[Federal Register Volume 77, Number 172 (Wednesday, September 5, 2012)]
[Proposed Rules]
[Pages 54482-54490]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-21743]
[[Page 54482]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-126770-06]
RIN 1545-BG07
Allocation of Costs Under the Simplified Methods
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations on allocating
costs to certain property produced by the taxpayer or acquired by the
taxpayer for resale. The proposed regulations affect taxpayers that are
producers or resellers of property that are required to capitalize
certain costs to the property and that allocate costs under the
simplified production method or the simplified resale method. The
proposed regulations provide rules for the treatment of negative
additional costs.
DATES: Written (including electronic) comments and requests for a
public hearing must be received by December 4, 2012.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-126770-06), room
5205, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-126770-06), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. Taxpayers also may submit comments electronically via
the Federal eRulemaking Portal at www.regulations.gov (IRS REG-126770-
06).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Christopher Call, (202) 622-4970; concerning submissions of comments or
to request a public hearing, Oluwafunmilayo Taylor, (202) 622-7180 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax
Regulations, 26 CFR part 1, relating to the allocation of costs under
the simplified methods of accounting under section 263A of the Internal
Revenue Code (Code).
Section 263A requires taxpayers to capitalize the direct costs and
indirect costs that are properly allocable to: (1) Real or tangible
personal property the taxpayer produces, and (2) real property and
personal property described in section 1221(a)(1) that the taxpayer
acquires for resale. Section 1.263A-1(e)(2)(i) of the Income Tax
Regulations provides that direct costs for producers are direct
material costs and direct labor costs. Section 1.263A-1(e)(2)(ii)
provides that resellers must capitalize the acquisition cost of
property acquired for resale. Section 1.263A-1(e)(3)(i) defines
indirect costs as all costs other than direct material costs and direct
labor costs (in the case of property produced) or acquisition costs (in
the case of property acquired for resale). Indirect costs are properly
allocable to property produced or acquired for resale when the costs
directly benefit or are incurred by reason of the performance of
production or resale activities.
Section 263A generally requires taxpayers to allocate capitalizable
section 263A costs to specific items in inventory. The legislative
history of section 263A indicates that Congress intended that taxpayers
would allocate additional section 263A costs (costs, other than
interest, that were not capitalized under the taxpayer's method of
accounting immediately prior to the effective date of section 263A, but
that are required to be capitalized under section 263A) with the same
degree of specificity that was required of inventoriable costs prior to
the enactment of section 263A. Congress contemplated that taxpayers
would continue to use the same methods of allocating costs to items in
their inventory that were available under prior law. See S. Rep. No.
313, 99th Cong. 2d Sess. 142 (1986). Consistent with these principles,
the regulations under Sec. 1.263A-1(f)(2) and (f)(3) provide that
taxpayers may elect to use a ``facts-and-circumstances'' allocation
method, such as the specific identification method, burden rate,
standard cost method, or any other method to allocate direct and
indirect costs to units of property produced or acquired for resale, if
the method is reasonable within the meaning of Sec. 1.263A-1(f)(4).
Section 1.263A-1(f)(1) authorizes taxpayers to use the simplified
methods provided in Sec. 1.263A-2(b) (the simplified production
method) or Sec. 1.263A-3(d) (the simplified resale method) to allocate
costs to eligible property produced or eligible property acquired for
resale in lieu of a facts-and-circumstances allocation method. The
simplified methods differ from facts-and-circumstances methods in that,
as applied to inventories, they allocate a pool of capitalizable costs
(additional section 263A costs) between ending inventory and cost of
goods sold using a defined ratio and are an exception to the general
rule that additional section 263A costs must be allocated to specific
items of inventory. Thus, the simplified methods are intended to reduce
the complexity and administrative burdens of having to develop detailed
cost accounting systems for the additional costs required to be
capitalized under section 263A.
Under the simplified production method, a taxpayer must allocate
additional section 263A costs to produced property on hand at the end
of the taxable year based on the ratio of these costs incurred during
the year to the taxpayer's total section 471 costs incurred during the
year (the absorption ratio). The current regulations define additional
section 263A costs as the costs, other than interest, that were not
capitalized under the taxpayer's method of accounting immediately prior
to the effective date of section 263A, but that are required to be
capitalized under section 263A. See Sec. 1.263A-1(d)(3). The current
regulations define section 471 costs as costs, other than interest,
capitalized under the taxpayer's method of accounting immediately prior
to the effective date of section 263A. If a taxpayer was not in
existence before the effective date of section 263A, section 471 costs
are generally those costs that would have been required to be
capitalized under Sec. 1.471-11. See Sec. 1.263A-1(d)(2). The
absorption ratio is multiplied by the section 471 costs incurred during
the taxable year that remain in ending inventory or are otherwise on
hand at year end to determine the additional section 263A costs
allocable to produced property on hand at the end of the taxable year.
Under the simplified resale method, an eligible taxpayer computes a
combined absorption ratio and multiplies it by the section 471 costs
incurred during the taxable year that remain in its ending inventory or
are otherwise on hand at year end to determine the additional section
263A costs allocable to eligible property on hand at year end. Section
1.263A-3(d)(3)(i)(C)(1) defines the combined absorption ratio as the
sum of the storage and handling costs absorption ratio as defined by
Sec. 1.263A-3(d)(3)(i)(D) and the purchasing costs absorption ratio as
defined by Sec. 1.263A-3(d)(3)(i)(E).
Notice 2007-29 (2007-1 CB 881) requests comments on the treatment
of negative amounts under the simplified methods. A negative amount
generally occurs when a taxpayer capitalizes a cost as a section 471
cost in an amount that is greater than the amount required to be
capitalized for tax purposes. For
[[Page 54483]]
example, if a taxpayer included book depreciation in section 471 costs
in accordance with Sec. 1.471-11(c)(2)(iii)(b) and the book
depreciation is greater than tax depreciation for the year, the
taxpayer would have capitalized more depreciation than is required to
be capitalized under section 263A for that year. A negative amount may
result if the taxpayer does not remove this excess depreciation amount
by adjusting section 471 costs but instead makes an adjustment to its
additional section 263A costs. See Sec. 601.601(d)(2)(ii)(b).
In some situations, including negative amounts in the numerator of
the simplified production method formula may result in significant
distortions of the amount of additional section 263A costs that is
allocated to ending inventory. Distortions may also occur when the
method used to capitalize a cost under section 471 is different than
the method used under the simplified production method to remove the
cost from ending inventory. The extent of the distortion, and whether
it is favorable or unfavorable to the taxpayer, generally depends on
when the cost is incurred in the production process and how the cost
was allocated to raw materials, work-in-process, or finished goods
inventories for purposes of section 471.
Notice 2007-29 provides that, pending the issuance of additional
published guidance, the IRS will not challenge the inclusion of
negative amounts in computing additional costs under section 263A or
the permissibility of aggregate negative additional section 263A costs.
The notice solicits public comments regarding possible changes to the
simplified methods involving negative additional section 263A costs.
Comments were received and considered in developing these proposed
regulations.
Explanation of Provisions
1. Prohibition on Negative Amounts
To reduce the distortions that occur by including negative amounts
under the simplified methods, the proposed regulations provide that,
subject to certain exceptions described later in this preamble,
taxpayers may not include negative amounts in additional section 263A
costs. Specific comments are requested on transition rules for
taxpayers currently using the simplified production method with the
historic absorption ratio election (see section 1.263A-2(b)(4)),
including comments on how the regulations should apply to taxpayers
that are part way through the qualifying period as described in section
1.263A-2(b)(4)(ii)(C).
To reduce the administrative burden for smaller taxpayers using the
simplified production method for which the costs and burdens of
excluding negative amounts from additional section 263A costs may
otherwise outweigh the benefits, the proposed regulations allow
producers with average annual gross receipts of $10,000,000 or less to
include negative amounts in additional section 263A costs under the
simplified production method.
Additionally, because negative additional section 263A costs cause
less distortion under the simplified resale method than under the
simplified production method, the proposed regulations allow taxpayers
using the simplified resale method to remove section 471 costs that are
not required to be capitalized for tax purposes from ending inventory
by treating them as negative additional section 263A costs.
The proposed regulations generally prohibit treating cash or trade
discounts described in Sec. 1.471-3(b) as negative amounts under any
of the simplified methods. Comments are requested on reasonable methods
of allocating between ending inventory and cost of goods sold cash or
trade discounts that taxpayers do not capitalize for book purposes (and
therefore are not section 471 costs within the meaning of Sec. 1.263A-
1(d)(2)).
2. New Modified Simplified Production Method
In response to Notice 2007-29, a commentator suggested an
alternative to the simplified production method that would reduce
overcapitalization and distortion, including distortions resulting from
including negative amounts in additional section 263A costs. The
commentator suggested that the simplified production method may
allocate an excessive amount of section 263A costs to raw materials
inventories because the formula does not take into account the fact
that taxpayers incur fewer indirect costs for raw materials and because
different inventoriable costs turn over at different rates. The
commentator's alternative simplified method would allocate additional
section 263A costs related to raw materials using a formula that is
different from the formula used to allocate additional section 263A
costs related to work-in-process and finished goods.
As suggested by this comment, the proposed regulations allow
producers to use a new modified simplified production method that
reduces the distortions that exist under the traditional simplified
methods by more precisely allocating additional section 263A costs,
including negative amounts, among raw materials, work-in-process, and
finished goods inventories. Under the modified simplified production
method, producers determine the allocable portion of preproduction
related additional section 263A costs (such as storage and handling for
raw materials) using a preproduction cost absorption ratio. The
preproduction cost absorption ratio is applied to raw material section
471 costs incurred during the taxable year and remaining on hand at
year end. For purposes of computing the allocable portion of
preproduction related additional section 263A costs, raw material costs
on hand at year end include unprocessed raw materials and raw materials
that are integrated into work-in-progress and finished goods. Under the
modified simplified production method, producers determine the
allocable portion of all other additional section 263A costs using a
production cost absorption ratio.
In addition to reducing distortions that exist under the simplified
production method by more precisely allocating additional section 263A
costs to raw materials, the modified simplified production method
provides producers with a method to remove section 471 costs that are
not required to be capitalized for tax purposes from ending inventory
by treating them as negative additional section 263A costs. Both
resellers and producers, thereby, are allowed to use methods that more
precisely allocate additional section 263A costs while alleviating
administrative burden, consistent with the purpose of the simplified
methods.
As with other simplified methods, a taxpayer must maintain adequate
records substantiating proper use of the modified simplified production
method (see section 6001).
Comments are requested on the modified simplified production
method, including: (1) Whether distortions will occur if preproduction
related additional section 263A costs are not directly traced from raw
materials through work-in-process and finished goods inventories from
year to year; (2) how mixed service costs should be allocated between
raw materials, work-in-process, and finished goods inventories under
the new formula; and (3) how the new formula should apply to a taxpayer
using the last-in, first-out method of accounting.
[[Page 54484]]
3. Simplified Definition of Section 471 Costs and Elimination of
Separate Provisions for New Taxpayers
For most taxpayers, section 471 costs generally are the acquisition
or production costs, other than interest, that the taxpayer capitalized
under its method of accounting immediately before the effective date of
section 263A. See Sec. 1.263A-1(d)(2)(i). If a taxpayer was not in
existence at that time, section 471 costs generally are the acquisition
or production costs, other than interest, that the taxpayer would have
been required to capitalize if the taxpayer had been in existence
immediately before the effective date of section 263A. See Sec.
1.263A-1(d)(2)(ii).
To provide greater simplicity and consistency among taxpayers, the
proposed regulations adopt a single definition of section 471 costs
that applies to taxpayers that were in existence before the effective
date of section 263A and to newer taxpayers, whether using the
simplified production method, the modified simplified production
method, or the simplified resale method. The proposed regulations
provide that, for purposes of the simplified methods, a taxpayer's
section 471 costs, in general, are the costs, other than interest, that
a taxpayer capitalizes to its inventory in its financial statements.
However, a taxpayer must include all direct costs in its section 471
costs regardless of the taxpayer's treatment of the costs in its
financial statements. The proposed regulations require a taxpayer that
is not permitted to remove section 471 costs as negative additional
section 263A costs to reduce its section 471 costs. The proposed
regulations provide that a taxpayer that reduces its section 471 costs
must use a reasonable method that approximates the manner in which the
taxpayer originally capitalized the costs.
Effective/Applicability Date
The regulations are proposed to apply to taxable years ending on or
after the date the regulations are published as final regulations in
the Federal Register.
Effect on Other Documents
Notice 2007-29 would be superseded as of the date these regulations
are published as final regulations in the Federal Register.
Special Analyses
This notice of proposed rulemaking is not a significant regulatory
action as defined in Executive Order 12866, as supplemented by
Executive Order 13563. Therefore, a regulatory assessment is not
required. Section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations. Because the regulations
do not impose a collection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking has been submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Comments and Requests for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
The IRS and the Treasury Department request comments on all aspects of
the proposed rules. All comments will be available at
www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits written comments. If a public hearing is
scheduled, notice of the date, time, and place for the public hearing
will be published in the Federal Register.
Drafting Information
The principal author of these proposed regulations is W. Thomas
McElroy, Jr. of the Office of Associate Chief Counsel (Income Tax and
Accounting). However, other personnel from the IRS and the Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART I--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.263A-1 also issued under 26 U.S.C. 263A. * * *
Section 1.263A-2 also issued under 26 U.S.C. 263A. * * *
Par. 2. Section 1.263A-0 is amended as follows:
1. Revising the entries in Sec. 1.263A-1 for paragraphs (d)(2) and
(d)(3).
2. Revising the entries in Sec. 1.263A-2 for paragraphs (c) and
(d).
3. Adding new entries to Sec. 1.263A-2 for paragraphs (e), (f) and
(g).
The revisions and addition read as follows:
Sec. 1.263A-0 Outline of regulations under section 263A.
* * * * *
Sec. 1.263A-1 Uniform capitalization of costs.
* * * * *
(d) * * *
(2) Section 471 costs.
(i) In general.
(ii) Removal of costs from inventory.
(iii) Method changes.
(3) Additional section 263A costs
(i) In general.
(ii) Negative amounts.
(A) In general.
(B) Exception for small taxpayers using the simplified production
method.
(C) Exception for modified simplified production method and
simplified resale method.
* * * * *
Sec. 1.263A-2 Rules relating to property produced by the taxpayer.
* * * * *
(c) Modified simplified production method.
(1) In general.
(2) Eligible property.
(3) Modified simplified production method without historic
absorption ratio election.
(i) General allocation formula.
(A) In general.
(B) Allocable preproduction additional section 263A costs.
(C) Allocable production additional section 263A costs.
(D) Effect of allocation.
(E) Treatment of mixed service costs.
(ii) Definitions
(A) Preproduction absorption ratio.
(1) In general.
(2) Preproduction additional section 263A costs.
(3) Raw material costs.
(B) Production absorption ratio.
(1) In general.
(2) Production additional section 263A costs.
(3) Production section 471 costs.
(iii) LIFO taxpayers electing the modified simplified production
method.
(A) In general.
(B) LIFO increment.
(1) In general.
(2) Combined absorption ratio defined.
(C) LIFO decrement.
(iv) De minimis rule for producers with total indirect costs of
$200,000 or less.
(v) Examples.
(4) Modified simplified production method with historic absorption
ratio election.
[[Page 54485]]
(i) In general.
(ii) General allocation formula.
(A) In general.
(B) Preproduction historic absorption ratio.
(C) Production historic absorption ratio.
(iii) LIFO taxpayers making the historic absorption ratio election.
(A) In general.
(B) Combined historic absorption ratio.
(C) Total allocable additional section 263A costs incurred during
the test period.
(D) Total section 471 costs remaining on hand at year end during
the test period.
(iv) Extension of qualifying period.
(v) Transition rule.
(vi) Examples.
(d) Additional simplified methods for producers.
(e) Cross reference.
(f) Change in method of accounting.
(1) In general.
(2) Scope limitations.
(3) Audit protection.
(4) Section 481(a) adjustment.
(5) Time for requesting change.
(g) Effective/applicability date.
Par. 3. Section 1.263A-1 is amended by:
1. Revising paragraphs (d)(2) and (d)(3).
2. Adding a sentence to the end of paragraph (m).
The addition and revisions read as follows:
Sec. 1.263A-1 Uniform capitalization of costs.
* * * * *
(d) * * *
(2) Section 471 costs--(i) In general. Except as otherwise provided
in paragraph (d)(2)(ii) of this section, for purposes of section 263A,
a taxpayer's section 471 costs are the costs, other than interest, that
a taxpayer capitalizes to its inventory (or other eligible property) in
its financial statements. Thus, although section 471 applies only to
inventories, section 471 costs include any non-inventory costs, other
than interest, that a taxpayer capitalizes or includes in acquisition
or production costs in its financial statements. However,
notwithstanding the last sentence of paragraph (g)(2) of this section,
section 471 costs must include all direct costs of producing property
and of acquiring property held for resale, whether or not a taxpayer
capitalizes these costs to inventory or to other eligible property in
its financial statements. See paragraph (e)(2) of this section for a
description of direct production costs and direct costs of acquiring
property held for resale.
(ii) Removal of costs from inventory. A taxpayer must reduce its
section 471 costs by those costs that the taxpayer capitalizes to its
inventory (or other eligible property) in its financial statements that
may not be capitalized under either Sec. 1.263A-1(c)(2) or Sec.
1.263A-1(j)(2)(ii), and those period costs that the taxpayer
capitalizes to its inventory (or other eligible property) in its
financial statements that, under Sec. 1.263A-1(j)(2), the taxpayer
chooses not to capitalize under section 263A (for example, section 179
costs). A taxpayer described in paragraph (d)(3)(ii)(B) or
(d)(3)(ii)(C) of this section that may remove these costs from
inventory by including them as negative amounts in additional section
263A costs instead may reduce its section 471 costs for these costs. A
taxpayer that reduces its section 471 costs must use a reasonable
method that approximates the manner in which the taxpayer originally
capitalized the costs to its inventory (or other eligible property) in
its financial statements.
(iii) Method changes. A taxpayer may change its method of
accounting for determining section 471 costs only with the consent of
the Commissioner as required under section 446(e) and the corresponding
regulations. If a taxpayer is using the simplified production method
described in Sec. 1.263A-2(b), the modified simplified production
method described in Sec. 1.263A-2(c), or the simplified resale method
described in Sec. 1.263A-3(d), and changes its financial reporting
practices regarding the costs capitalized to its inventory (or other
eligible property) in a manner that would change its section 471 costs
under the general provisions of paragraph (d)(2)(i) of this section,
then the taxpayer must secure the Commissioner's consent prior to
computing its taxable income under the new method of accounting for
section 471 costs.
(3) Additional section 263A costs--(i) In general. Additional
section 263A costs are defined as the costs, other than interest, that
are not included in a taxpayer's section 471 costs, but that are
required to be capitalized under section 263A. Additional section 263A
costs do not include the direct costs that are required to be included
in a taxpayer's section 471 costs under paragraph (d)(2)(i) of this
section.
(ii) Negative amounts--(A) In general. Except as otherwise provided
by regulations or other published guidance, see Sec. 601.601(d)(2), a
taxpayer may not include negative amounts in additional section 263A
costs.
(B) Exception for small taxpayers using the simplified production
method. Paragraph (d)(3)(ii)(A) of this section does not apply to a
taxpayer using the simplified production method under Sec. 1.263A-2(b)
if the taxpayer's (or its predecessors') average annual gross receipts
for the three previous taxable years (test period) do not exceed
$10,000,000. The rules of Sec. 1.263A-3(b) apply for purposes of
determining the amount of a taxpayer's gross receipts and the test
period.
(C) Exception for modified simplified production method and
simplified resale method. In general, a taxpayer using the modified
simplified production method under Sec. 1.263A-2(c) or the simplified
resale method under Sec. 1.263A-3(d) may (but is not required to)
remove as negative amounts under section 263A indirect costs that are
included in the taxpayer's section 471 costs but that are not required
to be, or may not be, capitalized into inventory (or other eligible
property) for federal income tax purposes. However, a taxpayer using
the modified simplified production method or the simplified resale
method may not use negative amounts to adjust additional section 263A
costs for cash or trade discounts described in Sec. 1.471-3(b).
* * * * *
(m) * * * Paragraphs (d)(2) and (d)(3) of this section apply for
taxable years ending on or after the date these regulations are
published as final regulations in the Federal Register.
Par. 4. Section 1.263A-2 is amended by:
1. Redesignating paragraphs (c), (d), (e), and (f) as paragraphs
(d), (e), (f), and (g).
2. Adding a new paragraph (c).
3. Revising newly designated paragraph (g).
The addition and revisions read as follows:
Sec. 1.263A-2 Rules relating to property produced by the taxpayer.
* * * * *
(c) Modified simplified production method--(1) In general. This
paragraph (c) provides a modified simplified method for determining the
additional section 263A costs properly allocable to ending inventories
of property produced and other eligible property on hand at the end of
the taxable year.
(2) Eligible property. For purposes of this paragraph (c), eligible
property has the same meaning as in paragraph (b)(2) of this section.
(3) Modified simplified production method without historic
absorption ratio election--(i) General allocation formula--(A) In
general. Except as otherwise provided in paragraph (c)(3)(iv) of this
section, a taxpayer may
[[Page 54486]]
compute the total additional section 263A costs allocable to eligible
property remaining on hand at the close of the taxable year under the
modified simplified production method as follows:
Allocable preproduction additional section 263A costs + Allocable
production additional section 263A costs.
(B) Allocable preproduction additional section 263A costs. The
amount of preproduction additional section 263A costs allocable to
ending inventory or to other eligible property on hand at the end of
the taxable year is computed as follows:
Preproduction absorption ratio x raw material section 471 costs
incurred during the taxable year and remaining on hand at year end.
(C) Allocable production additional section 263A costs. The amount
of production additional section 263A costs allocable to ending
inventory or to other eligible property on hand at the end of the
taxable year is computed as follows:
Production absorption ratio x production section 471 costs incurred
during the taxable year and remaining on hand at year end.
(D) Effect of allocation. The allocable preproduction additional
section 263A costs and the allocable production additional section 263A
costs are totaled to compute the additional section 263A costs, which
are added to the taxpayer's ending section 471 costs to determine the
total section 263A costs that are capitalized. See, however, paragraph
(c)(3)(iii) of this section for special rules for LIFO taxpayers.
Except as otherwise provided in this section or in Sec. 1.263A-1 or
Sec. 1.263A-3, additional section 263A costs that are allocated to
inventories on hand at the close of the taxable year under the modified
simplified production method are treated as inventory costs for all
purposes of the Internal Revenue Code.
(E) Treatment of mixed service costs. A taxpayer must apportion
capitalizable mixed service costs (the aggregate portion of mixed
service costs that are properly allocable to the taxpayer's production
or resale activities as additional section 263A costs) between
preproduction additional section 263A costs described in paragraph
(c)(3)(ii)(A)(2) of this section and production additional section 263A
costs described in paragraph (c)(3)(ii)(B)(2) of this section. Under
the modified simplified production method, a taxpayer must allocate
capitalizable mixed service costs to preproduction additional section
263A costs in proportion to the raw material costs in total section 471
costs. The taxpayer must include the capitalizable mixed service costs
that are not allocated to preproduction additional section 263A costs
in production additional section 263A costs.
(ii) Definitions--(A) Preproduction absorption ratio--(1) In
general. Under the modified simplified production method, the
preproduction absorption ratio is determined as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.013
(2) Preproduction additional section 263A costs. Preproduction
additional section 263A costs are the sum of the additional section
263A costs (as defined in Sec. 1.263A-1(d)(3)) incurred during the
current taxable year that are described in paragraph (a)(3)(ii) of this
section to the extent the costs are not treated as section 471 costs
and the allocable portion of capitalizable mixed service costs as
described in paragraph (c)(3)(i)(E) of this section.
(3) Raw material costs. Raw material costs are defined as the
direct costs of acquiring raw materials that a taxpayer purchases
during its current taxable year. Raw material section 471 costs
incurred during the taxable year and remaining on hand at year end
include the raw material costs in work-in-process and finished goods as
well as unprocessed raw materials.
(B) Production absorption ratio--(1) In general. Under the modified
simplified production method, the production absorption ratio is
determined as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.014
(2) Production additional section 263A costs. Production additional
section 263A costs are the sum of all additional section 263A costs (as
defined in Sec. 1.263A-1(d)(3)) incurred during the current taxable
year that are not preproduction additional section 263A costs as
described in this section and the allocable portion of capitalizable
mixed service costs as described in paragraph (c)(3)(i)(E) of this
section. For example, production additional section 263A costs include
the additional section 263A costs that constitute post-production costs
as defined in paragraph (a)(3)(iii) of this section.
(3) Production section 471 costs. Production section 471 costs are
defined as the total section 471 costs that a taxpayer incurs during
its current taxable year less the taxpayer's raw material costs.
(iii) LIFO taxpayers electing the modified simplified production
method--(A) In general. Under the modified simplified production
method, a taxpayer using a LIFO method must calculate a particular
year's index (for example, under Sec. 1.472-8(e)) without regard to
its additional section 263A costs. Similarly, a taxpayer that adjusts
current-year costs by applicable indexes to determine whether there has
been an inventory increment or decrement in the current year for a
particular LIFO pool must disregard the additional section 263A costs
in making that determination.
(B) LIFO increment--(1) In general. If a taxpayer determines there
has been an inventory increment, the taxpayer must state the amount of
the increment in current-year dollars (stated in terms of section 471
costs). The taxpayer then multiplies this amount by the combined
absorption ratio, as defined in paragraph (c)(3)(iii)(B)(2) of this
section. The resulting product is the additional section 263A costs
that must be added to the taxpayer's increment for the year stated in
terms of section 471 costs.
(2) Combined absorption ratio defined. For purposes of this
paragraph (c)(3)(iii), the numerator of the combined absorption ratio
is the total additional section 263A costs allocable to eligible
property remaining on hand at the close of the taxable year, as
[[Page 54487]]
described in paragraph (c)(3)(i)(A) of this section. The denominator of
the combined absorption ratio is the total section 471 costs remaining
on hand at year end, as described in paragraph (b)(3)(ii)(B) of this
section.
(C) LIFO decrement. If a taxpayer determines there has been an
inventory decrement, the taxpayer must state the amount of the
decrement in dollars for the particular year for which the LIFO
decrement has occurred. The additional section 263A costs incurred in
prior years that apply to the decrement are included in cost of goods
sold. The taxpayer determines the additional section 263A costs that
apply to the decrement by multiplying the additional section 263A costs
allocated to the layer of the pool in which the decrement occurred by
the ratio of the decrement (excluding additional section 263A costs) to
the section 471 costs in the layer of that pool.
(iv) De minimis rule for producers with total indirect costs of
$200,000 or less. Paragraph (b)(3)(iv) of this section, which provides
that the additional section 263A costs allocable to eligible property
remaining on hand at the close of the taxable year are deemed to be
zero for producers with total indirect costs of $200,000 or less,
applies to the modified simplified production method.
(v) Examples. The rules of this paragraph (c)(3) are illustrated by
the following examples:
Example 1. FIFO inventory method. (i) Taxpayer P uses the first-
in, first-out (FIFO) method of accounting for inventories and a
calendar taxable year. P's beginning inventory for 2010 is
$2,500,000, including $2,000,000 of section 471 costs and $500,000
of additional section 263A costs.
(ii) During 2010, P incurs $10,000,000 of section 471 costs,
including $4,000,000 of raw material costs (as defined in paragraph
(c)(3)(ii)(A)(3) of this section) and $6,000,000 of production
section 471 costs (as defined in paragraph (c)(3)(ii)(B)(3) of this
section). P also incurs $1,060,000 of additional section 263A costs,
including $340,000 of preproduction additional section 263A costs
(as defined in paragraph (c)(3)(ii)(A)(2) of this section) and
$720,000 of production additional section 263A costs (as defined in
paragraph (c)(3)(ii)(B)(2) of this section).
(iii) At the end of 2010, P's section 471 costs incurred during
the taxable year remaining in ending inventory are $3,500,000,
including $2,000,000 of raw materials section 471 costs and
$1,500,000 of production section 471 costs.
(iv) P computes its preproduction absorption ratio for 2010
under paragraph (c)(3)(ii)(A) of this section as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.015
(v) P computes its production absorption ratio for 2010 under
paragraph (c)(3)(ii)(B)(1) of this section as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.016
(vi) Under paragraph (c)(3)(i)(B) of this section, P computes
its allocable preproduction additional section 263A costs by
multiplying the preproduction absorption ratio by raw materials
section 471 costs incurred during the taxable year and remaining in
ending inventory (8.5 percent * $2,000,000 = $170,000).
(vii) Under paragraph (c)(3)(i)(C) of this section, P computes
its allocable production additional section 263A costs by
multiplying the production absorption ratio by production section
471 costs incurred during the taxable year and remaining in ending
inventory at year end (12 percent * $1,500,000 = $180,000).
(viii) Under paragraph (c)(3)(i)(A) of this section, P computes
its total additional section 263A costs allocable to ending
inventory by adding its allocable preproduction additional section
263A costs to its allocable production additional section 263A costs
($170,000 + $180,000 = $350,000).
(ix) P adds the $350,000 additional section 263A costs to the
$3,500,000 of section 471 costs remaining in its ending inventory to
calculate its total ending inventory of $3,850,000. P includes the
balance of P's additional section 263A costs incurred during 2010,
$710,000 ($1,060,000 less $350,000), in P's cost of goods sold.
Example 2. LIFO inventory method. (i) The facts are the same
as in Example 1, except that P uses the LIFO inventory method rather
than the FIFO method. P's 2010 LIFO increment is $1,500,000.
(ii) Under paragraph (c)(3)(iii)(B)(1) of this section, P
determines the additional section 263A costs allocable to its 2010
LIFO increment by multiplying the increment by a combined absorption
ratio. Under paragraph (c)(3)(iii)(B)(2) of this section, P computes
the combined absorption ratio as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.017
(iii) P's additional section 263A costs allocable to its 2010
increment are $150,000 (10 percent * $1,500,000). Under paragraph
(c)(3)(iii)(B)(1) of this section, P adds the $150,000 additional
section 263A costs to its $1,500,000 LIFO increment to determine a
total 2010 LIFO increment of $1,650,000. P's ending inventory is
$4,150,000 (its beginning inventory of $2,500,000 plus the
$1,650,000 increment). P includes the remaining $910,000 ($1,060,000
less $150,000) of additional section 263A costs incurred during 2010
in P's cost of goods sold.
Example 3. Mixed service costs. (i) During 2010, Taxpayer R
incurs $200,000 of capitalizable mixed service costs (within the
meaning of paragraph (c)(3)(i)(E) of this section). R incurs
$8,000,000 of section 471 costs, including $2,000,000 of raw
material costs (as defined in paragraph (c)(3)(ii)(A)(3) of this
section).
(ii) Under paragraph (c)(3)(i)(E) of this section, R allocates
its mixed service costs to preproduction additional section 263A
costs
[[Page 54488]]
by computing the proportion of raw material costs in its section 471
costs and multiplying its mixed service costs by this percentage.
The proportion of raw material costs in R's section 471 costs is 25
percent ($2,000,000/$8,000,000). R allocates $50,000 (25 percent *
$200,000) of mixed service costs to preproduction additional section
263A costs. R includes the remaining $150,000 ($200,000 less
$50,000) of capitalizable mixed service costs as production
additional section 263A costs.
(4) Modified simplified production method with historic absorption
ratio election--(i) In general. Except as otherwise provided in this
paragraph (c)(4), paragraph (b)(4) of this section applies to the
historic absorption ratio election under the modified simplified
production method.
(ii) General allocation formula--(A) In general. Except as provided
in paragraph (c)(4)(iii) of this section (relating to LIFO taxpayers),
a taxpayer making the historic absorption ratio election under the
modified simplified production method uses a preproduction historic
absorption ratio and a production historic absorption ratio in place of
the actual preproduction absorption ratio and production absorption
ratio under paragraph (c)(3)(ii) of this section. The preproduction and
production historic absorption ratios are based on costs a taxpayer
capitalizes during its test period.
(B) Preproduction historic absorption ratio. The preproduction
historic absorption ratio is computed as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.018
(C) Production historic absorption ratio. The production historic
absorption ratio is computed as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.019
(iii) LIFO taxpayers making the historic absorption ratio
election--(A) In general. Instead of the combined absorption ratio
under paragraph (c)(3)(iii)(B)(2) of this section, a LIFO taxpayer
making the historic absorption ratio election under the modified
simplified production method calculates a combined historic absorption
ratio based on costs a taxpayer capitalizes during its test period.
(B) Combined historic absorption ratio. The combined historic
absorption ratio is computed as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.020
(C) Total allocable additional section 263A costs incurred during
the test period. Total allocable additional section 263A costs incurred
during the test period are the sum of the total additional section 263A
costs allocable to eligible property on hand at year end as described
in paragraph (c)(3)(i)(A) of this section, for all years in the test
period.
(D) Total section 471 costs remaining on hand at each year end of
the test period. Total section 471 costs remaining on hand at each year
end of the test period are the sum of the total section 471 costs
remaining on hand at year end described in paragraph (b)(3)(ii)(B) of
this section, for all taxable years in the test period.
(iv) Extension of qualifying period. In the first taxable year
following the close of each qualifying period (for example, the sixth
taxable year following the test period), a taxpayer must compute the
actual absorption ratios under paragraph (c)(3) of this section
(preproduction and production absorption ratios or, for LIFO taxpayers,
the combined absorption ratio). If the actual combined absorption ratio
or both the actual preproduction and production absorption ratios, as
applicable, computed for this taxable year (the recomputation year) is
within one-half of one percentage point (plus or minus) of the
corresponding historic absorption ratio or ratios used in determining
capitalizable costs for the qualifying period (the previous five
taxable years), the qualifying period is extended to include the
recomputation year and the following five taxable years, and the
taxpayer must continue to use the historic absorption ratio or ratios
throughout the extended qualifying period. If, however, the actual
combined historic absorption ratio or either the actual preproduction
absorption ratio or production absorption ratio, as applicable, is not
within one-half of one percentage point (plus or minus) of the
corresponding historic absorption ratio, the taxpayer must use the
actual absorption ratio or ratios beginning with the recomputation year
and throughout the updated test period. The taxpayer must resume using
the historic absorption ratio or ratios based on the updated test
period in the third taxable year following the recomputation year.
(v) Transition rule. [Reserved].
(vi) Examples. The provisions of this paragraph (c)(4) are
illustrated by the following examples:
Example 1. FIFO inventory method. (i) Taxpayer S uses the FIFO
method of accounting for inventories and a calendar taxable year,
and in 2010 elects to use the modified simplified production method.
In 2013, S makes the historic absorption ratio election. S
identifies the following costs incurred during the test period:
----------------------------------------------------------------------------------------------------------------
2010 2011 2012
----------------------------------------------------------------------------------------------------------------
Preproduction additional section 263A costs..................... $ 100 $ 200 $ 300
Production additional section 263A costs........................ 200 350 450
[[Page 54489]]
Raw material costs.............................................. 2,000 2,500 3,000
Production section 471 costs.................................... 2,500 3,500 4,000
----------------------------------------------------------------------------------------------------------------
In 2013, S incurs $10,000 of section 471 costs of which $1,000
raw material costs and $2,000 production 471 costs remain in ending
inventory.
(ii) Under paragraph (c)(4)(ii)(B) of this section, in 2013 S
computes the preproduction historic absorption ratio as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.021
(iii) Under paragraph (c)(4)(ii)(C) of this section, S computes
the production historic absorption ratio as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.022
(iv) Under paragraph (c)(4)(ii)(A) of this section, S determines
the preproduction additional section 263A costs allocable to its
ending inventory for 2013 by multiplying its raw materials section
471 costs incurred during the 2013 taxable year and remaining in its
ending inventory by its preproduction historic absorption ratio. S
allocates $80 preproduction additional section 263A costs to its
ending inventory ($1,000 * 8 percent).
(v) S determines the production additional section 263A costs
allocable to its ending inventory for 2013 by multiplying its
production section 471 costs incurred during the 2013 taxable year
and remaining in its ending inventory by its production historic
absorption ratio. S allocates $200 production additional section
263A costs to its ending inventory ($2,000 * 10 percent).
(vi) Under paragraph (c)(4)(ii) of this section, S's total
additional section 263A costs allocable to ending inventory in 2013
are $280, which is the sum of the allocable preproduction additional
section 263A costs ($80) and the allocable production additional
section 263A costs ($200). S's ending inventory in 2013 is $3,280,
which is the sum of S's additional section 263A costs allocable to
ending inventory and S's section 471 costs remaining in ending
inventory ($280 + $3,000). S includes the balance of S's additional
section 263A costs incurred during 2013 in S's cost of goods sold.
Example 2. LIFO inventory method. (i) The facts are the same as
in Example 1, except that S uses the LIFO inventory method rather
than the FIFO method. S calculates additional section 263A costs
incurred during the taxable year and allocable to ending inventory
under paragraph (c)(3)(iii) of this section and identifies the
following costs incurred during the test period:
----------------------------------------------------------------------------------------------------------------
2010 2011 2012
----------------------------------------------------------------------------------------------------------------
Additional section 263A costs incurred during the taxable year $ 100 $ 150 $ 200
allocable to ending inventory..................................
Section 471 costs incurred during the taxable year that remain 1,000 1,400 2,100
in ending inventory............................................
----------------------------------------------------------------------------------------------------------------
In 2013, the LIFO value of S's increment is $1,500.
(ii) Under paragraph (c)(4)(iii) of this section, S computes a
combined historic absorption ratio as follows:
[GRAPHIC] [TIFF OMITTED] TP05SE12.023
(iii) S's additional section 263A costs allocable to its 2013
LIFO increment is $150 ($1,500 beginning LIFO increment * 10 percent
combined historic absorption ratio). S adds the $150 to the $1,500
LIFO increment to determine a total 2013 LIFO increment of $1,650.
* * * * *
(g) Effective/applicability date. Paragraphs (b)(2)(i)(D), and (f)
of this section apply for taxable years ending on or after August 2,
2005. Paragraph (c) of this section applies for taxable years ending on
or after the date these
[[Page 54490]]
regulations are published as final regulations in the Federal Register.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2012-21743 Filed 9-4-12; 8:45 am]
BILLING CODE 4830-01-P