What is Section 263A?
Section 263A, often referred to as the Uniform Capitalization rules or UNICAP, requires taxpayers to capitalize direct and indirect costs properly allocable to real or tangible personal property produced or acquired for resale by the taxpayer. For example, manufacturers, resellers and distributors of inventory generally must undertake an analysis every tax year to determine which costs must be capitalized, rather than currently expensed, under Section 263A. The costs that must be capitalized for tax purposes typically exceed the amounts capitalized for financial accounting purposes. Accordingly, many taxpayers must capitalize “additional Section 263A” costs to property acquired or produced as an unfavorable temporary book/tax adjustment (i.e., an addback to taxable income).
What do the final Section 263A regulations address?
Taxpayers can use a
variety of methods to identify and allocate additional Section 263A costs, including
certain simplified methods for producers and resellers of inventory. Issued in
November 2018, the final Section 263A regulations contain significant
changes for taxpayers who are currently using the simplified methods by
providing definitional guidance for Section 471 costs and adding a new method
for certain taxpayers with average annual gross receipts exceeding $50 million.
The regulations also address the treatment of so-called “negative Section 263A
costs,” which arise when a particular expense is capitalized for book purposes
but is not required to be capitalized for tax purposes (e.g., R&D
costs or freight-out costs).
Who do the regulations impact?
Large producers of
inventory (including taxpayers that utilize contract manufacturers) that are
presently using the simplified production method will have to change their
method if their average annual gross receipts exceed $50 million on an
aggregated basis. If a large producer wishes to use a simplified method going
forward, it must change to the new modified simplified production method.
Otherwise, taxpayers also have the option to change to a facts and
circumstances method, which is generally more time-consuming to implement and
maintain.
Smaller producers with gross receipts under $50 million and resellers of any
size may have to change their existing simplified method as well to adopt the
new definitional guidance for Section 471 costs provided in the final
regulations. Further, the regulations offer several simplifying de minimis
tests that producers/resellers of inventory of all sizes should consider.
What should companies do?
Taxpayers subject to
UNICAP should evaluate their existing methodologies and determine what changes
are necessary in order to comply with the final regulations for tax years
beginning after November 20, 2018. In general, implementing an accounting
method change requires the preparation and filing of Form 3115, Application
for Change in Accounting Method, and the computation of a Section 481(a)
“catch-up” adjustment. As the preparation of the Form 3115 and the related
Section 481(a) adjustment can require extensive analysis, taxpayers should take
immediate action to begin assessing the impact of the new rules. To ensure
adequate time to properly reflect the adjustment for both tax return and
financial accounting purposes (if applicable), these conversations should
begin, at the very latest, during the first few months of the 2019 taxable
year.
How can we help?
We can review existing Section 263A calculations to identify what changes must be made to comply with the regulations. In many instances, we may be able to identify additional opportunities or address exposures associated with historical calculations. We can also assist with the preparation, review and filing of the Form 3115 to ensure that all procedural considerations are appropriately addressed.