The IRS and Treasury recently published final regulations on the treatment of ‘negative additional Section 263A’ costs that arise when a taxpayer uses a simplified method to allocate costs to ending inventory. Under Section 263A, also known as uniform capitalization (UNICAP), taxpayers required to maintain inventories must capitalize (i.e., treat as inventory costs) all direct costs and certain indirect costs allocable to production or resale activities.
The final regulations generally apply for tax years beginning on or after November 20, 2018. Thus, calendar-year taxpayers must comply with the regulations beginning in 2019. For tax years that both begin before and end after November 20, 2018 (for example, calendar year 2018), the preamble states that the IRS will not challenge tax positions consistent with the final regulations. The final regulations can be accessed here.
The IRS also released Rev. Proc. 2018-56, which provides automatic consent and procedures for taxpayers to change their methods of accounting consistent with the final regulations for the first, second, or third tax year ending on or after November 20, 2018. The revenue procedure can be accessed here.
This Insight discusses in detail the rules in the final regulations addressing the definition of Section 471 costs, and making negative adjustments to additional Section 263A costs, for purposes of Section 263A. A later Insight will discuss the simplified methods, including the new modified simplified production method (MSPM), and method changes under Rev. Proc. 2018-56. PwC professionals also will discuss the regulations in a webcast on December 18, 2018. Registration for the webcast and can be accessed here.
The extensive rules defining Section 471 costs and additional Section 263A costs in the final regulations result in more complexity in determining whether taxpayers must treat certain costs, whether positive or negative, as Section 471 costs or as additional Section 263A costs, and when taxpayers may include negative amounts in additional Section 263A costs. Notably, eligible taxpayers that use the AFS method (for book-tax differences) and taxpayers that qualify for the de minimis and safe harbor rules (for direct costs) generally may continue to treat their Section 471 costs as equal to their book costs. However, taxpayers that are not eligible to use the AFS method or that do not qualify for the de minimis and safe harbor rules and/or taxpayers that have capitalized non-deductible costs in their book costs and must adjust their Section 471 costs using detailed and complicated methods, likely will have difficulty applying the final regulations. Taxpayers should analyze these definitions to determine whether they are treating costs properly under the final regulations.