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Lane
Lane, CFP, MBA, CRPS
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Experience:  Providing Financial & Tax advice since 1986
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What are the practical steps to analyze Sec 263A for a manufacturer

Resolved Question:

What are the practical steps to analyze Sec 263A for a manufacturer that produces gadgets?
Submitted: 6 months ago.
Category: Tax
Expert:  Lane replied 6 months ago.

Lane :

The Uniform Capitalization (UNICAP) rules of section 263A of the Internal Revenue Code (IRC) prescribe the method for determining the types and amounts of costs that must be capitalized, rather than expensed in the current period.

The UNICAP rules apply to those, who in the course of a trade or business, produce real or tangible personal property for the use in the business or activity; produce real or tangible personal property for sale to customers; or acquire property for resale. However, if the taxpayer’s annual gross receipts do not exceed $10 million the rules do not apply.

To determine whether or not an activity is a production activity, several factors must be considered, including whether the process adds utility to the product, makes the product more suitable for use or consumption, or transforms the material into more readily marketable materials.


The UNICAP rules require a taxpayer to capitalize all direct costs and certain indirect costs properly allocable to property produced or property acquired for resale.

Direct costs are defined as the direct material costs and direct labor costs for a producer and the acquisition costs for a reseller.

Indirect costs are defined as all costs other than those considered direct material costs and direct labor costs or acquisition costs. Indirect costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities. Indirect costs can be categorized into two groups: those that must be capitalized and those that are allowed to be expensed in the current period.


The UNICAP rules allow for certain indirect costs to be expensed in the current period. These costs include the marketing, selling, advertising, and distribution expenses, general and administrative expenses not related to production, non-production officers salaries, research and experimental expenses, as well as depreciation, amortization and cost recovery allowances on equipment and facilities that are temporarily idle.


A taxpayer that produces property must capitalize all costs incurred before, during and after the production process of the property. Pre-production costs must be capitalized, including the costs of storing raw materials and the carrying costs related to the holding of realty for future development. Production period costs are those costs that fall between the date on which production begins and production ends. Production is deemed to have ended once the property is placed in service or ready for sale. Any costs incurred after the production process would be considered a post production costs. Post production activities include storage, warehousing, insurance, and handling. Interest, however, need only be capitalized during the production stage.


There are various methods that can be used to allocate the direct and indirect costs to the property produced. Depending on the taxpayer’s needs and type of production, a specific and detailed identification method can be used. These methods, the burden rate method and the standard cost method tend to be rather complex and may not be suitable for all taxpayers.
The most common approach to capitalizing indirect costs to inventory under the UNICAP rules is to use the simplified service cost method in conjunction with its simplified production method.


The approach uses a three step process to apply the UNICAP rules. The taxpayer determines what portion of the mixed service costs is allocable to production. The costs should be classified into one of three different categories:



  1. Costs that can be capitalized

  2. Deductible costs and

  3. Mixed service costs. Mixed service costs are defined as those costs that are only partially allocable to production activities. These costs are generally administrative or supportive in nature.


The taxpayer will then calculate the percentage of additional section 263A costs to capitalize to production costs. The additional 263A costs include mixed service costs allocable to production activities and indirect production costs that have not already been capitalized by the taxpayer. The additional 263A costs are then divided by the current year’s code section 471 costs. These are the costs that were included in the entities method of accounting immediately prior to the effective date of the UNICAP rules. The regulations refer to this computation as the absorption ratio.


Finally, the taxpayer will multiply the computed absorption ratio with the code section 471 costs. The resulting number will then be added to the ending inventory amount.


The UNICAP rules will affect almost any corporation that has inventories. Many of the costs that were previously deductible as period costs are now accumulated and allocated between the costs of goods sold and inventory. The UNICAP rules delay the expensing of capitalized costs which ultimately results in the acceleration of taxable income.

Lane :

I still don't see you coming into the chat session, so I'll move us to the "Q&A" mode. … Maybe that will help … (We can still continue a dialogue there, just not in real-time chat, as we can here)

Lane :

Let me know if you need anything else at all on this.



Lane

Expert:  Lane replied 6 months ago.
Our chat has ended, but you can still continue to ask me questions here until you are satisfied with your answer. Come back to this page to view our conversation and any other new information.

What happens now?

If you haven’t already done so, please rate your answer above. Or, you can reply to me using the box below.
Expert:  Lane replied 6 months ago.


Hi kendrick,

... just checking back in here, as I never saw you come into the chat.

Again, let me know if you have questions.

DO read through what I provided above.

Then if you still have any questions, specific to YOUR situation, let me know.

Lane

Expert:  Lane replied 6 months ago.

As a quick follow-up, here's the IRS guidance (the revenue ruling that applies here) AND some specific steps/examples that might help to apply...

Part I Section 263A. - Internal Revenue Service



Hope this helps

Lane
Customer: replied 6 months ago.


I am online now. Can we chat now?

Expert:  Lane replied 6 months ago.

So sorry ... waited for about 5 minutes... was afraid I'd lost you.

And by moving to Q&A, that gives all the time we need to go back and forth BUT they (JustAnswer) don't provide a way to go back.

We can either continue here (again we can still continue a dialogue back and for the, just not in real-time chat...

OR you can just let this one time out and ask a new question.

As long as you don't rate my answer, your deposit won't be used.

Let me know... (OR, again, just let this one time out and ask the question again) ...

If nothing else maybe by reading what I provided, you can ask a more pointed question next time around.

Lane




Lane, CFP, MBA, CRPS
Category: Tax
Satisfied Customers: 3119
Experience: Providing Financial & Tax advice since 1986
Lane and 6 other Tax Specialists are ready to help you
Customer: replied 6 months ago.

Thank you. I will first read what you sent me and will ask you specific questions if I have any. Appreciate your help!

Expert:  Lane replied 6 months ago.

Sounds good.

Let me know.

Lane

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