rp-01-10.pdf

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Part III
Administrative, Procedural, and Miscellaneous
26 CFR 601.204: Changes in accounting periods and in methods of accounting.
(Also Part 1 , §§ 162, 263A, 446, 471, 481, 1001; 1.162-3, 1.263A-1, 1.446-1, 1.471-1,
1.481-1, 1.481-4, 1.1001-1.)
Rev. Proc. 2001-10
SECTION 1. PURPOSE
This revenue procedure modifies and supersedes Rev. Proc. 2000-22, 2000-20
I.R.B. 1008, and provides that the Commissioner of Internal Revenue will exercise his
discretion to except a qualifying taxpayer with average annual gross receipts of
$1,000,000 or less from the requirements to use an accrual method of accounting
under § 446 of the Internal Revenue Code and to account for inventories under § 471.
This revenue procedure also provides the procedures by which a qualifying taxpayer
(as defined in section 3 of this revenue procedure) may obtain automatic consent to
change to the cash receipts and disbursements method of accounting (the cash
method) and to a method of accounting for inventory as materials and supplies that are
not incidental under § 1.162-3 of the Income Tax Regulations.
SECTION 2. BACKGROUND AND CHANGES
.01 Section 446(a) provides that taxable income must be computed under the
method of accounting on the basis of which the taxpayer regularly computes income in
keeping the taxpayer’s books.

.02 Section 446(c) generally allows a taxpayer to select the method of
accounting it will use to compute its taxable income. A taxpayer is entitled to adopt any
one of the permissible methods for each separate trade or business, including the cash
method and an accrual method, subject to certain restrictions. For example, § 446(b)
provides that the selected method must clearly reflect income. In addition, § 1.446-
1(c)(2)(i) requires that a taxpayer use an accrual method of accounting with regard to
purchases and sales of merchandise whenever § 471 requires the taxpayer to account
for inventories, unless otherwise authorized by the Commissioner under § 1.446-
1(c)(2)(ii). Under § 1.446-1(c)(2)(ii), the Commissioner has the authority to permit a
taxpayer to use a method of accounting that clearly reflects income even though the
method is not specifically authorized by the regulations.
.03 The cash method generally requires an item to be included in income when
actually or constructively received and permits a deduction for an expense when paid.
§ 1.446-1(c)(1)(i).
.04 Section 471 provides that whenever, in the opinion of the Secretary, the use
of inventories is necessary to clearly determine the income of the taxpayer, inventories
must be taken by the taxpayer. Section 1.471-1 requires a taxpayer to account for
inventories when the production, purchase, or sale of merchandise is an income-
producing factor in the taxpayer's business.
.05 Section 1.162-3 requires taxpayers carrying materials and supplies (other
than incidental materials and supplies) on hand to deduct the cost of materials and

supplies only in the amount that they are actually consumed and used in operations
during the tax year.
.06 Section 263A generally requires direct costs and an allocable portion of
indirect costs of certain property produced or acquired for resale by a taxpayer to be
included in inventory costs, in the case of property that is inventory, or to be capitalized,
in the case of other property. However, resellers with gross receipts of $10,000,000 or
less and producers with $200,000 or less of indirect costs are not required to capitalize
costs under § 263A. See §§ 263A(b)(2)(B) and 1.263A-2(b)(3)(iv).
.07 Sections 446(e) and 1.446-1(e) state that, except as otherwise provided, a
taxpayer must secure the consent of the Commissioner before changing a method of
accounting for federal income tax purposes. Section 1.446-1(e)(3)(ii) authorizes the
Commissioner to prescribe administrative procedures setting forth the limitations, terms,
and conditions deemed necessary to permit a taxpayer to obtain consent to change a
method of accounting in accordance with § 446(e).
.08 Section 481(a) requires those adjustments necessary to prevent amounts
from being duplicated or omitted to be taken into account when the taxpayer's taxable
income is computed under a method of accounting different from the method used to
compute taxable income for the preceding tax year.
.09 Rev. Proc. 2000-22 is modified in the following respects:
(1) Section 3 is modified to make clear that this revenue procedure does
not apply to taxpayers described in § 448(a)(3) (tax shelters).

(2) Section 4.02 is added to clarify the proper time to take into account the
cost of inventoriable items (i.e., merchandise purchased for resale and raw materials
purchased for use in producing finished goods) that are treated as materials and
supplies that are not incidental under § 1.162-3;
(3) The conformity requirement of section 5.07 has been removed.
Taxpayers are reminded that they must comply with the requirements under § 446(a)
and the regulations thereunder to maintain adequate books and records, which may
include a reconciliation of any differences between such books and records and their
return. See § 1.446-1(a)(4);
(4) Section 6.02(1) is modified to provide that qualifying taxpayers using
an accrual method of accounting that are not required under § 471 to account for
inventories may use the automatic consent provisions of this revenue procedure to
change to the cash method;
(5) Section 6.02(2) is modified to provide that qualifying taxpayers
(including taxpayers not currently accounting for inventories) may use the automatic
consent provisions of this revenue procedure to change to the method of accounting for
inventoriable items as materials and supplies that are not incidental under § 1.162-3;
(6) Section 6.03 is added to provide guidance on the computation of the
adjustment required under § 481(a) in connection with the automatic changes in
method of accounting under this revenue procedure; and
(7) Section 8 is modified in accordance with the removal of the conformity
requirement of section 5.07.

SECTION 3. SCOPE
This revenue procedure applies to taxpayers (other than a taxpayer described in
§ 448(a)(3)) with “average annual gross receipts” of $1,000,000 or less (as defined in
section 5.01 of this revenue procedure)(“qualifying taxpayers”).
SECTION 4. SMALL TAXPAYER EXCEPTION
.01 Pursuant to the discretion under §§ 446(b) and 471, and to simplify
bookkeeping requirements for small taxpayers, the Commissioner, as a matter of
administrative convenience, will except qualifying taxpayers from the requirements to
use an accrual method under § 446 and to account for inventories under § 471. For
purposes of this revenue procedure, notwithstanding § 1001 and the regulations
thereunder, qualifying taxpayers that use the cash method include amounts in income
attributable to open accounts receivable (i.e., receivables due in 120 days or less) as
amounts are actually or constructively received. However, § 1001 may be applicable to
other transactions. Qualifying taxpayers that do not want to account for inventories
must treat inventoriable items (i.e., merchandise purchased for resale and raw materials
purchased for use in producing finished goods) in the same manner as materials and
supplies that are not incidental under § 1.162-3. Section 263A does not apply to
inventoriable items that are treated as materials and supplies that are not incidental.
.02 Under § 1.162-3, materials and supplies that are not incidental are
deductible only in the year in which they are actually consumed and used in the
taxpayer's business. For purposes of this revenue procedure, inventoriable items that
are treated as materials and supplies that are not incidental are consumed and used in

the year in which the taxpayer sells the merchandise or finished goods. Thus, under
the cash method, the cost of such inventoriable items are deductible only in that year,
or in the year in which the taxpayer actually pays for the inventoriable items, whichever
is later. Producers may use any reasonable method of estimating the amount of raw
materials in their year-end work-in-process and finished goods inventory to determine
the amount of raw materials that were used to produce finished goods that are sold
during the tax year, provided that method is used consistently.
.03 The Service and Treasury expect to provide further guidance on when items
may be treated as incidental materials and supplies (the cost of which may be deducted
currently under § 1.162-3) and when items are inventoriable items (the cost of which,
under this revenue procedure, may be deducted no earlier than the year in which the
items are consumed and used).
SECTION 5. DEFINITIONS
.01 Average annual gross receipts defined. A taxpayer has average annual
gross receipts of $1,000,000 or less if, for each prior tax year ending on or after
December 17, 1998, the taxpayer’s average annual gross receipts for the 3-tax-year
period ending with the applicable prior tax year does not exceed $1,000,000.
.02 Gross receipts defined. Gross receipts is defined consistent with § 1.448-
1T(f)(2)(iv) of the temporary regulations. Thus, gross receipts for a tax year equal all
receipts derived from all of the taxpayer’s trades or businesses that must be recognized
under the method of accounting actually used by the taxpayer for that tax year for
federal income tax purposes. For example, gross receipts include total sales (net of

returns and allowances), all amounts received from services, interest, dividends, and
rents. However, gross receipts do not include amounts received by the taxpayer with
respect to sales tax or other similar state and local taxes if, under the applicable state
or local law, the tax is legally imposed on the purchaser of the good or service, and the
taxpayer merely collects and remits the tax to the taxing authority.
.03 Aggregation of gross receipts. For purposes of computing gross receipts, all
taxpayers treated as a single employer under subsection (a) or (b) of § 52 or subsection
(m) or (o) of § 414 (or that would be treated as a single employer under these sections
if the taxpayers had employees) will be treated as a single taxpayer. However, when
transactions occur between taxpayers that are treated as a single taxpayer by the
previous sentence, gross receipts arising from these transactions will not be treated as
gross receipts for purposes of the average annual gross receipts limitation. See §
1.448-1T(f)(2)(ii).
.04 Taxpayer not in existence for 3 tax years. If a taxpayer has been in
existence for less than the 3-tax-year period referred to in section 5.01 of this revenue
procedure, the taxpayer must determine its average annual gross receipts for the
number of years (including short tax years) that the taxpayer has been in existence.
.05 Treatment of short tax years. In the case of a short tax year, the taxpayer's
gross receipts must be annualized by multiplying the gross receipts of the short tax year
by 12 and then dividing the product by the number of months in the short tax year. See
§ 1.448-1T(f)(2)(iii).

.06 Treatment of predecessors. Any reference to taxpayer in this section 5
includes a reference to any predecessor of such taxpayer.
.07 Example. Taxpayer A, a calendar year taxpayer, manufactures and sells
widgets. For federal income tax purposes, Taxpayer A uses an overall accrual method
of accounting. Further, Taxpayer A complies with the requirements of § 1.471-1 to use
inventory accounts and § 263A to capitalize direct and indirect costs.
Taxpayer A has gross receipts (as defined in section 5.02 of this revenue
procedure) of $200,000 in 1996, $800,000 in 1997 and $1,100,000 in 1998.
To determine whether it qualifies for the small taxpayer exception set forth in
section 4 of this revenue procedure beginning with the 1999 tax year, Taxpayer A
computes its average annual gross receipts for each prior tax year ending on or after
December 17, 1998, that is, its 1998 tax year. Taxpayer A's average annual gross
receipts for 1998 is $700,000 ($200,000 (1996) + $800,000 (1997) + $1,100,000 (1998)
= $2,100,000/3).
Taxpayer A’s average annual gross receipts for each prior tax year ending after
December 17, 1998, does not exceed $1,000,000. Therefore, Taxpayer A qualifies for
the small taxpayer exception for its 1999 tax year. By following the procedures set forth
in section 6.02 of this revenue procedure, Taxpayer A may change to the cash method
and a method of treating inventoriable items in the same manner as materials and
supplies that are not incidental under § 1.162-3 for the tax year ending December 31,
1999.

Taxpayer A must determine its applicability for the small taxpayer exception set
forth in section 4 of this revenue procedure each year. Thus, to qualify for the
exception for its 2000 tax year, Taxpayer A’s average annual gross receipts for 1999
(i.e., the average of A’s gross receipts for 1999, 1998, and 1997) also must be
$1,000,000 or less. If, in any later year, Taxpayer A ceases to qualify for the small
taxpayer exception set forth in section 4 of this revenue procedure, it must change to an
inventory method and an accrual method with respect to the production and sale of
widgets in accordance with section 6.04 of this revenue procedure.
SECTION 6. CHANGE IN ACCOUNTING METHOD
.01 In general. Any change in a taxpayer's method of accounting pursuant to
this revenue procedure is a change in method of accounting to which the provisions of
§§ 446 and 481 and the regulations thereunder apply.
.02 Automatic change for taxpayers within the scope of this revenue procedure.
(1) Automatic change to the cash method. A qualifying taxpayer that
wants to change to the cash method must follow the automatic change in accounting
method provisions of Rev. Proc. 99-49, 1999-52 I.R.B. 725 (or its successor) with the
following modifications:
(a) The scope limitations in section 4.02 of Rev. Proc. 99-49 do not
apply. However, if the taxpayer is under examination, before an appeals office, or
before a federal court with respect to any income tax issue, the taxpayer must provide a
copy of the Form 3115, Application for Change in Accounting Method, to the examining
agent(s), appeals officer, or counsel for the government, as appropriate, at the same

time that it files the copy of the Form 3115 with the national office. The Form 3115
must contain the name(s) and telephone number(s) of the examining agent(s), appeals
officer, or counsel for the government, as appropriate;
(b) A taxpayer making a change under section 6.02 of this revenue
procedure for its first tax year ending on or after December 17, 1999, that, on or before
January 16, 2001, files or filed its original federal income tax return for such year, is not
required to comply with the filing requirement in section 6.02(2)(a) of Rev. Proc. 99-49,
provided the taxpayer complies with the following filing requirement. The taxpayer must
complete and file a Form 3115 in duplicate. The original must be attached to the
taxpayer’s amended federal income tax return for the taxpayer’s first tax year ending on
or after December 17, 1999. This amended return must be filed no later than June 15,
2001. A copy of the Form 3115 must be filed with the national office (see section
6.02(5) of Rev. Proc. 99-49 for the address) no later than when the taxpayer’s amended
return is filed;
(c) For a change in method of accounting within the scope of this
revenue procedure, the provisions of Rev. Proc. 99-49 are effective for tax years ending
on or after December 17, 1999; and
(d) Taxpayers filing Form 3115 for a change in method of
accounting under section 6.02 of this revenue procedure are reminded to complete all
applicable parts of the form, including Part II, line 17 (regarding information on gross
receipts in previous years) and Part III (regarding the § 481(a) adjustment). Such
taxpayers must also complete Part I of Schedule A of Form 3115, but need not

complete Part II. Taxpayers should write “Filed under Rev. Proc. 2001-10” at the top of
the form.
(2) Automatic change to § 1.162-3. A qualifying taxpayer that does not
want to account for inventories must make any necessary change from the taxpayer’s
current method of accounting for inventoriable items (including, if applicable, from the
method of capitalizing costs under § 263A) to treat inventoriable items in the same
manner as materials and supplies that are not incidental under § 1.162-3. For
purposes of such a change, the rules of section 6.02(1) of this revenue procedure
apply. Taxpayers may file a single Form 3115 for both changes described in sections
6.02(1) and (2).
.03 Section 481(a) adjustment. The net amount of the § 481(a) adjustment
computed under this revenue procedure must take into account both increases and
decreases in the applicable account balances such as accounts receivable, accounts
payable, and inventory. For example, a taxpayer that wants to treat inventory as
materials and supplies that are not incidental under § 1.162-3 must take into account
the difference resulting from this recharacterization in determining the § 481(a)
adjustment.
.04 Taxpayers not within the scope of this revenue procedure. A taxpayer that
ceases to qualify for the small taxpayer exception described in section 4 of this revenue
procedure and otherwise is required to use an accrual method (e.g., a taxpayer
otherwise required to account for inventories) must change to an accrual method and, if
applicable, an inventory method that complies with §§ 263A and 471 using either the

automatic change in accounting method provisions of section 5.01 of the APPENDIX to
Rev. Proc. 99-49, if applicable, or the advance consent provisions of Rev. Proc. 97-27,
1997-1 C.B. 680 (or its successor).
SECTION 7. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 2000-22 is modified and, as modified, is superseded. Rev. Proc. 99-
49 is modified and amplified to include this automatic change in section 5 of the
APPENDIX.
SECTION 8. EFFECTIVE DATE
This revenue procedure is effective for tax years ending on or after December
17, 1999. However, the Service will not challenge a taxpayer's use of the cash method
under § 446 (or a taxpayer’s failure to account for inventories under § 471) in an earlier
year if the taxpayer would satisfy the 3-tax-year-period gross receipts test of section
5.01 of this revenue procedure (applied by testing the 3-tax-year period ending prior to
such earlier year).
DRAFTING INFORMATION
The principal author of this revenue procedure is Cheryl Lynn Oseekey of the
Office of Associate Chief Counsel (Income Tax and Accounting). For further
information regarding this revenue procedure, contact Ms. Oseekey on (202) 622-4970
(not a toll-free call).