Reg. § 1.263A-2 Rules relating to property produced by the taxpayer.
(a) In general Section applies to real property and tangible personal property produced by a taxpayer for use in its trade or business or for sale to its customers. In addition, section applies to property produced for a taxpayer under a contract with another party. The principal terms related to the scope of section with respect to producers are provided in this . See for an exception in the case of certain de minimis property provided to customers incident to the provision of services. For taxable years beginning after December 31, 2017, see for an exception in the case of a small business taxpayer that meets the gross receipts test of section and .
(1) Produce
(i) In general For purposes of section , produce includes the following: construct, build, install, manufacture, develop, improve, create, raise, or grow.
(ii) Ownership
(A) General rule Except as provided in and of this section, a taxpayer is not considered to be producing property unless the taxpayer is considered an owner of the property produced under federal income tax principles. The determination as to whether a taxpayer is an owner is based on all of the facts and circumstances, including the various benefits and burdens of ownership vested with the taxpayer. A taxpayer may be considered an owner of property produced, even though the taxpayer does not have legal title to the property.
(B) Property produced for the taxpayer under a contract
(1) In general Property produced for the taxpayer under a contract with another party is treated as property produced by the taxpayer to the extent the taxpayer makes payments or otherwise incurs costs with respect to the property. A taxpayer has made payment under this section if the transaction would be considered payment by a taxpayer using the cash receipts and disbursements method of accounting.
(2) Definition of a contract
(i) General rule Except as provided under of this section, a contract is any agreement providing for the production of property if the agreement is entered into before the production of the property to be delivered under the contract is completed. Whether an agreement exists depends on all the facts and circumstances. Facts and circumstances indicating an agreement include, for example, the making of a prepayment, or an arrangement to make a prepayment, for property prior to the date of the completion of production of the property, or the incurring of significant expenditures for property of specialized design or specialized application that is not intended for self-use.
(ii) Routine purchase order exception A routine purchase order for fungible property is not treated as a contract for purposes of this section. An agreement will not be treated as a routine purchase order for fungible property, however, if the contractor is required to make more than de minimis modifications to the property to tailor it to the customer's specific needs, or if at the time the agreement is entered into, the customer knows or has reason to know that the contractor cannot satisfy the agreement within 30 days out of existing stocks and normal production of finished goods.
(C) Home construction contracts. Section applies to a home construction contract unless that contract will be completed within two years of the contract commencement date, and, for contracts entered into after December 31, 2017, in taxable years ending after December 31, 2017, the taxpayer meets the gross receipts test of section and for the taxable year in which such contract is entered into. Except as otherwise provided in this , section applies to such a contract even if the contractor is not considered the owner of the property produced under the contract under Federal income tax principles.
(2) Tangible personal property
(i) General rule In general, section applies to the costs of producing tangible personal property, and not to the costs of producing intangible property. For example, section applies to the costs manufacturers incur to produce goods, but does not apply to the costs financial institutions incur to originate loans.
(ii) Intellectual or creative property For purposes of determining whether a taxpayer producing intellectual or creative property is producing tangible personal property or intangible property, the term tangible personal property includes films, sound recordings, video tapes, books, and other similar property embodying words, ideas, concepts, images, or sounds by the creator thereof. Other similar property for this purpose generally means intellectual or creative property for which, as costs are incurred in producing the property, it is intended (or is reasonably likely) that any tangible medium in which the property is embodied will be mass distributed by the creator or any one or more third parties in a form that is not substantially altered. However, any intellectual or creative property that is embodied in a tangible medium that is mass distributed merely incident to the distribution of a principal product or good of the creator is not other similar property for these purposes.
(A) Intellectual or creative property that is tangible personal property Section applies to tangible personal property defined in this without regard to whether such property is treated as tangible or intangible property under other sections of the Internal Revenue Code. Thus, for example, section applies to the costs of producing a motion picture or researching and writing a book even though these assets may be considered intangible for other purposes of the Internal Revenue Code. Tangible personal property includes, for example, the following:
(1) Books The costs of producing and developing books (including teaching aids and other literary works) required to be capitalized under this section include costs incurred by an author in researching, preparing, and writing the book. (However, see section , which provides an exemption from the capitalization requirements of section in the case of certain free-lance authors.) In addition, the costs of producing and developing books include prepublication expenditures incurred by publishers, including payments made to authors (other than commissions for sales of books that have already taken place), as well as costs incurred by publishers in writing, editing, compiling, illustrating, designing, and developing the books. The costs of producing a book also include the costs of producing the underlying manuscript, copyright, or license. (These costs are distinguished from the separately capitalizable costs of printing and binding the tangible medium embodying the book (e.g., paper and ink).) See , which provides that the term research or experimental expenditures does not include expenditures incurred for research in connection with literary, historical, or similar projects.
(2) Sound recordings A sound recording is a work that results from the fixation of a series of musical, spoken, or other sounds, regardless of the nature of the material objects, such as discs, tapes, or other phonorecordings, in which such sounds are embodied.
(B) Intellectual or creative property that is not tangible personal property Items that are not considered tangible personal property within the meaning of section and of this section include:
(1) Evidences of value Tangible personal property does not include property that is representative or evidence of value, such as stock, securities, debt instruments, mortgages, or loans.
(2) Property provided incident to services Tangible personal property does not include de minimis property provided to a client or customer incident to the provision of services, such as wills prepared by attorneys, or blueprints prepared by architects. See .
(3) Costs required to be capitalized by producers
(i) In general Except as specifically provided in section with respect to interest costs, producers must capitalize direct and indirect costs properly allocable to property produced under section , without regard to whether those costs are incurred before, during, or after the production period (as defined in section ).
(ii) Pre-production costs If property is held for future production, taxpayers must capitalize direct and indirect costs allocable to such property (e.g., purchasing, storage, handling, and other costs), even though production has not begun. If property is not held for production, indirect costs incurred prior to the beginning of the production period must be allocated to the property and capitalized if, at the time the costs are incurred, it is reasonably likely that production will occur at some future date. Thus, for example, a manufacturer must capitalize the costs of storing and handling raw materials before the raw materials are committed to production. In addition, a real estate developer must capitalize property taxes incurred with respect to property if, at the time the taxes are incurred, it is reasonably likely that the property will be subsequently developed.
(iii) Post-production costs Generally, producers must capitalize all indirect costs incurred subsequent to completion of production that are properly allocable to the property produced. Thus, for example, storage and handling costs incurred while holding the property produced for sale after production must be capitalized to the property to the extent properly allocable to the property. However, see for exceptions.
(4) Practical capacity concept Notwithstanding any provision to the contrary, the use, directly or indirectly, of the practical capacity concept is not permitted under section . For purposes of section , the term practical capacity concept means any concept, method, procedure, or formula (such as the practical capacity concept described in ) whereunder fixed costs are not capitalized because of the relationship between the actual production at the taxpayer's production facility and the practical capacity of the facility. For purposes of this section, the practical capacity of a facility includes either the practical capacity or theoretical capacity of the facility, as defined in , or any similar determination of productive or operating capacity. The practical capacity concept may not be used with respect to any activity to which section applies (i.e., production or resale activities). A taxpayer shall not be considered to be using the practical capacity concept solely because the taxpayer properly does not capitalize costs described in , relating to certain costs attributable to temporarily idle equipment.
(5) Taxpayers required to capitalize costs under this section This section generally applies to taxpayers that produce property. If a taxpayer is engaged in both production activities and resale activities, the taxpayer applies the principles of this section as if it read production or resale activities, and by applying appropriate principles from . If a taxpayer is engaged in both production and resale activities, the taxpayer may elect the simplified production method or the modified simplified production method provided in this section, but generally may not elect the simplified resale method discussed in . If elected, the simplified production method or the modified simplified production method must be applied to all eligible property produced and all eligible property acquired for resale by the taxpayer.
(b) Simplified production method
(1) Introduction This provides a simplified method for determining the additional section costs properly allocable to ending inventories of property produced and other eligible property on hand at the end of the taxable year.
(2) Eligible property
(i) In general Except as otherwise provided in of this section, the simplified production method, if elected for any trade or business of a producer, must be used for all production and resale activities associated with any of the following categories of property to which section applies:
(A) Inventory property Stock in trade or other property properly includible in the inventory of the taxpayer.
(B) Non-inventory property held for sale Non-inventory property held by a taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.
(C) Certain self-constructed assets Self-constructed assets substantially identical in nature to, and produced in the same manner as, inventory property produced by the taxpayer or other property produced by the taxpayer and held primarily for sale to customers in the ordinary course of the taxpayer's trade or business.
(D) Self-constructed tangible personal property produced on a routine and repetitive basis
(1) In general Self-constructed tangible personal property produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer's trade or business. Self-constructed tangible personal property is produced by the taxpayer on a routine and repetitive basis in the ordinary course of the taxpayer's trade or business when units of tangible personal property (as defined in ) are mass-produced, that is, numerous substantially identical assets are manufactured within a taxable year using standardized designs and assembly line techniques, and either the applicable recovery period of the property determined under section is not longer than 3 years or the property is a material or supply that will be used and consumed within 3 years of being produced. For purposes of this , the applicable recovery period of the assets will be determined at the end of the taxable year in which the assets are placed in service for purposes of . Subsequent changes to the applicable recovery period after the assets are placed in service will not affect the determination of whether the assets are produced on a routine and repetitive basis for purposes of this .
(2) Examples The following examples illustrate this :
Example 1. Y is a manufacturer of automobiles. During the taxable year Y produces numerous substantially identical dies and molds using standardized designs and assembly line techniques. The dies and molds have a 3-year applicable recovery period for purposes of section . Y uses the dies and molds to produce or process particular automobile components and does not hold them for sale. The dies and molds are produced on a routine and repetitive basis in the ordinary course of Y's business for purposes of this paragraph because the dies and molds are both mass-produced and have a recovery period of not longer than 3 years.
Example 2. Z is an electric utility that regularly manufactures and installs identical poles that are used in transmitting and distributing electricity. The poles have a 20-year applicable recovery period for purposes of section . The poles are not produced on a routine and repetitive basis in the ordinary course of Z's business for purposes of this paragraph because the poles have an applicable recovery period that is longer than 3 years.
(ii) Election to exclude self-constructed assets At the taxpayer's election, the simplified production method may be applied within a trade or business to only the categories of inventory property and non-inventory property held for sale described in and of this section. Taxpayers electing to exclude the self- constructed assets, defined in and of this section, from application of the simplified production method must, however, allocate additional section costs to such property in accordance with .
(3) Simplified production method without historic absorption ratio election
(i) General allocation formula
(A) In general Except as otherwise provided in of this section, the additional section costs allocable to eligible property remaining on hand at the close of the taxable year under the simplified production method are computed as follows:
(B) Effect of allocation The absorption ratio generally is multiplied by the section costs remaining in ending inventory or otherwise on hand at the end of each taxable year in which the simplified production method is applied. The resulting product is the additional section costs that are added to the taxpayer's ending section costs to determine the section costs that are capitalized. See, however, of this section for special rules applicable to LIFO taxpayers. Except as otherwise provided in this section or in or , additional section costs that are allocated to inventories on hand at the close of the taxable year under the simplified production method of this are treated as inventory costs for all purposes of the Internal Revenue Code.
(ii) Definitions
(A) Absorption ratio Under the simplified production method, the absorption ratio is determined as follows:
(1) Additional section 263A costs incurred during the taxable year Additional section costs incurred during the taxable year are defined as the additional section costs described in that a taxpayer incurs during its current taxable year.
(2) Section 471 costs incurred during the taxable year Section costs incurred during the taxable year are defined as the section costs described in that a taxpayer incurs during its current taxable year.
(B) Section 471 costs remaining on hand at year end Section costs remaining on hand at year end means the section costs, as defined in , that a taxpayer incurs during its current taxable year which remain in its ending inventory or are otherwise on hand at year end. For LIFO inventories of a taxpayer, the section costs remaining on hand at year end means the increment, if any, for the current year stated in terms of section costs. See of this section.
(C) Costs allocated to property sold Additional section costs incurred during the taxable year, as defined in of this section, section costs incurred during the taxable year, as defined in of this section, and section costs remaining on hand at year end, as defined in of this section, do not include costs described in or cost reductions described in that a taxpayer properly allocates entirely to property that has been sold.
(iii) LIFO taxpayers electing the simplified production method
(A) In general Under the simplified production method, a taxpayer using a LIFO method must calculate a particular year's index (e.g., under ) without regard to its additional section costs. Similarly, a taxpayer that adjusts current-year costs by applicable indexes to determine whether there has been an inventory increment or decrement in the current year for a particular LIFO pool must disregard the additional section costs in making that determination.
(B) LIFO increment If the taxpayer determines there has been an inventory increment, the taxpayer must state the amount of the increment in current-year dollars (stated in terms of section costs). The taxpayer then multiplies this amount by the absorption ratio. The resulting product is the additional section costs that must be added to the taxpayer's increment for the year stated in terms of section costs.
(C) LIFO decrement If the taxpayer determines there has been an inventory decrement, the taxpayer must state the amount of the decrement in dollars applicable to the particular year for which the LIFO layer has been invaded. The additional section costs incurred in prior years that are applicable to the decrement are charged to cost of goods sold. The additional section costs that are applicable to the decrement are determined by multiplying the additional section costs allocated to the layer of the pool in which the decrement occurred by the ratio of the decrement (excluding additional section costs) to the section costs in the layer of that pool.
(iv) De minimis rule for producers with total indirect costs of $200,000 or less
(A) In general If a producer using the simplified production method incurs $200,000 or less of total indirect costs in a taxable year, the additional section costs allocable to eligible property remaining on hand at the close of the taxable year are deemed to be zero. Solely for purposes of this , taxpayers are permitted to exclude any category of indirect costs (listed in ) that is not required to be capitalized (e.g., selling and distribution costs) in determining total indirect costs.
(B) Related party and aggregation rules In determining whether the producer incurs $200,000 or less of total indirect costs in a taxable year, the related party and aggregation rules of are applied by substituting total indirect costs for gross receipts wherever gross receipts appears.
(v) Examples The provisions of this are illustrated by the following examples.
Example 1. FIFO inventory method.
(i) Taxpayer J uses the FIFO method of accounting for inventories. J's beginning inventory for 1994 (all of which is sold during 1994) is $2,500,000 (consisting of $2,000,000 of section costs and $500,000 of additional section costs). During 1994, J incurs $10,000,000 of section costs and $1,000,000 of additional section costs. J's additional section costs include capitalizable mixed service costs computed under the simplified service cost method as well as other allocable costs. J's section costs remaining in ending inventory at the end of 1994 are $3,000,000. J computes its absorption ratio for 1994, as follows:
(ii) Under the simplified production method, J determines the additional section costs allocable to its ending inventory by multiplying the absorption ratio by the section costs remaining in its ending inventory:
(iii) J adds this $300,000 to the $3,000,000 of section costs remaining in its ending inventory to calculate its total ending inventory of $3,300,000. The balance of J's additional section costs incurred during 1994, $700,000, ($1,000,000 less $300,000) is taken into account in 1994 as part of J's cost of goods sold.
Example 2. LIFO inventory method.
(i) Taxpayer K uses a dollar-value LIFO inventory method. K's beginning inventory for 1994 is $2,500,000 (consisting of $2,000,000 of section costs and $500,000 of additional section costs). During 1994, K incurs $10,000,000 of section costs and $1,000,000 of additional section costs. K's 1994 LIFO increment is $1,000,000 ($3,000,000 of section costs in ending inventory less $2,000,000 of section costs in beginning inventory).
(ii) To determine the additional section costs allocable to its ending inventory, K multiplies the 10% absorption ratio ($1,000,000 of additional section costs divided by $10,000,000 of section costs) by the $1,000,000 LIFO increment. Thus, K's additional section costs allocable to its ending inventory are $100,000 ($1,000,000 multiplied by 10%). This $100,000 is added to the $1,000,000 to determine a total 1994 LIFO increment of $1,100,000. K's ending inventory is $3,600,000 (its beginning inventory of $2,500,000 plus the $1,100,000 increment). The balance of K's additional section costs incurred during 1994, $900,000 ($1,000,000 less $100,000), is taken into account in 1994 as part of K's cost of goods sold.
(iii) In 1995, K sells one-half of the inventory in its 1994 LIFO increment. K must include in its cost of goods sold for 1995 the amount of additional section costs relating to this inventory, $50,000 (one-half of the tional section costs capitalized in 1994 ending inventory, or $100,000).
Example 3. LIFO pools.
(i) Taxpayer U begins its business in 1994 and adopts the LIFO inventory method. During 1994, L incurs $10,000 of section costs and $1,000 of additional section costs. At the end of 1994, L's ending inventory includes $3,000 of section costs contained in three LIFO pools (X, Y, and Z) as shown below. Under the simplified production method, L computes its absorption ratio and inventory for 1994 as follows:
| Total | X | Y | Z | |
|---|---|---|---|---|
| 1994: | ||||
| Ending section 471 costs | $3,000 | $1,600 | $600 | $800 |
| Additional section 263A costs (10%) | 300 | 160 | 60 | 80 |
| 1994 ending inventory | $3,300 | $1,760 | $660 | $880 |
(ii) During 1995, L incurs $2,000 of section costs as shown below and $400 of additional section costs. Moreover, L sells goods from pools X, Y, and Z having a total cost of $1,000. L computes its absorption ratio and inventory for 1995:
| Total | X | Y | Z | |
|---|---|---|---|---|
| 1995: | ||||
| Beginning section 471 costs | $3,000 | $1,600 | $600 | $800 |
| 1995 section 471 costs | 2,000 | 1,500 | 300 | 200 |
| Section 471 cost of goods sold | (1,000) | (300) | (300) | (400) |
| 1995 ending section 471 costs | $4,000 | $2,800 | $600 | $600 |
| Consisting of: | ||||
| 1994 layer | $2,800 | $1,600 | $600 | $600 |
| 1995 layer | 1,200 | 1,200 | ||
| $4,000 | $2,800 | $600 | $600 | |
| Additional section 263A costs: | ||||
| 1994 (10%) | $280 | $160 | $60 | $60 |
| 1995 (20%) | 240 | 240 | ||
| $520 | $400 | $60 | $60 | |
| 1995 ending inventory | $4,520 | $3,200 | $660 | $660 |
(iii) In 1995, L experiences a $200 decrement in pool Z. Thus, L must charge the additional section costs incurred in prior years applicable to the decrement to 1995's cost of goods sold. To do so, L determines a ratio by dividing the decrement by the section costs in the 1994 layer ($200 divided by $800, or 25%). L then multiplies this ratio (25%) by the additional section costs in the 1994 layer ($80) to determine the additional section costs applicable to the decrement ($20). Therefore, $20 is taken into account by L in 1995 as part of its cost of goods sold ($80 multiplied by 25%).
(4) Simplified production method with historic absorption ratio election
(i) In general This generally permits producers using the simplified production method to elect a historic absorption ratio in determining additional section costs allocable to eligible property remaining on hand at the close of their taxable years. Except as provided in of this section, a taxpayer may only make a historic absorption ratio election if it has used the simplified production method for three or more consecutive taxable years immediately prior to the year of election and has capitalized additional section costs using an actual absorption ratio (as defined under
of this section) for its three most recent consecutive taxable years. This method is not available to a taxpayer that is deemed to have zero additional section costs under of this section. The historic absorption ratio is used in lieu of an actual absorption ratio computed under of this section and is based on costs capitalized by a taxpayer during its test period. If elected, the historic absorption ratio must be used for each taxable year within the qualifying period described in of this section.
(ii) Operating rules and definitions
(A) Historic absorption ratio
(1) The historic absorption ratio is equal to the following ratio:
(2) Additional section costs incurred during the test period are defined as the additional section costs described in that the taxpayer incurs during the test period described in of this section.
(3) Section costs incurred during the test period mean the section costs described in that the taxpayer incurs during the test period described in of this section.
(4) Additional section costs incurred during the test period, as defined in of this section, and section costs incurred during the test period, as defined in of this section, do not include costs specifically described in or cost reductions described in that a taxpayer properly allocates entirely to property that has been sold.
(B) Test period
(1) In general The test period is generally the three taxable-year period immediately prior to the taxable year that the historic absorption ratio is elected.
(2) Updated test period The test period begins again with the beginning of the first taxable year after the close of a qualifying period. This new test period, the updated test period, is the three taxable-year period beginning with the first taxable year after the close of the qualifying period as defined in of this section.
(C) Qualifying period
(1) In general A qualifying period includes each of the first five taxable years beginning with the first taxable year after a test period (or an updated test period).
(2) Extension of qualifying period In the first taxable year following the close of each qualifying period, (e.g., the sixth taxable year following the test period), the taxpayer must compute the actual absorption ratio under the simplified production method. If the actual absorption ratio computed for this taxable year (the recomputation year) is within one-half of one percentage point (plus or minus) of the historic absorption ratio used in determining capitalizable costs for the qualifying period (i.e., the previous five taxable years), the qualifying period is extended to include the recomputation year and the following five taxable years, and the taxpayer must continue to use the historic absorption ratio throughout the extended qualifying period. If, however, the actual absorption ratio computed for the recomputation year is not within one-half of one percentage point (plus or minus) of the historic absorption ratio, the taxpayer must use actual absorption ratios beginning with the recomputation year under the simplified production method and throughout the updated test period. The taxpayer must resume using the historic absorption ratio (determined with reference to the updated test period) in the third taxable year following the recomputation year.
(iii) Method of accounting
(A) Adoption and use The election to use the historic absorption ratio is a method of accounting. A taxpayer using the simplified production method may elect the historic absorption ratio in any taxable year if permitted under this , provided the taxpayer has not obtained the Commissioner's consent to revoke the historic absorption ratio election within its prior six taxable years. The election is to be effected on a cut-off basis, and thus, no adjustment under section is required or permitted. The use of a historic absorption ratio has no effect on other methods of accounting adopted by the taxpayer and used in conjunction with the simplified production method in determining its section costs. Accordingly, in computing its actual absorption ratios, the taxpayer must use the same methods of accounting used in computing its historic absorption ratio during its most recent test period unless the taxpayer obtains the consent of the Commissioner. Finally, for purposes of this , the recomputation of the historic absorption ratio during an updated test period and the change from a historic absorption ratio to an actual absorption ratio by reason of the requirements of this are not considered changes in methods of accounting under section and, thus, do not require the consent of the Commissioner or any adjustments under section .
(B) Revocation of election A taxpayer may only revoke its election to use the historic absorption ratio with the consent of the Commissioner in a manner prescribed under section and the regulations thereunder. Consent to the change for any taxable year that is included in the qualifying period (or an extended qualifying period) will be granted only upon a showing of unusual circumstances.
(iv) Reporting and recordkeeping requirements
(A) Reporting A taxpayer making an election under this must attach a statement to its federal income tax return for the taxable year in which the election is made showing the actual absorption ratios determined under the simplified production method during its first test period. This statement must disclose the historic absorption ratio to be used by the taxpayer during its qualifying period. A similar statement must be attached to the federal income tax return for the first taxable year within any subsequent qualifying period (i.e., after an updated test period).
(B) Recordkeeping A taxpayer must maintain all appropriate records and details supporting the historic absorption ratio until the expiration of the statute of limitations for the last year for which the taxpayer applied the particular historic absorption ratio in determining additional section costs capitalized to eligible property.
(v)
(A) Transition to elect historic absorption ratio Taxpayers will be permitted to elect a historic absorption ratio in their first, second, or third taxable year beginning after December 31, 1993, under such terms and conditions as may be prescribed by the Commissioner. Taxpayers are eligible to make an election under these transition rules whether or not they previously used the simplified production method. A taxpayer making such an election must recompute (or compute) its additional section costs, and thus, its historic absorption ratio for its first test period as if the rules prescribed in this section and and had applied throughout the test period.
(B) Transition to revoke historic absorption ratio Notwithstanding the requirements provided in of this section regarding revocations of the historic absorption ratio during a qualifying period, a taxpayer will be permitted to revoke the historic absorption ratio in their first, second, or third taxable year ending on or after November 20, 2018, under such administrative procedures and with terms and conditions prescribed by the Commissioner.
(vi) Example The provisions of this are illustrated by the following example:
Example.
(i) Taxpayer M uses the FIFO method of accounting for inventories and for 1994 elects to use the historic absorption ratio with the simplified production method. After recomputing its additional section costs in accordance with the transition rules of of this section, M identifies the following costs incurred during the test period:
1991:
Add'l section costs—$100
Section costs—$3,000
1992:
Add'l section costs—$200
Section costs—$4,000
1993:
Add'l section costs—$300
Section costs—$5,000
(ii) Therefore, M computes a 5% historic absorption ratio determined as follows:
(iii) In 1994, M incurs $10,000 of section costs of which $3,000 remain in inventory at the end of the year. Under the simplified production method using a historic absorption ratio, M determines the additional section costs allocable to its ending inventory by multiplying its historic absorption ratio (5%) by the section costs remaining in its ending inventory as follows:
(iv) To determine its ending inventory under section , M adds the additional section costs allocable to ending inventory to its section costs remaining in ending inventory ($3,150 = $150 + $3,000). The balance of M's additional section costs incurred during 1994 is taken into account in 1994 as part of M's cost of goods sold.
(v) M's qualifying period ends with the close of its 1998 taxable year. Therefore, 1999 is a recomputation year in which M must compute its actual absorption ratio. M determines its actual absorption ratio for 1999 to be 5.25% and compares that ratio to its historic absorption ratio (5.0%). Therefore, M must continue to use its historic absorption ratio of 5.0% throughout an extended qualifying period, 1999 through 2004 (the recomputation year and the following five taxable years).
(vi) If, instead, M's actual absorption ratio for 1999 were not between 4.5% and 5.5%, M's qualifying period would end and M would be required to compute a new historic absorption ratio with reference to an updated test period of 1999, 2000, and 2001. Once M's historic absorption ratio is determined for the updated test period, it would be used for a new qualifying period beginning in 2002.
(c) Modified simplified production method
(1) Introduction This provides a simplified method for determining the additional section costs properly allocable to ending inventories of property produced and other eligible property on hand at the end of the taxable year.
(2) Eligible property
(i) In general Except as otherwise provided in of this section, the modified simplified production method, if elected for any trade or business of a producer, must be used for all production and resale activities associated with any of the categories of property to which section applies as described in of this section.
(ii) Election to exclude-self-constructed assets A taxpayer using the modified simplified production method may elect to exclude self-constructed assets from application of the modified simplified production method by following the same rules applicable to a taxpayer using the simplified production method provided in of this section.
(3) Modified simplified production method without historic absorption ratio election
(i) General allocation formula
(A) In general Except as otherwise provided in of this section, the additional section costs allocable to eligible property remaining on hand at the close of the taxable year under the modified simplified production method are computed as follows:
(B) Effect of allocation The pre-production and production absorption ratios generally are multiplied by the pre-production and production section costs, respectively, remaining in ending inventory or otherwise on hand at the end of each taxable year in which the modified simplified production method is applied. The sum of the resulting products is the additional section costs that are added to the taxpayer's ending section costs to determine the section costs that are capitalized. See, however, of this section for special rules applicable to LIFO taxpayers. Except as otherwise provided in this section or in or , additional section costs that are allocated to inventories on hand at the close of the taxable year under the modified simplified production method of this are treated as inventory costs for all purposes of the Internal Revenue Code.
(ii) Definitions
(A) Direct material costs For purposes of of this section, direct material costs has the same meaning as described in . For purposes of of this section, direct material costs include property produced for the taxpayer under a contract with another party that are direct material costs for the taxpayer to be used in an additional production process of the taxpayer.
(B) Pre-production absorption ratio Under the modified simplified production method, the pre-production absorption ratio is determined as follows:
(1) Pre-production additional section 263A costs Pre-production additional section costs are defined as the additional section costs described in that are pre-production costs, as described in of this section, that a taxpayer incurs during its current taxable year, including capitalizable mixed service costs allocable to pre-production additional section costs, as described in of this section, that a taxpayer incurs during its current taxable year:
(i) Plus additional section costs properly allocable to property acquired for resale that a taxpayer incurs during its current taxable year; and
(ii) Plus additional section costs properly allocable to property produced for the taxpayer under a contract with another party that is treated as property produced by the taxpayer, as described in of this section, that a taxpayer incurs during its current taxable year.
(2) Pre-production section 471 costs Pre-production section costs are defined as the section costs described in that are direct material costs that a taxpayer incurs during its current taxable year plus the section costs for property acquired for resale (see ) that a taxpayer incurs during its current taxable year, including property produced for the taxpayer under a contract with another party that is acquired for resale.
(C) Pre-production section 471 costs remaining on hand at year end Pre-production section costs remaining on hand at year end means the pre-production section costs, as defined in of this section, that a taxpayer incurs during its current taxable year which remain in its ending inventory or are otherwise on hand at year end, excluding the section costs that are direct material costs that have entered or completed production at year end (for example, direct material costs in ending work-in-process inventory and ending finished goods inventory). For LIFO inventories of a taxpayer, see of this section.
(D) Production absorption ratio Under the modified simplified production method, the production absorption ratio is determined as follows:
(1) Production additional section 263A costs Production additional section costs are defined as the additional section costs described in that are not pre-production additional section costs, as defined in of this section, that a taxpayer incurs during its current taxable year, including capitalizable mixed service costs not allocable to pre-production additional section costs, as described in of this section, that a taxpayer incurs during its current taxable year. For example, production additional section costs include post-production costs, other than post-production costs included in section costs, as described in of this section.
(2) Residual pre-production additional section 263A costs Residual pre-production additional section costs are defined as the pre-production additional section costs, as defined in of this section, that a taxpayer incurs during its current taxable year less the product of the pre-production absorption ratio, as determined in of this section, and the pre-production section costs remaining on hand at year end, as defined in of this section.
(3) Production section 471 costs Production section costs are defined as the section costs described in that a taxpayer incurs during its current taxable year less pre-production section costs, as defined in of this section, that a taxpayer incurs during its current taxable year.
(4) Direct materials adjustment The direct materials adjustment is defined as the section costs that are direct material costs, including property produced for a taxpayer under a contract with another party that are direct material costs for the taxpayer to be used in an additional production process of the taxpayer, that had not entered production at the beginning of the current taxable year:
(i) Plus the section costs that are direct material costs incurred during the current taxable year (that is, direct material purchases); and
(ii) Less the section costs that are direct material costs that have not entered production at the end of the current taxable year.
(E) Production section 471 costs remaining on hand at year end Production section costs remaining on hand at year end means the section costs, as defined in , that a taxpayer incurs during its current taxable year which remain in its ending inventory or are otherwise on hand at year end, less the pre-production section costs remaining on hand at year end, as described in of this section. For LIFO inventories of a taxpayer, see of this section.
(F) Costs allocated to property sold The terms defined in of this section do not include costs described in or cost reductions described in that a taxpayer properly allocates entirely to property that has been sold.
(iii) Allocable mixed service costs
(A) In general If a taxpayer using the modified simplified production method determines its capitalizable mixed service costs using a method described in , the taxpayer must use a reasonable method to allocate the costs (for example, department or activity costs) between production and pre-production additional section costs. If the taxpayer's method allocates costs to a department or activity that is exclusively identified as production or pre-production, those costs must be allocated to production or pre-production additional section costs, respectively.
(B) Taxpayer using the simplified service cost method If a taxpayer using the modified simplified production method determines its capitalizable mixed service costs using the simplified service cost method described in , the amount of capitalizable mixed service costs, as computed using the general allocation formula in , allocated to and included in pre-production additional section costs in the absorption ratio described in of this section is determined based on either of the following: The proportion of direct material costs to total section costs that a taxpayer incurs during its current taxable year or the proportion of pre-production labor costs to total labor costs that a taxpayer incurs during its current taxable year. The taxpayer must include the capitalizable mixed service costs that are not allocated to pre-production additional section costs in production additional section costs in the absorption ratio described in of this section. A taxpayer that allocates capitalizable mixed service costs based on labor under this must exclude mixed service labor costs from both pre-production labor costs and total labor costs.
(C) De minimis rule Notwithstanding and of this section, if 90 percent or more of a taxpayer's capitalizable mixed service costs determined under or of this section are allocated to pre-production additional section costs or production additional section costs, the taxpayer may elect to allocate 100 percent of its capitalizable mixed service costs to that amount. For example, if 90 percent of capitalizable mixed service costs are allocated to production additional section costs based on the labor costs that are pre-production costs in total labor costs incurred in the taxpayer's trade or business during the taxable year, then 100 percent of capitalizable mixed service costs may be allocated to production additional section costs. An election to allocate capitalizable mixed service costs under this is the adoption of, or a change in, a method of accounting under section of the Internal Revenue Code.
(iv) LIFO taxpayers electing the modified simplified production method
(A) In general Under the modified simplified production method, a taxpayer using a LIFO method must calculate a particular year's index (for example, under ) without regard to its additional section costs. Similarly, a taxpayer that adjusts current-year costs by applicable indexes to determine whether there has been an inventory increment or decrement in the current year for a particular LIFO pool must disregard the additional section costs in making that determination.
(B) LIFO increment
(1) In general If the taxpayer determines there has been an inventory increment, the taxpayer must state the amount of the increment in terms of section costs in current-year dollars. The taxpayer then multiplies this amount by the combined absorption ratio, as defined in of this section. The resulting product is the additional section costs that must be added to the taxpayer's increment in terms of section costs in current-year dollars for the taxable year.
(2) Combined absorption ratio defined For purposes of of this section, the combined absorption ratio is the additional section costs allocable to eligible property remaining on hand at the close of the taxable year, as described in of this section, determined on a non-LIFO basis, divided by the pre-production and production section costs remaining on hand at year end, determined on a non-LIFO basis.
(C) LIFO decrement If the taxpayer determines there has been an inventory decrement, the taxpayer must state the amount of the decrement in dollars applicable to the particular year for which the LIFO layer has been invaded. The additional section costs incurred in prior years that are applicable to the decrement are charged to cost of goods sold. The additional section costs that are applicable to the decrement are determined by multiplying the additional section costs allocated to the layer of the pool in which the decrement occurred by the ratio of the decrement, excluding additional section costs, to the section costs in the layer of that pool.
(v) De minimis rule for producers with total indirect costs of $200,000 or less of this section, which provides that the additional section costs allocable to eligible property remaining on hand at the close of the taxable year are deemed to be zero for producers with total indirect costs of $200,000 or less, applies to the modified simplified production method.
(vi) Examples The provisions of this are illustrated by the following examples:
(A) Example 1—FIFO inventory method
(1) Taxpayer P uses the FIFO method of accounting for inventories valued at cost. P's beginning inventory for 2018 (all of which is sold during 2018) is $2,500,000, consisting of $500,000 of pre-production section costs (including $400,000 of direct material costs and $100,000 of property acquired for resale), $1,500,000 of production section costs, and $500,000 of additional section costs. During 2018, P incurs $2,500,000 of pre-production section costs (including $1,900,000 of direct material costs and $600,000 of property acquired for resale), $7,500,000 of production section costs, $200,000 of pre-production additional section costs, and $800,000 of production additional section costs. P's additional section costs include capitalizable mixed service costs under the simplified service cost method. P's pre-production and production section costs remaining in ending inventory at the end of 2018 are $1,000,000 (including $800,000 of direct material costs and $200,000 of property acquired for resale) and $2,000,000, respectively. P computes its pre-production absorption ratio for 2018 under of this section, as follows:
(2) Under of this section, P's residual pre-production additional section costs for 2018 are $120,000 ($200,000 of pre-production additional section costs less $80,000 (the product of the 8% pre-production absorption ratio and the $1,000,000 of pre-production section costs remaining on hand at year end)).
(3) Under of this section, P's direct materials adjustment for 2018 is $1,500,000 ($400,000 of direct material costs in beginning raw materials inventory, plus $1,900,000 of direct material costs incurred to acquire raw materials during the taxable year, less $800,000 direct material costs in ending raw materials inventory).
(4) P computes its production absorption ratio for 2018 under of this section, as follows:
(5) Under the modified simplified production method, P determines the additional section costs allocable to its ending inventory under of this section by multiplying the pre-production absorption ratio by the pre-production section costs remaining on hand at year end and the production absorption ratio by the production section costs remaining on hand at year end, as follows:
Additional section costs = (8% × $1,000,000) + (10.22% × $2,000,000) = $284,400
(6) P adds this $284,400 to the $3,000,000 of section costs remaining on hand at year end to calculate its total ending inventory of $3,284,400. The balance of P's additional section costs incurred during 2018, $715,600 ($1,000,000 less $284,400), is taken into account in 2018 as part of P's cost of goods sold.
(7) P's computation is summarized in the following table:
| Reference | Amount | |
|---|---|---|
| Beginning Inventory: | ||
| Direct material costs | a | $ 400,000 |
| Property acquired for resale | b | 100,000 |
| Pre-production section 471 costs | c = a + b | 500,000 |
| Production section 471 costs | d | 1,500,000 |
| Additional section 263A costs | e | 500,000 |
| Total | f = c d + e | 2,500,000 |
| Incurred During 2018: | ||
| Direct material costs | g | 1,900,000 |
| Property acquired for resale | h | 600,000 |
| Pre-production section 471 costs | i = g + h | 2,500,000 |
| Production section 471 costs | j | 7,500,000 |
| Pre-production additional section 263A costs | k | 200,000 |
| Production additional section 263A costs | l | 800,000 |
| Total | m = i + j + k + l | 11,000,000 |
| Ending Inventory: | ||
| Direct material costs | n | 800,000 |
| Property acquired for resale | o | 200,000 |
| Pre-production section 471 costs | p = n + o | 1,000,000 |
| Production section 471 costs | q | 2,000,000 |
| Section 471 costs | r = p + q | 3,000,000 |
| Additional section 263A costs allocable to ending inventory | s = v + z | 284,400 |
| Total | t = r + s | 3,284,400 |
| Modified Simplified Production Method: | ||
| Pre-production additional section 263A costs | k | 200,000 |
| Pre-production section 471 costs | i | 2,500,000 |
| Pre-production absorption ratio | u = k / i | 8.00% |
| Pre-production section 471 costs remaining on hand at year end | p | 1,000,000 |
| Pre-production additional section 263A costs allocable to ending inventory | v = u * p | 80,000 |
| Production additional section 263A costs | l | 800,000 |
| Residual pre-production additional section 263A costs | w = k−(u * p) | 120,000 |
| Production section 471 costs | j | 7,500,000 |
| Direct materials adjustment | x = a + g−n | 1,500,000 |
| Production absorption ratio | y = (l + w) / (j + x) | 10.22% |
| Production section 471 costs remaining on hand at year end | q | 2,000,000 |
| Production additional section 263A costs allocable to ending inventory | z = y * q | 204,400 |
| Summary: | ||
| Pre-production additional section 263A costs allocable to ending inventory | v | 80,000 |
| Production additional section 263A costs allocable to ending inventory | z | 204,400 |
| Additional section 263A costs allocable to ending inventory | s | 284,400 |
| Section 471 costs | r | 3,000,000 |
| Total Ending Inventory | t | 3,284,400 |
(B) Example 2—FIFO inventory method with alternative method to determine amounts of section 471 costs
(1) The facts are the same as in Example 1 of of this section, except that P uses the alternative method to determine amounts of section costs by using its financial statement under rather than tax amounts under . In 2018, P's production section costs exclude $40,000 of tax depreciation in excess of financial statement depreciation and include $50,000 of financial statement direct labor in excess of tax direct labor. These are P's only differences in its book and tax amounts.
(2) Under , the positive $40,000 depreciation adjustment and the negative $50,000 direct labor adjustment must be included in additional section costs. Accordingly, P's production additional section costs are $790,000 ($800,000 plus $40,000 less $50,000).
(3) P computes its production absorption ratio for 2018 under of this section, as follows:
(4) Under the modified simplified production method, P determines the additional section costs allocable to its ending inventory under of this section by multiplying the pre-production absorption ratio by the pre-production section costs remaining on hand at year end and the production absorption ratio by the production section costs remaining on hand at year end, as follows:
Additional section costs = (8.00% × $1,000,000) + (10.11% × $2,000,000) = $282,200
(5) P adds this $282,200 to the $3,000,000 of section costs remaining on hand at year end to calculate its total ending inventory of $3,282,200. The balance of P's additional section costs incurred during 2018, $717,800 ($1,000,000 less $282,200), is taken into account in 2018 as part of P's cost of goods sold.
(C) Example 3—LIFO inventory method
(1) The facts are the same as in Example 1 of of this section, except that P uses a dollar-value LIFO inventory method rather than the FIFO method. P's 2018 LIFO increment is $1,500,000.
(2) Under of this section, to determine the additional section costs allocable to its ending inventory, P multiplies the combined absorption ratio by the $1,500,000 of LIFO increment. Under of this section, the combined absorption ratio is 9.48% ($284,400 additional section costs allocable to ending inventory, determined on a non-LIFO basis, divided by $3,000,000 of section costs on hand at year end, determined on a non-LIFO basis). Thus, P's additional section costs allocable to its ending inventory are $142,200 ($1,500,000 multiplied by 9.48%). This $142,200 is added to the $1,500,000 to determine a total 2018 LIFO increment of $1,642,200. The balance of P's additional section costs incurred during 2018, $857,800 ($1,000,000 less $142,200), is taken into account in 2018 as part of P's cost of goods sold.
(3) In 2019, P sells one-half of the inventory in its 2018 increment. P must include in its cost of goods sold for 2019 the amount of additional section costs relating to this inventory, $71,100 (one-half of the $142,200 additional section costs capitalized in 2018 ending inventory).
(D) Example 4—Direct materials-based allocation of mixed service costs
(1) Taxpayer R computes its capitalizable mixed service costs using the simplified service cost method described in . During 2018, R incurs $200,000 of capitalizable mixed service costs, computed using the general allocation formula in . During 2018, R also incurs $8,000,000 of total section costs, including $2,000,000 of direct material costs.
(2) Under of this section, R determines its capitalizable mixed service costs allocable to pre-production additional section costs based on the proportion of direct material costs in total section costs. R's direct material costs are 25% of total section costs ($2,000,000 of direct material costs incurred during the year divided by $8,000,000 of total section costs incurred during the year). Thus, R allocates $50,000 (25% × $200,000) of mixed service costs to pre-production additional section costs. R includes the remaining $150,000 ($200,000 less $50,000) of capitalizable mixed service costs as production additional section costs.
(E) Example 5—Labor-based allocation of mixed service costs
(1) Taxpayer S computes its capitalizable mixed service costs using the simplified service cost method described in . During 2018, S incurs $200,000 of capitalizable mixed service costs, computed using the general allocation formula in . During 2018, S also incurs $10,000,000 of total labor costs (excluding any labor costs included in mixed service costs), including $1,000,000 of labor costs that are pre-production costs as described in of this section (excluding any labor costs included in mixed service costs).
(2) Under of this section, S determines its capitalizable mixed service costs allocable to pre-production additional section costs based on the proportion of labor costs that are pre-production costs in labor costs. S's pre-production labor costs are 10% of labor costs ($1,000,000 of labor costs incurred during the year that are pre-production costs (excluding any labor costs included in mixed service costs), divided by $10,000,000 of total labor costs incurred during the year (excluding any labor costs included in mixed service costs). Thus, S allocates $20,000 (10% × $200,000) of mixed service costs to pre-production additional section costs. S includes the remaining $180,000 ($200,000 less $20,000) of capitalizable mixed service costs as production additional section costs.
(F) Example 6—De minimis rule for allocation of mixed service costs The facts are the same as in of this section, except that S uses the de minimis rule for mixed service costs in of this section. Because 90% or more of S's capitalizable mixed service costs are allocated to production additional section costs, under the de minimis rule, S allocates all $200,000 of capitalizable mixed service costs to production additional section costs. None of the capitalizable mixed service costs are allocated to pre-production additional section costs.
(4) Modified simplified production method with historic absorption ratio election
(i) In general This generally permits taxpayers using the modified simplified production method to elect a historic absorption ratio in determining additional section costs allocable to eligible property remaining on hand at the close of their taxable years. A taxpayer may only make a historic absorption ratio election under this if it has used the modified simplified production method for three or more consecutive taxable years immediately prior to the year of election and has capitalized additional section costs using an actual pre-production absorption ratio, as defined in of this section, and an actual production absorption ratio, as defined in of this section, or an actual combined absorption ratio, as defined in of this section, for its three most recent consecutive taxable years. This method is not available to a taxpayer that is deemed to have zero additional section costs under of this section. The historic absorption ratio is used in lieu of the actual absorption ratios computed under of this section or the actual combined absorption ratio computed under paragraph (c)(3)(iv) and is based on costs capitalized by a taxpayer during its test period. If elected, the historic absorption ratio must be used for each taxable year within the qualifying period described in of this section. Except as otherwise provided in this , of this section applies to the historic absorption ratio election under the modified simplified production method.
(ii) Operating rules and definitions
(A) Pre-production historic absorption ratio The pre-production historic absorption ratio is computed as follows:
(1) Pre-production additional section costs incurred during the test period are defined as the pre-production additional section costs described in of this section that the taxpayer incurs during the test period described in of this section.
(2) Pre-production section costs incurred during the test period are defined as the pre-production section costs described in of this section that the taxpayer incurs during the test period described in of this section.
(B) Production historic absorption ratio The production historic absorption ratio is computed as follows:
(1) Production additional section costs incurred during the test period are defined as the production additional section costs described in of this section that the taxpayer incurs during the test period described in of this section.
(2) Residual pre-production additional section costs incurred during the test period are defined as the residual pre-production additional section costs described in of this section that the taxpayer incurs during the test period described in of this section.
(3) Production section costs incurred during the test period are defined as the production section costs described in of this section that the taxpayer incurs during the test period described in of this section.
(4) Direct materials adjustments made during the test period are defined as the direct materials adjustments described in of this section that the taxpayer incurs during the test period described in of this section.
(iii) LIFO taxpayers making the historic absorption ratio election
(A) In general Instead of the pre-production and production historic absorption ratios defined in of this section, a LIFO taxpayer making the historic absorption ratio election under the modified simplified production method calculates a combined historic absorption ratio based on costs the taxpayer capitalizes during its test period.
(B) Combined historic absorption ratio The combined historic absorption ratio is computed as follows:
(1) Total allocable additional section 263A costs incurred during the test period Total allocable additional section costs incurred during the test period are the sum of the total additional section costs allocable to eligible property on hand at year end as described in of this section, determined on a non-LIFO basis, for all taxable years in the test period.
(2) Total section 471 costs remaining on hand at each year end of the test period Total section costs remaining on hand at each year end of the test period are the sum of the total pre-production section costs remaining on hand at year end as described in of this section and the total production section costs remaining on hand at year end as described in of this section, determined on a non-LIFO basis, for all taxable years in the test period.
(iv) Extension of qualifying period In the first taxable year following the close of each qualifying period (for example, the sixth taxable year following the test period), a taxpayer must compute the actual absorption ratios under of this section (pre-production and production absorption ratios or, for LIFO taxpayers, the combined absorption ratio). If the actual combined absorption ratio or both the actual pre-production and production absorption ratios, as applicable, computed for this taxable year (the recomputation year) is within one-half of one percentage point, plus or minus, of the corresponding historic absorption ratio or ratios used in determining capitalizable costs for the qualifying period (the previous five taxable years), the qualifying period is extended to include the recomputation year and the following five taxable years, and the taxpayer must continue to use the historic absorption ratio or ratios throughout the extended qualifying period. If, however, the actual combined historic absorption ratio or either the actual pre-production absorption ratio or production absorption ratio, as applicable, is not within one-half of one percentage point, plus or minus, of the corresponding historic absorption ratio, the taxpayer must use the actual combined absorption ratio or ratios beginning with the recomputation year and throughout the updated test period. The taxpayer must resume using the historic absorption ratio or ratios based on the updated test period in the third taxable year following the recomputation year.
(v) Examples The provisions of this are illustrated by the following examples:
(A) Example 1—HAR and FIFO inventory method
(1) Taxpayer S uses the FIFO method of accounting for inventories valued at cost and for 2021 elects to use the historic absorption ratio with the modified simplified production method. S identifies the following costs incurred during the test period:
| 2018 | 2019 | 2020 | |
|---|---|---|---|
| Pre-production additional section 263A costs | $100 | $200 | $300 |
| Production additional section 263A costs | 200 | 350 | 450 |
| Pre-production section 471 costs | 2,000 | 2,500 | 3,000 |
| Production section 471 costs | 2,500 | 3,500 | 4,000 |
| Residual pre-production additional section 263A costs | 60 | 136 | 220 |
| Direct materials adjustments | 2,700 | 3,200 | 3,700 |
(2) Under of this section, S computes the pre-production historic absorption ratio as follows:
(3) Under of this section, S computes the production historic absorption ratio as follows:
(4) In 2021, S incurs $10,000 of section costs of which $1,000 pre-production section costs and $2,000 production 471 costs remain in ending inventory. Under the modified simplified production method using a historic absorption ratio, S determines the pre-production additional section costs allocable to its ending inventory by multiplying its pre-production historic absorption ratio (8.00%) by the pre-production section costs remaining on hand at year end ($1,000). Thus, S allocates $80 of pre-production additional section costs to its ending inventory (8.00% × $1,000). S determines the production additional section costs allocable to its ending inventory by multiplying its production historic absorption ratio (7.22%) by the production section costs remaining on hand at year end ($2,000). Thus, S allocates $144 of production additional section costs to its ending inventory (7.22% × $2,000).
(5) Under of this section, S's total additional section costs allocable to ending inventory in 2021 are $224, which is the sum of the allocable pre-production additional section costs ($80) and the allocable production additional section costs ($144). S's ending inventory in 2021 is $3,224, which is the sum of S's additional section costs allocable to ending inventory and S's section costs remaining in ending inventory ($224 + $3,000). The balance of S's additional section costs incurred during 2021 is taken into account in 2021 as part of S's cost of goods sold.
(B) Example 2—HAR and LIFO inventory method
(1)
(i) The facts are the same as in of this section, except that S uses a dollar-value LIFO inventory method rather than the FIFO method. S calculates additional section costs incurred during the taxable year and allocable to ending inventory under of this section and identifies the following costs incurred during the test period:
| 2018 | 2019 | 2020 | |
|---|---|---|---|
| Additional section 263A costs incurred during the taxable year allocable to ending inventory | $90 | $137 | $167 |
| Section 471 costs incurred during the taxable year that remain in ending inventory | 1,000 | 1,400 | 2,100 |
(ii) In 2021, the LIFO value of S's increment is $1,500.
(2) Under of this section, S computes a combined historic absorption ratio as follows:
(3) S's additional section costs allocable to its 2021 LIFO increment are $131 ($1,500 beginning LIFO increment × 8.76% combined historic absorption ratio). S adds the $131 to the $1,500 LIFO increment to determine a total 2021 LIFO increment of $1,631.
(d) Additional simplified methods for producers The Commissioner may prescribe additional elective simplified methods by revenue ruling or revenue procedure.
(e) Cross reference See regarding the duty of taxpayers to keep such records as are sufficient to establish the amount of gross income, deductions, etc.
(f) Change in method of accounting
(1) In general A change in a taxpayer's treatment of additional section costs to comply with of this section is a change in method of accounting to which the provisions of sections and and the regulations under those sections apply. See . For a taxpayer's first taxable year ending on or after August 2, 2005, the taxpayer is granted the consent of the Commissioner to change its method of accounting to comply with of this section, provided the taxpayer follows the administrative procedures, as modified by through of this section, issued under for obtaining the Commissioner's automatic consent to a change in accounting method (for further guidance, for example, see Rev. Proc. 2002-9 (2002-1 CB 327), as modified and clarified by Announcement 2002-17 (2002-1 CB 561), modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), and amplified, clarified, and modified by Rev. Proc. 2002-54 (2002-2 CB 432), and ). For purposes of Form 3115, “Application for Change in Accounting Method,” the designated number for the automatic accounting method change authorized by this is “95.” If Form 3115 is revised or renumbered, any reference in this section to that form is treated as a reference to the revised or renumbered form. Alternatively, notwithstanding the provisions of any administrative procedures that preclude a taxpayer from requesting the advance consent of the Commissioner to change a method of accounting that is required to be made pursuant to a published automatic change procedure, for its first taxable year ending on or after August 2, 2005, a taxpayer may request the advance consent of the Commissioner to change its method of accounting to comply with of this section, provided the taxpayer follows the administrative procedures, as modified by through of this section, for obtaining the advance consent of the Commissioner (for further guidance, for example, see Rev. Proc. 97-27 (1997-1 CB 680), as modified and amplified by Rev. Proc. 2002-19 (2002-1 CB 696), as amplified and clarified by Rev. Proc. 2002-54 (2002-2 CB 432), and ). For the taxpayer's second and subsequent taxable years ending on or after August 2, 2005, requests to secure the consent of the Commissioner must be made under the administrative procedures, as modified by and of this section, for obtaining the Commissioner's advance consent to a change in accounting method.
(2) Scope limitations Any limitations on obtaining the automatic consent or advance consent of the Commissioner do not apply to a taxpayer seeking to change its method of accounting to comply with of this section for its first taxable year ending on or after August 2, 2005.
(3) Audit protection A taxpayer that changes its method of accounting in accordance with this to comply with of this section does not receive audit protection if its method of accounting for additional section costs is an issue under consideration at the time the application is filed with the national office.
(4) Section 481(a) adjustment A change in method of accounting to conform to of this section requires a section adjustment. The section adjustment period is two taxable years for a net positive adjustment for an accounting method change that is made to conform to of this section.
(5) Time for requesting change Notwithstanding the provisions of and any contrary administrative procedure, a taxpayer may submit a request for advance consent to change its method of accounting to comply with paragraph (b)(2)(i)D) of this section for its first taxable year ending on or after August 2, 2005, on or before the date that is 30 days after the end of the taxable year for which the change is requested.
(g) Applicability dates
(1) , , and of this section apply for taxable years ending on or after August 2, 2005.
(2) and of this section apply for taxable years ending on or after January 13, 2014.
(3) of this section applies for taxable years beginning on or after November 20, 2018. For any taxable year that both begins before November 20, 2018 and ends after November 20, 2018, the IRS will not challenge return positions consistent with all of of this section.
(4) The rules set forth in the last sentence of the introductory text of of this section and in of this section apply for taxable years beginning on or after January 5, 2021. However, for a taxable year beginning after December 31, 2017, and before January 5, 2021, a taxpayer may apply the paragraphs described in the first sentence of this , provided that the taxpayer follows all the applicable rules contained in the regulations under section for such taxable year and all subsequent taxable years.
[T.D. 8482, 58 FR 42219, Aug. 9, 1993, as amended by 59 FR 3318, 3319, Jan. 21, 1994; T.D. 8584, 59 FR 67197, Dec. 29, 1994; T.D. 9217, 70 FR 44469, Aug. 3, 2005; T.D. 9318, 72 FR 14677, Mar. 29, 2007; T.D. 9652, 79 FR 2097, Jan. 13, 2014; T.D. 9843, 83 FR 58491, Nov. 20, 2018; T.D. 9942, 86 FR 266, Jan. 5, 2021]