Sec. 263A: historic absorption ratio - simplify your UNICAP calculation.

• Author: Cesnik, Gary R.
• Position: Uniform capitalization

The August 1993 issuance of final uniform capitalization (UNICAP) regulations under Sec. 263A introduced the "historic absorption ratio," allowing taxpayers the opportunity to elect this method in their first, second or third tax year beginning after Dec. 31, 1993. The historic absorption ratio could be a very favorable option for taxpayers to consider.

Historic absorption ratio--the basics

The historic absorption ratio is available to taxpayers using (or changing to) the simplified production method under Regs. Sec. 1.263A-2(b)(4) or the simplified resale method under Regs. Sec. 1.263A-3(d)(4). The historic absorption ratio is based on a three-year test period preceding the year of change. It is calculated by taking the ratio of the prior three years' additional Sec. 263A costs to Sec. 471 costs (e.g., 1994 historic ratio is based on 1991 through 1993). Once the historic absorption ratio is determined and elected, the taxpayer uses this ratio for five years without the need to recalculate UNICAP each year.

In the sixth year, the taxpayer recalculates an absorption ratio for this year (recomputation year). If the computed ratio for the sixth year alone is within one-half of one percentage point (plus or minus) of the previous historic absorption ratio (i.e., the ratio used in the previous five tax years), the taxpayer continues with the previous historic ratio for the recomputation year and the following five tax years. If, however, the recomputed ratio is not within those limits, the taxpayer must use the actual absorption ratios calculated for each of the sixth, seventh and eighth tax years. Then, in the ninth year, the taxpayer resumes with a new historic absorption ratio based on the actual ratios calculated for each of the sixth, seventh and eighth tax years. Note: The historic absorption ratio is elected by attaching a statement to the taxpayer's tax return showing the calculation of the historic absorption ratio to be used.

Transition rules--adopt a simplified method and correct UNICAP

calculation

The historic absorption ratio transition rules permit taxpayers to elect the historic absorption ratio method in their first, second or third tax year beginning after Dec. 31, 1993, with the IRS's automatic consent. This election is permitted during this transition period whether or not the taxpayer used the simplified production method or simplified resale method in prior tax years. (Remember the historic absorption ratio is normally...