IRS Eases Change to Simplified UNICAP Rules

Rev. Procs. 2002-9 and 2002-54 greatly improve taxpayers ability to adopt the simplified method for capitalizing costs into inventory (UNICAP). Significantly, the procedures can be used by taxpayers previously not in compliance with the Sec. 263A UNICAP rules, and by taxpayers seeking to make an automatic change.

The latter point is noteworthy: unless a change in accounting method qualifies under the automatic-change procedures, the IRS must consent to it, even if the change is to correct an erroneous method.

The automatic-change procedures have several advantages over the nonautomatic procedures. They allow a taxpayer to file an automatic change by the extended due date of the return for the change year (otherwise, the taxpayer would have to request the change within the tax year for which it is sought). Thus, for example, a taxpayer could make a change for a calendar 2002 tax year under the automatic-change procedures, but not under the IRS-consent procedure.

A taxpayer filing under the automatic-change procedures does not have to wait for IRS approval before filing its return or preparing its income tax provision. Moreover, it pays no user fee for automatically filing a change under the new procedures. To make a change, the taxpayer completes Form 3115, Application for Change in Accounting Method, and attaches a copy to its timely filed Federal return for the change year. It must file a second copy of Form 3115 with the IRS National Office on or before the date it filed the return. The Service has not revised the Form 3115 instructions to reflect these revenue procedures.

Rev. Proc. 2002-9 expands the automatic-change procedure to include certain changes in accounting method under Sec. 263A.  According to Appendix Section 4.02(1), it applies to a producer of real or tangible personal property described in 1.263A-2 that wants to change to a UNICAP method (or methods) specifically described in the regulations. The procedure was modified by Rev. Proc. 2002-54, which states, under Section 6.03, that the above Appendix also applies to a reseller-producer. Thus, if a taxpayer wants to adopt Sec. 263A, but not use a regulatory (simplified) cost-capitalization method, the automatic-change procedure would not be available. On the other hand, a change from a nonsimplified method to a simplified method qualifies for the automatic change. The regulations simplified methods are useful in computing the costs that are inventoriable and how much of these costs are properly includible in ending inventory.

Other considerations include the Sec. 481(a) adjustment and financial-statement treatment. Sec. 481(a) provides for an adjustment to prevent a duplication or an omission of income or deductions stemming from an accounting-method change. Under Regs. Sec. 1.263A-7(c)(2)(i), a taxpayer adopting UNICAP must revalue its inventory as of the beginning of the change year, as if it had always been using Sec. 263A. This would be the amount of the Sec. 481(a) adjustment.

A principal benefit of voluntarily adopting UNICAP (instead of waiting for the Service to raise the issue) is that this so-called positive adjustment can generally be taken into income over a four-year period, without interest on the deferred tax. The four-year spread would not be available if the IRS makes an assessment based on failure to comply with the UNICAP rules. In such case, it would generally force the change in the earliest year open under the statute of limitations, which often results in an assessment of penalties and interest.

Once a taxpayer makes a Sec. 263A calculation, it may want to revisit its financial-statement accounting method; some of the costs now being capitalized for tax purposes may also be properly capitalized for financial-accounting purposes.

From Michael J. Goldberg, CPA, M.R. Weiser & Co., LLP, New York, NY (Not affiliated with Grant Thornton LLP)