Final Regulations Issued on Small Business Tax Accounting & Long-term Contracts
The IRS has issued final regs that implement legislative changes to Code §263A, Code §448, Code
- 460, and Code §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 ($26 million for 2019 and 2020). The final regs also contain special accounting rules for long-term contracts under Code §460 to implement legislative changes applicable to corporate taxpayers.
Background: The Tax Cuts and Jobs Act made changes to “small taxpayer exceptions” to the Code §448 cash method of accounting requirement, the Code §263A uniform capitalization (UNICAP) rules, the Code §460(e) restrictions on the completed contract method of accounting, and the Code §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).
The TCJA made additional amendments to the Code §460 rules for long-term contracts to reflect the fact that the TCJA repealed the corporate alternative minimum tax (AMT) imposed by Code §55 while adding the “base erosion anti-abuse tax” (Code §59A).
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 §448(d)(3) for the current tax year. Under the proposed regs, a taxpayer that made this election was required to apply the election to all subsequent taxable years, and for all purposes for which status as a “tax shelter” under Code §448(d)(3) is relevant unless the IRS permits 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 §448(c) “gross receipts test” in the current tax year must obtain the written consent from the 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.
- Inventory treated as “non-incidental materials and supplies:” The preamble to the proposed regs notes that the IRS interprets the statutory language of Code §471(c)(1)(B) to mean that the property excepted from Code §471(a) by that provision continues to be “inventory property” even though the “general inventory rules” under Code §471(a) are not required to be applied to that property. Code §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 §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.” 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.
Inventory costs: Under the TCJA “Section 263A small business taxpayer exemption,” small businesses are exempt from the Code §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) (i.e., “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 (i.e., “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 practitioners 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, however, did not specifically address these costs.
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 §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.
The final regs clarify that costs capitalized for the “non-AFS section 471(c) inventory method” are those costs 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.”
Authored by:
Dr. John Connors, J.D., CPA, LLM
Tax Educator’s Network, LLC
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