IRS has issued final regs that implement legislative changes to Code Sec. 263A, Code Sec. 448, Code Sec. 460, and Code Sec. 471 that simplify the application of those tax accounting provisions for certain businesses having average annual gross receipts that do not exceed $25,000,000, adjusted for inflation. The final regs also contain special accounting rules for long-term contracts under Code Sec. 460 to implement legislative changes applicable to corporate taxpayers.
Background.
The Tax Cuts and Jobs Act (P.L. 115-97, TCJA) made changes to small taxpayer exceptions to the Code Sec. 448 cash method of accounting requirement, the Code Sec. 263A uniform capitalization (UNICAP) rules, the Code Sec. 460(e) restrictions on the completed contract method of accounting, and the Code Sec. 471 inventory accounting rules. One of the changes was to make a uniform threshold for qualifying as a small taxpayer under these provisions—i.e., average annual gross receipts that do not exceed $25,000,000, adjusted for inflation. (TCJA Sec. 13102)
The TCJA made additional amendments to the Code Sec. 460 rules for long-term contracts to reflect the fact that the TCJA repealed the corporate alternative minimum tax (AMT) imposed by Code Sec. 55 and added the base erosion anti-abuse tax (Code Sec. 59A). (TCJA Sec. 12001 and TCJA Sec. 14401)
In July, IRS issued proposed reliance regs (“proposed regs”) that: a) implemented legislative changes to Code Sec. 263A, Code Sec. 448, Code Sec. 460, and Code Sec. 471—those changes simplified the application of those tax accounting provisions for certain businesses having average annual gross receipts that do not exceed $25,000,000, adjusted for inflation; and b) contained special accounting rules for long-term contracts under Code Sec. 460 to implement legislative changes applicable to corporate taxpayers. (Preamble to Prop Reg REG-132766-18, seeProposed reliance regs on small business tax accounting rules (07/31/2020))
Final regs.
The final regs adopt the proposed regs with the following changes:
Syndicate election procedure. Prop Reg §1.448-2(b)(2)(iii)(B) permitted a taxpayer to elect to use the allocated taxable income or loss of the immediately preceding taxable year to determine whether the taxpayer is a syndicate under Code Sec. 448(d)(3) for the current tax year. Under the proposed regs, a taxpayer that made this election must apply the election to all subsequent taxable years, and for all purposes for which status as a tax shelter under Code Sec. 448(d)(3) is relevant, unless the IRS permits a revocation of the election.
The final regs modify the syndicate election provided in the proposed regs by making it an annual election. (Reg §1.448-2(b)(2)(iii)(B))
Five-year restriction on automatic accounting change. Under the proposed regs, a taxpayer that met the Code Sec. 448(c) gross receipts test in the current tax year must obtain the written consent from IRS before changing to the cash method if the taxpayer had previously changed its overall method from the cash method during any of the five tax years ending with the current tax year. (Prop Reg §1.448-2(g)(3))
The final regs remove the 5-year restriction on making automatic method changes for certain situations. (Preamble to TD 9942)
Inventory treated as non-incidental materials and supplies. The preamble to the proposed regs notes that the IRS interprets the statutory language of Code Sec. 471(c)(1)(B) to mean that the property excepted from Code Sec. 471(a) by that provision continues to be inventory property even though the general inventory rules under Code Sec. 471(a) are not required to be applied to that property. (Preamble to TD 9942)
Code Sec. 471(c)(1)(B) provides that a qualifying taxpayer’s “method of accounting for inventory for such taxable year” will not be treated as failing to clearly reflect income if the method “treats inventory as non-incidental materials and supplies.” To reduce confusion about the nature of property treated as non-incidental materials and supplies under Code Sec. 471(c)(1)(B)(i), the final regs refer to the method under that provision of the Code as the “section 471(c) NIMS inventory method.” (Preamble to TD 9942)
Prop Reg §1.471-1(b)(4)(ii) provided that inventory costs includible in the section 471(c) NIMS inventory method are the direct costs of the property produced or property acquired for resale. However, an inventory cost does not include a cost for which a deduction would be disallowed or that is not otherwise recoverable, in whole or in part, but for Prop Reg §1.471-1(b)(4), under another provision of the Code.
One commenter requested that direct labor costs be excluded from the inventory costs required to be included in inventory treated as non-incidental materials and supplies. The IRS agreed with this request and, as a result, the final regs provide that inventory costs includible in the section 471(c) NIMS inventory method are direct material costs of the property produced or the costs of property acquired for resale. (Reg §1.471-1(b)(4)(ii))
Inventory costs. Under the TCJA “Section 263A small business taxpayer exemption,” small businesses are exempt from the Code Sec. 263A UNICAP rules. A taxpayer that chooses to use the Section 263A small business taxpayer exemption may account for its inventory by using the method for each item that is reflected in the taxpayer’s applicable financial statement (AFS) (AFS section 471(c) inventory method); or, if the taxpayer does not have an AFS for the tax year, the books and records of the taxpayer prepared in accordance with the taxpayer’s accounting procedures (non-AFS section 471(c) inventory method). (Reg. §1.471-1(b)(3))
The proposed regs defined “inventory costs” for the non-AFS section 471(c) inventory method generally as costs that the taxpayer capitalizes to property produced or property acquired for resale, in its books and records. Certain commenters requested that the final regs clarify how a taxpayer treats costs to acquire or produce tangible property that the taxpayer does not capitalize in its books and records; the proposed regs did not specifically address these costs. (Preamble to TD 9942)
The final regs clarify in Reg §1.471-1(b)(6)(i) that, costs that are generally required to be capitalized to inventory under Code Sec. 471(a) but that the taxpayer is not capitalizing in its books and records are not required to be capitalized to inventory. The IRS has also determined that, under this method, such costs are not treated as amounts paid to acquire or produce tangible property under Reg § 1.263(a)-2, and therefore, are generally deductible when they are paid or incurred if such costs may be otherwise deducted or recovered, notwithstanding Reg § 1.471-1(b)(4), under another provision of the Code and regs. (Preamble to TD 9942)
Additionally, the final regs clarify that costs capitalized for the non-AFS section 471(c) inventory method are those costs that related to the production or resale of the inventory to which they are capitalized in the taxpayer’s books and records. Similar clarifications have been made in Reg § 1.471-1(b)(5) regarding the AFS section 471(c) inventory method. (Preamble to TD 9942)
Applicable date.
The final regs are applicable for tax years beginning on or after the date the final regs are published in the Federal Register. However, a taxpayer may apply the final regs for a tax year beginning after December 31, 2017, and before the date the final regs are published in the Federal Register, provided that if the taxpayer applies any aspect of the final regs under a particular Code provision, the taxpayer must follow all the applicable rules contained in the final regs that relate to that Code provision for such tax year and all subsequent tax years, and must follow the administrative procedures for filing a change in method of accounting in accordance with Reg §1.446-1(e)(3)(ii). (Preamble to TD 9942)
For example, a taxpayer that wants to apply Reg §1.263A-1(j) to be exempt from capitalizing costs under Code Sec. 263A must apply Reg §1.448-2 to determine whether it is eligible for the exemption. The same taxpayer must apply Reg §1.448-2 to determine whether it is eligible to apply Reg §1.471-1(b) to be exempt from the general inventory rules under Code Sec. 471(a). However, it may choose not to apply Reg §1.471-1(b) even though it chooses to apply Reg §1.263A-1(j) and Reg §1.448-2. (Preamble to TD 9942)
Alternatively, a taxpayer may rely on the proposed regs for a tax year beginning after December 31, 2017 and before the date the final regs are published in the Federal Register, provided that if the taxpayer applies any aspect of the proposed regs under a particular Code provision, the taxpayer must follow all of the applicable rules contained in the proposed regs that relate to that Code provision for such tax year, and follow the administrative procedures for filing a change in method of accounting in accordance with Reg §1.446-1(e)(3)(ii). (Preamble to TD 9942)
Regs are advance copy.
The final regs are in an advance release document that has been forwarded to the Office of the Federal Register for publication. The regs published in the Federal Register will be the official version of the final regs.
To continue your research on small taxpayer exception to the UNICAP rules, see FTC 2d/FIN ¶G-5479.
This article originally appeared in the December 24, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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