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

2. 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. Agenda Accounting method changes trends Tangible property regulations
Inventory update

4. Accounting method changes trends

5. Accounting method timeline and procedural considerations
2012 automatic 3115 due1
1 For properly extended corporate and partnership tax returns.
03/31/2013
01/01/2013
12/31/2012
11/13/2012
90 day window period
Typical timeline for calendar-year taxpayers
2012 non-automatic 3115 due
2013 non-automatic 3115 due1
09/15/2013
12/31/2013
Automatic Accounting Method Changes
Non-automatic Accounting Method Changes
Filing Deadline
Due date of tax return for year of change
Last day of tax year of change
Implementation of Change
Implement on tax return for year of change; no user fees
May not implement on tax return until consent received; user fee required
Taxpayers 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 taxes
Non-automatic method changes being considered as part of cash tax planning strategy
During 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 window
File accounting method changes to mitigate Form UTP disclosure exposure

6. Accounting method changes trends
Top 5 method changes we’ve 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 10th will be UNICAP
BONUSES – continues to be a hot area
Is an automatic method change
Focus – 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 year
Problems arise with respect to requirements in place to receive bonus
Bonus “pools” ok – allow deduction under 2 ½ month rule
DEPRECIATION
Automatic depreciation method changes include:
Impermissible to permissible method of accounting for depreciation or amortization
Permissible to permissible method of accounting for depreciation or amortization
Recent trends of taxpayers addressing items such as
Recovery periods
Missed bonus depreciation
Useful for catching-up alternative minimum tax (“AMT”) depreciation deductions to reduce AMT
UNICAP -Recent trends of taxpayers:
Changing to burden rate methods
Non-automatic method change
Changing to simplified methods
Generally an automatic method change
Electing/revoking the historic absorption ratio
Lock in a low rate
Reduce administrative effort
May be an automatic or non-automatic method change
Compliance
Requirement to be in compliance for many automatic method changes
ADVANCE 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 Cards
Two 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).

7. Tangible property regulations

8. Materials and supplies Depreciation and dispositions
Overview - tangible property regulations
Materials and supplies
Acquisitions
Improvements
Depreciation 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)
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
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

9. Transition rules Revenue Procedures 2012-19 and 2012-20
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. 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
Success-based fees are amounts paid that are contingent on the successful closing of a transaction
Treatment under Treas. Reg. §1.263(a)-5
Amounts 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 capitalized
Generally, amounts are paid to facilitate a covered transaction if they are paid in the process of investigating or otherwise pursuing the transaction
Success-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 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. Inventory Agenda: Legislative / Regulatory Update
Section 263A (UNICAP)
Overview
Proposed regulations for negative Section 263A costs
Self-constructed assets
Other inventory planning

13. 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. 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. UNICAP planning: Common 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. 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. 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. 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 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. 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. 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. 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. Questions and answers ?

24. Thanks for participating