Presentation on theme: "Capitalization and Accounting Methods Update"— Presentation transcript:
1 Capitalization and Accounting Methods Update Presented by:Sharon Kay – Washington National Tax:Kristine Mora – Washington National Tax:
2 NoticeAny US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code, or applicable state or local tax law provisionsThese slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice
5 Accounting method timeline and procedural considerations 2012 automatic 3115 due11 For properly extended corporate and partnership tax returns.03/31/201301/01/201312/31/201211/13/201290 day window periodTypical timeline for calendar-year taxpayers2012 non-automatic 3115 due2013 non-automatic 3115 due109/15/201312/31/2013Automatic Accounting Method ChangesNon-automatic Accounting Method ChangesFiling DeadlineDue date of tax return for year of changeLast day of tax year of changeImplementation of ChangeImplement on tax return for year of change; no user feesMay not implement on tax return until consent received; user fee requiredTaxpayers Under Examination may only file(1) Within first 90 days of a tax year if taxpayer has been under examination for at least 12 months;(2) Within 120 days of an examination ending; or(3) With the consent of the Director(4) For automatic changes, taxpayer may file method change if automatic change procedure specifies the change is not subject to audit protection.Things to consider:Information needed to file a Form 3115?How long will it take to document a method change?Implementation impacts timing of section 481(a) adjustment, financial statement reporting and potentially estimated taxesNon-automatic method changes being considered as part of cash tax planning strategyDuring window period, taxpayers under exam may file with no consent requirement (as long as item not raised during exam)Audit protection for unfavorable changes filed during 90-day windowFile accounting method changes to mitigate Form UTP disclosure exposure
6 Accounting method changes trends Top 5 method changes we’ve filed in the past yearAccrued bonus liability – typically unfavorable adjustmentDepreciation – typically favorable adjustmentUNICAP – both favorable and unfavorable adjustmentsDeferral of advance payments – typically favorable adjustmentsRepairs – typically favorable adjustmentsLatest trendsChanges for earnings and profits of CFCsComputer software development and ERP implementationsOpportunity if there is corporate tax reformCrystal ball for the next yearPredict that 9 out of top 10 most commonly filed will be from the 19 tangibles regulations method changes, if IRS does not delay effective dateThe 10th will be UNICAPBONUSES – continues to be a hot areaIs an automatic method changeFocus – amount fixed and determinable, and amount paid within 2 ½ months of year-end (economic performance met in most instances)Key – amount must be fixed in taxable year to take deduction in taxable yearProblems arise with respect to requirements in place to receive bonusBonus “pools” ok – allow deduction under 2 ½ month ruleDEPRECIATIONAutomatic depreciation method changes include:Impermissible to permissible method of accounting for depreciation or amortizationPermissible to permissible method of accounting for depreciation or amortizationRecent trends of taxpayers addressing items such asRecovery periodsMissed bonus depreciationUseful for catching-up alternative minimum tax (“AMT”) depreciation deductions to reduce AMTUNICAP -Recent trends of taxpayers:Changing to burden rate methodsNon-automatic method changeChanging to simplified methodsGenerally an automatic method changeElecting/revoking the historic absorption ratioLock in a low rateReduce administrative effortMay be an automatic or non-automatic method changeComplianceRequirement to be in compliance for many automatic method changesADVANCE PMTS - To qualify as an advance payment, a taxpayer must have a continuing obligation under the requisite contract. Common categories to consider are: (1)Service agreements; (2)Goods; (3)Guaranty and warranty contracts; (4)Payments for the use of certain intellectual property; (5)Sale, license, lease or maintenance of computer software; (6)Subscriptions; (7)Memberships; (8)Gift CardsTwo methods of accounting for advance payments under Rev. Proc : Full inclusion method ;and Deferral method .For advance payments for goods, taxpayers may also consider deferral under Treas. Reg. Sec (BUT Longer deferral period than under and requires advance consent of IRS).
8 Materials and supplies Depreciation and dispositions Overview - tangible property regulationsMaterials and suppliesAcquisitionsImprovementsDepreciation and dispositions§ T§1.263(a)-2T§1.263(a)-3T§§1.168(i)-1T, -7T, -8T§1.263(a)-1TDefinition of material and supplyThree categories that determine when deductible:Incidental supplyNon-incidental supplyRotable spare partsElection to deduct under de minimis rule in acquisition regulationsElection to capitalize and depreciateDe minimis expensing used for AFS allowed if less than ceiling (applied to each regarded entity)Capitalize costs that facilitate acquisition of propertyWhether and which test for real propertyExpense employee compensation and overhead, but may elect to capitalizeCapitalize costs to defend or perfect title to propertyDefinition of unit of property is generally functional interdependence except for:BuildingsPlant propertyLeased propertyImprovement defined:BettermentRestorationNew or different useSafe harbor for routine maintenance on property other than buildingsSafe harbor for certain regulated entitiesNo plan of rehabilitationDepreciation accountsSingle asset accountsMass asset accountsGeneral asset accountsDispositionsGeneral rulesRequired to recognize disposition of structural componentsReasonable identification methodsCapitalize facilitative costs for sales of property by non-dealersDeduct dealer expenses for salesOther issues include: coordination with section 263A, mass asset accounting
9 Transition rules Revenue Procedures 2012-19 and 2012-20 What does compliance with Section 263A (UNICAP) mean?Improvements and other self-constructed propertyImprovement includes capitalized repairs and is subject to Section 263AMust allocate costs in addition to invoice price such asAllocable portion of the department that negotiates with repairmen and supervises the work performedAllocable portion of support departments such as payroll, HR, legal, etc. that support the above departmentProbably not eligible under the automatic procedures due to methods typically usedTherefore, must file by the last day of the tax year to request advance consentScope is not waivedInventoryMay be eligible to file under the automatic procedures, but for now scope is not waivedIRS is considering making selected methods automatic and waiving scope
10 Developing an implementation plan Assess current stateAssess current state of accounting methods and elections as well as the current processes and available data and systems that support themUnderstand required/allowed stateUnderstand required state under new regulations as well as elections/optional methods for potential opportunities and how these differ from current stateDetermine impact on other areasModel requirements/opportunities to determine impact on other federal tax items (e.g., §199 deduction, inventory and PCM computations), state taxable income, E&P, etc., and to evaluate financial statement considerationsDevelop solutions for implementing changesPrioritize issues and develop solutions for changes to data tracking and business processes/systems, computations and documentation of complianceSuccess-based fees are amounts paid that are contingent on the successful closing of a transactionTreatment under Treas. Reg. §1.263(a)-5Amounts paid to facilitate business acquisition or reorganization transactions described in Treas. Reg. §1.263(a)-5(e)(3) (i.e., covered transactions) are required to be capitalizedGenerally, amounts are paid to facilitate a covered transaction if they are paid in the process of investigating or otherwise pursuing the transactionSuccess-based fees are presumed to “facilitate the transaction”Presumption may be rebutted by sufficient documentation to establish that a portion of the fee is allocable to activities that do not facilitate the transaction (non-facilitative activities)Determine resources needed to implementDevelop workplan for implementation of new methods/elections, computation of §481(a) adjustments, tax return reporting (including Forms 3115 and elections), documentation for potential IRS exam, and financial statement considerations
13 Inventory accounting — legislative / regulatory update Proposed regulationsSales-based royaltiesVendor allowancesRetail inventory methodNegative 263A costsPresident's Fiscal 2013 budget proposals:Last in, first out (LIFO) repealLower of cost or market (LCM) repealSubnormal goods write-downs repeal
14 Uniform Capitalization (UNICAP) planning: Why now? Mandatory compliance in order to fall within automatic change procedures for the tangible property regulationsOther considerations:Bonus depreciationReduce taxable incomeRemediate potential exposureNet operating loss (NOL) companiesNewly acquired entitiesChanges to book inventory costing methods
15 UNICAP planning: Common opportunities Adopt a burden rate method or new proposed modified simplified production method (if finalized)Embedded costsR&DDeprecation on temporarily idle facilitiesWarranty and product liabilityPolicy-making/budgetingElect the historic absorption ratioLock in a low rateReduce administrative effort
16 UNICAP planning: Potential exposures Common exposure areasBook/tax differences are not allocatedAbsorption ratio has not been updatedOperations have changes since last UNICAP studyContract manufacturing for retailers or distributorsService providers (e.g., restaurants) should be treated as producersFollowing book capitalization for self-constructed assets
17 Other 263A Considerations – Self-constructed assets Applies to real or tangible personal property produced by the taxpayer and applies to property produced by a company for use in its trade or business (“self- constructed asset”).Definition includes construct, build, install, manufacture, develop, improveIncludes capitalizable improvementsApplies to taxpayers that have property produced by a contractorThe company that contracts to have property constructed for it is treated as self-constructing the asset to the extent it makes progress payments or otherwise incurs cost with respect to the property.Indirect costs incurred by the company (e.g., construction period interest, oversight and general and administrative expenses) for which the property is being produced must be capitalized by that company as a cost of the propertyCurrently most self-constructed asset Section 263A changes are non- automatic and must be filed by the last day of the tax year
18 UNICAP: Negative 263A costs Proposed Regulations A negative amount generally occurs when a taxpayer capitalizes a cost as a Section 471 cost that is greater than the amount required to be capitalized for tax purposes, which the taxpayer seeks to remove from inventory cost using its 263A formula.In Notice , the IRS stated that, pending the issuance of additional guidance, it would not challenge the inclusion of negative amounts in calculating additional costs under Section 263A or the permissibility of aggregate negative additional Section 263A costs.
19 UNICAP: Negative 263A costs Proposed Regulations Proposed regulations that generally prohibit the inclusion of negative additional 263A costs subject to a few exceptions:Small taxpayersSimplified resale methodModified simplified production method (discussed on next slide)All other taxpayers must reduce 471 costs using a method that approximates the manner in which the taxpayer originally capitalized the costsThe proposed regulations would generally prohibit treating cash or trade discounts under Reg. Section (b) as negative amounts under either simplified method.
20 UNICAP: Negative 263A costs Proposed Regulations New modified simplified production methodTwo absorption ratiosPreproductionProductionAllows negative additional Section 263A treatmentReduce the distortionsMay be favorable but additional work if currently using SPMPreproduction costs applied to raw material AND raw material content of WIP and finished goodsMany of the benefits of burden rate methods but with less work
21 UNICAP: Negative 263A costs Proposed Regulations Adopt a new definition of Section 471 costsApplies to all taxpayers regardless methods usedAll costs, other than interest, that a taxpayer capitalizes to its inventory in its financial statements.Must include direct labor and direct materialConsistent with what most taxpayers are currently doing in practice
22 Other inventory planning Reduce taxable incomeLIFOAutomate LIFO computationsAdopt LIFO for additional inventoryChange from internal to external inflation indexes or vice versaTerminate LIFO for deflationary goods (e.g., pools with debit LIFO reserve)Reconstruct base-year cost if inflationary; do not reconstruct if deflationaryInventory write-downs (non-LIFO taxpayers only)Lower of cost or marketSubnormal goods (e.g., expired products, obsolete inventory)Retail inventory methodInventory shrinkCharitable contributions of inventoryChargebacks