IRS Finalizes Negative Section 263A Regulations
The IRS issued final regulations (T.D. 9843) that, under Section 263A, amend the Uniform Capitalization (“UNICAP”) rules for taxpayers. In addition, the IRS simultaneously released Rev. Proc. 2018-56, which updates the automatic accounting method change procedures to assist taxpayers in complying with the final regulations. These final regulations are effective for taxable years beginning on or after November 20, 2018.
The following are key takeaways from the final regulations and automatic accounting method change procedures. The new regulations:
- Created a new Modified Simplified Production Method (“MSPM”) for calculating additional Section 263A costs.
- Clarified how certain inventory costs are calculated and allocated under the new methods.
- Provided guidance on de minimis rules for direct labor and direct materials costs.
- Detailed the rules of prohibiting the use of negative amounts when calculating Section 263A costs.
- Provided a list of a number of new or amended automatic accounting method changes, including temporarily permitting taxpayers to file automatic changes revoking a historic absorption ratio (“HAR”) election or changing to a different simplified method, including the new MSPM without the HAR election.
What is the MSPM?
- The new method allocates Section 263A costs, including negative adjustments, to raw materials, work-in-process and finished goods inventories on hand at the end of the taxable year.
- Taxpayers may now include negative amounts in allocating additional Section 263A costs by using a pre-production cost absorption ratio and a production cost absorption ratio.
- It expands the types of methods that are allowed to be used to allocate mixed service costs between pre-production and production.
- Under the new method, taxpayers are not required to separately track direct material costs that are integrated into the inventories of work-in-process and finished goods.
For many taxpayers, the final regulations provide a substantial benefit because raw materials are not burdened with production costs. In addition, administration, tracking, and calculation are simplified. The new method changes are intended to reduce distortions and complexity that used to be present under the old methods by precisely allocating additional Section 263A costs.
You should review your current Section 263A methods for inventory capitalization to confirm both compliance and determine if they are on the most optimal methods. If you need to adopt new methods of accounting to be in compliance with the final regulations, you will be able to file an automatic change pursuant to Rev. Proc. 2018-56 for a number of items within the final regulations. Now is a great time to reach out to your Cherry Bekaert C/AM team tax advisor who can assist in the reviewing of UNICAP methods and the implementation of any new or amended methods.