IRS will no longer challenge negative additional sec. 263A costs.

• Author: Lueck, Michael

Negative additional Sec. 263A costs generally arise when taxpayers capitalize certain expenses for financial accounting purposes, but are not required or permitted to capitalize them for tax purposes. The Service recently issued Notice 2007-29 to provide interim guidance on this issue. Until further guidance is published, the IRS has stated that it will not challenge taxpayers who use their Sec. 263A allocation methods to allocate negative costs between ending inventory and cost of goods sold.

Generally, negative additional Sec. 263A costs are costs that are not required or permitted to be capitalized for Federal income tax purposes, but are capitalized for financial reporting purposes. These costs may be reflected as unfavorable Schedule M adjustments (such as excess book over tax depreciation), or they may not be required to be capitalized for Federal income tax purposes (such as Sec. 174 costs),but have to be included in Sec. 471 costs.

Notice 2007-29

In the notice, Treasury and the IRS announced that they are reviewing the propriety of using negative Sec. 263A costs in computing additional costs for purposes of the simplified accounting methods under Sec. 263A (the uniform capitalization rules (UNICAP)). Until future guidance is published, Notice 2007-29 provides that:

1. The Service will not challenge the inclusion of negative amounts in computing additional costs under Sec. 263A or the permissibility of aggregate negative additional Sec. 263A costs;

2. The IRS will not raise these issues in any tax year ending on or before publication of anticipated guidance;

3. If already raised as an issue in examination or before Appeals or the Tax Court, the issue will not be pursued by the Service; and

4. The IRS will not deny consent for changes in method of accounting solely on the basis that the proposed method involves the inclusion of negative amounts in computing additional costs under Sec. 263A. However, it will not grant a taxpayer permission to treat a cost as a negative Sec. 263A cost unless the taxpayer already treats it as a Sec. 471 cost.

   In Notice 2007-29, the government also requested comments as to types of costs and instances in which negative Sec. 263A costs are appropriate, as well as possible modifications or additions to the existing simplified methods for allocating those costs.

   Overview

   Sec. 263A provides specific capitalization rules for certain producers and resellers. Prior to its enactment, manufacturers were required to...