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account under the AFS inclusion rule cost-offset method must use it con-
by a cost-of-goods-in-progress offset sistently for all relevant items of gross The regulations
(offset). The regulations require taxpay- income in a trade or business and also
ers to calculate the offset separately for must use the advance payment cost- require taxpayers to
each item of inventory. offset method under the Sec. 451(c) calculate the offset
A taxpayer calculates the offset for final regulations to account for advance
each item of inventory as (1) the cost of payment of inventory, which operates separately for each
goods incurred through the last day of substantially similarly to the cost-offset item of inventory.
the tax year, (2) reduced by the cumula- rules described above (see Regs. Secs.
tive “cost of goods in progress offset 1.451-3(l)(1) and 1.451-8(e)(1)).
amounts” attributable to the items of Observation: The cost-offset
inventory that were taken into account method applicable to Sec. 451(b) under a contract or to use the cost-
in earlier tax years. The costs taken accelerated revenue may be especially offset method generally may be made
into account under the offset rule must helpful when goods are accounted for under the automatic procedures with
have been incurred under Sec. 461 and under a percentage-of-completion audit protection.
included in inventory costs at the end of method for book purposes but not Rev. Proc. 2021-34 modified Rev.
the tax year. for tax purposes (which may result Proc. 2015-13 to require that a taxpayer
Under the regulations, costs are de- in a significant mismatch between make a change to its cost-offset method
termined by applying a taxpayer’s inven- revenue and costs under Sec. 451 for to conform to a permissible inventory
tory accounting methods and must be tax purposes) or when book recognizes method and a cost-offset–related inven-
properly capitalized to inventory under revenue and cost of goods sold in tory method change concurrently. A
those methods. A taxpayer using a sim- advance of transfer of ownership of cost-offset–related inventory method
plified method under Sec. 263A must the inventory. Similarly, the advance change is a change in accounting
determine the portion of additional payment cost-offset method applicable method for inventory or a liability
Sec. 263A costs allocable to an item of to Sec. 451(c) accelerated revenue may that could affect a taxpayer’s cost-of-
inventory in computing the offset by be beneficial to taxpayers required to goods-in-progress offset under the cost-
multiplying total additional Sec. 263A recognize advance payments under offset method.
costs by a ratio based on the tax basis of either the deferral method or full-
the item. inclusion method. However, while these Takeaway
In the tax year of sale, a taxpayer cost-offset methods may be favorable Taxpayers should consider using the
generally includes in gross income the options, they may be difficult to apply enforceable-right provision and optional
income reduced as a result of the offset. in practice, given that the regulations cost-offset method to reduce their
The taxpayer is not permitted a cost require taxpayers to identify and track revenue accelerated under Sec. 451(b)
offset for an item in the year of sale and costs incurred related to specific items or Sec. 451(c), but they also should take
instead recovers costs capitalized to the of inventory. into account the complexities regard-
item as cost of goods sold. ing implementation from a practi-
A taxpayer must include in gross Procedural considerations cal standpoint.
income all payments received for an In August 2021, the IRS released Rev. From Jasmine Hernandez, CPA,
item of inventory that the taxpayer did Proc. 2021-34, providing procedures Washington, D.C. ■
not previously include in gross income for taxpayers to change their methods
under the cost-offset rules if, in a tax of accounting to comply with the Sec.
year before the tax year of sale, either 451 amendments and the final regula-
(1) the taxpayer dies or ceases to exist tions. Rev. Proc. 2021-34 amended
in a transaction other than a Sec. 381(a) Rev. Proc. 2019-43, the description of
transaction or (2) the taxpayer’s obliga- automatic method changes and their Editor
tion to the customer regarding the terms and conditions (later superseded
item of inventory ends other than in a by Rev. Proc. 2022-14), and Rev. Proc. Christine M. Turgeon, CPA, is a partner
Sec. 381(a) transaction or certain Sec. 2015-13, the general method change with PricewaterhouseCoopers LLP,
351(a) transactions. procedures. A change to a method of Washington National Tax Services,
The cost-offset method is a method accounting to defer income for which in New York City.
of accounting. A taxpayer that uses the there is no enforceable right to payment

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