Sec. 263A Costs for LIFO Taxpayers
The normal manner in which Sec. 263A costs (a.k.a. UNICAP costs) are calculated for taxpayers using the LIFO inventory method and a simplified Sec. 263A method is to calculate an add-on amount for each year for each LIFO pool for which there is a LIFO layer. Shown below is LIFO-PRO’s Actual Year End LIFO Summary Report (Report 18) including Sec. 263A UNICAP Costs:
The calculation methodology shown above is that used for the simplified Section 263A methods (the simplified production method for manufacturers and producers and the simplified resale method for resellers).
The column B Sec. 263A cost ratios are referred to in the IRS Regs as the Section 263A absorption ratio for manufacturers and processors and as the Section 263A allocation ratio for resellers (retailers, wholesalers & distributors). These ratios are calculated as follows: total Sec. 263A costs incurred during the year / total Sec. 471 costs incurred during the year.
The amount of Sec. 263A costs to be capitalized for a FIFO taxpayer using a simplified Sec. 263A method is calculated by simply multiplying the Sec. 263A absorption or allocation ratio times the year end FIFO inventory balance. Because greater income tax deferral is achieved when Sec. 263A costs are minimized, LIFO taxpayers will usually have less Sec. 263A costs to capitalize than FIFO taxpayers. This will be true unless the base year and earlier year Sec. 263A absorption or allocation rates are a lot higher than in later years.
Resellers need not capitalize Sec. 263A costs if the average of their past 3 years’ sales are less than $10 million. If this sales threshold is not met in the year of a company’s LIFO election but is met in a subsequent year, LIFO taxpayers must calculate and use Sec. 263A absorption or allocation ratios for the years prior to the year in which the $10 million threshold was exceeded. There is a simplified method available to calculate the “old years” Sec. 263A absorption or allocation ratios that precludes the need to calculate these ratios for each of these old years which may be impractical.
There are less frequently used Section 263A methods than the simplified methods referred to above. In general, the Section 263A costs under the non-simplified methods for LIFO taxpayers are not add-ons to the Sec. 471 cost amounts because the unit cost values calculated include Section 263A costs. An example of a non-simplified Section 263A cost method is the burden rate method. For taxpayers using non-simplified Sec. 263A cost method, the type of add-on calculation shown in the example above is not applicable because the current-year cost value (the balance which is divided by the cumulative index to calculate the inventory at base balance) used for the LIFO calculation already includes Sec. 263A costs and so the LIFO inventory balance calculated will already include Sec. 263A costs.