The IRS has proposed regulations on uniform capitalization
(UNICAP) rules under Section 263A to address the use of negative
amounts in computing additional Section 263A costs for purposes of
the simplified production and simplified resale methods. The
proposed regulations address distortion concerns of both taxpayers
and the IRS relating to the simplified production method.
Under the proposed regulations, taxpayers are given the option
to use either the simplified production method (as exists in the
current regulations) or a modified simplified production method.
The modified simplified production method will provide a more
favorable outcome to many taxpayers because it will reduce the
amount of Section 263A costs that are capitalized to ending
inventory. Under the current simplified production method, costs
are capitalized to raw materials at the same rate that they are
capitalized to work in process and finished goods, which
overcapitalizes to raw materials because little if any of the costs
actually relate to raw materials. The new modified simplified
production method allows producers to use two different absorption
ratios, one for costs that relate to raw materials and one for
costs that relate to work in process and finished goods.
The proposed regulations also address the use of negative
additional Section 263A costs in the simplified production or
simplified resale method. In a technical advice memorandum released
in 2006 (TAM 2006-07-021), the IRS expressed concern regarding
situations in which a taxpayer was including negative costs in the
numerator of the simplified production method as a way to remove
costs not required to be capitalized under Section 263A, even
though they were being capitalized for purposes of their financial
statements and Section 471. This meant that a taxpayer's method
of removing the costs in the aggregate could result in the removal
of an amount different from the amount that would be removed if the
taxpayer readjusted its standard costs to stop including such costs
in Section 471 costs. Typically, the use of negative additional
costs would mean that the decrease in ending inventory would exceed
the amount of correlating costs that were originally capitalized
and included in ending inventory.
In 2007, the IRS provided interim guidance (Notice 2007-29) on
the use of negative additional Section 263A costs. The notice
provided a moratorium on the use of negative additional Section
263A costs until further guidance was issued. The IRS said it would
not challenge the use of negative additional Section 263A costs or
deny consent for changes in method of accounting solely on the
basis that the proposed method involved including negative amounts
in computing additional costs.
In the newly proposed regulations, the IRS has prohibited the
use of negative additional costs for taxpayers that use the
simplified production method (as it exists in the current
regulations), but will allow the use of negative additional costs
under the modified simplified production method. Taxpayers who do
not want to change or cannot change to the modified simplified
production method must remove costs that are not required to be
capitalized for purposes of Section 263A (such as book-over-tax
depreciation or book-over-tax compensation deductions) using a
reasonable method that approximates the manner in which the
taxpayer originally capitalized the costs to its inventory in its
financial statements. This will require a separate more complex
computation, so taxpayers will likely wish to change to the
modified simplified production method if at all possible.
The fact that the modified simplified production method will
capitalize less costs to ending inventory combined with the fact
that taxpayers using this method will be able to use negative
additional costs (rather than a more burdensome formula) should
motivate producers to change to this more favorable simplified
method, even if it requires a bit more work than the existing
simplified production method.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Program Content: Continued efforts to reform state and local tax (SALT) regimes by state legislatures, courts, tax authorities and the Multistate Tax Commission are transforming the way businesses are reporting their income tax obligations to the states. Evidence of those changes includes the shift to market-based sourcing, mandatory unitary combined reporting and other provisions. Businesses are also trying to come up with approaches to handle indirect tax complexity in light of legislation and litigation challenging the Quill physical presence rule. In addition, the recent federal and state elections’ effect on the SALT landscape will come into focus.
On October 5th, 2016, the Internal Revenue Service and Treasury Department published final, temporary and reproposed regulations1 under Sections 707 and 752 of the Internal Revenue Code of 1986, as amended.
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