sect. 263a: allocating direct and indirect costs...

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Sect. 263A: Allocating Direct and Indirect Costs,

Mastering Evolving Regs, Guidance and Rulings

TUESDAY, NOVEMBER 15, 2016, 1:00-2:50 pm Eastern

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Nov.15, 2016

Sect. 263A

Karen Rodriguez, Tax Partner

Deloitte, Chicago

[email protected]

David Strong, CPA, Managing Director

Crowe Horwath, Grand Rapids, Mich.

[email protected]



Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

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RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Copyright © 2016 Deloitte Development LLC. All rights reserved 5

Module/Lesson

Introductions

Fundamental Sect. 263A Concepts

Relevant Sect. 263A Guidance

Ongoing Compliance Changes under Sect. 263A

Conclusion - Questions

Course Length

Agenda

Introductions

Fundamental Sect. 471 and 263A Concepts


• Before the enactment of section 263A, costs capitalized to inventory

under section 471 depended in part on the financial statement treatment

of those costs

• Taxpayers in certain industries would capitalize certain costs while

taxpayers in other industries would currently deduct such costs

• Even within the same industry, different companies might capitalize

different costs

• Congress and Treasury designed the UNICAP rules to provide

consistent treatment among taxpayers

• Section 263A also achieves consistent treatment for items that are

produced and items that are purchased

UNICAP – Section 263A


• Inventories

– Valuation under LCM if replacement or reproduction cost is used as “market”

– Valuation of weighted average cost

• Self-Constructed Assets

• Manufacturing

• Retailing

• Wholesaling

• Construction of property for sale

• Farming

UNICAP Applies Uniformly To:


• Long-term contracts

• Section 174 expenditures

• De minimis property provided incident to services (cost of property is not

more than 5% of sales price and property is not inventory)

• Capitalizable indirect costs incurred during the year are less than $200K

under the simplified production method

• Specialized industries

Key Exceptions for Producers


• Small resellers exception ($10M gross receipts test)

• Gross receipts test, Treas. Reg. § 1.263A-3(b)

– Based upon average annual gross receipts for the taxpayer and any

predecessor for the preceding three tax years

– All persons treated as a single employer are treated as one person for

purposes of the gross receipts test (aggregation rule)

– Taxpayers not in existence for three tax years apply the test based upon the

period in existence

Key Exceptions for Resellers


• The uniform capitalization rules require the capitalization of all direct

and indirect costs allocable to:

– Real or tangible personal property produced by the taxpayer; and

– Property (either real or personal property) acquired by the taxpayer for resale

• Directs costs = direct materials and direct labor

• Indirect costs = costs that directly benefit or are incurred by reason of

production or resale activities

• Amounts capitalized to inventory under section 263A are deducted as

part of cost of goods sold as the inventory is subsequently sold to

customers

Property Subject to UNICAP


• § 471 Costs = Costs capitalized to inventory by the taxpayer prior to the

effective date of § 263A

• Additional § 263A Costs = Costs not capitalized by the taxpayer prior to

effective date of § 263A, but which are required to be capitalized under

the UNICAP rules

• § 263A Costs = § 471 Costs + Additional § 263A Costs

Section 263A – Definitions


• Wholesalers, Retailers, and Other Non-manufacturers

– Costs incurred in acquiring possession of the goods, e.g., invoice price less

discounts (section 471 costs)

– Indirect costs, e.g., purchasing, handling, and storage (warehousing), etc.

(additional section 263A costs)

• Manufacturers

– Direct material costs, including the cost of materials and supplies entering

into, or consumed in connection with the manufacture of, the product (section

471 costs);

– Direct labor costs (section 471 costs); and

– Indirect production costs and overhead (section 471 and additional section

263A costs)

Specific Application


• Cash Discount

– Reduction in invoice price due to

early or prompt payment

– Two options to account for cash

discount

• Net invoice method

– Reduction in purchase price

• Gross invoice price method

– Include in gross income

Discounts

• Trade Discount

– Not related to timeliness of

payment.

– Frequently available in connection

with purchases of a specified

quantity or an incentive program

offered by the seller

– Only one option to account for

trade discount

• Net invoice method


Overall Flow of Costs

Service Costs Production

Costs

Costs by Cost Centers

Deductible Mixed Capitalizable Indirect

Costs

Direct

Materials

Direct

Labor

Expense

Ending Inventory Simplified

Service or other

allocation

method

Simplified

Production or

other allocation

method

COGS


• Indirect labor

• Employee benefits

• Handling

• Depletion

• Insurance

• Engineering & Design

• Quality control

• Non-income taxes

• Officers' compensation

• Indirect materials

• Storage

• Successful bidding

• Rent

Costs Generally Subject to UNICAP

• Utilities

• Spoilage, including rework

• Occupancy costs for "pick, pack,

and ship" activities

• Pension, etc.

• Purchasing

• Cost recovery

• Interest

• Repairs and maintenance

• Tools and equipment

• Licensing & franchise fees

• Capitalizable service costs


• Purchasing costs include:

– Selecting merchandise

– Maintaining inventory stock assortment and volume

– Placing purchase orders

– Establishing & maintaining vendor contracts

– Comparing & testing merchandise or materials

• Purchasing costs under § 263A are often found outside the typical

Purchasing department (such as Inventory Control, Legal, etc.)

Purchasing Costs


• May be elected by a taxpayer for allocating labor costs of persons

performing both purchasing and non-purchasing activities

– If < 1/3 of a person’s activities are related to purchasing, none of that person’s

labor costs are allocated to purchasing

– If > 2/3 of a person’s activities are related to purchasing, all of that person’s

labor costs are allocated to purchasing

– All other purchasing personnel must be reasonably allocated to both

purchasing and non-purchasing activities

1/3 – 2/3 Rule for Purchasing Labor


• Handling costs include:

– Processing costs to make minor alterations to property purchased for resale

(ex: monogramming)

– Assembly costs necessary to ready inventory for resale

– Repackaging costs

– Transportation costs

• From a vendor to the taxpayer

• From one taxpayer facility to another (from one warehouse to another, from

warehouse to retail sales facility, etc.)

• Handling costs do not include:

– Distribution costs to outside customers

– Delivery of custom-ordered items to retail sales locations

– Picking & packing items for shipment to a customer

• Does not include occupancy & maintenance costs of the storage facility

Handling Costs


• Includes costs attributable to inventory storage and warehousing

facilities, except those physically connected to a retail sales facility

– Retail sales facility is defined as a location where goods are sold exclusively

to retail customers (final purchase) via on-site sales

• Consider picking and packing exception

• Consider allocation of warehousing costs to non-capitalizable activities

incurred in warehouse

– Use of burden rates including time-weighted allocations

Storage Costs


• Marketing, selling, advertising, and distribution costs

• Labor and equipment cost for "pick, pack, and ship" activities

• Bidding expenses on contracts not awarded

• Research and experimental expenditures under § 174

• Losses under § 165

• Depreciation on idle equipment and facilities

• Income taxes

• Warranty and product liability costs

• Costs attributable to strikes

• Deductible service costs

Costs Not Subject to UNICAP


• Many additional section 263A costs are service costs

• Service costs = Indirect costs that can be identified with a service

department or function

• Service department = departments that provide administrative, service,

and support functions, such as personnel, accounting, data processing,

security, legal, and other similar general or administrative departments

Service Costs


• Capitalizable service costs

– Directly benefit or incurred by reason of production or resale activities

• Deductible service costs

– Do not directly benefit or are not incurred by reason of production or resale

activities

• Mixed service costs

– Partially capitalizable and partially deductible

– Indirect production costs that are less than 100% capitalizable may not

necessarily be considered a mixed service cost

• Human resource time spent on manufacturing personnel

• Information Technology time spent on accounting department

Types of Service Costs


• Administration and coordination of production or resale activities

• Personnel operations, including recruiting, hiring, maintaining records,

etc.

• Materials handling, warehousing & storage

• Cost accounting, A/P, and payroll accounting

• Data processing services

• Security services

• Legal services

Capitalizable Service Costs


• Overall management & policy

setting

• Strategic business planning

• General financial accounting,

planning (budgeting), and

management (treasury and cash

management)

• Personnel policy setting,

developing training programs

unrelated to production or resale,

negotiating with unions and

retiree relations

• Quality control policy

• Safety & engineering policy

Deductible Service Costs

• Insurance or risk management

policy

• Environmental management

policy (except for specific costs

for procedures benefiting

production – such as remediation

costs)

• General economic analysis and

forecasting

• Internal audit

• Shareholder, public, and industrial

relations

• Tax services

• Marketing, selling, and

advertising


• Mixed service costs are service costs that are partially allocable to

production / resale activities (capitalizable service costs) and are

partially allocable to non-production / non-resale activities (deductible

service costs)

• The methods that may be used to determine the capitalizable portion of

the mixed service costs are:

– The direct reallocation method

– The step-allocation method

– Other reasonable method

– The simplified service cost method

Mixed Service Costs


Assume that a company has the following departments:

Receiving Personnel

Assembly Data Processing

Finishing Accounting

Shipping Legal

Sales

CEO

Classify the departments and allocate the costs of the mixed service

departments.

Service Cost Example


Personnel

Data

Processing Accounting Legal

Receiving 10% 20% 5% 0%

Assembly 30% 10% 10% 5%

Finishing 10% 10% 5% 5%

Shipping 20% 10% 10% 0%

Sales 25% 40% 10% 10%

CEO 5% 10% 60% 80%

Other Reasonable Method Based on Facts and Circumstances


• Costs of mixed service departments are allocated to departments or

activities other than mixed service departments

• The “capitalizable percentage” is the percentage of the mixed service

department costs allocated to capitalizable departments or activities

Other Reasonable Method Based on Facts and Circumstances

Mixed Service Departments Total Costs Capitalizable

Percentage

Allocated

Costs

Personnel $ 10,000 50% $ 5,000

Data Processing 5,000 40% 2,000

Accounting 7,500 20% 1,500

Legal 5,000 10% 500

27,500

Total Allocated Mixed Service Costs $ 9,000


• Costs of mixed service departments are allocated to other mixed service

departments as well as to production and non-production departments

• Costs are allocated first from the service departments benefiting the

greatest number of departments

Step-Allocation Method



Personnel Data


Receiving

Assembly

Finishing

Shipping

Sales

CEO



Personnel Data


Receiving

Assembly

Finishing

Shipping

Sales

CEO

Personnel Data


Assembly

Finishing

Shipping

Sales

CEO


• Costs allocated under the step-allocation methods or other reasonable

methods must be allocated using reasonable factors and relationships

• Different reasonable factors and relationships may need to be used for

different departments

• Costs are allocated only to the departments benefited, and not to all

departments

• Examples

– Square footage for facilities costs

– Headcount for human resources

– Wages for accounting

Reasonable Factors and Relationships


• A simplified method that is used to burden all labor dollars (or costs

incurred) with a percentage of mixed service costs

• May be used for:

(a) inventory

(b) non-inventory property held for sale

(c) self-constructed assets substantially identical to (a) or (b)

(d) self-constructed assets produced on a routine or repetitive basis, but only if:

• Mass-produced (numerous substantially identical assets manufactured in

same year using standardized designs and assembly line techniques) AND

• Applicable recovery period under section 168(c) is not longer than 3 years

OR assets are materials or supply that will be consumed within 3 years of

being produced

Simplified Service Cost Method


• Assume the company incurs the following costs:

– $100 mixed service costs

– $600 section 263A labor (which includes 471 labor)

– $100 management labor

– $300 sales labor

SSCM Labor Based Ratio Example


SSCM Labor Based Ratio Example

263A Labor X Mixed = Capitalizable

Total Labor Service Cost Mixed Service Costs

600 X 100 = 60 Capitalizable

600 + 100 + 300 Mixed Service Costs

• In effect:

– $600 of 263A labor attracts $60 MSC which are included in additional 263A costs

– $100 of mgmt labor attracts $10 MSC which are currently deducted

– $300 of sales labor attracts $30 MSC which are currently deducted



– $100 mixed service costs

– $1,000 263A costs (which includes 471 production costs)

– $200 management costs

– $400 sales costs

SSCM Production Cost Ratio Example


• In effect:

– $1,000 of 263A production costs attracts $62.50 MSC which are included in

additional 263A costs

– $200 of mgmt costs attracts $12.50 MSC which are currently deducted

– $400 of sales costs attracts $25 MSC which are currently deducted

SSCM Production Cost Ratio Example

263A Costs X Mixed = Capitalizable

Total Costs Service Costs Mixed Service Costs

1,000 X 100 = 62.50 Capitalizable

1,000 + 200 + 400 Mixed Service Costs


• If 90% or more of a mixed service department’s costs are deductible

service costs, taxpayer may elect to exclude 100% of that department’s

costs from additional 263A costs

– Conversely, if 90% or more of mixed service department’s costs are

capitalizable service costs, taxpayer must include 100% of that department’s

costs in additional 263A costs

• This is a method of accounting which, if elected, applies to all mixed

service departments

“90-10” De Minimis Rule


• Burden Rate Method

• Standard Cost Method

• Any other Reasonable Method

• Simplified Methods of allocating additional section 263A costs between

ending inventory and COGS

– Simplified Production (Treas. Reg. § 1.263A-2)

– Simplified Resale (Treas. Reg. § 1.263A-3)

– Historical Absorption Ratio (simplified production or resale methods only)

Allocation to Ending Inventory and Other Activities including Self-Constructed Assets


The simplified production method is available to producers and can be

used for the following:

a) Inventory

b) non-inventory property held for sale

c) self-constructed assets substantially identical to (a) or (b)

d) self-constructed assets produced on a routine or repetitive basis, but only if:

• Mass-produced (numerous substantially identical assets manufactured in

same year using standardized designs and assembly line techniques) AND

• Applicable recovery period under section 168(c) is not longer than 3 years

OR assets are materials or supply that will be consumed within 3 years of

being produced

Simplified Production Method


Absorption ratio:

Additional Sec. 263A costs incurred during the year

Section 471 costs incurred during the year

Allocation formula:

Absorption rate x Section 471 costs remaining

on hand at year end

• The end result is added to the section 471 costs on hand at year end to

determine the total costs capitalized under UNICAP (i.e. tax inventory

basis)

Simplified Production Method



– $2,000 section 471 costs incurred during the year

– $100 additional 263A costs (before adding in MSC)

– $60 of capitalizable MSC

• From SSCM Labor Based Ratio Example

– $200 section 471 costs remaining on hand at year end

Simplified Production Method Example


Simplified Production Method Example

Add’l 263A (incl. MSC) = SPM Absorption Ratio

471 Costs Incurred

100 + 60 = 8.0%

2,000

Absorption Ratio x Section 471 Costs on Hand = Add’l 263A Costs

Capitalized to Inventory

8.0% x 200 = 16

471 Costs on Hand + Add’l 263A Costs on Hand = Tax Ending Inventory

200 + 16 = 216


Allocation formula:

Combined absorption ratio x Section 471 costs remaining

on hand at year-end

Combined absorption ratio:

The purchasing costs ratio:

CY purchasing costs (incl. allocable MSCs)

CY purchases

PLUS

The storage and handling costs ratio:

CY storage & handling costs (incl. allocable MSCs)

Beginning inventory plus CY purchases

Simplified Resale Method



– $2,000 current year purchases

– $25 purchasing costs (before adding in MSC)

– $75 storage & handling costs (before adding in MSC)

– $60 of capitalizable MSC

• From SSCM Labor Based Ratio Example

• $15 allocable to purchasing activities

• $45 allocable to storage & handling activities

– $200 section 471 costs remaining on hand at year end

– $180 section 471 on hand at beginning of the year

Simplified Resale Method Example



Purchasing Costs Ratio:

CY Purchasing Costs (incl. MSC) = Purchasing Ratio

CY Purchases

25 + 15 = 2.0%

2,000

Storage & Handling Costs Ratio:

CY Storage & Handling Costs (incl. MSC) = Storage & Handling Ratio

Beginning Inventory + CY Purchases

75 + 45 = 5.5%

180 + 2,000



Purchasing % + Storage & Handling % = SRM Combined Ratio

2.0 % + 5.5 % = 7.5 %

Absorption Ratio x Section 471 Costs on Hand = Add’l 263A Costs

Capitalized to Inventory

7.5 % x 200 = 15

471 Costs on Hand + Add’l 263A Costs on Hand = Tax Ending Inventory

200 + 15 = 215


• Election may be made if taxpayer has used simplified production method

or simplified resale method for 3 years

• An average absorption ratio is computed based on the prior 3 years:

– Additional Sec. 263A costs incurred during three-year test period

Section 471 costs incurred during the three-year test period

• This absorption ratio is used for 5 years

• Caution: carefully consider the timing of changes to sub-methods

Historic Absorption Ratio Method (“HAR”)


• Client has used the simplified production method in 2008, 2009, and

2010. You are preparing the 2011 return

• The client may elect HAR on its 2011 return by attaching a statement to

the return

• The HAR is based upon the 2008-2010 information

• The HAR must be used for 2011-2015

• The client must “retest” in 2016

HAR Example


• Treas. Reg. § 1.263A-1(f)(4) permits the use of any other reasonable

method

• A method is considered reasonable when costs capitalized do not differ

significantly from aggregate costs that would have been capitalized

using another permissible method in Treas. Reg. § 1.263A-1, -2, or -3

Any Other Reasonable Method


• Appropriate consideration must be given to the following:

– Volume and value of the taxpayer's production or resale activities

– Availability of costing information

– Time and cost of using various allocation methods

– Accuracy of the allocation method chosen

• The method must be applied consistently

• The method must not circumvent the simplified allocation methods or the

principles of Sec. 263A

Any Other Reasonable Method


• Look out for variations of the simplified methods

• Examples:

– Exclusion of raw materials from section 471 costs

– One ratio for raw materials or in-transit inventory and another for finished

goods or stored inventory.

• IRS is focusing on this issue

• Taxpayers should be advised to change to a permissible method

Impermissible Variations


• Allocations based on:

– Labor dollars or hours

– Machine dollars or hours

– Space utilization in warehouse

– Sales-based for royalties

• Implementation best practice

– Check burden rates used for book costs

– May help with “reasonableness” argument

– SAP systems often have hundreds of different burden rates

Common Burden Rates

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©2016 Crowe Horwath LLP 61 61

Sec. 263A – Relevant Guidance

• Sales Based Royalties

• Sales Based Vendor Chargebacks

• Modified Simplified Production Method - Proposed Regulations

• Chief Council Advice – Restaurants


Sales-Based Royalties

• On January 13, 2014, the IRS issued final regulations for sales-based royalties for products

manufactured or purchased for resale inventory

• Sales-based royalties

• Royalties related to intellectual property used by a taxpayer in a manufactured product which are not

payable until the sale of the product (for example, taxpayer uses a third party’s brand name on a knife it

manufactures)

• The regulations allow taxpayers the option to allocate sales-based royalties entirely to cost of goods sold

or between cost of goods sold and ending inventory

• Rev Proc 2016-29 provides procedures to make accounting method changes for the final

regulations

• Automatic Method Change

• No filing fee

• Filed with the federal tax return by the due date (including extension)


Sales-Based Vendor Chargebacks

• On January 13, 2014, the IRS issued final regulations for sales-based vendor chargebacks

for products manufactured or purchased for resale inventory

•Sales-based vendor chargebacks • Discounts or rebates to which a taxpayer is unconditionally entitled as a result of selling a vendor’s

merchandise to a specific customer at a vendor-set price

• The regulations require sales-based vendor chargebacks to be treated as a reduction to cost of goods

sold in the year they are earned

•Rev. Proc. 2016-29 provides procedures to make accounting method changes for

the final regulations • Automatic Method Change

• No filing fee

• Filed with the federal tax return by the due date (including extension)


Application of Sec. 263A to Restaurants

• Whether an activity is production under § 263A(g)(1) and § 1.263A-2(a)(1) depends on all

the facts and circumstances.

• Restaurants generally purchase, process, and combine ingredients to produce food for sale

to customers.

• Restaurants have on hand at the end of the taxable year ending inventories consisting

entirely, or almost entirely, of ingredients that have not yet entered the restaurant's

production process. Accordingly, if kitchen labor were treated as additional § 263A costs

under the simplified production method, a significant amount of kitchen labor would be

capitalized to the raw materials in ending inventory, even though kitchen labor costs typically

relate almost entirely to the production of food that is no longer on hand.

• CCA 201439001 – IRS supports use of the simplified production method which treats all

direct production costs (including “kitchen labor”) as §471 costs rather than as additional

§263A costs.


Proposed Regulations

• Background

• When the UNICAP regulations were first issued, they provided manufacturers with the option

of using a simplified production method (“SPM”).

• While the method is considerably simpler than a facts and circumstances allocation method,

the SPM contained a bias towards overcapitalization.

• Overcapitalization resulted from the fact that additional section 263A costs tended to be

those costs incurred towards the end, or after the end, of the production cycle. However,

total inventory turnover was the ratio employed to determine the fraction of the annual

amount of additional section 263A costs that was required to be capitalized.

• The IRS attitude towards this overcapitalization is that this is the “price” that manufacturers

must pay if they want a simplified allocation method.



• Background continued

• However, in more recent years, the IRS became concerned that when taxpayers used SPM

in years when they had negative additional section 263A costs, the bias toward

overcapitalization resulted in undercapitalization of costs when a taxpayer had negative

additional section 263A costs. Notice 2007-29, 2007-1 C.B. 881.

• Negative additional section 263A costs tend to result from negative Schedule M adjustments

for depreciation (i.e., book depreciation exceeds tax depreciation), employee benefits (i.e.,

book pension accrual exceeds tax contribution to pension plan), and negative production

cost variances.

• To resolve this issue, in 2012, the IRS issued proposed regulations which contained a new

formula for computing the burden ration under the SPM that reduced the bias toward

overcapitalization in the existing regulations and required that taxpayers use that method if

they had negative additional section 263A costs.



• Proposed regulations were issued in 2012 to address the issues that resulted from

“negative” Sec. 263A costs as outline in Notice 2007-29. Pursuant to the proposed

regulations, taxpayers that do not change their UNICAP method to adopt the regulations will

not be able to include negative amounts in their UNICAP calculations. The IRS will not

pursue an adjustment related to the treatment of negative amounts in the UNICAP until the

regulations are finalized.

• Modified Simplified Production Method

• Changes the definition of Sec. 471 costs

• Computes a dual absorption ratio

• Preproduction ratio

• Production ratio

• Exception for small producers

• The proposed regulations are anticipated to be finalized early 2017 but it is uncertain what the effective

date of the regulations will be.



• Issues posed in proposed regulations

• Will the final regulations employ a more user-friendly formula for computing the burden ratio under the

modified SPM?

• How will the taxpayer deal with the issue of negative additional section 263A costs? Will such taxpayers

be required to use the modified SPM?

• Numerous comments were provided on the issue of how to allocate mixed service costs among the

separate ratios under the modified SPM. Will this subject be addressed in the forthcoming regulations?

• The proposed regulations added a new definition of section 471 costs, i.e., costs treated as inventoriable

for financial reporting purposes. The question is posed whether that new definition applies only to the type

of cost incurred, or is intended to also apply to the actual amount of costs treated as inventoriable for

financial reporting purposes.

• How will the IRS deal with the treatment of section 263A adjustments to the cost of raw materials and

direct labor? For example, under some variations of SAP, freight-in is not tracked to the specific purchase

of materials to which the freight relates?



• Issues posed in proposed regulations continued

• In the same vein, how will standard costs variances for raw materials and direct labor be treated? Must

they be treated as an adjustment to section 471 costs, or may they be treated as additional section 263A

costs?

• What treatment is contemplated for cash discounts?

• What treatment is contemplated for trade discounts? For both cash and trade discounts, will overall

averaging methods be allowed or will discounts be required to be tracked to the precise purchased goods

to which the discounts relate?

• Many of the foregoing issues also affect taxpayers using a facts and circumstances allocation method.

Will the IRS be addressing those issues outside the context of the SPM?

• What is the impact of these new regulations on taxpayers using HAR?



• Effective Date and Implementation

• Regulations will be effective when published as temporary or final in the federal register

• Regulations may be issued as final, temporary or proposed

• It has been speculated that the regulations will be finalized early to mid 2017

• It is anticipated that when finalized, a taxpayer will be able to adopt the new regulation by

filing an automatic accounting method change


Reseller Issues

• Property Produced Under a Contract

• Property produced under a contract with another party is treated as produced by the

taxpayer, to the extent the taxpayer makes payments or otherwise incurs cost with respect to

the property Treasury Regulation Sec. 1.263A-2(a)(1)(ii)(B)(1)

• Producer v. Reseller

• Private label goods or specialty products

• De minimis production activites

• Implications of being treated as a producer rather than a reseller

• Unable to use simplified resale method

• Unable to use $10 million small reseller exception

• Use of simplified production method may result in the capitalization of more costs

• Interplay with Sec. 199

• Producer under Sec 263A may qualify for the deduction

• Benefits and burdens of ownership


Interest Capitalization

• Interest is required to be capitalized in situations where the production period of the tangible

personal property is longer term, the production costs are significant or relates to a real

property item.

• Required to be capitalized when

• Relates to real property or

• Relates to tangible personal property with:

• Production period is greater than 2 year

• Cost is greater than $1 million and production period is greater than a year

• The regulations outline the method to identify production costs and the calculations of interest required to

be capitalized during the production period

• Rev Proc 2016-29 provides procedures to make accounting method changes for the final

regulations


Method Change Implications

• Method change implications

• Limitation for qualifying for an automatic method change

• Method changes outlined in Rev. Proc. 2016-29 (depreciation, bonus accrual, self-insured medical benefits, etc.)

• Makes compliance with Sec. 263A a requirement to filing under the automatic method change rules

• Ability to make a concurrent Sec. 263A method change

• Automatic Sec 263A Method Changes

• Burden rate method

• Standard cost method

• Simplified production method

• Simplified resale method


LIFO Taxpayers

• Application of Sec 263A to LIFO inventory

• Additional cost added to overall inventory value

• Absorption ratio applied to LIFO layer

• Method change implications

• 3 year averaging

• Historic absorption ratio

sect. 263a: allocating direct and indirect costs...

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