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Capitalization and Accounting Methods Update Presented by: Sharon Kay – Washington National Tax: 202 327 6556 Kristine Mora – Washington National Tax:

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Presentation on theme: "Capitalization and Accounting Methods Update Presented by: Sharon Kay – Washington National Tax: 202 327 6556 Kristine Mora – Washington National Tax:"— Presentation transcript:

1 Capitalization and Accounting Methods Update Presented by: Sharon Kay – Washington National Tax: Kristine Mora – Washington National Tax:

2 Page Notice Any 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 provisions These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice

3 Page Agenda Accounting method changes trends Tangible property regulations Inventory update

4 Accounting method changes trends

5 Page 5 Accounting method timeline and procedural considerations 2012 automatic 3115 due 1 1 For properly extended corporate and partnership tax returns. 03/31/ /01/ /31/ /13/ day window period Typical timeline for calendar-year taxpayers 2012 non- automatic 3115 due 09/15/ non- automatic 3115 due 1 12/31/2013

6 Page Accounting method changes trends Top 5 method changes weve filed in the past year Accrued bonus liability – typically unfavorable adjustment Depreciation – typically favorable adjustment UNICAP – both favorable and unfavorable adjustments Deferral of advance payments – typically favorable adjustments Repairs – typically favorable adjustments Latest trends Changes for earnings and profits of CFCs Computer software development and ERP implementations Opportunity if there is corporate tax reform Crystal ball for the next year Predict that 9 out of top 10 most commonly filed will be from the 19 tangibles regulations method changes, if IRS does not delay effective date The 10 th will be UNICAP

7 Tangible property regulations

8 Page 8 Materials and supplies AcquisitionsImprovementsDepreciation and dispositions § T§1.263(a)-2T§1.263(a)-3T§§1.168(i)-1T, -7T, -8T §1.263(a)-1T Definition of material and supply Three categories that determine when deductible: Incidental supply Non-incidental supply Rotable spare parts Election to deduct under de minimis rule in acquisition regulations Election to capitalize and depreciate De minimis expensing used for AFS allowed if less than ceiling (applied to each regarded entity) Election to capitalize and depreciate Capitalize costs that facilitate acquisition of property Whether and which test for real property Expense employee compensation and overhead, but may elect to capitalize Capitalize costs to defend or perfect title to property Definition of unit of property is generally functional interdependence except for: Buildings Plant property Leased property Improvement defined: Betterment Restoration New or different use Safe harbor for routine maintenance on property other than buildings Safe harbor for certain regulated entities No plan of rehabilitation Leased property Depreciation accounts Single asset accounts Mass asset accounts General asset accounts Dispositions General rules Required to recognize disposition of structural components Reasonable identification methods Capitalize facilitative costs for sales of property by non-dealers Deduct dealer expenses for sales Other issues include: coordination with section 263A, mass asset accounting Overview - tangible property regulations

9 Page 9 Transition rules Revenue Procedures and What does compliance with Section 263A (UNICAP) mean? Improvements and other self-constructed property Improvement includes capitalized repairs and is subject to Section 263A Must allocate costs in addition to invoice price such as Allocable portion of the department that negotiates with repairmen and supervises the work performed Allocable portion of support departments such as payroll, HR, legal, etc. that support the above department Probably not eligible under the automatic procedures due to methods typically used Therefore, must file by the last day of the tax year to request advance consent Scope is not waived Inventory May be eligible to file under the automatic procedures, but for now scope is not waived IRS is considering making selected methods automatic and waiving scope

10 Page 10 Developing an implementation plan Assess current state Assess current state of accounting methods and elections as well as the current processes and available data and systems that support them Understand required/allowed state Understand required state under new regulations as well as elections/optional methods for potential opportunities and how these differ from current state Determine impact on other areas Model 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 considerations Develop solutions for implementing changes Prioritize issues and develop solutions for changes to data tracking and business processes/systems, computations and documentation of compliance Determine resources needed to implement Develop 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

11 Inventory update

12 Page Inventory Agenda: Legislative / Regulatory Update Section 263A (UNICAP) Overview Proposed regulations for negative Section 263A costs Self-constructed assets Other inventory planning

13 Page Inventory accounting legislative / regulatory update Proposed regulations Sales-based royalties Vendor allowances Retail inventory method Negative 263A costs President's Fiscal 2013 budget proposals: Last in, first out (LIFO) repeal Lower of cost or market (LCM) repeal Subnormal goods write-downs repeal

14 Page Uniform Capitalization (UNICAP) planning: Why now? Mandatory compliance in order to fall within automatic change procedures for the tangible property regulations Other considerations: Bonus depreciation Reduce taxable income Remediate potential exposure Net operating loss (NOL) companies Newly acquired entities Changes to book inventory costing methods

15 Page UNICAP planning: Common opportunities Opportunities: Adopt a burden rate method or new proposed modified simplified production method (if finalized) Embedded costs R&D Deprecation on temporarily idle facilities Warranty and product liability Policy-making/budgeting Elect the historic absorption ratio Lock in a low rate Reduce administrative effort

16 Page UNICAP planning: Potential exposures Common exposure areas Book/tax differences are not allocated Absorption ratio has not been updated Operations have changes since last UNICAP study Contract manufacturing for retailers or distributors Service providers (e.g., restaurants) should be treated as producers Following book capitalization for self-constructed assets

17 Page 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, improve Includes capitalizable improvements Applies to taxpayers that have property produced by a contractor The 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 property Currently most self-constructed asset Section 263A changes are non- automatic and must be filed by the last day of the tax year

18 Page 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 Page UNICAP: Negative 263A costs Proposed Regulations Proposed regulations that generally prohibit the inclusion of negative additional 263A costs subject to a few exceptions: Small taxpayers Simplified resale method Modified 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 costs The proposed regulations would generally prohibit treating cash or trade discounts under Reg. Section (b) as negative amounts under either simplified method.

20 Page UNICAP: Negative 263A costs Proposed Regulations New modified simplified production method Two absorption ratios Preproduction Production Allows negative additional Section 263A treatment Reduce the distortions May be favorable but additional work if currently using SPM Preproduction costs applied to raw material AND raw material content of WIP and finished goods Many of the benefits of burden rate methods but with less work

21 Page UNICAP: Negative 263A costs Proposed Regulations Adopt a new definition of Section 471 costs Applies to all taxpayers regardless methods used All costs, other than interest, that a taxpayer capitalizes to its inventory in its financial statements. Must include direct labor and direct material Consistent with what most taxpayers are currently doing in practice

22 Page Other inventory planning Reduce taxable income LIFO Automate LIFO computations Adopt LIFO for additional inventory Change from internal to external inflation indexes or vice versa Terminate LIFO for deflationary goods (e.g., pools with debit LIFO reserve) Reconstruct base-year cost if inflationary; do not reconstruct if deflationary Inventory write-downs (non-LIFO taxpayers only) Lower of cost or market Subnormal goods (e.g., expired products, obsolete inventory) Retail inventory method Inventory shrink Charitable contributions of inventory Chargebacks

23 Page Questions and answers

24 Page Thanks for participating


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