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Focus on Manufacturing & Distribution: Unique Opportunities with UNICAP for 2014 Tax Returns

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In recent years, the IRS has dramatically stepped-up its examination activity around the Uniform Capitalization of Inventory rules (UNICAP). Most taxpayers in the manufacturing and distribution industries can benefit from a UNICAP review to proactively identify potential UNICAP exposures before the IRS has a chance to do so upon exam.
January 12, 2015

In recent years, the IRS has dramatically stepped-up its examination activity around the Uniform Capitalization of Inventory rules (UNICAP). Most taxpayers in the manufacturing and distribution industries can benefit from a UNICAP review to proactively identify potential UNICAP exposures before the IRS has a chance to do so upon exam.

Background

Originally enacted in 1986, the UNICAP rules require taxpayers that produce and or sell tangible property to capitalize certain additional costs to inventory for tax purposes (sometimes referred to as 263A costs) versus those costs already capitalized to inventory for books. Taxpayers can use a number of methods to compute these costs, ranging from internally developed reasonable allocation methods to a number of simplified (although sometimes less favorable) methods defined by the IRS.

For many years, the IRS largely ignored UNICAP computations during examinations as long as taxpayers were doing something to capitalize additional costs for tax versus books. In recent years, however, the IRS has focused more intently on UNICAP issues and has aggressively pursued adjustments unfavorable to taxpayers. Their scrutiny isn’t limited to complex or aggressive UNICAP methodologies.

Companies that haven’t adapted their UNICAP methodologies to changes in their business or to changes in their accounting systems may find that their UNICAP methodologies have inadvertently or improperly evolved over time. Companies may be using overly simplified methods or, in some cases, not using UNICAP at all. Even if the IRS hasn’t uncovered these issues in past exams, it is likely they will be uncovered and proposed as adjustments on future examinations.

Planning Opportunities

Companies could benefit by conducting a review to identify potential UNICAP exposures before the IRS has the opportunity to do so. Companies that self-identify these exposures will, in many cases, have the opportunity to file automatic method changes (Form 3115) which provide IRS audit protection and take advantage of a four-year spread for any unfavorable adjustments.

In contrast, if companies wait for the IRS to identify these exposures upon exam, the IRS will likely propose methodologies less favorable than those companies may propose on their own. In addition, any unfavorable adjustments made upon examination will not have the advantage of the same four-year spread available with automatic method changes (i.e. must be taken into income immediately).

For certain companies, 2014 presents a unique opportunity to change UNICAP methodologies that would not otherwise be available. Companies under current or recent IRS examination, or who have changed UNICAP methodologies within the last five years (“the scope limitations”), are generally ineligible to change UNICAP methodologies under the automatic change procedures. However, the Tangible Property Regulations contain a provision unique to 2014 returns that waive these “scope limitations” for UNICAP changes filed in conjunction with the adoption of the Tangible Property Regulations.

What you should do?

Contact your RubinBrown advisor today to see if your UNICAP methodology is up-to-date and if a UNICAP review could be of benefit to your company for the 2014 tax return.

 

Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.

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