IRS issues prop. regs. on allocation of costs under simplified sec. 263A methods.

• Author: Mora, Kristine

The IRS has issued proposed regulations (REG-126770-06) on allocating costs to property produced or acquired by a taxpayer for resale.

Background

Under Sec. 263A, taxpayers must capitalize the direct and indirect costs that are properly allocable to (1) real or tangible personal property the taxpayer produces and (2) real and personal property described in Sec. 1221(a)(1) that the taxpayer acquires for resale. Existing Regs. Sec. 1.263A-1(e)(2)(i) defines "direct costs" for producers as direct material costs and direct labor costs. Existing Regs. Sec. 1.263A-1(e)(2)(ii) requires resellers to capitalize the acquisition cost of property acquired for resale. Existing Regs. Sec. 1.263A-1(e)(3)(i) defines "indirect costs" as all costs other than direct material and labor costs for property produced and as all other costs other than acquisition costs for 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 production or resale activities.

To allocate capitalizable Sec. 263A costs to specific items in inventory, Regs. Secs. 1.263A-1(f)(1), (f)(2), and (f)(3) allow taxpayers to elect a facts-and-circumstances allocation method (e.g., specific identification method, burden rate, or standard cost method), provided the method is reasonable within the meaning of Regs. Sec. 1.263A-1(f)(4). Taxpayers may also use one of the simplified methods provided in Regs. Sec. 1.263A-2(b) or 1.263A-3(d) in lieu of a facts-and-circumstances allocation method. Many taxpayers have adopted one of the simplified methods to ease the administrative burden associated with preparing these tax calculations.

Under the simplified production method in Regs. Sec. 1.263A-2(b), a taxpayer must capitalize additional Sec. 263A costs to produced property that is on hand at the end of the tax year, based on the ratio of those additional Sec. 263A costs incurred during the year to the taxpayer's total Sec. 471 inventory costs incurred during the year (the absorption ratio). Additional Sec. 263A costs are costs, other than interest, that were not capitalized under the taxpayer's accounting method immediately before the effective date of Sec. 263A, but that are required to be capitalized under Sec. 263A (preamble to REG-126770-06). Under Regs. Sec. 1.263A-1(d)(2), Sec. 471 costs generally are the costs, other than interest, capitalized under a taxpayer's method of...