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:
- 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.
- Indirect Costs – all costs that are not direct but directly benefit or are incurred by production activities.
- 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.All Insights