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Capitalization and Accounting Methods Update

Capitalization and Accounting Methods Update. Presented by: Sharon Kay – Washington National Tax: 202 327 6556 Kristine Mora – Washington National Tax: 202 327 6092 . Notice.

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Capitalization and Accounting Methods Update

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  1. Capitalization and Accounting Methods Update Presented by: Sharon Kay – Washington National Tax: 202 327 6556 Kristine Mora – Washington National Tax: 202 327 6092

  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 2013 non-automatic 3115 due1 Typical timeline for calendar-year taxpayers 2012 automatic 3115 due1 2012 non-automatic 3115 due 90 day window period 12/31/2013 09/15/2013 03/31/2013 01/01/2013 12/31/2012 11/13/2012 1For properly extended corporate and partnership tax returns.

  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

  7. Tangible property regulations

  8. Overview - tangible property regulations

  9. 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 Transition rules

  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. 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 • 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 costsProposed 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 2007-29, 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 costsProposed 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 1.471-3(b) as negative amounts under either simplified method.

  20. UNICAP: Negative 263A costsProposed 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 costsProposed 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

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