With 2019 coming to a close, taxpayers should consider the impact of the final IRC Section 263A regulations on their operations as part of their year-end planning efforts. The final IRC Section 263A regulations:

1. May be material to 2019 annual financial statements - Taxpayers may need to quantify any impact of the final IRC Section 263A regulations (i.e., the difference in IRC Section 263A costs under the old and new methods) to determine potential materiality of impact on current and deferred taxes. Many taxpayers (i.e., both producers and resellers) will be affected by the regulations.
2. Will continue to receive increased focus from the IRS on exam - The IRS has indicated that IRC Section 263A will be an area of focus on future exams given the tax law changes of the Tax Cuts and Jobs Act (TCJA). Taxpayers not presently under exam that are using impermissible IRC Section 263A inventory or self-constructed asset methods should consider filing accounting method changes as soon as possible to obtain audit protection for prior years. Taxpayers under exam generally do not receive audit protection when filing a Form 3115 unless certain exceptions are met (such as being eligible to file within a three-month window, which is generally the period between the 15th day of the 7th month and the 15th day of the 10th month of a taxpayer's tax year). Fiscal-year taxpayers under exam may currently be within that three-month window and have the ability to file changes now (or before the end of the window) to obtain audit protection.
3. Can supplement overall tax reform planning for the 2019 tax year - In light of new tax provisions from the TCJA, IRC Section 263A compliance is important; in particular, taxpayers should confirm that costs are capitalized to the extent required. IRC Section 263A methods may potentially affect computations related to base erosion and anti-abuse tax (BEAT), global intangible low-taxed income (GILTI), the IRC Section 163(j) interest deduction limitation, and other areas. Additionally, many taxpayers may have additional incentives to engage in an IRC Section 263A study for 2019 tax years.

The final IRC Section 263A regulations went into effect on November 20, 2018. For a summary of the regulations and the simultaneously released Revenue Procedure 2018-56, see Tax Alert 2018-2357.

What taxpayers need to do in light of the TCJA provisions?

BEAT

Amounts paid to foreign related parties that are properly capitalizable under IRC Section 263A, to either inventory or self-constructed assets, are not base erosion payments. As taxpayers review existing IRC Section 263A methodologies to assess the impact of the final IRC Section 263A regulations, they should concurrently review the treatment of amounts paid to or incurred with foreign related parties. Specifically, they should either identify whether the capitalization of amounts under a present method is permissible or determine whether amounts presently deducted must be capitalized. The IRS has indicated it will have an increased focus on IRC Section 263A, in particular the classification of costs between deductible expenses and cost of goods sold (and the effect such classification has on tax provisions such as BEAT).

GILTI

As taxpayers are reviewing their methods of accounting for controlled foreign corporations and determining required or desired changes in methods of accounting, they must be comply with IRC Section 263A (for both inventory and self-constructed assets) for certain automatic method changes. Taxpayers that do not currently capitalize costs to the extent required must file a concurrent accounting method change to a permissible method under IRC Section 263A. Filing required or desired accounting method changes for the final IRC Section 263A regulations may also serve to meet the IRC Section 263A compliance requirement for other automatic changes, as necessary. Common method changes requiring compliance with IRC Section 263A include depreciation, timing of incurring certain liabilities (such as certain automatic changes for bonuses, vacation pay), etc.

IRC Section 163(j) interest deduction limitation

In conjunction with reviewing broader IRC Section 263A methodologies, taxpayers should ensure their methods for capitalizing interest comply with IRC Section 263A(f). Interest capitalized under IRC Section 263A is no longer "business interest expense" subject to the IRC Section 163(j) limitation and may be recovered more quickly than deductible interest for taxpayers that are severely limited under IRC Section 163(j). To the extent such interest is recovered through non-cost of goods sold depreciation, capitalizing the interest under IRC Section 263A generates a second benefit by increasing the taxpayer's adjusted taxable income (ATI) amount for purposes of determining the IRC Section 163(j) limitation. The general IRC Section 263A rules applied to all self-constructed assets also increases the basis of assets subject to depreciation and, as such, increases ATI. We hope the IRC Section 163(j) final regulations will clarify that even cost of goods sold (COGS) depreciation can be added back for purposes of ATI.

Implications

The final IRC Section 263A regulations provide an opportunity for taxpayers to review their current inventory costing methodologies and identify changes that are available or required and the tax impacts of each. Many taxpayers will be required to file accounting method changes in some capacity and action may be appropriate before financial statements are issued. The automatic accounting method changes available, along with certain scope limitations, allow taxpayers to comply with the final IRC 263A regulations and adopt appropriate methods consistent with tax reform planning.

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