayer’s obligation with
respect to the advance payment was satis-
fied in that year. Accordingly, in the final
regulations, this example has been moved
and revised into an example of the rules on
the acceleration of advance payments. In
addition, the analysis has been changed to
clarify that (1) the commission income is
an advance payment, and (2) the taxpayer’s
satisfaction of its obligation for the advance
payment caused the commission to be in-
cluded in income in the year of receipt.
D. Proposed §1.451-8(c)(5): Contracts
with Multiple Performance Obligations
Section 451(c)(4) provides that for pur-
poses of the rules for advance payments,
rules similar to the rules in section 451(b)
(4), which allocate transaction price
among multiple performance obligations,
apply. Proposed §1.451-8(c)(5) provides
rules for taxpayers with an AFS for allo-
cating the transaction price when there is
more than one performance obligation in
a contract. Specifically, those taxpayers
allocate the transaction price based on the
method in proposed §1.451-3(g), namely,
using the allocation in the taxpayer’s AFS.
No formal comments were received on
this provision.
Under the proposed regulations it was
not clear whether the taxpayer was re-

January 19, 2021 410 Bulletin No. 2021–3
quired to allocate the payment to multiple
performance obligations based on their
relative transaction price or based on the
payment allocation used for AFS purpos-
es. Accordingly, the final regulations clar-
ify that advance payments received under
a contract with multiple performance obli-
gations are allocated to the corresponding
item of gross income in the same manner
that the payments are allocated to the per-
formance obligations in the taxpayer’s
AFS. This rule is consistent with the re-
quirement in section 451(c)(4)(D) that
“rules similar to the rules in [section 451]
(b)(4) shall apply,” because it follows the
manner in which the taxpayer allocates
the payment for AFS purposes.
The rule for taxpayers without an AFS
remains unchanged. See §1.451-8(d)(4).
2. Proposed §1.451-8(c)(6): Contracts
with advance payments that include items
subject to a special method of accounting.
The proposed regulations requested
comments on the allocation of a payment
when the contract includes income sub-
ject to section 451(c) and income subject
to section 460, but no comments were re-
ceived.
Consistent with the objective crite-
ria standard under Section 5.02(4) of
Rev. Proc. 2004-34, the final regulations
provide that if (1) a contract with a cus-
tomer includes item(s) of gross income
subject to a special method of accounting
and item(s) of gross income described in
§1.451-8(a)(1)(i)(C), and (2) the taxpay-
er receives an allocable payment, then the
taxpayer must determine the portion of the
payment allocable to the items of gross
income described in §1.451-8(a)(1)(i)(C)
based on objective criteria. The taxpayer
is deemed to satisfy the objective criteria
standard when it allocates the payment to
each item of gross income in proportion
to the amounts determined in §1.451-3(d)
(5) or as otherwise provided in guidance
published in the Internal Revenue Bulletin
(see §601.601(d)).
This rule is consistent with the require-
ment in section 451(c)(4)(D) that “rules
similar to the rules in [section 451](b)(4)
shall apply.” The final regulations also
provide a similar allocation rule for tax-
payers using the non-AFS deferral meth-
od.
E. Cost offset for advance payments
The proposed regulations do not pro-
vide for a cost offset. The preamble to the
proposed regulations explains the ratio-
nale for rejecting a cost offset and requests
comments on this issue.
As they did with respect to the pro-
posed section 451(b) regulations, com-
menters requested that the final regula-
tions under section 451(c) provide a cost
offset, such as a COGS offset for expected
future costs against advance payments for
the sale of goods. Commenters asserted
that a COGS offset is supported by the
definition of “receipt” in section 451(c)(4)
(C), which refers to an “item of gross in-
come.” Under section 61 and §1.61-3(a),
for the sale of goods, an item of gross in-
come generally means total sales revenue
minus the cost of goods sold. Commenters
cited Hagen Advertising Displays, Inc. v.
Commissioner, 407 F.2d 1105 (6th Cir.
1969), as support for this position. In Ha-
gen Advertising, the Sixth Circuit Court of
Appeals acknowledged that, to determine
the proper amount of gross income for ad-
vance payments for the sale of goods to be
delivered in the future, it would be appro-
priate for a taxpayer to reduce the amount
of the advance payment by the estimated
cost of the goods to be delivered. Other-
wise, denying an offset for related COGS
would tax the return of capital. Id. at 1110.
Accordingly, commenters asserted that
denying a COGS offset could result in an
impermissible tax on gross receipts.
Commenters also asserted that not al-
lowing a cost offset could result in a mis-
match of revenue and costs and fails to
clearly reflect income. According to com-
menters, a taxpayer would be required
to report the full amount of an advance
payment in income, in excess of the ex-
pected profit associated with that portion
of the total contract price being report-
ed. When the costs are actually incurred
in subsequent years, the taxpayer would
report losses with no associated revenue,
which, in extreme cases where the losses
cannot be used, could result in a perma-
nent loss of the tax benefit of the cost. For
a limited-life business, the acceleration of
revenue recognition may result in NOLs
that are permanently lost, as expenses
trail income throughout the life cycle of
the business. The commenters pointed out
that this mismatch of income and associ-
ated costs does not reflect the reality of the
overall amount of gross income realized
by the taxpayer on the contract as a whole.
Further, commenters reasoned that al-
lowing a cost offset under section 451(c)
will not violate the economic performance
requirement of section 461(h). Since the
acceleration of advance payments under
section 451(c) is a departure from accrual
method accounting, the costs related to the
payments should also depart from accru-
al method concepts. Commenters pointed
out that the allowance of a cost offset for
expected future COGS against substantial
advance payments under former §1.451-
5(c), based on Hagen Advertising, coexist-
ed with section 461(h) for over 33 years.
In addition, the purpose of section 461(h)
was not to eliminate an offset for estimat-
ed COGS for inventory to be delivered in
the near future, but to defer a deduction
for costs where the obligation was fixed
but was going to be performed many years
in the future. Here, commenters asserted
that a COGS offset would help to deter-
mine the proper amount of gross income
to be accelerated, which is not what the
economic performance requirement was
intended to prevent.
Commenters also reasoned that section
451(c) was not meant to codify all aspects
of Revenue Procedure 2004-34, including
the lack of a cost offset in Revenue Pro-
cedure 2004-34. Announcement 2004-48,
2004-1 C.B. 998, explains that a COGS
offset was not permitted in Revenue Pro-
cedure 2004-34 because it was inconsis-
tent with the simplification that the reve-
nue procedure was meant to achieve, and
taxpayers could still qualify for a COGS
offset under former §1.451-5(c). Com-
menters also found it significant that the
term “receipt” in section 451(c) uses the
specific term “an item of gross income,”
while the definition of received in Reve-
nue Procedure 2004-34 uses the general
term “income.”
The Treasury Department and the IRS
have considered these comments and have
determined that a cost offset based on
estimates of future costs would be inap-
propriate. As discussed in the preamble to
the proposed section 451(c) regulations,
allowing a cost offset based on estimated
costs would be inconsistent with sections
461, 263A, and 471, and the regulations

Bulletin No. 2021–3 411 January 19, 2021
under those sections of the Code and dif-
ficult for the IRS to administer. Addition-
ally, allowing a cost offset based on esti-
mated costs is inconsistent with Congress’
intent to override former §1.451-5(c). For-
mer §1.451-5(c) permitted a cost offset for
both incurred and estimated costs against
certain advance payments that were re-
quired to be included in gross income in
a taxable year prior to the year in which
ownership of the item of inventory was
transferred to the customer, and was re-
cently withdrawn in final regulations pub-
lished in the Federal Register on July 15,
2019. See H.R. Rep. No. 115-466, at 429
fn. 880 (2017) (Conf. Rep.); see also, 84
FR 33691 (July 15, 2019). However, the
Treasury Department and the IRS agree
with comments suggesting that taxpayers
should be afforded the flexibility of ap-
plying an offset for costs incurred against
advance payments for the future sale of
inventory. In this case, the final regula-
tions provide that a taxpayer determines
the amount of the advance payment that
is included in gross income for the taxable
year by reducing the amount that would
otherwise be included in gross income for
such taxable year under the taxpayer’s full
inclusion method or deferral method, as
applicable (advance payment inventory
inclusion amount) by the cost of goods
related to the item of inventory, the “cost
of goods in progress offset.” The method
allows taxpayers to offset advance pay-
ments included in income under either the
full inclusion method or under the defer-
ral method. The portion of any advance
payment that is offset by a cost of goods
in progress offset for a taxable year is de-
ferred and generally included in gross in-
come in the taxable year in which owner-
ship of the item of inventory is transferred
to the customer.
Specifically, the final regulations pro-
vide that the cost of goods in progress
offset for an item of inventory for each
taxable year is calculated as the cost of
goods incurred for such item through the
last day of the taxable year, reduced by the
cumulative cost of goods in progress off-
set amounts in prior taxable years, if any.
However, the cost of goods in progress
offset cannot reduce the advance payment
inventory inclusion amount for the taxable
year below zero. Further, the cost of goods
in progress offset attributable to one item
of inventory cannot reduce the advance
payment inventory inclusion amount at-
tributable to a separate item of inventory.
Any incurred costs that were not used to
offset the advance payment for the item
of inventory because they were subject to
limitation are considered when the taxpay-
er determines the cost of goods in progress
offset in a subsequent taxable year. In ad-
dition, the cost of goods in progress offset
does not apply to the advance payment
inventory inclusion amount that is includ-
ed in gross income as a result of the ac-
celeration rules in §1.451-8(c)(4), and any
advance payments previously deferred by
way of a cost of goods in progress offset
in a prior year are accelerated under such
rule.
The cost of goods in progress offset is
determined by reference to the costs and
expenditures related to items of invento-
ry produced or acquired for resale, which
costs have been incurred under section
461 and have been capitalized and in-
cluded in inventory under sections 471
and 263A or any other applicable provi-
sion of the Code as of the end of the year.
The taxpayer must be able to demonstrate
that the costs are properly capitalizable
under the Code to the items of inventory
produced or acquired for resale under the
contract to which the taxpayer is applying
the cost of goods in progress offset. For
a sale of a gift card or customer reward
program points, this requirement cannot
be met, and no cost of goods in progress
offset is permitted. However, the cost of
goods in progress offset does not reduce
the costs that are capitalized to the items
of inventory produced or acquired for re-
sale by the taxpayer under the contract.
That is, while the cost of goods in progress
offset reduces the amount of the advance
payment included in income, it does not
affect how and when costs are capitalized
to inventory under sections 471 and 263A
or any other applicable provision of the
Code or when those capitalized costs will
be recovered.
The costs of goods comprising the
cost of goods in progress offset must be
determined by applying the taxpayer’s in-
ventory accounting methods. A taxpayer
must calculate its cost of goods in prog-
ress offset by reference to all costs that the
taxpayer has permissibly capitalized and
allocated to items of inventory under its
method of accounting for inventories for
federal income tax purposes, but may not
consider costs that are not properly capi-
talized under such method.
The Treasury Department and the IRS
provided this cost offset method in the fi-
nal regulations because it provides a rea-
sonable matching of income from advance
payments and incurred cost of goods, and
more clearly reflects income. The advance
payment cost offset method is a method of
accounting that applies to all advance pay-
ments received by a trade or business for
items of inventory that satisfy the criteria
in §1.451-8(e). If a taxpayer chooses to
use the advance payment cost offset meth-
od for a trade or business, it must also use
the AFS cost offset method in §1.451-3(c)
for that trade or business. See prior dis-
cussion regarding coordination between
the AFS cost offset method and the ad-
vance payment cost offset method. Addi-
tional guidance on the cost offset method
for advance payments may be provided in
guidance published in the Internal Reve-
nue Bulletin (see §601.601(d)).
F. Continued application of Revenue
Procedure 2004-32 and Revenue
Procedure 79-38
Commenters requested clarification
of whether Revenue Procedure 2004-32,
2004-1 C.B. 988, and Revenue Procedure
79-38, 1997-2 C.B. 501, remain in effect
after the enactment of section 451(c).
Revenue Procedure 2004-32 allows an
accrual method taxpayer to account for
income from credit card annual fees rat-
ably over the period covered by the fees,
as described in section 4 of Revenue Pro-
cedure 2004-32. Revenue Procedure 79-
38 generally allows accrual method man-
ufacturers, wholesalers, and retailers of
motor vehicles or other durable goods to
include a portion of an advance payment
related to the sale of a multi-year service
warranty contract in gross income over
the life of the service warranty obligation.
Revenue Procedure 2004-32 and Revenue
Procedure 79-38 remain effective after the
enactment of section 451(c) and may be
relied upon after these regulations are fi-
nalized.

January 19, 2021 412 Bulletin No. 2021–3
Effect on other documents
The preamble to proposed §1.451-3 re-
quested comments on the proposed obso-
lescence of Revenue Procedure 2004-33,
2004-1 C.B. 989 (relating to credit card
late fees), Revenue Procedure 2005-47,
2005-2 C.B. 269 (relating to credit card
cash advance fees), Revenue Procedure
2013-26, 2013-22 I.R.B. 1160 (relating
to a safe harbor method of accounting for
OID on a pool of credit card receivables),
and Chief Counsel Notice CC-2010-018
(relating to interchange). Instead of ob-
soleting Revenue Procedure 2013-26,
commenters recommended limiting the
scope of Revenue Procedure 2013-26
to OID that is not subject to the timing
rules in proposed §1.451-3(i) and thus,
not excluded from the OID rules under
proposed §1.1275-2(l). Commenters ex-
plained that retaining Revenue Procedure
2013-26 would allow taxpayers to con-
tinue to use the proportional method de-
scribed in the revenue procedure as a safe
harbor method of accounting for certain
amounts that are not OID under section
1272, such as bond premium and market
discount, as well as certain kinds of OID
such as promotional discount. See dis-
cussion of promotional discount in part
II.F. of the Summary of Comments and
Explanation of Revisions. The Treasury
Department and the IRS agree with the
recommendations not to obsolete Reve-
nue Procedure 2013-26. In addition, the
Treasury Department and the IRS intend
to modify Revenue Procedure 2013-26
to make clear that the safe harbor meth-
od does not apply to any specified fees,
including the specified credit card fees.
However, based on section 451(b) and
the final regulations, Revenue Procedure
2004-33, Revenue Procedure 2005-47,
and Chief Counsel Notice CC-2010-018
no longer provide current guidance on
the treatment of the specified credit card
fees. Accordingly, these items are obso-
lete as of January 1, 2021.
In addition, Revenue Procedure 2004-
34, Revenue Procedure 2011-18, Revenue
Procedure 2013-29 and Notice 2018-35
are obsolete for taxable years beginning
on or after January 1, 2021. Taxpayers
that relied on the now obsoleted guid-
ance should determine whether a change
in method of accounting occurs once they
cease to use the obsoleted guidance.
Applicability dates
In general, the rules in §§1.451-3 and
1.451-8 apply for taxable years beginning
on or after January 1, 2021. However,
the rules in §1.451-3(j) for specified fees
that are not specified credit card fees ap-
ply for taxable years beginning on or af-
ter January 6, 2022. Also, for a specified
credit card fee as defined in §1.451-3(j)
(2), §1.1275-2(l)(1) applies for taxable
years beginning on or after January 1,
2021, and, for a specified fee that is not a
specified credit card fee, §1.1275-2(l)(1)
applies for taxable years beginning on or
after January 6, 2022.
However, pursuant to section 7805(b)
(7), taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b), may apply the rules in these final
regulations, in their entirety and in a con-
sistent manner, to a taxable year beginning
after December 31, 2017, and before Janu-
ary 1, 2021, provided that, once applied to
such a taxable year, such rules are applied
in their entirety and in a consistent manner
to all subsequent taxable years. Notwith-
standing the preceding sentence, pursuant
to section 7805(b)(7), taxpayers and their
related parties, within the meaning of sec-
tions 267(b) and 707(b), may apply the
rules in these final regulations that apply
to specified credit card fees in their entire-
ty and in a consistent manner, to a taxable
year beginning after December 31, 2018,
and before January 1, 2021, provided that,
once applied to such a taxable year, such
rules are applied in their entirety and in a
consistent manner to all subsequent taxable
years. Taxpayers that choose to apply the
rules in the final regulations to a taxable
year beginning before January 1, 2021
must follow the rules for changes in meth-
od of accounting under section 446 and the
applicable procedural guidance.
Alternatively, a taxpayer may rely on
the proposed regulations for taxable years
beginning after December 31, 2017 (or
December 31, 2018, in the case of spec-
ified credit card fees) and before January
1, 2021.
In the case of a specified fee that is not
a specified credit card fee, a taxpayer may
neither choose to apply the final regula-
tions to, nor rely on the proposed regu-
lations for, a taxable year beginning after
December 31, 2018, and before January 6,
2022.
Statement of Availability of IRS
Documents
The IRS Notices, Revenue Rulings,
and Revenue Procedures cited in this doc-
ument are published in the Internal Reve-
nue Bulletin (or Cumulative Bulletin) and
are available from the Superintendent of
Documents, U.S. Government Publish-
ing Office, Washington, DC 20402, or by
visiting the IRS website at http://www.irs.
gov.
Special Analyses
I. Regulatory Planning and Review –
Economic Analysis
Executive Orders 12866, 13563, and
13771 direct agencies to assess costs and
benefits of available regulatory alterna-
tives and, if regulation is necessary, to se-
lect regulatory approaches that maximize
net benefits (including potential econom-
ic, environmental, public health and safety
effects, distributive impacts, and equity).
Executive Order 13563 emphasizes the
importance of quantifying both costs and
benefits, of reducing costs, of harmoniz-
ing rules, and of promoting flexibility. For
purposes of E.O. 13771 this rule is regu-
latory.
These regulations have been designated
as subject to review under Executive Or-
der 12866 pursuant to the Memorandum
of Agreement (April 11, 2018) between
the Treasury Department and the Office of
Management and Budget (OMB) regard-
ing review of tax regulations. The Office
of Information and Regulatory Affairs
has designated these regulations as eco-
nomically significant under section 1(c)
of the MOA. Accordingly, the OMB has
reviewed these regulations.
A. Need for the Final Regulations
The Tax Cuts and Jobs Act (TCJA)
substantially modified the statutory rules
of section 451, which generally governs

Bulletin No. 2021–3 413 January 19, 2021
when income is recognized for Federal
tax purposes. As a result of those chang-
es, the Treasury Department and the IRS
recognized that questions were likely to
arise regarding the definitions and rules
that taxpayers are required to apply in
calculating a business’s gross income. To
provide greater specificity, the Treasury
Department and the IRS previously issued
separate proposed regulations related to
section 451(b) and 451(c) on September
9, 2019.
The proposed regulations regarding
section 451(b): (1) clarify how section
451(b) applies to multi-year contracts; (2)
provide rules for taxpayers whose finan-
cial results are included on an Applicable
Financial Statement (AFS) covering a
group of entities; (3) describe and clari-
fy the definition of transaction price and
revenue; (4) specify the allocation of a
transaction price in the case of a contract
which contains multiple performance ob-
ligations; and (5) specify rules for certain
debt instruments.
The proposed regulations for section
451(c) describe the deferral rules for ad-
vance payments for taxpayers with and
without an AFS; (2) provide acceleration
rules for taxpayers that cease to exist; (3)
clarify the treatment of financial statement
adjustments for taxpayers with deferred
advance payments; (4) provide rules relat-
ing to the treatment of short taxable years
for taxpayers deferring advance payments;
and (5) define and clarify the treatment of
performance obligations. They also list
items excluded from the definition of an
advance payment. In response to taxpayer
comments received during the develop-
ment of the proposed regulations, that list
includes goods for which (1) the taxpay-
er does not have goods of a substantially
similar kind and in a sufficient quantity
at the end of the taxable year the upfront
payment is received; and (2) the taxpay-
er recognizes all of the revenue from the
sale of the good in its AFS in the year of
delivery.
Comments were received on the pro-
posed regulations for 451(b) and 451(c)
requesting further clarification of or
changes to those regulations. Based on
these comments, the Treasury Department
and the IRS determined that final regu-
lations are needed to bring clarity to in-
stances where the statute may be subject
to multiple interpretations in the absence
of further guidance and to respond to
comments received on the proposed reg-
ulations. Among other benefits, the final
regulations provide greater certainty and
consistency in the application of section
451 by taxpayers and the IRS.
B. Background and Overview of Final
Regulations
Under section 451(a) of the Code, in-
come is “recognized” (that is, included in
gross income for tax purposes) in the year
in which it is received by the taxpayer un-
less it is properly accounted for in a dif-
ferent period under the taxpayer’s method
of accounting. Because of this latter con-
dition, the tax treatment of certain items
of income depends on the method of ac-
counting a taxpayer is using. For taxpay-
ers using the accrual method of account-
ing, income is generally recognized in the
year in which all events have occurred that
fix the right to receive that income and the
amount of income can be determined with
reasonable accuracy (all events test).
The timing of income recognition on
a firm’s financial statement may devi-
ate from these principles. Both the U.S.
generally accepted accounting principles
(GAAP) and the international financial re-
porting standards (IFRS) provide income
recognition rules that differ from tax re-
porting rules under certain circumstances.
For example, financial accounting rules
may require revenue to be recognized
when the costs of providing goods or ser-
vices pursuant to a contract are incurred,
while the all-events test may not be sat-
isfied until the contract obligation is ful-
filled. New accounting standards released
by the Financial Accounting Standards
Board (FASB) and the International Ac-
counting Standards Board (IASB) in 2014
further accelerated the timing of income
recognition for financial reporting purpos-
es, widening the gap between financial
and tax reporting.
The timing of income recognition for
tax purposes may also deviate from the
all-events test in certain circumstances.
For instance, receipt of payment by the
business satisfies the all events test. How-
ever, recognition of certain payments for
goods or services not yet provided may be
deferred to the year following receipt of
payment, to the extent that recognition is
also deferred on the taxpayer’s AFS. Such
payments are referred to as “advance pay-
ments.”
Prior to the enactment of TCJA on
December 22, 2017, taxpayers were gen-
erally permitted to defer the tax on these
advance payments; in other words, ad-
vance payments could be recognized in
a later taxable year. Under prior law, the
period over which an advance payment
was deferred varied depending on the
alternative regulatory treatment chosen
(Revenue Procedure 2004-34 or §1.451-5)
and, within §1.451-5, the type of good for
which an advance payment was accepted
(inventoriable goods versus non-invento-
riable goods).
Under Revenue Procedure 2004-34, a
taxpayer who receives an advance pay-
ment includes the advance payment in
taxable income in the year of receipt to
the extent that the payment is earned (if
the taxpayer does not have an AFS) or, if
the taxpayer has an AFS, to the extent that
the payment is included in revenues in the
AFS. The taxpayer includes the remaining
amount of the advance payment in taxable
income in the next taxable year, unless the
next taxable year is a short year of 92 days
or less. In the event of such a short year,
the taxpayer includes in taxable income
the part of the advance payment includ-
ed in revenue in the AFS for the short tax
year or, in the case of a taxpayer that does
not have an AFS, the part of the advance
payment which is earned in the short tax
year. The remaining balance of the ad-
vance payment is included in income for
the taxable year following the short tax
year. Revenue Procedure 2004-34 applies
to numerous types of advance payments
beyond advance payments for the provi-
sion of services and sales of goods. For
example, it applies to advance payments
for the use of intellectual property and
software, the occupancy or use of prop-
erty if the occupancy or use is ancillary
to the provision of services, guaranty or
warranty contracts, subscriptions, mem-
berships in organizations, and eligible gift
card sales.
Under §1.451-5, advance payments
were defined more narrowly than under

January 19, 2021 414 Bulletin No. 2021–3
Revenue Procedure 2004-34 to include
payments received by an accrual-method
taxpayer for the future sale of goods held
by the taxpayer in the ordinary course of
trade or business and as payments for the
building, installing, constructing, or man-
ufacturing of goods by the taxpayer in a
future taxable year. Such advance pay-
ments were generally included in taxable
income either in the year of receipt or in
the year in which the payment was proper-
ly accruable under the taxpayer’s method
of accounting.
An exception to this general rule oc-
curred in the case of certain advance pay-
ments for certain goods properly held in
inventory by the taxpayer. In the case of
such goods, the receipt of a substantial
advance payment required that all previ-
ously unrecognized advance payments be
included in taxable income by the end of
the second taxable year following the tax-
able year in which the substantial advance
payment was received. The taxpayer was
considered to have received a substan-
tial advance payment if the sum of the
advance payment received in the current
taxable year and prior taxable years for the
same contract was greater than or equal to
total inventoriable costs and expenditures.
The TCJA substantially amended sec-
tion 451 providing, among other things,
new rules addressing deviations from
the all-events test. The amended section
451(b) more closely aligns when income
is recognized for Federal tax purposes
with when it is recognized on businesses’
financial accounting statements. In partic-
ular, section 13221 of the TCJA amends
section 451(b), such that an item of gross
income must be included in gross income
no later than the period when the item is
included in revenue on an AFS. Thus, this
new rule requires taxpayers to recognize
income upon the earlier of when the all-
events test is met or when the taxpayer
includes the amount in revenue (broadly
defined) in its AFS (AFS income inclusion
rule). For these taxpayers, income recog-
nition is accelerated for tax purposes when
income has been recognized for financial
accounting purposes before the all events
test has been satisfied.
The amendments made to section
451(b) only apply to taxpayers that use
accrual accounting and have an AFS.
Neither the statutory changes to 451(b)
nor the final regulations regarding 451(b)
change the time at which income is rec-
ognized for accrual method taxpayers
without an AFS.
Section 451(c), added by the TCJA,
allows accrual-method taxpayers to elect
to recognize as income only a portion of
an advance payment in the taxable year in
which it is received, and then recognize
the remainder in the following taxable
year. Section 451(c) essentially codifies
the deferral method of accounting for
advance payments that was permitted in
Revenue Procedure 2004-34. (Joint Com-
mittee on Taxation, General Explanation
of Public Law 115-97, (Washington, U.S.
Government Publishing Office, December
2018), at 167.) The new section 451(c), a
subject of the final regulations, addresses
how advance payments are defined and
when they need to be recognized in a busi-
ness’s gross income.
C. Economic Analysis
1. Baseline
In this analysis, the Treasury Depart-
ment and the IRS assess the benefits and
costs of the final regulations relative to a
no-action baseline reflecting anticipated
Federal income tax-related behavior in the
absence of these final regulations.
2. Summary of Economic Effects
The final regulations provide certain-
ty and consistency in the application of
sections 451(b) and 451(c) by providing
definitions and clarifications regarding the
statute’s terms and rules. In the absence of
the guidance provided in these final regu-
lations, the chance that different taxpayers
might interpret the statute differently is
exacerbated. For example, two similar-
ly situated taxpayers might interpret the
statutory provisions pertaining to the defi-
nition of advanced payments differently,
with one taxpayer pursuing a project that
another comparable taxpayer might de-
cline because of a different interpretation
of how the income may be treated under
section 451(c). If this second taxpayer’s
activity is more profitable, an economic
loss arises. Similar situations may arise
under each of the provisions addressed
by these regulations. Certainty and clarity
over tax treatment generally also reduce
compliance costs for taxpayers.
An economic loss might also arise if
all taxpayers have similar interpretations
under the baseline of the tax treatment
of particular items of income but those
interpretations differ slightly from the in-
terpretation Congress intended for these
income streams. For example, the final
regulations may specify a tax treatment
that few or no taxpayers would adopt in
the absence of specific guidance but that
nonetheless advances Congressional in-
tent. In these cases, guidance provides
value by bringing economic decisions
closer in line with the intent and purpose
of the statute.
While no guidance can curtail all dif-
ferential or inaccurate interpretations of
the statute, the final regulations signifi-
cantly mitigate the chance for differential
or inaccurate interpretations and thereby
increase economic efficiency.
Because the final regulations clarify
the tax treatment of items of gross income
for certain taxpayers, there is the possi-
bility that business decisions may change
as a result of these regulations. The final
regulations generally have the effect of
delaying the timing of tax liability, thus
reducing effective tax rates for affected
taxpayers. This reduction in effective tax
rates, viewed in isolation, will generally
lead to an increase in economic activity
by these taxpayers.
This delay in the timing of tax lia-
bility, viewed in isolation, will also de-
crease Federal tax revenue. A decrease in
Federal tax revenue either increases the
deficit or necessitates increases in other
taxes or a reduction in spending. This
revenue effect will be mitigated to some
degree by improved economic perfor-
mance (and accompanying tax revenues)
under these regulations due to (i) the en-
hanced alignment in the timing of taxes
on income and costs; (ii) the enhanced
certainty and clarity provided by the fi-
nal regulations as described previously;
and (iii) enhanced economic activity due
to lower effective tax rates for affected
taxpayers.
The Treasury Department and the IRS
have not estimated these effects relative

Bulletin No. 2021–3 415 January 19, 2021
to the no-action baseline or alternative
regulatory approaches because they do
not have readily available data or mod-
els that measure: (i) the volume of cost
offsets allowed under the final regula-
tions;
1
(ii) the effect on economic activity
by affected taxpayers from the enhanced
alignment of income and costs under the
final regulations relative to the no-ac-
tion baseline or alternative regulatory
approaches; (iii) the tax positions that
taxpayers would take on other provisions
of the final regulations, relative to the
no-action baseline or alternative regu-
latory approaches; or (iv) the economic
activities that taxpayers would engage in
under those tax positions.
The Treasury Department and the IRS
have also not made projections of any
change in compliance costs arising from
the final regulations, relative to the no-ac-
tion baseline. Treasury generally projects
that compliance costs will be lower un-
der the final regulations relative to the
no-action baseline because enhanced
clarity and certainty reduce compliance
costs. The Treasury Department and the
IRS recognize that some taxpayers may
take advantage of favorable provisions
in the final regulations and that this de-
cision could increase their compliance
costs. Taxpayers would not take advan-
tage of these provisions, however, unless
the overall treatment was beneficial to
the taxpayer.
The proposed regulations noted that
the economic analysis of the final regu-
lations under section 451(c) would ad-
dress the economic effects of regulatory
guidance, if any, under sections 460 and
461(h) or other sections of the Code that
interact with section 451(c), that was
issued between the proposed and final
regulations. Since the release of the pro-
posed regulations on September 5, 2019,
no such regulatory guidance has been is-
sued.
The proposed regulations for 451(b)
and 451(c)) solicited comments on the
economic effects of the proposed reg-
ulations. No such comments were re-
ceived.
3. Number of Affected Taxpayers
The Treasury Department and the
IRS estimate that between 174,000 and
299,000 entities are likely to be affected
by the final regulations.
Section 451(b) and (c) and the regu-
lations under §1.451-3 affect only those
business entities that (i) use an accrual
method of accounting, and (ii) have an
AFS. One provision in §1.451-8 applies
to accrual method taxpayers without an
AFS. Regarding the accrual method of
accounting, section 13102 of TCJA mod-
ified section 448 to expand the number of
taxpayers eligible to use the cash receipts
and disbursements method of accounting
(cash method of accounting). In general,
C corporations and partnerships with a
C corporation partner are now permitted
to use the cash method of accounting if
average annual gross receipts are $25
million or less for taxable years begin-
ning in 2018 (up from $5 million or less
in 2017). This amount was adjusted for
inflation for taxable years beginning after
December 31, 2018. The amount was $26
million in taxable year 2019.
The statute and the regulations gen-
erally affect only those entities that also
have an AFS although one provision in the
regulations under §1.451-8 applies to non-
AFS taxpayers. The Treasury Department
and the IRS do not have readily available
data to measure the prevalence of these
affected entities. However, Schedule M-3,
which is used to reconcile an entity’s net
income or loss for tax purposes with its
book income or loss, reports whether an
entity has a certified audited income state-
ment. Schedule M-3 is required to be filed
only by entities with at least $10 million
of assets. This population is more likely to
possess an AFS and, conversely, entities
that do not file Schedule M-3 are less like-
ly to possess an AFS or otherwise be af-
fected by the regulations as owners and/or
creditors of such smaller entities are less
likely to require the entity to certify its
financial results via a financial statement
audit. Data are currently available only for
electronic filers.
The Treasury Department and the IRS
estimated the number of affected tax-
payers separately for entities with gross
receipts of $26 million or less and those
with gross receipts above $26 million.
For taxable year 2017, 89 percent of ac-
crual-method entities filing Forms 1120,
1120-S, and 1065 with gross receipts of
$26 million or less were filers of elec-
tronic tax forms. About 11 percent, or
288,000 returns, included a Schedule
M-3. About 40 percent of the returns
with Schedule M-3, or 113,000, indicated
they had a certified audited income state-
ment.
2
Based on the assumption that fil-
ers of paper tax forms have the same inci-
dence as electronic filers and that entities
that do not file a Schedule M-3 generally
do not have an AFS, then the Treasury
Department and the IRS estimate that
roughly 127,000 (113,000/0.89) entities
with gross receipts of $26 million or less
are accrual-method entities that have an
AFS. If 5 percent of entities that do not
file a Schedule M-3 also have an AFS,
then approximately 251,000 of these en-
tities are potentially impacted by the final
regulations.
For entities with gross receipts above
$26 million and that are accrual meth-
od entities, the comparable calculations
are that 95 percent of returns are e-filed
and that 73 percent of those included a
Schedule M-3. Based on the assump-
tion that filers of paper tax forms have
the same incidence as electronic filers
and that entities that do not include a
Schedule M-3 generally do not have an
AFS, the Treasury Department and the
IRS estimate that 47,000 (45,000/0.95)
entities with gross receipts above $26
million are accrual-method entities that
have an AFS. If 5 percent of entities that
do not file a Schedule M-3 also have an
AFS, then approximately 48,000 of these
entities are potentially affected by these
regulations.
Together, these calculations imply that
between 174,000 and 299,000 entities are
potentially affected by the final regula-
tions.
1
Cost offsets are not reported on current tax returns and will not be separately reported on future tax returns.
2
Data are based on estimates from the IRS’s Research, Applied Analytics and Statistics Division using data from the Compliance Data Warehouse.

January 19, 2021 416 Bulletin No. 2021–3
Corporation and Partnership Returns Using an Accrual Method of Accounting***
(Taxable year 2017; thousands of returns)
Entities with gross receipts not greater
than $26 million
Entities with gross receipts greater than
$26 million
E-FiledPaper-FiledTotalE-FiledPaper-FiledTotal
Returns2,5033072,81073477
Returns with a Schedule M-328835*323*623*65*
Returns with a Schedule M-3 and an audited
income statement11314*127*452*47*
Returns without a Schedule M-32,215272*2,487*111*12*
Returns without a Schedule M-3, but with an
audited income statement (estimated)111**13**124**1**0**1**
Returns with an audited income statement224**27** 251**46**2**48**
*Estimates are obtained by assuming paper-filed returns are similar to e-filed returns as regards the incidence of a filing entity
having a Schedule M-3 and an audited income statement.
**Estimates are obtained by assuming that 5 percent of returns without a Schedule M-3 have an audited income statement.
***This table does not include sole proprietorships because the number of sole proprietorships with gross receipts above $26 mil-
lion that used accrual accounting was statistically indistinguishable from zero in 2017. The number of sole proprietorships with
gross receipts of $26 million or below that are affected by these regulations is projected to be minimal.
Source: Data compiled by the IRS Research, Applied Analytics and Statistics Division using data from the Compliance Data
Warehouse. The total number of accrual method returns of corporations and partnerships may differ slightly from other estimates
due to different data sources.
4. Economic Effects of Provisions under
Section 451(b)
a. Provisions Substantially Revised from
the Proposed Section 451(b) Regulations
i. Cost offset under section 451(b)
Section 451(b) as amended by TCJA
addresses the timing of revenue recogni-
tion for tax purposes but makes no men-
tion of the timing of cost recognition. The
Treasury Department and the IRS consid-
ered three options for addressing the treat-
ment of costs under section 451(b): (i) do
not allow a cost offset; (ii) allow a cost
offset for incurred costs; and (iii) expand
the allowance for incurred costs by further
allowing a cost offset for projected costs.
The proposed regulations did not provide
a cost offset for the AFS income inclusion
rule.
In the proposed section 451(b) reg-
ulations (in this part C.4, proposed reg-
ulations), the Treasury Department and
the IRS argued that allowing a cost offset
would be inconsistent with the economic
performance rules under section 461 and
inventory accounting rules under section
471. The proposed regulations further
argued that Congress did not make clear
any intention to alter those sections of the
Code or their associated regulations. The
proposed regulations stated, however, that
the subject was still under consideration
and requested comments addressing ap-
propriate cost offset rules.
In response to the comments received,
the Treasury Department and the IRS have
decided to include in the final regulations
an offset for the cost of goods in progress
(cost offset). This cost offset allows tax-
payers to reduce the amount of revenue
from the sale of inventory that is otherwise
required to be included in gross income
under the AFS income inclusion rule in
a taxable year prior to the year in which
ownership of the inventory is transferred
to the customer and defer such revenue to
the taxable year in which the ownership of
the inventory is transferred to the custom-
er. The amount of such reduction, or cost
offset, is determined by reference to the
inventoriable costs incurred to date. The
offset applies only to incurred costs, not
estimated or projected costs. Further, the
cost offset cannot reduce the amount of
revenue that is included in gross income
under the AFS inclusion rule below zero.
Any incurred costs subject to this limita
-
tion may be carried forward to determine
the cost offset in subsequent taxable years.
The cost offset in the final regulations
generally reduces the amount of revenue
that is required to be included in gross in-
come in a taxable year prior to the year
in which ownership of inventory is trans-
ferred to the customer relative to the pro-
posed regulations. An improved match of
income and cost timing is generally held
to provide a more accurate measure of
economic activity and thus would lead to
a more efficient tax system than under the
proposed regulations, within the context
of the statute and the overall Code.
This enhanced alignment in the tax
treatment of revenue and costs can be ex-
pected to reduce financing costs for at
least some projects and taxpayers. This
reduction in financing costs relative to the
proposed regulations may arise because
in some cases under the proposed regula-
tions, the inability of taxpayers to match
the timing of revenue and cost associated
with a project leads to a large, front-load-
ed tax liability, which may require a costly
rebalancing of other assets, particularly for

Bulletin No. 2021–3 417 January 19, 2021
liquidity-constrained taxpayers. Taxpayers
who experience a reduction in financing
costs as a result of these final regulations,
relative to the proposed regulations, may,
as a result, increase other expenditures, in-
cluding investment. The provision of the
cost offset in the final regulations may fur-
ther encourage longer-run projects relative
to the proposed regulations.
The Treasury Department and the IRS
considered expanding the cost offset to
allow for projected costs, with several
possible formats for how projected costs
would be accounted for. Allowing an
offset for projected costs would entail
a higher administrative burden than the
offset (only) for incurred costs and would
not definitively improve the alignment of
when income and costs are recognized
for tax purposes relative to the offset for
incurred costs. The Treasury Department
and the IRS project that under an offset
for projected costs, more disputes would
likely arise over the projected costs be-
cause taxpayers would have an incentive
to overstate projected costs in order to de-
lay income recognition.
The Treasury Department and the IRS
have not estimated the difference in com-
pliance costs, administrative burden, or in-
come-cost alignment (and any subsequent
effects on economic activity) between the
final regulations and alternative regulato-
ry approaches using projected costs. The
Treasury Department and the IRS have
not undertaken this estimation because
they do not have sufficiently detailed data
or models that capture possible differenc-
es in cost offset formats that use incurred
costs versus projected costs.
ii. Scope of the AFS income inclusion rule
The final regulations also address con-
cerns raised by commenters regarding re-
cent changes to the financial accounting
standards. The commenters suggested that
the AFS inclusion rule is overly broad in
light of these new standards, which gen-
erally accelerate AFS revenue recognition
relative to the prior standards, and could
cause taxpayers to incur a tax liability
before they receive, or have a fixed right
to receive, the money to pay the liability.
Accordingly, the final regulations provide
that under the AFS inclusion rule, amounts
taken into account as AFS revenue include
only those amounts that the taxpayer has
an enforceable right to recover if the cus-
tomer were to terminate the contract at the
end of the taxable year.
The final regulations further provide,
however, that a taxpayer may treat any
amount reported as AFS revenue as be-
ing taken into account as AFS revenue
regardless of whether the taxpayer has an
enforceable right to recover such amounts.
The Treasury Department and the IRS
project that this option will lead to reduced
compliance burden, reduced administrative
burden, and to fewer taxpayer disputes rel-
ative to an alternative regulatory approach
under which amounts taken into account as
AFS revenue include only those amounts
that the taxpayer has an enforceable right
to recover if the customer were to terminate
the contract at the end of the taxable year.
Under this “enforceable right” approach,
taxpayers would be required to analyze
each contract to determine amounts for
which the taxpayer has an enforceable right
to recover if the customer were to terminate
the contract at the end of the year; this anal-
ysis would be potentially costly.
The Treasury Department and the IRS
also considered an alternative regulatory
approach under which taxpayers would be
permitted to defer “increases” in the trans-
actions price that are taken into account as
AFS revenue in a given year but to which
a taxpayer’s entitlement is contingent on a
future event (contingent transaction price
approach). This alternative regulatory ap-
proach was reflected in the proposed reg-
ulations. However, commenters expressed
confusion as to what constitutes an “in-
crease” in the transaction price and the
types of contingencies that were intended
to be included within the scope of the rule.
Because of the uncertainties created by the
contingent transaction price approach, and
the potential for multiple interpretations,
the Treasury Department and the IRS de-
cided against this approach. The enforce-
able right standard adopted by the final reg-
ulations may accelerate income inclusion
relative to the contingent transaction price
approach, although the Treasury Depart-
ment and the IRS recognize that the oppo-
site result may hold for some taxpayers.
The Treasury Department and the IRS
have not estimated the differences in in-
come inclusion between the final regula-
tions and this alternative regulatory ap-
proach because they do not have readily
available data on the income inclusion tim-
ing differences under an enforceable right
standard versus the contingent transactions
price approach. Because of this lack of data,
the Treasury Department and the IRS have
further not estimated the difference in com-
pliance costs between the final regulations
and the alternative regulatory approach.
b. Provisions Not Substantially Revised
from the Proposed Section 451(b)
Regulations
i. Application of the AFS Income
Inclusion Rule to Multi-year Contracts
The final regulations clarify how section
451(b) applies to multi-year contracts. The
Treasury Department and the IRS consid-
ered two alternative approaches for such
contracts: (i) an annual approach and (ii)
a cumulative approach. Under an annual
approach, for each taxable year under the
contract a taxpayer would compare the
amount of income taken into account as
AFS revenue for that taxable year and the
amount of income that meets the require-
ments for recognition under the all events
test for that same taxable year to determine
its gross income inclusion for that taxable
year; that is, the taxpayer would include the
larger of the two amounts. The total amount
of gross income recognized under the con-
tract through the end of such taxable year is
not to exceed the total contract price.
In contrast, under a cumulative approach,
in each taxable year a taxpayer would com-
pare the cumulative amount of revenue in-
cluded in its AFS up to and including that
taxable year with the cumulative amount
of income that meets the requirements for
recognition under the all events test up to
and including that taxable year. The tax-
payer would then take the larger of the two
amounts and reduce it for any prior tax-
able year income inclusions with respect
to that item of gross income to determine
the amount that is required to be included
in gross income in the current taxable year.
The difference between the annual ap-
proach and the cumulative approach are
illustrated by the following example. In
2021, D, an engineering services provider,
enters into a non-severable contract with a
customer to provide engineering services
through 2024 for a total of $100x. Under

January 19, 2021 418 Bulletin No. 2021–3
the contract, D receives payments of $25x
in each calendar year of the contract. For its
AFS, D reports $50x, $0, $20x, and $30x
of AFS revenue from the contract for 2021,
2022, 2023, and 2024, respectively. D has an
enforceable right, as defined in §1.451-3(a)
(9), to recover all amounts reported as AFS
revenue through the end of a given contract
year if the customer were to terminate the
contract on the last day of such year. The
$25x payment received for 2023 is an ad-
vance payment, as defined in §1.451-8(a)
(1), because $5x of the $25x payment is re-
ported as AFS revenue for 2024. D uses the
full inclusion method for advance payments.
The accompanying table shows the
treatment of gross income under the two
approaches.
2021202220232024Total
Payments$25x$25x$25x$25x$100x
AFS Revenue$50x$0x$20x$30x$100x
Gross Income (cumulative approach)$50x$0x$25x$25x$100x
Gross Income (annual approach)$50x$25x$25x$0x$100x
An annual approach could acceler-
ate the recognition of taxable income to
a greater degree than what is reflected in
revenue for AFS purposes. In this exam-
ple, such an approach would ignore in
2022 the fact that cumulative AFS reve-
nue of $50x had been recognized as tax-
able gross income in 2021. Accordingly,
the annual approach would require that an
additional $25x of income be recognized
in 2022, since a payment of that amount
was received in that year. In effect, an an-
nual approach would accelerate the recog-
nition of $25x from 2023 to 2022 relative
to gross income recognition under the cu-
mulative AFS income inclusion rule.
The Treasury Department and IRS
concluded that the extent of acceleration
of income that may occur when using an
annual approach would be excessive rela-
tive to the cumulative approach when con-
sidered against the intent and purpose of
the statute. The final regulations therefore
adopt the cumulative approach.
The Treasury Department and the IRS
have not estimated the difference in com-
pliance costs, administrative burden, or
economic activity between the final reg-
ulations and an alternative regulatory ap-
proach of using an annual comparison. The
Treasury Department and the IRS have not
undertaken this estimation because they do
not have sufficiently detailed data or mod-
els that capture possible differences in tax-
payers’ income inclusions under these two
alternative regulatory approaches.
ii. Applicable Financial Statement
covering a group of entities
The final regulations provide rules for
taxpayers whose financial results are in-
cluded on an AFS covering a group of en-
tities. These rules specify that, if a taxpay-
er’s financial results are reported on the
AFS for a group of entities, the taxpayer’s
AFS is the group’s AFS. However, if the
taxpayer also reports financial results on
a separate AFS that is of equal or higher
priority, then the separate AFS is the tax-
payer’s AFS. The rules also specify how
a taxpayer using a group AFS is to deter-
mine the amount of revenue allocated to
the taxpayer. The Treasury Department
and the IRS considered as an alternative
not providing substantive rules on how
taxpayers should apply the AFS income
inclusion rule when their financial results
are included in an AFS for a group of enti-
ties. This alternative was rejected because
it would have increased compliance bur-
dens and potentially led to similarly situ-
ated taxpayers applying the AFS income
inclusion rule differently.
The Code does not specify how the
AFS income inclusion rule is to function
whenever the AFS accounting period and
the taxable year do not coincide. The
final regulations do not adopt a single,
one-size-fits-all approach, but rather pro-
vide taxpayers three separate options for
addressing this situation. A change from
one option to another, however, would
be considered a change in method of ac-
counting requiring the permission of the
IRS. By providing taxpayers with several
options, the final regulations will min-
imize taxpayer compliance costs when
dealing with non-congruent tax and fi-
nancial accounting periods relative to
an alternative approach of specifying a
single option, with no significant revenue
implications or effects on economic de-
cisions.
iii. Revenue in an AFS
The final regulations describe and
clarify the definition of AFS revenue to
broadly include amounts characterized
as revenue in a taxpayer’s AFS as well as
amounts reported in other comprehensive
income or retained earnings provided such
amounts relate to an item of gross income
that is subject to the rules under section
451(b) and (c). The Treasury Department
and the IRS considered and rejected a nar-
rower definition of revenue or a definition
that was tied to the AFS definition of rev-
enue. The definition of revenue advanced
in the final regulations is consistent with
the current application of the all events
test under §1.451-1(a) and ensures that
all relevant financial statement items are
taken into account for tax purposes. In
contrast, a narrow definition of revenue
would allow, or even encourage, taxpay-
ers to avoid the AFS income inclusion rule
by not classifying an item as revenue on
their financial statement.
iv. Rules for certain debt instruments
Section 451(b)(2) states that the AFS
inclusion rule does not apply to items of
gross income for which a taxpayer uses
a special method of accounting provid-
ed under the Code. However, the Code
does not apply this exception to special
accounting rules that apply to original is-
sue discount (OID), market discount, and
certain other items with respect to debt
instruments under part V of Subchapter
P of the Code.
The final regulations implement this
provision by providing a non-exhaus-
tive list of special methods of account-

Bulletin No. 2021–3 419 January 19, 2021
ing, and by clarifying how section 451(b)
applies to certain credit card receivables.
The final regulations specifically except
from section 451(b) the timing rules for
accrued market discount on bonds and
the general OID timing rules, as well
as the timing rules for OID determined
with respect to special debt instruments
(contingent payment and variable rate
debt instruments, certain hedged debt
instruments, and inflation-indexed debt
instruments). Nevertheless, following
the legislative history of the TCJA (see
Conference Report, p. 276), the final
regulations provide that credit card late
fees, credit card cash advance fees, and
interchange fees are subject to the AFS
income inclusion rule. The final regula-
tions further specify that if these credit
card fees are subject to the AFS income
inclusion rule, they are not to be taken
into account in determining whether a
debt instrument associated with them has
OID. Existing rules continue to apply to
these items for taxpayers not possessing
an AFS. The Treasury Department and
the IRS expect that this treatment will
provide a straightforward application of
section 451(b) consistent with Congres-
sional intent without unnecessarily com-
plicating OID calculations and adding to
taxpayer compliance burdens.
The Treasury Department and the
IRS considered and rejected a broader
application of the AFS income inclusion
rule to include all amounts determined
under the OID and market discount ac-
counting methods, even in cases where
the items are treated as discount or as an
adjustment to the yield of a debt instru-
ment over the life of the instrument in
its AFS for financial reporting purpos-
es. The final regulations do not subject
these amounts to the AFS income inclu-
sion rule because these special account-
ing methods do not generally rely on the
all events test to determine the timing of
income inclusion and these current spe-
cial accounting methods provide work-
able income-recognition timing rules
that appropriately measure income. The
Treasury Department and the IRS expect
that subjecting these items to the AFS
income inclusion rule of section 451(b)
would disrupt and complicate current
tax accounting practices with no general
economic benefit.
5. Economic Effects of Provisions under
451(c)
a. Provisions Substantially Revised from
the Proposed Section 451(c) Regulations
i. Cost offset for advance payments
The Treasury Department and the IRS
considered three options for address-
ing the treatment of costs under section
451(c): (i) no cost offset; (ii) a cost offset
for incurred costs; and (iii) a cost offset
that further allowed for projected costs.
The proposed section 451(c) regulations
(in this part C.5, proposed regulations) did
not provide for a cost offset for advanced
payments. At the time, the Treasury De-
partment and the IRS argued that Con-
gress intentionally simplified the rules for
advance payments by limiting the deferral
of advance payments for taxpayers with
an AFS to a prescribed statutory method
that (1) does not include an accelerated
cost offset, (2) is consistent with Reve-
nue Procedure 2004-34, and (3) overrides
§1.451-5. Taxpayers commenting on the
proposed regulations were concerned that
the failure to provide a cost offset rule in
451(c) would cause a mismatch of income
and expenses and result in the taxation
of gross receipts. For example, if a busi-
ness has a multi-year contract to build or
manufacture a highly customized good, it
would report any advance payment in in-
come in the year of receipt or in the fol-
lowing taxable year. If it uses the advance
payment to purchase materials and to pay
workers as part of the project, it would re-
cover those costs only when the sale takes
place. Under the proposed regulations, the
statute would generate a tax on the total
amount of the advance payment in the first
years of the contract with all related costs
being recovered later in the contract.
In response to these comments on the
proposed regulations, the Treasury De-
partment and the IRS have written the
final regulations to include an offset for
cost of goods in progress (cost offset).
This cost offset allows taxpayers to re-
duce the amount of an advance payment
for the future sale of inventory that is re-
quired to be included in gross income in
a year prior to the year in which owner-
ship of the inventory is transferred to the
customer. The amount of such reduction,
or cost offset, is equal to the inventori-
able costs incurred as of the end of the
taxable year in which the advance pay-
ment is required to be included in gross
income under the taxpayer’s method of
accounting for advance payments. This
provision of the final regulations allows
taxpayers to offset advance payments
included in income under either the full
inclusion method or the deferral method.
However, the cost of goods in progress
offset cannot reduce the amount of the
advance payment income inclusion be-
low zero. Any incurred costs subject to
this limitation may be carried forward to
determine the cost of goods in progress in
subsequent taxable years.
The cost offset in the final regulations
generally reduces the amount of the ad-
vance payment that is required to be in-
cluded in gross income in a taxable year
prior to the year in which ownership of
the inventory is transferred to the cus-
tomer relative to the proposed regula-
tions. An improved match of income and
cost timing is generally held to provide a
more accurate measure of economic ac-
tivity and thus provide a more efficient
tax system than under the proposed reg-
ulations. For further discussion of the
economic effects of the cost offset for
advance payments and for income more
generally see 4.a.i.
The Treasury Department and the IRS
considered expanding the cost offset to al-
low for projected costs, with several pos-
sible formats being considered for how
projected costs would be treated. Allowing
an offset for projected costs would entail a
higher administrative burden than the offset
for incurred costs and may not definitively
improve the alignment of when income and
costs are recognized for tax purposes rela-
tive to the offset for incurred costs.
The Treasury Department and the IRS
have not estimated the difference in com-
pliance costs, administrative burden, or in-
come-cost alignment (and any subsequent
effects on economic activity) between the
final regulations and alternative regulatory
approaches using projected costs associated
with advance payments. The Treasury De-
partment and the IRS have not undertaken
this estimation because they do not have suf-
ficiently detailed data or models that capture
possible differences in cost offset formats
that use incurred costs versus projected costs.

January 19, 2021 420 Bulletin No. 2021–3
b. Provisions not Substantially Revised
from the Proposed Regulations
i. Deferral Methods under section 451(c)
The statute prescribes a particular de-
ferral method for accrual-method taxpay-
ers that have an AFS (AFS taxpayers)
but does not explicitly describe a deferral
method to be used by taxpayers that do
not have an AFS (non-AFS taxpayers).
To remedy this gap, the proposed and fi-
nal regulations describe and clarify that
a method similar to the deferral method
available to non-AFS taxpayers under
Revenue Procedure 2004-34 will be avail-
able to non-AFS taxpayers.
The Treasury Department and the IRS
considered and rejected a narrow interpre-
tation of section 451(c) that would have
precluded non-AFS taxpayers from using
a deferral method similar to that provided
in Revenue Procedure 2004-34. Section
451(c) does not explicitly prohibit the use
of such a method by non-AFS taxpayers,
and the Treasury Department and IRS con-
tinue to have authority under the Code to
prescribe a deferral method for such tax-
payers. Precluding non-AFS taxpayers
from using a deferral method similar to
that of AFS taxpayers would treat AFS
and non-AFS taxpayers quite differently
regarding business decisions they might
make that are otherwise similar. Such treat-
ment would result in a less economically
efficient tax system, which generally treats
similar economic decisions similarly.
ii. Advance Payment Acceleration
Provisions
If a taxpayer ceases to exist by the close
of a taxable year in which an advance pay-
ment has been received and deferred, then
issues may arise as to when or whether
the remaining amount of the payment will
be recognized as taxable income because
there may not be a succeeding taxable year
in which such income can be recognized.
Under the statute, if the taxpayer dies or
ceases to exist by the close of the taxable
year in which the advance payment was
received, any remaining untaxed amounts
of advance payments must be included in
income in the year they were received.
The final regulations extend this payment
“acceleration” rule to situations in which
a performance obligation is satisfied or
otherwise ends in the taxable year of re-
ceipt or in a succeeding short taxable year,
a treatment that is consistent with a similar
rule in Revenue Procedure 2004-34.
The Treasury Department and the IRS
considered not modifying or expanding
the acceleration rule contained in section
451(c) but rejected this alternative be-
cause the remaining amount may never be
included in income, thus risking a perma-
nent exclusion of the amount from taxable
income. The possibility of a permanent
exclusion of income provides incentives
for taxpayers to structure payments in
ways that avoid tax liability, thus reducing
Federal tax revenue without providing an
accompanying general economic benefit.
The proposed and final regulations treat
the expanded set of accelerated trans-
actions consistently with similar types
of transactions based on the timing and
structure of the payments involved.
iii. Advance Payments and Financial
Statement Adjustments
Under the statute, if a taxpayer counts
an advance payment as an item of de-
ferred revenue, under certain conditions
(for example, certain acquisitions of one
corporation by another), the taxpayer may
be required by its system of accounting to
adjust that item on the balance sheet in a
subsequent year. The item would then not
be included in current earnings or AFS rev-
enues. In this case, taxpayers might argue
that they can exclude the amount deferred
from taxable income because it is never
“earned” nor included in revenue under
their AFS. If this argument were upheld,
taxpayers could convert an income “defer-
ral” amount into an income “exemption”
amount. To address this issue and avoid
this possibility, the proposed and final regu-
lations specify that such financial statement
adjustments are to be treated as “revenue.”
The Treasury Department and the IRS
considered not providing clarity on the
treatment of financial statement write-
downs but rejected that approach because it
would have risked an inappropriate perma-
nent exclusion of income. The possibility
of a permanent exclusion of income pro-
vides incentives for taxpayers to structure
payments in ways that avoid tax liability,
thus reducing Federal tax revenue without
providing an accompanying general eco-
nomic benefit.
iv. Short Taxable Years and the 92-Day
Rule
Section 451(c) does not provide a rule
relating to the treatment of short taxable
years. In the absence of such a rule, it will
be unclear to taxpayers how they should
implement the deferral method provided in
section 451(c) in the case of a short taxable
year. To address this issue, the proposed
and final regulations provide rules relat-
ing to the treatment of short taxable years
for advance payments that are generally
consistent with Revenue Procedure 2004-
34. The Treasury Department and the IRS
considered and rejected not providing short
taxable year rules because such a decision
would have created significant confusion
among taxpayers, increased administrative
costs for the IRS, and increased compli-
ance costs for taxpayers.
v. Performance Obligations for Non-AFS
Taxpayers
A performance obligation is generally a
contractual arrangement with a customer to
provide a good, service or a series of goods
or services that are basically the same and
have a routine pattern of transfer. Further,
each performance obligation in a contract
generally yields a separate item of gross
income. The Treasury Department and the
IRS interpret the statute as requiring tax-
payers to allocate payments attributable to
multiple items of gross income in the same
manner as such payments are allocated to
the corresponding performance obligations
in the taxpayer’s AFS. The statute does not,
however, specify the allocation rules to be
used by non-AFS taxpayers.
To address this issue, the proposed and
final regulations provide allocation rules for
non-AFS taxpayers consistent with a similar
rule in Revenue Procedure 2004-34. That
rule specifies that a payment that is attrib-
utable to multiple items of gross income is
required to be allocated to such items in a
manner that is based on objective criteria.
The objective criteria standard will be sat-
isfied if the allocation method is based on
payments the taxpayer regularly receives for
an item or items that are regularly sold or
provided separately. The Treasury Depart-

Bulletin No. 2021–3 421 January 19, 2021
ment and the IRS considered not providing
allocation rules for non-AFS taxpayers but
rejected such an approach because it would
have treated similarly situated taxpayers
quite differently and would have led to in-
creased administrative costs for the IRS and
increased compliance costs for taxpayers
relative to the rules provided in the final reg-
ulations. While the allocation rules for AFS
taxpayers and non-AFS taxpayers differ to
some degree under the final regulations,
the chosen provision provides a rule upon
which non-AFS taxpayers can rely, while
minimizing the differences between AFS
and non-AFS taxpayers in this regard within
the constraints imposed by the statute.
vi. Specified Good Exception
Section 451(c) provides that certain
items are excluded from the definition of
an advance payment. Those items include
rent; insurance premiums governed by
subchapter L; payments with respect to
financial instruments; payments with re-
spect to certain warranty or guaranty con-
tracts; payments subject to section 871(a),
881, 1441, or 1442; payments in proper-
ty to which section 83 applies; and other
payments identified by the Secretary. This
list of items excluded from the definition
of an advance payment is generally com-
parable to the list of items excluded from
the definition of an advance payment in
Revenue Procedure 2004-34.
Prior to release of the proposed regula-
tions, several commenters requested that
the list of excluded items be expanded to
include certain goods that require a sig-
nificant amount of capital to produce and
that may require considerable time from
development to delivery. Generally, for
financial statement purposes, such man-
ufacturers recognize revenue related to
these goods when the product is complet-
ed and delivered and the title and risk of
loss have transferred to the customer.
To address this issue, the proposed regu-
lations crafted a narrow specified-goods ex-
ception for taxpayers who receive advance
payments but do not perform the work or
deliver the good for several years in the
future. Specifically, an exclusion was intro-
duced for certain goods for which a taxpayer
requires a customer to make an upfront pay-
ment under the contract if (i) the contracted
delivery month and year of the good occurs
at least two taxable years after an upfront
payment, (ii) the taxpayer does not have the
good or a substantially similar good on hand
at the end of the year the upfront payment
is received, and (iii) the taxpayer recognizes
all of the revenue from the sale of the good
in its AFS in the year of delivery.
The final regulations make one minor
modification to the specified good excep-
tion. In response to comments, the final reg-
ulations give taxpayers the option to treat
upfront payments that satisfy the criteria for
the specified good exception as a typical ad-
vance payment under section 451(c). In other
words, taxpayers have the option of includ-
ing the advance payment in gross income un-
der the full inclusion method or the deferral
method. This flexibility in the section 451(c)
regime reduces uncertainty for taxpayers
who may be unsure if a contract meets the
specified good exception relative to the pro-
posed regulations. It also allows taxpayers
using the 1-year deferral under Revenue Pro-
cedure 2004-34 prior to the passage of the
TCJA the option to continue to do so.
The Treasury Department and the IRS
considered as an alternative not using the
authority granted to the Secretary in sec-
tion 451(c)(4)(B)(vii) to exclude certain
payments. For manufacturers of highly
customizable goods with a delivery date
more than two years after the upfront pay-
ment, the one-year deferral period has the
potential to increase book-tax accounting
differences relative to the final regulations.
For some companies, a one-year deferral
period may require the creation of sepa-
rate records to track advance payments
for accounting and tax purposes. Thus,
for these taxpayers, the final regulations
may provide greater conformity between
accounting (book) income and taxable
income to the extent that applicable case
law would defer the inclusion of income
related to the specified goods exception.
II. Paperwork Reduction Act
These regulations do not impose any
additional information collection require-
ments in the form of reporting, recordkeep-
ing requirements or third-party disclosure
requirements related to tax compliance.
Instead, because section 451(b) and sec-
tion 451(c) and these regulations provide
various methods of accounting affecting
the timing of income inclusion, taxpayers
without an existing method of accounting
for these items may initially adopt such
method without the consent of the Com-
missioner. However, the consent of the
Commissioner under section 446(e) and
the accompanying regulations is required
before implementing method changes
from one method to another method. See
§§1.451-3(l) and 1.451-8(g). Some of the
methods of accounting referenced by and
discussed in these regulations are repre-
sented in the following chart.
SectionBrief Description of Method
§1.451-3(b)(2)(i)Application of AFS income inclusion rule by making all AFS revenue adjustments
§1.451-3(b)(2)(ii)Application of AFS income inclusion rule by making certain AFS revenue adjustments (Alternative AFS
Revenue method)
§1.451-3(c)AFS cost offset method
§1.451-3(i)(4)Computing revenue when the AFS and taxable years are mismatched
§1.451-3(l)Change in the method of recognizing revenue in an AFS
§1.451-8(c)Deferral method for taxpayers with an AFS
§1.451-8(d)Deferral method for taxpayer without an AFS
§1.451-8(e)Advance payment cost offset method
§1.451-8(f)Election for the specified goods exception to not apply.
§1.451-8(g)Change in the method for recognizing advance payments on an AFS.

January 19, 2021 422 Bulletin No. 2021–3
Taxpayers request consent to use a
method in these regulations by filing
Form 3115, Application for Change in
Accounting Method (Parts I, II, IV and
Schedule B). Filing of Form 3115 and any
statements attached thereto (for taxpayers
who are required to do so or who elect
certain methods of accounting described
in the regulations) is the sole collection of
information requirement imposed by the
statute and the regulations.
For the Paperwork Reduction Act
(PRA), the reporting burden associat-
ed with the collections of information in
these regulations will be reflected in the
IRS Form 3115 PRA Submissions (OMB
control numbers 1545-0074 for individual
filers, 1545-0123 for business filers, and
1545-2070 for all other types of filers).
In 2018, the IRS released and invit-
ed comment on a draft of Form 3115 to
give the public the opportunity to benefit
from certain specific revisions made to
the Code. The IRS received no comments
on the forms during the comment period.
Consequently, the IRS made the forms
available in January 2019 for use by the
public. Form 3115 applies to changes
of accounting methods generally and is
therefore broader than section 451(b).
On November 25, 2019, the Treasury
Department and the IRS published Rev-
enue Procedure 2019-43, 2019-28 I.R.B.
1107, which updated Revenue Proce-
dure 2018-31, and provides a global list
of automatic method change procedures,
including procedures for taxpayers to
comply with various provisions in section
451(b) and (c) and the proposed regula-
tions. Under the procedures, taxpayers can
request permission to change to a method
of accounting to comply with the various
provisions in section 451(b) and (c) and
the proposed regulations using reduced
filing requirements, such as by filing a
short Form 3115, or for certain taxpayers,
by using a streamlined method change
procedure that involves not filing a Form
3115.
The current status of the PRA submis-
sions that will be revised as a result of
the information collections in these reg-
ulations is provided in the accompanying
table. As described earlier, the reporting
burdens associated with the information
collections in these regulations are in-
cluded in the aggregated burden estimates
for OMB control numbers 1545-0074
(in the case of individual filers of Form
3115), 1545-0123 (in the case of business
filers of Form 3115 and filers subject to
Revenue Procedure 2018-31). The over-
all burden estimates associated with the
OMB control numbers identified later are
aggregate amounts that relate to the en-
tire package of forms associated with the
applicable OMB control number and will
in the future include, but not isolate, the
estimated burden of the tax forms that will
be created or revised as a result of the in-
formation collections in these regulations.
These numbers are therefore unrelated to
the future calculations needed to assess
the burden imposed by these regulations.
These burdens have been reported for
other income tax regulations that rely on
the same information collections, and the
Treasury Department and the IRS urge
readers to recognize that these numbers
are duplicates and to guard against over-
counting the burdens imposed by tax pro-
visions prior to the TCJA.
No burden estimates specific to the
forms affected by these regulations are
currently available. The Treasury Depart-
ment and the IRS have not estimated the
burden, including that of any new infor-
mation collections, related to the require-
ments under these regulations. For the
OMB control numbers discussed in the
preceding paragraphs, the Treasury De-
partment and the IRS estimate PRA bur-
dens on a taxpayer-type basis rather than a
provision-specific basis. Those estimates
capture both changes made by the TCJA
and those that arise out of discretionary
authority exercised in these regulations
and other regulations that affect the com-
pliance burden for that form.
The Treasury Department and IRS re-
quest comment on all aspects of informa-
tion collection burdens related to these
regulations, including estimates for how
much time it would take to comply with the
paperwork burdens described earlier for
each relevant form and ways for the IRS
to minimize the paperwork burden. In ad-
dition, when available, drafts of IRS forms
are posted for comment at https://apps.irs.
gov/app/picklist/list/draftTaxForms.htm.
IRS forms are available at https://www.
irs.gov/forms-instructions. Forms will not
be finalized until after they have been ap-
proved by OMB under the PRA.
Form/
Revenue Procedure
Type of Filer
OMB
Number(s)
Status
Form 3115
All other Filers (mainly
trusts and estates)
(Legacy system)
1545-2070
Published in the Federal Register on 2/15/17. Public comment
period closed on 4/17/17.
Link: https://www.federalregister.gov/documents/2017/02/15/2017-02985/proposed-information-collec-
tion-comment-request
Business (NEW Model)1545-0123
Published in the Federal Register on 10/8/18. Public comment
period closed on 12/10/18.
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-
request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd
Individual
(NEW Model)
1545-0074
Limited scope submission (1040 only) on 10/11/18 at OIRA for
review. Full ICR submission for all forms in 2019.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031

Bulletin No. 2021–3 423 January 19, 2021
Form/
Revenue Procedure
Type of Filer
OMB
Number(s)
Status
Revenue Procedure
2018-31
IRS Research estimates1545-0123
Published in the Federal Register on 9/30/19. Public Comment
period closed on 12/23/19.
Link: https://www.federalregister.gov/documents/2019/10/22/2019-23009/proposed-collection-comment-
request-for-rev-proc-2018-31
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibili-
ty Act (5 U.S.C. chapter 6), it is hereby
certified that these regulations will not
have a significant economic impact on a
substantial number of small entities with-
in the meaning of section 601(6) of the
Regulatory Flexibility Act (small entities).
This certification can be made because the
Treasury Department and the IRS have
determined that the regulations may affect
a substantial number of small entities but
have also concluded that the economic ef-
fect on small entities as a result of these
regulations is not expected to be signifi-
cant. Section 451(b) requires that an item
of income be included in gross income for
tax purposes no later than when the item is
counted as revenue in an AFS. Due to the
revised financial accounting standards for
calculating revenue in an AFS under ASC
606, the result of section 451(b) generally
will be to move the recognition of income
forward by a year or two compared to pre-
vious law. Section 451(c) provides rules
regarding the treatment of advance pay-
ments. These regulations provide general
guidance on the rules, including the scope
of the rules, exceptions to the rules, defini-
tions of key terms, and examples demon-
strating applicability of the rules.
The Treasury Department and the
IRS have estimated the number of small
business entities that may be affected by
the statute and these regulations. Section
451(b) and (c) and the regulations under
§1.451-3 affect only those business enti-
ties that (i) use an accrual method of ac-
counting, and (ii) have an AFS. One provi-
sion in §1.451-8 applies to accrual method
taxpayers without an AFS. The remaining
provisions in §1.451-8 apply to accrual
method taxpayers with an AFS.
Regarding the accrual method of ac-
counting, section 13102 of TCJA modi-
fied section 448 to expand the number of
taxpayers eligible to use the cash receipts
and disbursements method of accounting
(cash method of accounting). In general,
C corporations and partnerships with a C
corporation partner are now permitted to
use the cash method of accounting if av-
erage annual gross receipts are $25 mil-
lion or less for taxable years beginning in
2018 (up from $5 million or less in 2017).
The $25 million figure is considered for
adjustment for inflation annually. This
amount was adjusted for inflation for tax-
able years beginning after December 31,
2018. The amount was $26 million for tax-
able year 2019. The Treasury Department
and the IRS estimate that approximately
3,128,000 business entities with gross re-
ceipts of $26 million or less used an accru-
al method of accounting in taxable year
2017, which represents approximately 8.5
percent of all business entities with gross
receipts of $26 million or less. The Trea-
sury Department and the IRS project that
in future years, the number of entities with
gross receipts not greater than $26 million
that will be using the accrual method will
be less than 8.5 percent of all entities with
gross receipts of $26 million or less.
Many small business entities use the
cash method of accounting, as opposed
to an accrual method, and thus are not
subject to these regulations. The percent
of returns that use an accrual method of
accounting, by entity types and for entities
with gross receipts not greater than $26
million, is shown in the accompanying
table.
Total returns and returns using accrual method of accounting (Taxable year 2017)
Entities with gross receipts not greater than $26 million
Entity
Total returns
(thousands)
Returns using an accrual
method of accounting
(thousands)
Percent of returns using
accrual method of
accounting
C corporations1,57069144
S corporations4,6841,14624
Partnerships3,88491223
Sole proprietors and LLCs26,4253791
All entities36,4253,1288.5
Source: Internal Revenue Service, RAAS, KDA
The Treasury Department and the
IRS next examined the second condi-
tion, that entities with an AFS are af-
fected by section 451(b) and the regula-
tions. The Treasury Department and the
IRS do not have readily available data
to measure the prevalence of entities
with an AFS, as defined in the statute
and in §1.451-3(b)(1). However, Sched-
ule M-3, which is used to reconcile an
entity’s net income or loss for tax pur-
poses with its book income or loss, re-

January 19, 2021 424 Bulletin No. 2021–3
ports whether an entity has a certified
audited income statement. The Sched-
ule M-3 is required to be filed only by
entities with at least $10 million of as-
sets. This population is more likely to
possess an AFS and, conversely, entities
that do not file Schedule M-3 are less
likely to possess an AFS as owners and/
or creditors of such smaller entities are
less likely to require the entity to certify
its financial results via a financial state-
ment audit. Data is currently available
only for electronic filers.
For taxable year 2017, approximate-
ly 89 percent of accrual-method entities
filing Forms 1120, 1120-S, and 1065
with gross receipts of $26 million or
less were filers of electronic tax forms.
About 11 percent, or 288,000 returns,
included a Schedule M-3. About 40 per-
cent of the returns with Schedule M-3,
or 113,000, indicated they had a certified
audited income statement. Based on the
assumption that filers of paper tax forms
have the same incidence as electronic
filers and that entities that do not file a
Schedule M-3 generally do not have an
AFS, then the Treasury Department and
the IRS estimate that roughly 127,000
(113,000/0.89) entities with gross re-
ceipts of $26 million or less are accru-
al-method entities that have an AFS.
If 5 percent of entities that do not file a
Schedule M-3 also have an AFS then ap-
proximately 224,000 entities with gross
receipts of $26 million or less are poten-
tially affected by these regulations. These
estimates of affected filing entities are re-
produced in the following table.
Corporation and Partnership Returns Using An Accrual Method of Accounting
Taxable year 2017
(Thousands of returns)
Entities with gross receipts not greater than $26 million
E-Filed
Returns
Paper-Filed
Returns
Total
Returns
Returns2,5033072,810
Returns with a Schedule M-3288
35*323*
Returns with a Schedule M-3 and an audited income statement113
14*127*
Returns without a Schedule M-32,215
272*2,487*
Returns without a Schedule M-3, but with an audited income
statement
111**13**124**
Returns with an audited income statement
224**27**251**
*Estimates are obtained by assuming paper-filed returns are similar to e-filed returns as regards the incidence of a filing entity
having a Schedule M-3 and an audited income statement.
**Estimates are obtained by assuming that 5% of returns without a Schedule M-3 have an audited income statement. This
compares with approximately 40% of returns with a Schedule M-3 having such a statement.
Source: Non-italic entries are estimates taken from the IRS Research, Applied Analytics and Statistics KDA Division using
data from the Compliance Data Warehouse. The total number of accrual method returns of corporations and partnerships differs
slightly from that reported in the earlier table due to the use of different data sources for the two estimates. Italicized entries are
additional estimates obtained in the manner indicated in the table notes.
This rule would not have a significant
economic impact on small entities affect-
ed. The costs to comply with these regu-
lations are reflected in modest reporting
activities. Taxpayers needing to make
method changes pursuant to these regula-
tions will be required to file a Form 3115.
The Treasury Department and the IRS
have provided streamlined procedures for
certain taxpayers to change their meth-
od of accounting to comply with sec-
tion 451(b) and (c), and plan to provide
streamlined procedures for such taxpayers
to change to the methods of accounting
described in these regulations. Under the
streamlined procedures, eligible taxpay-
ers would either complete only a portion
of the Form 3115 or would not complete
the Form 3115 at all to comply with the
guidance. The streamlined method change
procedures are available to taxpayers, oth-
er than a tax shelter, who satisfy the gross
receipts test under section 448(c) and for
taxpayers making such a method change
which results in a zero section 481(a) ad-
justment. In addition, contemporaneous
with these regulations, the Treasury De-
partment and the IRS are issuing a stream-
lined procedure for taxpayers using a sec-
tion 451(b) method who have a change in
their AFS for revenue recognition that re-
quires a method change for tax purposes.
The estimated cumulative annual re-
porting and/or recordkeeping burden for
the statutory method changes relating to
the streamlined procedures used to be de-
scribed under OMB control number 1545-
1551. In 2019, OMB number 1545-1551
was merged into OMB number 1545-
0123. The estimated number of respon-
dents, after taking into account the stream-
lined procedures that are being issued is
28,046 respondents, and a total annual
reporting and/or recordkeeping burden of
34,279 hours. The estimated annual bur-
den per respondent/recordkeeper under
OMB control number 1545-0123 before
publication of this revenue procedure var-

Bulletin No. 2021–3 425 January 19, 2021
ies from 1/6 hour to 8½ hours, depending
on individual circumstances, with an esti-
mated average of 1½ hours. The estimated
monetized burden for compliance is $95
per hour. The estimated cumulative annu-
al reporting and/or recordkeeping burden
for the method changes described under
OMB control number 1545-0123 after
the revenue procedure is accounted for
is 28,046 respondents, and a total annual
reporting and/or recordkeeping burden is
34,279 hours. These burdens are essential-
ly unaffected by these regulations.
Accordingly, the Secretary certifies
that the rule will not have a significant
economic impact on a substantial number
of small entities.
Pursuant to section 7805(f), the no-
tice of proposed rulemaking preceding
this final rule was submitted to the Chief
Counsel for the Office of Advocacy of the
Small Business Administration for com-
ment on its impact on small business. No
comments on the notice were received
from the Chief Counsel for the Office of
Advocacy of the Small Business Admin-
istration.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates
Reform Act of 1995 (UMRA) requires
that agencies assess anticipated costs and
benefits and take certain actions before is-
suing a final rule that includes any Federal
mandate that may result in expenditures
in any one year by a state, local, or trib-
al government, in the aggregate, or by the
private section, of $100 million in 1995
dollars, update annually for inflation. This
rule does not include any Federal mandate
that may result in expenditures by state,
local, or tribal governments, or by the pri-
vate section in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state law,
unless the agency meets the consultation
and funding requirements of section 6 of
the Executive order. This final rule does
not have federalism implications and does
not impose substantial direct compliance
costs on state and local governments or
preempt state law within the meaning of
the Executive order.
VI. Congressional Review Act
The Administrator of the Office of In-
formation and Regulatory Affairs of the
Office of Management and Budget has de-
termined that this is a major rule for pur-
poses of the Congressional Review Act (5
U.S.C. 801 et seq.). Under 5 U.S.C. 801(a)
(3), a major rule takes effect 60 days after
the rule is published in the Federal Reg-
ister.
Notwithstanding this requirement, 5
U.S.C. 808(2) allows agencies to dispense
with the requirements of 5 U.S.C. 801
when the agency for good cause finds that
such procedure would be impracticable,
unnecessary, or contrary to the public in-
terest and the rule shall take effect at such
time as the agency promulgating the rule
determines. Pursuant to 5 U.S.C. 808(2),
the Treasury Department and the IRS find,
for good cause, that a 60-day delay in the
effective date is contrary to the public in-
terest.
Following the amendments to section
451(b) and (c) by the TCJA, the Treasury
Department and the IRS published the
proposed regulations to provide certain-
ty to taxpayers. In particular, as demon-
strated by the wide variety of public
comments in response to the proposed
regulations received, taxpayers continue
to express uncertainty regarding the prop-
er application of the statutory rules under
section 451(b) and (c). This is especially
the case for taxpayers in the manufac-
turing and retail industries producing or
reselling inventoriable goods because the
final regulations allow such taxpayers to
more clearly reflect their income for Fed-
eral income tax purposes compared to
the approach of the proposed regulations.
An earlier effective date will allow tax-
payers to implement the final regulations
earlier to take advantage of certain pro-
visions in the Coronavirus Aid, Relief,
and Economic Security Act, Pub. L. 116-
136 (March 27, 2020) that were designed
to enhance liquidity, such as the 5-year
net operating loss carryback provisions.
Consistent with Executive Order 13924
(May 19, 2020), the Treasury Department
and the IRS have therefore determined
that an expedited effective date of the fi-
nal regulations would more appropriately
provide such critical businesses greater
liquidity needed to remain open or “re-
open by providing guidance on what the
law requires.” 85 FR 31353-54. Accord-
ingly, the Treasury Department and the
IRS have determined that the rules in this
Treasury decision will take effect on the
date of filing for public inspection in the
Federal Register.
Drafting Information
The principal author of these regu-
lations is Jo Lynn Ricks (Office of the
Associate Chief Counsel (Income Tax
and Accounting)). Other personnel from
the Treasury Department and the IRS,
including Kate Abdoo, John Aramburu,
James Beatty (formerly Income Tax and
Accounting), David Christensen, Alexa
Dubert, Sean Dwyer, Peter Ford, Christi-
na Glendening, Anna Gleysteen, Charlie
Gorham, Evan Hewitt, William Jackson,
Doug Kim, Tom McElroy, and Karla Me-
ola, Office of the Associate Chief Coun-
sel (Income Tax and Accounting); and
William E. Blanchard, Charles Culmer,
and Deepan Patel, Office of the Associate
Chief Counsel (Financial Institutions and
Products), participated in their develop-
ment.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries in nu-
merical order for §§ 1.451-3 and 1.451-8
to read, in part, as follows:
Authority: 26 U.S.C. 7805.
* * * * *
Section 1.451-3 also issued under 26
U.S.C. 451(b)(1)(A)(ii), (b)(3)(C) and
461(h).

January 19, 2021 426 Bulletin No. 2021–3
Section 1.451-8 also issued under 26
U.S.C. 451(c)(2)(A), (3), (4)(A)(iii), (4)
(b)(vii), and 461(h).
* * * * *
Par. 2. Section 1.446-1 is amended by
adding a parenthetical sentence between
the first and second sentences of para-
graph (c)(1)(ii)(A) to read as follows:
§1.446-1 General rule for methods of
accounting.
* * * * *
(c) * * *
(1) * * *
(ii) * * *
(A) * * * (See §1.451-1 for rules relat-
ing to the taxable year of inclusion.) * * *
Par. 3. Section 1.446-2 is amended by
removing “or” at the end of paragraph (a)
(2)(i)(E), removing the period at the end
of paragraph (a)(2)(i)(F) and adding “; or”
in its place, and adding paragraph (a)(2)(i)
(G) to read as follows:
§1.446-2 Method of accounting for
interest.
(a) * * *
(2) * * *
(i) * * *
(G) Section 1.451-3(j) (special order-
ing rule for specified fees).
* * * * *
Par. 4. Section 1.451-1 is amended by:
a. Adding “(all events test)” to the end
of the second sentence of paragraph (a).
b. Redesignating paragraphs (b)
through (g) as (d) through (i).
c. Adding new paragraphs (b) and (c).
The additions read as follows:
§1.451-1 General rule for taxable year of
inclusion.
* * * * *
(b) Timing of income inclusion for ac-
crual method taxpayers with an applica-
ble financial statement. For the timing of
income inclusion for taxpayers that have
an applicable financial statement, as de-
fined in §1.451-3(b)(1), and that use an
accrual method of accounting, see section
451(b) and §1.451-3.
(c) Special rule for timing of income
inclusion from advance payments. For the
timing of income inclusion for taxpayers
that receive advance payments, as defined
in §1.451-8(a)(1), and that use an accrual
method of accounting, see section 451(c)
and §1.451-8.
* * * * *
Par. 5. Section 1.451-3 is added to read
as follows:
§1.451-3 Timing of income inclusion for
taxpayers with an applicable financial
statement using an accrual method of
accounting.
(a) Definitions. The following defini-
tions apply for this section:
(1) AFS income inclusion amount. The
term AFS income inclusion amount means
the amount of an item of gross income that
is required to be included in gross income
under the AFS income inclusion rule in
paragraph (b)(1) of this section.
(2) AFS income inclusion rule. The
term AFS income inclusion rule has the
meaning provided in paragraph (b)(1) of
this section.
(3) AFS inventory inclusion amount.
The term AFS inventory inclusion amount
has the meaning provided in paragraph (c)
(2)(i)(A) of this section.
(4) AFS revenue. The term AFS revenue
means revenue reported in the taxpayer’s
AFS. The characterization of an amount in
the AFS is not determinative of whether
the amount is AFS revenue. For exam-
ple, AFS revenue can include amounts
reported as other comprehensive income
or adjustments to retained earnings in an
AFS. See paragraph (b) of this section
for adjustments to AFS revenue that may
need to be made to apply the rules of this
section.
(5) Applicable financial statement
(AFS). Subject to the rules in paragraph
(a)(5)(iv) of this section, the terms ap-
plicable financial statement and AFS are
synonymous and mean the taxpayer’s fi-
nancial statement listed in paragraph (a)
(5)(i) through (iii) of this section that has
the highest priority, including priority
within paragraphs (a)(5)(i)(B) and (a)(5)
(ii)(B) of this section. The financial state-
ments are, in order of descending priority:
(i) GAAP statements. A financial state-
ment that is certified as being prepared in
accordance with United States generally
accepted accounting principles (GAAP)
and is:
(A) A Form 10-K (or successor form),
or annual statement to shareholders, filed
with the United States Securities and Ex-
change Commission (SEC);
(B) An audited financial statement of
the taxpayer that is used for:
(1) Credit purposes;
(2) Reporting to shareholders, partners,
or other proprietors, or to beneficiaries; or
(3) Any other substantial non-tax pur-
pose; or
(C) A financial statement, other than
a tax return, filed with the Federal Gov-
ernment or any Federal agency, other than
the SEC or the Internal Revenue Service
(IRS);
(ii) IFRS statements. A financial state-
ment that is certified as being prepared in
accordance with international financial re-
porting standards (IFRS) and is:
(A) Filed by the taxpayer with an agen-
cy of a foreign government that is equiv-
alent to the SEC, and has financial report-
ing standards not less stringent than the
standards required by the SEC;
(B) An audited financial statement of
the taxpayer that is used for:
(1) Credit purposes;
(2) Reporting to shareholders, partners,
or other proprietors, or to beneficiaries; or
(3) Any other substantial non-tax pur-
pose; or
(C) A financial statement, other than a
tax return, filed with the Federal Govern-
ment, Federal agency, a foreign govern-
ment, or agency of a foreign government,
other than the SEC, IRS, or an agency that
is equivalent to the SEC or the IRS; or
(iii) Other statements. A financial state-
ment, other than a tax return, filed with the
Federal Government or any Federal agen-
cy, a state government or state agency, or
a self-regulatory organization including,
for example, a financial statement filed
with a state agency that regulates insur-
ance companies or the Financial Industry
Regulatory Authority. Additional financial
statements beyond those included in this
paragraph (a)(5)(iii) may be provided in
guidance published in the Internal Rev-
enue Bulletin (see §601.601(d) of this
chapter).
(iv) Additional rules for determining
priority. If a taxpayer restates AFS reve-
nue for a taxable year prior to the date that
the taxpayer files its Federal income tax
return for such taxable year, the restated

Bulletin No. 2021–3 427 January 19, 2021
AFS must be used instead of the original
AFS. If using the restated AFS revenue re-
sults in a change in method of accounting,
the preceding sentence applies only if the
taxpayer receives permission to change its
method of accounting to use the restated
AFS revenue. In addition, if a taxpayer
with different financial accounting and
taxable years is required to file both annu-
al financial statements and periodic finan-
cial statements covering less than a year
with a government or government agency,
the taxpayer must prioritize the annual fi-
nancial statement in accordance with this
paragraph (a)(5).
(6) Cost of goods. The term cost of
goods means the costs that are proper-
ly capitalized and included in inventory
under sections 471 and 263A or any oth-
er applicable provision of the Internal
Revenue Code (Code) and that are allo-
cable to an item of inventory for which
an AFS inventory inclusion amount is
calculated. See paragraph (c)(5)(iii) of
this section for specific rules for tax-
payers using simplified methods under
section 263A.
(7) Cost of goods in progress offset.
The term cost of goods in progress offset
has the meaning provided in paragraph (c)
(3) of this section.
(8) Cumulative cost of goods in prog-
ress offset. The term cumulative cost of
goods in progress offset means the cu-
mulative cost of goods in progress offset
amounts under paragraph (c) of this sec-
tion for a specific item of inventory that
have reduced an AFS inventory inclusion
amount attributable to such item of inven-
tory in prior taxable years.
(9) Enforceable right. The term en-
forceable right means any right that a
taxpayer has under the terms of a contract
or under applicable Federal, state, or inter-
national law, including rights to amounts
recoverable in equity and liquidated dam-
ages. A contract can include, but is not
limited to, a statement of work, purchase
order, or invoice.
(10) Equity method. The term equity
method means a method of accounting
for financial accounting purposes under
which an investment is initially recorded
at cost and subsequently increased or de-
creased in carrying value by the investor’s
proportionate share of income and losses
and such income or losses are reported as
separate items on the investor’s statement
of income.
(11) Performance obligation. The
term performance obligation means a
promise in a contract with a customer to
transfer to the customer a distinct good,
service, or right; or a series of distinct
goods, services, or rights, or a combi-
nation thereof, that are substantially the
same and that have the same pattern of
transfer to the customer. A performance
obligation includes a promise to grant or
transfer a right to use or access intangi-
ble property. Performance obligations in
a contract are identified by applying the
accounting standards the taxpayer uses
to prepare its AFS. Additionally, to the
extent the contract with the customer
provides the taxpayer with an enforce-
able right to payment, the revenue from
which is not allocated to a performance
obligation described in the first two sen-
tences of this paragraph (a)(11) in the
taxpayer’s AFS but is accounted for as a
separate source of revenue in the taxpay-
er’s AFS, such right shall be treated as
a separate performance obligation under
this section. A fee described in paragraph
(j)(2) of this section is an example of an
enforceable right that is treated as a sepa-
rate performance obligation.
(12) Prior income inclusion amounts.
The term prior income inclusion amounts
means amounts of an item of gross income
that were required to be included in the
taxpayer’s gross income under this section
or §1.451-8 in prior taxable years.
(13) Special method of accounting.
The term special method of accounting
means a method of accounting expressly
permitted or required under any provision
of the Code, the regulations in this part,
or other guidance published in the Internal
Revenue Bulletin (see §601.601(d) of this
chapter) under which the time for taking
an item of gross income into account in a
taxable year is not determined under the
all events test in §1.451-1(a). See, how-
ever, paragraph (j) of this section relat-
ing to certain items of income for debt
instruments. The term special method of
accounting does not include any method
of accounting expressly permitted or re-
quired under this section. The following
are examples of special methods of ac-
counting to which the AFS income inclu-
sion rule does not apply:
(i) The crop method of accounting un-
der sections 61 and 162;
(ii) Methods of accounting provided in
sections 453 through 460;
(iii) Methods of accounting for notion-
al principal contracts under §1.446-3;
(iv) Methods of accounting for hedging
transactions under §1.446-4;
(v) Methods of accounting for REMIC
inducement fees under §1.446-6;
(vi) Methods of accounting for gain
on shares in a money market fund under
§1.446-7;
(vii) Methods of accounting for certain
rental payments under section 467;
(viii) The mark-to-market method of
accounting under section 475;
(ix) Timing rules for income and gain
associated with a transaction that is inte-
grated under §1.988-5, and income and
gain under the nonfunctional currency
contingent payment debt instrument rules
in §1.988-6;
(x) Except as otherwise provided in
paragraph (j) of this section, timing rules
for original issue discount (OID) under
section 811(b)(3) or 1272 (and the regula-
tions in this part under section 1272 of the
Code), income under the contingent pay-
ment debt instrument rules in §1.1275-4,
income under the variable rate debt instru-
ment rules in §1.1275-5, income and gain
associated with a transaction that is inte-
grated under §1.1275-6, and income under
the inflation-indexed debt instrument rules
in §1.1275-7;
(xi) Timing rules for de minimis OID
under §1.1273-1(d) and for de minimis
market discount (as defined in section
1278(a)(2)(C));
(xii) Timing rules for accrued market
discount under sections 1276 and 1278(b);
(xiii) Timing rules for short-term obli-
gations under sections 1281 through 1283;
(xiv) Timing rules for stripped bonds
under section 1286; and
(xv) Methods of accounting provided
in sections 1502 and 1503 and the regula-
tions thereunder, including the method of
accounting relating to intercompany trans-
actions under §1.1502-13.
(14) Transaction price amount. The
term transaction price amount means the
total amount of consideration to which a
taxpayer is, or expects to be, entitled from
all performance obligations under a con-
tract. The transaction price amount is de-

January 19, 2021 428 Bulletin No. 2021–3
termined under the standards the taxpayer
uses to prepare its AFS.
(b) AFS income inclusion rule—(1)
In general. Except as otherwise provided
in this section, if a taxpayer uses an ac-
crual method of accounting for Federal
income tax purposes and has an AFS, the
all events test under §1.451-1(a) for any
item of gross income, or portion thereof,
is met no later than when that item, or por-
tion thereof, is taken into account as AFS
revenue (AFS income inclusion rule). See
paragraph (b)(2) of this section for rules
regarding when an item of gross income,
or portion thereof, is treated as taken into
account as AFS revenue under the AFS in-
come inclusion rule. See paragraph (c) of
this section for optional rules to determine
the AFS income inclusion amount for an
item of gross income from the sale of in-
ventory. See paragraph (d) of this section
for rules regarding the allocation of the
transaction price amount to multiple items
of gross income. See paragraph (e) of this
section for rules to determine the AFS
income inclusion amount for an item of
gross income from a multi-year contract.
See paragraphs (f) and (g) of this section
for limitations of the AFS income inclu-
sion rule. See paragraph (h) of this section
for special rules that may affect the deter-
mination of AFS revenue under the AFS
income inclusion rule. See paragraph (j)
of this section for special ordering rules
for certain items of income with respect to
debt instruments.
(2) Amounts taken into account as AFS
revenue—(i) General rule. Unless the tax-
payer uses the alternative AFS revenue
method described in paragraph (b)(2)(ii)
of this section, the amount of the item of
gross income that is treated as taken into
account as AFS revenue under paragraph
(b)(1) of this section is determined by
making adjustments to AFS revenue for
the amounts described in paragraphs (b)
(2)(i)(A) through (D) of this section.
(A) If AFS revenue reflects a reduction
for amounts described in paragraph (b)(2)
(i)(A)(1) or (2) of this section, AFS reve-
nue is increased by the amount of the re-
duction.
(1) Cost of goods sold and liabilities
that are required to be accounted for un-
der other provisions of the Code such as
section 461, including liabilities for al-
lowances, rebates, chargebacks, rewards
issued in credit card transactions and oth-
er reward programs, and refunds, regard-
less of when any amount described in this
paragraph (b)(2)(i)(A)(1) is incurred.
(2) Amounts anticipated to be in dis-
pute or anticipated to be uncollectable.
(B) If AFS revenue includes an
amount the taxpayer does not have an en-
forceable right to recover if the custom-
er were to terminate the contract on the
last day of the taxable year (regardless of
whether the customer actually terminates
the contract), AFS revenue is reduced by
such amount.
(C) If the transaction price was in-
creased because a significant financing
component is deemed to exist under the
standards the taxpayer uses to prepare its
AFS, then any AFS revenue attributable to
such increase is disregarded.
(D) AFS revenue may be increased or
reduced by additional amounts as provid-
ed in guidance published in the Internal
Revenue Bulletin (see §601.601(d) of this
chapter).
(ii) Alternative AFS revenue method. A
taxpayer that chooses to apply the AFS in-
come inclusion rule by using the alterna-
tive AFS revenue method described in this
paragraph (b)(2)(ii) in lieu of the rules in
paragraph (b)(2)(i) of this section, deter-
mines the amount of the item of gross in-
come that is treated as taken into account
as AFS revenue under paragraph (b)(1) of
this section by making adjustments to AFS
revenue for only the amounts described in
paragraphs (b)(2)(i)(A), (C), and (D) of
this section. A taxpayer that uses the al-
ternative AFS revenue method for a trade
or business must apply the method to all
items of gross income in the trade or busi-
ness that are subject to the AFS income
inclusion rule.
(3) Exceptions. The AFS income inclu-
sion rule in paragraph (b)(1) of this sec-
tion does not apply to:
(i) Any item of gross income, or por-
tion thereof, if the timing of income in-
clusion for that item, or portion thereof,
is determined using a special method of
accounting;
(ii) Any item of gross income, or por-
tion thereof, in connection with a mort-
gage servicing contract; or
(iii) Any taxable year that is not cov-
ered for the entire year by one or more
AFS.
(4) Examples. The following examples
illustrate the provisions of paragraph (b)
of this section. Unless the facts specifi-
cally state otherwise, the taxpayer has an
AFS, is on a calendar year for Federal in-
come tax purposes and AFS purposes, and
uses an accrual method of accounting for
Federal income tax purposes. Further, the
taxpayer does not use the alternative AFS
revenue method under paragraph (b)(2)
(ii) of this section or the AFS cost offset
method under paragraph (d) of this sec-
tion, and does not use a special method of
accounting:
(i) Example 1: Provision of installation ser-
vices—(A) Facts. In 2021, B enters into a 2-year
service contract with a customer to install the cus-
tomer’s manufacturing equipment for $100,000.
Throughout the term of the contract, the customer
retains control of the equipment. B begins providing
the installation services in 2021 and completes the
installation services in 2022. Under the contract, B
bills the customer $55,000 in 2021 when installation
begins, but does not have a fixed right to receive the
remaining $45,000 until installation is complete and
approved by the customer. However, if the customer
were to terminate the contract prior to completion, B
would have an enforceable right to payment for all
services performed prior to the termination date. For
its AFS, B reports $60,000 of AFS revenue for 2021
and $40,000 of AFS revenue for 2022, in accordance
with the services performed in each respective year.
(B) Analysis. Under the all events test in §1.451-
1(a), B is required to include $55,000 in gross income
in 2021 as B has a fixed right to receive $55,000 as
of the end of 2021. However, under the AFS income
inclusion rule, because B has an enforceable right to
recover the entire $60,000 that was reported in AFS
revenue for 2021 had the customer terminated the
contract on the last day of 2021, the entire $60,000 is
treated as taken into account as AFS revenue in 2021.
Accordingly, the all events test is met for the $60,000
of gross income no later than the end of 2021 and
B is required to include $60,000 in gross income in
2021.
(ii) Example 2: Provision of goods included in
AFS with enforceable right—(A) Facts. In Novem-
ber 2021, C enters into a contract with a customer
to provide 50 customized computers for $80,000.
Under the contract, C can bill $80,000 after the cus-
tomer accepts delivery of the computers. However,
the contract provides that C has an enforceable right
to be paid for work performed to date if the custom-
er were to terminate the contract prior to delivery. C
produces and ships all of the computers in 2021. In
2022, the customer accepts delivery of the comput-
ers and C bills the customer. For its AFS, C reports
$80,000 of AFS revenue for 2021.
(B) Analysis. Under the all events test in §1.451-
1(a), C does not have a fixed right to receive the
$80,000 until the customer accepts delivery of the
computers in 2022. However, under the AFS income
inclusion rule, because C has an enforceable right to
recover the entire $80,000 of AFS revenue that was
reported for 2021 had the customer terminated the
contract on the last day of 2021, the entire $80,000

Bulletin No. 2021–3 429 January 19, 2021
is treated as “taken into account as AFS revenue” in
2021. Accordingly, the all events test is met for the
$80,000 no later than in 2021 and C is required to
include $80,000 in gross income in 2021.
(iii) Example 3: Provision of services included in
AFS with enforceable right—(A) Facts. In 2021, D,
an engineering services provider, enters into a 4-year
contract with a customer to provide services for a to-
tal of $100x. Under the contract, D bills and receives
$25x for each year of the contract. If the customer
were to terminate the contract prior to completion, D
has an enforceable right to only the billed amounts.
For its AFS, D reports $60x, $0, $20x, and $20x of
AFS revenue from the contract for 2021, 2022, 2023,
and 2024, respectively.
(B) Analysis. Under the all events test in §1.451-
1(a), D is required to include $25x in gross income
in 2021 as D has a fixed right to receive $25x as of
the end of 2021. Although D reports $60x of AFS
revenue from the provision of services for 2021, D
has an enforceable right to recover only $25x if the
customer were to terminate the contract on the last
day of 2021. Accordingly, pursuant to paragraph (b)
(2)(i)(B) of this section, of the $60x of AFS revenue
reported for 2021, only $25x is treated as “taken into
account as AFS revenue” under the AFS income in-
clusion rule. As a result, D is required to include only
$25x in gross income in 2021. Similarly, in 2022,
2023 and 2024, D includes in gross income only the
yearly $25x contract payments under the all events
test as only the billed amounts are treated as “taken
into account as AFS revenue” under the AFS income
inclusion rule.
(iv) Example 4: Sale of good under cost-plus
contract—(A) Facts. In 2021, E, a manufacturer,
enters into a contract with Fire Department for the
manufacture and delivery of a fire truck. The fire
truck takes 10 months to manufacture at an estimat-
ed cost of $60,000. The contract provides E with an
enforceable right to recover costs incurred in man-
ufacturing the fire truck regardless of whether the
Fire Department accepts delivery of the fire truck or
terminates the contract, and an enforceable right to
an additional $20,000 if the fire truck is accepted by
the Fire Department. E does not have an enforceable
right to recover any portion of the additional $20,000
if the Fire Department were to terminate the contract
before it accepts the fire truck. E has an obligation to
cure any defects if the customer rejects the fire truck.
In August 2021, E begins manufacturing the fire
truck ordered by Fire Department and incurs $30,000
of costs for materials and labor for the contract. For
its AFS, E reports $40,000 of AFS revenue for 2021
($30,000 costs plus $10,000 expected profit on the
sale of the fire truck).
(B) Analysis for 2021 taxable year. Under the all
events test in §1.451-1(a), E is required to include
$30,000 in gross income in 2021 as E has a fixed
right to receive $30,000 as of the end of 2021. Al-
though E reports $40,000 of AFS revenue for 2021,
E has an enforceable right to recover only $30,000 if
the Fire Department were to terminate the contract
on the last day of 2021. Accordingly, pursuant to
paragraph (b)(2)(i)(B) of this section, of the $40,000
of AFS revenue reported for 2021, only $30,000 is
treated as “taken into account as AFS revenue” un-
der the AFS income inclusion rule. As a result, E is
required to include only $30,000 in gross income in
2021.
(v) Example 5: Sale of goods with AFS revenue
adjustments—(A) Facts. In July 2021, F, a manu-
facturer of automobile parts, enters into a contract
to sell 1,000 parts to a customer for $10 per part, for
a total of $10,000 (1,000 x $10). The contract also
provides that F will receive a $200 bonus if it deliv-
ers all the parts to the customer by February 1, 2022.
F delivers 500 non-defective parts to the customer
on December 31, 2021 and schedules the remaining
500 parts for delivery to the customer on January 1,
2022. F does not have an enforceable right to recover
any portion of the $200 bonus if the customer were
to terminate the contract before all 1,000 parts are
delivered. F expects to earn the $200 bonus and have
5% of the non-defective parts returned. For its AFS,
F reports $4,850 ($5,000 + $100 - $250) of AFS rev-
enue for 2021, which includes a $100 (50% x $200)
adjustment to increase AFS revenue for the expected
bonus and a $250 (5% x $5,000) adjustment to de-
crease AFS revenue for anticipated returns.
(B) Analysis. Under the all events test in
§1.451-1(a), F is required to include $5,000, less
the corresponding cost of goods sold under sections
263A and 471 as applicable, in gross income in
2021 as F has a fixed right to receive $5,000 from
the delivery of 500 parts to the customer in 2021.
However, F does not have a fixed right to receive
any portion of the $200 delivery bonus as of the
end of 2021 as the remaining 500 parts had yet to
be delivered. Under the AFS income inclusion rule
and, specifically, paragraphs (b)(2)(i)(A)(1) and
(b)(2)(i)(B) of this section, the amount treated as
“taken into account as AFS revenue” for 2021 is
also $5,000, calculated as $4,850 of AFS revenue
that was reported for 2021, decreased by $100 for
the expected delivery bonus that F does not have an
enforceable right to recover if the customer were
to terminate the contract as of the end of 2021 and
increased by $250 for anticipated return liabilities
that are accounted for under section 461 ($4,850 -
$100 + $250 = $5,000). Accordingly, F is required
to include $5,000, less the corresponding cost of
goods sold determined under sections 263A and
471 as applicable, in gross income in 2021.
(vi) Example 6: Chargebacks—(A) Facts. In
November 2021, G, a pharmaceutical manufactur-
er, enters into a contract to sell 1,000 units to W, a
wholesaler, for $10 per unit, totaling $10,000 (1,000
x $10). The contract also provides that G will credit
or pay W $4 per unit (a 40% “chargeback”) for sales
W makes to certain qualifying customers. G deliv-
ers 600 units to W on December 31, 2021, and bills
W $6,000 under the contract. W does not make any
sales to qualifying customers in 2021. For its AFS,
G reports $3,600 ($6,000 - $2,400) of AFS revenue
for 2021, which includes a reduction of the $6,000 of
sales revenue by $2,400 (40% x $6,000) for antici-
pated chargebacks.
(B) Analysis. Under the all events test in §1.451-
1(a), G is required to include $6,000, less the corre-
sponding cost of goods sold under sections 263A and
471 as applicable, in gross income in 2021 as G has a
fixed right to receive $6,000 from the delivery of 600
units to W in 2021. The anticipated chargebacks are
liabilities that are accounted for under section 461.
Under the AFS income inclusion rule and, specifi-
cally, paragraph (b)(2)(i)(A)(1) of this section, the
amount treated as “taken into account as AFS reve-
nue” for 2021 is also $6,000, calculated as $3,600 of
AFS revenue reported for 2021, increased by $2,400
of anticipated chargeback liabilities that are account-
ed for under section 461 ($3,600 + $2,400 = $6,000).
Accordingly, G is required to include $6,000, less
the corresponding cost of goods sold under sections
263A and 471 as applicable, in gross income in 2021.
(vii) Example 7: Sale of property using a special
method of accounting. In 2021, H, a financial ser-
vices provider, sells a building for $100,000, payable
in five annual payments of $20,000 together with ad-
equate stated interest, starting in 2021. For its AFS,
H reports $100,000 of AFS revenue for 2021 from
the sale of the building. For Federal income tax pur-
poses, H uses the installment method under section
453 for the sale of the building. Because the install-
ment method under section 453 is a special method
of accounting under paragraphs (a)(13)(ii) and (b)
(3)(i) of this section, the AFS income inclusion rule
does not apply to H’s sale of the building. Accord-
ingly, the gain from the sale is included in income as
prescribed in section 453.
(viii) Example 8: Insurance contract renew-
als—(A) Facts. J, an insurance agent, is engaged
by an insurance carrier to sell insurance. Pursuant
to the contract between J and the insurance carrier,
J is entitled to receive a $50 commission from the
insurance carrier at the time a policy is sold to a cus-
tomer. The contract also provides that J is entitled
to receive an additional $25 commission each time
a policy is renewed. J does not have an enforceable
right to a renewal commission if the insurance carrier
terminates the contract before a policy is renewed. J
sells 1,000 one-year policies in 2021, of which 800
are expected to be renewed in 2022 and 700 are ex-
pected to be renewed in 2023. J does not have any
ongoing obligation to provide additional services to
the insurance carrier or the customers after the initial
sale of the policy. For its AFS, J reports $87,500 of
AFS revenue for 2021, which includes $50,000 ($50
x 1,000) of commission income for policies sold in
2021 and an estimate of $37,500 ($25 x 1,500) of
commission income for the policies expected to be
renewed in 2022 and 2023.
(B) Analysis. Under the all events test in §1.451-
1(a), J is required to include $50,000 in gross income
in 2021 as J has a fixed right to receive $50,000 of
commission income for the policies it sold during
2021. However, as of the end of 2021, J does not
have a fixed right to receive any commission income
from anticipated policy renewals. Under the AFS in-
come inclusion rule, although J reports $87,500 of
AFS revenue for 2021, J does not have an enforce-
able right to recover the $37,500 of anticipated com-
mission income from future policy renewals if the in-
surance carrier were to terminate the contract on the
last day of 2021. Accordingly, pursuant to paragraph
(b)(2)(i)(B) of this section, of the $87,500 of AFS
revenue reported for 2021, only $50,000 is treated as
“taken into account as AFS revenue” under the AFS
income inclusion rule. As a result, J is required to
include $50,000 in gross income in 2021. Alterna-
tively, if J uses the alternative AFS revenue method
in paragraph (b)(2)(ii) of this section, all $87,500 of
AFS revenue reported for 2021 would be treated as
“taken into account as AFS revenue” under the AFS

January 19, 2021 430 Bulletin No. 2021–3
income inclusion rule and J would be required to
include $87,500 of commission income in gross in-
come in 2021.
(ix) Example 9: Escalating rents—(A) Facts. (1)
K is a landlord in the business of leasing office space.
On January 1, 2021, K enters into a 5-year lease with
a tenant that provides for annual rent of $30,000 for
2021 and increases by 5% each year over the lease
term. The annual rents are due at the end of each
year. Accordingly, the rent for each year (rounded to
the nearest dollar) is as follows:
Table 1 to paragraph (b)(4)(ix)(A)
YearCalculationTotal Rent
2021$30,000$30,000
2022$30,000 * 1.05$31,500
2023$31,500 * 1.05$33,075
2024$33,075 * 1.05$34,729
2025$34,729 * 1.05$36,465
Total Rent for Five Years$165,769
(2) The lease is not a section 467 rental agree-
ment as defined under section 467(d). If the tenant
terminates the lease early, the tenant must pay K
the balance of the rent due for the remainder of the
termination year. On its AFS, K reports AFS reve-
nue from rents on a straight-line basis over the term
of the lease, or approximately $33,154 per year
($165,769 total rent / 5 years). Accordingly, for its
AFS, K reports $33,154 of AFS revenue for 2021.
(B) Analysis. Under the all events test in §1.451-
1(a), K is required to include $30,000 in gross income
in 2021 as K has a fixed right to receive $30,000 for
the 2021 rental period under the terms of the lease
agreement. Under the AFS income inclusion rule, al-
though K reports $33,154 of AFS revenue for 2021,
K has an enforceable right to recover only $30,000
if the tenant were to cancel the lease on the last day
of 2021. Accordingly, pursuant to paragraph (b)(2)
(i)(B) of this section, of the $33,154 of AFS revenue
reported for 2021, only $30,000 is treated as “taken
into account in AFS revenue” under the AFS income
inclusion rule. As a result, K is required to include
$30,000 in gross income in 2021.
(x) Example 10: Licensing income from digital
services—(A) Facts. M is engaged in the business of
licensing media entertainment content packages. M
licenses content packages to customers by entering
into subscription plans with customers. In January
2021, M enters into a two-year subscription plan
with Customer. M charges Customer $40 per month
billed monthly in arrears. If Customer terminates the
plan prior to the two-year term, it must pay the bal-
ance of the subscription fee for the remaining term of
the contract. For its AFS, M reports $960 ($40 x 24
months) of AFS revenue for2021.
(B) Analysis. Under the all events test in §1.451-
1(a), M is required to include $480 in gross income
in 2021 as M has a fixed right to receive $480 ($40
x 12) for the 12 months of media content licensed to
Customer in 2021. M does not have a fixed right to
receive any portion of the 2022 subscription fee as of
the end of 2021 as such fee is not due under the terms
of the subscription agreement until 2022 and M has
yet to provide the media content for the 2022 sub-
scription period. However, under the AFS income
inclusion rule, because M has an enforceable right
to recover all $960 of AFS revenue reported for 2021
if Customer were to terminate the contract at the end
of 2021, all $960 is treated as “taken into account as
AFS revenue” in 2021. Accordingly, M is required to
include $960 in gross income in 2021.
(c) Cost offsets—(1) In general.
This paragraph (c) provides an optional
method of accounting that may be used
to determine the AFS income inclusion
amount for an item of gross income from
the sale of inventory (AFS cost offset
method). A taxpayer that uses the AFS
cost offset method for a trade or busi-
ness must apply this method to all items
of gross income in the trade or business
that meet the criteria in this paragraph
(c). Additionally, a taxpayer that uses
this method for a trade or business must
also use the advance payment cost offset
method described in §1.451-8(e) to ac-
count for all advance payments received
by such trade or business that meet the
criteria in §1.451-8(e), if applicable. A
taxpayer that uses the AFS cost offset
method to account for gross income from
the sale of an item of inventory, but not
the advance payment cost offset method
because it does not receive any advance
payments for such item, determines the
corresponding AFS income inclusion
amount for a taxable year by following
the rules in paragraph (c)(2) of this sec-
tion. A taxpayer that uses the AFS cost
offset method and the advance payment
cost offset method to account for gross
income, including advance payments,
from the sale of an item of inventory, de-
termines the corresponding AFS income
inclusion amount and the advance pay-
ment income inclusion amount, as de-
fined in §1.451-8(a)(2), for a taxable year
by following the rules in paragraph (c)(2)
of this section rather than the rules under
§1.451-8(e). However, if all payments re-
ceived for the sale of an item of inventory
meet the definition of an advance pay-
ment under §1.451-8(a)(1), a taxpayer
that uses the advance payment cost offset
method determines the corresponding ad-
vance payment income inclusion amount
for a taxable year by following the rules
in §1.451-8(e).
(2) AFS cost offset method. A taxpayer
that uses the AFS cost offset method and,
if applicable, the advance payment cost
offset method, to account for gross in-
come from the sale of an item of invento-
ry determines the AFS income inclusion
amount, or, if applicable, the advance
payment income inclusion amount, for a
taxable year prior to the taxable year in
which ownership of the item of inven-
tory is transferred to the customer by
following the rules in paragraph (c)(2)(i)
of this section, subject to the additional
rules and limitations in paragraphs (c)(4)
through (6) of this section. Such taxpay-
er determines the AFS income inclusion
amount or, if applicable, the advance
payment income inclusion amount, for
the taxable year in which ownership of
the item of inventory is transferred to the
customer by following the rules in para-
graph (c)(2)(ii) of this section. A taxpay-
er described in this paragraph (c)(2) that
receives advance payments for the sale
of the item of inventory may be required
to include in gross income for a taxable
year an amount that is comprised of both
an AFS income inclusion amount and
an advance payment income inclusion
amount. In such case, it is not necessary
to determine the portion of the total in-
clusion that is comprised of the AFS in-
come inclusion amount and the portion

Bulletin No. 2021–3 431 January 19, 2021
of the total inclusion that is comprised of
the advance payment income inclusion
amount.
(i) Determining gross income for a
year prior to the year of sale. To deter-
mine the amount required to be included
in gross income from the sale of an item
of inventory for a taxable year prior to the
taxable year in which ownership of the
item of inventory is transferred to the cus-
tomer, a taxpayer must first determine the
AFS inventory inclusion amount for such
item for such year by applying the steps in
paragraph (c)(2)(i)(A) of this section. This
AFS inventory inclusion amount is then
reduced by the cost of goods in progress
offset for the taxable year, as determined
under paragraphs (c)(3) through (5) of this
section. This net amount is required to be
included in gross income for the taxable
year.
(A) AFS inventory inclusion amount
for a taxable year. To determine the AFS
inventory inclusion amount for an item of
inventory for a taxable year:
(1) The taxpayer first takes the great-
er of the amount described in paragraph
(c)(2)(i)(A)(1)(i) of this section, or the
amount described in paragraph (c)(2)(i)
(A)(1)(ii) of this section (or if the two
amounts are equal, the equal amount).
(i) The cumulative amount of reve-
nue from the item of inventory that satis-
fies the all events test under §1.451-1(a)
through the last day of the taxable year,
less any advance payment inventory in-
clusion amount, as defined in §1.451-8(a)
(3), with respect to a subsequent taxable
year.
(ii) The cumulative amount of revenue
from the item of inventory that is treated
as “taken into account as AFS revenue”
under paragraph (b)(2) of this section
through the last day of the taxable year.
(2) The taxpayer then reduces the
amount determined under paragraph (c)
(2)(i)(A)(1) of this section by the amount
computed under paragraph (c)(2)(i)(A)(1)
of this section for that item of inventory
for the immediately preceding taxable
year.
(B) [Reserved]
(ii) Determining the gross income for
the year of sale. To determine the amount
required to be included in gross income
from the sale of an item of inventory for
the taxable year in which ownership of
the item of inventory is transferred to the
customer:
(A) The taxpayer first takes the greater
of the amount described in paragraph (c)
(2)(ii)(A)(1) of this section, or the amount
described in paragraph (c)(2)(ii)(A)(2)
of this section (or if the two amounts are
equal, the equal amount).
(1) The cumulative amount of revenue
from the item of inventory that satisfies the
all events test under §1.451-1(a) through
the last day of the taxable year, including
the full amount of any advance payment
received for the item of inventory.
(2) The cumulative amount of revenue
from the item of inventory that is treated
as “taken into account as AFS revenue”
under paragraph (b)(2) of this section
through the last day of the taxable year.
(B) The taxpayer then reduces such
amount by any prior income inclusion
amounts with respect to such item of in-
ventory. This net amount is required to be
included in gross income for the taxable
year. The taxpayer does not further reduce
such amount by a cost of goods in prog-
ress offset under paragraph (c)(3) of this
section. However, the taxpayer is entitled
to recover the costs capitalized to the item
of inventory as cost of goods sold in ac-
cordance with sections 471 and 263A or
any other applicable provision of the In-
ternal Revenue Code. See §1.61-3.
(3) Cost of goods in progress offset for
a taxable year. The cost of goods in prog-
ress offset for the taxable year is calculat-
ed as:
(i) The cost of goods allocable to the
item of inventory through the last day of
the taxable year; reduced by
(ii) The cumulative cost of goods in
progress offset attributable to the item of
inventory, if any.
(4) Limitations to the cost of goods in
progress offset. The cost of goods in prog-
ress offset is determined separately for
each item of inventory. Further, the cost of
goods in progress offset attributable to one
item of inventory cannot reduce the AFS
inventory inclusion amount attributable to
a separate item of inventory. The cost of
goods in progress offset cannot reduce the
AFS inventory inclusion amount for the
taxable year below zero.
(5) Inventory methods—(i) Inventory
costs not affected by cost of goods in prog-
ress offset. The cost of goods comprising
the cost of goods in progress offset does
not reduce the costs that are capitalized to
the items of inventory produced or items
of inventory acquired for resale by the tax-
payer. While the cost of goods in progress
offset reduces the AFS inventory inclusion
amount, the cost of goods in progress off-
set does not affect how and when costs are
capitalized to inventory under sections 471
and 263A or any other applicable provi-
sion of the Internal Revenue Code or when
those capitalized costs will be recovered.
(ii) Consistency between inventory meth-
ods and AFS cost offset method. The costs
of goods comprising the cost of goods in
progress offset must be determined by ap-
plying the taxpayer’s method of accounting
for inventory for Federal income tax pur-
poses. A taxpayer using the AFS cost offset
method and, if applicable, the advance pay-
ment cost offset method must calculate its
cost of goods in progress offset by reference
to all costs that the taxpayer has permissi-
bly capitalized and allocated to items of in-
ventory under its method of accounting for
inventory for Federal income tax purposes,
but including no more costs than what the
taxpayer has permissibly capitalized and al-
located to items of inventory.
(iii) Allocation of “additional section
263A costs” for taxpayers using simpli-
fied methods. If a taxpayer uses the sim-
plified production method as defined
under §1.263A-2(b), the modified simpli-
fied production method as defined under
§1.263A-2(c), or the simplified resale meth-
od as defined under §1.263A-3(d) to deter-
mine the amount of its additional section
263A costs, as defined under §1.263A-1(d)
(3), to be included in ending inventory, then
solely to compute the cost of goods in prog-
ress offset, the taxpayer must determine the
portion of additional section 263A costs al-
locable to an item of inventory by multiply-
ing its total additional section 263A costs
accounted for under the simplified method
for all items of inventory subject to the sim-
plified method by the following ratio:
Section 471 costs allocable to the specific
item of inventory
Total section 471 costs for all items of in-
ventory subject to the simplified method
(6) Acceleration of gross income. A
taxpayer that uses the AFS cost offset

January 19, 2021 432 Bulletin No. 2021–3
method or the advance payment cost offset
method must include in gross income for
a taxable year prior to the taxable year in
which an item of inventory is transferred
to the customer, all payments received for
the item of inventory that were not previ-
ously included in gross income:
(i) If, in that taxable year, the taxpayer
either dies or ceases to exist in a transac-
tion other than a transaction to which sec-
tion 381(a) applies; or
(ii) If, and to the extent that, in that
taxable year, the taxpayer’s obligation to
the customer with respect to the item of
inventory ends other than in:
(A) A transaction to which section
381(a) applies; or
(B) A section 351(a) transfer that is part
of a section 351 transaction in which:
(1) Substantially all assets of the trade
or business, including the item of invento-
ry, are transferred;
(2) The transferee adopts or uses, in the
year of the transfer, the same methods of
accounting for the item of inventory under
this section and §1.451-8 as those used by
the transferor; and
(3) The transferee and the transferor
are members of the same consolidated
group, as defined in §1.1502-1(h).
(7) Additional procedural guidance.
The IRS may publish procedural guid-
ance in the Internal Revenue Bulletin (see
§601.601(d) of this chapter) that provides
alternative procedures for complying with
the rules under this paragraph (c), includ-
ing alternative methods of accounting for
cost offsets.
(8) Examples. The following examples
illustrate the AFS cost offset method. Un-
less the facts specifically state otherwise,
the taxpayer has an AFS, is on a calendar
year for both Federal income tax purposes
and AFS purposes, uses an accrual meth-
od of accounting for Federal income tax
purposes, and does not use a special meth-
od of accounting. Further, the taxpayer
properly applies its inventory accounting
method, uses the AFS cost offset method
under paragraph (c) of this section, and,
except as otherwise provided, does not
receive advance payments. Lastly, the
taxpayer does not produce unique items,
as described in §1.460-2(a)(1) and (b), or
any item that normally requires more than
12 calendar months to complete, as deter-
mined under §1.460-2(a)(2) and (c). Any
production period that exceeds 12 calen-
dar months is due to unforeseen produc-
tion delays.
(i) Example 1—(A) Facts. During 2021, A enters
into a contract with Customer to manufacture and de-
liver a good with a total contract price of $100x. The
costs to produce the good are required to be capital-
ized under sections 471 and 263A as the good is in-
ventory in the hands of A. Ownership of the good is
transferred from A to Customer upon its delivery in
2022. A determines, under paragraph (c)(2)(i)(A) of
this section, that its AFS inventory inclusion amount
for 2021 is $20x. A incurs $12x of costs in 2021, and
$48x of costs in 2022 ($60x in total) that are permis-
sibly capitalized and allocated to the produced good
under sections 471 and 263A. A has a fixed right to
receive the $100x contract price when it delivers
the good in 2022. A does not receive any payments
from Customer prior to delivery. Further, all $100x is
treated as “taken into account as AFS revenue” as of
the last day of 2022.
(B) Analysis for 2021. For 2021, A’s AFS income
inclusion amount, as determined under paragraph (c)
(2)(i) of this section, is $8x ($20x AFS inventory in-
clusion amount less $12x cost of goods in progress
offset, which is the cost of goods incurred through
December 31, 2021).
(C) Analysis for 2022. During 2022, ownership
of the good is transferred to Customer. Accordingly,
pursuant to paragraph (c)(2)(ii) of this section, A de-
termines the AFS income inclusion amount for 2022
by:
(1) First taking the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2022 ($100x); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2022 ($100x) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($100x)
the prior income inclusion amounts attributable to
the transferred good ($8x). This net amount of $92x
is the AFS income inclusion amount for 2022. Al-
though A does not reduce such amount by a cost of
goods in progress offset under this paragraph (c), A
is entitled to recover the $60x of costs capitalized to
the good as cost of goods sold in 2022 in accordance
with sections 471 and 263A. See §1.61-3. Accord-
ingly, A’s gross income for 2022 is $32x.
(ii) Example 2—(A) Facts. In December of
2021, A enters into a contract with Customer to
manufacture and deliver 10 items of inventory at a
price of $10x per item by the end of 2023. A deter-
mines, under paragraph (c)(2)(i)(A) of this section,
that the AFS inventory inclusion amount attribut-
able to each item of inventory under the contract is
$3x for 2021. A also incurs $10x of inventory costs
during 2021. Such costs are permissibly capitalized
and allocated under sections 471 and 263A and are
allocated equally to each item of inventory under
the contract ($1x per item). During 2022, the tax-
payer incurs $18x of costs to finish manufacturing 6
of the 10 items and delivers such items to Customer
in October of 2022. Such costs are permissibly cap-
italized and allocated under sections 471 and 263A
and are allocated equally to each of the 6 items de-
livered in October of 2022 ($3x per item). Upon
delivering the 6 items, ownership of the delivered
items transfers to Customer, A has a fixed right to
receive $60x of the total contract price, and all $60x
is treated as “taken into account as AFS revenue.” A
does not incur any inventory costs during 2022 that
are allocable to the 4 remaining undelivered items,
nor does the taxpayer have an AFS inventory in-
clusion amount attributable to such items for 2022.
During 2023, A incurs $12x of costs to finish man-
ufacturing the 4 remaining items and delivers such
items to Customer. Such costs are permissibly cap-
italized and allocated under sections 471 and 263A
and are allocated equally to each of the 4 items de-
livered in 2023 ($3x per item). Upon delivering the
4 remaining items, ownership of the items transfers
to Customer, A has a fixed right to receive the re-
maining $40x contract price, and all $40x is treated
as “taken into account as AFS revenue.”
(B) Analysis for 2021 A’s AFS income inclusion
amount for 2021 is $2x per item ($3x AFS inventory
inclusion amount per item less $1x cost of goods in
progress offset per item, which is the cost of goods as
of December 31, 2021). Accordingly, A’s total gross
income inclusion for 2021 is $20x.
(C) Analysis for 2022. During 2022, ownership
of 6 of the 10 items is transferred to Customer. Ac-
cordingly, pursuant to paragraph (c)(2)(ii) of this
section, A determines the AFS income inclusion
amount for 2022 by:
(1) First taking the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2022 ($10x per item); or
(ii) The cumulative amount of revenue that is
treated as taken into account as AFS revenue through
the last day of 2022 ($10x per item) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($10x
per item) the prior income inclusion amounts attrib-
utable to each transferred item ($2x per item). This
net amount of $8x per item is the AFS income in-
clusion amount for each transferred item for 2022.
Although A does not reduce such amount by a cost
of goods in progress offset under this paragraph (c),
A is entitled to recover the $4x of costs capitalized to
each item delivered as cost of goods sold in 2022 in
accordance with sections 471 and 263A. According-
ly, on an aggregate basis, A’s gross income for 2022
is $24x (aggregate AFS income inclusion amount for
the 6 items delivered in 2022 of $ 48x less aggregate
cost of goods sold of $24x). A does not include any
amounts in gross income for 2022 with respect to
the 4 items of inventory that were not delivered to
Customer until 2023 as A does not have an AFS in-
ventory inclusion amount attributable to such items
for 2022.
(D) Analysis for 2023. During 2023, ownership
of the 4 remaining items are transferred to Cus-
tomer. Based on the facts, A did not have an AFS
inventory inclusion amount attributable to the 4
remaining items for 2022, nor did it incur any cost
for such items in 2022 so the analysis for the 4 re-
maining items for 2023 is similar to the analysis for
the 6 items transferred to the customer in 2022 on
a per item basis. Pursuant to paragraph (c)(2)(ii) of
this section, A determines the AFS income inclusion
amount for 2023 by:
(1) First taking the greater of:

Bulletin No. 2021–3 433 January 19, 2021
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2023 ($10x per item); or
(ii) The cumulative amount of revenue that is
treated as taken into account as AFS revenue through
the last day of 2023 ($10x per item) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($10x per
item) the prior income inclusion amounts attribut-
able to each transferred item ($2x per item). This net
amount of $8x per item is the AFS income inclusion
amount for each transferred item for 2023. Although
A does not reduce such amount by a cost of goods in
progress offset under this paragraph (c), A is entitled
to recover the $4x of costs capitalized to each item
delivered as cost of goods sold in 2023 in accordance
with sections 471 and 263A. On an aggregate basis,
A’s gross income for 2023 is $16x (aggregate AFS
income inclusion amount for the 4 items delivered
in 2023 of $32x less aggregate cost of goods sold
of $16x).
(iii) Example 3—(A) Facts. In December of
2021, A enters into a contract with Customer to man-
ufacture and deliver a good with a total contract price
of $100x. The costs to produce the good are required
to be capitalized under sections 471 and 263A as the
good is inventory in the hands of the taxpayer. Own-
ership of the good is transferred from A to Customer
upon its delivery in January of 2023. A determines,
under paragraph (c)(2)(i)(A) of this section, that its
AFS inventory inclusion amount for 2021 and 2022
is $40x per year. A incurs $25x of costs each year
($75x in total) that are permissibly capitalized and
allocated to the manufactured good under sections
471 and 263A. A has a fixed right to receive the
$100x contract price when it delivers the good in
January of 2023. A does not receive any payments
from Customer prior to delivery. Further, all $100x
is treated as “taken into account as AFS revenue” as
of the last day of 2023.
(B) Analysis for 2021 and 2022. For 2021, A’s
AFS income inclusion amount, as determined under
paragraph (c)(2)(i) of this section, is $15x ($40x AFS
inventory inclusion amount for 2021 less the $25x
cost of goods in progress offset for 2021, which is
equal to the cost of goods as of December 31, 2021).
For 2022, A’s AFS income inclusion amount is $15x
($40x AFS inventory inclusion amount for 2022 less
the $25x cost of goods in progress offset for 2022,
which is the $50x cost of goods as of December 31,
2022 less the 25x cumulative cost of goods in prog-
ress offset amount taken into account in 2021).
(C) Analysis for 2023. During 2023, ownership
of the good is transferred to Customer. Accordingly,
pursuant to paragraph (c)(2)(ii) of this section, A de-
termines the AFS income inclusion amount for 2023
by:
(1) First taking the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2023 ($100x); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2023 ($100x) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($100x)
the prior income inclusion amounts attributable to
the transferred good of $30x ($15x for 2021 and
$15x for 2022). This net amount of $70x is the AFS
income inclusion amount for 2023. Although A does
not reduce such amount by a cost of goods in prog-
ress offset under this paragraph (c), A is entitled to
recover the $75x of costs capitalized to the good as
cost of goods sold in 2023 in accordance with sec-
tions 471 and 263A. See §1.61-3. Accordingly, A’s
gross income for 2025 is -$5x.
(iv) Example 4—(A) Facts. In December 2021,
A enters into a contract with Customer to manufac-
ture and deliver a good with a total contract price of
$100x. A reports $5x of AFS revenue for 2021, $90x
of cumulative AFS revenue through the end of 2022,
and $100x of cumulative AFS revenue through the
end of 2023. A has an enforceable right to recover all
AFS revenue reported through the end of each con-
tract year if Customer were to terminate the contract
on the last day of each year. Under the terms of the
contract, A is entitled to and receives a payment of
$40x in 2021 and a payment of $60x when Customer
accepts delivery of the good in 2023, which is also
when ownership of the good transfers to Customer.
The costs to produce the good are required to be cap-
italized under sections 471 and 263A as the good is
inventory in the hands of A. A incurs $10x of costs
in 2021, $55x of costs in 2022, and $5x of costs in
2023 ($70x in total). Such costs are permissibly cap-
italized and allocated to the produced good under
sections 471 and 263A. A uses the AFS cost offset
method under paragraph (c) of this section and ac-
counts for advance payments, as defined in §1.451-
8(a)(1), under the deferral method and advance pay-
ment cost offset method under §1.451-8(c) and (e),
respectively.
(B) Analysis for 2021. The $40x payment A re-
ceives in 2021 meets the definition of an advance
payment under §1.451-8(a)(1) as the full inclusion
of $40x in gross income in the year of receipt is a
permissible method of accounting, a portion of the
payment ($35x) is “taken into account as AFS reve-
nue” in a subsequent year, and the payment is for a
good. Pursuant to §1.451-8(a)(3), A’s advance pay-
ment inventory inclusion amount for 2022 is $35x
(the portion of the payment deferred for AFS purpos-
es). Pursuant to paragraph (c)(2)(i) of this section,
A must first determine the AFS inventory inclusion
amount for 2021 by applying the rules in paragraph
(c)(2)(i)(A) of this section. A then reduces such
amount by the cost of goods in progress offset for
2021, as determined under paragraphs (c)(3) through
(5) of this section.
(1) Pursuant to paragraph (c)(2)(i)(A)(1) of this
section, A first takes the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2021, less any advance payment invento-
ry inclusion amount attributable to a subsequent year
($5x, determined as the $40x under the all events
test, less the $35x of advance payment inventory in-
clusion amount attributable to 2022); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2021 ($5x) (or if the two
amounts are equal, the equal amount).
(2) Pursuant to paragraph (c)(2)(i)(A)(2) of this
section, A then subtracts from such amount ($5x) the
amount determined under paragraph (c)(2)(i)(A)(1)
of this section for the item of inventory for the im-
mediately preceding year ($0). This net amount of
$5x is the AFS inventory inclusion amount for 2021.
(3) Pursuant to paragraph (c)(2)(i) of this section,
A reduces this $5x AFS inventory inclusion amount
by the cost of goods in progress offset for 2021 of
$5x, determined as the cost of goods as of December
31, 2021 of $10x, less the cumulative cost of goods
in progress offset taken into account in prior years of
$0, less 5x for the AFS inventory inclusion amount
limitation under paragraph (c)(4) of this section. Ac-
cordingly, A is required to include $0 in gross income
for 2021.
(C) Analysis for 2022. Pursuant to paragraph (c)
(2)(i) of this section, A must first determine the AFS
inventory inclusion amount for 2022 by applying the
rules in paragraph (c)(2)(i)(A) of this section. A then
reduces such amount by the cost of goods in progress
offset for 2022, as determined under paragraphs (c)
(3) through (5) of this section.
(1) Pursuant to paragraph (c)(2)(i)(A)(1) of this
section, A first takes the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2022 ($40x); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2022 ($90x).
(2) Pursuant to (c)(2)(i)(A)(2) of this section, A
then subtracts from such amount ($90x) the amount
determined under paragraph (c)(2)(i)(A)(1) of this
section for the item of inventory for 2021 ($5x). This
net amount of $85x is the AFS inventory inclusion
amount for 2022.
(3) Pursuant to paragraph (c)(2)(i) of this sec-
tion, A reduces this $85x AFS inventory inclusion
amount by the cost of goods in progress offset for
2022 of $60x, determined as the cost of goods as of
December 31, 2022 of $65x, less the cumulative cost
of goods in progress offset taken into account in prior
years of $5x. Accordingly, A is required to include
$25x in gross income for 2022.
(D) Analysis for 2023. During 2023, ownership
of the good is transferred to Customer. According-
ly, pursuant to paragraph (c)(2)(ii) of this section, A
determines its gross income inclusion for 2023 by:
(1) First taking the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2023 ($100x); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2023 ($100x) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($100x)
the prior income inclusion amounts attributable to
the transferred good of $25x ($0 for 2021 plus $25x
for 2022). A is required to include this net amount of
$75x in gross income for 2023. Although A does not
reduce such amount by a cost of goods in progress
offset under this paragraph (c), A is entitled to recov-
er the $70x of costs capitalized to the good as cost
of goods sold in 2023 in accordance with sections
471 and 263A. See §1.61-3. Accordingly, A’s gross
income for 2023 is $5x.
(v) Example 5—(A) Facts. The same facts as in
paragraph (c)(8)(iv) of this section (Example 4) ap-
ply, except that in 2022, A’s obligation to Customer
with respect to the good ends other than in a trans-

January 19, 2021 434 Bulletin No. 2021–3
action to which section 381(a) applies, or a section
351 transaction described in paragraph (c)(6)(ii)(B)
of this section. A does not receive any additional pay-
ments in 2022.
(B) Analysis for 2021. The analysis for 2021 is
the same as in paragraph (c)(8)(iv) of this section
(Example 4).
(C) Analysis for 2022. Because, in 2022, A’s ob-
ligation to Customer with respect to the good ends
in a transaction other than a transaction described
in paragraph (c)(6)(ii)(A) or (B) of this section, A
is required to apply the acceleration rules in para-
graph (c)(6) of this section. Accordingly, because
A received $40x of payments as of the date of the
transaction, but did not include any portion of such
payments in gross income in prior years, A is re-
quired to include the remaining $40x of the pay-
ments received in gross income in 2022 pursuant to
paragraph (c)(6) of this section. A is not permitted
to further reduce the $40x income inclusion by a
cost of goods in progress offset under this para-
graph (c).
(vi) Example 6—(A) Facts. In 2021, A enters
into a contract with Customer to produce and deliv-
er a good. The contract provides that A will receive
payments equal to AFS costs plus a 100% mark-
up, however, A can only bill the customer on De-
cember 31, 2022 and, if the good is not delivered
by December 31, 2022, A can also bill Customer
upon delivery of the good, for the AFS costs (plus
markup) incurred to date, less any amounts previ-
ously billed. A recognizes AFS revenue based on a
percentage of completion (cost to cost) method. A
recognizes AFS revenue of $100 through the last
day of 2021, $150 through the last day of 2022,
and $300 through the last day of 2023, and has an
enforceable right to all AFS revenue reported as of
the end of each year if the customer were to ter-
minate the contract on the last day of the year. A
bills the customer $150 on December 31 of 2022
and $150 in 2023 when A delivers the good and
ownership transfers to Customer. The costs to pro-
duce the good are required to be capitalized under
sections 471 and 263A as the good is inventory in
the hands of the taxpayer. A incurs the following
costs each year that are permissibly capitalized and
allocated to the produced good under sections 471
and 263A: $125 in 2021; $0 in 2022; and $25 in
year 2023.
(B) Analysis for taxable year 2021. Pursuant to
paragraph (c)(2)(i) of this section, A must first deter-
mine the AFS inventory inclusion amount for 2021
by applying the rules in paragraph (c)(2)(i)(A) of
this section. A then reduces such amount by the cost
of goods in progress offset for 2021, as determined
under paragraphs (c)(3) through (5) of this section.
(1) Pursuant to paragraph (c)(2)(i)(A)(1) of this
section, A first takes the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2021 ($0); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2021 ($100).
(2) Pursuant to paragraph (c)(2)(i)(A)(2) of this
section, A then subtracts from such amount ($100)
the amount determined under paragraph (c)(2)(i)(A)
(1) of this section for the item of inventory for the
immediately preceding year ($0). This net amount
of $100 is the AFS inventory inclusion amount for
2021.
(3) Pursuant to paragraph (c)(2)(i) of this section,
A reduces this $100 AFS inventory inclusion amount
by the cost of goods in progress offset for 2021 of
$100. Although A’s cost of goods in progress as of
the end of 2021 is $125, the cost of goods in prog-
ress offset is limited to $100, the amount of A’s AFS
inventory inclusion amount for 2021. Accordingly,
A is required to include $0 in gross income in 2021.
(C) Analysis for taxable year 2022. Pursuant to
paragraph (c)(2)(i) of this section, A must first deter-
mine the AFS inventory inclusion amount for 2022
by applying the rules in paragraph (c)(2)(i)(A) of
this section. A then reduces such amount by the cost
of goods in progress offset for 2022, as determined
under paragraphs (c)(3) through (5) of this section.
(1) Pursuant to paragraph (c)(2)(i)(A)(1) of this
section, A first takes the greater of:
(i) The cumulative amount of revenue that sat-
isfies the all events test under §1.451-1(a) through
the last day of 2022 ($150 due under the terms of
the contract); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2022 ($150) (or if the two
amounts are equal, the equal amount).
(2) Pursuant to paragraph (c)(2)(i)(A)(2) of this
section, A then subtracts from such amount ($150)
the amount determined under paragraph (c)(2)(i)(A)
(1) of this section for the item of inventory for the
immediately preceding year ($100). This net amount
of $50 is the AFS inventory inclusion amount for
2022.
(3) Pursuant to paragraph (c)(2)(i) of this section,
A reduces this $50 AFS inventory inclusion amount
by the cost of goods in progress offset for 2022 of
$25, determined as $125 cost of goods as of Decem-
ber 31, 2022 minus $100 cumulative cost of goods in
progress offset amount taken into account in 2021.
Accordingly, A is required to include $25 in gross
income for 2022.
(D) Analysis for taxable year 2023. During 2023,
ownership of the good is transferred to the customer.
Accordingly, pursuant to paragraph (c)(2)(ii) of this
section, A determines its gross income inclusion for
2023 by:
(1) First taking the greater of:
(i) The cumulative amount of revenue that satis-
fies the all events test under §1.451-1(a) through the
last day of 2023 ($300x); or
(ii) The cumulative amount of revenue that is
treated as “taken into account as AFS revenue”
through the last day of 2025 ($300x) (or if the two
amounts are equal, the equal amount).
(2) Then subtracting from such amount ($300x)
the prior income inclusion amounts attributable to
the transferred good of $25 ($0 for 2021 plus $25 for
2022). This net amount of $275 is the AFS income
inclusion amount for 2023. Although A does not re-
duce such amount by a cost of goods in progress off-
set under this paragraph (c), A is entitled to recover
the $150 of costs capitalized to the good as cost of
goods sold in 2023 in accordance with sections 471
and 263A. See §1.61-3. Accordingly, A’s gross in-
come for 2023 is $125 ($275 AFS income inclusion
amount less $150 cost of goods sold).
(d) Contracts with multiple perfor-
mance obligations—(1) In general. Each
performance obligation generally yields a
corresponding item of gross income that
must be accounted for separately under
the AFS income inclusion rule in para-
graph (b)(1) of this section. Except as pro-
vided in paragraph (d)(5) of this section,
if a contract contains more than one per-
formance obligation, and thus yields more
than one corresponding item of gross in-
come, the transaction price amount shall
be allocated to each corresponding item
of gross income in accordance with the
transaction price amount allocated to each
performance obligation for AFS purposes,
subject to the adjustments to the transac-
tion price amount and special allocation
rules in paragraph (d)(3) of this section.
(2) Single performance obligation with
more than one item of gross income. If a
single performance obligation yields more
than one corresponding item of gross in-
come, the transaction price amount allo-
cated to the single performance obligation
for AFS purposes must be further allocat-
ed among the corresponding items of gross
income using any reasonable method.
(3) Adjustments to transaction price
amount and special allocation rules—(i)
Increases to transaction price amount. If
the transaction price amount includes a
reduction for amounts described in para-
graph (b)(2)(i)(A)(1) or (2) of this section,
or has been reduced because a significant
financing component is deemed to exist
under the standards the taxpayer uses to
prepare its AFS, the taxpayer must deter-
mine the specific performance obligation
to which such reduction relates and in-
crease the transaction price amount allo-
cable to the corresponding item of gross
income by the amount of such reduction
(specific identification approach). If it is
impracticable from the taxpayer’s records
to use the specific identification approach,
the taxpayer may use any reasonable
method to allocate the reduction amount
to the items of gross income in the con-
tract. A pro-rata allocation of the reduction
amount across all items of gross income
under the contract based on the relative
transaction price amounts allocated to
such items under paragraph (d)(1) of this
section is a reasonable method.
(ii) Decrease to transaction price
amount. If the transaction price amount

Bulletin No. 2021–3 435 January 19, 2021
has been increased because a significant
financing component is deemed to exist
under the standards the taxpayer uses to
prepare its AFS, the taxpayer must deter-
mine the specific performance obligation
to which such amount relates and decrease
the transaction price amount allocable to
the corresponding item of gross income
by such amount (specific identification
approach). If it is impracticable from the
taxpayer’s records to use the specific iden-
tification approach, the taxpayer may use
any reasonable method to allocate such
amount to the items of gross income in
the contract. A pro-rata allocation of such
amount across all items of gross income
under the contract based on the relative
transaction price amounts allocated to
such items under paragraph (d)(1) of this
section is a reasonable method.
(4) Examples. The following exam-
ples illustrate the rules of paragraph (d)
(1) through (3) of this section. Unless the
facts specifically state otherwise, the tax-
payer has an AFS, is on a calendar year
for Federal income tax purposes and AFS
purposes, and uses an accrual method of
accounting for Federal income tax purpos-
es.
(i) Example 1—(A) Facts. On November 1,
2021, A, a software developer, enters into a contract
with a customer to transfer a software license, per-
form software installation services, and provide tech-
nical support for a two-year period for $100x. The
installation service does not significantly modify the
software and the software remains functional with-
out the technical support. A receives an additional
$10x bonus if the installation service is performed
before February 1, 2022, which A expects to receive.
Further, the customer is entitled to a refund of $2x if
technical support does not meet performance stan-
dards set forth in the contract, which A expects it will
pay to the customer. For its AFS, A identifies three
performance obligations in the contract:
(1)(i) The software license;
(ii) The installation service; and
(iii) Technical support.
(2) Also, for its AFS, A determines that the trans-
action price amount is $108x, determined as $100x
contract price plus $10x bonus for installation ser-
vices minus $2x customer refund. Finally, for its
AFS, A allocates the $108x transaction price amount
to the three performance obligations as follows:
$60x to the software license; $40x to the installation
service ($30x + $10x bonus); and $8x to technical
support ($10x - $2x refund).
(B) Analysis. Pursuant to paragraph (d)(1) of this
section, A’s contract with the customer has three per-
formance obligations, and each performance obliga-
tion yields a corresponding item of gross income that
is accounted for separately. Pursuant to paragraph (d)
(1) of this section, A is required to allocate the $108x
transaction price amount to each corresponding item
of gross income in accordance with the transaction
price amount allocated to each respective perfor-
mance obligation for AFS purposes. Accordingly, A
initially allocates $60x to the software license item,
$40x to the installation service item, and $8 to the
technical support item. However, because the trans-
action price amount was reduced by the anticipated
refund of $2x, which relates specifically to the tech-
nical support item, A must increase the transaction
price allocable to that item of gross income pursuant
to the specific identification approach in paragraph
(d)(3) of this section. Accordingly, the amount allo-
cated to the item of gross income related to technical
support is $10x.
(ii) Example 2—(A) Facts. In 2021, B, a man-
ufacturer and servicer of airplane parts, enters into
a contract with a customer to sell airplane parts in
2021 and to service those parts, as necessary, in
2021, 2022, and 2023 for $100x. B regularly sells
the airline parts and the services separately. For its
AFS, B identifies two performance obligations in the
contract:
(1)(i) The sale of airplane parts; and
(ii) The services for those parts.
(2) The customer receives a refund of $5x if it
does not require a specified level of service for the
parts, which B expects it will pay to the customer.
Also, for its AFS, B determines that the transaction
price amount is $95x, determined as the $100x con-
tract price minus the $5x refund that it expects to
pay the customer. Finally, for its AFS, B allocates
the $95x transaction price amount to the two per-
formance obligations as follows: $40x to the sale of
parts and $55x to the provision of services ($60x -
$5x refund).
(B) Analysis. Pursuant to paragraph (d)(1) of
this section, B’s contract with the customer has two
performance obligations, and each performance
obligation yields a corresponding item of gross in-
come that is accounted for separately. Pursuant to
paragraph (d)(1) of this section, B is required to
allocate the $95x transaction price amount to each
corresponding item of gross income in accordance
with the transaction price amount allocated to each
respective performance obligation for AFS purpos-
es. Accordingly, B initially allocates $40x to the sale
of parts item and $55x to the provision of services
item. However, because the transaction price amount
was reduced by the anticipated refund of $5x, which
relates specifically to provision of services item, B
must increase the transaction price allocable to that
item of gross income pursuant to the specific identi-
fication approach in paragraph (d)(3) of this section.
Accordingly, the amount allocated to the item of
gross income related to servicing the parts is $60x.
(iii) Example 3: Reward points—(A) Facts. On
December 31, 2021, U, in the business of selling
consumer electronics, sells a new TV for $1,000 and
gives the customer 50 reward points. Each reward
point is redeemable for a $1 discount on any future
purchase of U’s products. For its AFS, U identifies
two performance obligations from the transaction:
(1)(i) The sale of the TV; and
(ii) The provision of rewards points.
(2) Also, for its AFS, U allocates $950 of trans-
action price amount to the sale of the TV and the
remaining $50 of the transaction price amount to the
reward points.
(B) Analysis. Pursuant to paragraph (d)(1) of this
section, U’s contract with the customer has two per-
formance obligations, and each performance obliga-
tion yields a corresponding item of gross income that
is accounted for separately. Pursuant to paragraph
(d)(1) of this section, U is required to allocate the
$1,000 transaction price amount to each correspond-
ing item of gross income in accordance with the
transaction price amount allocated to each respec-
tive performance obligation for AFS purposes. Ac-
cordingly, U allocates the transaction price amount
as follows: $950 to the TV sale item and $50 to the
reward points item. If U reports any portion of the
$50 payment allocated to the reward points as AFS
revenue for 2022, or later, the payment is an advance
payment, as defined in §1.451-8(a)(1), and may be
accounted for under the deferral method if U satisfies
the criteria in §1.451-8(c).
(iv) Example 4: Airline reward miles—(A)
Facts. On January 1, 2021, W, a passenger airline
company, sells a customer a $700 airline ticket to fly
roundtrip in 2021. As part of the purchase, the cus-
tomer receives 7,000 points (air miles) from W to be
redeemed for future air travel. For its AFS, W identi-
fies two performance obligations in the contract:
(1)(i) The sale of the airline ticket; and
(ii) The provision of air miles.
(2) W also anticipates that it will issue a rebate
to the customer for $10. Also, for its AFS, W de-
termines that the transaction price amount is $690,
determined as the $700 ticket price minus the antici-
pated $10 rebate. Finally, for its AFS, W allocates the
$690 transaction price amount to the separate per-
formance obligations as follows: $660 to the ticket
($670 - $10 rebate = $660) and $30 to the air miles.
(B) Analysis. Pursuant to paragraph (d)(1) of this
section, W’s contract with the customer has two per-
formance obligations, and each performance obliga-
tion yields a corresponding item of gross income that
is accounted for separately. Pursuant to paragraph (d)
(1) of this section, W must allocate the $690 trans-
action price amount to each corresponding item of
gross income in accordance with the transaction
price amount allocated to each respective perfor-
mance obligation for AFS purposes. Accordingly, W
initially allocates $660 to the ticket sale item and $30
to the air miles item. However, because the transac-
tion price amount was reduced by the anticipated re-
bate of $10x, which relates to the ticket sale item, W
must increase the transaction price allocable to that
item of gross income pursuant to paragraph (d)(3)
of this section. Accordingly, the amount allocated to
the item of gross income related to the ticket sale is
$670. If W reports any portion of the $30 payment
allocated to the air miles item as AFS revenue for
2022, or later, the payment is an advance payment, as
defined in §1.451-8(a)(1), and may be accounted for
under the deferral method if W satisfies the criteria
in §1.451-8(c).
(v) Example 5: Contract with significant financ-
ing component amounts—(A) Facts. On January 1,
2021, C, a manufacturer and servicer of airline parts,
enters into a contract with a customer to sell airline
parts in December 2022, and to service those parts,
as necessary, through 2024. The contract contains
two alternative payment options: payment of $5,000
in December 2022 when the customer obtains con-
trol of the parts or payment of $4,000 when the con-

January 19, 2021 436 Bulletin No. 2021–3
tract is signed. The customer pays $4,000 when the
contract is signed, which reflects an implicit interest
rate of 11.8% and is C’s incremental borrowing rate.
C regularly sells the airline parts and the services
separately. For its AFS, C identifies two performance
obligations in the contract:
(1)(i) The sale of airplane parts; and
(ii) The services for those parts.
(2) Also, for its AFS, although the contract only
requires the customer to pay $4,000, the transaction
price is increased by $1,000 to $5,000 because the
customer is deemed to provide financing to C under
the standards C uses to prepare its AFS. The $1,000
increase is attributable to a significant financing
component. Finally, for its AFS, C allocates the
$5,000 transaction price amount to the separate per-
formance obligations as follows: $3,750 to the sale
of parts ($3,000 upfront payment plus $750 financ-
ing component) and $1,250 ($1,000 upfront payment
plus $250 financing component) to the provision of
services.
(B) Analysis. Pursuant to paragraph (d)(1) of this
section, C’s contract with the customer has two per-
formance obligations, and each performance obliga-
tion yields a corresponding item of gross income that
is accounted for separately. Pursuant to paragraph
(d)(1) of this section, C must allocate the $5,000
transaction price amount to each corresponding item
of gross income in accordance with the transaction
price amount allocated to each respective perfor-
mance obligation for AFS purposes. Accordingly, C
initially allocates $3,750 to the sale of the parts item
and $1,250 to the provision of services item. How-
ever, because the transaction price was increased by
a significant financing component of $1,000, $750
of which was allocated to sale of the parts item and
$250 of which was allocated to the provision of ser-
vices item, pursuant to paragraph (d)(3) of this sec-
tion, C must decrease the transaction price amount
allocable to the sale of parts item from $3,750 to
$3,000 and must decrease the transaction price al-
locable to the provision of services from $1,250 to
$1,000.
(5) Contracts accounted for in part un-
der this section and in part under a spe-
cial method of accounting—(i) In general.
If a taxpayer has a contract with a custom-
er that includes one or more items of gross
income that are subject to a special meth-
od of accounting and one or more items
of gross income that are subject to this
section (special method/451 contract), the
transaction price allocation rule in para-
graph (d)(1) of this section does not apply
to determine the amount of each item of
gross income that is subject to a special
method of accounting. For purposes of
this paragraph (d)(5)(i), a special method
of accounting has the meaning set forth in
paragraph (a)(13) of this section, except as
otherwise provided in guidance published
in the Internal Revenue Bulletin (see
§601.601(d) of this chapter). For special
method/451 contracts, paragraphs (d)(5)
(ii) and (iii) of this section apply to deter-
mine the transaction price amount and the
portion of such amount that is allocated to
each item of gross income that is subject
to this section.
(ii) Transaction price adjustments. If
the transaction price amount for the spe-
cial method/451 contract includes a reduc-
tion for amounts described in paragraph
(b)(2)(i)(A)(1) or (2) of this section, or has
been reduced because a significant financ-
ing component is deemed to exist under
the standards the taxpayer uses to prepare
its AFS, the taxpayer must increase the
transaction price amount by the amount
of such reduction. If the transaction price
amount for the special method/451 con-
tract has been increased because a sig-
nificant financing component is deemed
to exist under the standards the taxpayer
uses to prepare its AFS, the taxpayer must
decrease the transaction price amount by
the amount of such increase.
(iii) Transaction price allocation. Af-
ter the taxpayer determines the adjusted
transaction price amount for the special
method/451 contract under paragraph (d)
(5)(ii) of this section, the taxpayer first al-
locates such amount to the item(s) of gross
income subject to a special method of ac-
counting and then allocates the remainder
(residual amount) to the item(s) of gross
income that are subject to this section. If
the contract contains more than one item
of gross income that is subject to this sec-
tion, the taxpayer allocates the residual
amount to such items in proportion to the
amounts allocated to the corresponding
performance obligations for AFS purpos-
es or as otherwise provided in guidance
published in the Internal Revenue Bulletin
(see §601.601(d) of this chapter).
(iv) Example—(1) Facts. B is a calendar-year
accrual method taxpayer with an AFS. In 2020, B
enters into a $100x contract to design, build, operate
and maintain a toll road. The contract meets the defi-
nition of a long-term contract under §1.460-1(b)(1).
B determines that the obligations to design and build
the toll road are long-term contract activities under
§1.460-1(d)(1) and accounts for the gross income
from these activities under section 460 and the regu-
lations in this part under section 460 of the Code. In
addition, B determines that the obligations to operate
and maintain the toll road are non-long-term contract
activities under §1.460-1(d)(2) and that the gross in-
come attributable to these activities is required to be
accounted for under this section. B determines that
of the $100x transaction price amount, $60x is prop-
erly allocable to the items of gross income that are
subject to section 460 and the regulations in this part
under section 460 of the Code. However, for its AFS,
B allocates $55x of the transaction price amount to
performance obligations that are long-term contract
activities, $30x to the toll road operation perfor-
mance obligation and $15x to the toll road mainte-
nance performance obligation.
(2) Analysis. A method of accounting under
section 460 is a special method of accounting that
is within the scope of paragraph (d)(5) of this sec-
tion. Pursuant to paragraph (d)(5) of this section, B
first allocates $60x of the transaction price amount
to the items of gross income that are subject to sec-
tion 460 and the regulations in this part under sec-
tion 460 of the Code and then allocates the residual
amount of $40x to the two items of gross income that
are required to be accounted for under this section
in proportion to the amounts allocated to the corre-
sponding performance obligations for AFS purposes.
Accordingly, B allocates $26.7x ($30x / $45x x $40x
residual amount) to the toll road operations item of
gross income and $13.3x ($15x / $45x x $40x re-
sidual amount) to the toll road maintenance item of
gross income.
(e) Cumulative rule for multi-year con-
tracts—(1) In general. In the case of an
item of gross income from a multi-year
contract, a taxpayer determines the AFS
income inclusion amount for a taxable
year by applying the steps in paragraph (e)
(1)(i) or (ii) of this section. For this para-
graph (e), the term multi-year contract
means a contract that spans more than one
taxable year.
(i) Inventory items. If the item of gross
income is from the sale of an item of in-
ventory and the taxpayer uses the cost
offset method under paragraph (c) of this
section, see paragraph (c) of this section.
(ii) Other items of gross income. For all
other items of gross income, the taxpayer
first compares the cumulative amount of
the item of gross income that satisfies the
all events test under §1.451-1(a) through
the last day of the taxable year, including
the full amount of any advance payment re-
ceived for such item in a prior taxable year,
with the cumulative amount of the item of
gross income that is treated as “taken into
account as AFS revenue” under paragraph
(b)(2) of this section through the last day
of the taxable year and identifies the larger
of the two amounts (or, if the two amounts
are equal, the equal amount). The taxpayer
then reduces such amount by all prior year
inclusion amounts attributable to the item
of gross income, if any, to determine the
AFS income inclusion amount for the cur-
rent taxable year. If, however, the taxpayer
receives an advance payment, as defined in
§1.451-8(a)(1), that is allocable to an item
of gross income from a multi-year contract,

Bulletin No. 2021–3 437 January 19, 2021
the taxpayer applies the applicable rules in
§1.451-8, rather than the rules in this para-
graph (e)(1)(ii), to determine the amount of
the item of gross income that is required to
be included in gross income in the taxable
year in which such advance payment is re-
ceived, or, if applicable, in a short taxable
year described in §1.451-8(c)(6).
(2) Examples. The following examples
illustrate the rules of paragraph (e)(1) of
this section. Unless the facts specifically
state otherwise, the taxpayer has an AFS, is
on a calendar year for both Federal income
tax purposes and AFS purposes and uses an
accrual method of accounting for Federal
income tax purposes. Further, the taxpayer
does not use a special method of accounting.
(i) Example 1: Provision of services included in
AFS revenue with full inclusion method for advance
payments—(A) Facts. In 2021, D, an engineering
services provider, enters into a nonseverable con-
tract with a customer to provide engineering services
through 2024 for a total of $100x. Under the con-
tract, D receives payments of $25x in each calendar
year of the contract. For its AFS, D reports $50x, $0,
$20x, and $30x of AFS revenue from the contract
for 2021, 2022, 2023, and 2024, respectively. D has
an enforceable right to recover all amounts reported
as AFS revenue through the end of a given contract
year if the customer were to terminate the contract on
the last day of such year. The $25x payment received
in 2023 is an advance payment, as defined in §1.451-
8(a)(1), because $5x of the $25x payment is reported
as AFS revenue for 2024. D uses the full inclusion
method for advance payments.
(B) Taxable year 2021. Under the all events test
in §1.451-1(a), D is required to include $25x in gross
income in 2021 as $25x is due under the terms of
the contract and received by D during 2021. D does
not have a fixed right to receive any portion of the
remaining $75 as such amount is not due under the
terms of the contract until future years and is also
contingent on D’s completion of the nonseverable
services. Under the AFS income inclusion rule, be-
cause D has an enforceable right to recover all $50x
reported as AFS revenue for 2021 if the customer
were to terminate the contract on the last day of such
year, all $50x is treated as “taken into account as
AFS revenue” in 2021. Accordingly, D is required to
include $50x in gross income in 2021.
(C) Taxable year 2022. Under the all events test
in §1.451-1(a), D is required to include $50x in gross
income through the end of 2022 as $50x is due under
the terms of the contract and received by D as of the
end of 2022. D does not have a fixed right to receive
any portion of the remaining $50 as such amount is
not due under the terms of the contract until future
years and is also contingent on D’s completion of the
nonseverable services. Under the AFS income inclu-
sion rule, because D has an enforceable right to re-
cover all $50x reported as AFS revenue through the
end of 2022 if the customer were to terminate the con-
tract on the last day of such year, all $50x is treated
as “taken into account as AFS revenue” as of the last
day of 2022. Under the cumulative rule in paragraph
(e)(1)(ii) of this section, D compares the cumulative
all events test amount of $50x with the cumulative
AFS revenue amount of $50x and selects the larger
of the two amounts (or if the two amounts are equal,
the equal amount). From this equal amount of $50x, D
subtracts the prior income inclusion amount of $50x.
Accordingly, under the cumulative rule D is not re-
quired to include any amount in gross income in 2022.
(D) Taxable year 2023. The payment received
during 2023 meets the definition of an advance pay-
ment under §1.451-8(a)(1). Accordingly, pursuant to
paragraph (e)(1)(ii) of this section, D must determine
the amount that is required to be included in gross
income in 2023 under the rules in §1.451-8. Because
D uses the full inclusion method under §1.451-8(b),
D is required to include the $25x that was due and
received during 2023 in gross income in 2023.
(E) Taxable year 2024. Under the all events test
in §1.451-1(a), D is required to include $100x in
gross income through the end of 2024 as $100x is
due under the terms of the contract and received by
D as of the end of 2024. Under the AFS income in-
clusion rule, because D has an enforceable right to
recover all $100x reported as AFS revenue through
the end of 2024 if the customer were to terminate
the contract on the last day of such year, all $100x
is treated as “taken into account as AFS revenue”
through the last day of 2024. Under the cumula-
tive rule in paragraph (e)(1)(ii) of this section, D
compares the cumulative all events test amount of
$100x with the cumulative AFS revenue amount of
$100x and selects the larger of the two amounts (or,
if the two amounts are equal, the equal amount).
From this equal amount of $100x, D subtracts the
prior income inclusion amount of $75x ($50x from
2021 plus $0x from 2022 plus $25x from 2023).
Accordingly, under the cumulative rule D is re-
quired to include $25 in gross income in 2024. The
example in this paragraph (e)(2)(i)(E) is summa-
rized in the following table:
Table 2 to paragaph (e)(2)(i)(E)
2021202220232024Total
All Events / Full Inclusion Income$25x$25x$25x$25x$100x
AFS Revenue$50x$0$20x$30x$100x
Cumulative rule income$50x$0$25x$25x$100x
(ii) Example 2: Provision of services included in
AFS revenue with deferral method for advance pay-
ments—(A) Facts. The facts are the same as in para-
graph (e)(2)(i) of this section (Example 1), except D
elects to use the deferral method under §1.451-8(c)
to account for advance payments.
(B) Taxable years 2021 and 2022. The analysis
for tax years 2021 and 2022 is the same as in para-
graph (e)(2)(i) of this section (Example 1).
(C) Taxable year 2023. The payment received
during 2023 meets the definition of an advance pay-
ment under §1.451-8(a)(1). Accordingly, pursuant to
paragraph (e)(1)(ii) of this section, D must determine
the amount that is required to be included in gross
income in 2023 under the rules in §1.451-8. Because
D uses the deferral method under §1.451-8(b), D
is required to include $20x of the $25x payment in
gross income in 2023 as $20x of such payment was
treated as “taken into account as AFS revenue” as of
the end of 2023.
(D) Taxable year 2024. Under the all events
test in §1.451-1(a), D is required to include $100x
in gross income through the end of 2024. Under the
AFS income inclusion rule, because D has an en-
forceable right to recover all $100x reported as AFS
revenue through the end of 2024 if the customer
were to terminate the contract on the last day of such
year, all $100x is treated as “taken into account as
AFS revenue” through the last day of 2024. Under
the cumulative rule in paragraph (e)(1)(ii) of this
section, D compares the cumulative all events test
amount of $100x, which includes the full amount
of the $25 advance payment received in 2023, with
the cumulative AFS revenue amount of $100x and
selects the larger of the two amounts (or, if the two
amounts are equal, the equal amount). From this
equal amount of $100x, D subtracts the prior income
inclusion amount of $70x ($50x from 2021 plus $0x
from 2022 plus $20x from 2023). Accordingly, under
the cumulative rule D is required to include $30x in
gross income in 2024. The example in this paragraph
(e)(2)(ii)(D) is summarized in the following table:
Table 3 to paragraph (e)(2)(ii)(D)
2021202220232024Total
All Events Test / Deferral Method Income$25x$25x$20x
1
$30x$100x
AFS Revenue amount$50x$0$20x$30x$100x
Cumulative rule income$50x$0$20x$30x$100x

January 19, 2021 438 Bulletin No. 2021–3
1
$5x of the advance payment in 2023 is deferred
and taken into income in 2024.
(f) No change in the treatment of a
transaction. Except as provided in para-
graph (j) of this section and §1.1275-2(l),
the AFS income inclusion rule does not
change the treatment of a transaction or
the character of an item for Federal in-
come tax purposes. The following are
examples of transactions where the treat-
ment or character for AFS purposes does
not change the treatment of the transac-
tion or character of the item for Federal
income tax purposes:
(1) A transaction treated as a lease, li-
cense, or similar transaction for Federal
income tax purposes that is treated as a
sale or financing for AFS purposes, and
vice versa;
(2) A transaction or instrument that is
not required to be marked-to-market for
Federal income tax purposes but that is
marked-to-market for AFS purposes;
(3) Asset sale and liquidation treatment
under section 336(e) or 338(h)(10);
(4) A distribution of a corporation or
the allocable share of partnership items
or an income inclusion under section 951,
951A, or 1293(a) for Federal income tax
purposes that is accounted for under the
equity method for AFS purposes;
(5) A distribution of previously taxed
earnings and profits of a foreign corpora-
tion; and
(6) A deposit, return of capital, or con-
duit payment that is not gross income for
Federal income tax purposes that is treat-
ed as AFS revenue.
(g) No change to exclusion provisions
and the treatment of non-recognition
transactions—(1) In general. The AFS
income inclusion rule accelerates the time
at which the all events test under §1.451-
1(a) is treated as satisfied, and therefore
does not change the applicability of any
exclusion provision, or the treatment of
non-recognition transactions, in the Code,
the regulations in this part, or other guid-
ance published in the Internal Revenue
Bulletin (see §601.601(d) of this chapter).
The following are examples of exclusion
provisions and non-recognition transac-
tions that are not affected by the AFS in-
come inclusion rule:
(i) Any non-recognition transaction,
within the meaning of section 7701(a)
(45), including, for example, a liquida-
tion described in sections 332 and 337,
an exchange described in section 351, a
distribution described in section 355, a
reorganization described in section 368, a
contribution described in section 721, or
transactions described in sections 1031
through 1045; and
(ii) Items specifically excluded from
income under sections 101 through 140.
(2) Example: Non-recognition provisions not
changed for Federal income tax purposes—(i)
Facts. Taxpayer (Distributing) is a calendar-year
accrual method C corporation with an AFS. On De-
cember 31, 2021, Distributing:
(A)(1) Contributes assets to a wholly owned sub-
sidiary (Controlled) in exchange for Controlled stock
and $100x; and
(2) Distributes all the Controlled stock pro rata
to its shareholders.
(B) The transaction qualifies as a reorganiza-
tion under section 368(a)(1)(D) and a distribution
to which section 355 applies (D reorganization).
Distributing’s realized gain on the transferred assets
for book and tax purposes is $150x. On January 15,
2022, in pursuance of the plan of reorganization,
Distributing distributes the $100x to its shareholders.
Consequently, no gain to Distributing is recognized
under section 361(b)(1)(A). On Distributing’s 2021
AFS, Distributing recognizes revenue of $150x re-
lated to the D reorganization.
(ii) Analysis. For Federal income tax purposes,
under section 361, Distributing does not recognize
gain on Distributing’s:
(A)(1) Contribution of assets to Controlled;
(2) Receipt of Controlled stock and cash; and
(3) Distribution of Controlled stock and cash to
Distributing’s shareholders.
(B) Pursuant to paragraph (g) of this
section, the AFS income inclusion rule
does not change the result of this para-
graph (g)(2).
(h) Additional AFS issues—(1) AFS
covering groups of entities—(i) In gen-
eral. If a taxpayer’s financial results are
reported on the AFS for a group of en-
tities (consolidated AFS), the taxpayer’s
AFS is the consolidated AFS. Howev-
er, if the taxpayer’s financial results are
also reported on a separate AFS that is
of equal or higher priority to the consoli-
dated AFS under paragraph (a)(5) of this
section, then the taxpayer’s AFS is the
separate AFS.
(ii) Example. Taxpayer B, a reseller of computers
and electronics, is a calendar-year accrual method
taxpayer. In 2021, B’s financial results are included
in P’s consolidated financial statement, which is cer-
tified as being prepared in accordance with GAAP,
and is a Form 10-K filed with the SEC. B also has a
separate audited financial statement prepared in ac-
cordance with GAAP that is used for credit purpos-
es. B must use its parent corporation’s consolidated
Form 10-K as its AFS.
(2) Separately listed items. If a con-
solidated AFS is treated as the taxpay-
er’s AFS, the taxpayer must include the
amount of any items listed separately in
the consolidated AFS, including any notes
or other supplementary data that is con-
sidered part of the consolidated AFS, in
determining the amount of AFS revenue
allocated to the taxpayer.
(3) Non-separately listed items. If a
consolidated AFS does not separately list
items for the taxpayer, the portion of the
AFS revenue allocable to the taxpayer is
determined by relying on the taxpayer’s
separate source documents that were used
to create the consolidated AFS and in-
cludes amounts subsequently eliminated
in the consolidated AFS. Whether a tax-
payer that changes the source documents
it uses for this purpose from one taxable
year to another taxable year has changed
its method of accounting is determined
under the rules of section 446.
(4) Computation of AFS revenue for
the taxable year when the AFS covers mis-
matched reportable periods—(i) In gener-
al. If a taxpayer’s AFS is prepared on the
basis of a financial accounting year that
differs from the taxpayer’s taxable year,
the taxpayer must use one of the follow-
ing permissible methods of accounting de-
scribed in paragraph (h)(4)(i)(A) through
(C) of this section to determine the AFS
income inclusion amount for the taxable
year:
(A) The taxpayer computes AFS reve-
nue as if its financial reporting period is
the same as its taxable year by conducting
an interim closing of its books using the
accounting principles it uses to prepare its
AFS.
(B) The taxpayer computes AFS reve-
nue by including a pro rata portion of AFS
revenue for each financial accounting year
that includes any part of the taxpayer’s
taxable year. If the taxpayer’s AFS for part
of the taxable year is not available by the
due date of the return (with extension), the
taxpayer must make a reasonable estimate
of AFS revenue for the pro rata portion
of the taxable year for which an AFS is
not yet available. See §1.451-1(a) for ad-
justments after actual amounts are deter-
mined.
(C) If a taxpayer’s financial accounting
year ends five or more months after the
end of its taxable year, the taxpayer com-

Bulletin No. 2021–3 439 January 19, 2021
putes AFS revenue for the taxable year
based on the AFS revenue reported on the
AFS prepared for the financial accounting
year ending within the taxpayer’s taxable
year. For this paragraph (h)(4)(i)(C), if a
taxpayer uses a 52-53 week year for fi-
nancial accounting or Federal income tax
purposes, the last day of such year shall
be deemed to occur on the last day of the
calendar month ending closest to the end
of such year.
(ii) Examples. The following examples
illustrate the principles of paragraph (j)(4)
of this section.
(A) Example 1: Interim closing of the books. A
is a calendar year taxpayer. For its AFS, A’s financial
results are reported on a June 30 fiscal year. Using
the method described in paragraph (h)(4)(i)(A) of
this section, for the taxable year 2021, A uses the fi-
nancial results reported on its June 30, 2021 AFS to
determine whether an item of gross income is treated
as “taken into account as AFS revenue” from January
1, 2021, through June 30, 2021, and uses financial
data and accounting procedures from its June 30,
2022 AFS to prepare an interim closing of the books
as of December 31, 2021 to determine whether an
item of gross income is treated as “taken into account
as AFS revenue” from July 1, 2021, through Decem-
ber 31, 2021.
(B) Example 2: Pro rata approach. A is a calen-
dar year taxpayer. For its AFS, A’s financial results
are reported on a June 30 fiscal year. Using the meth-
od described in paragraph (h)(4)(i)(B) of this section,
for the taxable year 2021, A computes AFS revenue
for the 2021 tax year by taking the AFS revenue for
the financial accounting year ending June 30, 2021
and multiplying it by a ratio equal to the number of
days in the financial accounting year that are part of
the 2021 tax year/365 and then adding to that amount
the AFS revenue for the financial accounting year
ending June 30, 2022 multiplied by the number of
days in the financial accounting year that are part of
the 2021 tax year/365.
(C) Example 3: AFS revenue for the taxable year
based on AFS ending in taxpayer’s taxable year.
The same facts as in paragraph (h)(4)(ii)(B) of this
section (Example 2) apply, except that A uses the
method described in paragraph (h)(4)(i)(C) of this
section. For the taxable year 2021, A uses the finan-
cial results reported on its June 30, 2021 AFS to de-
termine whether an item of gross income is treated
as “taken into account as AFS revenue” as of the end
of its 2021 taxable year. Accordingly, any AFS rev-
enue reported on the taxpayer’s June 30, 2022 AFS
is disregarded when determining whether an item of
gross income is treated as “taken into account as AFS
revenue” as of the end of the 2021 taxable year.
(i) [Reserved]
(j) Special ordering rule for certain
items of income for debt instruments—(1)
In general. If an item of income, or por-
tion thereof, with respect to a debt instru-
ment is described in paragraph (j)(2) of
this section, the rules of this section apply
before the rules in sections 1271 through
1275 and §§1.1271-1 through 1.1275-7
(OID rules). Therefore, an item of income,
or portion thereof, described in paragraph
(j)(2) of this section may not be included
in income later than when that item, or
portion thereof, is treated as taken into ac-
count as AFS revenue, as determined under
paragraph (b)(2) of this section, regardless
of whether the timing of income inclusion
for that item is normally determined using
a special method of accounting. See also
§1.1275-2(l) for the treatment of the items
described in paragraph (j)(2) of this sec-
tion under the OID rules.
(2) Specified fees. Paragraph (j)(1) of
this section applies to fees (specified fees)
that are not spread over a period of time as
discount or as an adjustment to the yield
of a debt instrument (such as points) in the
taxpayer’s AFS and, but for paragraph (j)
of this section and §1.1275-2(l), would be
treated as creating or increasing OID for
Federal income tax purposes. For exam-
ple, the following specified fees (specified
credit card fees) are described in this para-
graph (j)(2):
(i) A payment of additional interest or
a similar charge provided with respect to
amounts that are not paid when due on a
credit card account (for example, credit
card late fees);
(ii) Amounts charged under a credit
card agreement when the cardholder uses
the credit card to conduct a cash advance
transaction (for example, credit card cash
advance fees); and
(iii) Amounts a credit or debit card
issuer is entitled to upon a purchase of
goods or services by one of its cardhold-
ers (for example, interchange fees, which
are sometimes labeled merchant discount
in certain private label credit card trans-
actions).
(3) Example. C, a credit card issuer, is a calen-
dar-year accrual method taxpayer with a calendar
year AFS. In 2021, a cardholder uses C’s credit card
to purchase $100 of merchandise from a merchant
and the cardholder earns a reward of 1% of the pur-
chase price of $100 ($1) as part of C’s cardholder
loyalty program. Upon purchase, C becomes entitled
to an interchange fee equal to 2% of the purchase
price of $100 ($2). For its AFS, C reports the $2 of
interchange fees as AFS revenue for 2021. C’s $2 of
interchange fees is described in paragraph (j)(2)(iii)
of this section. Under paragraph (j)(1) of this section,
C must apply the rules in this section before applying
the OID rules. See also §1.1275-2(l). Therefore, C’s
$2 of interchange fees is included in gross income in
2021, the year it is treated as “taken into account as
AFS revenue.” Under paragraph (b)(2)(i)(A) of this
section, the $2 of interchange revenue is not reduced
by the $1 reward. Even if C reports interchange fees
net of rewards in its AFS for 2021 ($2 of interchange
fee minus $1 reward liability), under paragraph (b)
(2)(i)(A) of this section, C includes $2 of interchange
revenue in gross income in 2021. See sections 162
and 461(h) for the treatment of the reward by C.
(k) Treatment of adjustments to de-
ferred revenue in an AFS—(1) In gener-
al. If a taxpayer treats an item of gross
income as deferred revenue in its AFS
and writes down or adjusts that item, or
portion thereof, to an equity account (for
example, retained earnings) or otherwise
writes down or adjusts that item of de-
ferred revenue in a subsequent taxable
year, AFS revenue for that subsequent
taxable year is increased or decreased, as
applicable by the amount of that item, or
portion thereof, that is written down or ad-
justed. See §1.451-8(c)(5).
(2) Example—(i) Facts. D, a remanufacturer
of industrial equipment, is a calendar-year, accrual
method taxpayer with a calendar year AFS. On Janu-
ary 1, 2021, D enters into a contract with a customer
and receives a payment of $100x to remanufacture
equipment in 2021 and 2022. The contract is not a
long-term contract under section 460. For its AFS
2021, D performs remanufacturing services and re-
ports $40x of the $100x payment as AFS revenue
for 2021, and treats $60x of the $100x payment as
deferred revenue.
(ii) Facts for taxable year 2022. On January 1,
2022, all of the stock of D is acquired by an unrelat-
ed third party and D adjusts deferred AFS revenue
to $50x (the expected cost to provide the services)
by charging $10x ($60x - $50x = $10x) to retained
earnings. In addition, for 2022, D performs remanu-
facturing services and reports $50x of the deferred
revenue as AFS revenue.
(iii) Analysis for taxable year 2022. Under para-
graph (k)(1) of this section, D’s $10x write down to
deferred revenue for 2022 is treated as “taken into
account as AFS revenue” for 2022.
(l) Methods of accounting—(1) In gen-
eral. Except as otherwise provided in this
section, a change to comply with this sec-
tion is a change in method of accounting to
which the provisions of sections 446 and
481 and the regulations in this part under
sections 446 and 481 of the Code apply. A
taxpayer seeking to change to a method of
accounting permitted in this section must
secure the consent of the Commissioner
in accordance with §1.446-1(e) and fol-
low the administrative procedures issued
under §1.446-1(e)(3)(ii) for obtaining the
Commissioner’s consent to change its ac-
counting method. For example, the use of
the AFS income inclusion rule under para-
graph (b)(1) of this section under which

January 19, 2021 440 Bulletin No. 2021–3
the taxpayer determines the amount of
the item of gross income that is treated as
“taken into account as AFS revenue” by
making the adjustments provided in para-
graph (b)(2)(i) of this section, the use of
the AFS income inclusion rule under para-
graph (b)(1) of this section under which
the taxpayer determines the amount of
the item of gross income that is treated as
“taken into account as AFS revenue” by
making only the adjustments provided in
paragraph (b)(2)(ii) of this section (the al-
ternative AFS revenue method), the AFS
cost offset method under paragraph (c) of
this section, the use of a method of deter-
mining AFS revenue under paragraph (i)
(4) of this section, are methods of account-
ing under section 446 and the regulations
in this part under section 446 of the Code.
In addition, a change in the manner of rec-
ognizing revenue in an AFS that changes
or could change the timing of the inclu-
sion of income for Federal income tax
purposes is generally a change in method
of accounting under section 446 and the
regulations in this part under section 446
of the Code. However, a change resulting
from the restatement of AFS revenue may
not always constitute a change in method
of accounting under section 446 and the
regulations in this part under section 446
of the Code. For example, a restatement of
AFS revenue to correct an error described
in §1.446-1(e)(2)(ii)(b) does not consti-
tute a change in method of accounting un-
der section 446.
(2) Transition rule for changes in meth-
od of accounting—(i) In general. Except
as provided in paragraph (l)(2)(ii) of this
section, a taxpayer that makes a qualified
change in method of accounting for the
taxpayer’s first taxable year beginning
after December 31, 2017, is treated as
making a change in method of account-
ing initiated by the taxpayer under section
481(a)(2). A taxpayer obtains the consent
of the Commissioner to make the change
in method of accounting by using the ap-
plicable administrative procedures that
govern changes in method of accounting
under section 446(e). See §1.446-1(e)(3).
(ii) Special rules for OID and specified
credit card fees. The rules of paragraph (l)
(2)(i) of this section apply to a qualified
change in method of accounting for the
taxpayer’s first taxable year beginning
after December 31, 2018, if the change
relates to a specified credit card fee as de-
fined in paragraph (j)(2) of this section.
For paragraph (l) of this section, the sec-
tion 481(a) adjustment period for any ad-
justment under section 481(a) for a change
in method of accounting described in the
preceding sentence is six taxable years.
(iii) Qualified change in method of
accounting. For paragraph (l)(2) of this
section, a qualified change in method of
accounting means any change in method
of accounting that is required by section
13221 of Public Law 115-97, 131 Stat.
2054 (2017) (TCJA), or was prohibited
under the Internal Revenue Code of 1986
prior to TCJA section 13221 and is now
permitted as a result of TCJA section
13221.
(m) Applicability date—(1) In general.
Except as provided in paragraph (m)(2) of
this section, this section applies for tax-
able years beginning on or after January
1, 2021.
(2) Delayed application with respect to
certain fees. Notwithstanding paragraph
(m)(1) of this section, paragraph (j) of
this section applies to specified fees (as
defined in paragraph (j)(2) of this section)
that are not specified credit card fees (as
defined in paragraph (j)(2) of this section)
for taxable years beginning on or after
January 6, 2022.
(3) Early application of this section—
(i) In general. Except as provided in para-
graph (m)(3)(ii) of this section, taxpayers
and their related parties, within the mean-
ing of sections 267(b) and 707(b), may ap-
ply both the rules in this section and, to the
extent relevant, the rules in §1.451-8, in
their entirety and in a consistent manner,
to a taxable year beginning after Decem-
ber 31, 2017, and before January 1, 2021,
provided that, once applied to a taxable
year, the rules in this section and, to the
extent relevant, the rules in §1.451-8, are
applied in their entirety and in a consistent
manner to all subsequent taxable years.
See section 7508(b)(7) and §1.451-8(h).
(ii) Certain fees—(A) Specified credit
card fees. In the case of specified credit
card fees, a taxpayer and its related par-
ties, within the meaning of sections 267(b)
and 707(b), may apply both the rules in
this section and the rules in §1.1275-
2(l), in their entirety and in a consistent
manner, to a taxable year beginning after
December 31, 2018, and before January
1, 2021, provided that, once applied to a
taxable year, the rules in this section and
§1.1275-2(l) that apply to specified credit
card fees are applied in their entirety and
in a consistent manner to all subsequent
taxable years (other than the rules applica-
ble to specified fees that are not specified
credit card fees). See section 7508(b)(7)
and §1.1275-2(l)(2).
(B) Specified fees. Paragraphs (m)(3)(i)
and (m)(3)(ii)(A) of this section do not ap-
ply to specified fees that are not specified
credit card fees.
Par. 6. Section 1.451-8 is added to read
as follows:
§1.451-8 Advance payments for goods,
services, and certain other items.
(a) Definitions. Except as otherwise
provided in this section, the following
definitions apply for this section:
(1) Advance payment—(i) In general.
An advance payment is a payment re-
ceived by a taxpayer if:
(A) The full inclusion of the payment
in the gross income of the taxpayer for
the taxable year of receipt is a permissible
method of accounting, without regard to
this section;
(B) Any portion of the payment is
taken into account as AFS revenue for a
subsequent taxable year, or, if the taxpay-
er does not have an applicable financial
statement any portion of the payment is
earned by the taxpayer in a subsequent
taxable year. To determine the amount
of the payment that is treated as “taken
into account as AFS revenue,” the tax-
payer must adjust AFS revenue for any
amounts described in §1.451-3(b)(2)(i)
(A), (C), and (D);
(C) The payment is for:
(1) Services;
(2) The sale of goods;
(3) The use, including by license or
lease, of intellectual property, including
copyrights, patents, trademarks, service
marks, trade names, and similar intangible
property rights, such as franchise rights
and arena naming rights;
(4) The occupancy or use of property
if the occupancy or use is ancillary to the
provision of services, for example, ad-
vance payments for the use of rooms or
other quarters in a hotel, booth space at
a trade show, campsite space at a mobile

Bulletin No. 2021–3 441 January 19, 2021
home park, and recreational or banquet fa-
cilities, or other uses of property, so long
as the use is ancillary to the provision of
services to the property user;
(5) The sale, lease, or license of com-
puter software;
(6) Guaranty or warranty contracts
ancillary to an item or items described in
paragraph (a)(1)(i)(C)(1), (2), (3), (4), or
(5) of this section;
(7) Subscriptions in tangible or intan-
gible format. Subscriptions for which an
election under section 455 is in effect is
not included in this paragraph (a)(1)(i)(C)
(7);
(8) Memberships in an organization.
Memberships for which an election under
section 456 is in effect are not included in
this paragraph (a)(1)(i)(C)(8);
(9) An eligible gift card sale;
(10) Any other payment identified by
the Secretary of the Treasury or his del-
egate (Secretary) under section 451(c)(4)
(A)(iii), including in guidance published
in the Internal Revenue Bulletin (see
§601.601(d)(2) of this chapter); or
(11) Any combination of items de-
scribed in paragraphs (a)(1)(i)(C)(1)
through (10) of this section.
(ii) Exclusions from the definition of
advance payment. An advance payment
does not include:
(A) Rent, except for amounts paid for
an item or items described in paragraph
(a)(1)(i)(C)(3), (4), or (5) of this section;
(B) Insurance premiums, to the extent
the inclusion of those premiums is gov-
erned by Subchapter L of the Internal
Revenue Code;
(C) Payments with respect to financial
instruments (for example, debt instru-
ments, deposits, letters of credit, notional
principal contracts, options, forward con-
tracts, futures contracts, foreign currency
contracts, credit card agreements (includ-
ing rewards or loyalty points under such
agreements), financial derivatives, or sim-
ilar items), including purported prepay-
ments of interest;
(D) Payments with respect to service
warranty contracts for which the taxpayer
uses the accounting method provided in
Revenue Procedure 97-38, 1997-2 C.B.
479 (see §601.601(d)(2) of this chapter);
(E) Payments with respect to warran-
ty and guaranty contracts under which a
third party is the primary obligor;
(F) Payments subject to section 871(a),
881, 1441, or 1442;
(G) Payments in property to which sec-
tion 83 applies;
(H) Payments received in a taxable
year earlier than the taxable year imme-
diately preceding the taxable year of the
contractual delivery date for a specified
good (specified good exception) unless
the taxpayer uses the method under para-
graph (f) of this section;
(I) Any other payment identified by the
Secretary under section 451(c)(4)(B)(vii),
including in guidance published in the In-
ternal Revenue Bulletin (see §601.601(d)
(2) of this chapter); and
(J) Any combination of items described
in paragraphs (a)(1)(ii)(A) through (I) of
this section.
(2) Advance payment income inclusion
amount. The term advance payment in-
come inclusion amount means the amount
of the advance payment that is required to
be included in gross income for the tax-
able year under the applicable rules in this
section.
(3) Advance payment inventory inclu-
sion amount. The term advance payment
inventory inclusion amount means the
amount of the advance payment from the
sale of an item of inventory that, but for
the cost of goods in progress offset, would
be includable in gross income under para-
graph (b), (c), or (d) of this section, as ap-
plicable, for the taxable year.
(4) AFS revenue. The term AFS reve-
nue has the same meaning as provided in
§1.451-3(a)(4).
(5) Applicable financial statement.
The term applicable financial statement
(AFS) has the same meaning as provided
in §1.451-3(a)(5).
(6) Contractual delivery date. The
term contractual delivery date means the
month and year of delivery listed in the
original written contract to the transaction
entered into between the parties prior to
initial receipt of any payments.
(7) Cost of goods. The term cost of
goods means the costs that are properly
capitalized and included in inventory un-
der sections 471 and 263A or any other
applicable provision of the Internal Reve-
nue Code and that are allocable to an item
of inventory for which an advance pay-
ment inventory inclusion amount is calcu-
lated. See paragraph (e)(6) of this section
for specific rules for a taxpayer using the
simplified methods under section 263A.
(8) Cost of goods in progress offset.
The term cost of goods in progress offset
has the meaning provided in paragraph (e)
(4) of this section.
(9) Cumulative cost of goods in prog-
ress offset. The term cumulative cost of
goods in progress offset means the cu-
mulative cost of goods in progress off-
set amounts under paragraph (e) of this
section for a specific item of inventory
that have reduced an advance payment
inventory inclusion amount attributable
to such item of inventory in prior taxable
years.
(10) Eligible gift card sale. The term
eligible gift card sale means the sale of a
gift card or gift certificate if:
(i) The taxpayer is primarily liable to
the customer, or holder of the gift card, for
the value of the card until redemption or
expiration; and
(ii) The gift card is redeemable by the
taxpayer or by any other entity that is le-
gally obligated to the taxpayer to accept
the gift card from a customer as payment
for items listed in paragraphs (a)(1)(i)(C)
(1) through (11) of this section.
(11) Enforceable right. The term en-
forceable right has the same meaning as
provided in §1.451-3(a)(9).
(12) Performance obligation. The term
performance obligation has the same
meaning as provided in §1.451-3(a)(11).
(13) Prior income inclusion amounts.
The term prior income inclusion amounts
means the amount of an item of gross in-
come that was included in the taxpayer’s
gross income under this section or §1.451-
3 in a prior taxable year.
(14) Received. An item of gross income
is received by the taxpayer if it is actually
or constructively received, or if it is due
and payable to the taxpayer.
(15) Specified good. The term specified
good means a good for which:
(i) During the taxable year a payment
is received, the taxpayer does not have
on hand, or available to it in such year
through its normal source of supply, goods
of a substantially similar kind and in a suf-
ficient quantity to satisfy the contract to
transfer the good to the customer; and
(ii) All the revenue from the sale of the
good is recognized in the taxpayer’s AFS
in the year of delivery.

January 19, 2021 442 Bulletin No. 2021–3
(16) Transaction price. The term trans-
action price has the same meaning as pro-
vided in §1.451-3(a)(14).
(b) In general. Except as provided in
paragraph (c) or (d) of this section, an
accrual method taxpayer shall include an
advance payment in gross income no later
than in the taxable year in which the tax-
payer receives the advance payment.
(c) Deferral method for taxpayers with
an applicable financial statement (AFS)—
(1) In general. An accrual method taxpay-
er with an AFS that receives an advance
payment may elect the deferral method
described in this paragraph (c) if the tax-
payer can determine the extent to which
the advance payment is taken into account
as AFS revenue as of the end of the tax-
able year of receipt and, if applicable, a
short taxable year described in paragraph
(c)(6) of this section. Except as otherwise
provided in this section, a taxpayer that
uses the deferral method described in this
paragraph (c) must:
(i) Include the advance payment, or
any portion thereof, in gross income in the
taxable year of receipt to the extent taken
into account as AFS revenue as of the end
of such taxable year, as determined under
paragraph (c)(2) of this section; and
(ii) Include the remaining portion of
such advance payment in gross income in
the taxable year following the taxable year
in which such payment is received (next
succeeding year).
(2) Adjustments to AFS revenue. The
amount of an advance payment that is
treated as “taken into account as AFS rev-
enue” as of the end of the taxable year of
receipt under paragraph (c)(1)(i) of this
section is determined by adjusting AFS
revenue by amounts described in §1.451-
3(b)(2)(i)(A), (C), and (D), as applicable.
(3) Examples. The following examples
demonstrate the rules in paragraphs (c)(1)
and (2) of this section.
(i) Example 1: Gift cards not eligible for defer-
ral method. E, a hair styling salon, receives advance
payments for gift cards that may later be redeemed at
the salon for hair styling services or hair care prod-
ucts at the face value of the gift card. The gift cards
may not be redeemed for cash and have no expiration
date. E does not track the sale date of the gift cards
and includes advance payments for gift cards in AFS
revenue when redeemed. Because E is unable to de-
termine the extent to which advance payments are
taken into account as AFS revenue for the taxable
year of receipt, E cannot use the deferral method for
these advance payments.
(ii) Example 2: Gift cards eligible for deferral
method. The same facts as in paragraph (c)(3)(i) of
this section (Example 1) apply, except that the gift
cards have an expiration date 12 months from the
date of sale, E does not accept expired gift cards, and
E includes unredeemed gift cards in AFS revenue for
the taxable year in which the cards expire. Because
E tracks the sale date and the expiration date of the
gift cards for its AFS, E can determine the extent to
which advance payments are taken into account as
AFS revenue for the taxable year of receipt. There-
fore, E meets the requirement of paragraph (c)(1) of
this section and may elect the deferral method for
these advance payments.
(4) Acceleration of advance pay-
ments—(i) In general. A taxpayer that
uses the deferral method described in
this paragraph (c) must include in gross
income for the taxable year, all advance
payments not previously included in gross
income:
(A) If, in that taxable year, the taxpayer
either dies or ceases to exist in a transac-
tion other than a transaction to which sec-
tion 381(a) applies; or
(B) If, and to the extent that, in that tax-
able year, the taxpayer’s obligation for the
advance payments is satisfied or otherwise
ends other than in:
(1) A transaction to which section
381(a) applies; or
(2) A section 351(a) transfer that is part
of a section 351 transaction in which:
(i) Substantially all assets of the trade
or business, including advance payments,
are transferred;
(ii) The transferee adopts or uses the
deferral method in the year of transfer; and
(iii) The transferee and the transferor
are members of the same consolidated
group, as defined in §1.1502-1(h).
(ii) Examples. The following examples
illustrate the rules in paragraph (c)(4) of
this section. In each of the following ex-
amples, the taxpayer is a C corporation,
uses an accrual method of accounting for
Federal income tax purposes and files its
returns on a calendar year basis. In addi-
tion, the taxpayer has an AFS and uses the
deferral method in paragraph (c) of this
section.
(A) Example 1: Ceasing to exist. A is in the
business of selling and licensing off the shelf, fully
customized, and semi-customized computer soft-
ware and providing customer support. On July 1,
2021, A enters into a 2-year software maintenance
contract and receives an advance payment. Under
the contract, A will provide software updates if it de-
velops an update within the contract period, as well
as online and telephone customer support. A ceases
to exist on December 1, 2021, in a transaction that
does not involve a section 351(a) transfer described
in paragraph (c)(4)(i)(B)(2) of this section and is not
a transaction to which section 381(a) applies. For
Federal income tax purposes, A must include the
entire advance payment in gross income in its 2021
taxable year.
(B) Example 2: Satisfaction of obligation—(1)
Facts. On November 1, 2021, J, a travel agent, re-
ceives payment from a customer for an airline flight
that will take place in April 2022. J purchases and de-
livers the airline ticket to the customer on November
14, 2021. J retains the excess of the customer’s pay-
ment over the cost of the airline ticket as its commis-
sion. The customer may cancel the flight and receive
a refund from J only to the extent the airline itself
provides refunds. In its AFS, J includes its commis-
sion in revenue for 2022.
(2) Analysis. The payment for commission in-
come is an advance payment. Because J is not re-
quired to provide any services after the ticket is
delivered to the customer on November 14, 2021, J
satisfies its obligation to the customer for its com-
mission when the airline ticket is delivered. Thus,
for Federal income tax purposes, J must include the
commission in gross income for 2021.
(5) Financial statement adjustments—
(i) In general. If a taxpayer treats an ad-
vance payment as an item of deferred rev-
enue in its AFS and writes-down or adjusts
that item, or portion thereof, to an equity
account such as retained earnings, or oth-
erwise writes-down or adjusts that item of
deferred revenue in a subsequent taxable
year, AFS revenue for that subsequent
taxable year is increased or decreased, as
applicable, by the amount that is written
down or adjusted. See §1.451-3(k).
(ii) Examples. The following examples
illustrate the rules in paragraph (c)(5) of
this section. In each of the following ex-
amples, the taxpayer is a C corporation,
uses an accrual method of accounting for
Federal income tax purposes and files its
returns on a calendar year basis. In addi-
tion, the taxpayer has an AFS and uses the
deferral method in paragraph (c) of this
section.
(A) Example 1—(1) Facts. On May 1, 2021, A
received $100 as an advance payment for a 2-year
contract to provide services. For financial account-
ing purposes, A recorded $100 as a deferred revenue
liability in its AFS, expecting to report 1/4 ($25) of
the advance payment in AFS revenue for 2021, 1/2
($50) for 2022, and 1/4 ($25) for 2023. On August
31, 2021, C, an unrelated corporation that files its
Federal income tax return on a calendar year basis
and that is a member of a consolidated group, ac-
quired all of the stock of A, and A joined C’s consol-
idated group. A’s short taxable year ended on August
31, 2021, and, as of that date, A had included 1/4
($25) of the advance payment in AFS revenue. On
September 1, 2021, after the stock acquisition, and in
accordance with purchase accounting rules, C wrote
down A’s deferred revenue liability to its fair value

Bulletin No. 2021–3 443 January 19, 2021
of $10 as of the date of the acquisition. The $10 is in-
cluded in revenue on A’s AFS in accordance with the
method of accounting A uses for financial accounting
purposes.
(2) Analysis. For Federal income tax purposes,
A must take 1/4 ($25) of the advance payment into
income for its short taxable year ending August 31,
2021 and must include the remainder of the advance
payment ($75) ($65 write down + $10 future finan-
cial statement revenue) in income for its next suc-
ceeding taxable year.
(B) Example 2—(1) Facts. On May 1, 2021, B
received $100 as an advance payment for a contract
to be performed in 2021, 2022, and 2023. On August
31, 2021, D, a corporation that is not a member of a
consolidated group for Federal income tax purposes,
acquired all of the stock of B. Before the stock ac-
quisition, for 2021, B included $40 of the advance
payment in AFS revenue, and $60 as a deferred
revenue liability. On September 1, 2021, after the
stock acquisition and in accordance with purchase
accounting rules, B, at D’s direction, wrote down its
$60 deferred revenue liability to $10 (its fair value)
as of the date of the acquisition. After the acquisition,
B does not take into account as AFS revenue any of
the $10 deferred revenue liability in its 2021 AFS. B
does include $5 in revenue in 2022, and $5 in reve-
nue in 2023.
(2) Analysis. For Federal income tax purposes,
B must include $40 of the advance payment into in-
come in 2021 and must include the remainder of the
advance payment ($60) ($50 write down plus $10
future financial statement revenue) in income for the
2022 taxable year.
(6) Short taxable year rule—(i) In gen-
eral. If the taxpayer’s next succeeding
taxable year is a short taxable year, other
than a taxable year in which the taxpay-
er dies or ceases to exist in a transaction
other than a transaction to which section
381(a) applies, and the short taxable year
consists of 92 days or less, a taxpayer
using the deferral method must include
the portion of the advance payment not
included in the taxable year of receipt in
gross income for the short taxable year to
the extent taken into account as AFS rev-
enue as of the end of such taxable year, as
determined under paragraph (c)(2) of this
section. Any amount of the advance pay-
ment not included in gross income in the
taxable year of receipt or the short taxable
year, must be included in gross income for
the taxable year immediately following
the short taxable year.
(ii) Example 1—(A) Facts. A is a calendar year
taxpayer and is in the business of selling and licens-
ing off the shelf, fully customized, and semi-custom-
ized computer software and providing customer sup-
port. On July 1, 2021, A enters into a 2-year software
maintenance contract and receives an advance pay-
ment of $240 under the contract. Under the contract,
A will provide software updates if it develops an up-
date within the contract period, as well as provides
online and telephone customer support. A changes its
taxable period to a fiscal year ending March 31. As a
result, A has a short taxable year beginning January
1, 2022, and ending March 31, 2022. In its AFS, A
includes 6/24 ($60) of the payment in revenue for the
taxable year ending December 31, 2021 to account
for the six-month period July 1 through December
31, 2021; 3/24 ($30) in revenue for the short taxable
year ending March 31, 2022 to account for the three-
month period January 1 through March 31, 2022;
12/24 ($120) in revenue for the taxable year ending
March 31, 2023; and 3/24 ($30) in revenue for the
taxable year ending March 31, 2024.
(B) Analysis. Because the taxable year ending
March 31, 2021, is 92 days or less, A must include
6/24 ($60) of the payment in gross income for the
taxable year ending December 31, 2021, 3/24 ($30)
in gross income for the short taxable year ending
March 31, 2022, and 15/24 ($150), the remaining
amount, in gross income for the taxable year ending
March 31, 2023.
(iii) Example 2—(A) Facts. On May 1, 2021,
B received $100 as an advance payment for a con-
tract to be performed in 2021, 2022, and 2023. On
October 31, 2021, C, an unrelated corporation that
files its federal income tax return on a calendar year
basis and that is a member of a consolidated group,
acquired all the stock of B and B joined C’s consol-
idated group. Before the stock acquisition, for 2021,
B included $40 of the advance payment in AFS rev-
enue, and $60 as a deferred revenue liability. On
November 1, 2021, after the stock acquisition and in
accordance with purchase accounting rules, C wrote
down B’s $60 deferred revenue liability to $10 (its
fair value) as of the date of the acquisition. After the
acquisition, B does not include in revenue any of the
$10 deferred revenue liability in its 2021 AFS. B in-
cludes $5 in revenue in 2022, and $5 in revenue in
2023.
(B) Analysis. For Federal income tax purposes, B
must take $40 of the advance payment into income
in its short tax year ending October 31, 2021. B’s
subsequent tax year, the short tax year ending De-
cember 31, 2021, is a tax year that is 92 days or less.
Therefore, under paragraph (c)(6)(i) of this section,
B generally will include the portion of the advance
payment not included in the taxable year of receipt
in gross income for this short taxable year to the ex-
tent taken into account as AFS revenue. Although for
AFS purposes, no amount is recognized in revenue
for the short period beginning November 1, 2021
and ending on December 31, 2021, under paragraph
(c)(5)(i) of this section, B must treat the amount of
the write-down as AFS revenue in the taxable year
in which the write-down occurs. Therefore, B must
include $50 of the advance payment into income in
the short tax year ending December 31, 2021 (equal
to the $50 write down plus $0 recognized in B’s AFS
for the period beginning on November 1, 2021 and
ending December 31, 2021), and must include the
remainder of the advance payment ($10) in income
for the 2022 taxable year.
(7) Financial statement conformity re-
quirement. A taxpayer that uses an AFS to
apply the rules under §1.451-3 must use
the same AFS and, if applicable, the same
method of accounting under §1.451-3(h)
(4), to apply the deferral method in para-
graph (c) of this section. Additionally, the
AFS rules under §1.451-3(h) also apply
for purposes of this section.
(8) Contracts with multiple perfor-
mance obligations—(i) General rule. If
a taxpayer is using the deferral method
under this paragraph (c) and the taxpay-
er’s contract with a customer has more
than one performance obligation, then
any payments received under the contract
are allocated to the corresponding item of
gross income in the same manner as such
payments are allocated to the performance
obligations in the taxpayer’s AFS.
(ii) Example: Computer software subscription
with multiple performance obligations—(A) Facts. P
is in the business of licensing off the shelf, fully cus-
tomized, and semi-customized computer software
and providing customer support. P uses an accrual
method of accounting for Federal income tax pur-
poses, files its returns on a calendar year basis, and
has an AFS. On July 1, 2021, P receives an advance
payment of $100 for a 2-year software subscription
comprised of:
(1)(i) A 1-year “software maintenance contract”
under which P will provide software updates within
the contract period; and
(ii) A “customer support agreement” for online
and telephone customer support.
(2) P reflects the software maintenance contract
and the customer support agreement as two separate
performance obligations in its AFS and allocates $80
of the payment to the software maintenance contract
and $20 to the customer support agreement. P in-
cludes the $80 allocable to the software maintenance
payment in AFS revenue as follows: 1/4 ($20) in
AFS revenue for 2021; 1/2 ($40) in AFS revenue for
2022; and the remaining 1/4 ($20) in AFS revenue
for 2023. Regarding the $20 allocable to the custom-
er support payment, P includes 1/2 ($10) in AFS rev-
enue for 2021, and the remaining 1/2 ($10) in AFS
revenue for 2022 regardless of when P provides the
customer support.
(B) Analysis. Since the software maintenance
contract and the customer support agreement are two
separate performance obligations, each yielding a
separate item of gross income, paragraph (c)(8) of
this section requires P to allocate the $100 payment
to each item of gross income in the same manner as
the payment is allocated to each performance obliga-
tion in P’s AFS. For Federal income tax purposes, P
must include $30 in gross income for 2021 ($20 allo-
cable to the software maintenance contract and $10
allocable to the customer support agreement) and the
remaining $70 is included in gross income for 2022.
(iii) Contracts with advance pay-
ments that include items subject to a
special method of accounting—(A) In
general. The portion of the payment al-
locable to the items of gross income de-
scribed in paragraph (a)(1)(i)(C) of this
section from a contract that includes one
or more items of gross income subject to

January 19, 2021 444 Bulletin No. 2021–3
a special method of accounting and one
or more items of gross income described
in paragraph (a)(1)(i)(C) of this section
must be determined based on objective
criteria.
(B) Allocation deemed to be based on
objective criteria. A taxpayer’s alloca-
tion method is based on objective criteria
if an allocation of the payment to each
item of gross income is in proportion to
the amounts determined in §1.451-3(d)
(5) or as otherwise provided in guidance
published in the Internal Revenue Bulletin
(see §601.601(d) of this chapter).
(iv) Example—(A) Facts. B is a calendar-year
accrual method taxpayer with an AFS. In 2020, B
enters into a $100x contract to design, build, oper-
ate and maintain a toll road and receives an up-front
payment of $100x. The contract meets the defini-
tion of a long-term contract under §1.460-1(b)(1).
B properly determines that the obligations to design
and build the toll road are long-term contract activi-
ties under §1.460-1(d)(1) and accounts for the gross
income from these activities under section 460. In
addition, B properly determines that the obligations
to operate and maintain the toll road are non-long-
term contract activities under §1.460-1(d)(2) and
that the gross income attributable to these activities
is accounted for under section 451(b). B allocates
$60x of the transaction price amount to the long-term
contract activities and the remaining $40x to the non-
long-term contract activity pursuant to §1.451-3(d)
(5). For AFS purposes, B allocates $55x of the trans-
action price amount to the performance obligations
that are long-term contract activities and $45x to the
non-long-term contract activities. B uses the deferral
method of accounting.
(B) Analysis. For Federal income tax purposes,
a method of accounting under section 460 is a spe-
cial method of accounting under paragraph (c)(8)
(iv) of this section. Pursuant to paragraph (c)(8)(iv)
of this section, B must allocate the payment among
the item(s) of gross income that are subject to sec-
tion 460 and the item(s) of gross income described
in paragraph (a)(1)(i)(C) of this section based on ob-
jective criteria. B’s allocation is deemed to be based
on objective criteria if it allocates the payment in
proportion to the amounts determined under §1.451-
3(d)(5). That is, $60x to the items of gross income
subject to section 460 and $40x to the items of gross
income described in paragraph (a)(1)(i)(C) of this
section.
(9) Special rule relating to eligible
gift card sales. For paragraphs (a)(1)(i)
(B) and (c)(1) of this section, if an eligi-
ble gift card is redeemable by an entity
described in paragraph (a)(10)(ii) of this
section whose financial results are not in-
cluded in the taxpayer’s AFS, a payment
will be treated as included by the taxpayer
in its AFS revenue to the extent the gift
card is redeemed by such entity during the
taxable year.
(10) Examples. The following exam-
ples illustrate the rules of paragraph (c)
of this section. In each of the following
examples, the taxpayer uses an accrual
method of accounting for Federal in-
come tax purposes and files its returns
on a calendar year basis. In addition, the
taxpayer in each example has an AFS
and uses the deferral method under para-
graph (c) of this section. Further, the tax-
payer does not use the advance payment
cost offset method in paragraph (e) of
this section.
(i) Example 1: Services. On November 1, 2021,
A, in the business of giving dancing lessons, receives
an advance payment of $480 for a 1-year contract
commencing on that date and providing for up to 48
individual, 1-hour lessons. A provides eight lessons
in 2021 and another 35 lessons in 2022. A takes into
account 1/6 ($80) of the payment as AFS revenue for
2021, and 5/6 ($400) of the payment as AFS revenue
for 2022. For Federal income tax purposes, under the
deferral method in paragraph (c) of this section, A
must include 1/6 ($80) of the payment in gross in-
come for 2021, and the remaining 5/6 ($400) of the
payment in gross income for 2022.
(ii) Example 2: Services. The same facts as in
paragraph (c)(10)(i) of this section (Example 1) ap-
ply. A receives an advance payment of $960 for a
3-year contract under which A provides up to 96 les-
sons. A provides eight lessons in 2021, 48 lessons in
2022, and 40 lessons in 2023. A takes into account
1/12 ($80) of the payment as AFS revenue for 2021,
1/2 ($480) of the payment as AFS revenue for 2022,
and 5/12 ($400) of the payment as AFS revenue for
2023. For Federal income tax purposes, under the de-
ferral method in paragraph (c) of this section, A must
include 1/12 ($80) of the payment in gross income
for 2021, and the remaining 11/12 ($880) of the pay-
ment in gross income for 2022.
(iii) Example 3: Services. On June 1, 2021, B,
a landscape architecture firm, receives an advance
payment of $100 for landscape services that, under
the terms of the agreement, must be provided by De-
cember 2022. On December 31, 2021, B estimates
that 3/4 of the work under the agreement has been
completed. B takes into account 3/4 ($75) of the
payment as AFS revenue for 2021, and 1/4 ($25) of
the payment as AFS revenue for 2022. For Feder-
al income tax purposes, under the deferral method
in paragraph (c) of this section, B must include 3/4
($75) of the payment in gross income for 2021, and
the remaining 1/4 ($25) of the payment in gross in-
come for 2022, regardless of whether B completes
the job in 2022.
(iv) Example 4: Repair contracts. On July 1,
2021, C, in the business of selling and repairing tele-
vision sets, receives an advance payment of $100 for
a 2-year contract under which C agrees to repair the
customer’s television set. C takes into account 1/4
($25) of the payment as AFS revenue for 2021, 1/2
($50) of the payment as AFS revenue for 2022, and
1/4 ($25) of the payment as AFS revenue for 2023.
For Federal income tax purposes, under the deferral
method in paragraph (c) of this section, C must in-
clude 1/4 ($25) of the payment in gross income for
2021 and the remaining 3/4 ($75) of the payment in
gross income for 2022.
(v) Example 5: Online website design. On July
20, 2021, D, a website designer, receives an online
payment of $75 to design a website for Customer to
be completed on February 1, 2023. D designs and
completes Customer’s website on February 1, 2023.
D takes into account the $75 payment for Customer’s
website as AFS revenue for 2023. The $75 payment
D receives for Customer’s website is an advance
payment. For Federal income tax purposes, under
the deferral method in paragraph (c) of this section,
D must include the $75 payment for the website in
gross income for 2022.
(vi) Example 6: Online subscriptions. G is in the
business of compiling and providing business infor-
mation for a particular industry in an online format
accessible over the internet. On September 1, 2021,
G receives an advance payment from a subscriber for
1 year of access to its online database, beginning on
that date. G takes into account 1/3 of the payment
as AFS revenue for 2021 and the remaining 2/3 as
AFS revenue for 2022. For Federal income tax pur-
poses, under the deferral method in paragraph (c) of
this section, G must include 1/3 of the payment in
gross income for 2021 and the remaining 2/3 of the
payment in gross income for 2022.
(vii) Example 7: Membership fees. On Decem-
ber 1, 2021, H, in the business of operating a chain
of “shopping club” retail stores, receives advance
payments for membership fees. The membership
fees are not prepaid dues income subject to section
456. Upon payment of the fee, a member is allowed
access for a 1-year period to H’s stores, which offer
discounted merchandise and services. H takes into
account 1/12 of the payment as AFS revenue for
2021 and 11/12 of the payment as AFS revenue for
2022. For Federal income tax purposes, under the
deferral method in paragraph (c) of this section, H
must include 1/12 of the payment in gross income
for 2021, and the remaining 11/12 of the payment in
gross income for 2022.
(viii) Example 8: Cruise. In 2021, I, in the busi-
ness of operating tours, receives $20x payments from
customers for a 10-day cruise that will take place in
April 2022. Under the agreement, I charters a cruise
ship, hires a crew and a tour guide, and arranges for
entertainment and shore trips for the customers. I
takes into account the $20x payments as AFS rev-
enue for 2022. For Federal income tax purposes, I
must include the $20x payments in gross income for
2022.
(ix) Example 9: Broadcasting rights—(A) Facts.
K, a professional sports franchise, is a member of a
sports league that enters into contracts with televi-
sion networks for the right to broadcast games to be
played between teams in the league. The league en-
tered into a 2-year broadcasting contract beginning
October 1, 2021. K receives two payments of $100x
on October 1 of each contract year, beginning in
2021. K estimates that for each contract year, 25% of
the broadcasting rights are transferred by December
31 of the year of payment, and the remaining 75% of
the broadcasting rights are transferred in the follow-
ing year. K takes into account 1/4 ($25x) of the first
installment payment as AFS revenue for 2021 and
3/4 ($75x) as AFS revenue for 2022. K takes into
account 1/4 ($25x) of the second payment as AFS

Bulletin No. 2021–3 445 January 19, 2021
revenue for 2022 and 3/4 ($75x) as AFS revenue for
2023.
(B) Analysis. Each installment payment is an ad-
vance payment under paragraph (a)(1) of this section
because a portion of each payment is included in
AFS revenue for a subsequent taxable year and the
payment relates to the use of intellectual property.
For Federal income tax purposes, under the deferral
method in paragraph (c) of this section, K must in-
clude 1/4 ($25x) of the first $100x installment pay-
ment in gross income for 2021 and 3/4 ($75x) of the
first installment payment in gross income for 2022.
In addition, K must include 1/4 ($25x) of the second
$100x payment in gross income for 2022 and 3/4
($75x) of the second installment payment in gross
income for 2023.
(x) Example 10: Insurance claims administra-
tion—(A) Facts. L is in the business of negotiat-
ing, placing, and servicing insurance coverage and
administering claims for insurance companies. On
December 1, 2021, L enters into a contract with an
insurance company to provide property and casual-
ty claims administration services for a 4-year period
beginning January 1, 2022. Pursuant to the contract,
the insurance company makes four equal annual pay-
ments to L; each payment relates to a year of service
and is made during the month prior to the service year.
Since L does not perform any services related to the
payment prior to the service year, L does not meet the
requirements of §1.451-1(a) for the payment prior to
the service year. For example, L is paid on Decem-
ber 1, 2021, for the service year beginning January 1,
2022. L takes into account the first payment as AFS
revenue for 2022; the second payment as AFS revenue
for 2023; the third payment as AFS revenue for 2024;
and the fourth payment as AFS revenue for 2025.
(B) Analysis. Each annual payment is an ad-
vance payment under paragraph (a)(1) of this sec-
tion because each payment is taken into account as
AFS revenue for a subsequent taxable year and the
payment relates to services. For Federal income tax
purposes, under the deferral method in paragraph (c)
of this section, L must include: the first payment in
gross income for 2022; the second payment in gross
income for 2023; the third payment in gross income
for 2024; and the fourth payment in gross income
for 2025.
(xi) Example 11: Internet services—(A) Facts.
M is a cable internet service provider that enters
into contracts with subscribers to provide internet
services for a monthly fee that is paid prior to the
service month. For those subscribers who do not
own a compatible modem, M provides a rental ca-
ble modem for an additional monthly charge, that is
also paid prior to the service month. Pursuant to the
contract, M will replace or repair the cable modem if
it proves defective during the contract period. In De-
cember 2021, M receives $100x payments from sub-
scribers for January 2022 internet service and cable
modem use. M takes into account the entire $100x
payments as AFS revenue for 2022.
(B) Analysis. For Federal income tax purposes,
the $100x payments are advance payments. Because
M uses the deferral method in paragraph (c) of this
section, M must include $100x in gross income for
2022.
(xii) Example 12: License agreement—(A)
Facts. On January 1, 2021, N receives a payment of
$250 for entering into a 3-year license agreement for
the use of N’s trademark throughout the term of the
agreement. The $250 payment reflects the first year
(2021) license fee of $100 and the third year (2023)
license fee of $150. The fee of $125 for the second
year is payable on January 1, 2022. N takes into ac-
count $100 of the $250 upfront payment as AFS rev-
enue for 2021, $125 as AFS revenue for 2022, and
$150 of the $250 payment as AFS revenue for 2023.
(B) Analysis. For Federal income tax purposes,
N received an advance payment of $150, the 2023
license fee, in 2021. Because N uses the deferral
method in paragraph (c) of this section, N must defer
the $150 payment and include it in gross income for
2022.
(xiii) Example 13: Computer software subscrip-
tion with one performance obligation—(A) Facts.
On July 1, 2021, O, in the business of licensing off
the shelf, fully customized, and semi-customized
computer software and providing customer support,
receives a payment of $100 for a 2-year “software
subscription contract” under which O will provide
software updates if it develops an update within the
contract period, as well as online and telephone cus-
tomer support. O determines that its obligations un-
der the software subscription contract are one perfor-
mance obligation for financial accounting purposes,
which yields one item of gross income. O takes into
account 1/4 ($25) of the payment as AFS revenue
for 2021, 1/2 ($50) as AFS revenue for 2022, and
the remaining 1/4 ($25) as AFS revenue for 2023,
regardless of when O provides updates or customer
support.
(B) Analysis. For Federal income tax purposes,
the $100 payment is an advance payment. Because
O uses the deferral method in paragraph (c) of this
section, O must include 1/4 ($25) of the payment in
gross income for 2021 and 3/4 ($75) in gross income
for 2022.
(xiv) Example 14: Gift cards administered by
another—(A) General facts. Q is a corporation that
operates department stores and is the common parent
of a consolidated group (the Q group). U, V, and W
are domestic corporations wholly owned by Q and
members of the Q group. X is a foreign corpora-
tion wholly owned by Q and not a member of the
Q group. U sells Brand A goods, V sells Brand B
goods, X sells Brand C goods, and Z is an unrelated
entity that sells Brand D goods. W administers a gift
card program for the members of the Q group, X, and
Z. Pursuant to the underlying agreements, W issues
gift cards that are redeemable for goods or services
offered by U, V, X, and Z. In addition, U, V, X, and Z
sell gift cards to customers on behalf of W and remit
amounts received to W. The agreements provide that
W is primarily liable to the customer for the value
of the gift card until redemption, and U, V, X, and Z
are obligated to accept the gift card as payment for
goods or services. When a customer purchases goods
or services with a gift card at U, V, X, or Z, W reim-
burses that entity for the sales price of the goods or
services purchased with the gift card, up to the total
gift card value.
(B) Facts for taxable year 2021. In 2021, W sells
gift cards with a total value of $900, and, at the end
of 2021, the unredeemed balance of the gift cards
is $100. In Q group’s AFS, the group includes rev-
enue from the sale of a gift card when the gift card
is redeemed. Accordingly, of the $900 of gift cards
sold in 2021, $800 were redeemed and taken into ac-
count as AFS revenue for 2021. W tracks sales and
redemptions of gift cards electronically, determines
the extent to which advance payments are taken into
account as AFS revenue in Q group’s AFS for the
taxable year of receipt and meets the requirements of
paragraph (c)(1) of this section.
(C) Analysis. The payments W receives from the
sale of gift cards are advance payments because they
are payments for eligible gift cards. Under the defer-
ral method, W must include $800 of the payments
from gift card sales in gross income in 2021 and the
remaining $100 of the payments in gross income in
2022.
(xv) Example 15: Gift cards of affiliates—(A)
Facts. R is a Subchapter S corporation that operates
an affiliated restaurant corporation and manages oth-
er affiliated restaurants. These other restaurants are
owned by other Subchapter S corporations, partner-
ships, and limited liability companies. R has a part-
nership interest or an equity interest in some of the
restaurants. R administers a gift card program for
participating restaurants. Each participating restau-
rant operates under a different trade name. Under the
gift card program, R and each of the participating
restaurants sell gift cards, which are issued with R’s
brand name and are redeemable at all participating
restaurants. Participating restaurants sell the gift
cards to customers and remit the proceeds to R, R
is primarily liable to the customer for the value of
the gift card until redemption, and the participating
restaurants are obligated under an agreement with R
to accept the gift card as payment for food, beverag-
es, taxes, and gratuities. When a customer uses a gift
card to make a purchase at a participating restaurant,
R is obligated to reimburse that restaurant for the
amount of the purchase, up to the total gift card val-
ue. In R’s AFS, R includes revenue from the sale of a
gift card when a gift card is redeemed at a participat-
ing restaurant. R tracks sales and redemptions of gift
cards electronically, is able to determine the extent to
which advance payments are taken into account as
AFS revenue for the taxable year of receipt and meet
the requirements of paragraph (c)(1) of this section.
(B) Analysis. The payments R receives from the
sale of gift cards are advance payments because they
are payments for eligible gift card sales. For Federal
income tax purposes, R is eligible to use the deferral
method. Using the deferral method, in the taxable
year of receipt, R must include the advance payment
in income to the extent taken into account as AFS
revenue and must include any remaining amount in
income in the taxable year following the taxable year
of receipt. Under paragraph (c)(9) of this section, R
is treated as taking into account revenue from the
sale of a gift card as AFS revenue when a gift card is
redeemed at a participating restaurant.
(xvi) Example 16: Gift cards for domestic and in-
ternational hotels—(A) Facts. S is a corporation that
operates for the benefit of its franchisee members,
who own and operate domestic and international
individual member hotels. S administers a gift card
program for its members by selling gift cards that
may be redeemed for hotel rooms and food or bever-
ages provided by any member hotel. The agreements
underlying the gift card program provide that S is en-
titled to the proceeds from the sale of the gift cards,

January 19, 2021 446 Bulletin No. 2021–3
must reimburse the member hotel for the value of
a gift card redeemed, and until redemption remains
primarily liable to the customer for the value of the
card. In S’s AFS, S includes payments from the sale
of a gift card when the card is redeemed. S tracks
sales and redemptions of gift cards electronically,
determines the extent to which advance payments
are included in AFS revenue for the taxable year of
receipt and meets the requirements of paragraph (c)
(1) of this section.
(B) Analysis. The payments S receives from the
sale of gift cards are advance payments because they
are payments for eligible gift card sales. Thus, for
Federal income tax purposes, S is eligible to use the
deferral method. Under the deferral method, in the
taxable year of receipt, S must include in income the
advance payment to the extent taken into account
as AFS revenue and must include any remaining
amount in income in the taxable year following the
taxable year of receipt.
(xvii) Example 17: Discount voucher—(A)
Facts. On December 10, 2021, T, in the business of
selling home appliances, sells a washing machine
for $500. As part of the sale, T gives the customer
a 40% discount voucher for any future purchases of
T’s goods up to $100 in the next 60 days. In its AFS,
T treats the discount voucher as a separate perfor-
mance obligation and allocates $30 of the $500 sales
price to the discount voucher. T takes into account
$12 of the amount allocated to the discount voucher
as AFS revenue for 2021 and includes $18 of the dis-
count voucher as AFS revenue for 2022.
(B) Analysis. For Federal income tax purposes,
the $30 payment allocated to the discount voucher
is an advance payment. Using the deferral method, T
must include the $12 allocable to the discount vouch-
er in gross income in 2021 and the remaining $18
allocated to the discount voucher in gross income in
2022.
(xviii) Example 18: Rewards—(A) Facts. On
December 31, 2021, U, in the business of selling
consumer electronics, sells a new TV for $1,000 and
gives the customer 50 reward points. Each reward
point is redeemable for a $1 discount on any future
purchase of U’s products. The reward points are not
redeemable for cash and have a 2-year expiration
date. U tracks the issue date, redemption date, and
expiration date of each customer’s reward points.
Under the terms of U’s reward program, when the
customer redeems reward points they are deemed to
use the earliest issued points first. In its AFS, U treats
the rewards points as a separate performance obliga-
tion and allocates $50 of the $1,000 sales price to the
rewards points. U is able to determine the extent to
which a payment that is allocated to a reward point
is taken into account in AFS revenue in the year of
receipt. U does not take any of the amount allocated
to the reward points into account as AFS revenue for
2021. U takes into account $25 of the reward points
as AFS revenue for 2022 and $25 of the reward
points as AFS revenue for 2023.
(B) Analysis. For Federal income tax purposes,
U’s treatment of the reward points as a separate per-
formance obligation for AFS purposes yields an item
of gross income that must be accounted for separate-
ly. The $50 payment allocated to the reward points
item is an advance payment as the full inclusion of
the payment in gross income in the year of receipt is
a permissible method of accounting without regard
to this section, a portion of the payment is taken into
account as AFS revenue in a subsequent taxable year,
and the reward points are redeemable for an item
described in paragraph (a)(1)(i)(C) of this section
(goods). Because the entire amount of the $50 ad-
vance payment is taken into account as AFS revenue
in tax years following the year of receipt, U defers
the payment and includes the $50 payment in gross
income in 2022.
(xix) Example 19: Credit card rewards—(A)
Facts. V issues credit cards and has a loyalty pro-
gram under which cardholders earn reward points
when they use V’s credit card to make purchases.
Each reward point is redeemable for $1 on any fu-
ture purchases.
(B) Analysis. Payments under credit card agree-
ments, including rewards for credit card purchases,
are excluded from the definition of an advance pay-
ment under paragraph (a)(1)(ii)(C) of this section.
Accordingly, V cannot use the deferral method for
these amounts.
(xx) Example 20: Airline reward miles—(A)
Facts. On January 1, 2021, W, a passenger airline
company, sells a customer a $700 airline ticket to
fly roundtrip in 2021. As part of the purchase, the
customer receives 7,000 reward points (air miles)
from W to be used for future air travel. The reward
points are not redeemable for cash and have a 2-year
expiration date. W tracks the issue date, redemption
date, and expiration date of each customer’s reward
points. Under the terms of U’s reward program,
when the customer redeems reward points they are
deemed to use the earliest issued points first. In its
AFS, W treats the rewards points as a separate per-
formance obligation and allocates $35 of the $700
ticket price to the reward points. W is able to deter-
mine the extent to which a payment that is allocat-
ed to a reward point is taken into account in AFS
revenue in the year of receipt. W takes into account
all $35 as AFS revenue in 2023 when the customer
redeems the air miles.
(B) Analysis. For Federal income tax purposes,
W’s treatment of the reward points as a separate
performance obligation for AFS purposes yields an
item of gross income that must be accounted for sep-
arately. The $35 allocated to the reward points item
is an advance payment as the full inclusion of the
payment in gross income in the taxable year of re-
ceipt is a permissible method of accounting without
regard to this section, a portion of the payment is
taken into account as AFS revenue in a subsequent
taxable year, and the reward points are redeemable
for an item described in paragraph (a)(1)(i)(C) of this
section (services). Because the entire amount of the
$35 advance payment is taken into account as AFS
revenue in a tax year following the year of receipt, W
defers the payment and includes the $35 payment in
gross income in 2022.
(xxi) Example 21: Chargebacks—(A) Facts. In
2021, X, a manufacturer of pharmaceuticals, enters
into a contract to sell 1,000 units to W, a wholesal-
er, for $10 per unit, totaling $10,000 (1,000 x $10
= $10,000). The contract also provides that X will
credit W $4 per unit (chargeback) for sales W makes
to qualifying customers. X delivers 600 units to W
on December 31, 2021, and bills W $6,000 under the
contract. X anticipates that all of W’s sales will be to
qualifying customers and subject to chargeback. For
AFS purposes, X adjusts its 2021 AFS revenue of
$6,000 by $2,400, the anticipated chargebacks, and
reports $3,600 of AFS revenue.
(B) Analysis. For Federal income tax purposes,
under paragraph (a)(1)(i)(B) of this section, for a
payment to qualify as an advance payment, a portion
of the payment must be taken into account as AFS
revenue for a subsequent taxable year. Under para-
graph (a)(1)(i)(B) of this section, the amount of the
payment included in AFS revenue for a subsequent
taxable year is $0, calculated as the $6,000 payment
reduced by $6,000 that is treated as taken into ac-
count as AFS revenue for 2021 ($3,600 of AFS rev-
enue for 2021 + $2,400 of anticipated chargebacks
(section 461 liabilities) which had reduced AFS rev-
enue for 2021). Because no portion of the $6,000 is
taken into account as AFS revenue in a subsequent
taxable year (that is, on an AFS after 2021), the
$6,000 payment received in 2021 is not an advance
payment under paragraph (a)(1)(i) of this section.
(d) Deferral method for taxpayers with-
out an AFS (non-AFS deferral method)—
(1) In general. Only a taxpayer described
in paragraph (d)(2) of this section may
elect to use the non-AFS deferral method
of accounting described in paragraph (d)
(4) of this section.
(2) Taxpayers eligible to use the non-
AFS deferral method. A taxpayer is eligi-
ble to use the non-AFS deferral method if
the taxpayer does not have an applicable
financial statement and can determine the
extent to which advance payments are
earned in the taxable year of receipt and, if
applicable, a short taxable year described
in paragraph (d)(6) of this section. The de-
termination whether the advance payment
is earned in the taxable year of receipt,
or a short taxable year described in para-
graph (d)(6) of this section, if applicable,
is determined on an item by item basis.
(3) Deferral of advance payments
based on when payment is earned—(i)
In general. Except as otherwise provid-
ed in this section, a taxpayer that uses the
non-AFS deferral method of accounting
includes the advance payment in gross in-
come for the taxable year of receipt to the
extent that it is earned in that taxable year
and includes the remaining portion of the
advance payment in gross income in the
next succeeding taxable year.
(ii) When payment is earned. Under the
non-AFS deferral method, a payment is
earned when the all events test described
in §1.451-1(a) is met, without regard to
when the amount is received, as defined
under paragraph (a)(14) of this section, by
the taxpayer. If a taxpayer is unable to de-

Bulletin No. 2021–3 447 January 19, 2021
termine the extent to which a payment is
earned in the taxable year of receipt, or a
short taxable year described in paragraph
(d)(6) of this section, if applicable, the
taxpayer may calculate the amount:
(A) On a statistical basis if adequate
data are available to the taxpayer;
(B) On a straight-line basis over the
term of the agreement if the taxpayer re-
ceives the advance payment under a fixed
term agreement and if it is reasonable to
anticipate at the end of the taxable year of
receipt that the advance payment will be
earned ratably over the term of the agree-
ment; or
(C) Using any other method that may be
provided in guidance published in the In-
ternal Revenue Bulletin (see §601.601(d)
of this chapter).
(4) Contracts with multiple items of
gross income—(i) In general. If a taxpay-
er receives a payment that is attributable to
one or more items described in paragraph
(a)(1)(i)(C) of this section, the taxpayer
must determine the portion of the payment
that is allocable to such item(s) by using
an allocation method that is based on ob-
jective criteria.
(ii) Objective criteria. A taxpayer’s al-
location method for a payment described
in paragraph (d)(4)(i) of this section is
deemed to be based on objective criteria
if the allocation method is based on pay-
ments the taxpayer receives for an item or
items it regularly sells or provides sepa-
rately or any method that may be provid-
ed in guidance published in the Internal
Revenue Bulletin (see §601.601(d) of this
chapter).
(5) Acceleration of advance payments.
The acceleration rules in paragraph (c)(4)
of this section also apply to a taxpayer that
uses the non-AFS deferral method under
paragraph (d) of this section.
(6) Short taxable year rule. If the tax-
payer’s next succeeding taxable year is
a short taxable year, other than a taxable
year in which the taxpayer dies or ceas-
es to exist in a transaction other than a
transaction to which section 381(a) ap-
plies, and the short taxable year consists
of 92 days or less, a taxpayer using the
non-AFS deferral method must include
the portion of the advance payment not
included in the taxable year of receipt in
gross income for the short taxable year
to the extent earned in such taxable year.
Any amount of the advance payment not
included in gross income in the taxable
year of receipt, or the short taxable year,
must be included in gross income for the
taxable year immediately following the
short taxable year.
(7) Eligible gift card sale. For para-
graphs (a)(1)(i)(B) and (d)(3) of this sec-
tion, if an eligible gift card is redeemable
by an entity described in paragraph (a)
(10)(ii) of this section, including an enti-
ty whose financial results are not includ-
ed in the taxpayer’s financial statement, a
payment will be treated as earned by the
taxpayer to the extent the gift card is re-
deemed by such entity during the taxable
year.
(8) Examples. The following examples
illustrate the rules of paragraph (d) of this
section. In the examples in this paragaph
(d)(8), the taxpayer is a calendar year
taxpayer that uses the non-AFS defer-
ral method described in paragraph (d) of
this section. None of the taxable years are
short taxable years.
(i) Example 1—(A) Facts. A, a video arcade
operator, receives payments in 2021 for tokens that
customers use to play A’s arcade games. The tokens
cannot be redeemed for cash, are imprinted with the
name of the arcade, but are not individually marked
for identification. A completed a study on a statisti-
cal basis, based on adequate data available to A, and
concluded that for payments received in 2021, 70%
of tokens are expected to be used in 2021, 20% of
tokens are expected to be used in 2022, and 10% of
tokens are expected to never be used. Based on the
study, under paragraph (d)(3)(ii)(A) of this section,
A determines that 80% of the advance payments are
earned for 2021 (70% for tokens expected to be used
in 2021 plus 10% for tokens that are expected to nev-
er be used).
(B) Analysis. For Federal income tax purposes, A
must include 80% of the advance payments in gross
income for 2021 and 20% of the advance payments
in gross income for 2022.
(ii) Example 2—(A) Facts. B is in the business of
providing internet services. On September 1, 2021,
B receives an advance payment from a customer for
a 2-year term for access to its internet services, be-
ginning on that date. B does not have an AFS. B is
unable to determine the extent to which the payment
is earned in the taxable year of receipt. However, at
the close of the 2021 taxable year, it is reasonable
for B to anticipate that the advance payment will be
earned ratably over the term of the agreement.
(B) Analysis. For Federal income tax purposes,
pursuant to paragraph (d)(3)(ii)(B) of this section, B
determines the extent to which the payment is earned
in tax year 2021 on a straight-line basis over the term
of the agreement and takes that amount into income
in 2021. The remaining amount of the advance pay-
ment is taken into gross income in the 2022 taxable
year.
(e) Advance payment cost offset meth-
od—(1) In general. This paragraph (e)
provides an optional method of account-
ing for advance payments from the sale
of inventory (advance payment cost offset
method). A taxpayer that chooses to use
the advance payment cost offset method
for a trade or business must use the meth-
od of accounting for all advance payments
received by that trade or business that
meet the criteria in this paragraph (e). Ad-
ditionally, a taxpayer that chooses to use
this method for a trade or business and that
has an AFS must also use the AFS cost
offset method described in §1.451-3(c).
A taxpayer that uses the AFS cost offset
method and the advance payment cost off-
set method to account for gross income,
including advance payments, from the
sale of an item of inventory, determines
the corresponding AFS income inclusion
amount, as defined in §1.451-3(a)(1), and
the advance payment income inclusion
amount for a taxable year by following
the rules in §1.451-3(c)(2) rather than the
rules under this paragraph (e). However,
if all payments received for the sale of
item of inventory meet the definition of
an advance payment under paragraph (a)
(1) of this section, a taxpayer that uses
the advance payment cost offset method
determines the corresponding advance
payment income inclusion amount for a
taxable year by:
(i) Following the rules in paragraph (e)
(2) of this section, subject to the additional
rules and limitations in paragraphs (e)(5)
through (8) of this section, if the taxable
year is a taxable year prior to the taxable
year in which ownership of the item of in-
ventory is transferred to the customer; and
(ii) Following the rules in paragraph (e)
(3) of this section, subject to the additional
rules and limitations in paragraphs (e)(5)
through (8) of this section, if the taxable
year is the taxable year in which owner-
ship of the item of inventory is transferred
to the customer.
(2) Determining the advance payment
income inclusion amount in a year prior
to the year of sale. To determine the ad-
vance payment income inclusion amount
for a taxable year prior to the year in
which ownership of the item of inventory
is transferred to the customer, the taxpayer
must first determine the advance payment
inventory inclusion amount for such item

January 19, 2021 448 Bulletin No. 2021–3
for such year. This advance payment in-
ventory inclusion amount is then reduced
by the cost of goods in progress offset
for the taxable year, as determined un-
der paragraphs (e)(4), (5), and (8) of this
section. This net amount is the advance
payment income inclusion amount for the
taxable year.
(3) Determining the advance payment
income inclusion amount in the year of
sale. The advance payment income inclu-
sion amount for the taxable year in which
ownership of the item of inventory is
transferred to the customer is equal to the
portion of any advance payment for such
item that was not required to be included in
gross income in a prior taxable year. This
amount is not reduced by a cost of goods
in progress offset under paragraph (e)(4)
of this section. However, the taxpayer is
entitled to recover the costs capitalized to
the item of inventory as cost of goods sold
in accordance with sections 471 and 263A
or any other applicable provision of the
Internal Revenue Code. See §1.61-3.
(4) Cost of goods in progress offset.
The cost of goods in progress offset for
the taxable year is calculated as:
(i) The cost of goods allocable to the
item of inventory through the last day of
the taxable year; reduced by
(ii) The cumulative cost of goods in
progress offset attributable to the item of
inventory, if any.
(5) Limitations to the cost of goods in
progress offset. The cost of goods in prog-
ress offset is determined separately for each
item of inventory. The cost of goods in prog-
ress offset attributable to one item of inven-
tory cannot reduce the advance payment
inventory inclusion amount attributable to a
different item of inventory. Further, the cost
of goods in progress offset cannot reduce
the advance payment inventory inclusion
amount for the taxable year below zero.
(6) Exception for gift cards. The cost of
goods in progress offset in this paragraph
(e) does not apply to eligible gift card
sales or payments received for customer
reward points.
(7) Acceleration of advance payments.
The acceleration rules in paragraph (c)(4)
of this section also apply to a taxpayer that
uses the advance payment cost offset meth-
od under this paragraph (e), regardless of
whether the taxpayer uses such method in
connection with the full inclusion method
under paragraph (b) of this section, or the
deferral method under paragraph (c) or
(d) of this section. If an advance payment
is subject to the acceleration rules, para-
graph (e)(2) of this section does not apply
to determine the advance payment income
inclusion amount for the taxable year de-
scribed in paragraph (c)(4) of this section.
Further, a taxpayer that uses the advance
payment cost offset method under this
paragraph (e) applies paragraph (c)(4)(i)
(B)(2)(ii) of this section by substituting
“same advance payment method as the
transferor” for “deferral method.”
(8) Inventory costs for the advance
payment cost offset method—(i) Inventory
costs not affected by cost of goods in prog-
ress offset. The cost of goods comprising
the cost of goods in progress offset does
not reduce the costs that are capitalized to
the items of inventory produced or items
of inventory acquired for resale by the tax-
payer. While the cost of goods in progress
offset reduces the amount of the advance
payment inventory inclusion amount, the
cost of goods in progress offset does not
affect how and when costs are capitalized
to inventory under sections 471 and 263A
or any other applicable provision of the
Internal Revenue Code or when those cap-
italized costs will be recovered.
(ii) Consistency between inventory
methods and advance payment cost offset
method. The costs of goods comprising
the cost of goods in progress offset must
be determined by applying the taxpayer’s
methods of accounting for inventory for
Federal income tax purposes. A taxpay-
er using the advance payment cost offset
method must calculate its cost of goods
in progress offset by reference to all costs
that the taxpayer has permissibly capital-
ized and allocated to items of inventory
under its methods of accounting for in-
ventory for Federal income tax purposes,
but including no more costs than what the
taxpayer has permissibly capitalized and
allocated to items of inventory.
(iii) Allocation of “additional section
263A costs” for taxpayers using sim-
plified methods. If a taxpayer uses the
simplified production method as defined
under §1.263A-2(b), the modified sim-
plified production method as defined un-
der §1.263A-2(c), or the simplified resale
method as defined under §1.263A-3(d)
to determine the amount of its “addition-
al section 263A costs,” as defined under
§1.263A-1(d)(3), to be included in ending
inventory, then solely for computing the
cost of goods in progress offset, the tax-
payer must determine the portion of addi-
tional section 263A costs allocable to an
item of inventory by multiplying its total
additional section 263A costs accounted
for under the simplified method for all
items of inventory subject to the simpli-
fied method by the following ratio:
Section 471 costs allocable to the specific
item of inventory
Total section 471 costs for all items of in-
ventory subject to the simplified method
(9) Additional procedural guidance. The
IRS may publish procedural guidance in the
Internal Revenue Bulletin (see §601.601(d)
of this chapter) that provides alternative
procedures for complying with the rules un-
der this paragraph (e), including alternative
methods of accounting for cost offsets.
(10) Examples. The following examples
illustrate the rules of paragraph (e) of this
section. In each of the following examples,
the taxpayer is a C corporation, has an
AFS, uses an accrual method of account-
ing for Federal income tax purposes, and
uses a calendar year for Federal income tax
purposes and AFS purposes. In addition, in
each example, the taxpayer uses the defer-
ral method and the advance payment cost
offset method under paragraph (e) of this
section. Lastly, the taxpayer does not pro-
duce unique items, as described in §1.460-
2(a)(1) and (b), or any item that normally
requires more than 12 calendar months to
complete, as determined under §1.460-2(a)
(2) and (c). Any production period that ex-
ceeds 12 calendar months is due to unfore-
seen production delays.
(i) Example 1—(A) Facts. In December 2021, A
enters into a contract with Customer to manufacture
and deliver a good in 2024, with a total contract price
of $100x. The costs to produce the good are required
to be capitalized under sections 471 and 263A as the
good is inventory in the hands of A. On the same day,
A receives a payment of $40x from the customer. For
its AFS, A reports all of the revenue from the sale
of the good as AFS revenue in the year of delivery,
which is also the year in which ownership of the
good transfers from A to Customer. As of December
31, 2021, A has not incurred any cost to manufacture
the good. The payment of $40x does not satisfy the
specified good exception in paragraph (a)(1)(ii)(H)
of this section, and thus qualifies as an advance pay-
ment. During 2022, A does not receive any additional

Bulletin No. 2021–3 449 January 19, 2021
payments on the contract and incurs $10x of costs
to manufacture the good. A properly capitalizes and
allocates such costs to the manufactured good under
sections 471 and 263A.
(B) Analysis. Because no portion of the $40x ad-
vance payment is taken into account as AFS revenue
as of the end of 2021, A is not required to include
any portion of the advance payment in gross income
for 2021. For 2022, A’s advance payment inventory
inclusion amount is $40x, which is the amount of
the advance payment that, but for the cost of goods
in progress offset, would be includable in gross in-
come in 2022 under the deferral method. Pursuant
to paragraph (e)(2) of this section, A reduces such
amount by the $10x cost of goods in progress offset,
determined as the costs of goods through the end of
2022 ($0 costs incurred in 2021 plus 10x of costs
incurred in 2022 = $10x). A is required to include
this net amount of $30x in gross income in 2022. The
remaining portion of the payment ($10x) is deferred
and included in gross income in 2024, the taxable
year in which ownership of the good is transferred
to Customer.
(ii) Example 2—(A) Facts. The same facts as in
paragraph (e)(10)(i) of this section (Example 1) ap-
ply. In addition, in 2023, A incurs costs of $20x to
manufacture the good but does not receive any addi-
tional payments from Customer.
(B) Analysis. A includes $0 in gross income in
2023. A’s cost of goods in progress offset for 2023
is $20x under paragraph (e)(4) of this section ($30x
costs of goods through the last day of 2023 ($10x for
2022 plus $20x for 2023 = $30x) less $10x cumula-
tive cost of goods in progress offset amounts taken in
prior taxable years). However, because A’s advance
payment inventory inclusion amount for 2023 is $0,
which is the amount of the advance payment that,
but for the cost of goods in progress offset, would be
includable in gross income in 2023 under the defer-
ral method, paragraph (e)(5) of this section limits the
cost offset to $0.
(iii) Example 3—(A) Facts. The same facts as
in paragraph (e)(10)(i) of this section (Example 1)
apply, except that in taxable year 2022, A incurs ad-
ditional costs of $25x to manufacture the good, re-
sulting in total costs of $35x to manufacture the good
in taxable year 2022.
(B) Analysis. For 2022, A’s advance payment
inventory inclusion amount is $40x, which is the
amount of the advance payment that, but for the cost
of goods in progress offset, would be includable in
gross income in 2022 under the deferral method.
Pursuant to paragraph (e)(2) of this section A reduces
such amount by the $35x cost of goods in progress
offset, determined as the costs of goods through the
end of 2022 ($0 costs incurred in 2021 plus $35x
costs incurred in 2022 = $35x). A is required to
include this net amount of $5x in gross income in
2022. The remaining portion of the payment ($35x)
is deferred and included in gross income in 2024, the
taxable year in which ownership of the good is trans-
ferred to the customer.
(iv) Example 4—(A) Facts. The same facts as
in paragraph (e)(10)(iii) of this section (Example 3)
apply, except that for tax year 2023, A receives an
additional advance payment of $60x, and does not
incur any costs to manufacture the good in 2023. In
2024, A incurs the remaining $10x to manufacture
the good, and delivers the good to Customer.
(B) Analysis for 2023. Because no portion of the
$60x advance payment is taken into account as AFS
revenue as of the end of 2023, A is not required to
include any portion of the $60x advance payment in
gross income for 2023.
(C) Analysis for 2024. In 2024, the
ownership of the good is transferred to
Customer. Accordingly, pursuant to para-
graph (e)(3) of this section, A is required to
include $95x, the remaining portion of all
advance payments that were not required
to be included in gross income in a prior
taxable year ($100x of total advance pay-
ments received less $5x that was required
to be included in gross income in 2022).
Although A does not reduce such amount
by a cost offset, it reduces gross income in
2024 by recovering the $45x of costs cap-
italized to inventory as cost of goods sold
($35x costs incurred in 2022 plus $10x
costs incurred in 2024) in accordance with
sections 471 and 263A. Accordingly, A’s
gross income for 2024 is $50x.
(f) Method treating payments quali-
fying for the specified goods exception
as advance payments—(1) In general.
A taxpayer may choose to use the spec-
ified good section 451(c) method to treat
all payments that qualify for the specified
goods exception in paragraph (a)(1)(ii)(H)
of this section as advance payments that
are eligible to be accounted for under this
section. Under the specified good section
451(c) method, an advance payment is
a payment received by the taxpayer in a
taxable year earlier than the taxable year
immediately preceding the taxable year of
the contractual delivery date for a speci-
fied good. A taxpayer that chooses to use
the specified good section 451(c) method
for a trade or business must apply this
method of accounting for all advance pay-
ments that meet the criteria described in
paragraph (a)(1)(ii)(H) of this section.
(2) Example: Method for the specified goods
exception to not apply. On May 1, 2021, A, a cor-
poration that files its Federal income tax return on
the calendar year basis, receives a prepayment for
$100x, for a contract to manufacture and deliver a
good in September of 2023. All of the revenue from
the sale of the good is recognized in A’s AFS in the
year of delivery. During 2021, A does not have on
hand, or available to it in such year through its nor-
mal source of supply, goods of a substantially sim-
ilar kind and in a sufficient quantity to satisfy the
contract to transfer the good to the customer. The
payment of $100x satisfies the specified good excep-
tion. A uses the method under paragraph (f) of this
section to treat all payments that otherwise satisfy
the specified good exception as advance payments
under this section. For Federal income tax purposes,
A must treat the payment of $100x as an advance
payment and account for such payment under the full
inclusion method in paragraph (b) of this section, or
the deferral method in paragraph (c) of this section,
as applicable. Additionally, the taxpayer may choose
to apply the advance payment cost offset method in
paragraph (e) of this section.
(g) Election and methods of account-
ing—(1) Procedures for making election
under section 451(c)(1)(B). An election
to apply the deferral method under sec-
tion 451(c)(1)(B) is made by the taxpayer
filing a Federal income tax return reflect-
ing the deferral method in computing its
taxable income. If the application of the
deferral method under section 451(c)(1)
(B) results in the taxpayer changing its
method of accounting, the election may
only be made by the taxpayer complying
with the method change procedures under
this paragraph (g).
(2) Methods of accounting. A change
to comply with this section is a change
in method of accounting to which the
provisions of sections 446 and 481 and
the regulations in this part under sections
446 and 481 of the Code apply. A tax-
payer seeking to change to a method of
accounting permitted in this section must
secure the consent of the Commissioner
in accordance with §1.446-1(e) and fol-
low the administrative procedures issued
under §1.446-1(e)(3)(ii) for obtaining
the Commissioner’s consent to change
its accounting method. For example, use
of the full inclusion method under para-
graph (b) of this section, the AFS deferral
method under paragraph (c) of this sec-
tion, the non-AFS deferral method under
paragraph (d) of this section, the advance
payment cost offset method under para-
graph (e) of this section, and the specified
good section 451(c) method under para-
graph (f) of this section are adoptions of,
or changes in, a method of accounting
under section 446 of the Internal Revenue
Code or the regulations in this part un-
der section 446 of the Code. In addition,
a change in the manner of recognizing
advance payments in revenue in an AFS
that changes or could change the timing
of the inclusion of income for Federal in-
come tax purposes is a change in method
of accounting under section 446 and the
regulations in this part under section 446
of the Code.

January 19, 2021 450 Bulletin No. 2021–3
(h) Applicability date—(1) In general.
The rules of this section apply to taxable
years beginning on or after January 1,
2021.
(2) Early application. Taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b), may ap-
ply both the rules in this section and, to
the extent relevant, the rules in §1.451-
3, in their entirety and in a consistent
manner, to a taxable year beginning after
December 31, 2017, and before January
1, 2021, provided that, once applied to
a taxable year, the rules in this section
and, to the extent relevant, the rules in
§1.451-3, are applied in their entirety and
in a consistent manner to all subsequent
taxable years. See section 7805(b)(7) and
§1.451-3(m).
Par. 7. Section 1.1271-0 is amended by
adding entries for §1.1275-2(l) and (l)(1)
and (2) to read as follows:
§1.1271-0 Original issue discount;
effective date; table of contents.
* * * * *
§1.1275-2 Special rules relating to debt
instruments.
* * * * *
(l) OID rule for income item subject to
section 451(b).
(1) In general.
(2) Applicability dates.
* * * * *
Par. 8. Section 1.1275-2 is amended by
adding paragraph (l) to read as follows:
§1.1275-2 Special rules relating to debt
instruments.
* * * * *
(l) OID rule for income item subject to
section 451(b)—(1) In general. Notwith-
standing any other rule in sections 1271
through 1275 and §§1.1271-1 through
1.1275-7, if, and to the extent, a taxpay-
er’s item of income with respect to a debt
instrument is subject to the timing rules in
§1.451-3 because the item of income is a
specified fee described in §1.451-3(j) (such
as credit card late fees, credit card cash
advance fees, or interchange fees), then
the taxpayer does not take the item into
account to determine whether the debt in-
strument has any OID. As a result, the tax-
payer does not treat the item as creating or
increasing any OID on the debt instrument.
(2) Applicability dates—(i) In gener-
al. Except as provided in paragraph (l)(2)
(ii) and (iii) of this section, for a specified
credit card fee as defined in §1.451-3(j)
(2), paragraph (l)(1) of this section ap-
plies for taxable years beginning on or
after January 1, 2021, and, for a specified
fee that is not a specified credit card fee,
paragraph (l)(1) of this section applies for
taxable years beginning on or after Janu-
ary 6, 2022.
(ii) Early application. For a taxable
year beginning after December 31, 2018,
and before January 1, 2021, a taxpayer
and its related parties, within the mean-
ing of sections 267(b) and 707(b), may
choose to apply both paragraph (l)(1) of
this section and the rules in §1.451-3, in
their entirety and in a consistent manner,
to all specified credit card fees subject to
§1.451-3, provided that once applied to a
taxable year the rules in paragraph (l)(1)
of this section and the rules in §1.451-3
that apply to specified credit card fees, are
applied in their entirety and in a consistent
manner for all subsequent taxable years.
See section 7508(b)(7).
(iii) Applicability date for accounting
method changes. Paragraph (l)(1) of this
section will not apply in applying section
13221(e) of Public Law 115-97, 131 Stat.
2054 (2017), to determine the section
481(a) adjustment period for any adjust-
ment under section 481(a) for a qualified
change in method of accounting required
under section 451(b) and §1.451-3 for a
specified credit card fee.
Sunita Lough,
Deputy Commissioner for Services
and Enforcement.
Approved: December 14, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on De-
cember 30, 2020, 4:15 p.m., and published in the
issue of the Federal Register for January 6, 2021, 85
FR 810)
T.D. 9942
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Small Business Taxpayer
Exceptions Under Sections
263A, 448, 460 and 471
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations to implement legislative
changes to sections 263A, 448, 460, and
471 of the Internal Revenue Code (Code)
that simplify the application of those tax
accounting provisions for certain busi-
nesses having average annual gross re-
ceipts that do not exceed $25,000,000,
adjusted for inflation. This document also
contains final regulations regarding cer-
tain special accounting rules for long-term
contracts under section 460 to implement
legislative changes applicable to corporate
taxpayers. The final regulations generally
affect taxpayers with average annual gross
receipts of not more than $25 million, as
adjusted for inflation.
DATES: Effective date: The regulations
are effective on January 5, 2021.
Applicability dates: For dates of applicabil-
ity, see §§ 1.263A-1(a)(2)(i), 1.263A-1(m)
(6), 1.263A-2(g)(4), 1.263A-3(f)(2),
1.263A-4(g)(2), 1.263A-7(a)(4)(ii),
1.381(c)(5)-1(f), 1.446-1(c)(3), 1.448-
2(h), 1.448-3(h), 1.460-1(h)(3), 1.460-
3(d), 1.460-4(i), 1.460-6(k), and 1.471-
1(c).
FOR FURTHER INFORMATION CON-
TACT: Concerning §§1.460-1 through
1.460-6, Innessa Glazman, (202) 317-
7006; concerning all other regulations
in this document, Anna Gleysteen, (202)
317-7007.

Bulletin No. 2021–3 451 January 19, 2021
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) to implement statutory amend-
ments to sections 263A, 448, 460, and
471 of the Code made by section 13102 of
Public Law No. 115-97 (131 Stat. 2054),
commonly referred to as the Tax Cuts and
Jobs Act (TCJA). These statutory amend-
ments generally simplify the application
of the method of accounting rules un-
der those provisions to certain business-
es (other than tax shelters) with average
annual gross receipts that do not exceed
$25,000,000, adjusted for inflation.
The uniform capitalization (UNICAP)
rules of section 263A provide that, in gen-
eral, the direct costs and the properly al-
locable share of the indirect costs of real
or tangible personal property produced, or
real or personal property described in sec-
tion 1221(a)(1) acquired for resale, cannot
be deducted but must either be capitalized
into the basis of the property or included
in inventory costs, as applicable. Before
the enactment of the TCJA, certain types
of taxpayers and certain types of property
were exempt from UNICAP, but there was
no generally applicable exemption based
on gross receipts.
Section 448(a) generally prohibits C
corporations, partnerships with a C corpo-
ration as a partner, and tax shelters from
using the cash receipts and disbursements
method of accounting (cash method).
However, section 448(b)(3) provides that
section 448(a) does not apply to C cor-
porations and partnerships with a C cor-
poration as a partner that meet the gross
receipts test of section 448(c). Prior to
the TCJA’s enactment, a taxpayer met the
gross receipts test of section 448(c) if, for
all taxable years preceding the current
taxable year, the average annual gross re-
ceipts of the taxpayer (or any predecessor)
for any 3-taxable-year period did not ex-
ceed $5 million.
Section 460(a) provides that income
from a long-term contract must be deter-
mined using the percentage-of-comple-
tion method (PCM). A long-term contract
is defined in section 460(f) as generally
any contract for the manufacture, build-
ing, installation, or construction of proper-
ty if such contract is not completed within
the taxable year in which such contract is
entered into. Subject to special rules in
section 460(b)(3), section 460(b)(1)(A)
generally provides that the percentage of
completion of a long-term contract is de-
termined by comparing costs allocated to
the contract under section 460(c) and in-
curred before the close of the taxable year
with the estimated total contract costs.
Prior to the TCJA, section 460(e)(1)(B)
provided an exemption from the PCM
for a long-term construction contract of a
taxpayer who estimated that the contract
would be completed within the 2-year
period from the commencement of the
contract (two-year rule), and whose av-
erage annual gross receipts for the 3-tax-
able-year period ending with the year pre-
ceding the year the contract was entered
into did not exceed $10 million (Section
460(e) gross receipts test).
Section 471(a) requires inventories to
be taken by a taxpayer when, in the opin-
ion of the Secretary of the Treasury or his
delegate (Secretary), taking an inventory
is necessary to determine the income of
the taxpayer. Section 1.471-1 requires the
taking of an inventory at the beginning
and end of each taxable year in which the
production, purchase, or sale of merchan-
dise is an income-producing factor. Ad-
ditionally, when an inventory is required
to be taken, §1.446-1(c)(1)(iv) and (c)(2)
require that an accrual method be used for
purchases and sales. Prior to the enact-
ment of the TCJA, there were no regulato-
ry exceptions from the requirement to take
an inventory under § 1.471-1.
The statutory amendments of the TCJA
increase the gross receipts test amount
under section 448(c) to $25,000,000, ad-
justed for inflation, for eligibility to use
the cash method and also exempt taxpay-
ers, other than a tax shelter under section
448(a)(3), meeting the gross receipts test
(Section 448(c) Gross Receipts Test)
from: (1) the UNICAP rules under sec-
tion 263A; (2) the requirement to use the
percentage-of-completion method under
section 460 provided other requirements
of section 460(e) are satisfied; and (3) the
requirement to take inventories under sec-
tion 471(a) if their inventory is treated as
non-incidental materials and supplies, or
if the method of accounting for their in-
ventory conforms with the method reflect-
ed on their applicable financial statement
(AFS), or if they do not have an AFS, their
books and records prepared in accordance
with their accounting procedures. These
amendments generally apply to taxable
years beginning after December 31, 2017.
The amendments to section 460 apply to
contracts entered into after December 31,
2017, in taxable years ending after De-
cember 31, 2017.
On August 20, 2018, the Department
of the Treasury (Treasury Department)
and the IRS issued Revenue Procedure
2018-40 (2018-34 IRB 320), which pro-
vided administrative procedures for a tax-
payer, other than a tax shelter under sec-
tion 448(a)(3), meeting the requirements
of section 448(c) to obtain the consent to
change the taxpayer’s method of account-
ing to a method of accounting permitted
by section 263A, 448, 460 or 471. The
revenue procedure also requested com-
ments for future guidance regarding the
implementation of the TCJA modifica-
tions to sections 263A, 448, 460, and 471.
The record of public comments received
in response to Revenue Procedure 2018-
40 may be requested by sending an email
to Notice.Comments@irs.gov.
On August 5, 2020, the Treasury De-
partment and the IRS published a notice of
proposed rulemaking (REG-132766-18)
in the Federal Register (85 FR 47608),
correction published in the Federal Reg-
ister (85 FR 58307) on September 18,
2020, containing proposed regulations
under sections 263A, 448, 460, and 471
(proposed regulations). The proposed reg-
ulations reflect consideration of the com-
ments that were received in response to
Revenue Procedure 2018-40.
The Treasury Department and the IRS
received nine written comments respond-
ing to the proposed regulations. The Trea-
sury Department and the IRS received one
request to speak at a public hearing, which
was later withdrawn. Therefore, no public
hearing was held. Comments received be-
fore these final regulations were substan-
tially developed, including all comments
received on or before the deadline for
comments on September 14, 2020, were
carefully considered in developing these
final regulations.
Copies of the comments received are
available for public inspection at http://
www.regulations.gov or upon request.

January 19, 2021 452 Bulletin No. 2021–3
After consideration of the comments re-
ceived, this Treasury decision adopts
the proposed regulations as revised in
response to such comments. Those com-
ments and the revisions are discussed in
the Summary of Comments and Explana-
tion of Revisions section of this preamble.
Summary of Comments and
Explanation of Revisions
I. Overview
This Summary of Comments and Ex-
planation of Revisions section summa-
rizes the formal written comments that
were received addressing the proposed
regulations. However, comments merely
summarizing or interpreting the proposed
regulations or recommending statutory
revisions generally are not discussed in
this preamble. These final regulations pro-
vide guidance under sections 263A, 448,
460, and 471 to implement the TCJA’s
amendments to those provisions. These
final regulations also modify §§1.381(c)
(5)-1 and 1.446-1 to reflect these statutory
amendments. The rationale for provisions
in these final regulations that are not dis-
cussed in this Explanation of Revisions
remains the same as described in the Ex-
planation of Provisions section of the pre-
amble to the proposed regulations.
A. Section 263A(i)
1. Costing Rules for Self-Constructed
Assets
In response to Revenue Procedure
2018-40, a commenter stated that a small
business taxpayer that is exempted from
section 263A pursuant to section 263A(i)
would be subject to the costing rules prior
to the enactment of section 263A (pre-sec-
tion 263A costing rules) for self-con-
structed assets used in the taxpayer’s trade
or business. However, according to the
commenter, the pre-section 263A costing
rules were unclear as to what costs are
capitalizable to self-constructed assets. In
light of this comment, the preamble to the
proposed regulations requested comments
on specific clarifications needed regarding
the pre-section 263A costing rules. Only
one comment was received in response to
this request. The sole commenter noted
that one of the reasons for the enactment of
section 263A was that courts had reached
different conclusions as to the types of
costs that were required to be capitalized
under the pre-section 263A costing rules.
Compare Adolph Coors Co. v. Commis-
sioner, 519 F.2d 1280 (10th Cir. 1975),
cert. denied 423 U.S. 1087 (1976) (requir-
ing the full inclusion of all overhead costs
in the cost basis of self-constructed assets)
with Fort Howard Paper Co. v. Commis-
sioner, 49 T.C. 275 (1967) (requiring only
the inclusion of overhead costs directly
attributable to the self-constructed asset).
The commenter suggested that taxpayers
who used the exemption under section
263A(i) to not capitalize costs under sec-
tion 263A be permitted to use an incre-
mental costing method to determine the
costs of self-constructed assets, consistent
with the approach in Fort Howard Paper.
The commenter stated that identifying in-
direct costs not directly attributable to the
construction of specific self-constructed
assets would be difficult.
After considering this comment, the
Treasury Department and the IRS have
determined that the requested clarification
is beyond the scope of these regulations,
which is to implement section 263A(i) as
enacted by TCJA. For taxpayers that elect
under section 263A(i) to not apply section
263A, the requirement to capitalize cer-
tain costs to self-constructed assets comes
from other provisions of the Code, such
as section 263(a). TCJA did not amend
such provisions and thus the clarification
of permissible capitalization methods and
the types of costs required to be capital-
ized to self-constructed assets under such
provisions is beyond the scope of these
final regulations.
2. Changes to Regulations under Section
448
Under section 448(a)(3), a tax shelter
is prohibited from using the cash method.
Section 448(d)(3) cross references section
461(i)(3) to define the term “tax shelter.”
Section 461(i)(3)(B), in turn, includes a
cross reference to the definition of “syndi-
cate” in section 1256(e)(3)(B), which de-
fines a syndicate as a partnership or other
entity (other than a C corporation) if more
than 35 percent of the losses of that enti-
ty during the taxable year are allocable to
limited partners or limited entrepreneurs.
Sections 1.448-1T(b)(3) (for taxable years
beginning before January 1, 2018) and
proposed 1.448-2(b)(2)(iii) (for taxable
years beginning after December 31, 2017)
narrow this definition by providing that a
taxpayer is a syndicate only if more than
35 percent of its losses are allocated to
limited partners or limited entrepreneurs.
Consequently, a partnership or other entity
(other than a C corporation) may be con-
sidered a syndicate under section 448 only
for a taxable year in which it has losses.
Proposed §1.448-2(b)(2)(iii)(B) per-
mits a taxpayer to elect to use the allocat-
ed taxable income or loss of the immedi-
ately preceding taxable year to determine
whether the taxpayer is a syndicate under
section 448(d)(3) for the current taxable
year. Under the proposed regulations, a
taxpayer that makes this election must
apply the rule to all subsequent taxable
years, and for all purposes for which sta-
tus as a tax shelter under section 448(d)
(3) is relevant, unless the Commissioner
permits a revocation of the election.
Several comments were received con-
cerning issues related to tax shelters, in-
cluding the definition of “syndicate,” un-
der proposed §1.448-2(b)(2)(i)(B). Some
commenters recommend using the author-
ity granted under section 1256(e)(3)(C)(v)
to provide a deemed active participation
rule to disregard certain interests held by
limited entrepreneurs or limited partners
for applying the Section 448(c) Gross Re-
ceipts Test if certain conditions were met.
For example, conditions of the rule could
include that the entity had not been clas-
sified as a syndicate within the last three
taxable years, and that the average taxable
income of the entity for that period was
greater than zero.
The final regulations do not adopt this
recommendation. The Treasury Depart-
ment and the IRS have determined that
it would be inappropriate to provide an
exception to the active participation rules
in section 1256(e)(3)(C)(v) by “deeming”
active participation for small business
taxpayers. The Treasury Department and
the IRS believe that the deeming of ac-
tive participation in this context would be
overbroad and would run counter to Con-
gressional intent. Sections 448(b)(3) and
(d)(3), 461(i)(3) and 1256(e)(3)(C) were
not modified by the TCJA, and the legisla-

Bulletin No. 2021–3 453 January 19, 2021
tive history to section 13012 of the TCJA
does not indicate any Congressional intent
to modify the definition of “tax shelter” or
“syndicate.” By not modifying those pro-
visions, Congress presumably meant to
exclude tax shelters, including syndicates,
from being eligible to use the cash meth-
od of accounting and the small business
taxpayer exemptions in section 13102 of
the TCJA, even while otherwise expand-
ing eligibility to meet the Section 448(c)
Gross Receipts Test.
Other comments requested clarification
generally of what “active participation”
means and the circumstances, if any, un-
der which a member of a limited liability
company is treated as a “limited partner”
or “limited entrepreneur” under section
461(k)(4). The Treasury Department and
the IRS have determined that such guid-
ance is outside the scope of these final
regulations, which are to implement the
changes made by section 13102 of the
TCJA.
The Treasury Department and the IRS
remain aware of the increased relevance of
the definition of tax shelter under section
448(d)(3) after enactment of the TCJA
and the practical concerns regarding the
determination of tax shelter status for the
taxable year. To ameliorate these practical
concerns, these final regulations modify
the syndicate election provided in pro-
posed §1.448-2(b)(2)(iii)(B) to provide
additional relief by making the election
an annual election. The Treasury Depart-
ment and the IRS have determined that an
annual election appropriately balances the
statutory language with the consistency
requirement for use of a method of ac-
counting under section 446(a) and §1.446-
1. A cash method taxpayer that is generally
profitable year-to-year may experience an
unforeseen taxable loss for an anomalous
year but return to its profitable position in
subsequent years. If the taxpayer allocated
more than 35 percent of the taxable loss to
limited partners or limited entrepreneurs,
the taxpayer would be required to change
from the cash method to another method
for the anomalous year in accordance with
section 448(a)(3). However, that taxpayer
would otherwise not be prohibited under
section 448(a)(3) to use the cash method
in the next profitable taxable year. An an-
nual election under §1.448-2(b)(2)(iii)(B)
allows a taxpayer to elect in the loss year
to use the allocated taxable income or loss
of the immediately preceding taxable year
to determine whether the taxpayer is a
syndicate under section 448(d)(3) for the
current taxable year. The Treasury Depart-
ment and the IRS have determined that
permitting taxpayers to continue to use
the cash method, as well as other methods
impacted by a determination under section
448(d)(3), in such situations is consis-
tent with the requirements under section
446(a).
This election applies for all provisions
of the Code that specifically refer to sec-
tion 448(a)(3) to define tax shelter, such
as the small business exemptions under
sections 163(j)(3), 263A(i)(1), 460(e)(1)
(B) and 471(c)(1). A taxpayer is required
to file a statement with the original time-
ly filed Federal income tax return, with
extensions, to affirmatively make this
election under § 1.448-2(b)(2)(iii)(B) for
such taxable year. The election is valid
only for the taxable year for which it
is made, and once made, cannot be re-
voked. The Treasury Department and the
IRS intend to issue procedural guidance
to address the revocation of an election
made under proposed §1.448-2(b)(2)(iii)
(B) as a result of the application of the
final regulations.
Other commenters noted for some tax-
payers who took advantage of the small
business exception in section 448(b)(3) to
change to the cash method, the change in
method of accounting resulted in a neg-
ative section 481(a) adjustment, which
triggered an allocated loss and made the
taxpayer a tax shelter under section 448(a)
(3). As a result, the taxpayers became
ineligible to use the cash method for the
year in which the negative section 481(a)
adjustment was recognized but may be
otherwise eligible to use the cash method
for future years. Under proposed §1.448-
2(g)(3), these taxpayers would be ineligi-
ble for the automatic change procedures
to make a subsequent change back to the
cash method once they are no longer tax
shelters within a five-year period. The
commenters recommend relief for taxpay-
ers with this situation.
The commenters propose an exception
to the tax shelter rules for a taxpayer that
satisfies the Section 448 Gross Receipts
Test if a negative section 481(a) adjust-
ment from a change in method of account-
ing under the small business taxpayer ex-
emptions (for example, sections 263A(i),
471(c), 448(b)) results in the taxpayer
being considered a tax shelter under sec-
tion 448(d)(3) and proposed §1.448-2(b)
(2)(iii). These final regulations do not
adopt this suggestion. As described in the
Preamble to the proposed regulations, the
Treasury Department and the IRS have
determined that no exception was provid-
ed in the TCJA to limit the definition of
tax shelter in section 448(d)(3) for tax-
payers making method changes related to
the small business taxpayer exemptions.
However, the Treasury Department and
the IRS expect that the annual election un-
der §1.448-2(b)(2)(iii)(B), described ear-
lier, will provide relief for many taxpayers
in this situation.
Additionally, the Treasury Department
and the IRS have reconsidered the 5-year
restriction on automatic method changes
in light of these comments. Section 446(a),
unmodified by the TCJA, provides that
taxable income shall be computed under
the method of accounting on the basis of
which the taxpayer regularly computes his
income in keeping his books. A taxpayer
that changes its method of accounting for
the same item with regular frequency (for
example, annually or every other taxable
year) is not adhering to the consistency re-
quirement of section 446. The consistency
requirement of section 446(a) is distinct
from the authority granted the Commis-
sioner under section 446(b) to determine
whether the method of accounting used
by a taxpayer clearly reflects income. See
e.g., Advertisers Exchange, Inc. v. Com-
missioner, 25 T.C. 1086, 1092 (1956)
(“Consistency is the key and is required
regardless of the method or system of ac-
counting used.”) (citations omitted); Hun-
tington Securities Corporation v. Busey,
112 F.2d 368, 370 (1940) (“...whatever
method the taxpayer adopts must be con-
sistent from year to year unless the Com-
missioner authorizes a change.”)
The Treasury Department and the IRS
are aware that the 5-year restriction in
proposed §1.448-2(g)(3) could be bur-
densome for a small business taxpayer
that was required to change from the cash
method as a result of section 448(a)(3) or
not meeting the Section 448 Gross Re-
ceipts Test in a taxable year but that be-
comes eligible to use the cash method un-

January 19, 2021 454 Bulletin No. 2021–3
der section 448 in the subsequent taxable
year. Proposed §1.448-2(g)(3) would have
required this small business taxpayer to
request consent to change back to the cash
method using the non-automatic change
procedures in Revenue Procedure 2015-
13 (or successor). These final regulations
remove the 5-year restriction on making
automatic method changes for certain sit-
uations.
Sections 263A(i)(3), 448(d)(7), 460(e)
(2)(B) and 471(c)(4) provide that certain
changes in method of accounting for the
small business exemptions are made with
the consent of the Secretary. A taxpayer
must follow the applicable administrative
procedures related to a change in method
of accounting notwithstanding the deemed
consent of the Secretary. See, e.g., Capital
One Financial Corporation and Subsid-
iaries v. Commissioner of Internal Reve-
nue, 130 T.C. 147, 157 (2008) (“a taxpayer
forced to change its method of accounting
under section 448 must still file a Form
3115 with its return”). The Treasury De-
partment and the IRS intend to provide
procedural rules relating to changes in
method of accounting to implement the fi-
nal regulations using the automatic meth-
od change procedures of Revenue Proce-
dure 2015-13. Those procedural rules will
address whether a waiver of the 5-year
overall method eligibility rule in section
5.01(1)(e) of Revenue Procedure 2015-13
is appropriate for small business taxpay-
ers that were required to change from the
cash method in one taxable year but are
not subsequently limited by section 448.
The Treasury Department and the IRS
have determined that taxpayers that are
voluntarily changing (that is, not required
by section 448 to no longer use the cash
method) between overall methods are
distinguishable from taxpayers that are
required to change from the cash method
to another method because they no longer
meet the Section 448(c) Gross Receipts
Test or become a tax shelter under section
448(d)(3). The procedural guidance is ex-
pected to address both fact patterns. Addi-
tionally, the Treasury Department and the
IRS intend for the procedural guidance to
address similar fact patterns for taxpayers
making changes related to the regulations
under sections 263A(i), 460(e)(1)(B) and
471(c), as discussed in this Summary of
Comments and Explanation of Revisions.
3. Section 471 Small Business Taxpayer
Exemptions
A. Inventory Treated as Non-Incidental
Materials and Supplies
The preamble to the proposed regula-
tions notes that the Treasury Department
and the IRS interpret the statutory lan-
guage of section 471(c)(1)(B) to mean
that the property excepted from section
471(a) by that provision continues to be
inventory property even though the gener-
al inventory rules under section 471(a) are
not required to be applied to that property.
Section 471(c)(1)(B) provides that a qual-
ifying taxpayer’s “method of accounting
for inventory for such taxable year” (em-
phasis added) will not be treated as fail-
ing to clearly reflect income if the method
“treats inventory as non-incidental mate-
rials and supplies” (emphasis added). The
Treasury Department and the IRS read the
repeated use of the word “inventory” to
mean that Congress intended that inven-
tory property remains inventory property
while relieving taxpayers from the general
inventory rules of section 471(a). To re-
duce confusion about the nature of proper-
ty treated as non-incidental materials and
supplies under section 471(c)(1)(B)(i),
these final regulations refer to the meth-
od under that provision of the Code as the
“section 471(c) NIMS inventory method.”
The Treasury Department and the IRS
interpret section 471(c)(1)(B)(i) as pro-
viding three distinct benefits for taxpay-
ers. First, the provision significantly ex-
panded the types of taxpayers permitted to
treat their inventory as non-incidental ma-
terials and supplies. Under prior adminis-
trative guidance, as discussed later in sec-
tion 3.A.i of this Summary of Comments
and Explanation of Revisions, taxpayers
with gross receipts of no more than $1
million and taxpayers in certain industries
(generally not producers or resellers) with
gross receipts of no more than $10 mil-
lion were permitted to treat their inven-
tory as non-incidental materials and sup-
plies. Section 471(c) greatly expanded the
availability of this method of accounting
to taxpayers in all types of trades or busi-
nesses, including producers and resellers,
by reference to the increased cap on gross
receipts under the Section 448(c) Gross
Receipts Test. Second, treating inventory
as non-incidental materials and supplies
under § 1.471-1(b)(5) provides simplifica-
tion and burden reduction for taxpayers by
requiring only certain costs to be capital-
ized to inventory. For example, a taxpayer
using the section 471(c) NIMS inventory
method does not capitalize direct labor
costs or any indirect costs to inventory
costs. See discussion of direct labor costs
later in section 3.A.iii of this Summary of
Comments and Explanation of Revisions.
Simplification does not indicate that the
nature of the property was changed by
the TCJA, or that the intent of Congress
was to provide immediate expensing of
inventory costs. Thirdly, taxpayers, other
than a tax shelter under section 448(a)(3),
treating inventory as non-incidental ma-
terials and supplies under § 1.471-1(b)(5)
are eligible to use the overall cash method
of accounting for purchases and sales of
merchandise, rather than being required to
use an accrual method. See §1.446-1(a)(4)
(i).
i. Definition of the Term “Used or
Consumed”
The preamble to the proposed regula-
tions provides that the Treasury Depart-
ment and IRS interpret section 471(c)(1)
(B)(i) as generally codifying the admin-
istrative guidance existing at the time of
its enactment (that is, Revenue Procedure
2001-10 (2001-2 IRB 272) and Revenue
Procedure 2002-28 (2002-18 IRB 815))
and making that method available to sig-
nificantly more taxpayers. Accordingly,
the proposed regulations provided that
items of inventory treated as materials and
supplies under section 471(c) are used or
consumed in the taxable year in which the
taxpayer provides the item to a customer,
and the cost of such item is recovered in
that taxable year or the taxable year in
which the taxpayer pays for or incurs such
cost, whichever is later.
Comments were received on the defi-
nition of “used or consumed” in proposed
§1.471-1(b)(4)(i) as it relates to produc-
ers. A commenter asserted that the mean-
ing of the term “used or consumed” for a
producer using the section 471(c) NIMS
inventory supplies method should be con-
sistent with the meaning of the term “used
or consumed” in §1.162-3. The comment-
er states that a producer’s raw materials

Bulletin No. 2021–3 455 January 19, 2021
are “used or consumed” when the raw
materials enter the taxpayer’s production
process. The commenter states that under
section 471(c)(1)(B)(i) and §1.162-3(a)
(1), only section 263A would limit a pro-
ducer’s ability to recover the cost of its
raw materials when the raw materials are
first used in the production process, and
the final regulations should be modified to
provide that a producer does not wait until
the finished product is provided to a cus-
tomer to recover the costs of its raw ma-
terials. In addition, the commenter states
that the policy considerations underlying
this provision were to provide small busi-
ness taxpayers with simplification, and the
definition of “used or consumed” for pro-
ducers in proposed § 1.471-1(b)(4)(i) does
not result in simplification.
The Treasury Department and IRS de-
cline to change the definition of used or
consumed for a producer in these final
regulations. As discussed previously, the
Treasury Department and the IRS interpret
section 471(c)(1)(B)(i) as generally codi-
fying the administrative guidance existing
at the time of enactment of TCJA (that is,
Revenue Procedure 2001-10 and Revenue
Procedure 2002-28) and making it appli-
cable to significantly more taxpayers, in
addition to the other benefits discussed in
section 3.A of this Summary of Comments
and Explanation of Revisions. The com-
menter’s recommendation that the term
“used or consumed” for a producer should
be treated as occurring when the raw mate-
rial is used or consumed in the taxpayer’s
production process would allow a produc-
er to recover production costs earlier than
was previously allowed under the admin-
istrative guidance of Revenue Procedure
2001-10 and Revenue Procedure 2002-28.
Additionally, the commenter’s recom-
mendation suggests that the term “used or
consumed” should be interpreted literally
by looking to actual use or consumption
by the taxpayer. However, under such an
interpretation a reseller, unlike a producer,
would not be able to recover any invento-
ry costs as a reseller does not acquire raw
materials for use in a production process
nor does it use or consume finished inven-
tory; rather a reseller acquires and resells
finished inventory, unchanged, to custom-
ers. The Treasury Department and the IRS
have determined that the statute and leg-
islative history do not support a reading
of the provision that would provide such
a disparity in the recovery of inventory
costs between producers and resellers.
In addition, the commenter’s argu-
ment interprets the words “inventory
treated as non-incidental materials and
supplies” to mean that the components
used to produce the finished goods in-
ventory, rather than the finished goods
inventory itself, are treated as materials
and supplies. The interpretation advo-
cated by the commenter would result in
producers being permitted to recover the
cost inputs of their units of inventory in
the same manner as they recover the costs
of their materials and supplies (that is,
when the cost input is used or consumed
in producing the unit of inventory). The
Treasury Department and the IRS do not
believe Congress intended to break down
the traditional definition of the word “in-
ventory,” particularly since that position
benefits only a certain group of taxpayers
(producers). The Treasury Department
and the IRS determined that the defini-
tion for used or consumed should provide
an equitable rule for the timing of the re-
covery of the inventory between produc-
ers and resellers. Accordingly, these final
regulations adopt the proposed regula-
tions without change.
ii. De Minimis Safe Harbor under
§1.263(a)-1(f)
Several comments were received re-
garding the applicability of the de mini-
mis safe harbor under § 1.263(a)-1(f) (de
minimis safe harbor) to inventory treated
as non-incidental materials and supplies.
The commenters assert that the final reg-
ulations should permit a taxpayer that
uses the section 471(c) NIMS inventory
method to use the de minimis safe harbor
for its inventory treated as non-incidental
materials and supplies. The commenters
point to footnote 465 of the Bluebook,
which described the law, both before and
after TCJA, as generally permitting de-
duction of the cost of non-incidental ma-
terials and supplies in the taxable year in
which they are first used or are consumed
in the taxpayer’s operations in accordance
with §1.162-3(a)(1). Furthermore, under
§1.162-3(a)(1), a taxpayer may also be
able to elect to deduct such non-incidental
materials and supplies in the taxable year
the amount is paid under the de minimis
safe harbor election under §1.263(a)-1(f).
General Explanation of Pub. Law 115-97,
at 113 fn. 465.
The Treasury Department and the IRS
were aware of footnote 465 in the Blue-
book when drafting the proposed regula-
tions, but have a different understanding of
the rule for “inventory treated as non-inci-
dental materials and supplies” under Sec-
tion 471(c)(1)(B)(i) as explained in section
3.A.i of this Summary of Comments and
Explanation of Revisions. The Treasury
Department and the IRS interpret section
471(c)(1)(B)(i) as generally codifying the
administrative procedures that established
the non-incidental materials and supplies
method for inventoriable items, and pri-
or pronouncements of §§1.162-3 and
1.263(a)-1(f) that these regulations do not
apply to inventory property, including in-
ventory property treated as non-incidental
materials and supplies. See, e.g., Tangible
Property Regulations - Frequently Asked
Questions, available at https://www.irs.
gov/businesses/small-businesses-self-em-
ployed/tangible-property-final-regula-
tions#Ademinimis.
A commenter states that the de minimis
safe harbor was created after Revenue Pro-
cedure 2001-10 and Revenue Procedure
2002-28 were released, and therefore, did
not address the issue of the applicability
of the de minimis safe harbor. The Trea-
sury Department and the IRS agree with
the timeline described by the commenter.
However, as discussed in the immediately
preceding paragraph, the IRS’ position on
the de minimis safe harbor has been ad-
dressed in a prior pronouncement. As de-
scribed previously in section 3.A of this
Summary of Comments and Explanation
of Revisions, inventory treated as non-in-
cidental materials and supplies retains its
character as inventory property. The de
minimis safe harbor, which is a regulatory
election rather than a statutory one, does
not apply to inventory. Section 1.263(a)-
1(f)(2)(i).
Finally, the Treasury Department and
the IRS note that for amounts paid to
qualify for the de minimis safe harbor,
the amounts must have been expensed on
the taxpayer’s applicable financial state-
ment or books and records, as applicable.
Sections 1.263(a)-1(f)(1)(i)(B) and (ii)
(B). This applicable financial statement or

January 19, 2021 456 Bulletin No. 2021–3
books and records expensing requirement
under §1.263(a)-1(f) would be an imped-
iment to the application of the de minimis
safe harbor under the section 471(c) NIMS
inventory method for taxpayers who
maintain records of their inventory in their
applicable financial statement or books
and records, even if the section 471(c)
NIMS inventory method permitted the
use of the de minimis safe harbor method.
In addition, there is no need for the sepa-
rate de minimis safe harbor because small
business taxpayers may use the inventory
method provided in section 471(c)(1)(B)
which generally provides that a taxpayer
who expenses inventory costs in its appli-
cable financial statement or books and re-
cords may generally expense that cost for
Federal income tax purposes. For exam-
ple, a small business taxpayer that expens-
es the cost of “freight-in” in its books and
records and wants to expense the item for
Federal income tax purposes may general-
ly do so using the non-AFS section 471(c)
inventory method, as permitted by section
471(c)(1)(B)(ii) and discussed later in sec-
tion 3.C.ii of this Summary of Comments
and Explanation of Revisions.
iii. Direct Labor
Proposed §1.471-1(b)(4)(ii) provides
that inventory costs includible in the sec-
tion 471(c) NIMS inventory method are
the direct costs of the property produced
or property acquired for resale. However,
an inventory cost does not include a cost
for which a deduction would be disal-
lowed or that is not otherwise recoverable,
in whole or in part, but for §1.471-1(b)(4),
under another provision of the Code.
Some comments were received on the
types of direct costs required to be includ-
ed as an inventory cost under the section
471(c) NIMS inventory method. These
commenters recommended the final reg-
ulations exclude direct labor costs from
the definition of an inventory cost under
proposed §1.471-1(b)(4)(ii). The com-
menters reasoned that the preamble to the
proposed regulation indicated that section
471(c)(1)(B)(i) was generally a codifica-
tion of Revenue Procedure 2001-10 and
Revenue Procedure 2002-28. However,
the commenters point out that this admin-
istrative guidance did not provide for di-
rect labor or overhead costs to be included
in the non-incidental materials and sup-
plies method.
One commenter asserted that invento-
ry treated as non-incidental materials and
supplies are not inventory property but are
to be characterized as a material and sup-
ply. The commenter discussed Example
1, in Section III.D of Notice 88-86 (1988-
2 CB 401) to determine the treatment of
non-incidental materials and supplies
prior to the enactment of section 263A.
Example 1 involves an architect provid-
ing design services that include blueprints
and drawings and deals with the provision
of de minimis amounts of property by a
service provider. This commenter cites to
Notice 88-86 to provide, by analogy, that
inventory treated as non-incidental ma-
terials and supplies under section 471(c)
(1)(B)(i) should not include direct labor
costs.
The Treasury Department and the IRS
disagree with the application by analogy
to Example 1 in Section III.D of Notice
88-86. That example illustrates that an
individual providing services, such as an
architect, is not a producer despite pro-
viding a de minimis amount of property
to the client as part of the provision of
services. As discussed in section 3.A of
this Summary of Comments and Expla-
nation of Revisions, the Treasury Depart-
ment and the IRS believe that inventory
property treated as non-incidental mate-
rials and supplies retains its character as
inventory property, and so Example 1 is
inapposite.
The Treasury Department and the IRS
acknowledge that there was uncertainty
under Revenue Procedure 2001-10 and
Revenue Procedure 2002-28 as to whether
direct labor and overhead costs were re-
quired to be capitalized under the non-in-
cidental materials and supplies method
permitted by those revenue procedures.
The Treasury Department and the IRS are
also aware that tracking of direct labor
costs may be burdensome, and in some
cases, difficult to do for many small busi-
nesses. The Treasury Department and the
IRS agree with the commenters’ request
that direct labor costs be excluded from
the inventory costs required to be included
in inventory treated as non-incidental ma-
terials and supplies. As a result, these final
regulations provide that inventory costs
includible in the section 471(c) NIMS in-
ventory method are direct material costs
of the property produced or the costs of
property acquired for resale.
B. Treatment of Inventory by Taxpayers
with an Applicable Financial Statement
(AFS)
Under proposed §1.471-1(b)(5), a tax-
payer other than a tax shelter, that has an
AFS and that meets the Section 448(c)
Gross Receipts Test is not required to
take an inventory under section 471(a),
and may choose to treat its inventory as
reflected in its AFS. Proposed §1.471-
1(b)(5)(ii) defines AFS by reference to
section 451(b)(3) and the accompanying
regulations, which included the addi-
tional AFS rules provided in proposed
§1.451-3(h).
In section 4.C.i of the preamble to the
proposed regulations, the Treasury Depart-
ment and the IRS requested comments on
a proposed consistency rule for a taxpayer
with an AFS that has a financial account-
ing year that differs from the taxpayer’s
taxable year, and on other issues related
to the application of proposed §1.451-
3(h) to the AFS section 471(c) inventory
method. The Treasury Department and the
IRS proposed to require a taxpayer with
an AFS that uses the AFS section 471(c)
inventory method to consistently apply
the same mismatched reportable period
method of accounting provided in pro-
posed §1.451-3(h)(4) for its AFS section
471(c) inventory method of accounting
that is used for section 451 purposes. No
comments were received on the consisten-
cy rule or other issues related to the appli-
cation of proposed §1.451-3(h) to the AFS
section 471(c) inventory method.
These final regulations adopt this con-
sistency rule. The Treasury Department
and the IRS have determined that a tax-
payer using an accrual method with an
AFS that has a mismatched reporting pe-
riod with its taxable year should apply the
same mismatched reportable period meth-
od of accounting for revenue recognition
purposes and inventory purposes because
there is better matching of income and
cost of goods sold by applying the same
reportable period method.

Bulletin No. 2021–3 457 January 19, 2021
C. Treatment of Inventory by Taxpayers
Without an AFS
Under proposed §1.471-1(b)(6), a tax-
payer, other than a tax shelter, that does
not have an AFS and that meets the Sec-
tion 448(c) Gross Receipts Test is not re-
quired to take an inventory under section
471(a), and may choose to use the non-
AFS section 471(c) inventory method to
account for its inventory. The non-AFS
section 471(c) inventory method is the
method of accounting for inventory re-
flected in the taxpayer’s books and records
that are prepared in accordance with the
taxpayer’s accounting procedures and that
properly reflect the taxpayer’s business
activities for non-tax purposes. For ex-
ample, a books and records method that
determines ending inventory and cost of
goods sold that properly reflects the tax-
payer’s business activities for non-Federal
income tax purposes is to be used under
the taxpayer’s non-AFS section 471(c) in-
ventory method.
(i) Definition of books and records
Some comments were received on the
non-AFS section 471(c) inventory meth-
od and the standard used in proposed
§1.471-1(b)(6) for “books and records.”
One commenter reasoned that the pur-
pose of section 471(c)(1)(B)(ii) was to
provide simplification, and the reliance
on the definition of books and records
used in case law is too complex, creates
audit risks, and uncertainties as to what
books and records means. The commenter
recommended using a standard in which
“books and records” is a flexible term and
something the taxpayer and his account-
ing professional can agree on that is con-
sistent from year to year. For example,
the commenter suggests that any finan-
cial statement reporting of inventory that
is consistently applied be acceptable as
books and records.
Some comments discuss the issue of
work papers and physical counts of inven-
tory, and whether either should be used
if a taxpayer is expensing these items for
books and records purposes. The com-
menters asserted that even though a tax-
payer takes a physical count of inventory,
the taxpayer should be allowed to expense
the inventory for Federal income tax pur-
poses if the inventory is expensed on its
books and records.
The Treasury Department and the IRS
decline to change the definition of the term
“books and records” in these final regula-
tions, and the rules continue to generally
include both work papers and physical
counts of inventory. The term books and
records is used elsewhere in the Code and
regulations, and there is no indication in
the statute or legislative history to section
471(c)(1)(B)(ii) that a different definition
is intended from the general usage of this
term used elsewhere in the Code. Con-
sequently, these final regulations use the
well-established definition of books and
records of a taxpayer, which includes the
totality of the taxpayer’s documents and
electronically-stored data. See, for exam-
ple, United States v. Euge, 444 U.S. 707
(1980). See also Digby v. Commissioner,
103 T.C. 441 (1994), and §1.6001-1(a).
Certain commenters requested that the
final regulations provide additional clari-
fication on the significance of the taking
of a physical count of inventory under the
non-AFS section 471(c) inventory meth-
od. For example, commenters requested
that Example 1 in proposed §1.471-1(b)
(6)(iii) be modified to provide that the
physical count is ignored if the taxpayer
does not provide inventory information to
a creditor. These final regulations provide
additional examples, including variations
on Example 1, to clarify the relevance of a
physical count of inventory under the non-
AFS section 471(c) inventory method. For
example, a taxpayer that takes a physical
count of inventory for reordering purposes
but does not allocate cost to such invento-
ry is not required to use the physical count
for the non-AFS section 471(c) inventory
method, regardless of whether the infor-
mation is otherwise used for an internal
report purpose or provided to an external
third party, such as a creditor. Alternative-
ly, a taxpayer that takes an end-of-year
physical count and uses this information
in its accounting procedures to allocate
costs to inventory is required to use this
inventory information for the non-AFS
section 471(c) inventory method regard-
less of whether the taxpayer makes recon-
ciling entries to expense these costs in its
financial statements. Thus, the examples
in these final regulations clarify the princi-
ple that a taxpayer may not ignore its reg-
ular accounting procedures or portions of
its books and records under the non-AFS
section 471(c) inventory method.
(ii) Inventory costs
The proposed regulations defined “in-
ventory costs” for the non-AFS section
471(c) inventory method generally as costs
that the taxpayer capitalizes to property
produced or property acquired for resale in
its books and records. Certain commenters
requested that the final regulations clarify
how a taxpayer treats costs to acquire or
produce tangible property that the taxpayer
does not capitalize in its books and records
because the proposed regulations did not
specifically address these costs.
These final regulations clarify in
§ 1.471-1(b)(6)(i) that costs that are gen-
erally required to be capitalized to inven-
tory under section 471(a) but that the tax-
payer is not capitalizing in its books and
records are not required to be capitalized
to inventory. The Treasury Department
and the IRS have also determined that, un-
der this method, such costs are not treat-
ed as amounts paid to acquire or produce
tangible property under § 1.263(a)-2, and
therefore, are generally deductible when
they are paid or incurred if such costs
may be otherwise deducted or recovered
notwithstanding § 1.471-1(b)(4) under an-
other provision of the Code and Regula-
tions. Additionally, these final regulations
clarify that costs capitalized for the non-
AFS section 471(c) inventory method are
those costs that related to the production
or resale of the inventory to which they
are capitalized in the taxpayer’s books
and records. Similar clarifications have
been made in § 1.471-1(b)(5) regarding
the AFS section 471(c) inventory method.
APPLICABILITY DATES
These final regulations are applicable
for taxable years beginning on or after
January 5, 2021. However, a taxpayer
may apply these regulations for a taxable
year beginning after December 31, 2017,
and before January 5, 2021, provided
that if the taxpayer applies any aspect of
these final regulations under a particular
Code provision, the taxpayer must fol-
low all the applicable rules contained in
these regulations that relate to that Code

January 19, 2021 458 Bulletin No. 2021–3
provision for such taxable year and all
subsequent taxable years, and must fol-
low the administrative procedures for fil-
ing a change in method of accounting in
accordance with §1.446-1(e)(3)(ii). For
example, a taxpayer that wants to apply
§1.263A-1(j) to be exempt from capital-
izing costs under section 263A must ap-
ply §1.448-2 to determine whether it is
eligible for the exemption. The same tax-
payer must apply §1.448-2 to determine
whether it is eligible to apply §1.471-1(b)
to be exempt from the general inventory
rules under section 471(a). However, it
may choose not to apply §1.471-1(b) even
though it chooses to apply §1.263A-1(j)
and §1.448-2.
Alternatively, a taxpayer may rely on
the proposed regulations for a taxable
year beginning after December 31, 2017
and before January 5, 2021, provided that
if the taxpayer applies any aspect of the
proposed regulations under a particular
Code provision, the taxpayer must follow
all of the applicable rules contained in the
proposed regulations that relate to that
Code provision for such taxable year, and
follow the administrative procedures for
filing a change in method of accounting in
accordance with §1.446-1(e)(3)(ii).
Statement of Availability of IRS
Documents
The IRS notices, revenue rulings, and
revenue procedures cited in this pream-
ble are published in the Internal Revenue
Bulletin (or Cumulative Bulletin) and are
available from the Superintendent of Doc-
uments, U.S. Government Publishing Of-
fice, Washington, DC 20402, or by visit-
ing the IRS website at http://www.irs.gov.
Special Analyses
This regulation is not subject to review
under section 6(b) of Executive Order
12866 pursuant to the Memorandum of
Agreement (April 11, 2018) between the
Treasury Department and the Office of
Management and Budget regarding re-
view of tax regulations.
I. Paperwork Reduction Act
Section 1.448-2(b)(2)(iii)(B) imposes a
collection of information for an election to
use prior year’s allocated taxable income
or loss to determine whether a partnership
or other entity (other than a C corpora-
tion) is a “syndicate” for purposes of sec-
tion 448(d)(3) for the current tax year. The
election is made by attaching a statement
to the taxpayer’s original Federal income
tax return (including extensions) for the
taxable year that the election is made. The
election is an annual election and, if made
for a taxable year, cannot be revoked. The
collection of information is voluntary for
purposes of obtaining a benefit under the
proposed regulations. The likely respon-
dents are businesses or other for-profit
institutions, and small businesses or orga-
nizations.
Estimated total annual reporting bur-
den: 224,165 hours
Estimated average annual burden
hours per respondent: 1 hour
Estimated number of respondents:
224,165
Estimated annual frequency of re-
sponses: once.
Other than the election statement,
these regulations do not impose any
additional information collection re-
quirements in the form of reporting, re-
cordkeeping requirements or third-party
disclosure statements. However, because
the exemptions in sections 263A, 448,
460 and 471 are methods of accounting
under the statute, taxpayers are required
to request the consent of the Commis-
sioner for a change in method of ac-
counting under section 446(e) to imple-
ment the statutory exemptions. The IRS
expects that these taxpayers will request
this consent by filing Form 3115, Appli-
cation for Change in Accounting Method.
Taxpayers may request these changes us-
ing reduced filing requirements by com-
pleting only certain parts of Form 3115.
See Revenue Procedure 2018-40 (2018-
34 IRB 320). Revenue Procedure 2018-
40 provides procedures for a taxpayer to
make a change in method of accounting
using the automatic change procedures
of Revenue Procedure 2015-13 (2015-5
IRB 419) in order to use the exemptions
provided in sections 263A, 460 and/
or 471. See also the revenue procedure
accompanying these regulations for sim-
ilar method change procedures to make a
change in method of accounting to com-
ply with these final regulations.
For purposes of the Paperwork Re-
duction Act of 1995 (44 U.S.C. 3507(c))
(PRA), the reporting burden associated
with the collection of information for the
election statement and Form 3115 will be
reflected in the PRA submission associat-
ed with the income tax returns under the
OMB control number 1545-0074 (in the
case of individual filers of Form 3115) and
1545-0123 (in the case of business filers
of Form 3115).
In 2018, the IRS released and invited
comment on a draft of Form 3115 in or-
der to give members of the public the op-
portunity to benefit from certain specific
provisions made to the Code. The IRS re-
ceived no comments on the forms during
the comment period. Consequently, the
IRS made the forms available in January
2019 for use by the public. The IRS notes
that Form 3115 applies to changes of ac-
counting methods generally and is there-
fore broader than sections 263A, 448, 460
and 471.
As discussed earlier, the reporting bur-
dens associated with the proposed reg-
ulations are included in the aggregated
burden estimates for OMB control num-
bers 1545-0074 (in the case of individual
filers of Form 3115), 1545-0123 (in the
case of business filers of Form 3115 sub-
ject to Revenue Procedure 2019-43 and
business filers that make the election un-
der proposed §1.448-2(b)(2)(iii)(B)). The
overall burden estimates associated with
these OMB control numbers are aggre-
gate amounts related to the entire package
of forms associated with the applicable
OMB control number and will include,
but not isolate, the estimated burden of the
tax forms that will be created or revised
as a result of the information collections
in these regulations. These numbers are
therefore not specific to the burden im-
posed by these regulations. The burdens
have been reported for other income tax
regulations that rely on the same informa-
tion collections and the Treasury Depart-
ment and the IRS urge readers to recog-
nize that these numbers are duplicates and
to guard against overcounting the burdens
imposed by tax provisions prior to the
TCJA. No burden estimates specific to
the forms affected by the regulations are
currently available. For the OMB control
numbers discussed in the preceding para-
graphs, the Treasury Department and the

Bulletin No. 2021–3 459 January 19, 2021
IRS estimate PRA burdens on a taxpay-
er-type basis rather than a provision-spe-
cific basis. Those estimates capture both
changes made by the TCJA and those that
arise out of discretionary authority exer-
cised in the final regulations and other reg-
ulations that affect the compliance burden
for that form.
II. Regulatory Flexibility Act
The Regulatory Flexibility Act (5
U.S.C. 601 et seq.) (RFA) imposes certain
requirements with respect to federal rules
that are subject to the notice and comment
requirements of section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. 551
et seq.) and that are likely to have a sig-
nificant economic impact on a substantial
number of small entities. Unless an agen-
cy determines that a proposal is not likely
to have a significant economic impact on
a substantial number of small entities, sec-
tion 603 of the RFA requires the agency
to present an initial regulatory flexibility
analysis (IRFA) of the proposed rules.
At the proposed rule stage, the Treasury
Department and the IRS had not deter-
mined whether the proposed rules, when
finalized, would likely have a significant
economic impact on a substantial number
of small entities. The determination of
whether the voluntary exemptions under
sections 263A, 448, 460, and 471, and the
regulations providing guidance with re-
spect to such exemptions, will have a sig-
nificant economic impact on a substantial
number of small entities requires further
study. However, because there is a possi-
bility of significant economic impact on
a substantial number of small entities, an
IRFA was provided at the proposed rule
stage. In accordance with section 604 of
the RFA, following is the final regulatory
flexibility analysis.
1. Reasons for and Objectives of the Rule
As discussed earlier in the preamble,
these regulations largely implement vol-
untary exemptions that relieve small busi-
ness taxpayers from otherwise applicable
restrictions and requirements under sec-
tions 263A, 448, 460, and 471.
Section 448 provides a general re-
striction for C corporations and partner-
ships with C corporation partners from
using the cash method of accounting,
and sections 263A, 460 and 471 impose
specific rules on uniform capitalization
of direct and indirect production costs,
the percentage of completion method
for long-term contracts, and accounting
for inventory costs, respectively. Section
13102 of TCJA provided new statutory
exemptions from certain of these rules
and expanded the scope of existing stat-
utory exemptions from certain of these
rules to reduce compliance burdens for
small taxpayers. The regulations clarify
the exemption qualification requirements
and provide guidance with respect to the
applicable methods of accounting should
a taxpayer choose to apply one or more
exemptions.
The objective of the regulations is to
provide clarity and certainty for small
business taxpayers implementing the ex-
emptions. Under the Code, small business
taxpayers were able to implement these
provisions for taxable years beginning
after December 31, 2017 (or, in the case
of section 460, for contracts entered into
after December 31, 2017) even in the ab-
sence of these regulations. Thus, the Trea-
sury Department and the IRS expect that,
at the time these regulations are published,
many small business taxpayers may have
already implemented some aspects of the
regulations.
2. Significant Issues Raised by the Public
Comments in Response to the IRFA and
Comments Filed by the Chief Counsel
for Advocacy of the Small Business
Administration
No public comments were received in
response to the IRFA. Additionally, no
comments were filed by the Chief Counsel
for Advocacy of the Small Business Ad-
ministration in response to the proposed
regulations.
3. Affected Small Entities
The voluntary exemptions under sec-
tions 263A, 448, 460 and 471 generally
apply to taxpayers that meet the $25 mil-
lion (adjusted for inflation) gross receipts
test in section 448(c) and are otherwise
subject to general rules under sections
263A, 448, 460, or 471.
A. Section 263A
The Treasury Department and the IRS
expect that the addition of section 263A(i)
will expand the number of small business
taxpayers exempted from the require-
ment to capitalize costs, including inter-
est, under section 263A. Under section
263A(i), taxpayers (other than tax shel-
ters) that meet the $25 million (adjusted
for inflation) gross receipts test in section
448(c) can choose to deduct certain costs
that are otherwise required to be capital-
ized to the basis of property. Section 263A
applies to taxpayers that are producers, re-
sellers, and taxpayers with self-construct-
ed assets. The Treasury Department and
the IRS estimate that there are between
3,200,000 and 3,575,000 respondents
with gross receipts of not more than $25
million (adjusted for inflation) that have
inventories. The Treasury Department and
the IRS estimate that of these taxpayers
there are between 28,900 and 38,900 re-
spondents with gross receipts of not more
than $25 million (adjusted for inflation)
that are eligible to change their meth-
od of accounting to no longer capitalize
costs under section 263A. These estimates
come from information collected on: Form
1125-A, Cost of Goods Sold, and attached
to Form 1120, U.S. Corporation Income
Tax Return, Form 1065, U.S. Return of
Partnership Income or Form 1120-S, U.S.
Income Tax Return for an S Corporation,
on which the taxpayer also indicated it
had additional section 263A costs. The
Treasury Department and the IRS do not
have readily available data to measure the
prevalence of entities with self-construct-
ed assets. In addition, these data also do
not include other business entities, such as
a business reported on Schedule C, Profit
or Loss Form Business, of an individual’s
Form 1040, U.S. Individual Income Tax
Return.
Under section 263A, as modified by
the TCJA, small business entities that
qualified for Section 263A small reseller
exception will no longer be able to use this
exception. The Treasury Department and
the IRS estimate that nearly all taxpayers
that qualified for the small reseller excep-
tion will qualify for the small business
taxpayer exemption under section 263A(i)
since the small reseller exception utilized
a $10 million gross receipts test. The Trea-

January 19, 2021 460 Bulletin No. 2021–3
sury Department and the IRS estimate that
there are between 28,900 and 38,900 re-
spondents with gross receipts of not more
than $25 million that are eligible for the
exemption under section 263A(i). These
estimates come from information collect-
ed on: Form 1125-A, Cost of Goods Sold,
and attached to Form 1120, U.S. Corpora-
tion Income Tax Return, Form 1065, U.S.
Return of Partnership Income or Form
1120-S, U.S. Income Tax Return for an S
Corporation on which the taxpayer also
indicated it had additional section 263A
costs. These data provide an upper bound
for the number of taxpayers affected by
the repeal of the small reseller exception
and enactment of section 263A(i) because
the data includes taxpayers that were not
previously eligible for the small reseller
exception, such as producers and taxpay-
ers with gross receipts of more than $10
million.
The regulations modify the $50 mil-
lion gross receipts test in §1.263A-1(d)(3)
(ii)(B)(1) by using the Section 448 Gross
Receipts Test. The $50 million gross re-
ceipts amount is used by taxpayers to de-
termine whether they are eligible to treat
negative adjustments as additional section
263A costs for purposes of the simplified
production method (SPM) under section
263A. The Treasury Department and the
IRS do not have readily available data to
measure the prevalence of entities using
the SPM.
Section 1.263A-9 modifies the cur-
rent regulation to increase the eligibility
threshold to $25 million for the election
permitting taxpayers to use the highest
applicable Federal rate as a substitute for
the weighted average interest rate when
tracing debt for purposes of capitalizing
interest under section 263A(f). The Trea-
sury Department and the IRS estimate that
there are between 28,900 and 38,900 re-
spondents with gross receipts of not more
than $25 million that are eligible to make
this election. These estimates come from
information collected on: Form 1125-A,
Cost of Goods Sold, attached to Form
1120, U.S. Corporation Income Tax Re-
turn, Form 1065, U.S. Return of Part-
nership Income or Form 1120-S, U.S.
Income Tax Return for an S Corporation,
on which the taxpayer also indicated it had
additional section 263A costs. The Trea-
sury Department and the IRS expect that
many taxpayers eligible to make the elec-
tion for purposes of section 263A(f) will
instead elect the small business exemption
under section 263A(i). Additionally, tax-
payers who chose to apply section 263A
even though they qualify for the small
business exemption under section 263A(i)
may not have interest expense required to
be capitalized under section 263A(f). As a
result, although these data do not include
taxpayers with self-constructed assets that
are eligible for the election, the Treasury
Department and the IRS estimate that this
data provides an upper bound for the num-
ber of eligible taxpayers.
B. Section 448
The Treasury Department and the IRS
expect that the changes to section 448(c)
by the TCJA will expand the number of
taxpayers permitted to use the cash meth-
od. Section 448(a) provides that C corpo-
rations, partnerships with C corporations
as partners, and tax shelters are not per-
mitted to use the cash method of account-
ing; however section 448(c), as amended
by the TCJA, provides that C corporations
or partnerships with C corporations as
partners, other than tax shelters, are not
restricted from using the cash method if
their average annual gross receipts are $25
million (adjusted for inflation) or less. Pri-
or to the amendments made by the TCJA,
the applicable gross receipts threshold was
$5 million. Section 448 does not apply to
S corporations, partnerships without a C
corporation partner, or any other business
entities (including sole proprietorships
reported on an individual’s Form 1040).
The Treasury Department and the IRS es-
timate that there are between 587,000 and
605,000 respondents with gross receipts
of not more than $5 million presently
using an accrual method, and between
70,000 and 76,500 respondents with gross
receipts of more than $5 million but not
more than $25 million that are permitted
to use to the cash method. These estimates
come from information collected on Form
1120, U.S. Corporation Income Tax Re-
turn, Form 1065, U.S. Return of Part-
nership Income and Form 1120-S, U.S.
Income Tax Return for an S Corporation.
Under the regulations, taxpayers that
would meet the gross receipts test of sec-
tion 448(c) and seem to be eligible to use
the cash method but for the definition of
“syndicate” under section 448(d)(3), may
elect to use the allocated taxable income
or loss of the immediately preceding tax-
able year to determine whether the taxpay-
er is a “syndicate” for purposes of section
448(d)(3) for the current taxable year. The
Treasury Department and IRS estimate
that 224,165 respondents may potentially
make this election. This estimate comes
from information collected on the Form
1065, U.S. Return of Partnership Income
and Form 1120-S, U.S. Income Tax Re-
turn for an S Corporation., and the Form
1125-A, Cost of Goods Sold, attached to
the Forms 1065 and 1120-S. The Trea-
sury Department and the IRS estimate that
these data provide an upper bound for the
number of eligible taxpayers because not
all taxpayers eligible to make the election
will choose to do so.
C. Section 460
The Treasury Department and the
IRS expect that the modification of sec-
tion 460(e)(1)(B) by the TCJA will ex-
pand the number of taxpayers exempt-
ed from the requirement to apply the
percentage-of-completion method to
long-term construction contracts. Un-
der section 460(e)(1)(B), as modified
by the TCJA, taxpayers (other than tax
shelters) that meet the $25 million (ad-
justed for inflation) gross receipts test
in section 448(c) are not required to
use PCM to account for income from a
long-term construction contract expect-
ed to be completed in two years. Prior
to the modification of section 460(e)(1)
(B) by the TCJA, a separate $10 million
dollar gross receipts test applied. The
Treasury Department and the IRS esti-
mate that there are between 15,400 and
19,500 respondents with gross receipts
of between $10 million and $25 million
who are eligible to change their method
of accounting to apply the modified ex-
emption. This estimate comes from infor-
mation collected on the Form 1120, U.S.
Corporation Income Tax Return, Form
1065, U.S. Return of Partnership Income
and Form 1120-S, U.S. Income Tax Re-
turn for an S Corporation in which the
taxpayer indicated its principal business
activity was construction (NAICS codes
beginning with 23). These data available

Bulletin No. 2021–3 461 January 19, 2021
do not distinguish between long-term
contracts and other contracts, and also
do not include other business entities that
do not file Form 1120, U.S. Corporation
Income Tax Return, Form 1065, U.S. Re-
turn of Partnership Income, and Form
1120-S, U.S. Income Tax Return for an S
Corporation, such as a business reported
on Schedule C, Profit or Loss from Busi-
ness, of an individual’s Form 1040, U.S.
Individual Income Tax Return.
D. Section 471
The Treasury Department and the
IRS expect that the addition of section
471(c) will expand the number of tax-
payers exempted from the requirement
to take inventories under section 471(a).
Under section 471(c), taxpayers (oth-
er than tax shelters) that meet the $25
million (adjusted for inflation) gross re-
ceipts test in section 448(c) can choose
to apply certain simplified inventory
methods rather than those otherwise
required by section 471(a). The Trea-
sury Department and the IRS estimate
that there are between 3,200,000 and
3,575,000 respondents with gross re-
ceipts of not more than $25 million that
are exempted from the requirement to
take inventories, and will treat their in-
ventory either as non-incidental materi-
als and supplies, or conform their inven-
tory method to the method reflected in
their AFS, or if they do not have an AFS,
in their books and records. This estimate
comes from data collected on the Form
1125-A, Cost of Goods Sold. Within
that set of taxpayers, the Treasury De-
partment and the IRS estimate that there
are between 10,500 and 11,500 respon-
dents that may choose to conform their
method of accounting for inventories
to their method for inventory reflected
in their AFS. This estimate comes from
IRS-collected data on taxpayers that
filed the Form 1125-A, Cost of Goods
Sold, in addition to a Schedule M3, Net
Income (Loss) Reconciliation for Cor-
porations With Total Assets of $10 Mil-
lion or More, that indicated they had an
AFS. These data provide a lower bound
because they do not include other busi-
ness entities, such as a business report-
ed on Schedule C, Profit or Loss from
Business, of an individual’s Form 1040,
U.S. Individual Income Tax Return, that
are not required to file the Form 1125-A,
Cost of Goods Sold.
4. Projected Reporting, Recordkeeping,
Other Compliance Requirements, and
Costs
The Treasury Department and the
IRS have not performed an analysis with
respect to the projected reporting, re-
cordkeeping, and other compliance re-
quirements associated with the statutory
exemptions under sections 263A, 448,
460, and 471 and the final regulations
implementing these exemptions. The tax-
payer may expend time to read and un-
derstand the final regulations. The cost
to comply with these regulations are re-
flected in modest reporting activities. Tax-
payers needing to make method changes
pursuant to these regulations will be re-
quired to file a Form 3115. The Treasury
Department and the IRS are minimizing
the cost to comply with the regulations
by providing administrative procedures
that allow taxpayers to make multiple
changes in method of accounting related
to the statutory exemptions under sections
263A, 448, 460, and 471 for the same tax
year on a single Form 3115, instead of fil-
ing a separate Form 3115 for each exemp-
tion. Although there is a nominal imple-
mentation cost, the Treasury Department
and the IRS anticipate that the statutory
exemptions and the final regulations im-
plementing these exemptions will reduce
overall the reporting, recordkeeping, and
other compliance requirements of affected
taxpayers relative to the requirements that
exist under the general rules in sections
263A, 448, 460, and 471. For example,
a taxpayer that applies section 471(c)(1)
(B)(i) to treat inventory as non-incidental
materials and supplies will only need to
capitalize the direct material cost of pro-
ducing inventory instead of also having
to capitalize the direct labor and indirect
costs of producing inventory under the
general rules of section 471(a). Addition-
ally, a taxpayer that applies section 471(c)
(1)(B)(ii) can follow the inventory method
used in its applicable financial statement,
or its books and records if it does not have
an applicable financial statement, in lieu
of keeping a separate inventory method
under the general rules of section 471(a).
5. Steps Taken to Minimize the Economic
Impact on Small Entities
As discussed earlier in the preamble,
section 448 provides a general restriction
for C corporations, partnerships with C
corporation partners, and tax shelters
from using the cash method of account-
ing, and sections 263A, 460 and 471
impose specific rules on uniform capi-
talization of direct and indirect produc-
tion costs, the percentage of completion
method for long-term contracts, and ac-
counting for inventory costs, respective-
ly. Section 13102 of TCJA provided new
statutory exemptions and expanded the
scope of existing statutory exemptions
from these rules to reduce compliance
burdens for small taxpayers (for exam-
ple, reducing the burdens associated with
applying complex accrual rules under
section 451 and 461, maintaining inven-
tories, identifying and tracking costs that
are allocable to property produced or ac-
quired for resale, identifying and track-
ing costs that are allocable to long-term
contracts, applying the look-back meth-
od under section 460, etc.). For example,
a small business taxpayer with average
gross receipts of $20 million may pay an
accountant an annual fee of approximate-
ly $2,375 to perform a 25 hour analysis to
determine the section 263A costs that are
capitalized to inventory produced during
the year. If this taxpayer chooses to apply
the exemption under section 263A and
these regulations, it will no longer need
to pay an accountant for the annual sec-
tion 263A analysis.
The regulations implementing these
exemptions are completely voluntary be-
cause small business taxpayers may con-
tinue using an accrual method of account-
ing, and applying the general rules under
sections 263A, 460 and 471 if they so
choose. Thus, the exemptions increase the
flexibility small business taxpayers have
regarding their accounting methods rela-
tive to other businesses. The regulations
provide clarity and certainty for small
business taxpayers implementing the ex-
emptions.
As described in more detail earlier in
the preamble, the Treasury Department
and the IRS considered a number of al-
ternatives under the final regulations.
For example, in providing rules related

January 19, 2021 462 Bulletin No. 2021–3
to inventory exemption in section 471(c)
(1)(B)(i), which permits the taxpayer to
treat its inventory as non-incidental ma-
terials and supplies, the Treasury Depart-
ment and the IRS considered whether
inventoriable costs should be recovered
by (i) using an approach similar to the
approach set forth under Revenue Pro-
cedure 2001-10 (2001-2 IRB 272) and
Revenue Procedure 2002-28 (2002-28
IRB 815), which provided that inventory
treated as non-incidental materials and
supplies was “used and consumed,” and
thus recovered through costs of goods
sold by a cash basis taxpayer, when the
inventory items were provided to a cus-
tomer, or when the taxpayer paid for the
items, whichever was later, or (ii) us-
ing an alternative approach that treated
inventory as “used and consumed” and
thus recovered through costs of goods
sold by the taxpayer, in a taxable year
prior to the year in which the invento-
ry item is provided to the customer (for
example, in the taxable year in which an
inventory item is acquired or produced).
The alternative approach described in
(ii) would produce a savings equal the
amount of the cost recovery multiplied
by an applicable discount rate (deter-
mined based on the number of years
the cost of goods sold recovery would
be accelerated under this alternative).
The Treasury Department and the IRS
interpret section 471(c)(1)(B)(i) and its
legislative history generally as codifying
the rules provided in the administrative
guidance existing at the time TCJA was
enacted. Based on this interpretation, the
Treasury Department and the IRS have
determined that section 471(c) materials
and supplies are “used and consumed”
in the taxable year the taxpayer provides
the goods to a customer, and are recov-
ered through costs of goods sold in that
year or the taxable year in which the
cost of the goods is paid or incurred (in
accordance with the taxpayer’s method
of accounting), whichever is later. The
Treasury Department and the IRS do not
believe this approach creates or imposes
undue burdens on taxpayers.
III. Section 7805(f)
Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
preceding this Treasury Decision was sub-
mitted to the Chief Counsel of the Office
of Advocacy of the Small Business Ad-
ministration for comment on its impact on
small business.
IV. Executive Order 13132: Federalism
Executive Order 13132 (entitled
“Federalism”) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the con-
sultation and funding requirements of
section 6 of the Executive Order. This
final rule does not have federalism im-
plications and does not impose substan-
tial, direct compliance costs on state and
local governments or preempt state law
within the meaning of the Executive Or-
der.
Drafting Information
The principal author of these regula-
tions is Anna Gleysteen, IRS Office of
the Associate Chief Counsel (Income Tax
and Accounting). However, other person-
nel from the Treasury Department and the
IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and record-
keeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amend-
ed as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.263A-0 is amended
by:
1. Revising the entry in the table of
contents for §1.263A-1(b)(1).
2. Redesignating the entries in the table
of contents for §1.263A-1(j), (k), and (l)
as the entries for §1.263A-1(k), (l), and
(m).
3. Adding a new entry in the table of
contents for §1.263A-1(j).
4. Revising the newly designated en-
tries for §1.263A-1(k), (l), and adding an
entry for (m)(6).
5. Revising the entries in the table of
contents for §1.263A-3(a)(2)(ii).
6. Adding entries for §1.263A-3(a)(5)
and revising the entry for §1.263A-3(b).
7. Redesignating the entries in the table
of contents for §1.263A-4(a)(3) and (4) as
the entries for §1.263A-4(a)(4) and (5).
8. Adding in the table of contents a new
entry for §1.263A-4(a)(3).
9. Revising the entry in the table of
contents for §1.263A-4(d) introductory
text.
10. Redesignating the entry in the table
of contents for §1.263A-4(d)(5) as the en-
try for §1.263A-4(d)(7).
11. Adding in the table of contents a
new entry for §1.263A-4(d)(5).
12. Adding an entry in the table of con-
tents for §1.263A-4(d)(6).
13. Adding an entry in the table of con-
tents for §1.263A-4(e)(5).
14. Revising the entry in the table of
contents for §1.263A-4(f) introductory
text.
15. Adding an entry in the table of con-
tents for §1.263A-4(g).
16. Revising the entry in the table of
contents for §1.263A-7(a)(4).
The revisions and additions read as fol-
lows:
§1.263A-0 Outline of regulations under
section 263A.
* * * * *
§1.263A-1 Uniform Capitalization of
Costs.
* * * * *
(b) * * *
(1) Small business taxpayers.
* * * * *
(j) Exemption for certain small busi-
ness taxpayers.
(1) In general.
(2) Application of the section 448(c)
gross receipts test.
(i) In general.
(ii) Gross receipts of individuals, etc.
(iii) Partners and S corporation share-
holders.

Bulletin No. 2021–3 463 January 19, 2021
(iv) Examples.
(A) Example 1
(B) Example 2
(3) Change in method of accounting.
(i) In general.
(ii) Prior section 263A method change.
(k) Special rules
(1) Costs provided by a related person.
(i) In general
(ii) Exceptions
(2) Optional capitalization of period
costs.
(i) In general.
(ii) Period costs eligible for capitaliza-
tion.
(3) Trade or business application
(4) Transfers with a principal purpose
of tax avoidance. [Reserved]
(l) Change in method of accounting.
(1) In general.
(2) Scope limitations.
(3) Audit protection.
(4) Section 481(a) adjustment.
(5) Time for requesting change.
(m) * * *
(6) Exemption for certain small busi-
ness taxpayers.
§1.263A-3 Rules Relating to Property
Acquired for Resale.
(a) * * *
(2) * * *
(ii) Exemption for small business tax-
payers.
* * * * *
(5) De minimis production activities.
(i) In general.
(ii) Definition of gross receipts to de-
termine de minimis production activities.
(iii) Example.
(b) [Reserved].
* * * * *
§1.263A-4 Rules for Property Produced
in a Farming Business.
(a) * * *
(3) Exemption for certain small busi-
ness taxpayers.
* * * * *
(d) Election not to have section 263A
apply under section 263A(d)(3).
* * * * *
(5) Revocation of section 263A(d)(3)
election to permit exemption under sec-
tion 263A(i).
(6) Change from applying exemption
under section 263A(i) to making a section
263A(d)(3) election.
* * * * *
(e) * * *
(5) Special temporary rule for citrus
plants lost by reason of casualty.
(f) Change in method of accounting.
* * * * *
(g) Effective date.
(1) In general.
(2) Changes made by Tax Cuts and
Jobs Act (Pub. L. No. 115-97).
§1.263A-7 Changing a method of
accounting under section 263A.
(a) * * *
(4) Applicability dates.
(i) In general.
(ii) Changes made by Tax Cuts and
Jobs Act (Pub. L. No. 115-97).
* * * * *
Par. 3. Section 1.263A-1 is amended
by:
1. Revising paragraph (a)(2) subject
heading.
2. In paragraph (a)(2)(i), revising the
second sentence and adding a new third
sentence.
3. Revising paragraph (b)(1).
4. In the second sentence of para-
graph (d)(3)(ii)(B)(1), the language
“§1.263A-3(b)” is removed and the lan-
guage “§1.263A-1(j)”is added in its place.
5. Redesignating paragraphs (j) through
(l) as paragraphs (k) through (m).
6. Adding a new paragraph (j).
7. In newly-redesignated paragraph
(m), adding paragraph (m)(6).
The revisions and addition read as fol-
lows:
§1.263A-1 Uniform capitalization of
costs.
(a) * * *
(2) Applicability dates. (i) * * *In the
case of property that is inventory in the
hands of the taxpayer, however, these
sections are applicable for taxable years
beginning after December 31, 1993. The
small business taxpayer exception de-
scribed in paragraph (b)(1) of this section
and set forth in paragraph (j) of this sec-
tion is applicable for taxable years begin-
ning after December 31, 2017. * * *
* * * * *
(b) * * * (1) Small business taxpayers.
For taxable years beginning after Decem-
ber 31, 2017, see section 263A(i) and
paragraph (j) of this section for an exemp-
tion for certain small business taxpayers
from the requirements of section 263A.
* * * * *
(j) Exemption for certain small busi-
ness taxpayers—(1) In general. A tax-
payer, other than a tax shelter prohibited
from using the cash receipts and disburse-
ments method of accounting under section
448(a)(3), that meets the gross receipts
test under section 448(c) and §1.448-2(c)
(section 448(c) gross receipts test) for any
taxable year (small business taxpayer) is
not required to capitalize costs under sec-
tion 263A to any real or tangible personal
property produced, and any real or person-
al property described in section 1221(a)
(1) acquired for resale, during that taxable
year. This section 448(c) gross receipts
test applies even if the taxpayer is not oth-
erwise subject to section 448(a).
(2) Application of the section 448(c)
gross receipts test—(i) In general. In the
case of any taxpayer that is not a corpo-
ration or a partnership, and except as pro-
vided in paragraphs (j)(2)(ii) and (iii) of
this section, the section 448(c) gross re-
ceipts test is applied in the same manner
as if each trade or business of the taxpayer
were a corporation or partnership.
(ii) Gross receipts of individuals, etc.
Except when the aggregation rules of sec-
tion 448(c)(2) apply, the gross receipts
of a taxpayer other than a corporation or
partnership are the amount derived from
all trades or businesses of such taxpayer.
Amounts not related to a trade or business
are excluded from the gross receipts of
the taxpayer. For example, an individual
taxpayer’s gross receipts do not include
inherently personal amounts, such as per-
sonal injury awards or settlements with
respect to an injury of the individual tax-
payer, disability benefits, Social Security
benefits received by the taxpayer during
the taxable year, and wages received as an
employee that are reported on Form W-2.
(iii) Partners and S corporation share-
holders. Except when the aggregation rules
of section 448(c)(2) apply, each partner in
a partnership includes a share of the part-
nership’s gross receipts in proportion to
such partner’s distributive share, as deter-

January 19, 2021 464 Bulletin No. 2021–3
mined under section 704, of items of gross
income that were taken into account by the
partnership under section 703. Similarly, a
shareholder of an S corporation includes
such shareholder’s pro rata share of S cor-
poration gross receipts taken into account
by the S corporation under section 1363(b).
(iv) Examples. The operation of this
paragraph (j) is illustrated by the follow-
ing examples:
(A) Example 1. Taxpayer A is an individual who
operates two separate and distinct trades or business
that are reported on Schedule C, Profit or Loss from
Business, of A’s Federal income tax return. For 2020,
one trade or business has annual average gross re-
ceipts of $5 million, and the other trade or business
has average annual gross receipts of $35 million.
Under paragraph (j)(2)(ii) of this section, for 2020,
neither of A’s trades or businesses meets the gross
receipts test of paragraph (j)(2) of this section ($5
million + $35 million = $40 million, which is greater
than the inflation-adjusted gross receipts test amount
for 2020, which is $26 million).
(B) Example 2. Taxpayer B is an individual who
operates three separate and distinct trades or busi-
ness that are reported on Schedule C of B’s Federal
income tax return. For 2020, Business X is a retail
store with average annual gross receipts of $15 mil-
lion, Business Y is a dance studio with average annu-
al gross receipts of $6 million, and Business Z is a car
repair shop with average annual gross receipts of $12
million. Under paragraph (j)(2)(ii) of this section,
B’s gross receipts are the combined amount derived
from all three of B’s trades or businesses. Therefore,
for 2020, X, Y and Z do not meet the gross receipts
test of paragraph (j)(2)(i) of this section ($15 million
+ $6 million + $12 million = $33 million, which is
greater than the inflation-adjusted gross receipts test
amount for 2020, which is $26 million).
(3) Change in method of accounting—
(i) In general. A change from applying the
small business taxpayer exemption under
paragraph (j) of this section to not apply-
ing the exemption under this paragraph
(j), or vice versa, is a change in method
of accounting under section 446(e) and
§1.446-1(e). A taxpayer changing its
method of accounting under paragraph
(j) of this section may do so only with the
consent of the Commissioner as required
under section 446(e) and §1.446-1. In the
case of any taxpayer required by this sec-
tion to change its method of accounting
for any taxable year, the change shall be
treated as a change initiated by the taxpay-
er. For rules relating to the clear reflection
of income and the pattern of consistent
treatment of an item, see section 446 and
§1.446-1. The amount of the net section
481(a) adjustment and the adjustment
period necessary to implement a change
in method of accounting required under
this section are determined under §1.446-
1(e) and the applicable administrative
procedures to obtain the Commissioner’s
consent to change a method of account-
ing as published in the Internal Revenue
Bulletin (see Revenue Procedure 2015-13
(2015-5 IRB 419) (or successor) (see also
§601.601(d)(2) of this chapter).
(ii) Automatic consent for certain meth-
od changes. Certain changes in method of
accounting made under paragraph (j) of
this section may be made under the pro-
cedures to obtain the automatic consent of
the Commissioner to change a method of
accounting. See Revenue Procedure 2015-
13 (2015-5 IRB 419) (or successor) (see
also §601.601(d)(2) of this chapter)). In
certain situations, special terms and con-
ditions may apply.
* * * * *
(m) * * *.
(6) Exemption for certain small business
taxpayers. The second and third sentence in
paragraph (a)(2)(i), paragraphs (b)(1) and (j)
of this section apply to taxable years begin-
ning on or after January 5, 2021. However,
for a taxable year beginning after December
31, 2017, and before January 5, 2021, a tax-
payer may apply the paragraphs described in
the first sentence of this paragraph (m)(6),
provided that the taxpayer follows all the
applicable rules contained in the regulations
under section 263A for such taxable year
and all subsequent taxable years.
Par. 4. Section 1.263A-2 is amended
by:
1. Adding a sentence at the end of para-
graph (a) introductory text.
2. Revising paragraph (a)(1)(ii)(C).
3. Revising paragraph (g) subject head-
ing.
4. Adding paragraph (g)(4).
The additions and revisions read as fol-
lows:
§1.263A-2 Rules relating to property
produced by the taxpayer.
(a) * * * For taxable years beginning
after December 31, 2017, see §1.263A-1(j)
for an exception in the case of a small busi-
ness taxpayer that meets the gross receipts
test of section 448(c) and §1.448-2(c).
(1) * * *
(ii) * * *
(C) Home construction contracts. Sec-
tion 263A applies to a home construction
contract unless that contract will be com-
pleted within two years of the contract
commencement date, and, for contracts
entered into after December 31, 2017, in
taxable years ending after December 31,
2017, the taxpayer meets the gross receipts
test of section 448(c) and §1.448-2(c) for
the taxable year in which such contract is
entered into. Except as otherwise provid-
ed in this paragraph (a)(1)(ii)(C), section
263A applies to such a contract even if the
contractor is not considered the owner of
the property produced under the contract
under Federal income tax principles.
* * * * *
(g) Applicability dates.* * *
(4) The rules set forth in the last sentence
of the introductory text of paragraph (a) of
this section and in paragraph (a)(1)(ii)(C) of
this section apply for taxable years begin-
ning on or after January 5, 2021. However,
for a taxable year beginning after December
31, 2017, and before January 5, 2021, a tax-
payer may apply the paragraphs described
in the first sentence of this paragraph (g)(4),
provided that the taxpayer follows all the
applicable rules contained in the regulations
under section 263A for such taxable year
and all subsequent taxable years.
Par. 5. Section 1.263A-3 is amended:
1. In paragraph (a)(1), by revising the
second sentence.
2. By revising paragraphs (a)(2)(ii) and
(iii).
4. In paragraph (a)(3), by removing
the language “small reseller” and adding
in its place the language “small business
taxpayer”.
5. In paragraph (a)(4)(ii), removing
the language “(within the meaning of
paragraph (a)(2)(iii) of this section)” and
adding in its place the language “(within
the meaning of paragraph (a)(5) of this
section)”.
6. By adding paragraph (a)(5).
7. By removing and reserving para-
graph (b).
8. By revising paragraph (f).
The revisions and additions read as fol-
lows:
§1.263A-3 Rules relating to property
acquired for resale.
(a) * * *(1) * * *However, for taxable
years beginning after December 31, 2017,
a small business taxpayer, as defined in

Bulletin No. 2021–3 465 January 19, 2021
§1.263A-1(j), is not required to apply sec-
tion 263A in that taxable year.* * *
(2) * * *
(ii) Exemption for certain small busi-
ness taxpayers. For taxable years be-
ginning after December 31, 2017, see
§1.263A-1(j) for an exception in the case
of a small business taxpayer that meets the
gross receipts test of section 448(c) and
§1.448-2(c).
(iii) De minimis production activities.
See paragraph (a)(5) of this section for
rules relating to an exception for resellers
with de minimis production activities.
* * * * *
(5) De minimis production activities—
(i) In general. In determining whether a
taxpayer’s production activities are de
minimis, all facts and circumstances must
be considered. For example, the taxpay-
er must consider the volume of the pro-
duction activities in its trade or business.
Production activities are presumed de mi-
nimis if—
(A) The gross receipts from the sale of
the property produced by the reseller are
less than 10 percent of the total gross re-
ceipts of the trade or business; and
(B) The labor costs allocable to the trade
or business’s production activities are less
than 10 percent of the reseller’s total labor
costs allocable to its trade or business.
(ii) Definition of gross receipts to de-
termine de minimis production activities.
Gross receipts has the same definition as
for purposes of the gross receipts test un-
der §1.448-2(c), except that gross receipts
are measured at the trade-or-business lev-
el rather than at the single-employer level.
(iii) Example: Reseller with de minimis produc-
tion activities. Taxpayer N is in the retail grocery busi-
ness. In 2019, N’s average annual gross receipts for
the three previous taxable years are greater than the
gross receipts test of section 448(c). Thus, N is not
exempt from the requirement to capitalize costs un-
der section 263A. N’s grocery stores typically contain
bakeries where customers may purchase baked goods
produced by N. N produces no other goods in its retail
grocery business. N’s gross receipts from its bakeries
are 5 percent of the entire grocery business. N’s labor
costs from its bakeries are 3 percent of its total labor
costs allocable to the entire grocery business. Because
both ratios are less than 10 percent, N’s production
activities are de minimis. Further, because N’s pro-
duction activities are incident to its resale activities, N
may use the simplified resale method, as provided in
paragraph (a)(4)(ii) of this section.
* * * * *
(f) Applicability dates. (1) Paragraphs
(d)(3)(i)(C)(3), (d)(3)(i)(D)(3), and (d)(3)
(i)(E)(3) of this section apply for taxable
years ending on or after January 13, 2014.
(2) The rules set forth in the second
sentence of paragraph (a)(1) of this sec-
tion, paragraphs (a)(2)(ii) and (iii) of this
section, the third sentence of paragraph
(a)(3) of this section, and paragraphs (a)
(4)(ii) and (a)(5) of this section apply for
taxable years beginning on or after Janu-
ary 5, 2021. However, for a taxable year
beginning after December 31, 2017, and
before January 5, 2021, a taxpayer may
apply the paragraphs described in the first
sentence of this paragraph (f)(2), provid-
ed the taxpayer follows all the applicable
rules contained in the regulations under
section 263A for such taxable year and all
subsequent taxable years.
Par. 6. Section 1.263A-4 is amended:
1. In paragraph (a)(1), by revising the
last sentence.
2. In paragraph (a)(2)(ii)(A)(1), by re-
moving the language “section 464(c)” and
adding in its place the language with “sec-
tion 461(k)”.
3. By redesignating paragraphs (a)(3)
and (4) as paragraphs (a)(4) and (5) re-
spectively.
4. By adding new paragraph (a)(3).
5. By revising the paragraph (d) subject
heading.
6. In paragraph (d)(1), by revising the
last sentence and adding a new sentence at
the end of the paragraph.
7. In paragraph (d)(3)(i), by removing
the last sentence.
8. By revising paragraph (d)(3)(ii).
9. By redesignating paragraph (d)(5) as
paragraph (d)(7).
10. By adding new paragraphs (d)(5)
and (6).
11. By adding paragraph (e)(5).
12. By redesignating paragraph (f) as
paragraph (g).
13. By adding new paragraph (f).
14. By revising the subject headings
of newly-redesignated paragraphs (g) and
(g)(1), and by revising newly-designated
paragraph (g)(2).
The revisions and additions read as fol-
lows:
§1.263A-4 Rules for property produced in
a farming business.
(a) * * *(1) * * *Except as provided
in paragraphs (a)(2), (a)(3), and (e) of
this section, taxpayers must capitalize the
costs of producing all plants and animals
unless the election described in paragraph
(d) of this section is made.
* * * * *
(3) Exemption for certain small busi-
ness taxpayers. For taxable years be-
ginning after December 31, 2017, see
§1.263A-1(j) for an exception in the case
of a small business taxpayer that meets the
gross receipts test of section 448(c) and
§1.448-2(c).
* * * * *
(d) Election not to have section 263A
apply under section 263A(d)(3)—(1) * * *
Except as provided in paragraph (d)(5) and
(6) of this section, the election is a method
of accounting under section 446. An elec-
tion made under section 263A(d)(3) and
this paragraph (d) is revocable only with
the consent of the Commissioner.
* * * * *
(3) * * *
(ii) Nonautomatic election. Except as
provided in paragraphs (d)(5) and (6) of
this section, a taxpayer that does not make
the election under this paragraph (d) as
provided in paragraph (d)(3)(i) of this sec-
tion must obtain the consent of the Com-
missioner to make the election by filing
a Form 3115, Application for Change in
Method of Accounting, in accordance with
§1.446-1(e)(3).
* * * * *
(5) Revocation of section 263A(d)(3)
election to permit exemption under sec-
tion 263A(i). A taxpayer that elected under
section 263A(d)(3) and paragraph (d)(3)
of this section not to have section 263A
apply to any plant produced in a farming
business that wants to revoke its section
263A(d)(3) election, and in the same tax-
able year, apply the small business tax-
payer exemption under section 263A(i)
and §1.263A-1(j) may revoke the election
in accordance with the applicable admin-
istrative guidance as published in the In-
ternal Revenue Bulletin (see §601.601(d)
(2)(ii)(b) of this chapter). A revocation of
the taxpayer’s section 263A(d)(3) election
under this paragraph (d)(5) is not a change
in method of accounting under sections
446 and 481 and §§1.446-1 and 1.481-1
through 1.481-5.
(6) Change from applying exemption
under section 263A(i) to making a section
263A(d)(3) election. A taxpayer whose

January 19, 2021 466 Bulletin No. 2021–3
method of accounting is to not capitalize
costs under section 263A based on the
exemption under section 263A(i), that
becomes ineligible to use the exemption
under section 263A(i), and is eligible
and wants to elect under section 263A(d)
(3) for this same taxable year to not cap-
italize costs under section 263A for any
plant produced in the taxpayer’s farming
business, must make the election in accor-
dance with the applicable administrative
guidance as published in the Internal Rev-
enue Bulletin (see §601.601(d)(2)(ii)(b)
of this chapter). An election under section
263A(d)(3) made in accordance with this
paragraph (d)(6) is not a change in meth-
od of accounting under sections 446 and
481 and §§1.446-1 and 1.481-1 through
1.481-5.
* * * * *
(e) * * *
(5) Special temporary rule for citrus
plants lost by reason of casualty. Section
263A(d)(2)(A) provides that if plants bear-
ing an edible crop for human consumption
were lost or damaged while in the hands
of the taxpayer by reason of freezing tem-
peratures, disease, drought, pests, or casu-
alty, section 263A does not apply to any
costs of the taxpayer of replanting plants
bearing the same type of crop (whether
on the same parcel of land on which such
lost or damaged plants were located or any
other parcel of land of the same acreage in
the United States). The rules of this para-
graph (e)(5) apply to certain costs that are
paid or incurred after December 22, 2017,
and on or before December 22, 2027,
to replant citrus plants after the loss or
damage of citrus plants. Notwithstanding
paragraph (e)(2) of this section, in the case
of replanting citrus plants after the loss or
damage of citrus plants by reason of freez-
ing temperatures, disease, drought, pests,
or casualty, section 263A does not apply
to replanting costs paid or incurred by a
taxpayer other than the owner described in
section 263A(d)(2)(A) if—
(i) The owner described in section
263A(d)(2)(A) has an equity interest of
not less than 50 percent in the replanted
citrus plants at all times during the taxable
year in which such amounts were paid or
incurred and the taxpayer holds any part
of the remaining equity interest; or
(ii) The taxpayer acquired the entirety
of the equity interest in the land of that
owner described in section 263A(d)(2)(A)
and on which land the lost or damaged cit-
rus plants were located at the time of such
loss or damage, and the replanting is on
such land.
(f) Change in method of accounting.
Except as provided in paragraphs (d)(5)
and (6) of this section, any change in a tax-
payer’s method of accounting necessary
to comply with this section is a change in
method of accounting to which the provi-
sions of sections 446 and 481 and §1.446-
1 through 1.446-7 and §1.481-1 through
§1.481-3 apply.
(g) Applicability dates—(1) In gener-
al.* * *
(2) Changes made by Tax Cuts and
Jobs Act (Pub. L. No. 115-97). Paragraphs
(a)(3), (d)(5), (d)(6), and (e)(5) of this sec-
tion apply for taxable years beginning on
or after January 5, 2021. However, for a
taxable year beginning after December 31,
2017, and before January 5, 2021, a tax-
payer may apply the paragraphs described
in the first sentence of this paragraph (g)
(2), provided that the taxpayer follows all
the applicable rules contained in the reg-
ulations under section 263A for such tax-
able year and all subsequent taxable years.
Par. 7. §1.263A-7 is amended:
1. By revising paragraph (a)(3)(i).
2. By redesignating paragraph (a)(4) as
paragraph (a)(4)(i).
3. By adding a paragraph (a)(4) subject
heading.
4. By revising the newly-designated
paragraph (a)(4)(i) subject heading.
5. By adding paragraph (a)(4)(ii).
6. In paragraph (b)(1), by removing
the language “Rev. Proc. 97-27 (1997-
21 I.R.B.10)” and adding in its place the
language “Revenue Procedure 2015-13
(2015-5 IRB 419)”.
7. In paragraph (b)(2)(ii), by removing
the language “Rev. Proc. 2002-9 (2002-1
C.B. 327) and Rev. Proc. 97-27 (1991-1
C.B. 680)” and adding the language “Rev-
enue Procedure 2015-13, 2015-5 IRB 419
(or successor)” in its place.
The revisions and additions read as fol-
lows:
§1.263A-7 Changing a method of
accounting under section 263A.
(a) * * *
(3) * * *
(i) For taxable years beginning after
December 31, 2017, resellers of real or
personal property or producers of real or
tangible personal property whose average
annual gross receipts for the immediate-
ly preceding 3-taxable-year period, or
lesser period if the taxpayer was not in
existence for the three preceding taxable
years, annualized as required, exceed the
gross receipts test of section 448(c) and
the accompanying regulations where the
taxpayer was not subject to section 263A
in the prior taxable year;
* * * * *
(4) Applicability dates—(i) In gener-
al.* * *
(ii) Changes made by Tax Cuts and
Jobs Act (Pub. L. No. 115-97). Paragraph
(a)(3)(i) of this section applies to taxable
years beginning on or after January 5,
2021. However, for a taxable year begin-
ning after December 31, 2017, and before
January 5, 2021, a taxpayer may apply the
paragraph described in the first sentence
of this paragraph (a)(4)(ii), provided that
the taxpayer follows all the applicable
rules contained in the regulations under
section 263A for such taxable year and all
subsequent taxable years.
* * * * *
Par. 8. Section 1.263A-8 is amended by
adding a sentence to the end of paragraph
(a)(1) to read as follows:
§1.263A-8 Requirement to capitalize
interest.
(a)* * *(1)* * *However, a taxpayer,
other than a tax shelter prohibited from
using the cash receipts and disbursements
method of accounting under section 448(a)
(3), that meets the gross receipts test of
section 448(c) for the taxable year is not
required to capitalize costs, including inter-
est, under section 263A. See §1.263A-1(j).
* * * * *
Par. 9. Section 1.263A-9 is amended by
adding a sentence to the end of paragraph
(e)(2) to read as follows:
§1.263A-9 The avoided cost method.
* * * * *
(e)* * *
(2)* * *A taxpayer is an eligible tax-
payer for a taxable year for purposes
of this paragraph (e) if the taxpayer is a

Bulletin No. 2021–3 467 January 19, 2021
small business taxpayer, as defined in
§1.263A-1(j).
* * * * *
Par. 10. Section 1.263A-15 is amend-
ed by adding paragraph (a)(4) to read as
follows:
§1.263A-15 Effective dates, transitional
rules, and anti-abuse rule.
(a) * * *
(4) The last sentence of each of
§1.263A-8(a)(1) and §1.263A-9(e)
(2) apply to taxable years beginning
on or after January 5, 2021. However,
for a taxable year beginning after De-
cember 31, 2017, and before January
5, 2021, a taxpayer may apply the last
sentence of each of §1.263A-8(a)(1)
and §1.263A-9(e)(2), provided that the
taxpayer follows all the applicable rules
contained in the regulations under sec-
tion 263A for such taxable year and all
subsequent taxable years.
* * * * *
Par. 11. Section 1.381(c)(5)-1 is amended:
1. In paragraph (a)(6), by designating
Examples 1 and 2 as paragraphs (a)(6)(i)
and (ii), respectively.
2. In newly-designated paragraphs (a)
(6)(i) and (ii), by redesignating the para-
graphs in the first column as the para-
graphs in the second column:
Old ParagraphsNew Paragraphs
(a)(6)(i)(i) and (ii)(a)(6)(i)(A) and (B)
(a)(6)(ii)(i) and (ii)(a)(6)(ii)(A) and (B)
3. In newly designated paragraphs (a)
(6)(ii)(A) and (B), by removing the lan-
guage “small reseller” and adding in its
place the language “small business tax-
payer” everywhere it appears.
4. By adding a sentence to the end of
paragraph (f).
The addition reads as follows:
§1.381(c)(5)-1 Inventory method.
* * * * *
(f) * * * The designations of para-
graphs (a)(6)(ii)(A) and (B) of this section
and removal of the term “small reseller”
and replacement with the term “small
business taxpayer” apply to taxable years
beginning on or after January 5, 2021.
Par. 12. §1.446-1 is amended:
1. In paragraph (a)(4)(i), by revising
the first sentence.
2. By revising paragraph (c)(2)(i).
3. By adding paragraph (c)(3).
The revisions and additions read as fol-
lows:
§1.446-1 General rule for methods of
accounting.
(a) * * *
(4) * * *
(i) Except in the case of a taxpayer
qualifying as a small business taxpayer
for the taxable year under section 471(c),
in all cases in which the production, pur-
chase or sale of merchandise of any kind
is an income-producing factor, merchan-
dise on hand (including finished goods,
work in progress, raw materials, and sup-
plies) at the beginning and end of the year
shall be taken into account in computing
the taxable income of the year. * * *
* * * * *
(c) * * *
(2) * * *
(i) In any case in which it is necessary
to use an inventory, the accrual method of
accounting must be used with regard to
purchases and sales unless:
(A) The taxpayer qualifies as a small
business taxpayer for the taxable year un-
der section 471(c), or
(B) Otherwise authorized under para-
graph (c)(2)(ii) of this section.
* * * * *
(3) Applicability date. The first sen-
tence of paragraph (a)(4)(i) of this section
and paragraph (c)(2)(i) of this section ap-
ply to taxable years beginning on or after
January 5, 2021. However, for a taxable
year beginning after December 31, 2017,
and before January 5, 2021, a taxpayer
may apply the rules provided in the first
sentence of this paragraph (c)(3), provided
that the taxpayer follows all the applicable
rules contained in the regulations under
section 446 for such taxable year and all
subsequent taxable years.
* * * * *
Par. 13. Section 1.448-1 is amended
by adding new first and second sentences
to paragraphs (g)(1) and (h)(1) to read as
follows:
§1.448-1 Limitation on the use of the
cash receipts and disbursements method
of accounting.
* * * * *
(g) * * *(1) * * *The rules provided
in paragraph (g) of this section apply to
taxable years beginning before January 1,
2018. See §1.448-2 for rules relating to
taxable years beginning after December
31, 2017.* * *
* * * * *
(h) * * *(1) * * *The rules provided
in paragraph (h) of this section apply to
taxable years beginning before January 1,
2018. See §1.448-2 for rules relating to
taxable years beginning after December
31, 2017. * * *
* * * * *
§1.448-2 [Redesignated as §1.448-3]
Par. 14. Section 1.448-2 is redesignated
as §1.448-3.
Par. 15. A new §1.448-2 is added to
read as follows:
§1.448-2 Limitation on the use of the
cash receipts and disbursements method
of accounting for taxable years beginning
after December 31, 2017.
(a) Limitation on method of account-
ing—(1) In general. The rules of this sec-
tion relate to the limitation on the use of
the cash receipts and disbursements meth-
od of accounting (cash method) by certain
taxpayers applicable for taxable years
beginning after December 31, 2017. For
rules applicable to taxable years begin-
ning before January 1, 2018, see §§1.448-
1 and 1.448-1T.
(2) Limitation rule. Except as other-
wise provided in this section, the compu-
tation of taxable income using the cash
method is prohibited in the case of a:
(i) C corporation;

January 19, 2021 468 Bulletin No. 2021–3
(ii) Partnership with a C corporation as
a partner, or a partnership that had a C cor-
poration as a partner at any time during the
partnership’s taxable year beginning after
December 31, 1986; or
(iii) Tax shelter.
(3) Treatment of combination meth-
ods—(i) In general. For purposes of this
section, the use of a method of accounting
that records some, but not all, items on the
cash method is considered the use of the
cash method. Thus, a C corporation that
uses a combination of accounting meth-
ods including the use of the cash method
is subject to this section.
(ii) Example. The following example illustrates
the operation of this paragraph (a)(3). In 2020, A is
a C corporation with average annual gross receipts
for the prior three taxable years of greater than $30
million, is not a tax shelter under section 448(a)(3)
and does not qualify as a qualified personal service
corporation, as defined in paragraph (e) of this sec-
tion. For the last 20 years, A used an accrual method
for items of income and expenses related to purchas-
es and sales of inventory, and the cash method for
items related to its provision of services. A is using a
combination of accounting methods that include the
cash method. Thus, A is subject to section 448. A is
prohibited from using the cash method for any item
for 2020 and is required to change to a permissible
method.
(b) Definitions. For purposes of this
section—
(1) C corporation—(i) In general.
The term C corporation means any cor-
poration that is not an S corporation (as
defined in section 1361(a)(1)). For exam-
ple, a regulated investment company (as
defined in section 851) or a real estate in-
vestment trust (as defined in section 856)
is a C corporation for purposes of this
section. In addition, a trust subject to tax
under section 511(b) is treated, for pur-
poses of this section, as a C corporation,
but only with respect to the portion of
its activities that constitute an unrelated
trade or business. Similarly, for purposes
of this section, a corporation that is ex-
empt from Federal income taxes under
section 501(a) is treated as a C corpora-
tion only with respect to the portion of
its activities that constitute an unrelated
trade or business. Moreover, for purposes
of determining whether a partnership has
a C corporation as a partner, any partner-
ship described in paragraph (a)(2)(ii) of
this section is treated as a C corporation.
Thus, if partnership ABC has a partner
that is a partnership with a C corporation,
then, for purposes of this section, part-
nership ABC is treated as a partnership
with a C corporation partner.
(ii) [Reserved]
(2) Tax shelter—(i) In general. The
term tax shelter means any—
(A) Enterprise, other than a C corpora-
tion, if at any time, including taxable years
beginning before January 1, 1987, inter-
ests in such enterprise have been offered
for sale in any offering required to be reg-
istered with any Federal or state agency
having the authority to regulate the offer-
ing of securities for sale;
(B) Syndicate, within the meaning of
paragraph (b)(2)(iii) of this section; or
(C) Tax shelter, within the meaning of
section 6662(d)(2)(C).
(ii) Requirement of registration. For
purposes of paragraph (b)(2)(i)(A) of this
section, an offering is required to be reg-
istered with a Federal or state agency if,
under the applicable Federal or state law,
failure to register the offering would result
in a violation of the applicable Federal or
state law. This rule applies regardless of
whether the offering is in fact registered.
In addition, an offering is required to be
registered with a Federal or state agency
if, under the applicable Federal or state
law, failure to file a notice of exemption
from registration would result in a vio-
lation of the applicable Federal or state
law, regardless of whether the notice is
in fact filed. However, an S corporation is
not treated as a tax shelter for purposes of
section 448(d)(3) or this section merely by
reason of being required to file a notice of
exemption from registration with a state
agency described in section 461(i)(3)(A),
but only if all corporations offering secu-
rities for sale in the state must file such
a notice in order to be exempt from such
registration.
(iii) Syndicate—(A) In general. For
purposes of paragraph (b)(2)(i)(B) of
this section, the term syndicate means a
partnership or other entity (other than a
C corporation) if more than 35 percent of
the losses of such entity during the tax-
able year (for taxable years beginning
after December 31, 1986) are allocated
to limited partners or limited entrepre-
neurs. For purposes of this paragraph (b)
(2)(iii), the term limited entrepreneur has
the same meaning given such term in sec-
tion 461(k)(4). In addition, in determin-
ing whether an interest in a partnership is
held by a limited partner, or an interest in
an entity or enterprise is held by a limited
entrepreneur, section 461(k)(2) applies in
the case of the trade or business of farm-
ing (as defined in paragraph (d)(2) of
this section), and section 1256(e)(3)(C)
applies in all other cases. Moreover, for
purposes of paragraph (b)(2) of this sec-
tion, the losses of a partnership, entity, or
enterprise (entities) means the excess of
the deductions allowable to the entities
over the amount of income recognized
by such entities under the entities’ meth-
od of accounting used for Federal income
tax purposes (determined without regard
to this section). For this purpose, gains or
losses from the sale of capital assets or
assets described in section 1221(a)(2) are
not taken into account.
(B) Irrevocable annual election to test
the allocation of losses from prior taxable
year—(1) In general. For purposes of
paragraph (b)(2)(iii)(A) of this section, to
determine if more than 35 percent of the
losses of a venture are allocated to limited
partners or limited entrepreneurs, entities
may elect to use the allocations made in
the immediately preceding taxable year
instead of using the current taxable year’s
allocation. An election under this para-
graph (b)(2)(iii)(B) applies only to the tax-
able year for which the election is made.
Except as otherwise provided in guidance
published in the Internal Revenue Bulle-
tin (see §601.601(d)(2) of this chapter), a
taxpayer that makes an election under this
paragraph (b)(2)(iii)(B) must apply this
election for other provisions of the Code
that specifically apply the definition of tax
shelter in section 448(a)(3).
(2) Time and manner of making elec-
tion. A taxpayer makes this election for
the taxable year by attaching a statement
to its timely filed original Federal income
tax return (including extensions) for such
taxable year. The statement must state that
the taxpayer is making the election under
§1.448-2(b)(2)(iii)(B). In the case of an S
corporation or partnership, the election is
made by the S corporation or the partner-
ship and not by the shareholders or part-
ners. An election under this paragraph (b)
(2)(iii)(B) may not be made by the taxpay-
er in any other manner. For example, the
election cannot be made through a request
under section 446(e) to change the tax-
payer’s method of accounting. A taxpay-

Bulletin No. 2021–3 469 January 19, 2021
er may not revoke an election under this
paragraph (b)(2)(iii)(B).
(3) Administrative guidance. The IRS
may publish procedural guidance in the In-
ternal Revenue Bulletin (see §601.601(d)
(2) of this chapter) that provides alterna-
tive procedures for complying with para-
graph (b)(2)(iii)(B)(2) of this section.
(C) Examples. The following examples
illustrate the rules of paragraph (b)(2)(iii)
of this section. For purposes of the exam-
ples, the term “losses” has the meaning
stated in paragraph (b)(2)(iii)(A) of this
section.
(1) Example 1. Taxpayer B is a calendar year lim-
ited partnership, with no active management from its
limited partner. For 2019, B is profitable and has no
losses to allocate to its limited partner. For 2020, B
is not profitable and allocates 60 percent of its losses
to its general partner and 40 percent of its losses to
its limited partner. For 2021, B is not profitable and
allocates 50 percent of its losses to its general partner
and 50 percent of its losses to its limited partner. For
taxable year 2020, B makes an election under para-
graph (b)(2)(iii)(B) of this section to use its prior year
allocated amounts. Accordingly, for 2020, B is not a
syndicate because B was profitable for 2019 and did
not allocate any losses to its limited partner in 2019.
For 2021, B is a syndicate because B allocated 50
percent of its 2021 losses to its limited partner under
paragraph (b)(2)(ii)(3)(A) of this section. Even if B
made an election under paragraph (b)(2)(iii)(B) of
this section to use prior year allocated amounts, B is
a syndicate for 2021 because B allocated 40 percent
of its 2020 losses to its limited partner in 2020. Be-
cause B is a syndicate under paragraph (b)(2)(iii)(A)
of this section for 2021, B is a tax shelter prohibited
from using the cash method for taxable year 2021
under paragraph (b)(2)(i)(B) of this section.
(2) Example (2). Same facts as Example (1) in
paragraph (b)(2)(iii)(C)(1) of this section, except for
2021, B is profitable and has no losses to allocate to
its limited partner. For 2020, B makes an election un-
der paragraph (b)(2)(iii)(B) of this section to use its
prior year allocated amounts. Accordingly, for 2020,
B is not a syndicate because it did not any allocate
any losses to its limited partner in 2019. For 2021, B
chooses not to make the election under paragraph (b)
(2)(iii)(B) of this section. For 2021, B is not a syn-
dicate because it does not have any 2021 losses to
allocate to a limited partner. For taxable years 2019,
2020 and 2021, B is not a syndicate under paragraph
(b)(2)(iii)(A) of this section and is not prohibited
from using the cash method for taxable years 2019,
2020 or 2021 under paragraph (b)(2)(i)(B) of this
section.
(iv) Presumed tax avoidance. For
purposes of (b)(2)(i)(C) of this section,
marketed arrangements in which persons
carrying on farming activities using the
services of a common managerial or ad-
ministrative service will be presumed to
have the principal purpose of tax avoid-
ance if such persons use borrowed funds
to prepay a substantial portion of their
farming expenses. Payments for farm sup-
plies that will not be used or consumed
until a taxable year subsequent to the tax-
able year of payment are an example of
one type of such prepayment.
(v) Taxable year tax shelter must
change accounting method. A tax shelter
must change from the cash method for the
taxable year that it becomes a tax shelter,
as determined under paragraph (b)(2) of
this section.
(vi) Determination of loss amount. For
purposes of section 448(d)(3), the amount
of losses to be allocated under section
1256(e)(3)(B) is calculated without regard
to section 163(j).
(c) Exception for entities with gross
receipts not in excess of the amount pro-
vided in section 448(c)—(1) In general.
Except in the case of a tax shelter, this sec-
tion does not apply to any C corporation
or partnership with a C corporation as a
partner for any taxable year if such corpo-
ration or partnership (or any predecessor
thereof) meets the gross receipts test of
paragraph (c)(2) of this section.
(2) Gross receipts test—(i) In gener-
al. A corporation meets the gross receipts
test of this paragraph (c)(2) if the average
annual gross receipts of such corporation
for the 3 taxable years (or, if shorter, the
taxable years during which such corpo-
ration was in existence, annualized as
required) ending with such prior taxable
year does not exceed the gross receipts
test amount provided in paragraph (c)(2)
(v) of this section (section 448(c) gross re-
ceipts test). In the case of a C corporation
exempt from Federal income taxes under
section 501(a), or a trust subject to tax
under section 511(b) that is treated as a C
corporation under paragraph (b)(1) of this
section, only gross receipts from the activ-
ities of such corporation or trust that con-
stitute unrelated trades or businesses are
taken into account in determining whether
the gross receipts test is satisfied. A part-
nership with a C corporation as a partner
meets the gross receipts test of paragraph
(c)(2) of this section if the average annual
gross receipts of such partnership for the
3 taxable years (or, if shorter, the taxable
years during which such partnership was
in existence annualized as required) end-
ing with such prior year does not exceed
the gross receipts test amount of para-
graph (c)(2)(v) of this section. Except as
provided in paragraph (c)(2)(ii) of this
section, the gross receipts of the corporate
partner are not taken into account in de-
termining whether a partnership meets the
gross receipts test of paragraph (c)(2) of
this section.
(ii) Aggregation of gross receipts. The
aggregation rules in §1.448-1T(f)(2)(ii)
apply for purposes of aggregating gross
receipts for purposes of this section.
(iii) Treatment of short taxable year.
The short taxable year rules in §1.448-
1T(f)(2)(iii) apply for purposes of this
section.
(iv) Determination of gross receipts.
The determination of gross receipts rules
in §1.448-1T(f)(2)(iv) apply for purposes
of this section.
(v) Gross receipts test amount—(A) In
general. For purposes of paragraph (c) of
this section, the term gross receipts test
amount means $25,000,000, adjusted an-
nually for inflation in the manner provided
in section 448(c)(4). The inflation adjust-
ed gross receipts test amount is published
annually in guidance published in the In-
ternal Revenue Bulletin (see §601.601(d)
(2)(ii) of this chapter).
(B) Example. Taxpayer A, a C corporation, is a
plumbing contractor that installs plumbing fixtures
in customers’ homes or businesses. A’s gross receipts
for the 2017-2019 taxable years are $20 million, $16
million, and $30 million, respectively. A’s average
annual gross receipts for the three taxable-year pe-
riod preceding the 2020 taxable year is $22 million
(($20 million + $16 million + $30 million) / 3) = $22
million. A may use the cash method for its trade or
business for the 2020 taxable year because its av-
erage annual gross receipts for the preceding three
taxable years is not more than the gross receipts test
amount of paragraph (c)(2)(vi) of this section, which
is $26 million for 2020.
(d) Exception for farming businesses—
(1) In general. Except in the case of a tax
shelter, this section does not apply to any
farming business. A taxpayer engaged in a
farming business and a separate non-farm-
ing business is not prohibited by this sec-
tion from using the cash method with re-
spect to the farming business, even though
the taxpayer may be prohibited by this
section from using the cash method with
respect to the non-farming business.
(2) Farming business—(i) In general.
For purposes of paragraph (d) of this sec-
tion, the term farming business means—
(A) The trade or business of farming as
defined in section 263A(e)(4) (including

January 19, 2021 470 Bulletin No. 2021–3
the operation of a nursery or sod farm, or
the raising or harvesting of trees bearing
fruit, nuts or other crops, or ornamental
trees),
(B) The raising, harvesting, or grow-
ing of trees described in section 263A(c)
(5) (relating to trees raised, harvested, or
grown by the taxpayer other than trees
described in paragraph (d)(2)(i)(A) of this
section),
(C) The raising of timber, or
(D) Processing activities which are
normally incident to the growing, raising,
or harvesting of agricultural products.
(ii) Example. Assume a taxpayer is in the busi-
ness of growing fruits and vegetables. When the
fruits and vegetables are ready to be harvested, the
taxpayer picks, washes, inspects, and packages the
fruits and vegetables for sale. Such activities are
normally incident to the raising of these crops by
farmers. The taxpayer will be considered to be in the
business of farming with respect to the growing of
fruits and vegetables, and the processing activities
incident to the harvest.
(iii) Processing activities excluded
from farming businesses—(A) In gener-
al. For purposes of this section, a farming
business does not include the processing
of commodities or products beyond those
activities normally incident to the grow-
ing, raising, or harvesting of such prod-
ucts.
(B) Examples. (1) Example 1. Assume that a C
corporation taxpayer is in the business of growing
and harvesting wheat and other grains. The taxpay-
er processes the harvested grains to produce breads,
cereals, and similar food products which it sells to
customers in the course of its business. Although the
taxpayer is in the farming business with respect to
the growing and harvesting of grain, the taxpayer is
not in the farming business with respect to the pro-
cessing of such grains to produce breads, cereals,
and similar food products which the taxpayer sells
to customers.
(2) Example 2. Assume that a taxpayer is in the
business of raising livestock. The taxpayer uses the
livestock in a meat processing operation in which the
livestock are slaughtered, processed, and packaged
or canned for sale to customers. Although the tax-
payer is in the farming business with respect to the
raising of livestock, the taxpayer is not in the farming
business with respect to the meat processing opera-
tion.
(e) Exception for qualified personal
service corporation. The rules in §1.448-
1T(e) relating to the exception for quali-
fied personal service corporations apply
for taxable years beginning after Decem-
ber 31, 2017.
(f) Effect of section 448 on other pro-
visions. Except as provided in paragraph
(b)(2)(iii)(B) of this section, nothing in
section 448 shall have any effect on the
application of any other provision of law
that would otherwise limit the use of the
cash method, and no inference shall be
drawn from section 448 with respect to
the application of any such provision.
For example, nothing in section 448 af-
fects the requirement of section 447 that
certain corporations must use an accrual
method of accounting in computing tax-
able income from farming, or the require-
ment of §1.446-1(c)(2) that, in general,
an accrual method be used with regard to
purchases and sales of inventory. Simi-
larly, nothing in section 448 affects the
authority of the Commissioner under
section 446(b) to require the use of an
accounting method that clearly reflects
income, or the requirement under section
446(e) that a taxpayer secure the consent
of the Commissioner before changing its
method of accounting. For example, a
taxpayer using the cash method may be
required to change to an accrual meth-
od of accounting under section 446(b)
because such method clearly reflects the
taxpayer’s income, even though the tax-
payer is not prohibited by section 448
from using the cash method. Similarly, a
taxpayer using an accrual method of ac-
counting that is not prohibited by section
448 from using the cash method may not
change to the cash method unless the tax-
payer secures the consent of the Commis-
sioner under section 446(e).
(g) Treatment of accounting method
change and rules for section 481(a) ad-
justment—(1) In general. Any taxpayer to
whom section 448 applies must change its
method of accounting in accordance with
the provisions of this paragraph (g). In the
case of any taxpayer required by this sec-
tion to change its method of accounting,
the change shall be treated as a change
initiated by the taxpayer to compute the
adjustment required under section 481. A
taxpayer must change to an overall accrual
method of accounting for the first taxable
year the taxpayer is subject to this section
or a subsequent taxable year in which the
taxpayer is newly subject to this section
after previously making a change in meth-
od of accounting that complies with sec-
tion 448 (mandatory section 448 year). A
taxpayer may have more than one manda-
tory section 448 year. For example, a tax-
payer may exceed the gross receipts test of
section 448(c) in non-consecutive taxable
years. If the taxpayer complies with the
provisions of paragraph (g)(3) of this sec-
tion for its mandatory section 448 year, the
change shall be treated as made with the
consent of the Commissioner. The change
shall be implemented pursuant to the ap-
plicable administrative procedures to ob-
tain the automatic consent of the Commis-
sioner to change a method of accounting
under section 446(e) as published in the
Internal Revenue Bulletin (see Revenue
Procedure 2015-13 (2015-5 IRB 419) (or
successor) (see also §601.601(d)(2) of this
chapter)). This paragraph (g) applies only
to a taxpayer who changes from the cash
method as required by this section. This
paragraph (g) does not apply to a change
in method of accounting required by any
Code section (or applicable regulation)
other than this section.
(2) Section 481(a) adjustment. The
amount of the net section 481(a) adjust-
ment and the adjustment period necessary
to implement a change in method of ac-
counting required under this section are
determined under §1.446-1(e) and the ap-
plicable administrative procedures to ob-
tain the Commissioner’s consent to change
a method of accounting as published in the
Internal Revenue Bulletin (see Revenue
Procedure 2015-13 (2015-5 IRB 419) (or
successor) (see also §601.601(d)(2) of this
chapter).
(h) Applicability dates. The rules of this
section apply for taxable years beginning
on or after January 5, 2021. However, for
a taxable year beginning after December
31, 2017, and before January 5, 2021, a
taxpayer may apply the rules provided in
this section provided that the taxpayer fol-
lows all the applicable rules contained in
the regulations under section 448 for such
taxable year and all subsequent taxable
years.
Par. 16. Newly-redesignated § 1.448-3
is amended by revising paragraphs (a)(2)
and (h) to read as follows:
§1.448-3 Nonaccrual of certain amounts
by service providers.
(a) * * *

Bulletin No. 2021–3 471 January 19, 2021
(2) The taxpayer meets the gross re-
ceipts test of section 448(c) and §1.448-
1T(f)(2) (in the case of taxable years
beginning before January 1, 2018), or
§1.448-2(c) (in the case of taxable years
beginning after December 31, 2017) for
all prior taxable years.
* * * * *
(h) Applicability dates. (1) Except as
provided in paragraph (h)(2) of this sec-
tion, this section is applicable for taxable
years ending on or after August 31, 2006.
(2) The rules of paragraph (a)(2) of this
section apply for taxable years beginning
on or after January 5, 2021. However, for a
taxable year beginning after December 31,
2017, and before January 5, 2021, a tax-
payer may apply the paragraph described
in the first sentence of this paragraph (h)
(2), provided that the taxpayer follows all
the applicable rules contained in the regu-
lations under section 448 for such taxable
year and all subsequent taxable years.
Par. 17. Section 1.460-0 is amended by:
1. Adding an entry for §1.460-1(h)(3).
2. Revising the entries for §1.460-3(b)
(3), §1.460-3(b)(3)(i) and (ii), and adding
entries for §1.460-3(b)(3)(ii)(A), (B), (C)
and (D).
3. Removing the entry for §1.460-3(b)
(3)(iii).
4. Adding entries for §1.460-3(d),
§1.460-4(i), and §1.460-6(k).
The additions and revisions read as fol-
lows:
§1.460-0 Outline of regulations under
section 460.
* * * * *
§1.460-1 Long-term contracts.
* * * * *
(h) * * *
(3) Changes made by Tax Cuts and
Jobs Act (Pub. L. 115-97).
* * * * *
§1.460-3 Long-term construction
contracts.
* * * * *
(b) * * *
(3) Gross receipts test of section 448(c)
(i) In general
(ii) Application of gross receipts test
(A) In general
(B) Gross receipts of individuals, etc.
(C) Partners and S corporation share-
holders
(D) Examples
(1) Example 1.
(2) Example 2.
(iii) Method of accounting.
* * * * *
(d) Applicability dates.
§1.460-4 Methods of Accounting for
long-term contracts.
* * * * *
(i) Applicability date.
* * * * *
§1.460-6 Look-back method.
* * * * *
(k) Applicability date.
Par. 18. Section 1.460-1 is amended by
adding three sentences to the end of para-
graph (f)(3) and adding paragraph (h)(3)
to read as follows:
§1.460-1 Long-term contracts.
*****
(f) * * *
(3) * * * A taxpayer may adopt any per-
missible method of accounting for each
classification of contract. Such adoption
is not a change in method of accounting
under section 446 and the accompanying
regulations. For example, a taxpayer that
has had only contracts classified as non-
exempt long-term contracts and has used
the PCM for these contracts may adopt
an exempt contract method in the taxable
year it first enters into an exempt long-
term contract.
* * * * *
(h) * * *
(3) Changes made by Tax Cuts and
Jobs Act (Pub. L. 115-97). Paragraph (f)
(3) of this section, and §1.460-5(d)(1) and
(d)(3), apply for contracts entered into in
taxable years beginning on or after Jan-
uary 5, 2021. However, for contracts en-
tered into after December 31, 2017, in a
taxable year ending after December 31,
2017, and before January 5, 2021, a tax-
payer may apply paragraph (f)(3) of this
section, and §1.460-5(d)(1) and (d)(3),
provided that the taxpayer also applies the
applicable rules contained in the regula-
tions under section 460 for such taxable
year and all subsequent taxable years.
* * * * *
Par. 19. Section 1.460-3 is amended
by revising paragraphs (b)(1)(ii) and (b)
(3), and adding paragraph (d) to read as
follows:
§1.460-3 Long-term construction
contracts.
* * * * *
(b) * * *
(1) * * *
(ii) Other construction contract, en-
tered into after December 31, 2017, in a
taxable year ending after December 31,
2017, by a taxpayer, other than a tax shel-
ter prohibited from using the cash receipts
and disbursements method of accounting
(cash method) under section 448(a)(3),
who estimates at the time such contract
is entered into that such contract will be
completed within the 2-year period begin-
ning on the contract commencement date,
and who meets the gross receipts test de-
scribed in paragraph (b)(3) of this section
for the taxable year in which such contract
is entered into.
* * * * *
(3) Gross receipts test—(i) In general.
A taxpayer, other than a tax shelter pro-
hibited from using the cash method under
section 448(a)(3), meets the gross receipts
test of this paragraph (b)(3) if it meets the
gross receipts test of section 448(c) and
§1.448-2(c)(2). This gross receipts test ap-
plies even if the taxpayer is not otherwise
subject to section 448(a).
(ii) Application of gross receipts test—
(A) In general. In the case of any taxpayer
that is not a corporation or a partnership,
and except as provided in paragraphs (b)
(3)(ii)(B) and (C) of this section, the gross
receipts test of section 448(c) and the ac-
companying regulations are applied in the
same manner as if each trade or business
of such taxpayer were a corporation or
partnership.
(B) Gross receipts of individuals, etc.
Except when the aggregation rules of sec-
tion 448(c)(2) apply, the gross receipts
of a taxpayer other than a corporation or
partnership are the amount derived from
all trades or businesses of such taxpayer.
Amounts not related to a trade or business

January 19, 2021 472 Bulletin No. 2021–3
are excluded from the gross receipts of
the taxpayer. For example, an individual
taxpayer’s gross receipts do not include
inherently personal amounts, such as per-
sonal injury awards or settlements with
respect to an injury of the individual tax-
payer, disability benefits, Social Security
benefits received by the taxpayer during
the taxable year, and wages received as an
employee that are reported on Form W-2.
(C) Partners and S corporation share-
holders. Except when the aggregation
rules of section 448(c)(2) apply, each
partner in a partnership includes a share
of partnership gross receipts in proportion
to such partner’s distributive share (as de-
termined under section 704) of items of
gross income that were taken into account
by the partnership under section 703. Sim-
ilarly, a shareholder includes the pro rata
share of S corporation gross receipts taken
into account by the S corporation under
section 1363(b).
(D) Example. The operation of this
paragraph (b)(3) is illustrated by the fol-
lowing examples:
(1) Example 1. Taxpayer A is an individual who
operates two separate and distinct trades or business
that are reported on Schedule C, Profit or Loss from
Business, of A’s Federal income tax return. For 2020,
one trade or business has annual average gross re-
ceipts of $5 million, and the other trade or business
has average annual gross receipts of $35 million. Un-
der paragraph (b)(3)(ii)(B) of this section, for 2020,
neither of A’s trades or businesses meets the gross
receipts test of paragraph (b)(3) of this section ($5
million + $35 million = $40 million, which is greater
than the inflation-adjusted gross receipts test amount
for 2020, which is $26 million).
(2) Example 2. Taxpayer B is an individual who
operates three separate and distinct trades or busi-
ness that are reported on Schedule C of B’s Federal
income tax return. For 2020, Business X is a retail
store with average annual gross receipts of $15 mil-
lion, Business Y is a dance studio with average an-
nual gross receipts of $6 million, and Business Z is
a car repair shop with average annual gross receipts
of $12 million. Under paragraph (b)(3)(ii)(B) of this
section, B’s gross receipts are the combined amount
derived from all three of B’s trades or businesses.
Therefore, for 2020, X, Y and Z do not meet the
gross receipts test of paragraph (b)(3)(i) of this sec-
tion ($15 million + $6 million + $12 million = $33
million, which is greater than the inflation-adjusted
gross receipts test amount for 2020, which is $26
million).
(iii) Method of accounting. A change in
the method of accounting used for exempt
construction contracts described in para-
graph (b)(1)(ii) of this section is a change
in method of accounting under section
446 and the accompanying regulations.
For rules distinguishing a change in meth-
od from adoption of a method, see §1.460-
1(f)(3). A taxpayer changing its method of
accounting must obtain the consent of the
Commissioner in accordance with §1.446-
1(e)(3). For rules relating to the clear re-
flection of income and the pattern of con-
sistent treatment of an item, see section
446 and §1.446-1. A change in method of
accounting shall be implemented pursuant
to the applicable administrative proce-
dures to obtain the consent of the Com-
missioner to change a method of account-
ing under section 446(e) as published in
the Internal Revenue Bulletin (IRB) (see
Revenue Procedure 2015-13 (2015-5 IRB
419) (or successor) (see §601.601(d)(2)
of this chapter)). A taxpayer that uses the
percentage of completion method for ex-
empt contracts described in paragraph (b)
(1)(ii) of this section that wants to change
to another exempt contract method is to
use the applicable administrative proce-
dures to obtain the automatic consent of
the Commissioner to change such method
under section 446(e) as published in the
IRB. A taxpayer-initiated change in meth-
od of accounting will be permitted only on
a cut-off basis, and thus, a section 481(a)
adjustment will not be permitted or re-
quired. See § 1.460-4(g).
* * * * *
(d) Applicability Dates. Paragraphs
(b)(1)(ii) and (b)(3) of this section apply,
for contracts entered into in taxable years
beginning on or after January 5, 2021.
However, for contracts entered into after
December 31, 2017, in a taxable year end-
ing after December 31, 2017, and before
January 5, 2021, a taxpayer may apply the
paragraphs described in the first sentence
of this paragraph (d), provided that the
taxpayer follows all the applicable rules
contained in the regulations under section
460 for such taxable year and all subse-
quent taxable years.
Par. 20. Section 1.460-4 is amended
by revising the first sentence of paragraph
(f)(1) and adding paragraph (i) to read as
follows:
§1.460-4 Methods of Accounting for
long-term contracts.
*****
(f) * * *(1) * * *Under section 56(a)
(3), a taxpayer subject to the AMT must
use the PCM to determine its AMTI
from any long-term contract entered into
on or after March 1, 1986, that is not a
home construction contract, as defined in
§1.460–3(b)(2).* * *
* * * * *
(i) Applicability date. Paragraph (f)(1) of
this section applies to taxable years begin-
ning on or after January 5, 2021. However,
for a taxable year beginning after December
31, 2017, and before January 5, 2021, a tax-
payer may apply the paragraph described
in the first sentence of this paragraph (i),
provided that the taxpayer follows all the
applicable rules contained in the regulations
under section 460 for such taxable year and
all subsequent taxable years.
* * * * *
Par. 21. Section 1.460-5 is amended:
1. In paragraph (d)(1), by remov-
ing the language “(concerning contracts
of homebuilders that do not satisfy the
$10,000,000 gross receipts test described
in §1.460–3(b)(3) or will not be complet-
ed within two years of the contract com-
mencement date)”.
2. By revising paragraph (d)(3).
The revision reads as follows:
§1.460-5 Cost allocation rules.
* * * * *
(d) * * *
(3) Large homebuilders. A taxpayer
must capitalize the costs of home construc-
tion contracts under section 263A, unless
the taxpayer estimates, when entering into
the contract, that it will be completed with-
in two years of the contract commencement
date, and the taxpayer satisfies the gross
receipts test of section 448(c) described
in §1.460-3(b)(3) for the taxable year in
which the contract is entered into.
* * * * *
Par. 22. Section 1.460-6 is amended:
1. In paragraph (b)(2) introductory text,
by removing the language “section 460(e)
(4)” and adding in its place the language
“section 460(e)(3)”.
2. By revising the first and last sentenc-
es of paragraph (b)(2)(ii).
3. By designating the undesignated text
after paragraph (b)(3)(ii) as paragraph (b)
(3)(iii).
4. In newly designated paragraph (b)
(3)(iii), by adding a sentence to the end of
the paragraph.

Bulletin No. 2021–3 473 January 19, 2021
5. In paragraph (c)(1)(i), by revising
the fifth sentence.
6. In paragraph (c)(2)(i), by revising
the third sentence.
7. In paragraph (c)(2)(iv), by revising
the first sentence.
8. In paragraph (c)(3)(ii), by revising
the first sentence.
9. In paragraph (c)(3)(vi), by revising
the first sentence.
10. In paragraph (d)(2)(i), by removing
the language “whether or not the taxpayer
would have been subject to the alternative
minimum tax” and adding in its place the
language “for taxpayers subject to the al-
ternative minimum tax without regard to
whether tentative minimum tax exceeds
regular tax for the redetermination year”.
11. By revising paragraph (d)(4)(i)(A).
12. By designating paragraph (h)(8)(ii)
Example 7 as paragraph (h)(8)(iii).
13. By revising newly designated para-
graph (h)(8)(iii).
14. By adding paragraph (k).
The revisions and additions read as fol-
lows:
§1.460-6 Look-back method.
* * * * *
(b) * * *
(2) * * *
(ii) is not a home construction contract
but is estimated to be completed within a
2–year period by a taxpayer, other than a
tax shelter prohibited from using the cash
receipts and disbursements method of
accounting under section 448(a)(3), who
meets the gross receipts test of section
448(c) and §1.460-3(b)(3) for the taxable
year in which such contract is entered
into. * * *The look-back method, howev-
er, applies to the alternative minimum tax-
able income from a contract of this type,
for those taxpayers subject to the AMT
in taxable years prior to the filing taxable
year in which the look-back method is re-
quired, unless the contract is exempt from
required use of the percentage of comple-
tion method under section 56(a)(3).
(3) * * *
(iii) * * *For contracts entered into af-
ter December 31, 2017, in a taxable year
ending after December 31, 2017, a tax-
payer’s gross receipts are determined in
the manner required by regulations under
section 448(c).
* * * * *
(c)* * *
(1)* * *
(i)* * * Based on this reapplication,
the taxpayer determines the amount of
taxable income (and, when applicable,
alternative minimum taxable income and
modified taxable income under section
59A(c)) that would have been reported
for each year prior to the filing year that
is affected by contracts completed or ad-
justed in the filing year if the actual, rath-
er than estimated, total contract price and
costs had been used in applying the per-
centage of completion method to these
contracts, and to any other contracts
completed or adjusted in a year preced-
ing the filing year. * * *
* * * * *
(2)* * *(i) * * *The taxpayer then must
determine the amount of taxable income
(and, when applicable, alternative mini-
mum taxable income and modified taxable
income under section 59A(c)) that would
have been reported for each affected tax
year preceding the filing year if the per-
centage of completion method had been
applied on the basis of actual contract
price and contract costs in reporting in-
come from all contracts completed or ad-
justed in the filing year and in any preced-
ing year. * * *
* * * * *
(iv)* * * In general, because income
under the percentage of completion meth-
od is generally reported as costs are in-
curred, the taxable income and, when
applicable, alternative minimum taxable
income and modified taxable income un-
der section 59A(c), are recomputed only
for each year in which allocable contract
costs were incurred. * * *
* * * * *
(3)* * *
(ii)* * * Under the method described
in this paragraph (c)(3) (actual method), a
taxpayer first must determine what its reg-
ular and, when applicable, its alternative
minimum tax and base erosion minimum
tax liability would have been for each re-
determination year if the amounts of con-
tract income allocated in Step One for all
contracts completed or adjusted in the fil-
ing year and in any prior year were substi-
tuted for the amounts of contract income
reported under the percentage of com-
pletion method on the taxpayer’s original
return (or as subsequently adjusted on ex-
amination, or by amended return). * * *
* * * * *
(vi)* * *For purposes of Step Two, the
income tax liability must be redetermined
by taking into account all applicable ad-
ditions to tax, credits, and net operating
loss carrybacks and carryovers. Thus, the
taxes, if any, imposed under sections 55
and 59A (relating to alternative and base
erosion minimum tax, respectively) must
be taken into account. * * *
* * * * *
(d) * * *
(4) * * *(i) * * *(A) General rule. The
simplified marginal impact method is re-
quired to be used with respect to income
reported from domestic contracts by a
pass-through entity that is either a partner-
ship, an S corporation, or a trust, and that
is not closely held. With respect to con-
tracts described in the preceding sentence,
the simplified marginal impact method is
applied by the pass-through entity at the
entity level. The pass-through entity de-
termines the amount of any hypothetical
underpayment or overpayment for a rede-
termination year using the highest rate of
tax in effect for corporations under section
11. However, for redetermination years
beginning before January 1, 2018, the
pass-through entity uses the highest rates
of tax in effect for corporations under sec-
tion 11 and section 55(b)(1). Further, the
pass-through entity uses the highest rates
of tax imposed on individuals under sec-
tion 1 and section 55(b)(1) if, at all times
during the redetermination year involved
(that is, the year in which the hypotheti-
cal increase or decrease in income arises),
more than 50 percent of the interests in the
entity were held by individuals directly or
through 1 or more pass-through entities.
* * * * *
(h)* * *
(8)* * *
(iii) Example 7. X, a calendar year C corporation,
is engaged in the construction of real property under
contracts that are completed within a 24-month pe-
riod. Its average annual gross receipts for the prior
3-taxable-year period does not exceed $25,000,000.
As permitted by section 460(e)(1)(B), X uses the
completed contract method (CCM) for regular tax
purposes. However, X is engaged in the construction
of commercial real property and, for years begin-
ning before January 1, 2018, is required to use the
percentage of completion method (PCM) for alter-
native minimum tax (AMT) purposes. Assume that
for 2017, 2018, and 2019, X has only one long-term

January 19, 2021 474 Bulletin No. 2021–3
contract, which is entered into in 2017 and complet-
ed in 2019 and that in 2017 X’s average annual gross
receipts for the prior 3-taxable-years do not exceed
$10,000,000. Assume further that X estimates gross
income from the contract to be $2,000, total contract
costs to be $1,000, and that the contract is 25 per-
cent complete in 2017 and 70 percent complete in
2018, and 5 percent complete in 2019. In 2019, the
year of completion, gross income from the contract
is actually $3,000, instead of $2,000, and costs are
actually $1,000. Because X was required to use the
PCM for 2017 for AMT purposes, X must apply the
look-back method to its AMT reporting for that year.
X has elected to use the simplified marginal impact
method. For 2017, X’s income using estimated con-
tract price and costs is as follows:
Table 1 to paragraph (h)(8)(iii)
Estimates 2017
Gross Income $500 = ($2,000 x 25%)
Deductions $(250) = ($1,000 x 25%)
Contract Income–PCM $250
(A) When X files its federal income tax return
for 2019, the contract completion year, X applies the
look-back method. For 2017, X’s income using actu-
al contract price and costs is as follows:
Table 2 to paragraph (h)(8)(iii)(A)
Actual 2017
Gross Income $750 = ($3,000 x 25%)
Deductions $(250) = ($1,000 x 25%)
Contract Income–PCM $500
(B) Accordingly, the reallocation of contract
income under the look-back method results in an
increase of income for AMT purposes for 2017 of
$250 ($500-$250). Under the simplified marginal
impact method, X applies the highest rate of tax un-
der section 55(b)(1) to this increase, which produces
a hypothetical underpayment for 2017 of $50 (.20 x
$250). Interest is charged to X on this $50 underpay-
ment from the due date of X’s 2017 return until the
due date of X’s 2019 return. X, a C corporation, is
not subject to the AMT in 2018. X does not compute
alternative minimum taxable income or use the PCM
in that year. Accordingly, look-back does not apply
to 2018.
* * * * *
(k) Applicability date. Paragraphs (b)
(2), (b)(2)(ii), (b)(3)(iii), (c)(1)(i), (c)(2)
(i), (c)(2)(iv), (c)(3)(ii), (c)(3)(vi), (d)(2)
(i), (d)(4)(i)(A), and (h)(8)(iii) of this sec-
tion apply to taxable years beginning on
or after January 5, 2021. However, for a
taxable year beginning after December 31,
2017, and before January 5, 2021, a tax-
payer may apply the paragraphs described
in the first sentence of this paragraph (k),
provided that the taxpayer follows all the
applicable rules contained in the regula-
tions under section 460 for such taxable
year and all subsequent taxable years.
Further, a taxpayer may apply those por-
tions of paragraphs (b)(2)(ii) and (b)(3)
(iii) of this section that relate to section
460(e)(1)(B) for contracts entered into af-
ter December 31, 2017, in a taxable year
ending after December 31, 2017, provided
that the taxpayer follows all the applicable
rules contained in the regulations under
section 460 for such taxable year and all
subsequent taxable years.
Par. 23. §1.471-1 is amended by:
1. Designating the undesignated para-
graph as paragraph (a).
2. Adding a heading to newly desig-
nated paragraph (a) and revising the first
sentence.
3. Adding paragraphs (b) and (c).
The revision and addition read as fol-
lows:
§1.471-1 Need for inventories.
(a) In general. Except as provided in
paragraph (b) of this section, in order to
reflect taxable income correctly, inven-
tories at the beginning and end of each
taxable year are necessary in every case
in which the production, purchase, or sale
of merchandise is an income-producing
factor. * * *
(b) Exemption for certain small busi-
ness taxpayers—(1) In general. Paragraph
(a) of this section shall not apply to a tax-
payer, other than a tax shelter prohibited
from using the cash receipts and disburse-
ments method of accounting (cash meth-
od) under section 448(a)(3), in any tax-
able year if the taxpayer meets the gross
receipts test described in paragraph (b)
(2) of this section, and uses as a method
of accounting for its inventory a method
that is described in paragraph (b)(3) of this
section.
(2) Gross receipts test—(i) In general.
A taxpayer, other than a tax shelter pro-
hibited from using the cash method under
section 448(a)(3), meets the gross receipts
test of this paragraph (b)(2) if it meets the
gross receipts test of section 448(c) and
§1.448-2(c). This gross receipts test ap-
plies even if the taxpayer is not otherwise
subject to section 448(a).
(ii) Application of the gross receipts
test—(A) In general. In the case of any
taxpayer that is not a corporation or part-
nership, and except as otherwise provided
in paragraphs (b)(2)(ii)(B) and (C) of this
section, the gross receipts test of section
448(c) and the accompanying regulations
are applied in the same manner as each
trade or business of the taxpayer were a
corporation or partnership.
(B) Gross receipts of individuals, etc.
Except when the aggregation rules of sec-
tion 448(c)(2) apply, the gross receipts
of a taxpayer other than a corporation or
partnership are the amount derived from
all trades or businesses of such taxpayer.
Amounts not related to a trade or business-
es are excluded from the gross receipts of
the taxpayer. For example, an individual
taxpayer’s gross receipts do not include
inherently personal amounts, such as: per-
sonal injury awards or settlements with
respect to an injury of the individual tax-
payer, disability benefits, Social Security
benefits received by the taxpayer during
the taxable year, and wages received as an
employee that are reported on Form W-2.
(C) Partners and S corporation share-
holders—(1) In general. Except when the
aggregation rules of section 448(c)(2) ap-
ply, each partner in a partnership includes
a share of the partnership’s gross receipts
in proportion to such partner’s distributive
share (as determined under section 704) of
items of gross income that were taken into
account by the partnership under section
703. Similarly, a shareholder includes the
pro rata share of S corporation gross re-
ceipts taken into account by the S corpo-
ration under section 1363(b).
(2) [Reserved]
(D) Examples. The operation of this
paragraph (b)(2) is illustrated by the fol-
lowing examples:
(1) Example 1. Taxpayer A, a calendar year S
corporation, is a reseller and maintains inventories.
In 2017, 2018, and 2019, A’s gross receipts were $10
million, $11 million, and $13 million respectively. A
is not prohibited from using the cash method under
section 448(a)(3). For 2020, A meets the gross re-
ceipts test of paragraph (b)(2) of this section.
(2) Example 2. Taxpayer B operates two separate
and distinct trades or businesses that are reported on
Schedule C, Profit or Loss from Business, of B’s Fed-
eral income tax return. For 2020, one trade or busi-
ness has annual average gross receipts of $5 million,
and the other trade or business has average annual
gross receipts of $35 million. Under paragraph (b)(2)
(ii)(B) of this section, for 2020, neither of B’s trades
or businesses meets the gross receipts test of para-
graph (b)(2) of this section ($5 million + $35 million
= $40 million, which is greater than the inflation-ad-
justed gross receipts test amount for 2020, which is
$26 million).
(3) Example 3. Taxpayer C is an individual who
operates three separate and distinct trades or business
that are reported on Schedule C of C’s Federal income

Bulletin No. 2021–3 475 January 19, 2021
tax return. For 2020, Business X is a retail store with
average annual gross receipts of $15 million, Business
Y is a dance studio with average annual gross receipts
of $6 million, and Business Z is a car repair shop with
average annual gross receipts of $12 million. Under
paragraph (b)(2)(ii)(B) of this section, C’s gross re-
ceipts are the combined amount derived from all three
of C’s trades or businesses. Therefore, for 2020, X, Y
and Z do not meet the gross receipts test of paragraph
(b)(2)(i) of this section ($15 million + $6 million +
$12 million = $33 million, which is greater than the
inflation-adjusted gross receipts test amount for 2020,
which is $26 million).
(3) Methods of accounting under the
small business taxpayer exemption. A tax-
payer eligible to use, and that chooses to
use, the exemption described in paragraph
(b) of this section may account for its in-
ventory by either:
(i) Using a method that treats its in-
ventory as non-incidental materials and
supplies (section 471(c) NIMS inventory
method), as described in paragraph (b)(4)
of this section; or
(ii) Using the method for each item that
is reflected in the taxpayer’s applicable
financial statement (AFS) (AFS section
471(c) inventory method); or, if the tax-
payer does not have an AFS for the tax-
able year, the books and records of the
taxpayer prepared in accordance with the
taxpayer’s accounting procedures, as de-
fined in paragraph (b)(6)(ii) of this section
(non-AFS section 471(c) inventory meth-
od).
(4) Inventory treated as non-incidental
materials and supplies—(i) In general.
The costs of inventory treated as non-in-
cidental materials and supplies are recov-
ered through cost of goods sold only in the
taxable year in which the inventory is used
or consumed in the taxpayer’s business, or
in the taxable year in which the taxpayer
pays for or incurs the cost of the inven-
tory, whichever is later. Inventory treated
as non-incidental materials and supplies
is used or consumed in the taxpayer’s
business in the taxable year in which the
taxpayer provides the inventory to its cus-
tomer. The costs of inventory are treated
as non-incidental materials and supplies
under this paragraph (b)(4) are not eligi-
ble for the de minimis safe harbor election
under §1.263(a)-1(f)(2).
(ii) Identification and valuation of
inventory treated as non-incidental ma-
terials and supplies. A taxpayer may
determine the amount of the costs of its
inventory treated as non-incidental ma-
terials and supplies that are recoverable
through costs of goods sold by using
either a specific identification method,
a first-in, first-out (FIFO) method, or an
average cost method, provided that meth-
od is used consistently. See §1.471-2(d).
A taxpayer that uses the section 471(c)
NIMS inventory method may not use any
other method described in the regulations
under section 471, or the last-in, first-out
(LIFO) method described in section 472
and the accompanying regulations, to ei-
ther identify inventory treated as non-in-
cidental materials and supplies, or to
value that inventory treated as non-inci-
dental materials and supplies. The inven-
tory costs includible in the section 471(c)
NIMS inventory method are the direct
material costs of the property produced
or the costs of property acquired for re-
sale. However, an inventory cost does
not include a cost for which a deduction
would be disallowed, or that is not oth-
erwise recoverable but for paragraph (b)
(4) of this section, in whole or in part,
under a provision of the Internal Revenue
Code.
(iii) Allocation methods. A taxpayer
treating its inventory as non-incidental
materials and supplies under this para-
graph (b)(4) may allocate the costs of such
inventory by using specific identification
or any other reasonable method.
(iv) Example. Taxpayer D is a baker that reports
its baking trade or business on Schedule C, Profit or
Loss From Business, of the Form 1040, Individual
Tax Return, and D’s baking business has average
annual gross receipts for the 3-taxable years prior
to 2019 of less than $100,000. D meets the gross
receipts test of section 448(c) and is not prohibited
from using the cash method under section 448(a)(3)
in 2019. Therefore, D qualifies as a small business
taxpayer under paragraph (b)(2) of this section. D
uses the overall cash method, and the section 471(c)
NIMS inventory method. D purchases $50 of peanut
butter in November 2019. In December 2019, D uses
all of the peanut butter to bake cookies available for
immediate sale. D sells those peanut butter cookies
to customers in January 2020. The peanut butter
cookies are used or consumed under paragraph (b)
(4)(i) of this section in January 2020 when the cook-
ies are sold to customers, and D may recover the cost
of the peanut butter in 2020.
(5) AFS section 471(c) inventory meth-
od—(i) In general. A taxpayer that meets
the gross receipts test described in para-
graph (b)(2) of this section and that has
an AFS for such taxable year may use the
AFS section 471(c) inventory method de-
scribed in this paragraph to account for its
inventory costs for the taxable year. For
purposes of the AFS section 471(c) inven-
tory method, an inventory cost is a cost of
production or resale that a taxpayer capi-
talizes to inventory property produced or
property acquired for resale in its AFS.
For purposes of the AFS section 471(c)
inventory method, costs that are general-
ly required to be capitalized to inventory
under section 471(a) but that the taxpayer
does not capitalize to inventory on its AFS
are not required to be capitalized to inven-
tory. However, an inventory cost does not
include a cost that is neither deductible nor
otherwise recoverable but for paragraph
(b)(5) of this section, in whole or in part,
under a provision of the Internal Revenue
Code (for example, section 162(c), (e), (f),
(g), or 274). In lieu of the inventory meth-
od described in section 471(a), a taxpayer
using the AFS section 471(c) inventory
method recovers its inventory costs in ac-
cordance with the inventory method used
in its AFS.
(ii) Definition of Applicable Financial
Statement (AFS). The term applicable
financial statement (AFS) is defined in
section 451(b)(3) and the accompanying
regulations. See §1.451-3(a)(5). The rules
relating to additional AFS issues provided
in §1.451-3(h) apply to the AFS section
471(c) inventory method. In the case of a
taxpayer with a financial accounting year
that differs from the taxpayer’s taxable
year, the taxpayer must consistently use
the same method of accounting described
in §1.451-3(h)(4)(i)(A) through (C) that is
used for section 451(b) purposes to also
determine its inventory for the taxable
year under this paragraph (b)(5)(ii). A tax-
payer has an AFS for the taxable year if all
of the taxpayer’s taxable year is covered
by an AFS.
(iii) Timing of inventory costs. Not-
withstanding the timing rules used in
the taxpayer’s AFS, the amount of any
inventoriable cost may not be capital-
ized or otherwise taken into account for
Federal income tax purposes any earlier
than the taxable year during which the
amount is paid or incurred under the tax-
payer’s overall method of accounting, as
described in §1.446-1(c)(1). For example,
in the case of an accrual method taxpay-
er, inventoriable costs must satisfy the all
events test, including economic perfor-
mance, of section 461. See §1.446-1(c)(1)

January 19, 2021 476 Bulletin No. 2021–3
(ii) and section 461 and the accompanying
regulations.
(iv) Example. H is a calendar year C corporation
that is engaged in the trade or business of selling of-
fice supplies and providing copier repair services. H
meets the gross receipts test of section 448(c) and is
not prohibited from using the cash method under sec-
tion 448(a)(3) for 2019 or 2020. For Federal income
tax purposes, H chooses to account for purchases
and sales of inventory using an accrual method of
accounting and for all other items using the cash
method. For AFS purposes, H uses an overall accrual
method of accounting. H uses the AFS section 471(c)
inventory method of accounting. In H’s 2019 AFS, H
incurred $2 million in purchases of office supplies
held for resale and recovered the $2 million as cost
of goods sold. On January 5, 2020, H makes payment
on $1.5 million of these office supplies. For purposes
of the AFS section 471(c) inventory method of ac-
counting, H can recover the $2 million of office sup-
plies in 2019 because the amount has been included
in cost of goods sold in its AFS inventory method
and section 461 has been satisfied.
(6) Non-AFS section 471(c) inventory
method—(i) In general. A taxpayer that
meets the gross receipts test described in
paragraph (b)(2) of this section for a tax-
able year and that does not have an AFS,
as defined in paragraph (b)(5)(ii) of this
section, for such taxable year may use
the non-AFS section 471(c) inventory
method to account for its inventories for
the taxable year in accordance with this
paragraph (b)(6). The non-AFS section
471(c) inventory method is the method of
accounting used for inventory in the tax-
payer’s books and records that properly
reflect its business activities for non-tax
purposes and are prepared in accordance
with the taxpayer’s accounting proce-
dures. For purposes of the non-AFS sec-
tion 471(c) inventory method, an inven-
tory cost is a cost of production or resale
that the taxpayer capitalizes to inventory
property produced or property acquired
for resale in its books and records, except
as provided in paragraph (b)(6)(ii) of this
section. Costs that are generally required
to be capitalized to inventory under sec-
tion 471(a), but that the taxpayer does not
capitalize in its books and records are not
required to be capitalized to inventory.
However, an inventory cost does not in-
clude a cost that is neither deductible nor
otherwise recoverable but for paragraph
(b)(5) of this section, in whole or in part,
under a provision of the Internal Revenue
Code (for example, section 162(c), (e),
(f), (g), or 274). In lieu of the inventory
method described in section 471(a), a tax-
payer using the non-AFS section 471(c)
inventory method recovers its applicable
costs through its book inventory method
of accounting. A taxpayer that has an AFS
for such taxable year may not use the non-
AFS section 471(c) inventory method.
(ii) Timing and amounts of costs. Not-
withstanding the timing of costs reflected
in the taxpayer’s books and records, a tax-
payer may not recover any costs that have
not been paid or incurred under the tax-
payer’s overall method of accounting, as
described in §1.446-1(c)(1). For example,
in the case of an accrual method taxpayer
or a taxpayer using an accrual method for
purchases and sales, inventory costs must
satisfy the all events test, including eco-
nomic performance, under section 461(h).
See §1.446-1(c)(1)(ii), and section 461
and the accompanying regulations.
(iii) Examples. The following exam-
ples illustrate the rules of paragraph (b)(6)
of this section.
(A) Example 1. Taxpayer E is a C corporation
that is engaged in the retail trade or business of sell-
ing beer, wine, and liquor. In 2019, E has average
annual gross receipts for the prior 3-taxable-years of
$15 million and is not otherwise prohibited from us-
ing the cash method under section 448(a)(3). E does
not have an AFS for the 2019 taxable year. E is el-
igible to use the non-AFS section 471(c) inventory
method of accounting. E uses the overall cash meth-
od, and the non-AFS section 471(c) inventory meth-
od of accounting for Federal income tax purposes.
In E’s electronic bookkeeping software, E treats all
costs paid during the taxable year as presently de-
ductible. As part of its regular business practice, E’s
employees take a physical count of inventory on E’s
selling floor and its warehouse on December 31,
2019, and E uses this physical count as part of its
books and records for purposes of capitalizing and
allocating costs to inventory. E also makes represen-
tations to its creditor of the cost of inventory on hand
for specific categories of product it sells. E may not
expense all of its costs paid during the 2019 taxable
year because its books and records do not accurately
reflect the inventory records used for non-tax pur-
poses in its regular business activity. Instead, E must
use the physical inventory count taken at the end of
2019 to determine how its capitalized costs are allo-
cated and recovered.
(B) Example 2. Same facts as Example (1) in
paragraph (b)(6)(iii)(A) of this section but E does not
use the physical count to capitalize and allocate costs
to inventory and does not make any representations
about inventory on hand to any creditors. Although
E pays or incurs costs that are generally required to
be capitalized to inventory under section 471(a), be-
cause such costs are not capitalized to inventory in
E’s books and records, they are not required to be
capitalized to inventory under paragraph (b)(6)(i) of
this section.
(C) Example 3. Same facts as Example (1) in
paragraph (b)(6)(iii)(A) of this section but E does
not use the physical count to capitalize and allocate
costs to inventory in its electronic bookkeeping soft-
ware and does not make any representations about
inventory on hand to any external parties. E does
use the physical count to value inventory on hand
for internal reports to its shareholders. The internal
reports to its shareholders are part of E’s books and
records and must be taken into account for E’s non-
AFS section 471(c) inventory method. E recovers its
inventory costs consistent with its non-AFS section
471(c) inventory method.
(D) Example 4. Taxpayer F is a C corporation
that is engaged in the manufacture of baseball bats.
In 2019, F has average annual gross receipts for the
prior 3-taxable-years of less than $25 million and is
not otherwise prohibited from using the cash method
under section 448(a)(3). F does not have an AFS for
the 2019 taxable year. For Federal income tax pur-
poses, F uses the overall cash method of accounting,
and the non-AFS section 471(c) inventory method
of accounting. For its books and records, F uses an
overall accrual method and maintains inventories.
In December 2019, F’s financial statements show
$500,000 of direct and indirect material costs. F pays
its supplier in January 2020. Under paragraph (b)(6)
(ii) of this section, F recovers its direct and indirect
material costs in 2020.
(E) Example 5. Taxpayer G is a baker that reports
its baking trade or business on Schedule C, Profit or
Loss From Business, of the Form 1040, Individual
Tax Return. In 2020, G’s baking business has aver-
age annual gross receipts for the prior 3-taxable years
of less than $100,000 and is not otherwise prohibited
from using the cash method under section 448(a)(3).
G does not have an AFS for the 2020 taxable year.
For Federal income tax purposes, G uses the overall
cash method of accounting and the non-AFS section
471(c) inventory method. In G’s books and records
for 2020 that properly reflects its business activities
for non-tax purposes, G capitalizes the cost of its
cookie ingredients to inventory but immediately ex-
penses the cost of labor for G’s employee who bakes
the cookies. Under paragraphs (b)(6)(i) and (ii) of
this section, G treats as an inventory cost the cost
of its cookie ingredients and recovers such costs in
accordance with the accounting procedures used to
prepare its books and records, or, if later, when paid.
Additionally, although the cost of direct labor is gen-
erally required to be capitalized to inventory under
section 471(a), because such cost is not capitalized
to inventory in G’s books and records, it is not re-
quired to be capitalized to inventory under paragraph
(b)(6)(i) of this section. Further, because such direct
labor cost is generally deductible under section 162,
and not otherwise required to be capitalized under
section 263(a), G may deduct the cost of labor in the
year G pays that expense.
(F) Example 6. Taxpayer H is a partnership en-
gaged in the resale of beer, wine, and liquor. In 2020,
H has average annual gross receipts for the prior
3-taxable-years of less than $25 million and is not
otherwise prohibited from using the cash method un-
der section 448(a)(3). H does not have an AFS for the
2020 taxable year. For Federal income tax purposes,
H uses the overall cash method of accounting, and
the non-AFS section 471(c) inventory method of ac-
counting. For its books and records, H uses the over-
all cash method. As part of its regular business prac-

Bulletin No. 2021–3 477 January 19, 2021
tice, H’s employees take regular physical counts of
the inventory on the shop floor and in the storeroom,
however H’s method of accounting for inventory
for its books and records does not allocate costs be-
tween ending inventory and cost of goods sold, and
instead expenses the cost of the inventory in the year
it was paid for. Prior to December 2020, H acquires
and pays for $500,000 of beer, wine, and liquor. In
addition, on December 1, 2020, H acquires $50,000
in beer and wine, and pays for this beer and wine on
December 20, 2020. H may recover as deductions in
2020 the $550,000 of inventory costs.
(G) Example 7. Taxpayer J is a partnership en-
gaged in the resale of beer, wine, and liquor. In 2020,
J has average annual gross receipts for the prior
3-taxable-years of less than $25 million and is not
otherwise prohibited from using the cash method
under section 448(a)(3). J does not have an AFS for
the 2020 taxable year. For Federal income tax pur-
poses, J uses the overall cash method of accounting,
and the non-AFS section 471(c) inventory method
of accounting. For its books and records, J uses the
overall cash method. J maintains a point-of-sale
computer system that tracks acquisition costs and in-
ventory levels of the beer, wine, and liquor. The led-
ger is periodically reconciled with physical counts
performed by J’s employees. J must use the physical
inventory count and ledger to determine its ending
inventory. J includes in cost of goods sold for 2020
those inventory costs that are not properly allocated
to ending inventory.
(7) Effect of section 471(c) on other
provisions. Nothing in section 471(c) shall
have any effect on the application of any
other provision of law that would otherwise
apply, and no inference shall be drawn from
section 471(c) with respect to the applica-
tion of any such provision. For example,
an accrual method taxpayer that includes
inventory costs in its AFS is required to
satisfy section 461 before such cost can
be included in cost of goods sold for the
taxable year. Similarly, nothing in section
471(c) affects the requirement under sec-
tion 446(e) that a taxpayer secure the con-
sent of the Commissioner before changing
its method of accounting. If an item of in-
come or expense is not treated consistently
from year to year, that treatment may not
clearly reflect income, notwithstanding the
application of this section. Finally, nothing
in section 471(c) permits the deduction or
recovery of any cost that a taxpayer is oth-
erwise precluded from deducting or recov-
ering under any other provision in the Code
or Regulations.
(8) Method of accounting—(i) In gen-
eral. A change in the method of treating
inventory under this paragraph (b) is a
change in method of accounting under
sections 446 and 481 and the accompa-
nying regulations. A taxpayer changing
its method of accounting under paragraph
(b) of this section may do so only with
the consent of the Commissioner as re-
quired under section 446(e) and §1.446-
1. For example, a taxpayer using the AFS
section 471(c) inventory method or non-
AFS section 471(c) inventory method that
wants to change its method of accounting
for inventory in its AFS, or its books and
records, respectively, is required to secure
the consent of the Commissioner before
using this new method for Federal income
tax purposes. However, a change from
having an AFS to not having an AFS, or
vice versa, without a change in the under-
lying method for inventory for financial
reporting purposes that affects Federal
income tax is not a change in method of
accounting for such inventory under sec-
tion 446(e). In the case of any taxpayer re-
quired by this section to change its meth-
od of accounting for any taxable year, the
change shall be treated as a change initiat-
ed by the taxpayer. For rules relating to the
clear reflection of income and the pattern
of consistent treatment of an item, see sec-
tion 446 and §1.446-1. The amount of the
net section 481(a) adjustment and the ad-
justment period necessary to implement a
change in method of accounting required
under this section are determined under
§1.446-1(e) and the applicable adminis-
trative procedures to obtain the Commis-
sioner’s consent to change a method of
accounting as published in the Internal
Revenue Bulletin (see Revenue Procedure
2015-13 (2015-5 IRB 419) (or successor)
(see also §601.601(d)(2) of this chapter).
(ii) Automatic consent for certain meth-
od changes. Certain changes in method of
accounting made under paragraph (b) of
this section may be made under the pro-
cedures to obtain the automatic consent of
the Commissioner to change a method of
accounting. See Revenue Procedure 2015-
13 (2015-5 IRB 419) (or successor) (see
§601.601(d)(2) of this chapter)). In certain
situations, special terms and conditions
may apply.
(c) Applicability dates. This section
applies for taxable years beginning on
or after January 5, 2021. However, for a
taxable year beginning after December
31, 2017, and before January 5, 2021, a
taxpayer may apply this section provided
that the taxpayer follows all the applica-
ble rules contained in this section for such
taxable year and all subsequent taxable
years.
Douglas W. O’Donnell,
Acting Deputy Commissioner for
Services and Enforcement.
Approved: December 18, 2020.
David J. Kautter,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on
12/31/2020, 8:45 a.m., and published in the issue of
the Federal Register for 01/05/2021)

January 19, 2021 478 Bulletin No. 2021–3
Part III
2021 Standard Mileage
Rates
Notice 2021-2
SECTION 1. PURPOSE
This notice provides the optional 2021
standard mileage rates for taxpayers to use
in computing the deductible costs of oper-
ating an automobile for business, charita-
ble, medical, or moving expense purpos-
es. This notice also provides the amount
taxpayers must use in calculating reduc-
tions to basis for depreciation taken under
the business standard mileage rate, and the
maximum standard automobile cost that
may be used in computing the allowance
under a fixed and variable rate (FAVR)
plan. Additionally, this notice provides the
maximum fair market value (FMV) of em-
ployer-provided automobiles first made
available to employees for personal use in
calendar year 2021 for which employers
may use the fleet-average valuation rule
in § 1.61-21(d)(5)(v) of the Income Tax
Regulations or the vehicle cents-per-mile
valuation rule in § 1.61-21(e).
SECTION 2. BACKGROUND
Rev. Proc. 2019-46, 2019-49 I.R.B.
1301, provides rules for computing the
deductible costs of operating an automo-
bile for business, charitable, medical, or
moving expense purposes, and for sub-
stantiating, under § 274(d) of the Internal
Revenue Code and § 1.274-5, the amount
of ordinary and necessary business ex-
penses of local transportation or travel
away from home. Taxpayers using the
standard mileage rates must comply with
Rev. Proc. 2019-46. However, a taxpayer
is not required to use the substantiation
methods described in Rev. Proc. 2019-46,
but instead may substantiate using actual
allowable expense amounts if the taxpayer
maintains adequate records or other suffi-
cient evidence.
An independent contractor conducts
an annual study for the Internal Revenue
Service of the fixed and variable costs of
operating an automobile to determine the
standard mileage rates for business, med-
ical, and moving use reflected in this no-
tice. The standard mileage rate for charita-
ble use is set by § 170(i).
Longstanding regulations under § 61
provide special valuation rules for em-
ployer-provided automobiles. The amount
that must be included in the employee’s
income and wages for the personal use of
an employer-provided automobile gener-
ally is determined by reference to the au-
tomobile’s FMV. If an employer chooses
to use a special valuation rule, the special
value is treated as the FMV of the benefit
for income tax and employment tax pur-
poses. Section 1.61-21(b)(4). Two such
special valuation rules, the fleet-average
valuation rule and the vehicle cents-per-
mile valuation rule, are set forth in § 1.61-
21(d)(5)(v) and § 1.61-21(e), respective-
ly. These two special valuation rules are
subject to limitations, including that they
may be used only in connection with auto-
mobiles having values that do not exceed
a maximum amount set forth in the regu-
lations.
SECTION 3. STANDARD MILEAGE
RATES
The standard mileage rate for transpor-
tation or travel expenses is 56 cents per
mile for all miles of business use (busi-
ness standard mileage rate). See section 4
of Rev. Proc. 2019-46. However, § 11045
of the Tax Cuts and Jobs Act, Public Law
115-97, 131. Stat. 2054 (December 22,
2017) (the “TCJA”) suspends all miscella-
neous itemized deductions that are subject
to the two-percent of adjusted gross in-
come floor under § 67, including unreim-
bursed employee travel expenses, for tax-
able years beginning after December 31,
2017, and before January 1, 2026. Thus,
the business standard mileage rate provid-
ed in this notice cannot be used to claim
an itemized deduction for unreimbursed
employee travel expenses during the sus-
pension. Notwithstanding the foregoing
suspension of miscellaneous itemized
deductions, deductions for expenses that
are deductible in determining adjusted
gross income are not suspended. For ex-
ample, members of a reserve component
of the Armed Forces of the United States
(Armed Forces), state or local government
officials paid on a fee basis, and certain
performing artists are entitled to deduct
unreimbursed employee travel expenses
as an adjustment to total income on line
11 of Schedule 1 of Form 1040 (2020),
not as an itemized deduction on Sched-
ule A of Form 1040 (2020), and therefore
may continue to use the business standard
mileage rate.
The standard mileage rate is 14 cents
per mile for use of an automobile in ren-
dering gratuitous services to a charitable
organization under § 170. See section 5 of
Rev. Proc. 2019-46.
The standard mileage rate is 16 cents
per mile for use of an automobile: (1) for
medical care described in § 213; or (2) as
part of a move for which the expenses are
deductible under § 217(g). See section
5 of Rev. Proc. 2019-46. Section 11049
of the TCJA suspends the deduction for
moving expenses for taxable years begin-
ning after December 31, 2017, and before
January 1, 2026. However, the suspension
does not apply to members of the Armed
Forces on active duty who move pursuant
to a military order and incident to a per-
manent change of station. Thus, except
for taxpayers to whom § 217(g) applies,
the standard mileage rate provided in this
notice is not applicable for the use of an
automobile as part of a move occurring
during the suspension.
SECTION 4. BASIS REDUCTION
AMOUNT
For automobiles a taxpayer uses for
business purposes, the portion of the busi-
ness standard mileage rate treated as de-
preciation is 25 cents per mile for 2017, 25
cents per mile for 2018, 26 cents per mile
for 2019, 27 cents per mile for 2020, and
26 cents per mile for 2021. See section
4.04 of Rev. Proc. 2019-46.
SECTION 5. MAXIMUM STANDARD
AUTOMOBILE COST
For purposes of computing the allow-
ance under a FAVR plan, the standard au-
tomobile cost may not exceed $51,100 for

Bulletin No. 2021–3 479 January 19, 2021
automobiles (including trucks and vans).
See section 6.02(6) of Rev. Proc. 2019-46.
SECTION 6. MAXIMUM VALUE
OF EMPLOYER-PROVIDED
AUTOMOBILES
For purposes of the fleet-average val-
uation rule in § 1.61-21(d)(5)(v) and the
vehicle cents-per-mile valuation rule in
§ 1.61-21(e), the maximum FMV of au-
tomobiles (including trucks and vans) first
made available to employees in calendar
year 2021 is $51,100.
SECTION 7. EFFECTIVE DATE
This notice is effective for: (1) de-
ductible transportation expenses paid or
incurred on or after January 1, 2021; (2)
mileage allowances or reimbursements
paid to a charitable volunteer or a member
of the Armed Forces to whom § 217(g) ap-
plies: (a) on or after January 1, 2021, and
(b) for transportation expenses the char-
itable volunteer or such member of the
Armed Forces pays or incurs on or after
January 1, 2021; and (3) for purposes of
the maximum FMV of employer-provided
automobiles for which employers may use
the fleet-average valuation rule in §1.61-
21(d)(5)(v) or the vehicle cents-per-mile
rule in §1.61-21(e), automobiles first
made available to employees for personal
use on or after January 1, 2021.
SECTION 8. EFFECT ON OTHER
DOCUMENTS
Notice 2020-05 is superseded.
DRAFTING INFORMATION
The principal author of this notice is
Anna Gleysteen of the Office of Associate
Chief Counsel (Income Tax and Account-
ing). For further information on this notice
regarding the use of an employee-provid-
ed automobile, contact Ms. Gleysteen at
(202) 317-7007 (not a toll-free number).
For further information on this notice re-
garding the use of an employer-provided
automobile, contact Stephanie Caden of
the Office of Associate Chief Counsel
(Employee Benefits, Exempt Organiza-
tions, and Employment Taxes), at (202)
317-4774 (not a toll-free number).
Beginning of Construction
for Sections 45 and 48;
Extension of Continuity
Safe Harbor for Offshore
Projects and Federal Land
Projects
Notice 2021-5
SECTION 1. PURPOSE
This notice clarifies and modifies the
prior notices
1
published by the Department
of the Treasury (Treasury Department)
and the Internal Revenue Service (IRS)
that address the beginning of construction
requirement for qualified facility and en-
ergy property projects under §§ 45 and 48,
respectively, of the Internal Revenue Code
(Code). Specifically, section 4.01 of this
notice provides that a qualified facility or
energy property construction project that
is an Offshore Project or a Federal Land
Project (each as defined in section 4.02 of
this notice) satisfies the Continuity Safe
Harbor (as defined in section 2.04(3) of
this notice) if a taxpayer places the quali-
fied facility or energy property that is the
subject of the project into service within
10 calendar years after the calendar year
during which construction of the project
began.
SECTION 2. BACKGROUND
.01 Renewable Electricity Production
and Investment Tax Credits. Section 38 of
the Code allows certain business credits
against the tax imposed by chapter 1 of
subtitle A of the Code. Among the cred-
its allowed by § 38 are (i) the renewable
electricity production tax credit under § 45
of the Code (PTC), and (ii) the investment
tax credit determined under § 46 of the
Code (ITC). The ITC includes the energy
credit under § 48. See § 46(2).
.02 Qualification and Calculation of
PTC and ITC. To qualify for the PTC,
electricity must, among other things, be
produced by the taxpayer at a qualified fa-
cility described in § 45(d). See § 45(a)(2)
(A)(ii). The PTC for any taxable year is
calculated by multiplying an inflation-ad-
justed credit rate by kilowatt hours of
electricity produced and sold by the tax-
payer to an unrelated person. See § 45(a).
The ITC is calculated as a percentage of
the basis of energy property (as defined
in § 48(a)(3)) placed in service during the
taxable year. See § 48(a)(1). Additionally,
under § 48(a)(5), a taxpayer may elect to
claim the ITC in lieu of the PTC with re-
spect to qualified property that is part of
certain qualified facilities. Both the PTC
and the ITC have beginning of construc-
tion requirements.
.03 Recent amendments to PTC and
ITC statutes. The Taxpayer Certainty and
Disaster Tax Relief Act of 2020 (Act),
enacted as Division EE of the Consoli-
dated Appropriations Act, 2021, Public
Law 116-260 (Dec. 27, 2020), amend-
ed §§ 45 and 48 with regard to the PTC
and the ITC. Section 131(a) of the Act
extended the deadlines for the beginning
of construction requirements for certain
qualified facilities to December 31, 2021
(in other words, before January 1, 2022).
Section 131(b) of the Act extended the
beginning of construction deadline appli-
cable to the election to claim the ITC in
lieu of the PTC by one year with respect
to certain qualified facilities if construc-
tion of such facilities begins before Janu-
ary 1, 2022. Section 132(a) of the Act ex-
tended the deadlines for the beginning of
construction requirements for certain ITC
energy property to December 31, 2023 (in
other words, before January 1, 2024). In
addition, sections 131(c) and 132(b) of the
Act extended beginning of construction
deadlines for the phaseout provisions ap-
plicable to the PTC and the ITC. Finally,
section 204 of the Act amends § 48(a)(5)
of the Code to provide special rules for
“qualified offshore wind facilities.”
.04 Physical Work Test, Five Percent
Safe Harbor, and Continuity Requirement
for Qualified Facilities. Notice 2013-29
provides two methods to establish the
1
Notice 2013-29, 2013-20 I.R.B. 1085; Notice 2013-60, 2013-44 I.R.B. 431; Notice 2014-46, 2014-36 I.R.B. 520; Notice 2015-25, 2015-13 I.R.B. 814; Notice 2016-31, 2016-23 I.R.B.
1025; Notice 2017-04, 2017-4 I.R.B. 541; Notice 2018-59, 2018-28 I.R.B. 196; Notice 2019-43, 2019-31 I.R.B. 487; and Notice 2020-41, 2020-25 I.R.B. 954 (collectively, the prior notices).

January 19, 2021 480 Bulletin No. 2021–3
beginning of construction for a qualified
facility: (i) the “Physical Work Test” and
(ii) the “Five Percent Safe Harbor.” Each
method requires a taxpayer to make con-
tinuous progress towards completion once
construction of the qualified facility proj-
ect has begun (Continuity Requirement).
(1) Physical Work Test. Section 4 of
Notice 2013-29 sets forth the Physical
Work Test. Section 4.01 of the notice
provides the following, which requires a
facts-and-circumstances analysis:
Construction of a qualified facility be-
gins when physical work of a significant
nature begins. . . . Whether a taxpayer has
begun construction of a facility before
[the statutory deadline], will depend on
the relevant facts and circumstances. The
[IRS] will closely scrutinize a facility, and
may determine that construction has not
begun on a facility before [the statutory
deadline], if a taxpayer does not maintain
a continuous program of construction as
determined under section 4.06 [(Continu-
ous Construction Test)]. (Emphasis add-
ed.)
Section 4.06(1) of Notice 2013-29
provides that a “continuous program of
construction” involves continuing physi-
cal work of a significant nature. Further,
section 4.06(1) provides that whether the
taxpayer has maintained a continuous pro-
gram of construction (and thus satisfied
the Continuous Construction Test) will be
determined by the relevant facts and cir-
cumstances.
(2) Five Percent Safe Harbor. Section
5 of Notice 2013-29 sets forth the Five
Percent Safe Harbor. Section 5.01 of the
notice provides the following general rule,
which also requires a facts-and-circum-
stances analysis:
Construction of a facility will be con-
sidered as having begun before [the
statutory deadline], if (1) a taxpayer
pays or incurs (within the meaning of
Treas. Reg. § 1.461-1(a)(1) and (2))
five percent or more of the total cost
of the facility, except as provided in
section 5.01(2), before [the statutory
deadline], and (2) thereafter, the tax-
payer makes continuous efforts to ad-
vance towards completion of the facil-
ity (as determined under section 5.02)
[(Continuous Efforts Test)]. (Emphasis
added.)
Section 5.02(1) of Notice 2013-29
provides that whether a taxpayer makes
continuous efforts to advance towards
completion of the facility (and thus satis-
fies the Continuous Efforts Test) will be
determined by the relevant facts and cir-
cumstances. Further, section 5.02(1) pro-
vides that facts and circumstances indicat-
ing continuous efforts to advance towards
completion of the facility may include, but
are not limited to: (i) paying or incurring
additional amounts included in the total
cost of the facility; (ii) entering into bind-
ing written contracts for components or
future work on construction of the facil-
ity; (iii) obtaining necessary permits; and
(iv) performing physical work of a signif-
icant nature (as described in section 4.02
of Notice 2013-29). See section 5.02(1)(a)
through (d).
(3) Continuity Safe Harbor for de-
termining satisfaction of the Continuity
Requirement. Notice 2013-60 provides
clarifications for determining whether a
taxpayer satisfies the Physical Work Test
or the Five Percent Safe Harbor with re-
gard to a qualified facility. In particular,
section 3.02 of Notice 2013-60 provides
a “Continuity Safe Harbor” that allows
a facility to be deemed to have satisfied
the Continuity Requirement. Under the
Continuity Safe Harbor, if a facility is
placed in service before January 1, 2016,
the facility will be considered to satis-
fy (i) the Continuous Construction Test,
for purposes of satisfying the Physical
Work Test, or (ii) the Continuous Efforts
Test, for purposes of satisfying the Five
Percent Safe Harbor. Section 3.02 of the
notice also provides that, if a facility is
not placed in service before January 1,
2016, whether the facility satisfies the
Continuous Construction Test or Con-
tinuous Efforts Test will be determined
by the relevant facts and circumstances,
as described in sections 4.06 and 5.02 of
Notice 2013-29, respectively.
.05 Additional notices further extend-
ing and modifying the Continuity Safe
Harbor. The Treasury Department and the
IRS have published several notices to ex-
tend and otherwise modify the Continuity
Safe Harbor, which include the following:
(1) Notice 2015-25, which extends the
Continuity Safe Harbor for one year.
(2) Notice 2016-31, which modifies
the Continuity Safe Harbor (as originally
provided in section 3.02 of Notice 2013-
60 and extended by Notice 2015-25) by
providing that, if a taxpayer places a fa-
cility in service by the later of (i) a calen-
dar year that is no more than four calendar
years after the calendar year during which
construction of the facility began, or (ii)
December 31, 2016, the facility will be
considered to satisfy the Continuity Safe
Harbor.
(3) Notice 2017-04, which further ex-
tends and modifies the Continuity Safe
Harbor by providing that, if a taxpayer
places a facility in service by the later of
(i) a calendar year that is no more than
four calendar years after the calendar year
during which construction of the facili-
ty began, or (ii) December 31, 2018, the
facility will be considered to satisfy the
Continuity Safe Harbor.
(4) Notice 2018-59, which provides
methods to establish the beginning of con-
struction of an energy property (that is,
the Physical Work Test and Five Percent
Safe Harbor), a Continuity Requirement
for both methods, rules for transferring
energy property, and additional rules ap-
plicable to the beginning of construction
requirement for energy property projects
for purposes of the ITC. Section 6.05 of
Notice 2018-59 provides a Continuity Safe
Harbor that mirrors the safe harbor provid-
ed for qualified facilities in the prior no-
tices:
Except as provided in this section, if a
taxpayer places an energy property in
service by the end of a calendar year
that is no more than four calendar years
after the calendar year during which
construction of the energy property be-
gan (the Continuity Safe Harbor Dead-
line), the energy property will be con-
sidered to satisfy the Continuity Safe
Harbor. The excusable disruption rules
in section 6.03 do not apply for purpos-
es of applying the Continuity Safe Har-
bor. However, if an energy property is
not placed in service before the end of
the fourth calendar year after the cal-
endar year during which construction
of the energy property began, whether
the energy property satisfies the Con-
tinuity Requirement under either the
Physical Work Test or the Five Percent
Safe Harbor will be determined by the
relevant facts and circumstances.

Bulletin No. 2021–3 481 January 19, 2021
(5) Notice 2019-43, which provides
that the Continuity Safe Harbor may be
tolled and extended in certain limited cir-
cumstances involving significant national
security concerns.
(6) Notice 2020-41, which, in response
to development delays caused by the
Coronavirus Disease 2019 (COVID-19)
pandemic, extended the Continuity Safe
Harbor from four years to five years for
qualified facilities or energy property that
began construction under the Physical
Work Test or the Five Percent Safe Harbor
in either calendar year 2016 or 2017.
.06 Relief provided to qualified off-
shore wind facilities by the Taxpayer Cer-
tainty and Disaster Tax Relief Act of 2020
— (1) Qualified offshore wind facilities.
Section 204 of the Act amends § 48(a)(5)
of the Code to provide special rules for
“qualified offshore wind facilities.” Under
amended § 48(a)(5)(F)(ii), a “qualified
offshore wind facility” means a qualified
facility described in § 45(d)(1) (deter-
mined without regard to any date by which
the construction of the facility is required
to begin) that is located in the inland navi-
gable waters of the United States or in the
coastal waters of the United States.
(2) Summary of relief. Solely with re-
gard to qualified offshore wind facilities,
amended § 48(a)(5)(F)(i) provides the
following relief. First, for purposes of
qualifying as a qualified investment credit
facility (as defined by § 48(a)(5)(C)), the
beginning of construction deadline under
§ 48(a)(5)(C)(ii) is extended to Decem-
ber 31, 2025. See § 48(a)(5)(F)(i)(I). In
addition, the phaseout of credit for wind
facilities under § 48(a)(5)(E) does not
apply. See § 48(a)(5)(F)(i)(II). Lastly, for
purposes of qualifying as a qualified fa-
cility (as defined by § 45(d)(1)) for which
a taxpayer can elect to claim the ITC in
lieu of the PTC under § 48(a)(5), the be-
ginning of construction deadline provided
in § 45(d)(1) is extended to December 31,
2025. See § 48(a)(5)(F)(i)(III).
(3) Applicability of relief. Amended §
48(a)(5)(F) applies to periods after De-
cember 31, 2016, under rules similar to
the rules of § 48(m) of the Code before
the amendment of § 48 by the Revenue
Reconciliation Act of 1990. This citation
makes applicable certain transitional rules
regarding the ability of a taxpayer to claim
qualified progress expenditures to the ex-
tent of their qualified investment. See sec-
tion 204(b) of the Act.
SECTION 3. RECOGNITION
OF GREATER DELAYS FOR
CONSTRUCTION OF PROJECTS
OFFSHORE AND ON FEDERAL
LAND
.01 Overview. The Treasury Depart-
ment and the IRS are aware of certain
qualified facilities and energy property
that are being constructed Offshore or on
Federal Land (each as defined in section
4.02 of this notice). Based on comments
received from Congress and project stake-
holders, the Treasury Department and the
IRS have determined that such projects or-
dinarily are subject to significantly greater
delays than projects not constructed Off-
shore or on Federal Land, and therefore
are at a significantly higher risk of failing
the Continuity Safe Harbor.
.02 Description of typical project de-
lays. The ordinary-course delays for the
qualified facility and energy property
projects described in section 3.01 of this
notice result from various complicating
factors, including (i) the applicability of
significantly more stringent permitting re-
quirements, (ii) lengthier engineering and
construction timelines due to, for exam-
ple, the difficulty of installing equipment
Offshore, (iii) heightened environmental
regulation (including, for example, the
environmental analysis process carried
out by the Director of the Bureau of Land
Management), and (iv) the need to con-
struct new transmission lines to connect
these projects to the electrical grid sys-
tem of the United States (Grid). In addi-
tion, such delays ordinarily are outside
the control of the project developers and
can result in project completion times of
up to twice as long as those experienced
by qualified facility and energy property
projects that are not constructed Offshore
or on Federal Land.
.03 Additional certainty to investors
provided by this notice. The Treasury
Department and the IRS are providing
this relief to complement previous relief
provided through the list of excusable dis-
ruptions under section 4.02(2) of Notice
2016-31 and section 6.03 of Notice 2018-
59, which potentially would cover the
complicating factors described in section
3.02 of this notice (and therefore would
disregard them, and the delays resulting
therefrom, for purposes of determining
whether a taxpayer satisfied the Continu-
ous Construction Test or Continuous Ef-
forts Test with regard to a qualified facility
or energy property).
SECTION 4. EXTENSION OF THE
CONTINUITY SAFE HARBOR FOR
SECTIONS 45 AND 48
.01 Qualification for Continuity Safe
Harbor Extension. A qualified facility or
an energy property construction project
that is an Offshore Project or a Federal
Land Project (each as defined in section
4.02 of this notice) satisfies the Continuity
Safe Harbor if a taxpayer places the qual-
ified facility or energy property that is the
subject of the project into service by the
end of a calendar year that is no more than
10 calendar years after the calendar year
during which construction of the project
began.
.02 Definitions. For purposes of qual-
ifying for the Continuity Safe Harbor ex-
tension under section 4.01 of this notice,
the following definitions apply:
(1) Federal Land. The term “Feder-
al Land” means any land owned or con-
trolled by the United States.
(2) Federal Land Project. The term
“Federal Land Project” means a qualified
facility or an energy property construction
project—
(a) more than 50 percent of which will
be placed in service on Federal Land, as
determined by relative value or relative
area; and
(b) that will require the construction
of one or more high-voltage transmission
lines to connect the qualified facility or
energy property to the Grid.
(3) Offshore. The term “Offshore”
means any inland navigable waters of the
United States or any coastal waters of the
United States.
(4) Offshore Project. The term “Off-
shore Project” means a qualified facility
or an energy property construction project
that will be placed in service Offshore.
SECTION 5. NO RULE
The IRS will not issue private letter
rulings or determination letters to a tax-

January 19, 2021 482 Bulletin No. 2021–3
payer regarding the application of this
notice, the prior IRS notices, or the begin-
ning of construction requirements under
§§ 45 and 48.
SECTION 6. EFFECT ON OTHER
DOCUMENTS
Each of Notice 2013-29, Notice 2013-
60, Notice 2014-46, Notice 2015-25,
Notice 2016-31, Notice 2017-04, Notice
2018-59, Notice 2019-43, and Notice
2020-41 is clarified and modified.
SECTION 7. DRAFTING
INFORMATION
The principal author of this notice is
Jennifer Bernardini of the Office of As-
sociate Chief Counsel (Passthroughs &
Special Industries). For further informa-
tion regarding this notice contact Jennifer
Bernardini on (202) 317-6853 (not a toll-
free number).
COVID-19 Relief for
Employers Using the
Automobile Lease Valuation
Rule
Notice 2021-7
I. PURPOSE
In response to the ongoing Coronavi-
rus Disease 2019 (COVID-19) pandemic,
this notice provides temporary relief for
employers and employees using the auto-
mobile lease valuation rule to determine
the value of an employee’s personal use
of an employer-provided automobile for
purposes of income inclusion, employ-
ment tax, and reporting. Due solely to
the COVID-19 pandemic, if certain re-
quirements are satisfied, employers and
employees that are using the automobile
lease valuation rule may instead use the
vehicle cents-per-mile valuation rule to
determine the value of an employee’s per-
sonal use of an employer-provided auto-
mobile beginning as of March 13, 2020.
For 2021, employers and employees may
revert to the automobile lease valuation
rule or continue using the vehicle cents-
per-mile valuation rule provided certain
requirements are met.
II. BACKGROUND
If an employer provides an employee
with an automobile that is available to
the employee for personal use, the value
of the personal use must be included in
the employee’s gross income. Treas. Reg.
section 1.61-21(b)(1) states that an em-
ployee must include in gross income the
amount by which the fair market value of
a fringe benefit exceeds the sum of: (1)
the amount, if any, paid for the benefit
by or on behalf of the recipient; and (2)
the amount, if any, specifically excluded
from gross income by some other section
of subtitle A of the Internal Revenue Code
of 1986. The value of an employee’s per-
sonal use of an employer-provided au-
tomobile may be determined under the
automobile lease valuation rule to the ex-
tent the employer meets the requirements
under section 1.61-21(d). Alternatively,
an employer may determine the value
of the personal use by using the vehicle
cents-per-mile valuation rule to the ex-
tent the employer meets the requirements
under section 1.61-21(e)(1) or the com-
muting valuation rule to the extent the
employer meets the requirements under
section 1.61-21(f).
1
The rules set forth in
sections 1.61-21(d)(7) and 1.61-21(e)(5)
(the “consistency rules”) provide that the
employer and the employee must use the
chosen valuation methodology consis-
tently, except that the employer and the
employee may use the commuting val-
uation rule if the requirements for it are
satisfied.
Section 132(a)(3) of the Internal Rev-
enue Code provides that gross income
does not include any fringe benefit that
qualifies as a working condition fringe. A
working condition fringe means any ben-
efit provided to an employee of the em-
ployer to the extent that, if the employee
paid for the benefit, the payment would
be allowable as a deduction under section
162 or 167. Employers that provide vehi-
cles for their employees’ use can exclude
as a working condition fringe the amount
that would be allowable as a deductible
business expense if the employee paid
for its use. If the employee uses the ve-
hicle for both business and personal use,
the value of the working condition fringe
is the part determined to be for business
use of the vehicle. Amounts that are ex-
cluded from gross income under section
132 are also excluded from Federal In-
surance Contributions Act (FICA) taxes
(social security and Medicare, includ-
ing Additional Medicare Tax), Federal
Unemployment Tax Act (FUTA) tax,
and Federal Income tax withholding.
Sections 3121(a)(20), 3306(b)(16), and
3401(a)(19).
On March 13, 2020, the President of
the United States issued an emergency
declaration under the Robert T. Stafford
Disaster Relief and Emergency Assistance
Act in response to the ongoing COVID-19
pandemic. As a result of the pandem-
ic, many employers suspended business
operations or implemented telework ar-
rangements for employees. Consequently,
employers have indicated that business
and personal use of employer-provided
automobiles has been reduced for employ-
ees. However, due to the way in which the
value of an employee’s personal use of an
employer-provided automobile is comput-
ed using the automobile lease valuation
rule under section 1.61-21(d), employ-
ers have noted a resulting increase in the
lease value required to be included in an
employee’s income for 2020 compared to
prior years. In contrast, determining the
value of an employee’s personal use of an
employer-provided automobile using the
vehicle cents-per-mile valuation rule re-
sults in income inclusion of only the value
that relates to actual personal use, thereby
providing a more accurate reflection of the
employee’s income in these circumstanc-
es.
1
Employers that qualify for use of the commuting valuation rule under section 1.61-21(f) determine the value of a vehicle they provide to an employee for commuting use by multiplying
the number of one-way commutes by $1.50. Use of this rule is subject to stringent requirements, such as having a written policy limiting the employee’s use to commuting and de minimis
personal use.

Bulletin No. 2021–3 483 January 19, 2021
A. AUTOMOBILE LEASE
VALUATION RULE
Under the automobile lease valuation
rule, the employer determines the fair
market value of the automobile when it
was first made available to any employ-
ee and applies the corresponding “Annual
Lease Value” from the table provided in
section 1.61-21(d)(2)(iii). “Automobile”
is defined in section 1.61-21(d)(1)(ii) as
any four-wheeled vehicle manufactured
primarily for use on public streets, roads,
and highways. Section 1.61-21(d)(1)(i)
specifies that absent any statutory exclu-
sions relating to the employer-provided
automobile, such as the exclusion for
working condition fringe benefits under
section 132(a)(3), the amount of the An-
nual Lease Value is included in the gross
income of the employee. If the automobile
is used by the employee in the employer’s
business, the employer generally reduces
the Annual Lease Value by the amount
that is excluded from the employee’s wag-
es as a working condition fringe.
Section 1.61-21(d)(4) provides that,
for periods of continuous availability of
at least thirty days, but less than an entire
calendar year, an employer may pro-rate
the Annual Lease Value in certain cir-
cumstances by multiplying the applicable
Annual Lease Value by a fraction, the nu-
merator of which is the number of days of
availability and the denominator of which
is 365.
An employer with a fleet of 20 or more
automobiles may use a fleet-average val-
ue for purposes of calculating the Annu-
al Lease Values of the automobiles in the
employer’s fleet, provided the require-
ments of section 1.61-21(d)(5)(v) are met.
The fleet-average value is the average of
the fair market value of each automobile
in the fleet.
Section 1.61-21(d)(7) provides various
consistency rules. Section 1.61-21(d)(7)
(i) states that an employer may adopt the
automobile lease valuation rule only if it
is adopted by the later of: (1) January 1,
1989; or (2) the first day on which the au-
tomobile is made available to an employee
of the employer for personal use (or, if the
commuting valuation rule is used when
the automobile is first made available to
an employee for personal use, the first day
on which the commuting valuation rule is
not used). Section 1.61-21(d)(7)(ii) pro-
vides that an employer must continue to
use the automobile lease valuation rule
for all subsequent years that the employer
makes the automobile available for use by
any employee, except the employer may
use the commuting valuation rule in any
year that the requirements for that rule are
met.
Section 1.61-21(d)(7)(iii) provides that
an employee may adopt the automobile
lease valuation rule only if the employer
adopts the rule. Further, the employee may
adopt the automobile lease valuation rule
as of the first day that the automobile is
made available for personal use or, if the
commuting valuation rule is used when
the automobile is first made available to
the employee for personal use, the first day
on which the commuting valuation rule is
not used. Section 1.61-21(d)(7)(iv) further
specifies that an employee is required to
use the automobile lease valuation rule for
all subsequent years after the rule has been
adopted and the automobile is available to
the employee, unless the employer uses
the commuting valuation rule.
B. VEHICLE CENTS-PER-MILE
VALUATION RULE
Under the vehicle cents-per-mile valu-
ation rule, the value of the benefit provid-
ed in the calendar year equals the standard
mileage rate (cents-per-mile rate) mul-
tiplied by the total number of miles the
vehicle is driven by the employee for per-
sonal purposes (personal miles). Section
1.61-21(e)(4) defines “personal miles”
as all miles for which the employee used
the automobile except miles driven in the
employee’s trade or business of being an
employee of the employer. Notice 2020-
05, 2020-4 I.R.B. 380, provides that the
standard mileage rate is 57.5 cents per
mile for 2020. For purposes of the vehicle
cents-per-mile valuation rule, “vehicle” is
defined to include “automobiles” under
section 1.61-21(d)(1)(ii).
2
Section 1.61-21(e)(1)(iii)(A) provides
that the vehicle cents-per-mile valuation
rule may not be used for a calendar year if
the fair market value of the vehicle (deter-
mined pursuant to section 1.61-21(d)(5)(i)
through (iv)) on the first day the vehicle is
made available to the employee exceeds
a base value of $50,000, as adjusted an-
nually for inflation under section 280F(d)
(7). For 2020, the vehicle cents-per-mile
valuation rule may not be used for vehi-
cles with a fair market value in excess of
$50,400. Notice 2020-05.
Section 1.61-21(e) provides that em-
ployers may use the vehicle cents-per-mile
valuation rule if the employer provides an
employee with the use of a vehicle that:
(1) the employer reasonably expects will
be regularly used in the employer’s trade
or business throughout the calendar year
(or such shorter period as the vehicle may
be owned or leased by the employer), or
(2) satisfies the requirements of the mile-
age rule (described in section 1.61-21(e)
(1)(ii)). Section 1.61-21(e)(1)(iv) provides
that the vehicle is considered to be regu-
larly used in an employer’s trade or busi-
ness if either of the following safe harbor
conditions are satisfied: (1) at least 50 per-
cent of the vehicle’s total annual mileage
is for the employer’s business, or (2) the
vehicle is generally used each workday to
transport at least three employees of the
employer to and from work in an employ-
er-sponsored commuting vehicle pool.
Section 1.61-21(e)(5) provides various
consistency rules. Section 1.61-21(e)(5)(i)
provides that an employer must adopt the
vehicle cents-per-mile valuation rule by
the first day on which the employer-pro-
vided vehicle is used by an employee for
personal use (or, if the commuting valua-
tion rule is used when the vehicle is first
used by an employee for personal use,
the first day on which the commuting val-
uation rule is not used). Further, section
1.61-21(e)(5)(ii) requires the employer to
use the vehicle cents-per-mile valuation
rule for all subsequent years in which the
vehicle qualifies, except that the employ-
er may use the commuting valuation rule
with respect to a particular vehicle to the
extent the requirements for the rule are
satisfied.
Section 1.61-21(e)(5)(iii) provides that
the employee may adopt the vehicle cents-
2
Vehicle is defined in section 1.61-21(e)(2) for purposes of the vehicle cents-per-mile valuation rule to mean “any motorized wheeled vehicle manufactured primarily for use on public streets,
roads, and highways”, including an “automobile” as defined for purposes of the automobile lease valuation rule.

January 19, 2021 484 Bulletin No. 2021–3
per-mile valuation rule only if the rule is
adopted by the employer and beginning
as of the first day on which the vehicle
for which the employer adopted the rule
is available to that employee for personal
use (or, if the commuting valuation rule is
used when the vehicle is first used by an
employee for personal use, the first day on
which the commuting valuation rule is not
used). Further, the employee must use the
vehicle cents-per-mile valuation rule for
all subsequent years of personal use of the
vehicle under section 1.61-21(e)(5)(iv)
unless the employer uses the commuting
valuation rule.
C. ANNOUNCEMENT 85-113
Employer-provided automobiles are
noncash fringe benefits. Employment
taxes imposed on noncash fringe benefits
are collected (or paid) by an employer at
the time and in the manner prescribed by
the Secretary in regulations.
3
Announce-
ment 85-113, 1985-31 I.R.B. 31, provides
guidelines for withholding, paying, and
reporting employment tax on taxable non-
cash fringe benefits. Announcement 85-
113 provides generally that taxpayers may
rely on the guidelines in the announce-
ment until the issuance of regulations that
supersede the temporary and proposed
regulations under section 3501(b).
4
An-
nouncement 85-113 generally is applica-
ble to current payments of noncash fringe
benefits, including automobiles.
Section 1 of Announcement 85-113
allows payors of certain noncash fringe
benefits to treat the benefits as paid on any
day(s) during the year so long as they treat
benefits provided in a calendar year as
paid not later than December 31 of the cal-
endar year. Section 5 of the announcement
allows employers to treat certain benefits
paid during the last two months of the year
(or any shorter period) as paid during the
subsequent calendar year.
III. GRANT OF RELIEF
Due to the suddenness and unexpected
onset of the COVID-19 pandemic, the De-
partment of the Treasury and the Internal
Revenue Service are providing relief from
the consistency rules in sections 1.61-21(d)
(7) and 1.61-21(e)(5). Accordingly, an em-
ployer using the automobile lease valuation
rule for the 2020 calendar year may instead
use the vehicle cents-per-mile valuation
rule beginning on March 13, 2020, notwith-
standing the consistency rules in section
1.61-21(d)(7), if, at the beginning of the
2020 calendar year, the employer reason-
ably expected that an automobile with a fair
market value not exceeding $50,400 would
be regularly used in the employer’s trade or
business throughout the year, but due to the
COVID-19 pandemic the automobile was
not regularly used in the employer’s trade
or business throughout the year. For this
purpose, the COVID-19 pandemic is con-
sidered to have commenced on March 13,
2020, the date of the President’s emergen-
cy declaration. Therefore, employers that
choose to switch from the automobile lease
valuation rule to the vehicle cents-per-mile
valuation rule in the 2020 calendar year
must prorate the value of the vehicle us-
ing the automobile lease valuation rule for
January 1, 2020, through March 12, 2020.
Employers should multiply the applicable
Annual Lease Value by a fraction, the nu-
merator of which is the number of days
during the period beginning on January 1,
2020, and ending on March 12, 2020 (72
days), and the denominator of which is
365. As of March 13, 2020, employers may
begin using the vehicle-cents-per-mile val-
uation rule. Employees using the automo-
bile lease valuation rule whose employers
switch from the automobile lease valuation
rule to the vehicle cents-per-mile valuation
rule under this notice must also switch to
the vehicle cents-per-mile valuation rule.
Further, notwithstanding the consisten-
cy rules in section 1.61-21(e)(5), employers
that choose to switch from the automobile
lease valuation rule to the vehicle cents-per-
mile valuation rule during 2020 may revert
to the automobile lease valuation rule for
2021, provided they meet the requirements
of section 1.61-21(d), other than the consis-
tency rules in section 1.61-21(d)(7). Alter-
natively, employers that choose to switch
to the vehicle cents-per-mile valuation rule
during 2020 may continue using that rule
for 2021, provided they meet the require-
ments of section 1.61-21(e), other than the
consistency rules in section 1.61-21(e)(5).
Employees that use one of the special val-
uation rules for vehicles must use the same
special valuation rule for vehicles that is
used by their employer. The consistency
rules in section 1.61-21(e)(5) will apply as
of January 1, 2021, as if January 1, 2021,
were the first day the vehicle was used by
the employee for personal use, and the con-
sistency rules in section 1.61-21(d)(7) will
apply as of January 1, 2021, as if January
1, 2021, were the first day the vehicle was
made available to the employee for person-
al use. Accordingly, the special valuation
rule used for 2021 must continue to be used
by the employer and the employee for all
subsequent years, except to the extent the
employer uses the commuting valuation
rule.
Employers that originally used the au-
tomobile lease valuation rule to calculate
the value of the personal use of an employ-
er-provided automobile during 2020 and
that want to instead begin using the ve-
hicle cents-per-mile valuation rule during
2020 based on the relief provided in this
notice may use the rules in Announcement
85-113 for reporting and withholding on
taxable noncash fringe benefits, or the ad-
justment process under section 6413 or the
refund claim process under section 6402
to correct any overpayment of federal em-
ployment taxes on these benefits (for in-
formation on these adjustment and refund
claim processes, see the regulations under
these sections, Rev. Rul. 2009-39, 2009-
52 I.R.B. 951, section 13 of Publication 15
(Circular E), Employer’s Tax Guide, and
the Instructions for Form 941-X, Adjust-
ed Employer’s QUARTERLY Federal Tax
Return or Claim for Refund).
IV. DRAFTING INFORMATION
The principal author of this notice
is Andrew Trujillo. For further informa-
tion regarding this notice contact Andrew
Trujillo on (202) 317-4826 (not a toll-free
number).
3
Section 3501(b).
4
As of the date of publication of this notice, no regulations have been issued that supersede the temporary and proposed regulations under section 3501(b).

Bulletin No. 2021–3 485 January 19, 2021
26 CFR 601.601. Rules and regulations.
(Also Part I, §163(j).)
Rev. Proc. 2021-9
SECTION 1. PURPOSE
This revenue procedure provides a safe
harbor that allows a trade or business that
manages or operates a qualified residential
living facility, as defined in section 3.01
of this revenue procedure, to be treated
as a real property trade or business, sole-
ly for purposes of qualifying to make the
election under section 163(j)(7)(B) of the
Internal Revenue Code (Code) to be an
electing real property trade or business.
SECTION 2. BACKGROUND
.01 On December 22, 2017, section
163(j) was amended by § 13301 of Pub-
lic Law No. 115-97, 131 Stat. 2054, com-
monly referred to as the Tax Cuts and Jobs
Act (TCJA). Section 163(j), as amended
by the TCJA, provides rules limiting the
amount of business interest expense that
can be deducted for taxable years begin-
ning after December 31, 2017. See TCJA
§ 13301(a).
.02 On March 27, 2020, section 163(j)
was further amended by § 2306 of the
Coronavirus Aid, Relief, and Economic
Security Act, Public Law No. 116-136, 13
Stat. 281 (CARES Act), to provide special
rules for applying section 163(j) to taxable
years beginning in 2019 or 2020.
.03 Under section 163(j)(1), the
amount allowed as a deduction for busi-
ness interest expense is limited to the
sum of: (1) the taxpayer’s business inter-
est income, as defined in section 163(j)
(6), for the taxable year; (2) 30 percent of
the taxpayer’s adjusted taxable income,
as defined in section 163(j)(8), for such
taxable year, or 50 percent of the taxpay-
er’s adjusted taxable income (if applica-
ble, as provided in section 163(j)(10));
and (3) the taxpayer’s floor plan financ-
ing interest, as defined in section 163(j)
(9), for such taxable year.
.04 The limitation under section 163(j)
on the deductibility of business interest
expense applies to all taxpayers with busi-
ness interest, as defined in section 163(j)
(5), except for taxpayers, other than tax
shelters under section 448(a)(3), that meet
the gross receipts test in section 448(c).
.05 Section 163(j)(5) generally pro-
vides that the term “business interest”
means any interest expense properly allo-
cable to a trade or business. Section 163(j)
(7)(A)(ii) provides that, for purposes of
the limitation on the deduction for busi-
ness interest, the term “trade or business”
does not include an “electing real property
trade or business.” Thus, interest expense
properly allocable to an electing real prop-
erty trade or business is not properly allo-
cable to a trade or business for purposes of
section 163(j), and is not business interest
expense that is subject to section 163(j)
(1).
.06 The term “electing real property
trade or business” under section 163(j)(7)
(B) means “any trade or business which
is described in section 469(c)(7)(C) and
which makes an election” to be an electing
real property trade or business.
.07 Section 168(g)(1)(F) provides that
an electing real property trade or business
within the meaning of section 163(j)(7)
(B) must use the alternative depreciation
system for property described in section
168(g)(8). See section 163(j)(11)(A).
.08 The Department of the Treasury
(Treasury Department) and the Internal
Revenue Service (IRS) published (1) pro-
posed regulations under section 163(j) in
a notice of proposed rulemaking (REG-
106089-18) in the Federal Register (83 FR
67490) on December 28, 2018 (2018 pro-
posed regulations), (2) final regulations
under section 163(j) (TD 9905) in the Fed-
eral Register (85 FR 56686) on Septem-
ber 14, 2020 (final regulations), and (3)
concurrently with the publication of the
final regulations, additional proposed reg-
ulations under section 163(j) in a notice of
proposed rulemaking (REG-107911-18)
in the Federal Register (85 FR 56846).
.09 Section 1.163(j)-1(b)(14) of the
final regulations defines an electing real
property trade or business as one that
makes an election under § 1.163(j)-9 or
other published guidance that is (1) a real
property trade or business described in
section 469(c)(7)(C) of the Code and §
1.469-9(b)(2) of the final regulations, (2)
a REIT that qualifies for the safe harbor
described in § 1.163(j)-9(h), or (3) a trade
or business specifically designated by the
Secretary of the Treasury or his delegate
in guidance published in the Federal Reg-
ister or the Internal Revenue Bulletin as a
real property trade or business for section
163(j).
.10 Section 1.163(j)-9 provides rules
and procedures for making an elec-
tion under section 163(j)(7)(B) to be an
electing real property trade or business.
The Treasury Department and the IRS
released Rev. Proc. 2020-22, 2020-18
I.R.B. 745, (April 27, 2020) to provide
the time and manner of making a late
election, or withdrawing an election un-
der section 163(j)(7)(B) to be an electing
real property trade or business for taxable
years beginning in 2018, 2019, or 2020.
Rev. Proc. 2020-22 also provides the time
and manner of making or revoking elec-
tions provided by the CARES Act under
section 163(j)(10) for taxable years be-
ginning in 2019 or 2020. See Rev. Proc.
2020-22 for more information regarding
the time and manner of making, revok-
ing, or withdrawing elections under sec-
tion 163(j)(7) and (10).
.11 Section 469(c)(7)(C) defines a real
property trade or business as any real
property development, redevelopment,
construction, reconstruction, acquisition,
conversion, rental, operation, manage-
ment, leasing, or brokerage trade or busi-
ness. See also § 1.469-9(b)(2).
.12 In response to the 2018 proposed
regulations, commenters expressed con-
cern as to whether a trade or business that
manages or operates a residential living
facility and also provides supplemental
assistive, nursing, or routine medical ser-
vices to its customers or patients is eligible
to make the election under section 163(j)
(7)(B) to be an electing real property trade
or business.
.13 On September 28, 2020, the Trea-
sury Department and the IRS published
Notice 2020-59, 2020-40 I.R.B. 782,
which contained a proposed revenue
procedure providing a safe harbor for a
trade or business that manages or oper-
ates a qualified residential living facility,
as defined in section 3.01 of the proposed
revenue procedure, to be treated as a real
property trade or business solely for pur-
poses of qualifying to make the election
under section 163(j)(7)(B) to be treated as
an electing real property trade or business.
Notice 2020-59 requested comments on
the proposed revenue procedure.

January 19, 2021 486 Bulletin No. 2021–3
.14 In response to the proposed revenue
procedure in Notice 2020-59, commenters
presented three distinct concerns:
(1) First, commenters requested that
the definition of a qualified residential
living facility be modified to reduce the
minimum threshold for the average peri-
od of customer or patient use of individual
dwelling units requirement from 90 days
to less than 90 days, and that the determi-
nation of the average period of customer
or patient use take into account that some
customers or patients may reside at the
facility without a rental contract or other
formal written lease agreement. Because
Medicare and Medicaid plans generally
pay for stays that are substantially less
than 90 days, commenters noted that the
90-day average period of customer or pa-
tient use requirement would unfairly pe-
nalize taxpayers with large numbers of
Medicare and Medicaid patients and po-
tentially exclude taxpayers that Congress
intended to be eligible to make a real
property trade or business election under
section 163(j)(7)(B). Commenters also
explicitly mentioned that certain facilities
that are wholly or partially licensed to re-
ceive Medicare and Medicaid payments
provide care outside of a rental contract or
other formal written lease agreement. The
Treasury Department and the IRS agree
with this comment, and accordingly, this
revenue procedure reduces the average
period for customer or patient use require-
ment from 90 days to 30 days, and allows
taxpayers to determine the average period
by reference to either the number of days
paid for by Medicare or Medicaid or the
number of days under a rental contract or
other formal written lease agreement.
(2) Second, commenters requested that
the revenue procedure provide an alter-
native test to meet certain requirements
of the definition of a qualified residential
living facility. Commenters specifically
proposed using the definition of “residen-
tial rental property” under section 168(e)
(2)(A) of the Code as an alternative to
the requirements in section 3.01(1) (pri-
mary residence requirement) and 3.01(3)
(average period of customer or patient
use requirement) of the proposed revenue
procedure, in part because the legislative
history of the TCJA confirms that the
trade or business of operating or manag-
ing “residential rental property” housing
the elderly is eligible to be a real property
trade or business despite the provision of
necessary supplemental assistive services
to the residents of the residential rental
property. Moreover, commenters pointed
out the linkage between section 168 and
section 163(j) because section 168(g)(1)
(F) provides that an electing real proper-
ty trade or business within the meaning
of section 163(j)(7)(B) must use the al-
ternative depreciation system for proper-
ty described in section 168(g)(8), which
includes residential rental property, and
because the IRS has previously concluded
that various types of retirement care facili-
ties, including independent living, assisted
living, and skilled nursing facilities, for
example, may qualify as residential rental
property for purposes of section 168(e)(2)
(A). Commenters also noted that taxpayers
have to determine whether their facilities
qualify as residential rental property un-
der section 168(e)(2)(A) for purposes of
calculating depreciation. They indicated
that allowing the section 168(e)(2)(A) test
to be used as an alternative to the prima-
ry residence requirement and the average
period of customer or patient use require-
ment would reduce taxpayer burden. The
Treasury Department and the IRS agree
with this comment and this revenue pro-
cedure includes an alternative test provid-
ing that if a taxpayer operates or manages
residential living facilities that qualify
as residential rental property under sec-
tion 168(e)(2)(A), then the facility also
meets the requirements set forth in section
3.01(1) and (3) of this revenue procedure.
(3) Third, commenters requested clar-
ification on whether a taxpayer’s reliance
on the residential living facility safe har-
bor to make an election under section
163(j)(7)(B) to be an electing real prop-
erty trade or business must be determined
on an annual basis or remains in effect
for taxable years after the taxable year in
which an initial election is made. Gener-
ally, taxpayers may make an irrevocable
one-time election under section 163(j)(7)
(B) and § 1.163(j)-9(c) to be an electing
real property trade or business. This elec-
tion, once made, applies to the taxable
year in which the election is made and
to all subsequent taxable years, and auto-
matically terminates under § 1.163(j)-9(e)
(1) if the taxpayer ceases to engage in the
electing trade or business. Thus, com-
menters requested that the proposed rev-
enue procedure be amended to clarify that
the same rules apply to a taxpayer relying
on the safe harbor to make the election
such that a trade or business may make
a one-time determination as to whether
it qualifies for the safe harbor. The Trea-
sury Department and the IRS decline to
adopt this comment. An annual test is
necessary under the safe harbor because,
unlike most trades or businesses that are
subject to the electing real property trade
or business provisions in § 1.163(j)-9,
taxpayers relying solely on the safe har-
bor provided in this revenue procedure
must perform a mathematical calculation
to determine their eligibility to make the
real property trade or business election
under section 163(j)(7)(B), and eligibili-
ty is conditioned upon continuing to meet
the eligibility requirements for each tax-
able year. This revenue procedure clari-
fies that, if the taxpayer fails to satisfy the
requirements to be a qualified residential
living facility in section 3.01 of this rev-
enue procedure in a subsequent taxable
year, the residential living facility safe
harbor no longer applies and the taxpay-
er is deemed to have ceased the electing
trade or business. This deemed cessation
of the electing trade or business does not
apply to taxpayers that otherwise contin-
ue to qualify as an electing real property
trade or business without the use of the
safe harbor. If, in a taxable year subse-
quent to the taxable year in which the tax-
payer is deemed to have ceased the elect-
ing trade or business the taxpayer again
satisfies the requirements in section 3.01
of this revenue procedure, the taxpayer’s
initial election pursuant to the residential
living facility safe harbor will be automat-
ically reinstated. See § 1.168(i)-4(d) and
section 4.02 of Rev. Proc. 2019-08, 2019-
03 I.R.B. 347 (January 14, 2019) for guid-
ance on how to change the computation of
depreciation for certain property held by
an electing real property trade or business.
.15 In light of the comments received in
response to the 2018 proposed regulations
and to Notice 2020-59, this revenue pro-
cedure provides a safe harbor that allows
a taxpayer engaged in a trade or business
that manages or operates a qualified resi-
dential living facility, as defined in section
3.01 of this revenue procedure, to treat the
trade or business as a real property trade or

Bulletin No. 2021–3 487 January 19, 2021
business solely for purposes of qualifying
to make an election under section 163(j)
(7)(B) to be an electing real property trade
or business (residential living facility safe
harbor).
SECTION 3. DEFINITIONS FOR
RESIDENTIAL LIVING FACILITY
SAFE HARBOR
The following definitions apply for
purposes of this revenue procedure:
.01 Qualified Residential Living Facili-
ty. Except as provided in sections 3.02 and
4.04 of this revenue procedure, a “quali-
fied residential living facility” is a resi-
dential living facility that:
(1) Consists of multiple rental dwell-
ing units within one or more buildings or
structures that generally serve as primary
residences on a permanent or semi- per-
manent basis to individual customers or
patients;
(2) Provides supplemental assistive,
nursing, or other routine medical services;
and
(3) Has an average period of customer
or patient use of individual rental dwelling
units of 30 days or more.
.02 Section 168(e)(2)(A) test. A res-
idential living facility that qualifies as
residential rental property under section
168(e)(2)(A) satisfies the requirements
in section 3.01(1) and (3) of this revenue
procedure.
.03 Average period of customer or pa-
tient use.
(1) In general. The “average period of
customer or patient use” is determined by
dividing: (i) the sum of the total number of
days in the taxable year that each custom-
er or patient resides in a rental dwelling
unit of the residential living facility, which
may be determined by reference to a rent-
al contract or other formal written lease
agreement, or by the number of days paid
for by Medicare or Medicaid; by (ii) the
total number of individual residential cus-
tomers or patients that reside in all of the
rental dwelling units of the facility for the
taxable year. For this purpose, a married
couple residing in a single rental dwelling
unit of the residential living facility will
be counted as one individual customer or
patient, unless each spouse is separately
properly treated as an individual customer
or patient of the residential living facili-
ty that receives supplemental assistive,
nursing, or other routine medical services
from or on behalf of the residential living
facility. Days in which a rental dwelling
unit of a residential living facility are not
occupied are not included in the calcula-
tion of the average period of customer or
patient use.
(2) Example. Facility has 100 rental
dwelling units. Of the 100 units, 60 units
are occupied by the same customer or
patient for the entire year, 25 other units
are occupied for 360 days of the year
with each customer or patient occupying
a unit for 90 days, and the remaining 15
units are occupied for a total of 10 months
(March through December = 306 days)
of the year. Of the 15 units occupied for
10 months of the year, 10 units are oc-
cupied by customers or patients during
the entire months of March through July
(153 days) and by different customers or
patients during the entire months of Au-
gust through December (153 days), for a
total of 20 customers for the 10-month
period. For the remaining 5 of the 15
units that are occupied for 10 months of
the year, 5 customers or patients occu-
py the units for 8 months (May through
December = 245 days) of the year, and
5 other customers or patients occupy the
units for 2 months (September and Octo-
ber = 61 days) of the year. The average
period of customer or patient use is de-
termined by dividing the sum of the total
number of days in the taxable year that
each customer resides in a rental dwell-
ing unit, by the total number of individ-
ual residential customers or patients that
reside in all of the rental dwelling units
for the taxable year. The total number of
days in the taxable year that the custom-
ers or patients reside in the rental dwell-
ing unit is 35,490 days [21,900 days (60
units that are occupied for the entire year
x 365 days per year) + 9,000 days (25
units that are occupied for 90 days each
x 90 days x 4 90-day periods) + 4,590
days (15 units that are occupied for 10
months x 306 days)]. The total number
of individual residential customers or
patients is 190 [60 customers or patients
occupying a unit for the entire year +
100 (25 customers or patients occupying
units for 90 days each x 4 90-day periods
in a year) + 20 customers or patients that
occupy a unit for a 5-month period + 5
customers or patients that occupy a unit
for a 8-month period + 5 customers or
patients that occupy a unit for a 2-month
period]. Accordingly, the average period
of customer or patient use is approxi-
mately 187 days (35,490/190).
.04 Supplemental assistive, nursing,
or other routine medical services. “Sup-
plemental assistive, nursing, or other
routine medical services” are personal
and professional services that are cus-
tomarily and routinely provided to indi-
vidual residential customers or patients
of nursing homes, assisted living facil-
ities, memory care residences, continu-
ing care retirement communities, skilled
nursing facilities, or similar facilities, as
needed, on a day-to-day basis. Such ser-
vices generally do not include surgical,
radiological, or other intensive or spe-
cialized medical services that are usually
provided only in emergency or short-
term in-patient or out-patient hospital or
surgical settings.
.05 Permanent or semi-permanent
basis. The rental dwelling units of a resi-
dential living facility serve as primary res-
idences on a “permanent or semi-perma-
nent basis” to customers or patients whose
use of the units is generally long-term
(30 days or more) in nature, even though
some customers or patients may arrive at
the residential living facility with signifi-
cantly shortened life expectancies due to
advanced age or terminal medical con-
ditions, and some customers or patients
otherwise may be expected to periodically
reside away from the residential living fa-
cility, such as at the primary residence of a
spouse or other relative, for short periods
of time.
SECTION 4. RESIDENTIAL LIVING
FACILITY SAFE HARBOR
.01 Safe harbor for residential living
facility trades or businesses. A taxpayer
engaged in a trade or business that manag-
es or operates a qualified residential living
facility, as defined in section 3.01 of this
revenue procedure, may treat such trade or
business as a real property trade or busi-
ness solely for purposes of the election un-
der section 163(j)(7)(B) to be an electing
real property trade or business. Satisfying
the requirements of this safe harbor is not
a determination that the taxpayer is en-

January 19, 2021 488 Bulletin No. 2021–3
gaged in a real property trade or business
under section 469.
.02 Effect of election and how to make the
election. If a taxpayer relies on this safe har-
bor in section 4.01 this revenue procedure
to make the election under section 163(j)(7)
(B) to be an electing real property trade or
business, the provisions in § 1.163(j)-9 ap-
ply, and the taxpayer must use the alterna-
tive depreciation system of section 168(g) to
depreciate the property described in section
168(g)(8). The taxpayer makes the election
under section 163(j)(7)(B) at the time, and
in the manner prescribed by § 1.163(j)-9(d).
See also Rev. Proc. 2020-22.
.03 Substantiation. A trade or business
that manages or operates a residential liv-
ing facility to which this revenue proce-
dure applies must retain books and records
to substantiate that all the requirements of
this section 4 have been met in accordance
with section 6001.
.04 Annual test; reinstated election. For
any taxable year, subsequent to the taxable
year in which a taxpayer relies on the safe
harbor in section 4.01 of this revenue pro-
cedure to make the election under section
163(j)(7)(B) to be treated as a real property
trade or business, in which a taxpayer does
not satisfy the requirements in section 3.01
of this revenue procedure, the taxpayer is
deemed to have ceased to engage in the
electing trade or business, as provided in §
1.163(j)-9(e) for such subsequent taxable
year. For any subsequent taxable year in
which a taxpayer satisfies the requirements
in section 3.01 of this revenue procedure
after a deemed cessation of the electing
trade or business, the taxpayer’s initial
election under section 163(j)(7)(B) will be
automatically reinstated.
.05 Anti-abuse. Taxpayers are not el-
igible to rely on the safe harbor in this
revenue procedure if a principal purpose
of an arrangement or transaction is to
avoid section 163(j) and its regulations
and in a manner that is contrary to the
purpose of this revenue procedure. See
§ 1.163(j)-2(j).
SECTION 5. APPLICABILITY
Taxpayers may apply the rules of this
revenue procedure to taxable years begin-
ning after December 31, 2017.
SECTION 6. PAPERWORK
REDUCTION ACT
.01 This revenue procedure does not
impose any additional information col-
lection requirements in the form of re-
porting, recordkeeping requirements, or
third-party disclosure requirements to the
burden that is accounted for in the final
regulations. However, this revenue pro-
cedure provides that qualified residential
living facilities, as defined in section 3.01
of this revenue procedure, may be treat-
ed as real property trades or businesses,
within the meaning of section 469(c)(7)
(C), solely for purposes of making the
election under section 163(j)(7)(B) to
qualify as an electing real property trade
or business. Taxpayers relying on the safe
harbor in section 4.01 of this revenue pro-
cedure must file a statement with their
return under the procedures set forth in,
and containing the information required
by, § 1.163(j)-9 and Rev. Proc. 2020-22,
if applicable. That collection of informa-
tion has been reviewed and approved by
the Office of Management and Budget in
accordance with the Paperwork Reduction
Act (44 U.S.C. 3507) under control num-
ber 1545–0123.
.02 This information is required to be
collected and retained for compliance pur-
poses, namely, to determine whether the
taxpayer has made an election for one of
its trades or businesses to be an electing
real property trade or business.
.03 The Treasury Department and the
IRS estimate that approximately 30,210
respondents are likely. This number was
determined by examining, for the 2017
tax year, Form 1120, Form 1120-S, Form
1065, and Form 1120-REIT filers with
NAICS codes of 623110 (nursing care fa-
cilities (skilled nursing facilities)), 623311
(continuing care retirement communities),
623312 (assisted living facilities for the
elderly) and 623990 (other residential care
facilities) with gross receipts of at least
$10 million.
.04 The estimated number of respon-
dents is 30,210. The estimated annu-
al burden per respondent/recordkeeper
varies from 0 to 30 minutes, depending
on individual circumstances, with an
estimated average of 15 minutes. The
estimated total annual reporting and/or
recordkeeping burden is 7,552.5 hours
(30,210 respondents x 15 minutes). The
estimated annual cost burden to respon-
dents is $95 per hour. Accordingly, we
expect the total annual cost burden for
the election statements to be $717,487.50
(30,210 * .25 * $95). The estimated an-
nual frequency of responses is once be-
cause the statements only have to be filed
once.
SECTION 7. DRAFTING
INFORMATION
The principal authors of this revenue
procedure are Susie Bird, Charles Gor-
ham, Justin Grill, Bernard Harvey and
Jaime Park of the Office of Associate
Chief Counsel (Income Tax & Account-
ing) and Adrienne Mikolashek and Wil-
liam Kostak of the Office of Associate
Chief Counsel (Passthroughs and Special
Industries). For further information re-
garding this revenue procedure, contact
Mr. Grill at (202) 317-7003 (not a toll-
free number).

Bulletin No. 2021–3 489 January 19, 2021
Part IV
26 CFR Part 300
Notice of Proposed
Rulemaking
User Fee for Estate Tax
Closing Letter
REG-114615-16
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This document contains
proposed regulations establishing a new
user fee for authorized persons who wish
to request the issuance of IRS Letter 627,
also referred to as an estate tax closing let-
ter. The Independent Offices Appropria-
tions Act of 1952 authorizes charging user
fees in appropriate circumstances. The
proposed regulations affect persons who
request an estate tax closing letter.
DATES: Written or electronic comments
and requests for a public hearing must be
received by March 1, 2021. Requests for a
public hearing must be submitted as pre-
scribed in the “Comments and Requests
for a Public Hearing” section.
ADDRESSES: Commenters are strong-
ly encouraged to submit public comments
electronically. Submit electronic submis-
sions via the Federal eRulemaking Portal
at http://www.regulations.gov (indicate IRS
and REG-114615-16) by following the on-
line instructions for submitting comments.
Once submitted to the Federal eRulemaking
Portal, comments cannot be edited or with-
drawn. The IRS expects to have limited per-
sonnel available to process public comments
that are submitted on paper through mail.
Until further notice, any comments submit-
ted on paper will be considered to the extent
practicable. The Department of the Treasury
(Treasury Department) and the IRS will
publish for public availability any comment
submitted electronically, and to the extent
practicable on paper, to its public docket.
Send paper submissions to: CC:PA:LPD:PR
(REG-114615-16), Room 5203, Internal
Revenue Service, PO Box 7604, Ben Frank-
lin Station, Washington, D.C. 20044.
FOR FURTHER INFORMATION CON-
TACT: Concerning submissions of com-
ments and/or requests for a public hear-
ing, Regina Johnson, at (202) 317-5177;
concerning cost methodology, Michael
Weber, at (202) 803-9738; concerning
the proposed regulations, Juli Ro Kim, at
(202) 317-6859 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background and Explanation of
Provisions
A. Overview
This document contains proposed
amendments to the User Fee Regulations
(26 CFR part 300) to establish a user fee
applicable to requests for estate tax closing
letters provided by the IRS to an authorized
person. (The term “authorized person” is
used herein to refer to a decedent’s estate
or other person properly authorized under
section 6103 of the Internal Revenue Code
(Code) to receive, and therefore, to request,
an estate tax closing letter with respect to
the estate.) The IRS issues estate tax closing
letters upon request of an authorized person
only after an estate tax return (generally,
Form 706, United States Estate (and Gen-
eration-Skipping Transfer) Tax Return) has
been accepted by the IRS (1) as filed, (2)
after an adjustment to which the estate has
agreed, or (3) after an adjustment in the de-
ceased spousal unused exclusion (DSUE)
amount. An estate tax closing letter informs
an authorized person of the acceptance of
the estate tax return and certain other re-
turn information, including the amount of
the net estate tax, the State death tax credit
or deduction, and any generation-skipping
transfer tax for which the estate is liable.
1
1
In the context of a Form 706 (a “return” as defined in section
6103(b)(1)), the term “return information” is broadly defined
in section 6103(b)(2) to include not only information appear-
ing on the Form 706, but also whether the estate’s return was,
is being, or will be examined or subject to other investiga-
tion or processing, or any other data, received by, recorded
by, prepared by, furnished to, or collected by the Secretary
of the Treasury or his delegate (Secretary) with respect to the
Form 706 or with respect to the determination of the exis-
tence, or possible existence, of liability (or the amount there-
of) of any person under the Code for any tax, penalty, interest,
fine, forfeiture, or other imposition, or offense.
The IRS understands that knowledge of
the acceptance by the IRS of the estate tax
return - including the amount of the gross
estate and the estate tax liability - is im-
portant to executors or other persons ad-
ministering estates because of the unique
nexus between an estate’s Federal estate
tax obligations and State and local law ob-
ligations to administer and close a probate
estate. This knowledge aids an executor’s
ability to make the final division and dis-
tribution of estate assets and to avoid po-
tential personal liability for unpaid estate
tax in making such distribution. Personal
liability can be imposed on an executor
when the executor makes preferential
payments to creditors or distributions to
beneficiaries, leaving insufficient funds
for the full payment of the tax owed to the
government. See 31 U.S.C. 3713(b). On
the other hand, an estate tax closing letter
does not indicate whether any of the estate
tax has been paid or the amount of estate
tax that has been paid.
The estate tax closing letter also in-
cludes relevant procedural and substan-
tive explanations. Addressing the poten-
tial for conflating an estate tax closing
letter with a formal closing agreement,
the letter confirms that it is not a for-
mal closing agreement with the IRS that
is described under section 7121 of the
Code. Additionally, the estate tax clos-
ing letter explains that, consistent with
Rev. Proc. 2005-32, 2005-1 C.B. 1206,
the IRS will not reopen or examine the
estate tax return to determine the estate
tax liability of a decedent’s estate unless
the estate notifies the IRS of changes to
the estate tax return or if there is (1) ev-
idence of fraud, malfeasance, collusion,
concealment, or misrepresentation of a
material fact, (2) a clearly defined sub-
stantial error based upon an established
IRS position, or (3) a serious adminis-
trative omission. However, the estate tax
closing letter does not limit or foreclose
future adjustments to the DSUE amount
shown on the estate tax return, so the es-
tate tax closing letter further explains that
the IRS has authority to examine returns
of a decedent in the context of determin-
ing the DSUE amount for portability
purposes. (See part C of this section for
a discussion of portability of the DSUE
amount.) Finally, the estate tax closing

January 19, 2021 490 Bulletin No. 2021–3
letter includes explanations related to
the potential application of sections 6166
and 6324A (installment payments and
special extended lien), 2204 (discharge
of personal liability), and 6324 (estate
tax lien). Currently, the IRS does not
charge for providing an estate tax closing
letter to authorized persons.
B. June 2015 Change to IRS Practice in
Issuing Estate Tax Closing Letters
The practice of issuing estate tax clos-
ing letters to authorized persons is not
mandated by any provision of the Code
or other statutory requirement. Instead,
the practice is fundamentally a custom-
er service convenience offered to au-
thorized persons in view of the unique
nature of estate tax return filings and the
bearing of an estate’s Federal estate tax
obligations on the obligation to adminis-
ter and close a probate estate under ap-
plicable State and local law. Essentially,
the practice takes into account estates’
and stakeholders’ need for information
regarding the status of an estate’s Federal
tax obligations in administering and clos-
ing a probate estate. Prior to June 2015,
the IRS generally issued an estate tax
closing letter for every estate tax return
filed. However, for estate tax returns filed
on or after June 1, 2015, the IRS changed
its practice and now offers an estate tax
closing letter only upon the request of an
authorized person.
The IRS changed its practice of is-
suing estate tax closing letters for every
filed Form 706 for two primary reasons.
First, the volume of estate tax return fil-
ings increased at the same time that the
IRS experienced additional budget and
resource constraints. In particular, the
number of estate tax filings increased
dramatically due to the enactment in De-
cember 2010 of portability of a deceased
spouse’s unused applicable exclusion
amount (DSUE amount) for the benefit
of a surviving spouse. (See part C for a
discussion of the impact of portability
of the DSUE amount on estate tax fil-
ings.) Second, the IRS recognized that
an account transcript with a transaction
code and explanation of “421 - Closed
examination of tax return” is an avail-
able alternative to the estate tax closing
letter. See Notice 2017-12, I.R.B. 2017-
5 (describing the utility of the account
transcript in lieu of the estate tax closing
letter and its availability at no charge).
Notwithstanding these considerations,
the IRS was aware that executors, local
probate courts, State tax departments,
and others had come to rely on the con-
venience of estate tax closing letters and
the return information and procedural
and substantive explanations such letters
provided for confirmation that the exam-
ination of the estate tax return by the IRS
had been completed and the IRS file had
been closed. Accordingly, in 2015 the
IRS decided to continue providing the
service of issuing estate tax closing let-
ters, still at no charge, but only upon the
request of an authorized person.
Until restrictions were added due to
the ongoing Coronavirus Disease 2019
(COVID-19) pandemic, an authorized
person was able to request an estate tax
closing letter by telephone or fax. Now,
due to the COVID-19 pandemic, an au-
thorized person may request an estate tax
closing letter only by fax (current proce-
dure and details available at http://www.
irs.gov).
C. The Continuing Impact of Portability
on Estate Tax Return Filings
Portability of the DSUE amount be-
came effective for estates of decedents
dying after December 31, 2010, upon
enactment of the Tax Relief, Unemploy-
ment Insurance Reauthorization, and Job
Creation Act of 2010, Pub. L. 111-312,
124 Stat. 3296, 3302 (Dec. 17, 2010),
and became permanent upon enactment
of the American Taxpayer Relief Act of
2012, Pub. L. 112-240, 126 Stat. 2313
(January 2, 2013). In order to elect por-
tability of the DSUE amount for the ben-
efit of the surviving spouse, the estate of
the deceased spouse must timely file an
estate tax return, even if the sum of the
value of the gross estate and the amount
of adjusted taxable gifts is insufficient to
trigger a filing requirement under sec-
tion 6018(a). In calendar year 2016, the
number of estate tax returns filed solely
to elect portability of the DSUE amount
was approximately 20,000, compared to
approximately 12,000 estate tax returns
filed because of a filing requirement un-
der section 6018(a).
D. Establishment of User Fee for Estate
Tax Closing Letters
The IRS continues to experience sig-
nificant budget and resource constraints
that require the IRS to allocate its existing
resources as efficiently as possible. The
volume of estate tax return filings remains
high (approximately 30,500 estate tax re-
turns filed in 2018), in large part attribut-
able to estate tax returns that are filed for
estates having no tax liability or filing
requirement under section 6018 and that
are filed solely to elect portability of the
DSUE amount for the benefit of the sur-
viving spouse of a decedent.
While the practice of issuing estate tax
closing letters is intended as a customer
service convenience to authorized persons
based on an understanding of the unique
nexus between an estate’s Federal estate
tax obligations and the estate’s obligations
under applicable local law for State and
local estate and inheritance taxes and to
administer and close a probate estate, the
Treasury Department and the IRS received
feedback from taxpayers and practitioners
that the procedure for requesting an estate
tax closing letter can be inconvenient and
burdensome. When requests had been ac-
cepted by telephone, a request could not
be made until the IRS’s examination of
the estate tax return had been completed.
Taxpayer representatives, therefore, often
needed to repeat the telephone request,
sometimes multiple times, before the re-
quest could be accepted by the IRS. Cur-
rently, the instructions on http://www.irs.
gov advise that, prior to faxing a request,
an account transcript should be requested
and reviewed to ensure the transaction
code and explanation of “421 - Closed
examination of tax return” are present.
Account transcripts are available online
to registered tax professionals using the
IRS’s Transcript Delivery System (TDS)
or to authorized persons making requests
using Form 4506-T.
In view of the resource constraints and
purpose of issuing estate tax closing let-
ters as a convenience to authorized per-
sons, the IRS has identified the provision
of estate tax closing letters as an appro-
priate service for which to establish a
user fee to recover the costs that the gov-
ernment incurs in providing such letters.
Accordingly, the Treasury Department

Bulletin No. 2021–3 491 January 19, 2021
and the IRS propose establishing a user
fee for estate tax closing letter requests
(see parts E and F for explanation of the
authority to establish the user fee). As
currently determined, the user fee is $67,
as detailed in part H.
Guidance on the procedure for re-
questing an estate tax closing letter and
paying the associated user fee is not pro-
vided in these proposed regulations. The
Treasury Department and the IRS expect
to implement a procedure that will im-
prove convenience and reduce burden for
authorized persons requesting estate tax
closing letters by initiating a one-step,
web-based procedure to accomplish the
request of the estate tax closing letter as
well as the payment of the user fee. As
presently contemplated, a Federal pay-
ment website, such as http://www.pay.
gov, will be used and multiple requests
will not be necessary. The Treasury De-
partment and the IRS believe implement-
ing such a one-step procedure will reduce
the current administrative burden on au-
thorized persons in requesting estate tax
closing letters and will limit the burden
associated with the establishment of a
user fee for providing such service.
E. User Fee Authority
The Independent Offices Appropri-
ations Act of 1952 (IOAA) (31 U.S.C.
9701) authorizes each agency to promul-
gate regulations establishing the charge
for services provided by the agency (user
fees). The IOAA provides that these user
fee regulations are subject to policies pre-
scribed by the President and shall be as
uniform as practicable. Those policies are
currently set forth in the Office of Man-
agement and Budget (OMB) Circular
A-25, 58 FR 38142 (July 15, 1993; OMB
Circular).
The IOAA states that the services pro-
vided by an agency should be self-sus-
taining to the extent possible. 31 U.S.C.
9701(a). The OMB Circular states that
agencies providing services that confer
special benefits on identifiable recipients
beyond those accruing to the general pub-
lic must identify those services, determine
whether user fees should be assessed for
those services, and, if so, establish user
fees that recover the full cost of providing
those services.
As required by the IOAA and the
OMB Circular, agencies are to review
user fees biennially and update them as
necessary to reflect changes in the cost
of providing the underlying services.
During these biennial reviews, an agency
must calculate the full cost of providing
each service, taking into account all di-
rect and indirect costs to any part of the
U.S. Government. The full cost of pro-
viding a service includes, but is not limit-
ed to, salaries, retirement benefits, rents,
utilities, travel, and management costs,
as well as an appropriate allocation of
overhead and other support costs associ-
ated with providing the service.
An agency should set the user fee at
an amount that recovers the full cost of
providing the service unless the agency
requests, and the OMB grants, an ex-
ception to the full cost requirement. The
OMB may grant exceptions only where
the cost of collecting the fees would rep-
resent an unduly large part of the fee for
the activity, or where any other condition
exists that, in the opinion of the agency
head, justifies an exception. When the
OMB grants an exception, the agency
does not collect the full cost of providing
the service and therefore must fund the
remaining cost of providing the service
from other available funding sources.
When the OMB grants an exception, the
agency, and by extension all taxpayers,
subsidize the cost of the service to the
recipients who otherwise would be re-
quired to pay the full cost of providing
the service, as the IOAA and the OMB
Circular directs.
F. Special Benefits Conferred by Issuance
of Estate Tax Closing Letters
The issuance of an estate tax closing
letter, and the return information and pro-
cedural and substantive explanations such
letters provide, constitutes the provision
of a service and confers special benefits
on identifiable recipients beyond those
accruing to the general public. Upon re-
ceipt of an estate tax closing letter, autho-
rized persons can make use of the return
information and procedural and substan-
tive explanations provided in the letter for
non-Federal tax purposes, for example, to
facilitate the executor’s ability to make
the final distribution of estate assets and to
respond as needed to non-Federal tax au-
thorities and entities, such as local probate
courts, State tax departments, and private
stakeholders. Further, executors of such
estates can make use of the return infor-
mation pertaining to the estate’s Federal
tax liability to avoid potential personal
liability for payment of the tax under 31
U.S.C. 3713.
Moreover, letters comparable to es-
tate tax closing letters are not universally
available or provided to taxpayers filing
Federal tax returns other than estate tax
returns, upon request by authorized per-
sons or otherwise. By comparison, ac-
count transcripts are universally provided
by the IRS upon request to all taxpayers.
After issuing Notice 2017-12 to publicize
the availability and utility of an account
transcript as an alternative in lieu of an
estate tax closing letter, the feedback the
IRS received from stakeholders reflects a
definite preference for the return informa-
tion and procedural and substantive expla-
nations provided by the IRS in an estate
tax closing letter. While the IRS will con-
tinue to offer transcripts as an alternative
in lieu of estate tax closing letters at no
charge, an authorized person may choose
which service best supports their needs
based upon the specific circumstances of
the decedent’s estate. Estate tax closing
letters are uniquely available for autho-
rized persons that have need of such spe-
cial benefits.
For these reasons, the issuance of an
estate tax closing letter constitutes the
provision of a service and confers special
benefits to authorized persons requesting
such letters beyond those accruing to the
general public. Accordingly, the IRS is
authorized, pursuant to the IOAA and the
OMB Circular, to charge a user fee for the
issuance of an estate tax closing letter that
reflects the full cost of providing this ser-
vice. See also section 6103(p)(2)(B) (al-
lowing for a reasonable fee for furnishing
return information to any person).
G. Calculation of User Fees Generally
User fee calculations begin by first
determining the full cost for the service.
The IRS follows the guidance provided
by the OMB Circular to compute the full
cost of the service, which includes all in-
direct and direct costs to any part of the

January 19, 2021 492 Bulletin No. 2021–3
U.S. Government including but not limit-
ed to direct and indirect personnel costs,
physical overhead, rents, utilities, travel,
and management costs. The IRS’s cost
methodology is described later in this
part G.
Once the total amount of direct and in-
direct costs associated with a service is de-
termined, the IRS follows the guidance in
the OMB Circular to determine the costs
associated with providing the service to
each recipient, which represents the av-
erage per unit cost of that service. This
average per unit cost is the amount of the
user fee that will recover the full cost of
the service.
The IRS follows generally accept-
ed accounting principles (GAAP), as
established by the Federal Accounting
Standards Advisory Board (FASAB),
in calculating the full cost of provid-
ing services. The FASAB Handbook
of Accounting Standards and Other
Pronouncements, as amended, which
is available at http://files.fasab.gov/
pdffiles/2019_fasab-handbook.pdf,
includes the Statement of Federal Fi-
nancial Accounting Standards 4: Man-
agerial Cost Accounting Standards and
Concepts (SFFAS No. 4) for the Federal
Government. SFFAS No. 4 establishes
internal costing standards under GAAP
to accurately measure and manage the
full cost of Federal programs. The meth-
odology described in the remainder of
this part G is in accordance with SFFAS
No. 4.
1. Cost center allocation
The IRS determines the cost of its ser-
vices and the activities involved in pro-
ducing them through a cost accounting
system that tracks costs to organizational
units. The lowest organizational unit in
the IRS’s cost accounting system is called
a cost center. Cost centers are usually
separate offices that are distinguished by
subject-matter area of responsibility or
geographic region. All costs of operating
a cost center are recorded in the IRS’s cost
accounting system and are allocated to
that cost center. The costs allocated to a
cost center are the direct costs for the cost
center’s activities as well as all indirect
costs, including overhead, associated with
that cost center. Each cost is recorded in
only one cost center.
2. Determining the per unit cost
To establish the per unit cost, the total
cost of providing the service is divided
by the volume of services provided. The
volume of services provided includes
both services for which a fee is charged
as well as subsidized services. The sub-
sidized services are those where OMB
has approved an exception to the full cost
requirement, for example, to charge a re-
duced fee to low-income taxpayers. The
volume of subsidized services is included
in the total volume of services provided to
ensure that the IRS, and not those who are
paying full cost, subsidizes the cost of the
reduced-cost services.
3. Cost estimation of direct labor and
benefits
Not all cost centers are fully devoted
to only one service for which the IRS
charges a user fee. Some cost centers
work on a number of different services.
In these cases, the IRS estimates the cost
incurred in those cost centers attribut-
able to the service for which a user fee is
being calculated by measuring the time
required to accomplish activities related
to the service, and estimating the aver-
age time required to accomplish these
activities. The average time required to
accomplish these activities is multiplied
by the relevant organizational unit’s av-
erage labor and benefits cost per unit of
time to determine the labor and benefits
cost incurred to provide the service. To
determine the full cost, the IRS then adds
an appropriate overhead charge, as dis-
cussed in part G.4.
4. Calculating overhead
Overhead is an indirect cost of oper-
ating an organization that cannot be im-
mediately associated with an activity that
the organization performs. Overhead in-
cludes costs of resources that are jointly
or commonly consumed by one or more
organizational unit’s activities but are not
specifically identifiable to a single activ-
ity.
These costs can include:
• General management and administra-
tive services of sustaining and sup-
port organizations;
• Facilities management and ground
maintenance services (security, rent,
utilities, and building maintenance);
• Procurement and contracting ser-
vices;
• Financial management and account-
ing services;
• Information technology services;
• Services to acquire and operate prop-
erty, plants, and equipment;
• Publication, reproduction, and graph-
ics and video services;
• Research, analytical, and statistical
services;
• Human resources/personnel services;
and
• Library and legal services.
To calculate the overhead allocable to
a service, the IRS multiplies a corporate
overhead rate (Corporate Overhead rate)
by the direct labor and benefits costs de-
termined as discussed above in part G.3.
The Corporate Overhead rate is the ratio
of the sum of the IRS’s indirect labor and
benefits costs from the supporting and
sustaining organizational units—those
that do not interact directly with taxpay-
ers—and all non-labor costs to the IRS’s
labor and benefits costs of its organiza-
tional units that interact directly with tax-
payers. The IRS calculates the Corporate
Overhead rate annually based on cost el-
ements underlying the Statement of Net
Cost included in the IRS Annual Financial
Statements, which are audited by the Gov-
ernment Accountability Office.
The Corporate Overhead rate of 74 per-
cent (rounded to the nearest hundredth)
for costs reviewed during fiscal year (FY)
2018 was calculated based on (FY) 2017
costs, as follows:
Indirect Labor and
Benefits Costs $ 1,705,152,274
Non-Labor Costs + $ 3,213,504,014
Total Indirect Costs $ 4,918,656,288
Direct Labor and
Benefits Costs ÷ $ 6,640,044,003
Corporate Overhead
Rate 74.08%

Bulletin No. 2021–3 493 January 19, 2021
H. Description and Tables Showing
Full Cost Determination for Estate Tax
Closing Letter
The IRS followed the guidance pro-
vided by the OMB Circular to compute
the full cost of issuing estate tax clos-
ing letters to an authorized person. The
OMB Circular explains that the full cost
includes all indirect and direct costs to
any part of the Federal Government in-
cluding but not limited to direct and indi-
rect personnel costs, physical overhead,
rents, utilities, travel, and management
costs.
1. Request Processing Costs
Requests for estate tax closing letters
are processed by GS Grade 5 and Grade 8
customer service representatives. Grade
5 representatives perform 80 percent of
the work and Grade 8 representatives
perform the remaining 20 percent of the
work. The customer service representa-
tive verifies that the request is authorized
and that the address information is cor-
rect. Because a separate estate tax closing
letter is prepared for each executor, re-
sponding to requests often requires more
than one letter, with an average of three
letters per request. It requires approx-
imately 0.65 staff hours for a customer
service representative to review the re-
turn, create the estate tax closing letters,
and prepare the letters for mailing. The
IRS received an average of 17,249 re-
quests for estate tax closing letters in FY
2017 and FY 2018 requiring 11,154 staff
hours.
Total hours allocated to the cost must
also include indirect hours for campus
employees. Indirect hours are calculat-
ed by multiplying the direct hours by the
indirect rate for employees, which is 60
percent. Using this information, IRS de-
termined the total staff hours to process
requests for estate tax closing letters are
17,846 as follows:
Staff Hours 11,154
Indirect Hours (60%) 6,692
Total Hours 17,846
To determine the labor and benefits
costs, IRS converted total hours to full
time employees (FTE) by dividing the to-
tal hours by 2,080, which is the number
of hours worked by a full time employee
during the year, resulting in 8.58 FTE. IRS
calculated the cost per FTE by adding 80
percent of the average salary and benefits
for a GS 5 to 20 percent of the average
salary and benefits for a GS 8 campus
employee and determined the cost of la-
bor and benefits related to this program is
$ 578,831 (rounded to the nearest whole
dollar), as follows:
GS-5 Salary and Benefits
($ 62,330 x 80%) $ 49,864
GS-8 Salary and Benefits
($ 87,993 x 20%) $ 17,599
Total Cost Per FTE $ 67,463
Total FTE 8.58
Total Labor & Benefits for
processing requests $ 578,831
2. Quality Assurance Review Costs
Outgoing estate tax closing letters are
subjected to quality review performed by
GS 8 Grade quality assurance profession-
als. Specifically, five of every 100 estate
tax closing letters mailed are reviewed
for quality assurance. A quality assurance
professional opens the return to (1) ensure
the estate tax closing letter was authorized,
(2) verify that the correct information was
included in the letter, and (3) verify the
address information. Quality assurance
professionals then document their review.
On average, quality assurance profes-
sionals spend .5 staff hours to review one
estate tax closing letter. The estimated la-
bor hours for quality assurance related to
estate tax closing letters are 1,294, deter-
mined as follows:
Estimated Volume of Requests 17,249
Average Number of Letters
per Request x 3
Total Letters Available for
Review 51,747
Estimated Letters Reviewed
(5%) 2,587
Hours per Review x 0.5
Estimated Quality Assurance
Hours 1,294
Indirect Hours (60%) 776
Total Quality Assurance Hours 2,070
Total FTE 1.00
Cost Per Grade 8 $ 87,993
Total Salary and Benefits for
Quality Assurance $ 87,563
3. Overhead Calculation
The IRS applied the Corporate Over-
head rate to the labor and benefits costs to
calculate the full cost for issuing an estate
tax closing letter. The full cost of the pro-
gram is $ 1,160,058, determined as follows:
Total Processing Labor &
Benefits $ 578,831
Total Quality Assurance
Labor & Benefits $ 87,563
Total Labor and Benefits $ 666,394
Corporate Overhead
(74.08%) + $ 493,664
Full Cost $ 1,160,058
To calculate the cost per request, IRS
divided $ 1,160,058 by the volume of
17,249 requests. The cost to issue an es-
tate tax closing letter is $ 67 (rounded to
the nearest whole dollar), determined as
follows:
Full Cost $ 1,160,058
Estimated Volume ÷ 17,249
Cost Per Request $ 67
Proposed Applicability Date
These regulations are proposed to apply
to requests for an estate tax closing letter
received by the IRS after the date that is
30 days after the date of publication in the
Federal Register of a Treasury decision
adopting these rules as final regulations.
Special Analyses
This regulation is not subject to re-
view under section 6(b) of Executive
Order 12866 pursuant to the Memo-
randum of Agreement (April 11, 2018)
between the Treasury Department and
the Office of Management and Budget
regarding review of tax regulations. Pur-
suant to the Regulatory Flexibility Act
(5 U.S.C. chapter 6), it is hereby certi-
fied that these regulations will not have
a significant economic impact on a sub-
stantial number of small entities. The
proposed regulations, which prescribe a
fee to obtain a particular service, affect
decedents’ estates, which generally are
not “small entities” as defined under 5
U.S.C. 601(6). Thus, these regulations
have no economic impact on small enti-
ties. In addition, the dollar amount of the

January 19, 2021 494 Bulletin No. 2021–3
fee ($67 as currently determined) is not
substantial enough to have a significant
economic impact on any entities that
could be affected by establishing such a
fee. Accordingly, the Secretary certifies
that the rule will not have a significant
economic impact on a substantial num-
ber of small entities.
Pursuant to section 7805(f) of the
Code, this notice of proposed rulemaking
will be submitted to the Chief Counsel for
the Office of Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Comments and Requests for a Public
Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are
submitted timely to the IRS as prescribed
in this preamble under the “ADDRESS-
ES” heading. The Treasury Department
and IRS request comments on all aspects
of the proposed regulations. Any electron-
ic comments submitted, and to the extent
practicable any paper comments submit-
ted, will be available at http://www.regu-
lations.gov or upon request.
A public hearing will be scheduled
if requested in writing by any person
who timely submits electronic or written
comments as prescribed in this preamble
under the “DATES” heading. Requests
for a public hearing are also encouraged
to be made electronically. If a public
hearing is scheduled, notice of the date
and time for the public hearing will be
published in the Federal Register. An-
nouncement 2020-4, 2020-17 I.R.B. 1,
provides that until further notice, public
hearings conducted by the IRS will be
held telephonically. Any telephonic hear-
ing will be made accessible to people
with disabilities.
Drafting Information
The principal author of these regula-
tions is Juli Ro Kim of the Office of As-
sociate Chief Counsel (Passthroughs and
Special Industries). Other personnel from
the Treasury Department and the IRS par-
ticipated in the development of the regu-
lations.
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings, Notices, and other guidance cit-
ed in this document are published in the
Internal Revenue Bulletin (or Cumulative
Bulletin) and are available from the Su-
perintendent of Documents, U.S. Govern-
ment Publishing Office, Washington, DC
20402, or by visiting the IRS website at
http://www.irs.gov.
List of Subjects in 26 CFR Part 300
Estate taxes, Excise taxes, Gift taxes,
Income taxes, Reporting and recordkeep-
ing requirements, User fees.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 300 is pro-
posed to be amended as follows:
PART 300—USER FEES
Paragraph 1. The authority citation for
part 300 continues to read as follows:
Authority: 31 U.S.C. 9701.
Par. 2. Section 300.0 is amended by add-
ing paragraph (b)(13) to read as follows:
§ 300.0 User fees; in general.
* * * * *
(b) * * *
(13) Requesting an estate tax closing
letter.
Par. 3. Section 300.13 is added to read
as follows:
§ 300.13 Fee for estate tax closing letter.
(a) Applicability. This section applies
to the request by a person described in
paragraph (c) of this section for an estate
tax closing letter from the IRS.
(b) Fee. The fee for issuing an estate
tax closing letter is $67.
(c) Person liable for the fee. The per-
son liable for the fee is the estate of the
decedent or other person properly autho-
rized under section 6103 of the Internal
Revenue Code to receive and therefore to
request the estate tax closing letter with
respect to the estate.
(d) Applicability date. This section ap-
plies to requests received by the IRS after
[date that is 30 days after these regulations
are published as final regulations in the
Federal Register].
Douglas W. O’Donnell,
Acting Deputy Commissioner for Ser-
vices and Enforcement.
(Filed by the Office of the Federal Register on Feb-
ruary 11, 2020, 4:15 p.m., and published in the issue
of the Federal Register for December 31, 2020, 85
FR 86871)

Bulletin No. 2021–3 i January 19, 2021
Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that
the same principle also applies to B, the
earlier ruling is amplified. (Compare with
modified, below).
Clarified is used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion. It
is not used where a position in a prior rul-
ing is being changed.
Distinguished describes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
with amplified and clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transactions.
This term is most commonly used in a ruling
that lists previously published rulings that
are obsoleted because of changes in laws or
regulations. A ruling may also be obsoleted
because the substance has been included in
regulations subsequently adopted.
Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the
new ruling does more than restate the sub-
stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previous-
ly published ruling in a new ruling that is
self contained. In this case, the previously
published ruling is first modified and then,
as modified, is superseded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of cas-
es in litigation, or the outcome of a Ser-
vice study.
Abbreviations
The following abbreviations in current use
and formerly used will appear in material
published in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.

January 19, 2021 ii Bulletin No. 2021–3
Numerical Finding List
1
Bulletin 2021–3
Notices:
2021-01, 2021-02 I.R.B. 315
2021-03, 2021-02 I.R.B. 316
2021-04, 2021-02 I.R.B. 319
2021-02, 2021-03 I.R.B. 478
2021-05, 2021-03 I.R.B. 479
2021-07, 2021-03 I.R.B. 482
Proposed Regulations:
REG-130081-19, 2021-02 I.R.B. 321
REG-114615-16, 2021-03 I.R.B. 489
Revenue Procedures:
2021-01, 2020-01 I.R.B. 1
2021-02, 2020-01 I.R.B. 116
2021-03, 2020-01 I.R.B. 140
2021-04, 2020-01 I.R.B. 157
2021-05, 2020-01 I.R.B. 250
2021-07, 2020-01 I.R.B. 290
2021-09, 2020-03 I.R.B. 485
Revenue Rulings:
2021-01, 2021-02 I.R.B. 294
Treasury Decisions:
9925, 2021-02 I.R.B. 296
9940, 2021-02 I.R.B. 311
9932, 2021-03 I.R.B. 345
9939, 2021-03 I.R.B. 376
9941, 2021-03 I.R.B. 396
9942, 2021-03 I.R.B. 450
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2020–27 through 2020–52 is in Internal Revenue Bulletin
2020–52, dated December 27, 2020.

Bulletin No. 2021–3 iii January 19, 2021
Finding List of Current Actions on
Previously Published Items
1
Bulletin 2021–3
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2020–27 through 2020–52 is in Internal Revenue Bulletin
2020–52, dated December 27, 2020.

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