February 21, 2012

Mixed Service Inventory Costs Used in UNICAP

We recently detailed some of the basics of the uniform capitalization rules (UNICAP) under IRC Sec. 263A. This code section requires that certain costs normally expensed be capitalized into inventory. One of the cost components that must be considered are mixed service costs. All companies have departments that perform administrative, service or support activities that are necessary for the overall operation of the company. These departments are not directly involved in the manufacturing process, but they do benefit and support the manufacturing department operations and therefore are subject to UNICAP. Some examples of these mixed service departments:

  • Accounting
  • Human Resources
  • Legal Services
  • Technology
  • Warehouse and Storage

Each year when determining the 263A adjustment for tax purposes, an allocation of these mixed service costs must be included. So how do you determine how much of these costs to allocate? A taxpayer could develop their own reasonable allocation method based on factors or relationships that reasonably relate the mixed service department costs to the benefits received. Measures based on the total output of each department (i.e. number of hours provided to a department as a fraction of the total number of service hours provided to all departments) are acceptable.

The IRS has also approved a simplified service cost method of allocating these expenses. With this method, the production mixed service costs equal:

Total production costs for the year (excluding mixed service costs and interest) Total Mixed
Total business costs (excluding mixed service costs, interest and income taxes) X Service Costs

The result is included with your additional 263A costs when you complete your UNICAP calculations.

Mixed service costs are an important component and should not be overlooked when analyzing total inventory costs to capitalize. These costs and the allocation should be reviewed annually when you complete your UNICAP calculations. If you have any questions on mixed service inventory costs contact an Anders advisor.

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February 14, 2012

What Is UNICAP All About?

You may have heard the terms UNICAP or 263A, but what does it mean? IRC Section 263A details the uniform capitalization rules that require certain costs normally expensed be capitalized as part of inventory for tax purposes. These rules apply to: (1) real or tangible personal property produced by the taxpayer, and (2) real or personal property acquired by the taxpayer for resale.

There are a few exceptions to this rule. If a taxpayer is allowed to use the cash method of accounting, they are not required to apply these capitalization rules. Another allows resellers whose average annual gross receipts for the three previous tax years do not exceed $10 million to be exempt from this rule.

So if you don’t meet an exception, you must look at what costs to capitalize. Costs include:

  1. Direct Costs – direct material costs that become an integral part of the property and direct labor costs. These normally would already be included in inventory.
  2. Indirect Costs – all costs that are not direct but directly benefit or are incurred by production activities.
  3. Service Costs – a type of indirect cost that can be identified specifically with a service department. These are usually general and administrative expenses.

Once the costs are identified, the taxpayer must determine what adjustment must be added to ending inventory for tax purposes. To minimize the burden of these rules, many taxpayers use the simplified production method. The first step is to calculate the absorption ratio – which is the additional 263A costs (those costs identified that are not already included in inventory for book purposes) divided by total inventory costs (Section 471 costs). This ratio is then multiplied by total ending inventory resulting in the UNICAP adjustment. This adjustment is then added to the ending inventory resulting in the ending tax inventory reported on your tax return.

Now that you have a basic understanding of UNICAP, find out when to review your UNICAP calculations.

These rules apply to many taxpayers and must be included in the year-end tax preparation. Your tax preparer should assist in making these calculations and complying with the rules of IRC Section 263A. If you have any questions on UNICAP, please contact an Anders advisor.

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February 9, 2012

Used Missouri Tax Credit Purchase to Save Thousands

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