Capitalization and Accounting
Methods Update
Presented by:
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Sharon Kay – Washington National Tax: 202 327 6556
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Kristine Mora – Washington National Tax: 202 327 6092
Notice
► Any
US tax advice contained herein was not intended or
written to be used, and cannot be used, for the purpose of
avoiding penalties that may be imposed under the Internal
Revenue Code, or applicable state or local tax law
provisions
► These
slides are for educational purposes only and are not
intended, and should not be relied upon, as accounting
advice
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Agenda
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Accounting method changes trends
Tangible property regulations
Inventory update
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Accounting method changes trends
Accounting method timeline and procedural
considerations
Typical timeline for calendar-year taxpayers
90 day
window
period
Automatic Accounting Method Changes
1
Non-automatic Accounting Method Changes
Filing Deadline
Due date of tax return for year of change
Last day of tax year of change
Implementation
of Change
Implement on tax return for year of change;
no user fees
May not implement on tax return until consent
received; user fee required
Taxpayers
Under
Examination
may only file
(1) Within first 90 days of a tax year if taxpayer has been under examination for at least 12 months;
(2) Within 120 days of an examination ending; or
(3) With the consent of the Director
(4) For automatic changes, taxpayer may file method change if automatic change procedure
specifies the change is not subject to audit protection.
For properly extended corporate and partnership tax returns.
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Accounting method changes trends
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Top 5 method changes we’ve filed in the past year
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Accrued bonus liability – typically unfavorable adjustment
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Depreciation – typically favorable adjustment
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UNICAP – both favorable and unfavorable adjustments
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Deferral of advance payments – typically favorable adjustments
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Repairs – typically favorable adjustments
Latest trends
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Changes for earnings and profits of CFCs
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Computer software development and ERP implementations
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Opportunity if there is corporate tax reform
Crystal ball for the next year
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Predict that 9 out of top 10 most commonly filed will be from the 19 tangibles
regulations method changes, if IRS does not delay effective date
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The 10th will be UNICAP
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Tangible property regulations
Overview - tangible property regulations
Materials and
supplies
Acquisitions
Improvements
Depreciation and
dispositions
§1.162-3T
§1.263(a)-2T
§1.263(a)-3T
§§1.168(i)-1T, -7T, -8T
§1.263(a)-1T
• Definition of material and
supply
• Three categories that
determine when
deductible:
• Incidental supply
• Non-incidental supply
• Rotable spare parts
• Election to deduct under
de minimis rule in
acquisition regulations
• Election to capitalize and
depreciate
• De minimis expensing
used for AFS allowed if
less than ceiling (applied
to each regarded entity)
• Election to capitalize
and depreciate
• Capitalize costs that
facilitate acquisition of
property
• Whether and which
test for real property
• Expense employee
compensation and
overhead, but may
elect to capitalize
• Capitalize costs to
defend or perfect title to
property
• Definition of unit of
property is generally
functional
interdependence except
for:
• Buildings
• Plant property
• Leased property
• Improvement defined:
• Betterment
• Restoration
• New or different use
• Safe harbor for routine
maintenance on property
other than buildings
• Safe harbor for certain
regulated entities
• No plan of rehabilitation
• Leased property
• Depreciation accounts
• Single asset accounts
• Mass asset accounts
• General asset
accounts
• Dispositions
• General rules
• Required to recognize
disposition of
structural components
• Reasonable
identification methods
• Capitalize facilitative
costs for sales of
property by non-dealers
• Deduct dealer expenses
for sales
• Other issues include: coordination with section 263A, mass asset accounting
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Transition rules
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Revenue Procedures 2012-19 and 2012-20
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What does compliance with Section 263A (UNICAP) mean?
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Improvements and other self-constructed property
► Improvement includes capitalized repairs and is subject to Section 263A
► Must allocate costs in addition to invoice price such as
► Allocable portion of the department that negotiates with repairmen
and supervises the work performed
► Allocable portion of support departments such as payroll, HR, legal,
etc. that support the above department
► Probably not eligible under the automatic procedures due to methods
typically used
► Therefore, must file by the last day of the tax year to request
advance consent
► Scope is not waived
Inventory
► May be eligible to file under the automatic procedures, but for now scope
is not waived
IRS is considering making selected methods automatic and waiving scope
Developing an implementation plan
Assess current state
Assess current state of accounting methods and elections as well as the current
processes and available data and systems that support them
Understand required/allowed state
Understand required state under new regulations as well as elections/optional
methods for potential opportunities and how these differ from current state
Determine impact on other areas
Model requirements/opportunities to determine impact on other federal tax items
(e.g., §199 deduction, inventory and PCM computations), state taxable income,
E&P, etc., and to evaluate financial statement considerations
Develop solutions for implementing changes
Prioritize issues and develop solutions for changes to data tracking and
business processes/systems, computations and documentation of compliance
Determine resources needed to implement
Develop workplan for implementation of new methods/elections, computation of
§481(a) adjustments, tax return reporting (including Forms 3115 and elections),
documentation for potential IRS exam, and financial statement considerations
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Inventory update
Inventory Agenda:
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Legislative / Regulatory Update
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Section 263A (UNICAP)
► Overview
► Proposed regulations for negative Section 263A
costs
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Self-constructed assets
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Other inventory planning
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Inventory accounting —
legislative / regulatory update
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Proposed regulations
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Sales-based royalties
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Vendor allowances
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Retail inventory method
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Negative 263A costs
President's Fiscal 2013 budget proposals:
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Last in, first out (LIFO) repeal
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Lower of cost or market (LCM) repeal
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Subnormal goods write-downs repeal
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Uniform Capitalization (UNICAP) planning:
Why now?
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Mandatory compliance in order to fall within automatic change
procedures for the tangible property regulations
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Other considerations:
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Bonus depreciation
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Reduce taxable income
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Remediate potential exposure
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Net operating loss (NOL) companies
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Newly acquired entities
Changes to book inventory costing methods
UNICAP planning: Common opportunities
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Opportunities:
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Adopt a burden rate method or new proposed modified simplified
production method (if finalized)
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Embedded costs
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R&D
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Deprecation on temporarily idle facilities
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Warranty and product liability
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Policy-making/budgeting
Elect the historic absorption ratio
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Lock in a low rate
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Reduce administrative effort
UNICAP planning: Potential exposures
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Common exposure areas
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Book/tax differences are not allocated
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Absorption ratio has not been updated
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Operations have changes since last UNICAP study
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Contract manufacturing for retailers or distributors
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Service providers (e.g., restaurants) should be treated as producers
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Following book capitalization for self-constructed assets
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Other 263A Considerations –
Self-constructed assets
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Applies to real or tangible personal property produced by the taxpayer
and applies to property produced by a company for use in its trade or
business (“self- constructed asset”).
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Definition includes construct, build, install, manufacture, develop, improve
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Includes capitalizable improvements
Applies to taxpayers that have property produced by a contractor
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The company that contracts to have property constructed for it is treated
as self-constructing the asset to the extent it makes progress payments or
otherwise incurs cost with respect to the property.
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Indirect costs incurred by the company (e.g., construction period interest,
oversight and general and administrative expenses) for which the property
is being produced must be capitalized by that company as a cost of the
property
Currently most self-constructed asset Section 263A changes are nonautomatic and must be filed by the last day of the tax year
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UNICAP: Negative 263A costs
Proposed Regulations
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A negative amount generally occurs when a taxpayer capitalizes a
cost as a Section 471 cost that is greater than the amount required to
be capitalized for tax purposes, which the taxpayer seeks to remove
from inventory cost using its 263A formula.
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In Notice 2007-29, the IRS stated that, pending the issuance of
additional guidance, it would not challenge the inclusion of negative
amounts in calculating additional costs under Section 263A or the
permissibility of aggregate negative additional Section 263A costs.
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UNICAP: Negative 263A costs
Proposed Regulations
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Proposed regulations that generally prohibit the inclusion of negative
additional 263A costs subject to a few exceptions:
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Small taxpayers
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Simplified resale method
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Modified simplified production method (discussed on next slide)
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All other taxpayers must reduce 471 costs using a method that
approximates the manner in which the taxpayer originally capitalized
the costs
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The proposed regulations would generally prohibit treating cash or
trade discounts under Reg. Section 1.471-3(b) as negative amounts
under either simplified method.
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UNICAP: Negative 263A costs
Proposed Regulations
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New modified simplified production method
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Two absorption ratios
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Preproduction
Production
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Allows negative additional Section 263A treatment
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Reduce the distortions
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May be favorable but additional work if currently using SPM
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Preproduction costs applied to raw material AND raw material content of WIP
and finished goods
Many of the benefits of burden rate methods but with less work
UNICAP: Negative 263A costs
Proposed Regulations
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Adopt a new definition of Section 471 costs
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Applies to all taxpayers regardless methods used
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All costs, other than interest, that a taxpayer capitalizes to its inventory in
its financial statements.
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Must include direct labor and direct material
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Consistent with what most taxpayers are currently doing in practice
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Other inventory planning
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Reduce taxable income
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LIFO
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Automate LIFO computations
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Adopt LIFO for additional inventory
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Change from internal to external inflation indexes or vice versa
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Terminate LIFO for deflationary goods (e.g., pools with debit LIFO reserve)
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Reconstruct base-year cost if inflationary; do not reconstruct if deflationary
Inventory write-downs (non-LIFO taxpayers only)
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Lower of cost or market
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Subnormal goods (e.g., expired products, obsolete inventory)
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Retail inventory method
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Inventory shrink
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Charitable contributions of inventory
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Chargebacks
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Questions and answers
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Thanks for participating
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