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IRS releases final regulations on allocation of inventory costs

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Manager In WarehouseThe IRS has released final regulations (TD 9843) under the uniform capitalization rules in Section 263A that broadly impact basic definitions relied on by all taxpayers with inventory and modify certain simplified methods. The regulations finalize proposed regulations commonly referred to as the “negative additional Section 263A regulations.” The final regulations are effective for taxable years beginning on or after Nov. 20, 2018, but may be applied to the taxpayer’s first taxable year ending on or after Nov. 20, 2018. The IRS concurrently issued Rev. Proc. 2018-56, which provides automatic consent to change certain methods of accounting to comply with the new regulations.

Background Under Section 263A, taxpayers other than certain small businesses must capitalize the direct and indirect costs that are properly allocable to inventory (whether produced or held for resale) and self-constructed property. Generally, taxpayers must capitalize most costs that are capitalized for book purposes plus certain additional costs like purchasing, storage and handling, mixed service costs and book-tax differences. To allocate capitalizable Section 263A costs, the regulations allow taxpayers to use a specific identification method, burden rate method, standard cost method, or another reasonable allocation method. Alternatively, taxpayers may also use one of the simplified methods to allocate costs between ending inventory and cost of goods sold. Many taxpayers use the simplified methods to ease the administrative burden associated with allocating and capitalizing additional Section 263A costs and book-tax differences.

The IRS and Treasury had previously requested comments in Notice 2007-29 and then proposed regulations REG-126770-06 on Sept. 5, 2012, regarding the simplified methods and, more broadly, certain definitions that would impact all taxpayers with inventory. In particular, the proposed regulations proposed to modify the treatment of “negative adjustments.” These negative adjustments generally occur if the costs capitalized to inventory for Section 471 purposes (typically book costs) are greater than the amount required to be capitalized for tax purposes under Section 263A.  For example, R&D costs that are capitalized for book purposes, but are not required to be capitalized for tax purposes, and excess book over tax depreciation may give rise to a negative adjustment.   

Final regulations The final regulations under Section 263A:

  1. Provide a new definition of Section 471 costs
  2. Provide rules for the treatment of negative adjustments related to certain costs required to be capitalized to property produced or acquired for resale
  3. Provide a new simplified method of accounting, the modified simplified production method, for determining the additional Section 263A costs that must be capitalized to ending inventory or other property on hand at the end of the year
  4. Redefine how certain types of costs are categorized for the simplified methods of determining the additional Section 263A costs that must be capitalized to ending inventory or other property on hand at the end of the year.

The regulations are effective for taxable years beginning on or after Nov. 20, 2018, but may be applied to the taxpayer’s first taxable year ending on or after Nov. 20, 2018.

A Grant Thornton Tax Insights that goes into greater detail regarding the new regulations and the method change procedures for implementing the regulations is forthcoming.

For more information contact:
Sharon Kay
Partner, Accounting Methods
Washington National Tax Office
Grant Thornton LLP
T +1 202 861 4140

John Suttora
Managing Director
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1523

Tom Stockdale
Director, Strategic Federal Tax Solutions
Grant Thornton LLP
T +1 312 602 8785
Caleb Cordonnier
Manager, Accounting Methods
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1555

Debbie Shi
Manager, Accounting Methods
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1501

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