2006 base period T-bill rate. The “base period T-bill rate” for the period ending September 30, 2006, is published as required by section 995(f) of the Code.

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate. For purposes of sections 382, 642, 1274, 1288, and other sections of the Code, tables set forth the rates for November 2006.

Final regulations under section 752 of the Code contain rules for taking into account certain obligations of a business entity that is disregarded as separate from its owner under section 856(i) or section 1361(b)(3), or regulations sections 301.7701-1 through 301.7701-3. The regulations clarify the existing regulations concerning when a partner may be treated as bearing the economic risk of loss for a partnership liability based upon an obligation of a disregarded entity.

This notice provides rules interpreting the reasonable mortality charge requirement contained in section 7702(c)(3)(B)(i) of the Code. Notice 88-128 supplemented. Notice 2004-61 modified and superseded.

The United States recently exchanged instruments of ratification for a new income tax treaty with Bangladesh and a new protocol with Sweden. The tables in this announcement can be used to supplement the tables in Publications 515 and 901.

The document describes how certain taxpayers may elect to use dual consolidated losses subject to section 1503(d) of the Code either in the United States or the United Kingdom, and contains background information for that election.

This document provides procedures under which a taxpayer may use the automatic consent procedures of Rev. Proc. 2002-9 to request a change in method of accounting to comply with regulations sections 1.168(k)-1 or 1.1400L(b)-1. Rev. Proc. 2002-9 modified and amplified.

This document provides the exclusive procedures for a corporation to obtain automatic approval from the Commissioner to change an annual accounting period under section 442 of the Code. Rev. Proc. 2002-37 clarified, modified, amplified, and superseded.

This document provides the exclusive procedures for a partnership, S corporation, electing S corporation, personal service corporation, or trust to obtain automatic approval from the Commissioner to adopt, change, or retain an annual accounting period under section 442 of the Code. Rev. Proc. 2002-38 clarified, modified, amplified, and superseded.

This document provides methods to determine the amount of “paragraph (e)(1) wages” for purposes of the limitation contained in section 199(b)(1) on the amount of the deduction provided by section 199(a)(1) for income attributable to domestic production activities. The procedure reflects changes in the definition of “W-2 wages” for purposes of section 199 made by the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA).

This document contains corrections to final and temporary regulations (T.D. 9281, 2006-39 I.R.B. 517) relating to the determination of the interest expense deduction of foreign corporations and applies to foreign corporations engaged in a trade or business within the United States.

This document contains corrections to final regulations (T.D. 9276, 2006-37 I.R.B. 423) concerning the definition of supplemental wages for income tax withholding purposes and income tax requirements for employers making payments of supplemental wages to employees.

Internal Revenue Service (IRS), Treasury.

Final regulations.

This document contains final regulations under section 752 for taking into account certain obligations of a business entity that is disregarded as separate from its owner under section 856(i) or section 1361(b)(3) of the Internal Revenue Code, or §§301.7701-1 through 301.7701-3 of the Procedure and Administration Regulations. These final regulations clarify the existing regulations concerning when a partner may be treated as bearing the economic risk of loss for a partnership liability based upon an obligation of a disregarded entity. The rules affect partnerships and their partners.

Effective Date: These regulations are effective on October 11, 2006.

Applicability Date: These regulations generally are applicable for liabilities incurred or assumed by a partnership on or after October 11, 2006.

Charlotte Chyr, 202-622-3070 (not a toll-free number).

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

The principal author of these regulations is Charlotte Chyr, Office of Associate Chief Counsel (Passthroughs and Special Industries).

* * * * *

Section 995(f)(1) of the Internal Revenue Code provides that a shareholder of a DISC shall pay interest each taxable year in an amount equal to the product of the shareholder’s DISC-related deferred tax liability for the year and the “base period T-bill rate.” Under section 995(f)(4), the base period T-bill rate is the annual rate of interest determined by the Secretary to be equivalent to the average of the 1-year constant maturity Treasury yields, as published by the Board of Governors of the Federal Reserve System, for the 1-year period ending on September 30 of the calendar year ending with (or of the most recent calendar year ending before) the close of the taxable year of the shareholder. The base period T-bill rate for the period ending September 30, 2006 is 4.76 percent.

Pursuant to section 6222 of the Code, interest must be compounded daily. The table below provides factors for compounding the base period T-bill rate daily for any number of days in the shareholder’s taxable year (including a 52-53 week accounting period) for the 2006 base period T-bill rate. To compute the amount of the interest charge for the shareholder’s taxable year, multiply the amount of the shareholder’s DISC-related deferred tax liability (as defined in section 995(f)(2)) for that year by the base period T-bill rate factor corresponding to the number of days in the shareholder’s taxable year for which the interest charge is being computed. Generally, one would use the factor for 365 days. One would use a different factor only if the shareholder’s taxable year for which the interest charge being determined is a short taxable year, if the shareholder uses the 52-53 week taxable year, or if the shareholder’s taxable year is a leap year.

For the base period T-bill rates for the periods ending in prior years, see Rev. Rul. 2005-70, 2005-45 I.R.B. 919, Rev. Rul. 2004-99, 2004-2 C.B. 720, Rev. Rul. 2003-111, 2003-2 C.B. 1009, Rev. Rul. 2002-68, 2002-2 C.B. 808, Rev. Rul. 2001-56, 2001-2 C.B. 500, and Rev. Rul. 2000-52, 2000-2 C.B. 516.

The principal author of this revenue ruling is David Bergkuist of the Office of the Associate Chief Counsel (International). For further information about this revenue ruling, contact Mr. Bergkuist at (202) 622-3850 (not a toll-free call).

This revenue ruling provides various prescribed rates for federal income tax purposes for November 2006 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

The United States recently exchanged instruments of ratification for a new income tax treaty with Bangladesh and a new protocol with Sweden.

Bangladesh. The provisions relating to withholding tax at source are effective for amounts paid or credited on or after October 1, 2006. For other taxes, the treaty is effective for tax periods beginning on or after January 1, 2007.

Sweden. The provisions relating to withholding tax at source are effective for amounts paid or credited on or after October 1, 2006. For other taxes, the protocol is effective for tax years beginning on or after January 1, 2007.

Tables 1 and 2. The following tables can be used to supplement Tables 1 and 2 in Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, and Publication 901, U.S. Tax Treaties. The footnotes in those publications that relate to the column headings in these tables generally apply to these entries.

The protocol with Sweden affects only the footnotes in columns 6 and 7 of Table 1. These are the only columns shown for Sweden. The tables in Publication 515 and Publication 901 for Sweden can be used for the other columns of Table 1 and for Table 2.

The following is a copy of the Mutual Agreement entered into on October 6, 2006, by the Competent Authorities of the United States and the United Kingdom, regarding the elimination of double taxation as a result of the interaction of the UK non-resident company group relief rules and the U.S. dual consolidated loss rules. The agreement constitutes a Mutual Agreement in accordance with paragraph 3 Article 26 (Mutual Agreement Procedure) of the Convention Between the United States of America and the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation with Respect to Taxes on Income signed at London on July 24, 2001.

For further information regarding this announcement, contact Kathleen Bellamy of the Office of the Deputy Commissioner (International), Large and Mid-Size Business at (202) 435-5040 (not a toll-free call) or Jeffrey Cowan of the Office of the Associate Chief Counsel (International) at (202) 622-3860 (not a toll-free call).

The text of the agreement is as follows:

Paragraph 3 of Article 26 of the Convention Between the Government of the United States of America and the Government of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains signed at London on July 24, 2001, and subsequently amended by a protocol signed July 19, 2002 (“Treaty”) allows the competent authorities of the Contracting States to consult together for the elimination of double taxation in cases not provided for in the Treaty.

The competent authority of each Contracting State recognizes that in certain situations the interaction of domestic loss relief rules can lead to double taxation. Those rules are, in the case of the United States, section 1503(d) of the Internal Revenue Code (Code) and the regulations thereunder, including Treas. Reg. §1.1503-2(b) and (c)(15)(iv), and, in the case of the United Kingdom, S 403D(1)(c) when subject to 403D(6) ICTA88. These rules are discussed below.

This notice provides rules interpreting the reasonable mortality charge requirement contained in § 7702(c)(3)(B)(i) of the Internal Revenue Code. Specifically, this notice supplements Notice 88-128, 1988-2 C.B. 540, and modifies and supersedes Notice 2004-61, 2004-2 C.B. 596, by providing safe harbors regarding the use by taxpayers of either the 1980 Commissioners’ Standard Ordinary mortality and morbidity tables (1980 CSO tables) or the 2001 Commissioners’ Standard Ordinary mortality and morbidity tables (2001 CSO tables) to determine whether mortality charges are reasonable. These safe harbors are designed to assist taxpayers in complying with the requirements of § 7702(c)(3)(B)(i).

Section 7702 of the Code defines the term “life insurance contract” for purposes of the Code. Section 7702(a) provides that a “life insurance contract” is any contract that is a life insurance contract under the applicable law, but only if such contract either (1) meets the cash value accumulation test of § 7702(b), or (2) both meets the guideline premium requirements of § 7702(c) and falls within the cash value corridor of § 7702(d).

Section 7702(c)(3)(B)(i) provides that the guideline single premium under § 7702(c) is determined on the basis of reasonable mortality charges that meet the requirements (if any) prescribed in regulations and that (except as provided in regulations) do not exceed the mortality charges specified in the prevailing commissioners’ standard tables (as defined in § 807(d)(5)) as of the time the contract is issued. The mortality charges specified in § 7702(c)(3)(B)(i) are also used for determining the “net single premium” (see § 7702(b)(2)(B)), and the “guideline level premium” (see § 7702(c)(4)). The same reasonable mortality charge standard applies for purposes of determining whether a life insurance contract is a modified endowment contract under § 7702A (see § 7702A(c)(1)(B)).

Section 807(d)(5)(A) provides that the term “prevailing commissioners’ standard tables” means, with respect to any contract, the most recent commissioners’ standard tables prescribed by the National Association of Insurance Commissioners (NAIC) that are permitted to be used in computing reserves for that type of contract under the insurance laws of at least 26 states when the contract was issued. Section 807(d)(5)(B) provides a 3-year transition period during which an insurer may use either the newly prevailing CSO tables or those that were previously prevailing.

The 2001 CSO tables prescribed by the NAIC became the prevailing commissioners’ standard tables within the meaning of § 807(d)(5) during calendar year 2004, and have now been adopted by all 50 states. The 1980 CSO tables may still be used in all states for contracts issued in calendar years through 2008. For contracts issued after 2008, use of the 2001 CSO tables will be mandatory.

Notice 88-128 was issued after § 7702 was amended to require that only “reasonable” mortality charges be taken into account for purposes of testing life insurance contract qualification under § 7702. Under Notice 88-128, interim safe harbors provided that the 1980 CSO tables (and, for certain previously issued contracts, the 1958 CSO tables) would satisfy the requirement that mortality charges be “reasonable” under § 7702(c)(3)(B)(i). Notice 2004-61 supplemented Notice 88-128 by providing additional safe harbors to account for the promulgation of the 2001 CSO tables. Neither Notice 88-128, Notice 2004-61, nor this notice addresses the reasonable mortality charge requirement in the case of substandard risk underwriting. See the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-647 (1988 Act), § 5011(c)(2).

Notice 2004-61 requested comments on the need for additional guidance on the adoption of the 2001 CSO tables. This notice modifies Notice 2004-61 in response to the comments that were received. First, the safe harbor for contracts issued based on the 1980 CSO tables (1980 CSO contracts) is modified to remove the requirement in Notice 2004-61 that mortality charges used to determine whether a contract qualifies as a life insurance contract under § 7702 not exceed the mortality charge specified in the contract at issuance. Second, the new rules for gender- or smoker-based tables are modified to apply only to contracts issued based upon the 2001 CSO tables (2001 CSO contracts). These two changes help to ensure that the notice does not subject 1980 CSO contracts to more stringent standards, retroactively, than applied under Notice 88-128. Third, the rule for determining the issue date of a contract that undergoes an increase or decrease in death benefit is simplified by eliminating the concept of “underwriting.” This change broadens the grandfather rule of Notice 2004-61 to encompass many routine transactions, but does not wholly defer to an issuer’s administrative practices and procedures. Fourth, additional examples are provided of changes, modifications, or exercises of contractual provisions that will not require a change from previous tables to the 2001 CSO tables. Except as described above, this notice does not modify the definition of “issue date” that was provided in Notice 2004-61.

The following safe harbors apply for purposes of determining reasonable mortality charges under § 7702:

.01 Notice 88-128. The interim rules described in Notice 88-128 remain in effect, except as otherwise modified by this notice.

.02 1980 CSO tables. A mortality charge with respect to a life insurance contract will satisfy the requirements of § 7702(c)(3)(B)(i) so long as (1) the mortality charge does not exceed 100 percent of the applicable mortality charge set forth in the 1980 CSO tables; (2) the contract is issued in a state that permits or requires the use of the 1980 CSO tables at the time the contract is issued; and (3) the contract is issued before January 1, 2009.

.03 2001 CSO tables. A mortality charge with respect to a life insurance contract will satisfy the requirements of § 7702(c)(3)(B)(i) so long as (1) the mortality charge does not exceed 100 percent of the applicable mortality charge set forth in the 2001 CSO tables; (2) the mortality charge does not exceed the mortality charge specified in the contract at issuance; and (3) either (a) the contract is issued after December 31, 2008, or (b) the contract is issued before January 1, 2009, in a state that permits or requires the use of the 2001 CSO tables at the time the contract is issued.

.01 For purposes of this notice, the date on which a contract was issued generally is to be determined according to the standards that applied for purposes of the original effective date of § 7702. See H.R. Conf. Rep. No. 861, 98th Cong., 2d Sess. 1076 (1984), 1984-3 (Vol. 2) C.B. 330; see also 1 Staff of Senate Comm. on Finance, 98th Cong., 2d Sess., Deficit Reduction Act of 1984, Explanation of Provisions Approved by the Committee on March 21, 1984, at 579 (Comm. Print 1984). Thus, contracts received in exchange for existing contracts are to be considered new contracts issued on the date of the exchange. For these purposes, a change in an existing contract is not considered to result in an exchange if the terms of the resulting contract (that is, the amount and pattern of death benefit, the premium pattern, the rate or rates guaranteed on issuance of the contract, and mortality and expense charges) are the same as the terms of the contract prior to the change.

.02 Notwithstanding section 5.01, if a life insurance contract satisfied section 4.01 or 4.02 when originally issued, a change from previous tables to the 2001 CSO tables is not required if (1) the change, modification, or exercise of a right to modify, add or delete benefits is pursuant to the terms of the contract; (2) the state in which the contract is issued does not require use of the 2001 CSO tables for that contract under its standard valuation and minimum nonforfeiture laws; and (3) the contract continues upon the same policy form or blank.

.03 The changes, modifications, or exercises of contractual provisions referred to in section 5.02 include (1) the addition or removal of a rider; (2) the addition or removal of a qualified additional benefit (QAB); (3) an increase or decrease in death benefit (whether or not the change is underwritten); (4) a change in death benefit option (such as a change from an option 1 to option 2 contract or vice versa); (5) reinstatement of a policy within 90 days after its lapse; and (6) reconsideration of ratings based on rated condition, lifestyle or activity (such as a change from smoker to nonsmoker status).

For purposes of section 4.03 (the 2001 CSO safe harbor), mortality charges that do not exceed the applicable charges in gender- or smoker-based variations of the 2001 CSO tables will be treated as reasonable mortality charges, provided the following requirements are satisfied:

.01 Unisex tables. If a state permits minimum nonforfeiture values for all contracts issued under a plan of insurance to be determined using the 2001 CSO Gender-Blended Mortality tables (“unisex tables”), then the applicable mortality charges in those tables are treated as reasonable mortality charges for female insureds provided the same tables are used to determine mortality charges for male insureds.

.02 Smoker/nonsmoker tables. If a state permits minimum nonforfeiture values for all contracts issued under a plan of insurance to be determined using the 2001 CSO Smoker and Nonsmoker Mortality tables (“smoker/nonsmoker tables”), then the applicable mortality charges in those tables for smoker insureds are treated as reasonable mortality charges provided nonsmoker tables are used to determine nonsmoker mortality charges.

This notice supplements Notice 88-128 and modifies and supersedes Notice 2004-61.

This notice is effective October 12, 2006, except that the provisions of this notice will not be applied adversely to taxpayers who issued, changed or modified contracts in compliance with Notice 2004-61 (without regard to the modifications made by this notice).

This notice serves as an “administrative pronouncement” as that term is described in § 1.6661-3(b)(2) of the regulations and may be relied upon to the same extent as a revenue ruling or a revenue procedure.

The principal author of this notice is Ann H. Logan of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this notice, contact Ann H. Logan at (202) 622-3970 (not a toll-free call).

This revenue procedure provides the exclusive administrative procedures under which a taxpayer described in section 3 of this revenue procedure may obtain automatic consent to change its method of accounting to comply with § 1.168(k)-1 or § 1.1400L(b)-1 of the Income Tax Regulations (the “final regulations”).

.01 On August 31, 2006, the Internal Revenue Service and Treasury Department published the final regulations in the Federal Register (T.D. 9283, 2006-41 I.R.B. 633 [71 FR 51727]). Section 1.168(k)-1 prescribes the requirements that must be met for depreciable property to qualify for the additional first year depreciation deduction provided by § 168(k) of the Internal Revenue Code (“bonus depreciation deduction”). Section 1.1400L(b)-1 prescribes the requirements that must be met for depreciable property to qualify for the additional first year depreciation deduction provided by § 1400L(b) (“Liberty Zone bonus depreciation deduction”). The final regulations under § 1.168(k)-1 generally apply to qualified property under § 168(k)(2) acquired by a taxpayer after September 10, 2001, and to 50-percent bonus depreciation property under § 168(k)(4) acquired by a taxpayer after May 5, 2003. The final regulations under § 1.1400L(b)-1 generally apply to qualified New York Liberty Zone property acquired by a taxpayer after September 10, 2001.

.02 Because of revisions made to T.D. 9091, 2003-2 C.B. 939 (68 FR 52986) by the final regulations, taxpayers may need to seek a change in method of accounting to comply with the final regulations. For example, § 1.1400L(b)-1T(b)(4) and (c)(2)(ii) disallowed certain depreciable property from qualifying for the Liberty Zone bonus depreciation deduction. Section 1.1400L(b)-1 amended § 1.1400L(b)-1T(b)(4) and (c)(2)(ii) and, as a result, more depreciable property may qualify for the Liberty Zone bonus depreciation deduction. Section 1.1400L(b)-1(g)(4)(iii) provides that if a taxpayer did not claim on a Federal tax return for a taxable year ending on or after September 11, 2001, and on or before September 1, 2006, any Liberty Zone bonus depreciation deduction for qualified New York Liberty Zone property because of the application of § 1.1400L(b)-1T(b)(4) or because the taxpayer made an election under § 1.168(k)-1T(e)(1) for a class of property that included such qualified New York Liberty Zone property, the taxpayer may claim the Liberty Zone bonus depreciation deduction for that qualified New York Liberty Zone property in accordance with the applicable administrative procedures issued under § 1.446-1(e)(3)(ii) for obtaining the Commissioner of Internal Revenue’s consent to a change in method of accounting.

.03 The preamble to the final regulations states that the Service and Treasury intend to issue administrative guidance providing procedures for automatic consent for taxpayers that wish to seek a change in method of accounting to comply with the final regulations.

.04 Under §§ 446(e) and 1.446-1(e)(2)(i), a taxpayer generally must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. To obtain the Commissioner’s consent to a change in method, § 1.446-1(e)(3)(i) generally requires a taxpayer to file Form 3115, Application for Change in Accounting Method, during the taxable year in which the taxpayer desires to make the proposed change. 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.

.05 Rev. Proc. 2002-9, 2002-1 C.B. 327 (as modified and clarified by Announcement 2002-17, 2002-1 C.B. 561, modified and amplified by Rev. Proc. 2002-19, 2002-1 C.B. 696, and amplified, clarified and modified by Rev. Proc. 2002-54, 2002-2 C.B. 432) provides procedures under §§ 446(e) and 1.446-1(e) for obtaining the automatic consent of the Commissioner to change a method of accounting described in the APPENDIX of Rev. Proc. 2002-9.

.06 Rev. Rul. 90-38, 1990-1 C.B. 57, provides that, if a taxpayer uses an erroneous method of accounting for two or more consecutive taxable years, the taxpayer has adopted a method of accounting. Rev. Rul. 90-38 further provides that a taxpayer may not, without the Commissioner’s consent, retroactively change from an erroneous to a permissible method of accounting by filing an amended return.

.07 Section 1.446-1T(e)(2)(ii)(d) provides the changes in computing depreciation that are, and are not, a change in method of accounting under § 446(e). Sections 1.446-1T(e)(2)(ii)(d)(2)(ii), (iii), and (iv) provide the changes in computing depreciation with respect to the bonus depreciation deduction and the Liberty Zone bonus depreciation deduction that are a change in method of accounting. Section 1.446-1T(e)(2)(ii)(d)(3) provides the changes in computing depreciation that are not a change in method of accounting. Section 1.446-1T(e)(2)(ii)(d) applies to property placed in service by the taxpayer in taxable years ending on or after December 30, 2003.

.08 For property placed in service by the taxpayer in taxable years ending before December 30, 2003, Notice CC-2004-007 (January 28, 2004) provides that the Service generally will not assert that a change in computing depreciation for such property that is treated as a capital asset under the taxpayer’s present and proposed methods of accounting is a change in method of accounting under § 446(e). Accordingly, the taxpayer may effect this change in computing depreciation by filing amended Federal tax returns or may treat this change in computing depreciation as a change in method of accounting by filing a Form 3115 in accordance with Rev. Proc. 2002-9.

.09 This revenue procedure applies either for a taxpayer’s last taxable year ending before October 18, 2006 (if the taxpayer timely files its Federal income tax return after October 18, 2006, for that last taxable year), or for the taxpayer’s first taxable year ending on or after October 18, 2006, for changes to methods of accounting provided in the final regulations. For subsequent taxable years, see the automatic change in method of accounting procedures in Rev. Proc. 2002-9 (or its successor), if applicable, or the advance consent change in method of accounting procedures in Rev. Proc. 97-27, 1997-1 C.B. 680 (as modified and amplified by Rev. Proc. 2002-19, and amplified, clarified, and modified by Rev. Proc. 2002-54) (or its successor). However, if a taxpayer is claiming the rehabilitation credit in accordance with § 1.168(k)-1(g)(6) or § 1.1400L(b)-1(g)(6), the resulting change in computing depreciation for the qualified rehabilitated building must be made by filing amended returns for its placed-in-service year and subsequent taxable years.

.01 Except as provided in section 3.02, this revenue procedure applies to a taxpayer that seeks a change in method of accounting under § 1.446-1T(e)(2)(ii)(d)(2)(ii), (iii), or (iv) to comply with the final regulations for either: (1) the taxpayer’s last taxable year ending before October 18, 2006, if the taxpayer timely files (including extensions) its Federal income tax return after October 18, 2006, for that last taxable year; or (2) the taxpayer’s first taxable year ending on or after October 18, 2006.

.02 This revenue procedure does not apply to:

(1) A change in computing depreciation resulting from a taxpayer claiming the rehabilitation credit in accordance with § 1.168(k)-1(g)(6) or § 1.1400L(b)-1(g)(6);

(2) A change in computing depreciation that is not a change in method of accounting under § 1.446-1T(e)(2)(ii)(d)(3). However if, in accordance with § 1.1400L(b)-1(g)(4)(iii), a taxpayer is changing its computation of depreciation for qualified New York Liberty Zone property because of the amendment made to § 1.1400L(b)-1T(c)(2)(ii) by the final regulations under § 1400L(b) and the taxpayer made an election under § 1.168(k)-1T(e)(1) for the class of property that included such qualified New York Liberty Zone property, § 1.1400L(b)-1(g)(4)(iii) expressly provides that this change in computing depreciation is a change in method of accounting and, thus, § 1.446-1T(e)(2)(ii)(d)(3)(iii) does not apply to such change in computing depreciation.

(3) A change in computing depreciation that is due to a posting error, mathematical error, or a change in underlying facts;

(4) A change in computing depreciation for depreciable property that is placed in service by a taxpayer in a taxable year ending before December 30, 2003, that is a capital asset under the taxpayer’s present and proposed methods of accountings, and for which the taxpayer wants to effect the change in computing depreciation to comply with the final regulations by filing amended Federal tax returns in accordance with Notice CC-2004-007 (January 28, 2004);

(5) A change in the treatment of property from a non-capital asset (for example, inventory, materials and supplies) to a capital, depreciable asset (or vice versa); or

(6) A change from expensing the cost of depreciable property to capitalizing and depreciating that cost (or vice versa).

.01 A taxpayer within the scope of this revenue procedure is, in accordance with section 6.01 of Rev. Proc. 2002-9, granted the consent of the Commissioner to change to a method of accounting within the scope of this revenue procedure to comply with the final regulations provided the taxpayer follows the automatic change in method of accounting procedures in Rev. Proc. 2002-9 (or its successor) with the following modifications:

(1) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply for the taxpayer’s first taxable year ending on or after October 18, 2006, or, if applicable, for the taxpayer’s last taxable year ending before October 18, 2006, if the taxpayer timely files its Federal income tax return after October 18, 2006, for that last taxable year; and

(2) For purposes of section 6.02(4)(a) of Rev. Proc. 2002-9, the taxpayer must include on line 1a of the Form 3115 the designated automatic accounting method change number 105.

.02 A change in method of accounting within the scope of this revenue procedure results in a § 481(a) adjustment.

Rev. Proc. 2002-9 is modified and amplified to include the automatic change in method of accounting provided in section 4 of this revenue procedure in section 2 of the APPENDIX of Rev. Proc. 2002-9.

This revenue procedure is effective October 18, 2006.

The principal author of this revenue procedure is Douglas Kim of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue procedure, contact Douglas Kim at (202) 622-3110 (not a toll-free call).

This revenue procedure provides the exclusive procedures for a corporation (as defined in section 5.01 of this revenue procedure) within its scope to obtain automatic approval to change its annual accounting period under § 442 of the Internal Revenue Code and § 1.442-1(b) of the Income Tax Regulations. This revenue procedure clarifies, modifies, amplifies, and supersedes Rev. Proc. 2002-37, 2002-1 C.B. 1030. A corporation complying with all the applicable provisions of this revenue procedure will be deemed to have established a business purpose and obtained the approval of the Commissioner of Internal Revenue to change its annual accounting period under § 442 and the regulations thereunder.

.01 Taxable Year Defined.

(1) In general. Section 441(b) and § 1.441-1(b)(1) provide that the term “taxable year” generally means the taxpayer’s annual accounting period, if it is a calendar or fiscal year, or, if applicable, the taxpayer’s required taxable year.

(2) Annual accounting period. Section 441(c) and § 1.441-1(b)(3) provide that the term “annual accounting period” means the annual period (calendar year or fiscal year) on the basis of which the taxpayer regularly computes its income in keeping its books.

(3) Required taxable year. Section 1.441-1(b)(2) provides that certain taxpayers must use the particular taxable year that is required under the Code and the regulations thereunder. See § 1.441-1(b)(2) for examples of taxpayers, including certain corporations, with required taxable years.

.02 Change in Taxable Year.

(1) In general. Section 1.442-1(a)(1) generally provides that a taxpayer that wants to change its annual accounting period and use a new taxable year must obtain the approval of the Commissioner.

(2) Annualization of short period return. Section 443(b) and § 1.443-1(b)(1)(i) generally provide that if a return is made for a short period resulting from a change of an annual accounting period, the taxable income for the short period must be placed on an annual basis by multiplying the income by 12 and dividing the result by the number of months in the short period. Unless § 443(b)(2) and § 1.443-1(b)(2) apply, the tax for the short period generally is the same part of the tax computed on an annual basis as the number of months in the short period is of 12 months. But see, for example, §§ 1.852-3(e), 1.857-2(a)(4), and 1.1502-76 for exceptions to this general rule for a regulated investment company (RIC), a real estate investment trust (REIT), and a subsidiary corporation ceasing to be a member of a consolidated group, respectively.

(3) No retroactive change in annual accounting period. Unless specifically authorized by the Commissioner, a taxpayer may not request, or otherwise make, a retroactive change in annual accounting period, regardless of whether the change is to a required taxable year.

.03 Approval of a Change. Section 1.442-1(b) provides, in part, that in order to secure the approval of the Commissioner to change an annual accounting period, a taxpayer must file an application, generally on Form 1128, “Application To Adopt, Change, or Retain a Tax Year,” with the Commissioner within such time and in such manner as is provided in administrative procedures published by the Commissioner. In general, a change in annual accounting period will be approved if the taxpayer establishes a business purpose for the requested annual accounting period and agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the change.

Significant changes to Rev. Proc. 2002-37 made by this revenue procedure include:

.01 Sections 4.01(2), 4.01(3), and 4.01(4) of Rev. Proc. 2002-37 are removed from the applicability section and are reinserted, where appropriate, in the relevant inapplicability subsections under section 4.02 of this revenue procedure.

.02 Section 4.02(2) of this revenue procedure removes section 4.02(2)(b) of Rev. Proc. 2002-37 because the entities formerly described by section 4.02(2)(b) of Rev. Proc. 2002-37 are included in section 4.02(2)(a) of this revenue procedure.

.03 Section 4.02(2)(e) of this revenue procedure provides that an interest in a pass-through entity that does not have a required taxable year is disregarded solely for purposes of section 4.02(2). Thus, having an interest in a pass-through entity that does not have a required taxable year does not make a corporation ineligible for use of this revenue procedure.

.04 Section 4.02(5) of this revenue procedure excludes from the scope an S or terminated S corporation. See Rev. Proc. 2006-46, 2006-45 I.R.B. , for procedures to follow for certain automatic changes in the annual accounting period of an S corporation.

.05 Section 4.02(8) of this revenue procedure excludes from the scope certain controlled foreign corporations (CFCs).

.06 Section 4.02(13) of this revenue procedure excludes from the scope a corporation that exits a consolidated group in its first effective year.

.07 Section 4.02(14) of this revenue procedure excludes from the scope certain changes to (or from) a 52-53 week taxable year by a member of a consolidated group.

.08 Section 6.02 of this revenue procedure provides that only certain short periods are exempt from the financial statement conformity requirement and incorporates the clarification in Notice 2002-72, 2002-2 C.B. 843, of the record keeping/book conformity term and condition with regard to CFCs.

.09 Section 6.03(1) of this revenue procedure provides that certain CFCs are not required to file a first effective year tax return.

.10 Sections 6.05 (changes in natural business year for an electing S corporation) and 6.06 (changes in ownership taxable year for an electing S corporation) of Rev. Proc. 2002-37 are not included in this revenue procedure because this revenue procedure does not apply to S corporations. The removal of these sections from the terms and conditions of this revenue procedure is not intended to imply that a corporation that elects to be an S corporation is not required to conform to the requirements for accounting periods for S corporations. See § 1378 and § 1.1378-1(a) for the permitted years of an S Corporation and see Rev. Proc. 2006-46 for procedures to follow for certain automatic changes in the annual accounting period of an S corporation.

.11 Section 6.06 of this revenue procedure incorporates the modified carryback term and condition of section 4.01 of Rev. Proc. 2003-34, 2003-1 C.B. 856.

.12 Section 6.08 of this revenue procedure clarifies that in the case of a change in annual accounting period by the common parent of a consolidated group, the consolidated return rules will apply (e.g., § 1.1502-21) unless this revenue procedure specifically provides otherwise.

.13 Section 6.09 of this revenue procedure incorporates the clarification in Notice 2002-72, that certain entities with required taxable years that must concurrently change their annual accounting period as a term and condition for the approval of a related taxpayer’s change of annual accounting period must do so under the applicable automatic approval procedures notwithstanding any limitations in those procedures to the contrary or any conflicting testing date provisions.

.14 Section 6.10 of this revenue procedure provides that a CFC that revokes its one month deferral election under § 898 is not eligible to make another change in taxable year for a period of 48 months following the first day of the first effective year.

.15 Sections 7.02(1)(b), 7.02(2)(b), and 7.02(4)(b) of this revenue procedure provide the filing requirements for certain CFCs and noncontrolled section 902 corporations.

.16 Section 7.02(2) of this revenue procedure provides that the Form 1128 or Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, must be filed no earlier than the day following the end of the first effective year.

.17 Section 7.02(7) of this revenue procedure provides that, for purposes of a change in annual accounting period, a consolidated group consists of the parent and any subsidiary that is a member of the group on the last day of the short period.

.01 Applicability. Except as provided in section 4.02, this revenue procedure is the exclusive procedure for a corporation within its scope to secure the Commissioner’s approval and applies to a corporation requesting approval to change its annual accounting period, including a corporation that wants to change to (or from) a 52-53-week taxable year.

.02 Inapplicability. This revenue procedure does not apply to the following corporations:

(1) Prior change. A corporation that has changed its annual accounting period within the most recent 48-month period ending with the last month of the requested taxable year, unless:

(a) the prior change was made in order to comply with the common taxable year requirement of either § 1.1502-75(d)(3)(v) or 1.1502-76(a)(1) (see § 1.442-1(c));

(b) the prior change was made by a corporation that either was acquired within the preceding 12 months by a new majority shareholder using a different taxable year, or whose majority shareholder changed its taxable year within the preceding 12 months, if that corporation does not file consolidated income tax returns with its majority shareholder and seeks to change to the taxable year of that shareholder in order to file consolidated financial statements. For purposes of this section 4.02(1)(b), “majority shareholder” means ownership that satisfies the test of § 1504(a)(2), substituting “more than 50 percent” for “at least 80 percent;”

(c) except in the case of a CFC, the prior change was from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa;

(d) the prior change was to a required taxable year (as defined in section 5.03 of this revenue procedure) or was a concurrent change required by either this revenue procedure or Rev. Proc. 2002-39 (or any successor);

(e) the corporation wants to change from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same month, and vice versa; or

(f) the corporation is a CFC that wants to revoke its one month deferral election under § 898(c)(1)(B) and change its taxable year to the majority U.S. shareholder year (as defined in § 898(c)(1)(C)).

(2) Interest in a pass-through entity or a CFC. A corporation that has an interest in a pass-through entity (as defined in section 5.02 of this revenue procedure) or a CFC as of the end of the first effective year (as defined in section 5.05 of this revenue procedure). However, an interest in a pass-through entity or CFC will be disregarded for this purpose if any of the following conditions are met:

(a) the pass-through entity or CFC would be required under the Code or regulations to change its taxable year to the new taxable year of the corporation (or, in the case of a CFC, to a taxable year that is described in section 4.02(8)(b)). See section 6.09 of this revenue procedure for a special term and condition related to this exception;

(b) the new taxable year of the corporation would result in no change in or less deferral (as described in § 1.706-1(b)(3)) from the pass-through entity or CFC than the present taxable year of the corporation. If the entity is a partnership or a CFC, the corporation should compare the existing deferral period (between the pass-through entity’s and the corporation’s current taxable years) with the new deferral period (between the new required taxable year of the pass-through entity or CFC and the corporation’s new taxable year). See section 4.04 of this revenue procedure for an example of this rule;

(c) the pass-through entity or CFC in which the corporation has an interest has been in existence for at least 3 taxable years and the interest is de minimis. For this purpose, an interest is de minimis if:

(i) for each of the prior 3 taxable years of the corporation, the amount of income (including ordinary income or loss, capital gains or losses, rents, royalties, interest, dividends and deduction equivalents of credits) from de minimis interest in a pass-through entity or CFC is less than or equal to (A) 5 percent of the corporation’s gross receipts (or, in the case of a member of a consolidated group, the consolidated group’s gross receipts) for each of those taxable years, and (B) $500,000; and

(ii) the amount of income from all de minimis interest in pass-through entities and CFCs in the aggregate is less than or equal to the amounts described in (A) and (B) of (c)(i) above. See section 4.04 of this revenue procedure for an example of this rule;

(d) the corporation wants to change from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same month, and vice versa;

(e) the pass-through entity or CFC does not have a required year;

(f) the corporation wants to change to a natural business year (as defined in section 5.04 of this revenue procedure) that satisfies the 25-percent gross receipts test described in that section; or

(g) the corporation is a CFC that wants to revoke its one month deferral election under § 898(c)(1)(B) and change its taxable year to the majority U.S. shareholder year (as defined in § 898(c)(1)(C)).

(3) Shareholder of certain FSCs or IC-DISCs. A corporation that is a shareholder of a foreign sales corporation (FSC) or interest charge domestic international sales corporation (IC-DISC), as of the end of the short period (as defined in section 5.06 of this revenue procedure). However, an interest in a FSC or IC-DISC is disregarded if any of the following conditions is met:

(a) the FSC or IC-DISC in which the corporation is the principal shareholder (i.e., the shareholder with the highest percentage of voting power as defined in § 441(h)) would be required to change its taxable year pursuant to §§ 1.921-1T(b)(4) and (6) to the new taxable year of the corporation. See section 6.09 of this revenue procedure for a special term and condition related to this exception;

(b) the new taxable year of the corporation would result in no change in or less deferral of income (as determined under the principles of § 1.706-1(a)(3)) from the FSC or IC-DISC than the present taxable year of the corporation;

(c) the corporation wants to change from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same month, and vice versa;

(d) the corporation wants to change to a natural business year that satisfies the 25-percent gross receipts test described in section 5.04 of this revenue procedure; or

(e) the corporation is a CFC that wants to revoke its one month deferral election under § 898(c)(1)(B) and change its taxable year to the majority U.S. shareholder year (as defined in § 898(c)(1)(C));

(4) FSC and IC-DISC. A corporation that is a FSC or an IC-DISC. See § 1.921-1T(b)(4) for rules regarding automatic changes of the annual accounting period of a FSC or IC-DISC to the taxable year of its principal shareholder;

(5) S or terminated S corporation. A corporation that either is an S corporation (as defined in § 1361) or a corporation that is requesting a change in annual accounting period that is within an S termination year (as defined in § 1362(e)(4)). See Rev. Proc. 2006-46 for procedures to follow for certain automatic changes in the annual accounting period of an S corporation;

(6) Electing S corporation. A corporation that attempts to make an S corporation election for the taxable year immediately following the short period, unless the change is to a permitted taxable year, or from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same month, and vice versa;

(7) PSC. A corporation that is a personal service corporation (PSC) (as defined in § 441(i)). See Rev. Proc. 2006-46 for procedures to follow for certain automatic changes in the annual accounting period of a PSC;

(8) CFC. A corporation that is a controlled foreign corporation as defined in § 957, including a CFC that also is a passive foreign investment company (PFIC) as defined in § 1297(a), unless:

(a) the CFC does not have a required taxable year under § 898;

(b) the CFC is changing to its required taxable year under § 898, to a 52-53-week taxable year that references that year, or, if the CFC has a majority U.S. shareholder year (as defined in § 898(c)(3)), to a one-month deferral year described in § 898(c)(2) or to a 52-53-week taxable year that references such one-month deferral year; or

(c) with respect to the CFC’s taxable years beginning after July 10, 1989, no U.S. shareholder has been required to include in gross income an amount described in § 951(a) (subpart F inclusion).

(9) Tax-exempt organization. A corporation that is a tax-exempt organization, other than an organization exempt from federal income tax under § 521, 526, 527, or 528. See Rev. Proc. 85-58, 1985-2 C.B. 740, for procedures to follow in changing an annual accounting period of a tax-exempt organization that is not within the scope of this revenue procedure;

(10) Possessions corporation. A corporation that has in effect an election under § 936;

(11) Cooperative association. A corporation that is a cooperative association (within the meaning of § 1381(a)) with a loss in the short period required to effect the change of annual accounting period, unless it is changing from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same month, and vice versa, or the patrons of the cooperative association are substantially the same in the year before the change of annual accounting period, in the short period required to effect the change, and in the year following the change. For purposes of this subsection, “substantially the same” means that ownership of more than 90 percent of the cooperative association’s stock is owned by the same members; or

(12) Corporation with a required taxable year. A corporation that has a required taxable year (e.g., a REIT, or a Qualified Settlement Fund or Designated Settlement Fund as defined in § 1.468B), unless the corporation is changing to their required taxable year.

(13) Corporation that exits a consolidated group. A corporation that ceases to be a member of a consolidated group during the consolidated group’s first effective year.

(14) Certain members of a consolidated group. A corporation that is a member of a consolidated group requesting to change to (or from) a 52-53-week taxable year unless the requested taxable year is identical to the taxable year of the consolidated group.

.03 Nonautomatic Changes. A corporation that is unable to obtain automatic approval for a change in accounting period under this or any other applicable revenue procedure, or under a regulation, must secure prior approval from the Commissioner for a change in an accounting period pursuant to § 442 and the regulations thereunder. See Rev. Proc. 2002-39 (or any successor).

.04 Examples.

(1) Example 1. (a) Corporations V, W, X, Y, and Z hold equal 20 percent interests in the capital and profits of partnership ABC. V and W are calendar year taxpayers. X and Y have taxable years ending June 30, and Z has a taxable year ending September 30. ABC does not have a business purpose for a particular taxable year, and thus, pursuant to § 1.706-1, ABC is required to use a taxable year ending June 30 because that taxable year results in the least aggregate deferral of income to its partners. Z currently has a 3-month deferral period (the number of months from the end of ABC’s taxable year to the end of Z’s taxable year). Z wants to change its taxable year to a calendar year.

(b) If Z changes its taxable year to a calendar year, ABC would be required to change its taxable year under § 706 to its majority interest taxable year, which would be the calendar year. As a result of Z’s new taxable year and ABC’s new taxable year, Z’s deferral period would be eliminated. Because Z’s new taxable year would reduce Z’s deferral, Z may disregard its interest in ABC under section 4.02(2)(b) of this revenue procedure.

(2) Example 2. (a) Corporation X, a calendar year taxpayer, wants to change its taxable year to a year ending June 30. X has interests in five partnerships, ABC, DEF, GHI, JKL, and MNO. All of the partnerships have been in existence for over three taxable years. X’s interests in each of ABC and DEF is greater than 50 percent. X’s interest in GHI, JKL, and MNO is 15 percent, 10 percent, and 5 percent, respectively. GHI uses the majority interest taxable year ending May 31 and JKL and MNO each use their respective majority interest taxable year ending December 31. X’s distributive share of income/(loss) from JKL for the prior three taxable years is $300,000, $(100,000), and $200,000, respectively, and from MNO is $300,000, $200,000, and $100,000, respectively. X’s gross receipts for each of those same taxable years was $15,000,000.

(b) X’s interests in its pass-through entities will be disregarded for purposes of section 4.02(2) of this revenue procedure only if each pass-through entity satisfies one of the exceptions enumerated under section 4.02(2) of this revenue procedure. In the instant case, X’s interests in ABC and DEF each meet the exception in section 4.02(2)(a) because X is the majority interest partner in each partnership. X’s interest in GHI meets the exception in section 4.02(2)(b) because X’s new taxable year would result in less deferral than its old taxable year (the deferral between May 31 and June 30 of 1 month as compared to the deferral between May 31 and December 31 of 7 months). Because X is not the majority interest partner in JKL and MNO and because its new taxable year would not result in less deferral from these partnerships, X’s interests in JKL and MNO may be disregarded only if they satisfy the de minimis exception in section 4.02(2)(c). Although the income from JKL and MNO for each of the prior three taxable years is less than 5 percent of X’s gross receipts and $500,000, the income for year 1 from JKL and MNO, in the aggregate ($300,000 and $300,000), exceeds the $500,000 amount specified in section 4.02(2)(c)(ii). Consequently, JKL and MNO fail to satisfy the de minimis exception in section 4.02(2)(c). Because X’s interests in all of its pass-through entities will not be disregarded, X is not within the scope of this revenue procedure.

The following definitions apply solely for the purpose of this revenue procedure:

.01 Corporation. The term “corporation” includes associations, joint-stock companies, and insurance companies, as provided in § 7701(a)(3) and the regulations thereunder, and includes each member of a consolidated group that is a member of the group on the last day of the first effective year.

.02 Pass-through Entity. The term “pass-through entity” means a partnership (as defined in § 7701(a)(2) and the regulations thereunder); a trust (as defined in § 301.7701-4); an estate; a common trust fund (as defined in § 584); a PFIC that the corporation has elected to treat as a qualified electing fund (as defined in § 1295); and a closely-held REIT (as defined in § 6655(e)(5)(B)), but only to the extent the corporation is described in § 6655(e)(5)(A).

.03 Required Taxable Year. The “required taxable year” is the particular taxable year that certain taxpayers are required to use under the Code and the regulations thereunder. See § 1.441-1(b)(2) for examples of taxpayers, including certain corporations, with required taxable years.

.04 Natural Business Year. A “natural business year” is a year for which a corporation satisfies the following “25-percent gross receipts test”:

(1) 25-percent gross receipts test. Except as provided in (2) below, the 25-percent gross receipts test is satisfied if each of the results described in (a) and (b) below equals or exceeds 25-percent:

(a) Gross receipts from sales and services for the most recent 12-month period that ends with the last month of the requested annual accounting period are totaled and then divided into the amount of gross receipts from sales and services for the last 2 months of this 12-month period.

(b) The same computation as in (1)(a) above is made for the two preceding 12-month periods ending with the last month of the requested annual accounting period.

(2) Exception. The corporation must determine whether any annual accounting period other than the requested annual accounting period also meets the 25-percent gross receipts test described in (1). If one or more other annual accounting periods produce higher averages of the three percentages (rounded to 1/100 of a percent) described in (1) than the requested annual accounting period, then the requested annual accounting period will not qualify as the corporation’s natural business year.

(3) Special rules.

(a) To apply the 25-percent gross receipts test for any particular year, the corporation must compute its gross receipts under the method of accounting used to prepare its federal income tax return for such taxable year.

(b) Regardless of the corporation’s method of accounting, the corporation’s share of taxable income from a pass-through entity generally must be reported as gross receipts from sales and services in the month that the pass-through entity’s taxable year ends.

(c) If a corporation has a predecessor organization and is continuing the same business as its predecessor, the corporation must use the gross receipts from sales and services of its predecessor for purposes of computing the 25-percent gross receipts test.

(d) If the corporation (including any predecessor organization) does not have a 47-month period of gross receipts (36-month period for requested taxable year plus additional 11-month period for comparing requested taxable year with other potential taxable years), then it cannot establish a natural business year under this revenue procedure.

(e) If the requested taxable year is a 52-53-week taxable year, the calendar month ending nearest to the last day of the 52-53-week taxable year is treated as the last month of the requested taxable year for purposes of computing the 25-percent gross receipts test.

.05 First Effective Year. The “first effective year” is the first taxable year for which a change in annual accounting period is effective. The first effective year generally is the short period required to effect the change. In the case of a short period of 6 days or less, the first effective year is the taxable year that includes such short period under § 1.441-2(b)(2)(ii). The first effective year also is the first taxable year for complying with all the terms and conditions set forth in this revenue procedure necessary to effect the change in annual accounting period.

.06 Short Period. In the case of a change in annual accounting period, a corporation’s “short period” is the period beginning with the day following the close of the old taxable year and ending with the day preceding the first day of the new taxable year.

.01 In General. A change in annual accounting period filed under this revenue procedure must be made pursuant to the terms and conditions provided in this revenue procedure.

.02 Record Keeping/Book Conformity.

(1) In general. The corporation must compute its income and keep its books and records (including financial statements and reports to creditors) on the basis of the requested taxable year. The books and records of the corporation must be closed as of the last day of the first effective year and the corporation must conform the accounting period used for financial statement purposes and reports to creditors concurrently.

(2) Certain short periods exempt from financial statement conformity. If the corporation is not required to issue financial statements for the short period required to effect the change, the corporation will be deemed to have met the financial statement conformity requirement for the first effective year provided the corporation’s accounting period used for financial statement purposes already conforms to the requested taxable year or the corporation makes the change in accounting period used for financial statement purposes and reports to creditors concurrently.

(3) Foreign law books and records. The terms and conditions in section 6.02(1) of this revenue procedure do not apply to require a corporation to close and conform books and records that are required to be maintained for foreign law purposes (e.g., foreign tax reporting purposes) on the basis of a different taxable year than the requested taxable year. In addition, the terms and conditions in section 6.02(1) of this revenue procedure do not apply to require a noncontrolled section 902 corporation to close and conform any books and records that are maintained for foreign law purposes, regardless of whether foreign law requires such books and records to be maintained on the basis of a different taxable year than the requested taxable year.

.03 First Effective Year Tax Return.

(1) When to file. The corporation generally must file a federal income tax return for the first effective year by the due date of that return, including extensions pursuant to § 1.443-1(a). A CFC or a noncontrolled section 902 corporation that is not required to file Form 1120F (because it is not engaged in United States trade or business) need not file a first effective year tax return (or have its U.S. shareholder file such a return on its behalf).

(2) Annualization. The corporation’s taxable income for the short period must be annualized and the tax must be computed in accordance with the provisions of § 443(b) and § 1.443-1(b). However, for changes to (or from) a 52-53-week taxable year referencing the same month as the current (or requested) taxable year, see special rules in § 1.441-2.

.04 Subsequent Year Tax Returns. Returns for subsequent taxable years generally must be made on the basis of a full 12 months (or on a 52-53-week basis) ending on the last day of the requested taxable year, unless the corporation secures the approval of the Commissioner to change that taxable year.

.05 52-53-week Taxable Years. If applicable, the corporation must comply with § 1.441-2(e) (relating to the timing of taking items into account in those cases where the taxable year of a pass-through entity ends with reference to the same calendar month as one or more of its owners).

.06 Creation of Net Operating Loss or Capital Loss. If the corporation generates a net operating loss (NOL) or capital loss (CL) in the short period required to effect a change in annual accounting period, the corporation may not carry the NOL or CL back, but must carry it over in accordance with the provisions of §§ 172 and 1212, respectively, beginning with the first taxable year after the short period. However, except as otherwise provided in the Code or regulations, the short period NOL or CL is carried back or carried over in accordance with § 172 or 1212, respectively, if it is either: (a) $50,000 or less, or (b) less than the NOL or CL, respectively, generated for the full 12-month period beginning with the first day of the short period. The corporation must wait until this 12-month period has expired to determine whether it qualifies for the exception in (b) above.

.07 Creation of General Business Credits. If there is an unused general business credit or any other unused credit generated in the short period, the corporation must carry that unused credit forward. An unused credit from the short period may not be carried back.

.08 Consolidated Groups. In the case of a change in annual accounting period by the common parent of a consolidated group, the consolidated return rules will apply (e.g., § 1.1502-21) unless this revenue procedure specifically provides otherwise. In addition, every member of the consolidated group must meet all the requirements and meet and comply with all the terms and conditions of this revenue procedure.

.09 Concurrent Change for Related Entities. If a corporation’s interest in a pass-through entity, FSC, or IC-DISC (related entity) is disregarded pursuant to section 4.02(2)(a) or 4.02(3)(a) of this revenue procedure because the related entity is required to change its taxable year to the corporation’s new taxable year (or, in the case of a CFC, because it does not have a required year under § 898), the related entity must change its taxable year concurrently with the corporation’s change in taxable year, either under this revenue procedure, Rev. Proc. 2006-46, or Rev. Proc. 2002-39 (or any successor), whichever is applicable. If the related entity that is required to change is a corporation, such as a CFC, it is deemed to be within section 4.01 of this revenue procedure and if the related entity is a pass-through entity, such as a partnership, it is deemed to be within section 4.01(1) of Rev. Proc. 2006-46. The preceding sentence applies notwithstanding any conflicting testing date provisions under the Code (e.g., § 706(b)(4)(A)(ii), § 898(c)(3)(B), § 1.921-1T(b)(6), and the special provision in § 706(b)(4)(B)) or regulations, or any other limitation under sections 4.02 and 7.02(2) of this revenue procedure or sections 4.02 and 7.02(2) of Rev. Proc. 2006-46.

.10 CFCs. In the case of a CFC that revokes its one month deferral election under § 898, the CFC shall not be eligible to change its taxable year during a 48-month period following the first day of the first effective year unless the change is necessary to conform to a new required taxable year under § 898.

.01 Approval. Approval is hereby granted to any corporation within the scope of this revenue procedure to change its annual accounting period, provided the corporation complies with all the applicable provisions of this revenue procedure. Approval is granted beginning with the first effective year. A corporation granted approval under this revenue procedure to change its annual accounting period is deemed to have established a business purpose for the change to the satisfaction of the Commissioner.

.02 Filing Requirements.

(1) Where to file.

(a) In general. Any corporation (including the common parent of a consolidated group) that wants to change its annual accounting period pursuant to the provisions of this revenue procedure must complete and file an application (i.e., a current Form 1128) with the Director, Internal Revenue Service Center, Attention: ENTITY CONTROL, where the corporation files its federal income tax return. No copies of Form 1128 should be sent to the national office. The corporation also should attach a copy of the Form 1128 to the federal income tax return filed for the first effective year.

(b) Certain foreign corporations. In the case of a CFC or a noncontrolled section 902 corporation that is not required to file a federal income tax return, the controlling domestic shareholders (as defined in § 1.964-1T(c)(5)) that want to change the foreign corporation’s accounting period on behalf of the foreign corporation pursuant to the provisions of this revenue procedure must satisfy the requirements set forth in § 1.964-1T(c)(3), and, except as provided in section 7.02(1)(c) of this revenue procedure, the designated shareholder who retains the jointly executed consent described in § 1.964-1T(c)(3)(ii) must complete and file a current Form 1128 on behalf of the foreign corporation with its federal income tax return for its taxable year with or within which ends the first effective year of the foreign corporation. Each other controlling domestic shareholder (or its common parent) should also attach a copy of the Form 1128 to its federal income tax return filed for its taxable year with or within which ends such taxable year of the designated shareholder. No copies of Form 1128 should be sent to the national office.

(c) Taxable years under section 898. In the case of a taxable year described in section 4.02(8)(b) of this revenue procedure, in lieu of filing Form 1128, the CFC’s controlling domestic shareholders must indicate the change in taxable year on the Form 5471 filed with respect to the CFC’s first effective year.

(2) When to file. (a) In general. The Form 1128 must be filed no earlier than the day following the end of the first effective year and no later than the due date (including extensions) for filing the federal income tax return for the first effective year.

(b) Certain foreign corporations. An application that is filed by a controlling domestic shareholder (or its common parent) on behalf of a CFC or a noncontrolled section 902 corporation is due no later than the due date (including extensions) of such shareholder’s (or its common parent’s) federal income tax return for its tax year with or within which ends the first effective year of the foreign corporation.

(3) Label. In order to assist in the processing of the change in annual accounting period, reference to this revenue procedure should be made a part of the Form 1128 or Form 5471 by either typing or legibly printing the following statement at the top of page 1 of the Form 1128 or Form 5471: “FILED UNDER REV. PROC. 2006-45.”

(4) Signature requirements.

(a) In general. Form 1128 must be signed on behalf of the corporation requesting the change of annual accounting period by an individual with authority to bind the corporation in such matters. If the corporation is a member of a consolidated group, the Form 1128 must be signed by a duly authorized officer of the common parent. If an agent is authorized to represent the corporation before the Service, to receive the original or a copy of correspondence concerning the application, or to perform any other act(s) regarding the application on behalf of the corporation, a power of attorney reflecting such authorization(s) should be attached to the application. A corporation’s representative without a power of attorney to represent the corporation will not be given any information about the application.

(b) Certain foreign corporations. An application that is filed on behalf of a CFC or a noncontrolled section 902 corporation need not be signed. However, the controlling domestic shareholders must satisfy the requirement set forth in § 1.964-1T(c)(3) and the designated shareholder must retain the jointly executed consent described in § 1.964-1T(c)(3)(ii).

(5) No user fee. A user fee is not required for an application filed under this revenue procedure and, except as provided in section 8.01 of this revenue procedure, the receipt of an application filed under this revenue procedure generally will not be acknowledged.

(6) Additional information. In the case of a corporation changing to a natural business year that satisfies the 25-percent gross receipts test described in section 5.06 of this revenue procedure, the corporation must supply the gross receipts from sales and services for the most recent 47 months for itself (or any predecessor) in compliance with the instructions to Form 1128.

(7) Consolidated application. A common parent must file a single application to change the annual accounting period of its consolidated group, which consists of the parent and any subsidiary that is a member of the group on the last day of the short period.

.01 Service Center Review. A Service Center may deny a change of annual accounting period under this revenue procedure only if: (a) the Form 1128 is not filed timely, or (b) the corporation fails to meet the scope or any term and condition of this revenue procedure. If the change is denied, the Service Center will return the Form 1128 with an explanation for the denial.

.02 Review of Director. The appropriate director may ascertain if the change in annual accounting period was made in compliance with all the applicable provisions of this revenue procedure. Corporations changing their annual accounting period pursuant to this revenue procedure without complying with all the provisions (including the terms and conditions) of this revenue procedure ordinarily will be deemed to have initiated the change in annual accounting period without the approval of the Commissioner. Upon examination, a corporation that has initiated an unauthorized change of annual accounting period may be denied the change. For example, the corporation may be required to recompute its taxable income or loss in accordance with its former (or required, if applicable) taxable year.

This revenue procedure generally is effective for all changes in annual accounting periods for which the first effective year ends on or after October 18, 2006. However, if the time period for filing Form 1128 or Form 5471 with respect to a taxable year set forth in section 7.02(2) of this revenue procedure has not yet expired, a corporation within the scope of this revenue procedure may elect early application of the revenue procedure by providing the notification set forth in section 7.02(3) on the top of page 1 of Form 1128 or Form 5471 and by satisfying the other procedural requirements of section 7.

Rev. Proc. 2002-37 is clarified, modified, amplified, and superseded.

The collection of information contained in this revenue procedure 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 number 1545-1786. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this revenue procedure is found in section 7. The information in section 7 is required in order to determine whether the corporation properly obtained automatic approval to change its annual accounting period. The likely respondents are corporations. The estimated total annual reporting burden for the requirements contained in section 7 of this revenue procedure is reflected in the burden estimates for Forms 1128 and 5471.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

The principal authors of this revenue procedure are Roy A. Hirschhorn and Jeffrey Marshall of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Marshall at (202) 622-4960 (not a toll-free call).

This revenue procedure provides the exclusive procedures for a partnership (as defined in section 5.02 of this revenue procedure), S corporation, electing S corporation (as defined in section 5.03 of this revenue procedure), personal service corporation (PSC) (as defined in section 5.04 of this revenue procedure), or trust within its scope — to obtain automatic approval to adopt, change, or retain its annual accounting period under § 442 of the Internal Revenue Code and § 1.442-1(b) of the Income Tax Regulations. This revenue procedure clarifies, modifies, amplifies, and supersedes Rev. Proc. 2002-38, 2002-1 C.B. 1037. A partnership, S corporation, electing S corporation, PSC, or trust complying with the applicable provisions of this revenue procedure will be deemed to have established a business purpose and obtained the approval of the Commissioner of Internal Revenue to adopt, change, or retain its annual accounting period under § 442 and the regulations thereunder.

.01 Taxable Year Defined.

(1) In general. Section 441(b) and § 1.441-1(b)(1) provide that the term “taxable year” generally means the taxpayer’s annual accounting period, if it is a calendar year or fiscal year, or, if applicable, the taxpayer’s required taxable year.

(2) Annual accounting period. Section 441(c) and § 1.441-1(b)(3) provide that the term “annual accounting period” means the annual period (calendar year or fiscal year) on the basis of which the taxpayer regularly computes its income in keeping its books.

(3) Required taxable year.

(a) In general. Section 1.441-1(b)(2) provides that certain taxpayers must use the particular taxable year that is required under the Code or regulations thereunder. Exceptions to the required taxable year are provided for certain taxpayers, including a partnership, S corporation, or PSC, that make an election under § 444, elect to use a 52-53-week taxable year that ends with reference to its required taxable year or a taxable year elected under § 444, or establish a business purpose for having a different taxable year and obtain approval under § 442.

(b) Partnerships. Section 706(b) and § 1.706-1(b)(2) generally provide that a partnership’s taxable year must be its required taxable year. However, a partnership may have a taxable year other than its required taxable year if it makes an election under § 444, elects to use a 52-53-week taxable year that ends with reference to its required taxable year or a taxable year elected under § 444, or establishes a business purpose for having a different taxable year and obtains the approval of the Commissioner under § 442. The required taxable year for a partnership is:

(i) the taxable year of one or more of its partners who have an aggregate interest in partnership profits and capital of greater than 50 percent;

(ii) if there is no taxable year described in clause (i), the taxable year of all the principal partners of the partnership (i.e., all the partners having an interest of 5 percent or more in partnership profits or capital); or

(iii) if there is no taxable year described in clause (i) or (ii), the taxable year that results in the least aggregate deferral of income to the partners.

(c) S corporations. Section 1378 and § 1.1378-1(a) provide that the taxable year of an S corporation must be a permitted year. The term “permitted year” means (1) the required taxable year (i.e., a taxable year ending on December 31), (2) a taxable year elected under § 444, (3) a 52-53-week taxable year ending with reference to the required taxable year or a taxable year elected under § 444, or (4) any other accounting period for which the corporation establishes to the satisfaction of the Commissioner a business purpose.

(d) PSCs. Section 441(i)(1) and § 1.441-3 provide that the taxable year of a PSC must be the calendar year unless the PSC makes an election under § 444, elects to use a 52-53-week taxable year that ends with reference to the calendar year or a taxable year elected under § 444, or establishes, to the satisfaction of the Commissioner, a business purpose for having a different period for its taxable year.

(e) Trusts. Section 644(a) provides that the taxable year of any trust generally must be the calendar year.

.02 Adoption of a Taxable Year. A newly-formed partnership, S corporation, or PSC may adopt its required taxable year, a taxable year elected under § 444, or a 52-53-week taxable year ending with reference to its required taxable year or a taxable year elected under § 444 without the approval of the Commissioner pursuant to § 441. If, however, a partnership, S corporation, or PSC wants to adopt any other taxable year, it must establish a business purpose and obtain approval under § 442. See § 1.441-1(c).

.03 Change in Taxable Year.

(1) In general. Section 1.442-1(a) generally provides that a taxpayer that wants to change its annual accounting period and use a new taxable year must obtain the approval of the Commissioner.

(2) Annualization of short period return. Section 443(b) and § 1.443-1(b)(1)(i) generally provide that if a return is made for a short period resulting from a change of an annual accounting period, the taxable income for the short period must be placed on an annual basis by multiplying the income by 12 and dividing the result by the number of months in the short period. Unless § 443(b)(2) and § 1.443-1(b)(2) apply, the tax for the short period generally is the same part of the tax computed on an annual basis as the number of months in the short period is of 12 months. But see §§ 1.706-1(b)(8)(i)(B) and 1.1378-1(c)(2) for exceptions to this general rule for partnerships and S corporations, respectively.

(3) No retroactive change in annual accounting period. Unless specifically authorized by the Commissioner, a taxpayer may not request, or otherwise make, a retroactive change in annual accounting period, regardless of whether the change is to a required taxable year.

.04 Retention of a Taxable Year. In certain cases, a partnership, S corporation, electing S corporation, or PSC will be required to change its taxable year unless it establishes a business purpose and obtains the approval of the Commissioner under § 442, or makes an election under § 444, to retain its current taxable year. See § 1.441-1(d). For example, a corporation on a June 30 fiscal year that either becomes a PSC or elects to be an S corporation, and as a result is required to use the calendar year, must obtain the approval of the Commissioner to retain its current fiscal year. Similarly, a partnership using a taxable year that corresponds to its required taxable year generally must obtain the approval of the Commissioner to retain that taxable year if its required taxable year changes as a result of a change in ownership. But see § 706(b)(4)(B). However, a partnership that previously has established a business purpose to the satisfaction of the Commissioner to use a particular fiscal year is not required to obtain the approval of the Commissioner to retain such fiscal year if its required taxable year changes provided such fiscal year currently qualifies as a permitted taxable year.

.05 Approval of an Adoption, Change, or Retention. Section 1.442-1(b) provides, in part, that in order to secure the approval of the Commissioner to adopt, change, or retain an annual accounting period, a taxpayer must file an application, generally on Form 1128, “Application To Adopt, Change, or Retain a Tax Year,” with the Commissioner within such time and in such manner as is provided in administrative procedures published by the Commissioner. In general, an adoption, change, or retention in annual accounting period will be approved if the taxpayer establishes a business purpose for the requested annual accounting period and agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the adoption, change, or retention.

.06 Business Purpose.

(1) Sufficient business purposes. Section 1.442-1(b)(2) provides that the requirement of a business purpose generally will be satisfied, and adjustments to neutralize any tax consequences will not be required, if the requested annual accounting period coincides with the taxpayer’s required taxable year, ownership taxable year, or natural business year. Section 1.442-1(b)(2) also provides that, in the case of a partnership, S corporation, electing S corporation, or PSC, deferral of income to partners, shareholders, or employee-owners will not be treated as a business purpose.

(2) Natural business year. A taxpayer is deemed to have established a natural business year if it satisfies the “25-percent gross receipts test” described in section 5.07 of this revenue procedure.

.07 Section 444 Elections. A partnership, S corporation, electing S corporation, or PSC generally can elect under § 444 to use a taxable year other than its required taxable year, but only if the deferral period of the taxable year elected is not longer than the shorter of 3 months or the deferral period of the taxable year being changed. A partnership and an S corporation with a § 444 election must make required payments under § 7519 that approximate the amount of deferral benefit and a PSC with a § 444 election is subject to the minimum distribution requirements of § 280H. A taxpayer may automatically adopt, change to, or retain a taxable year permitted under § 444 by filing a Form 8716, “Election To Have a Tax Year Other Than a Required Tax Year.” A taxpayer that wants to terminate its § 444 election must follow the automatic procedures under § 1.444-1T(a)(5) to change to its required taxable year or establish a business purpose for using a different taxable year pursuant to § 442, the regulations thereunder, Rev. Proc. 2002-39, 2002-1 C.B. 1046 (or any successor), or this revenue procedure (whichever is applicable).

Significant changes to Rev. Proc. 2002-38 made by this revenue procedure include:

.01 Section 4.01 of this revenue procedure removes from the scope a partnership that has a minor, temporary percentage change in ownership.

.02 Section 4.01(1) of this revenue procedure adds to the scope a trust that wants to change to its required taxable year.

.03 Section 4.01(5) of this revenue procedure clarifies that a taxpayer that is required to make a concurrent change as a term and condition for the approval of a related taxpayer’s change of accounting period is included in the scope notwithstanding any limitation in this revenue procedure to the contrary.

.04 Section 4.02(6) of this revenue procedure excludes from the scope a terminated S corporation.

.05 Section 4.02(7) of this revenue procedure excludes from the scope a partnership, S corporation, electing S corporation, or PSC that makes or terminates a § 444 election. A taxpayer that makes or terminates a § 444 election must follow the procedures in § 444 and the regulations thereunder.

.06 Section 5.05 of this revenue procedure adds a trust to the definition of a required taxable year.

.07 Section 5.08 of this revenue procedure clarifies that, for taxable years beginning after December 31, 2002, a shareholder that is tax-exempt under § 501(a) generally is disregarded for purposes of determining the ownership taxable year of an S or electing S corporation.

.08 Section 5.10 of this revenue procedure modifies the definition of first effective year to include a short period of 6 days or less.

.09 Section 6.02(1) of this revenue procedure provides that only certain short periods are exempt from the financial statement conformity requirement and incorporates the clarification in Notice 2002-72, 2002-2 C.B. 843, of the recordkeeping/book conformity term and condition with regard to certain taxpayers changing to their required taxable year.

.10 Section 6.08 of this revenue procedure incorporates the modified carryback term and condition of section 4.01 of Rev. Proc. 2003-34, 2003-1 C.B. 856.

.11 Section 9.02 of this revenue procedure clarifies that, for a taxpayer that must change to a required year, failure to comply with all the applicable provisions of this revenue procedure does not relieve the taxpayer from any applicable penalties or interest if the taxpayer fails to make the change.

.01 Applicability. Except as provided in section 4.02, this revenue procedure, which is the exclusive procedure for a taxpayer (as defined in section 5.01 of this revenue procedure) within its scope to secure the Commissioner’s approval, applies to:

(1) Required taxable year. A partnership, S corporation, electing S corporation, PSC, or trust that wants to change to its required taxable year (as defined in section 5.05 of this revenue procedure), or a partnership, S corporation, electing S corporation, or PSC that wants to change to a 52-53-week taxable year ending with reference to such required taxable year;

(2) Natural business year. A partnership, S corporation, electing S corporation, or PSC (other than a member of a tiered structure as defined in § 444 and § 1.444-2T) that wants to change to or retain a natural business year that satisfies the 25-percent gross receipts test described in section 5.07 of this revenue procedure, or to a 52-53-week taxable year ending with reference to such taxable year;

(3) Ownership taxable year. An S corporation or electing S corporation that wants to adopt, change to, or retain its ownership taxable year (as defined in section 5.08 of this revenue procedure), or to a 52-53-week taxable year ending with reference to such taxable year;

(4) Certain 52-53-week taxable years. A partnership, S corporation, electing S corporation, or PSC that wants to change from a 52-53-week taxable year that references a particular calendar month to a non-52-53-week taxable year that ends on the last day of the same calendar month that is a permitted taxable year, and vice versa;

(5) Certain taxpayers that are required to make concurrent changes. Notwithstanding any limitation in this revenue procedure to the contrary (including any limitations in section 4.02 of this revenue procedure) or any conflicting testing date provisions, this revenue procedure applies to a taxpayer that is required to concurrently change its annual accounting period as a term and condition for the approval of a related taxpayer’s change of annual accounting period.

.02 Inapplicability. Except as provided in section 4.01(5) of this revenue procedure, this revenue procedure does not apply to:

(1) Under examination. A change or retention in annual accounting period if the taxpayer is under examination (as defined in section 5.13 of this revenue procedure), unless it obtains consent of the appropriate director as provided in section 7.03(1) of this revenue procedure;

(2) Before an area office. A change or retention in annual accounting period if the taxpayer is before an area office with respect to any income tax issue and its annual accounting period is an issue under consideration (as defined in section 5.14 of this revenue procedure) by the area office;

(3) Before a federal court. A change or retention in annual accounting period if the taxpayer is before a federal court with respect to any income tax issue and its annual accounting period is an issue under consideration by the federal court;

(4) Issue under consideration in connection with partner or shareholder return. A change or retention in annual accounting period by a partnership or S corporation if, on the date the taxpayer otherwise would file its application with the Service Center, the taxpayer’s annual accounting period is an issue under consideration in the examination of a partner’s or shareholder’s federal income tax return or an issue under consideration by an area office or by a federal court with respect to a partner’s or shareholder’s federal income tax return; or

(5) Prior change. A change to, or retention of, a natural business year as described in section 4.01(2) of this revenue procedure if the taxpayer has changed its annual accounting period at any time within the most recent 48-month period ending with the last month of the requested taxable year. For this purpose, the following changes are not considered prior changes in annual accounting period:

(a) a change to a required taxable year or ownership taxable year;

(b) a change from a 52-53-week taxable year to a non-52-53-week taxable year that ends with reference to the same calendar month, and vice versa; or

(c) a change in accounting period by an S corporation, electing S corporation, or PSC, in order to comply with the common taxable year requirements of §§ 1.1502-75(d)(3)(v) and 1.1502-76(a)(1).

(6) Terminated S corporation. A corporation that is requesting a change in a taxable year that is within an S termination year (as defined in § 1362(e)(4)).

(7) Section 444 election. A partnership, S corporation, electing S corporation, or PSC that makes or terminates a § 444 election.

.03 Nonautomatic Changes. Any taxpayer that wants to adopt, change to, or retain an annual accounting period that cannot do so automatically under this revenue procedure (because the requested taxable year is not described in section 4.01 or because of any application of section 4.02) or pursuant to a provision in the Code, regulations, or other published administrative procedures, must obtain the approval of the Commissioner. See § 1.442-1(b) and Rev. Proc. 2002-39 (or any successor) for rules relating to nonautomatic changes of annual accounting periods by partnerships, S corporations, electing S corporations, PSCs, and trusts.

The following definitions apply solely for purposes of this revenue procedure:

.01 Taxpayer. The term “taxpayer” has the same meaning as the term “person” as defined in § 7701(a)(1) (e.g., an individual, trust, estate, partnership, association, or corporation) rather than the meaning of the term “taxpayer” as defined in § 7701(a)(14) (any person subject to tax).

.02 Partnership. A partnership is any entity classified as a partnership for purposes of § 7701(a)(3) or the regulations thereunder.

.03 Electing S Corporation. An “electing S corporation” is a corporation attempting to make an S corporation election for the short period (as defined in section 5.11 of this revenue procedure). See Rev. Proc. 2006-45, 2006-45 I.R.B. , for procedures for automatic approval to change an annual accounting period by corporations attempting to make an S corporation election for the taxable year immediately following the first effective year (as defined in section 5.10 of this revenue procedure).

.04 PSC. A PSC is a personal service corporation as defined in § 441(i)(2). For purposes of this revenue procedure, a PSC does not include a corporation that has a required taxable year under a provision of the Code other than § 441(i) (e.g., a specified foreign corporation as defined in § 898(b)(1)).

.05 Required Taxable Year. The “required taxable year” is the taxable year determined under § 706(b) in the case of a partnership, § 644 in the case of a trust, § 1378 in the case of an S corporation or an electing S corporation, or § 441(i) in the case of a PSC, without taking into account any taxable year that is allowable by reason of a business purpose (including a grandfathered fiscal year as defined in section 5.09 of this revenue procedure) or a § 444 election.

.06 Permitted Taxable Year. A “permitted taxable year” is the required taxable year; a natural business year; the ownership taxable year; a taxable year elected under § 444; a 52-53-week taxable year that references the required taxable year, natural business year, ownership taxable year, or a taxable year elected under § 444; or any other taxable year for which the taxpayer establishes a business purpose to the satisfaction of the Commissioner.

.07 Natural Business Year. A “natural business year” is a year for which a partnership, S corporation, electing S corporation, or PSC satisfies the following “25-percent gross receipts test”:

(1) 25-percent gross receipts test. Except as provided in (2) below, the 25-percent gross receipts test is satisfied if each of the results described in (a) and (b) below equals or exceeds 25-percent:

(a) Gross receipts from sales and services for the most recent 12-month period that ends with the last month of the requested annual accounting period are totaled and then divided into the amount of gross receipts from sales and services for the last 2 months of this 12-month period.

(b) The same computation as in (1)(a) above is made for the two preceding 12-month periods ending with the last month of the requested annual accounting period.

(2) Exception. The taxpayer must determine whether any annual accounting period other than the requested annual accounting period also meets the 25-percent test described in (1). If one or more other annual accounting periods produce higher averages of the three percentages (rounded to 1/100 of a percent) described in (1) than the requested annual accounting period, then the requested annual accounting period will not qualify as the taxpayer’s natural business year.

(3) Special rules.

(a) To apply the 25-percent gross receipts tests for any particular taxable year, the taxpayer must compute its gross receipts from sales and services under the method of accounting used to prepare its federal income tax returns for such taxable year.

(b) If a taxpayer has a predecessor organization and is continuing the same business as its predecessor, the taxpayer must use the gross receipts from sales and services of its predecessor for purposes of computing the 25-percent gross receipts test.

(c) If the taxpayer (including any predecessor organization) does not have a 47-month period of gross receipts (36-month period for requested taxable year plus additional 11-month period for comparing requested taxable year with other potential taxable years), then it cannot establish a natural business year under this revenue procedure.

(d) If the requested taxable year is a 52-53-week taxable year, the calendar month ending nearest to the last day of the 52-53-week taxable year is treated as the last month of the requested taxable year for purposes of computing the 25-percent gross receipts test.

.08 Ownership Taxable Year. For an S corporation or electing S corporation, an “ownership taxable year” is the taxable year (if any) that, as of the first day of the first effective year, constitutes the taxable year of one or more shareholders (including any shareholder that concurrently changes to such taxable year) holding more than 50-percent of the corporation’s issued and outstanding shares of stock. Under principles similar to § 1.706-1(b)(5) for determining the taxable year of a partnership, a shareholder that is tax-exempt under § 501(a) is disregarded if such shareholder is not subject to tax on any income attributable to the S corporation. Tax-exempt shareholders are not disregarded, however, if the S corporation is wholly-owned by such tax-exempt entities. A shareholder in an S corporation or electing S corporation that wants to concurrently change its taxable year must follow the instructions generally applicable to taxpayers changing their taxable years contained in § 1.442-1(b), Rev. Proc. 2002-39 (or any successor), or any other applicable administrative procedure published by the Commissioner.

.09 Grandfathered Fiscal Year. A “grandfathered fiscal year” is a fiscal year (other than a year that resulted in a three-month or less deferral of income) that a partnership or an S corporation received permission to use on or after July 1, 1974, by a letter ruling (i.e., not by automatic approval).

.10 First Effective Year. The “first effective year” is the first taxable year for which an adoption, change, or retention in annual accounting period is effective. The first effective year generally is the short period required to effect the change. In the case of a short period of 6 days or less, the first effective year is the taxable year that includes such short period under § 1.441-2(b)(2)(ii). The first effective year is also the first taxable year for complying with all the terms and conditions set forth in this revenue procedure necessary to effect the adoption, change, or retention in annual accounting period.

.11 Short Period. In the case of a change in annual accounting period, a taxpayer’s “short period” is the period beginning with the day following the close of the old taxable year and ending with the day preceding the first day of the new taxable year.

.12 Field Office, Area Office, Director. The terms “field office,” “area office,” and “director” have the same meaning as those terms have in Rev. Proc. 2006-1, 2006-1 I.R.B. 1 (or any successor).

.13 Under Examination.

(1) In general.

(a) Except as provided in section 5.13(2) of this revenue procedure, an examination of a taxpayer with respect to a federal income tax return begins on the date the taxpayer is contacted in any manner by a representative of the Service for the purpose of scheduling any type of examination of the return. An examination ends:

(i) in a case in which the Service accepts the return as filed, on the date of the “no change” letter sent to the taxpayer;

(ii) in a fully agreed case, on the earliest of the date the taxpayer executes a waiver of restrictions on assessment or acceptance of overassessment (for example, Form 870, 4549, or 4605), the date the taxpayer makes a payment of tax that equals or exceeds the proposed deficiency, or the date of the “closing” letter (for example, Letter 891(IN) or 987(DO)) sent to the taxpayer; or

(iii) in an unagreed or a partially agreed case, on the earliest of the date the taxpayer (or its representative) is notified by an area officer that the case has been referred to an area office from a field office, the date the taxpayer files a petition in the Tax Court, the date on which the period for filing a petition with the Tax Court expires, or the date of the notice of claim disallowance.

(b) An examination does not end as a result of the early referral of an issue to an area office under the provisions of Rev. Proc. 99-28, 1999-2 C.B. 109.

(c) An examination resumes on the date the taxpayer (or its representative) is notified by an appeals officer (or otherwise) that the case has been referred to a field office for reconsideration.

(2) Partnerships and S corporations subject to TEFRA. For a partnership or S corporation that is subject to the TEFRA unified audit and litigation provisions (note that an S corporation is not subject to the TEFRA unified audit and litigation provisions for taxable years beginning after December 31, 1996; see Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1317(a), 110 Stat. 1755, 1787 (1996)), an examination begins on the date that the notice of the beginning of an administrative proceeding is sent or personally delivered to the Tax Matters Partner/Tax Matters Person (TMP). An examination ends:

(a) in a case in which the Service accepts the partnership or S corporation return as filed, on the date of the “no adjustments” letter or the “no change” notice of final administrative adjustment sent to the TMP;

(b) in a case in which no formal notice is given, the period of limitations on assessment has expired for all partners with respect to the partnership items of the partnership;

(c) in a fully agreed case, when all the partners or shareholders execute a Form 870-P, 870-L, 870-S, or any variation thereof; or

(d) in an unagreed or a partially agreed case, on the earliest of the date the TMP (or its representative) is notified by an appeals officer that the case has been referred to an area office from a field office, the date the TMP (or a partner, member, or shareholder) requests judicial review, or the date on which the period for requesting judicial review expires.

.14 Issue Under Consideration.

(1) During an examination. A taxpayer’s annual accounting period is an issue under consideration for the taxable years under examination if the taxpayer receives written notification (for example, by examination plan, information document request (IDR), or notification of proposed adjustments or income tax examination changes) from the examining agent(s) specifically citing the taxpayer’s annual accounting period as an issue under consideration. For example, a taxpayer’s annual accounting period is an issue under consideration as a result of an examination plan that identifies the propriety of the taxpayer’s annual accounting period as a matter to be examined. The question of whether the taxpayer’s annual accounting period is an issue under consideration may be referred to the national office as a request for technical advice under the provisions of Rev. Proc. 2006-2, 2006-1 I.R.B. 89 (or any successor).

(2) Before an area office. A taxpayer’s annual accounting period is an issue under consideration for the taxable years before an area office if the taxpayer’s annual accounting period is included as an item of adjustment in the examination report referred to the area office or is specifically identified in writing to the taxpayer by the area office.

(3) Before a federal court. A taxpayer’s annual accounting period is an issue under consideration for the taxable years before a federal court if the taxpayer’s annual accounting period is an item included in the statutory notice of deficiency, the notice of claim disallowance, the notice of final administrative adjustment, the pleadings (for example, the petition, complaint, or answer) or amendments thereto, or is specifically identified in writing to the taxpayer by the government counsel.

.01 In General. An adoption, change, or retention in annual accounting period filed under this revenue procedure must be made pursuant to the terms and conditions provided in this revenue procedure.

.02 Record Keeping/Book Conformity.

(1) In general. The taxpayer must compute its income and keep its books and records (including financial statements and reports to creditors) on the basis of the requested taxable year. The books and records of the taxpayer must be closed as of the last day of the first effective year and the taxpayer must conform the accounting period used for financial statement purposes and reports to creditors concurrently.

(2) Certain short periods exempt from financial statement conformity. If the taxpayer is not required to issue financial statements for the short period required to effect the change, the taxpayer will be deemed to have met the financial statement conformity requirement for the first effective year provided the taxpayer’s accounting period used for financial statement purposes already conforms to the requested taxable year or the taxpayer makes the change in accounting period used for financial statement purposes and reports to creditors concurrently.

(3) Certain taxpayers using required year exempt from financial statement conformity. If the requested taxable year is the taxpayer’s required taxable year, the taxpayer must compute its income and keep its books and records for U.S. federal income tax purposes on the basis of the required taxable year, but is not required to conform its financial statements and reports to creditors on the basis of the required taxable year. The books and records of the taxpayer must be closed as of the last day of the first effective year.

.03 First Effective Year Tax Return.

(1) When to file. The taxpayer generally must file a federal income tax return for the first effective year by the due date of that return, including extensions, in accordance with § 1.443-1(a).

(2) Annualization. If the taxpayer is a PSC or a trust, the taxpayer’s taxable income for the short period must be annualized and the tax must be computed in accordance with the provisions of § 443(b) and § 1.443-1(b). However, for changes to (or from) a 52-53-week taxable year referencing the same month as the current (or requested) taxable year, see special rules in § 1.441-2.

.04 Subsequent Year Tax Returns. Returns for subsequent taxable years generally must be made on the basis of a full 12 months (or on a 52-53-week basis) ending on the last day of the requested taxable year, unless the taxpayer secures the approval of the Commissioner to change that taxable year.

.05 Changes in Natural Business Year. If a partnership, S corporation, electing S corporation, or PSC changes to or retains a natural business year and that year no longer qualifies as a permitted taxable year, the taxpayer is using an impermissible annual accounting period and must change to a permitted taxable year. Taxpayers qualifying under section 4 of this revenue procedure may request automatic approval for the change under the provisions of this revenue procedure. Other taxpayers must request approval under Rev. Proc. 2002-39 (or any successor).

.06 Changes in Ownership Taxable Year. An S corporation or electing S corporation that adopts, changes to, or retains an ownership taxable year under this revenue procedure must change to a permitted taxable year, or request approval to retain its current taxable year, if, as of the first day of any taxable year, its ownership taxable year changes. S corporations qualifying under section 4 of this revenue procedure may request automatic approval for the change or retention under the provisions of this revenue procedure. Other taxpayers must request approval under Rev. Proc. 2002-39 (or any successor).

.07 52-53-week Taxable Years. If applicable, the taxpayer must comply with § 1.441-2(e) (relating to the timing of taking items into account in those cases where the taxable year of a pass-through entity or PSC ends with reference to the same calendar month as one or more of its partners, shareholders, or employee-owners).

.08 Creation of Net Operating Loss or Capital Loss. In the case of a PSC changing its annual accounting period, if the PSC generates a net operating loss (NOL) or capital loss (CL) in the short period required to effect the change in annual accounting period, the PSC may not carry the NOL or CL back, but must carry it over in accordance with the provisions of §§ 172 and 1212, respectively, beginning with the first taxable year after the short period. However, except as provided in § 280H and the regulations thereunder, the short period NOL or CL must be carried back or carried over in accordance with § 172 or 1212, respectively, if it is either (a) $50,000 or less; or (b) less than the NOL or CL, respectively, generated for the full 12-month period beginning with the first day of the short period. The taxpayer must wait until this 12-month period has expired to determine whether the taxpayer qualifies for the exception in (b) above.

.09 Creation of General Business Credits. In the case of a PSC changing its annual accounting period, if there is an unused general business credit or any other unused credit generated in the short period, the PSC must carry that unused credit forward. An unused credit from the short period may not be carried back.

.01 Approval. Approval is hereby granted to any taxpayer within the scope of this revenue procedure to adopt, change, or retain its annual accounting period, provided the taxpayer complies with all the applicable provisions of this revenue procedure. Approval is granted beginning with the first effective year. A taxpayer granted approval under this revenue procedure to adopt, change to, or retain an annual accounting period other than its required year is deemed to have established a business purpose for the adoption, change, or retention to the satisfaction of the Commissioner.

.02 Filing Requirements.

(1) Where to file. A taxpayer within the scope of this revenue procedure that wants to adopt, change, or retain its annual accounting period under this revenue procedure must complete and file an application (i.e., a current Form 1128 or, in the case of an electing S corporation, a current Form 2553, Election by a Small Business Corporation) with the Director, Internal Revenue Service Center, Attention: ENTITY CONTROL, where the taxpayer files its federal income tax return. No copies of Form 1128 (or Form 2553) should be sent to the national office. The taxpayer also must attach a copy of the Form 1128 (or Form 2553) to the federal income tax return filed for the first effective year.

(2) When to file. The Form 1128 must be filed no earlier than the day following the end of the first effective year and no later than the due date (including extensions) for filing the federal income tax return for the first effective year. For electing S corporations, the Form 2553 must be filed when the election to be an S corporation is filed pursuant to § 1362(b) and § 1.1362-6. Generally, such election must be filed at any time during (a) the taxable year that immediately precedes the taxable year for which the election is to be effective, or (b) the taxable year for which the election is to be effective, provided the election is made before the 16^th day of the third month of the taxable year.

(3) Label. In order to assist in the processing of the adoption, change, or retention in annual accounting period, taxpayers should write at the top of page 1 of the Form 1128 (or Form 2553): “FILED UNDER REV. PROC. 2006-46.”

(4) Signature requirements. In the case of a partnership, the Form 1128 must be signed on behalf of the partnership by a general partner. In the case of a limited liability company that elects to be treated as a partnership, the Form 1128 must be signed by a member-manager who has personal knowledge of the facts set forth on the form. In all other cases, the Form 1128 (or Form 2553) must be signed by an authorized corporate officer. If an agent is authorized to represent the taxpayer before the Service, to receive the original or a copy of correspondence concerning the application, or to perform any other act(s) regarding the application on behalf of the taxpayer, a Form 2848, Power of Attorney and Declaration of Representative, reflecting such authorization(s) should be attached to the application. A taxpayer’s representative without a power of attorney to represent the taxpayer will not be given any information about the application.

(5) No user fee. A user fee is not required for applications filed under this revenue procedure and, except as provided in section 9.01 of this revenue procedure, the receipt of an application filed under this revenue procedure may not be acknowledged.

(6) Additional information. In the case of a taxpayer changing to a natural business year that satisfies the 25-percent gross receipts test described in section 5.07 of this revenue procedure, the taxpayer must supply the gross receipts from sales and services for the most recent 47 months for itself (or any predecessor) in compliance with the instructions to Form 1128 (or Form 2553).

.03 Additional Procedures If Under Examination, Before an Area Office, or Before a Federal Court.

(1) Taxpayer under examination.

(a) A taxpayer under examination may request approval to change or retain its annual accounting period under this revenue procedure only if the appropriate director consents to the change or retention. The director will consent to the change or retention unless, in the opinion of the director, the taxpayer’s annual accounting period ordinarily would be included as an item of adjustment in the year(s) for which the taxpayer is under examination. For example, the director will consent to a change if the taxpayer is using a permissible annual accounting period. The director also will consent to a change from an impermissible annual accounting period if the period became impermissible (e.g., due to a change in ownership or a change in the taxpayer’s business) subsequent to the years under examination. The question of whether the taxpayer’s annual accounting period from which the taxpayer is changing is permissible or became impermissible subsequent to the years under examination may be referred to the national office as a request for technical advice under the provisions of 2006-2, 2006-1 I.R.B. 89 (or any successor).

(b) A taxpayer changing or retaining an annual accounting period under this revenue procedure with the consent of the appropriate director must attach to the application a statement from the director consenting to the change or retention. The taxpayer must provide a copy of the application to the director at the same time it files the application with the Service Center. The application must contain the name(s) and telephone number(s) of the examining agent(s).

(2) Taxpayer before an area office. A taxpayer that is before an area office must attach to the application a separate statement signed by the taxpayer certifying that, to the best of the taxpayer’s knowledge, the taxpayer’s annual accounting period is not an issue under consideration by the area office. The taxpayer must provide a copy of the application to the appeals officer at the same time it files the application with the Service Center. The application must contain the name and telephone number of the appeals officer.

(3) Taxpayer before a federal court. A taxpayer that is before a federal court must attach to the application a separate statement signed by the taxpayer certifying that, to the best of the taxpayer’s knowledge, the taxpayer’s annual accounting period is not an issue under consideration by the federal court. The taxpayer must provide a copy of the application to the government counsel at the same time it files the application with the Service Center. The application must contain the name and telephone number of the government counsel.

.01 Audit Protection.

(1) In general. Except as provided in section 8.01(2) of this revenue procedure, a taxpayer that files an application in compliance with all the applicable provisions of this revenue procedure will not be required by the Service to change its annual accounting period for a taxable year prior to the first effective year.

(2) Exceptions. The Service may change a taxpayer’s annual accounting period for a prior taxable year if:

(a) the taxpayer fails to implement the change;

(b) the taxpayer implements the change but does not comply with all the applicable provisions of this revenue procedure; or

(c) there was a misstatement or omission of material facts.

.02 Subsequently Required Changes.

(1) In general. A taxpayer that adopts, changes, or retains its annual accounting period pursuant to this revenue procedure may be required to subsequently change its annual accounting period for the following reasons:

(a) the enactment of legislation;

(b) a decision of the United States Supreme Court;

(c) the issuance of temporary or final regulations;

(d) the issuance of a revenue ruling, revenue procedure, notice, or other statement published in the Internal Revenue Bulletin;

(e) the issuance of written notice to the taxpayer that the change in annual accounting period was not in compliance with all the applicable provisions of this revenue procedure or is not in accord with the current view of the Service; or

(f) a change in the material facts on which the approval was granted.

(2) Retroactive change. Except in rare circumstances, if a taxpayer that adopts, changes, or retains its annual accounting period under this revenue procedure is subsequently required under section 8.02(1) of this revenue procedure to change that annual accounting period, the required change will not be applied retroactively, provided that:

(a) the taxpayer complied with the applicable provisions of this revenue procedure;

(b) there has been no misstatement or omission of material facts;

(c) there has been no change in the material facts on which the approval was based;

(d) there has been no change in the applicable law; and

(e) the taxpayer to which the approval was granted acted in good faith in relying on the approval, and applying the change retroactively would be to the taxpayer’s detriment.

.01 Service Center Review. A Service Center may deny an adoption, change, or retention of an annual accounting period under this revenue procedure only if: (1) the Form 1128 (or Form 2553) is not filed timely, or (2) the taxpayer fails to meet the scope or any term and condition of this revenue procedure. If the application is denied, the Service Center will return the application with an explanation for the denial. In the case of a denial of an accounting period request filed on Form 2553, the taxpayer will be required to use the calendar year or, if applicable, make a § 444 election, if it chooses to be an S corporation.

.02 Review of Director. The appropriate director may ascertain if the adoption, change, or retention of annual accounting period was made in compliance with all the applicable provisions of this revenue procedure. Taxpayers adopting, changing, or retaining their annual accounting period pursuant to this revenue procedure without complying with all the provisions (including the terms and conditions) of this revenue procedure ordinarily will be deemed to have initiated the adoption, change, or retention of annual accounting period without the approval of the Commissioner. Upon examination, a taxpayer that has initiated an unauthorized adoption, change, or retention of annual accounting period may be denied the adoption, change, or retention. For example, the taxpayer may be required to recompute its taxable income or loss in accordance with its former (or required, if applicable) taxable year. For a taxpayer that must change to a required year, failure to comply with all the applicable provisions of this revenue procedure does not relieve the taxpayer from the requirement to change to the required year and, if the taxpayer does not change to the required year, does not prevent the imposition of any applicable penalty or addition of any amount to tax.

This revenue procedure generally is effective for adoptions, changes, or retentions of annual accounting periods for which the first effective year ends on or after October 18, 2006. However, if the time period for filing Form 1128 (or Form 2553) with respect to a taxable year set forth in section 7.02(2) of this revenue procedure has not yet expired, a taxpayer within the scope of this revenue procedure may elect early application of the revenue procedure by providing the notification set forth in section 7.02(3) on the top of page 1 of Form 1128 (or Form 2553) and by satisfying the other procedural requirements of section 7.

Rev. Proc. 2002-38 is clarified, modified, amplified, and superseded.

The collection of information contained in this revenue procedure 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 number 1545-1786. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this revenue procedure is found in section 7. The information in section 7 is required in order to determine whether the taxpayer properly obtained automatic approval to adopt, change, or retain its annual accounting period. The likely respondents are the following: partnerships, S corporations, electing S corporations, PSCs, and trusts. The estimated total annual burden for the requirements contained in section 7 of this revenue procedure is reflected in the burden estimates for Forms 1128 and 2553.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

The principal authors of this revenue procedure are Jeffrey S. Marshall and Roy A. Hirschhorn of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Marshall at (202) 622-4960 (not a toll-free call).

This revenue procedure provides methods used as part of calculating W-2 wages for purposes of § 199(b)(1) of the Internal Revenue Code, which limits the amount of the § 199 deduction for income attributable to domestic production activities to 50 percent of the W-2 wages of the taxpayer for the taxable year.

Section 514(a) of the Tax Increase Prevention and Reconciliation Act of 2005 (Public Law 109-222) (TIPRA) imposes a new limitation on W-2 wages for purposes of § 199 for taxable years beginning after May 17, 2006. Under the change made by TIPRA, W-2 wages, for purposes of § 199, include only amounts that are properly allocable to domestic production gross receipts (DPGR) for purposes of § 199(c)(1). Thus, to determine such W-2 wages for taxable years beginning after May 17, 2006, it is necessary to determine the amount that would have been W-2 wages for purposes of § 199 before the amendment by TIPRA and then to determine the portion of that amount properly allocable to DPGR.

This revenue procedure provides methods for calculating the amount of wages described in § 1.199-2(e)(1) of the Income Tax Regulations (“paragraph (e)(1) wages”). Section 1.199-2T(e)(2) of the temporary Income Tax Regulations provides that the term W-2 wages includes only paragraph (e)(1) wages that are properly allocable to DPGR for purposes of § 199(c)(1). Thus, for taxable years covered by this revenue procedure, a taxpayer first determines the amount of paragraph (e)(1) wages under this revenue procedure and then applies § 1.199-2T(e)(2) to determine the amount of W-2 wages.

Section 1.199-2(e)(3) of the regulations provides the Internal Revenue Service with authority to issue guidance providing the methods that may be used to calculate W-2 wages. Section 1.199-2(e)(3) is effective for taxable years beginning on or after June 1, 2006. In Rev. Proc. 2006-22, 2006-23 I.R.B. 1033, the Internal Revenue Service provided methods for calculating W-2 wages for taxpayers who choose to apply the final regulations to taxable years beginning before June 1, 2006, but only for taxable years beginning on or after January 1, 2005, and on or before May 17, 2006. For taxable years covered by this revenue procedure, this revenue procedure provides methods to determine paragraph (e)(1) wages, but taxpayers must then subject such wages to the limitation contained in § 1.199-2T(e)(2) of the temporary regulations to determine W-2 wages.

Section 199(a) provides a deduction for an amount equal to a percentage of the lesser of (A) the qualified production activities income of the taxpayer for the taxable year, or (B) taxable income (determined without regard to § 199) for the taxable year (or, in the case of an individual, adjusted gross income).

Section 199(b)(1) provides that the amount of the deduction allowable under § 199(a) for any taxable year shall not exceed 50 percent of the W-2 wages of the taxpayer for the taxable year. For this purpose, § 199(b)(2)(A) defines the term “W-2 wages” to mean, with respect to any person for any taxable year of such person, the sum of the amounts described in § 6051(a)(3) and (8) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year. Section 199(b)(2)(C) provides that W-2 wages shall not include any amount that is not properly included in a return filed with the Social Security Administration (SSA) on or before the 60th day after the due date (including extensions) for such return.

Section 514(a) of TIPRA added § 199(b)(2)(B) to exclude from the term W-2 wages any amount that is not properly allocable to domestic production gross receipts for purposes of § 199(c)(1). Section 199(b)(2)(B) is effective with respect to taxable years beginning after the date of enactment, May 17, 2006. Temporary and final regulations have been issued to reflect the changes in the definition of W-2 wages made by TIPRA. Section 1.199-2T(e)(2) of the temporary regulations provides rules for applying the TIPRA limitation on W-2 wages under § 199(b)(2)(B).

This revenue procedure provides three methods for calculating paragraph (e)(1) wages. These methods for calculating paragraph (e)(1) wages are generally similar to the methods used to calculate W-2 wages before the amendment made by TIPRA as set forth in Rev. Proc. 2006-22, § 1.199-2 of the proposed regulations that were published in the Federal Register on November 4, 2005 (REG-105847-05, 2005-47 I.R.B. 987 [70 FR 67220]), and section 4.02 of Notice 2005-14, 2005-1 C.B. 498, 514. The first method (the unmodified Box method) allows for a simplified calculation while the second and third methods (the modified Box 1 method and the tracking wages method) provide greater accuracy. After paragraph (e)(1) wages are determined under one of these methods, the amount of W-2 wages is then determined by applying § 1.199-2T(e)(2) of the temporary regulations.

.01 In general. Except as provided in section 3.03 and section 6.01 of this revenue procedure, the Forms W-2, “Wage and Tax Statement,” used in determining the amount of paragraph (e)(1) wages are those issued for the calendar year ending during the taxpayer’s taxable year for wages paid to employees (or former employees) of the taxpayer for employment by the taxpayer. For this purpose, employees of the taxpayer are limited to employees of the taxpayer as defined in § 3121(d)(1) and (2) (that is, officers of a corporate taxpayer and employees of the taxpayer under common law rules). See § 1.199-2(a)(1) of the regulations.

.02 Wages paid by entity other than common law employer. In determining paragraph (e)(1) wages, a taxpayer may take into account wages paid by another entity and reported by the other entity on Forms W-2 with the other entity as the employer listed in Box c of the Forms W-2, provided that the wages were paid to employees of the taxpayer for employment by the taxpayer. If the taxpayer is treated as an employer described in § 3401(d)(1) because of control of the payment of wages (that is, the taxpayer is not the common law employer of the payee of the wages), the payment of wages may not be included in determining paragraph (e)(1) wages of the taxpayer. If the taxpayer is paying wages as an agent of another entity to individuals who are not employees of the taxpayer, the wages may not be included in determining the paragraph (e)(1) wages of the taxpayer. See § 1.199-2(a)(2) of the regulations.

.03 Requirement that wages must be reported on return filed with Social Security Administration. Paragraph (e)(1) wages shall not include any amount that is not properly included in a return filed with SSA on or before the 60th day after the due date (including extensions) for such return. For this purpose, if a Form W-2c (or corrected return) is filed to correct a Form W-2 that was not filed with SSA on or before the 60th day after the due date (including extensions) of the Form W-2 (or to correct a Form W-2c relating to a Form W-2 that had not been filed with SSA on or before the 60th day after the due date (including extensions) of the Form W-2), then such Form W-2c (or corrected return) shall not be considered to have been filed with SSA on or before the 60th day after the due date (including extensions) for such Form W-2c (or corrected return), regardless of when such Form W-2c (or corrected return) is filed. See § 1.199-2(a)(3) of the regulations for further guidance related to this requirement.

.04 No application in determining whether amounts are wages for employment tax purposes. The discussions of “wages” in this revenue procedure and in the regulations under § 199 are for purposes of § 199 only and have no application in determining whether amounts are wages under § 3121(a) for purposes of the Federal Insurance Contributions Act, under § 3306(b) for purposes of the Federal Unemployment Tax Act, or under § 3401(a) for purposes of the Collection of Income Tax at Source on Wages (federal income tax withholding), or any other wage-related determination. See § 1.199-2(a)(1) of the regulations.

.05 Application for a taxpayer with a short taxable year. Subject to the other rules of application of the regulations and of this revenue procedure, paragraph (e)(1) wages of the taxpayer for a short taxable year shall include those wages paid during the short taxable year to employees of the taxpayer as determined under the tracking wages method described in section 5.03 of this revenue procedure. See section 6 of this revenue procedure.

.06 Acquisition or disposition of a trade or business (or major portion). If a taxpayer (a successor) acquires a trade or business, the major portion of a trade or business, or the major portion of a separate unit of a trade or business from another taxpayer (a predecessor), then, for purposes of computing the respective section 199 deduction of the successor and of the predecessor, paragraph (e)(1) wages paid for that calendar year shall be allocated between the successor and the predecessor based on whether the wages are for employment by the successor or for employment by the predecessor. Thus, in this situation, paragraph (e)(1) wages are allocated based on whether the wages are for employment for a period during which the employee was employed by the predecessor or for employment for a period during which the employee was employed by the successor, regardless of which permissible method for Form W-2 reporting is used. See § 1.199-2(c) of the regulations.

.07 Non-duplication rules. Amounts that are treated as paragraph (e)(1) wages for a taxable year under any method of calculating paragraph (e)(1) wages shall not be treated as paragraph (e)(1) wages for any other taxable year. Thus, for example, an amount of nonqualified deferred compensation that is treated as paragraph (e)(1) wages under the Unmodified Box Method described in section 5.01 of this revenue procedure shall not be treated as paragraph (e)(1) wages in any other taxable year. Also, an amount shall not be treated as paragraph (e)(1) wages by more than one taxpayer. See section 1.199-2(d) of the regulations.

.08 Trade or business requirement. Pursuant to § 1.199-8(c)(1), the term paragraph (e)(1) wages only includes those wages paid to employees of the taxpayer that are attributable to the actual conduct of a trade or business of the taxpayer. For example, remuneration paid to an employee for domestic service performed in the private home of the taxpayer is not included in paragraph (e)(1) wages of the taxpayer.

.01 Definition of paragraph (e)(1) wages. Paragraph (e)(1) wages means, with respect to any person for any taxable year of such person, the sum of the amounts described in § 6051(a)(3) and (8) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year. See § 1.199-1(e)(1) of the regulations. Thus, paragraph (e)(1) wages include: (i) the total amount of wages as defined in § 3401(a); (ii) the total amount of elective deferrals (within the meaning of § 402(g)(3)); (iii) the compensation deferred under § 457; and (iv) for tax years beginning after December 31, 2005, the amount of designated Roth contributions (as defined in § 402A).

.02 Correlation with Form W-2. Under the 2006 Forms W-2, the elective deferrals under § 402(g)(3) and the amounts deferred under § 457 directly correlate to coded items reported in Box 12 on Form W-2. Box 12, Code D is for elective deferrals to a § 401(k) cash or deferred arrangement (plan); Box 12, Code E is for elective deferrals under a § 403(b) salary reduction agreement; Box 12, Code F is for elective deferrals under a § 408(k)(6) salary reduction Simplified Employee Pension (SEP); Box 12, Code G is for elective deferrals and employer contributions (including nonelective deferrals) to any governmental or nongovernmental § 457(b) deferred compensation plan; Box 12, Code S is for employee salary reduction contributions under a § 408(p) SIMPLE (simple retirement account); Box 12, Code AA is for designated Roth contributions (as defined in section 402A) to a section 401(k) plan; and Box 12, Code BB is for designated Roth contributions (as defined in section 402A) under a section 403(b) salary reduction agreement. However, designated Roth contributions are also reported in Box 1, Wages, tips, other compensation, and Box 5, Medicare wages and tips, and are subject to income tax withholding.

For any taxable year, a taxpayer must calculate paragraph (e)(1) wages for purposes of § 199(b)(1) using one of the three methods described in section 5.01, 5.02, and 5.03 of this revenue procedure. These three methods are subject to the non-duplication rules provided in § 1.199-2(d) and in section 3.07 of this revenue procedure. For a taxpayer with a short taxable year, see Section 6 of this revenue procedure. In calculating paragraph (e)(1) wages for a taxable year under the methods below, the taxpayer includes only those Forms W-2 that are for the calendar year ending with or within the taxable year of the taxpayer and that meet the rules of application described in section 3 of this revenue procedure.

.01 Unmodified box method. Under the unmodified box method, paragraph (e)(1) wages are calculated by taking, without modification, the lesser of—

.02 Modified Box 1 method. Under the Modified Box 1 method, the taxpayer makes modifications to the total entries in Box 1 of Forms W-2 filed with respect to employees of the taxpayer. Paragraph (e)(1) wages under this method are calculated as follows—

.03 Tracking wages method. Under the tracking wages method, the taxpayer actually tracks total wages subject to Federal income tax withholding and makes appropriate modifications. Paragraph (e)(1) wages under this method are calculated as follows—

.01 Special rule for taxpayers with a short taxable year. In the case of a taxpayer with a short taxable year, subject to the rules of § 1.199-2(a), the paragraph (e)(1) wages of the taxpayer for the short taxable year shall include only those wages paid during the short taxable year to employees of the taxpayer, only those elective deferrals (within the meaning of § 402(g)(3)) made during the short taxable year by employees of the taxpayer, and only compensation actually deferred under § 457 during the short taxable year with respect to employees of the taxpayer. See § 1.199-2(b) of the regulations.

.02 Method required for a short taxable year and modifications required in application of method. The paragraph (e)(1) wages of a taxpayer with a short taxable year shall be determined under the tracking wages method described in section 5.03 of this revenue procedure. In applying the tracking wages method in the case of a short taxable year, the taxpayer must apply the method as follows—

This revenue procedure applies to taxpayers with taxable years beginning on or after October 19, 2006. A taxpayer may apply this revenue procedure to taxable years beginning after May 17, 2006, and before October 19, 2006. For taxable years beginning after May 17, 2006, a taxpayer may not apply any guidance under section 199 in a manner inconsistent with amendments made to section 199 by section 514 of TIPRA.

The principal author of this revenue procedure is Alfred G. Kelley of the Office of Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this revenue procedure, contact Mr. Kelley at (202) 622-6040 (not a toll-free call).

Internal Revenue Service (IRS), Treasury.

Correcting amendment.

This document contains a correction to final and temporary regulations (T.D. 9281, 2006-39 I.R.B. 517), that were published in the Federal Register on Thursday, August 17, 2006 (71 FR 47443). This regulation revised the Income Tax Regulations relating to the determination of the interest expense deduction of foreign corporations and applies to foreign corporations engaged in a trade or business within the United States.

This correction is effective August 17, 2006.

Gregory Spring or Paul Epstein, (202) 622-3870 (not a toll-free number).

Internal Revenue Service (IRS), Treasury.

Correcting amendment.

This document contains a correction to final regulations (T.D. 9276, 2006-37 I.R.B. 432), that were published in the Federal Register on Tuesday, July 25, 2006 (71 FR 142). These regulations apply to all employers and others making supplemental wage payments to employees.

This correction is effective January 1, 2007.

A. G. Kelley, (202) 622-6040 (not a toll-free number).