Sales-related expenses remove taxpayers from 'small reseller' exception of sec. 263A.

• Author: MacDonald, Brenna

Recent appellate court rulings unfavorable to taxpayers and their application of Sec. 263A provide additional guidance regarding the required capitalization of certain indirect costs and the interpretation of Robinson Knife Mfg. Co., 600 F.3d 121 (2d Cir. 2010), nonacq. 2011-1 C.B., for the exclusion of sales-related expenses. In September 2015, the Second and Fifth Circuits affirmed two 2013 Tax Court decisions regarding the application of Sec. 263A to inventory produced and acquired for resale by taxpayers that had considered themselves to be exempt from Sec. 263A.

The uniform capitalization (UNICAP) rules of Sec. 263A require capitalization of direct costs and indirect costs that directly benefit or are incurred by reason of production or resale activities. Under Sec. 263A and Regs. Sec. 1.263A-1(e), capitalizable indirect costs include purchasing costs, storage and handling costs, and general and administrative-type "service" costs that support or partially support production or resale activities. Capitalizable indirect costs specifically exclude sales- and marketing-related costs and service costs that do not support production or resale activities. However, Sec. 263A(b)(2)(B) provides a "small reseller" exception for taxpayers engaged in resale activities with average annual gross receipts of $10 million or less based on the prior three tax years. Taxpayers qualifying for the small reseller exception are exempt from the UNICAP rules.

In City Line Candy & Tobacco Corp., No. 14-3793-ag (2d Cir. 9/30/15), aff'g 141 T.C. 414 (2013), the Second Circuit affirmed the Tax Court's decision that a wholesale cigarette dealer was required to recognize tax stamp revenue in gross receipts and was therefore subject to Sec. 263A as a result of not meeting the small reseller exclusion. In addition, the court upheld the Tax Court's decision that the taxpayer was required under Sec. 263A to capitalize purchased cigarette tax stamps as an indirect storage and handling cost.

City Line, a wholesale cigarette dealer, was licensed as a stamping agent in the state of New York, which provided the company a commission for stamping services. New York state law imposes an excise tax on cigarettes by requiring a state-issued tax stamp on cigarettes packaged for sale. As a licensed stamping agent, City Line purchased tax stamps and applied the stamps to packages of cigarettes before selling them to retailers or wholesalers.

As required by state law, the taxpayer...