IA-62-91 Final

Section 263A
p l r t vII.-Additional

Itemized Beductions for

individuals
Section 213.-Medical,

fur medical insuranir {or ~ ~ t b rmedical
r
$,are)
rxtend~ngsubstanti~lly bcqond the dose ol the
ta~ablrysar may bc dzdu~tedunder wctirrn ? 13
LC, the ycsr of pdyliicrl:.
if thc cundrt~onsul
heclinn L 1 3 : 1 j ) / 7 ) are rol sd~rrtied Scc keb
Pro< Q j 4 3 pagr T A l

I'rlderal Rcgislcr regirding thr approach

for implementing method changes requirrd under the final regulations.

Dental, etc.,

Expenses
26 ( ' F R 1.213-1. ,V.rlrtxl, dcntd,
,]>,'Yl

,,A::.>

Parl IX.-Items

Hot Deductible

c.tc..

T,'%

Cr.:run 7,WT; .701.7305-1.)

Deduction of payments for luture
medical care. Rev. RuIr. 75-30?,75
JO?, and 76-48) should not be rnltrprcfzd ik) allo\v 3 c\lrrent deduction gf
p ~ > m u n t sfor future medical care tin-

Section 262.-Personal,
Family Expenses
14 CFR 1.762-1
t

Living and

P e m n ~ l ,lih'lng crnd fumtly

xpunsrs.

Whar eftctt J o e the I-yzru t~rn~rdtlonnn
travel, as added by stition 1938 t11 the
Energ! Pulicr Act vt' 1991. Puh L K O 1024Rh. have on thc dcducllib~l~lyof away trom
kornc travel cxpmsr. under \citjm Ib3aX11 r l f
the Codr? Cee Rcv Rul 93-36 psgc 7 l

eluding med~cnl insurance) cxtcndl~~g remporvy

subcta11t1nlI) beyond the close of the
tnvnhic yr:r

i n situations where rhc

t ~ t u r e<;ire IS ]lot purchased in cunner11or1 with obta~ningI~fztimec u e i d the
W ~ Cdcwribed
.
in thore rulings. Rev.
Rul\. 75-302.
c.l;trltied.

75-303, iu~d 7 6 4 8 1

Section 263A.-Capitalization and
inclusion in Inveniory Cbsts of
Certain Expenses

Rev. Rul. 93-72

This rcvenuc ruling clarifies Ret.
C.B. 86. Rev.
Rul. 75-303, 1975-2 C.B. 87, and Rev.
Kui. 75--302. 1975-2

Rul. 76 -181, L97C-2 C.B. 81. Thnsz
rcvrnuc rulings 3hould not he interprcred r!) d l o w n curr~hnt dcductlun or

payment5 L7r : :fllr2 ,!~cdicalcare {inihdinp rnci:
: A ~ I C ~extending
)
substantiall* 'nc),.
he close of the
taxable !r-.I- in aiifxit~onswhew the
futore tart i., . -+*r. hased in connection wirh obr, - '
I , -time care of the
typt: c l a s n h ~, ~, 1h41.rulings.
c
11%

+

PROSPEC'TIVE APPLICATION

T.D. 0482

DEPARTMENT OF THE TREASURY
Internal Revenue Senict
26 CFR Parts 1 and 602

Capitalization and inclusion in
Inventory of Certain Costs
AGENCY.

Internal Revenue Scrvice.

Trtasuq.
ACTION: F~nal d n d remporav regulnliuna.

Purhudnt to rhr au~hur~ty
canra~ncd
SUMMARY: lhis document contalns
secrlur~ 7b;OSrbj clt the Internal
tins) rrgulations under section 263A of
Rricnue Code, t h ~ srevenue ruling will

The collections of information contained rn thesc final regt~lations have
bren rewiewtd and approved by the
Office of Management and Budget in
accordance with the Paperwork Reductlon Art 144 U.SC. 3SW(h)) under
control number 1 5154987. The estimated snnusl burden per respondent
varies from 0.5 hour to 2 hours, depending nn individual circurnstunccs, with
an estimated average of 1 hour. The
estimated annual burdcn per recordkeeper varies from 8 houn to IU hours,
depending on individual circu~r~stance>.
with an estimated average of 5) hours.
These estirnales are approxiinatiuns
of the average time rxpected to be
rlcces$ary for a collection of tnformatlon. They are based on such ~nformalion 3s 1 5 available r i b rhe tntemal
Revenue Service. Individual respondedtsliecordkeepers rda y reqtlire more or
less titne. depending on their particul:w
C I ~ C U Mantes.
S~
Comments concerning the .iccurw);

of this burden estimale and suggesrions
for reducing this burdcn should bc
dircctd to the Internal Revenue Scrvice. Attn: 1RS Reports Clca~-arlct:Officer PC:FP, Washington, D.C. 20224,
:tnd to the Officz of Manilgcr~ir~~t
md

Budget. Attention: Desk Officer for the
Ilepartment of the Treasury, Office of
Infunn~tiun and Regu lator)r Affili~s,
W'nshington. U.C. 20503.

in

tile Inrrrnal Kevenuc C d e of 1986 relat~ngto accounting for costs ~ n c u m din
producing pruperty and ncquinng propen) for resak. Sectton 263A was enacted as part of the Tax Reform Act of
1986. C h i m p In the iippbcable law
wrrt made b) the Omnibus Budget Rrconciliarion Act of 1987. the Techmcal
EFFECT O N OTHER REVENUE
and ,W~scellaneous Revenue Act of
RULINGS
1938, and the Omnibus Budget Recnn~ (if 1989. T h ~ sfinal regulaRru Ruls. 75-rw2, 75-303, and 76- c t l i a t ~ oAct
tion affects :dl taxpayers ~ i ~ h j e c to
t
481 we ciarifjrd.

hc rlpyl~edto 2mounts pad before
Ocrober 14, 1993, or to amtmnts paid
h'n cr ,tfirr. Ocrober 13. 1993. pllTSUant
1" tr.rnls of a h~ndmgcontract entered
I n f ~hctorc rhnl date i t such t e r m acre
IWftcct on that date.

Buckground

nth

On .March 30.

1987, the Internal

Revenue Service published In the Fedcral Register a ~lutice of proposed
rulemaking [LR-I 68-86, i987- 1 C.B.
8081 (52 FR 101I81 by cross reference
to temporary regulations {T.D.813 1
11987-1 C.B. 981) publ~shed the same
day (52 FR 10052). Amendments to the
~iudce of proposed rulcn~akjng and
temporary regulations were published

in the Federal Kegister on August 7,
1987. by notice nf proposed rulernaking
ILR-37-87, 1987-2 C.8. lO54j ( 5 2 FR
DATES: Eltfective date: Jnnuary 1 . 1994. 29391) by crass reference t o tempraq
romments are ruqucslcd frc11t1 1 i i X - regulations {T.D. 81 48 t 1987-2 C.B.
payers fnr a YO-day period after the pub- 70]! published the same day (52 FR
iic;\tic~no t the* final repulatrtlrls in the 2 9 3 7 9 A public hearing v*xi held on

sectton 263A.

section 263A
December 'I, 1937. After considerarion
o i the public comments regarding the
proposed regulations, thry are adopted
as revised by this Treasury decis~un.
Explunution of Sfufutor)*Provisions

Section 263A (the uniform capitalizaas part of the
Tax Reform Act of 1986, Pub. L. 995 14, 100 Stat. 2085, 19%-3 C.3. Vol. 1
{the 1986 Act). The statute was
amended as pari of the Omnibus Budget
Reconciliation Act of 1987. h h . 1,.
IW203, 101 Stat. 1330. 1987-3 C.B.
Vol. 1 (the 1987 Act). the Technical and
MisceIlaneous Revenue Act of 1988,
Pub. L, 1MM47. 102 Stat. 3342. 19883 C.B. Vol. I (the 1988 Act), and the
Omnibus Budget Reconciliation Act of
1989, Pub. L. 101-239, 103 Stat. 2106
tion rulcs) was enacted

(the 1989 Act).

Prior to the enactment of section
1,63A, the rules regarding the capitali-

zation of costs incurred in prnducing
property were deficient in two respects.
First. no uniform system regarding thc
capitalization of costs incurred in produc~ng property existed. Rarher, cosis
were capitalized undtr a variety of
Internal Revenue Code provisions depending on the nature of the underlying
property a d i ~ sintended use. Second,
casts incurred in producing, acquiring.
or c q i n g property were penitted. in
some instances, to be deducted currently, rather than accounted for io the
year when the property was used or
sold.
Section 263A was enacted w provide
a single, comprehensi-ve set of rules to
govern the capitalizaiion of the costs of
producing, acquiring, and holding propcrty, subject to appropriate exceptions
where application of the rules might be
unduly burdensome. These rules are
des~gned to more accurateIy reflect
income and prevent unw manred deferrd of taxes by prnperly matching
income with related expenses. These
rules are also intended to make thc trtx
system more neutral by elrminating the
differences in the former capitalitalion
rules that created distortions in the
aliocaiion of econvrliic resources and in
the manner in which certain economic
activity is organized. See S. Rep. No.
313, 99th Cong.. 2d Sess. 140 (1986).
198+3 L.M. (Vol. 31. 140.
Sectinn 263A generally requires tht:
capitalization of direct costs and indirect costs properly allucable to real
property and tangible personal prpeny

a taxpayer. Produced certain portions of the follow
provrty includes both properiy that is notices continue tn remain in eff
sold to customers (e.g., inventory) and section I V (A) of Notice 88-86 (gt
property that is used in a taxpayer's ance regfitding defened intercomp,
wade or business (set f-constructed as- exchanges); section IV (0) of Noi
sets). Section 263A also requires the 8&86 (permission to elect u new b
uapltalization of direci costs and indi- year for LIK) taxpayers); seclion V
rect costs properly allocahle to real Notiw 88-86 (guidance for prope
property and personal property acquired produced in a fanning business); s~
by a taxpayer for resale. Pcrsonal tivn I1 (B) of Notice 84-67 (guidar
property acquired for resale includes for free-lance authors, artists, a
both tangible and intungibte personal photographers); section II (U) of Noti
property described in section 1221 (1). 89-67 (guidance for farmers); secti
Section 263A(b)(2#B), however, ex- 111 (E)of Notice 89-67 (application
crpts from the uniform capitalization section 263A to foreign persons).
ruks personal property acquired by a
The final regulations do not incorp
taxpayer for resale if irs average annual rate. in whole or in pan, Notice 88-7
gross receipts Tor the preceding three which provides guidance regarding a
faxable years do not exceed counting method changts for taxpaye
% I U,UU0.000 (small reseller).
that failed to timely comply with tl
uniform capitalization rules. Nevcrth~
Certlrin Adrrzinistra~ive Guidance
less, Nolice 88-78 does no1 remain i
effect. See the discussion of .4ccountin
The following notices regarding sec- Method Changes below.
tion 263A have been pubIished: Notice
87-76, 1987-2 C.B. 384; Notice 88-23. Puhtic Comments
1988-1 C.B. 490; Notice 88-24, 19E81 C.B.491 : Notice 88-62, 1988-1 C.B+
5.18; Notice 88-78, 1988-2 C.B. 394;
Notice 88-86, 1988-2 C.5 40 1; Notice
Cornrnentators made several suggcs
88-42, 1988-2 C.B. 416; Notice 88-99. tions for simplifying the rules providet
1988-2 C.B. 422; Notice B8-103, in the temporary regularions ant
1988-2 C.B. 442; Notjce 83-104.
notices. As discussed in mnre d~ra
1988-2 C.R. 343: Notice 88-113,
below, the final regulations irnglemen
1988-2 C.B. 448; Notice 89-59, 1989- many of these suggestions. For exam
1 C.R. 700;and Notice 8947, 1989-1
ple, the final regulations permit [he usc
C.B . 721. (See $60 1.60I(d](2#ii)ib) of of a "historic absorption ratia" t t
this chaptcr. I
determine additional capitaIizablr costs
The final regulations incorporate and under section 263A. In addition, the
supersede most of the guidance set final regulations provide ruks that
forb in the notices referred to above. expand the availability of reasonable
Therefore. unless otherwise noted. allocation methods in determining capthese notices are withdrawn for mxablc ilalicabIe costs, rules that except de
years to which this Treasury decision minimis production activities of small
applies However, certain notices or resellers from the capitalization reportions thereof are not incorporated in quirements of section 2 6 3 k and rules
this Treasury decisiort and continue lo under which producers w ~ l hde nlinimis
remain in effect in whole or in part as indirect casts that use the simplified
provided belu w.
production method are decmed to have
The following nodces cnrttinue to no additional capitalltable costs under
rematn in effect in their entirety: section 263A.
Based on specific suggestio~~sof
Notice 87-76 (guidance for farmers):
Notice 88-23 (ordering rules for commentators, the final regulations inmethnd changes); Noticc 88-24 (SFclude a table of contents for all final
cia1 election for farmers); Notice 88-62 and temporary regulations issued under
(safe haxbor for certai~i producers of
section 263A. The regulations have
creative properties): Notice 88-99 also been reorganiz~rl to rnske thcm
(gu~dallct:regarding Interest cap~taliza- easier to use. Insread of having one
tion issues): Notice $8-104 (application Imp section with rules for producers
of section 263A to foreign persons); and resellers as thz temporary regulaand Notice 89-59 (deadline for ac- tions did, thc film1 regulations ~nclud
counting method change requests re- three sections organized so that rules
garding pr;rctical capacity). I n addition. relating priraiuily to producers are

produccd by

Section 26311
11,.11-omrules relating primarily to
I
In particular. the regulations
, I L . general rules affecting both
%-I,.: and resellers in H 1.263A-1,
rl~rrmdy
pmdbm iR
, . \ -1. and rules primarily affect.i.llt.rs in $1.763A-3.

,I

I

,

\

111, final regulations clarify that
I. -;latutory or regulatory excep,II.>
li~llit the application of section
. \ . costs may still be subject to
I t.~lizationunder uther prov~sionsof
11

lrltzrnol Re-

!I.

C*

-

d

. , . I I , For example, a mxpym

an accrual method taxpayer any earlier
than the taxable year in which

economic performance occurs.

section 263A and research and experimental costs that are not. The final
regulations clarify that engineering and

design costs include pre-production
co~n,such as costs attribIabIe to
research. expenmental, engineering and
The temporary regulat ~ons define design acrivit~rs,that do nor qualify as
"direct material costs" differently research and experimental expenditures
from the definition of direct material under sezrion 174 and the regulations
costs contained in 3 1.47 1-1 l(b)(2)(i). thereunder.
Commentators questioned why lhrse
One commentator suggested that biddefinitions are different. To alleviate d ~ n gexpenses Incurred w ~ t hrespect to
any confusion, the definition of d~rect a contract to set1 standard stock items
material costs in the final regulations should not Ire capitalized because these
has been conformed to the definition of expenses are fssent~ally selling exdirect material costs provlded in penses, which get~erally are not cap8 1,471-1 l(b)(?)(i).
italized. In order to insure that taxpayers are not required to cap~talize
E. Indirect Costs Subject to
what are -idly
d i n g , expcmes.

D. m mmd Cum

cw

"

t k c ~ p w i d t ~ b i d d i n g

'

ROC

-

=

Q

w

e

w

h

to b m3A
c
m d tbc L~witbrcspectrocertain~
. l ~ ' s u b j e c c f O W
~ k
~ W r e g e l P t i s a s a f e tmxs TQ m
~ C
e popmy and tv
, I , Ilm*isirm, 06 ..ri..r ad3.
q u i r e proenZy for resale. Thw
loog-erM coainct reguMioPs of contracts include both (1) any a g r m
: t ' r - o p e q h d c d Incident lo rlk
51.451-3. See S . Rep. No. 313, 99th ment with respect to a spec~ficunir of
,
, ~~-t,\+im
af Semites
Cong., 2d Sess. 131-42 (1986), 1 9 8 6 3 property providing for the production
, I ,l,.v~dedto the cltent 1s ( 1 ) de minimis tion requirements of section 263A is
In amount, and (2j not Inventory in the
consistent with the extended-period
hands of the service provider.
long-term contract regulations. See
5 1.451-3(d)(6)(iii)iH).
Commentators objected to the treatment
of deplet~on in the temporary
Commentators requested clarification
on whether costs that have not met the regulat~onsas an indirect cost required
economic performance requirement of to be capitalized. [n response to these
section 461(h) must be capitallzed. The concerns. and as indicated in Notice
final regulations incorporate seclion 88-86. the final regulations provide that
461(h) and underlying regulations con- deple~ionis properly allocabIe only to
tained in T.D. 8408 [1892-1 C.B. 1551. property that has been sold for purgain or loss on
[57 FR 1241I (April 10, 1997)J. A t - poses of deternl~n~ng
the
sale
of
the
property.
cordingly, the final regulations provide
Commentators questioned the disthat the amount of any costs required
to be capitalized under section 263A t~nction in the temporary regulations
may not be included in inventory or between engineering aod design costs
charged to capital accounts or basis by that are subject to capitalization under

otnmentaton questioned whether
\p.iyers that provide property to
~ ~ ~ I o r n incident
ctS
to the provision of
I r I C M are subject to section 263A.
i 1 L C rind regulations g e ~ e r a l l yincorpo!

I

.

or sale of pmpm to a customer r f the
agreement is entered into t r e f n ~the
taxpayer produces or acquires the specific unlt of property tu be provided to
the customer under the agreement, and
(2) any agreement with a customtr with
respect to fungible property to the
extent that, at the time the agreemect is
entered Intrl, the taxpayer has fin hand
an insufficlcnt clunntity of completed
fung~blc Items of such propert) that
may be used to satisfy the agreement
(plus dny orhzr production or sales
agreemetlts of the taxpayer).

The final regulat~onsexpand the list
of costs that ere nor subject to capitalization by providing that section 179
costs and warranty and product liability
casts are not capitalized.
As in the temporary regulat~ons. the
final regulations except from sectron
263A. depreciation, atnortlzntiun. and
cost recovery allowances on equipment
and facilities that have bern pl;lced in
service hut are temporarily idle. Cenain
aspects of this exception have bzrn
clarified in the final regula~~onsIn
response to comments. The r r ~ ~ i ~ o r a r i l y
idle equipment and facilities exception
has not been expanded to include costs
other than depreciation. amortizat~on,
and cost recovery allowances. The

Section 26311
ing the amount of section 263A costs tion rules are not intended to affect the
that must be capi~dized.In response to valuation of inventories nn a basis
this concern. the final regulations ex- other than cost. Thus, the rules will not
plain that after section 263A costs are affect the valuation of inventories at
allocated to a production or resale market by a taxpayer using h e lower
actrvrty, these costs are generally allu- of cost or market method, or by a
cated to the items of property produced dealer in securities or commodities
or property acquired for resale during using the market method. However, the
the taxable year and capitalized to the rules will apply to inventories valued at
items that remain on hand at the end ot cost by a u p a y t r using the lower of
cost or market method." 2 H.R. Conf.
the taxable y e a .
The temporary regulations perrnit tax- Rep. No. 841, 99th Cong., 2d Scss. IIpayers to use a variety of methds for 305 (1 986), 1986-3 C.B. (Val. 4) 305.
The final regulations interpret the
allocatrng section 263A costs among
their activities and items of property above language in accordance with the
produced or acquired for resale. For overall Congressional intent underlying
example, the te~rlporaryregulations per- section 263A. The final regulations
G. Service Costs
mit the use of facts-and-circumstances provide that section 263A applies to
allocation methods, such as a specific inventories valued at cost, Iower of
Under the temporary regulations, the identification method, a burden rate cost or market (KM), or market.
total direct and indirect costs (service method, a standard cosr methd, ; u ~ d Section 263A does not apply. however,
cosis) of administrative, service, or
generally any other reasonabIe allwation in those cases where the market valuasupport functions or departments (serv- method. Generally, the final regulations tion used by the taxpayer generally
ice departments) that directly benefit a continue to allow the use of these equals the fair market value at which
parlicular production or resale activity methods and adopt, with slight modi- the taxpayer would sell its inventories
must be directly allocated to that ficahons, the criteria in the temporary to its customers less, if applicable, only
aduity. la addition, service costs that regulations and Notice 88-86 for deter- the direct cost of dispsition. Thus,
M p - d u c t i ~ nor reuile activities zi mining a reasonable allocation method. section 263A which applies in deterwdl m
d v i t i s p ( m i d service Tbe 6aal regrlptions a h continue to mining thc cwt of pmperty, must be
tom
bt 4
Irs activiticf ptnnit taxpyas to
cerrsin
sim- awed ia d e m n i u g tbe market vduc
..
ba&m.f.eserurr-clpllryreIatts
plified m d d s in d&ammmg their of m y iwentery for which markt IS
the-dQc
&cost
to the section 263A m s t s . W eimplified dwTmioc9 wifb r e m e to rcplrseCbEt oc . D p r w ~ n~
t T h .e
bedits Mby the a h * .
Corn- methods m discussed in mime detail
Service and tbe Tmsmy b t h &at
m e w
thak arrtwithstand- below .)
this approach -1w
dr1ing lhe h w guidance m t
k temporary
Under the temporary regulations, policy objective Coreg-&
mice
# di&cult h
mi#al service coas
k: A u L : ~
d - - a d b
-1m's-umIpWmgcmw3 rririiawreprrirseService and [he Treasury believe that
excluding other costs from th~sexception. such as insurance, taxes, etc.. is
consistent with Congressional intent that
the section 263A regulations be patterned after the extended-perid longterm contract regulations. See S. Rep.
No. 313, 99th Cong., 2d Sess. 14142
(19861, 19863 C.B. (Vol. 3) 141-42.
In addition, for the reasons set forth
in the preamble accompanying TD.
8148 (52 FR 29375), the find regulations continue to prohibit the use of any
pracljcal capacity concept or method to
identify the fixed indirect costs subject
to capitalization.

-

-

.
'

i
'
'

:
j

I1
+

3

-

Y . - 1 h - L

mi-,"-&

adrm~p*r-d&

-*,--*

~tDOsC~---m

*--.-&

--am-rrbrsdiew
deductible service costs. ~ I I addiiion, to (whichin @ice
costs
to
departments
engaged in
efimnate confusion about mixed service
production or resale activities) and a
costs, the final regulations identify the
portion of mixed service costs thar are step-allocation method [which in general
aliacable to production or resale ac- allmares mixed service costs to all
tivities (capitalizable mixed service departments benefining from the mixed
service costs includiag other mixed
costs) and the pnnion of mixed service
service
departments) are reasonable alcosts that are allocable to nonlocation methods. The final regulations
production or non-resale activities (deincorporate these provisions and provide
ductible mixed service costs).

examples of a direct reallocation method
and a step-allocation melhod.

The temporary regubtwms provide I. Section 263A und Vuluotians of
h-wyrnUar&
mW-hcm&Prd
ir&m m t s are allocated to crr among
the various activities of a taxpyer.
Section 263A does not explicitly
Commentators stated hat the tempwary address whether the uniform capitalizaregulations do not provide specfic tion rules affect market valuations of
guidance regarding how the all-tion
inventmy. However. the legislative hisof costs to activities relares to betermin- tory states, "[tlhe unifom capitaiiza-

-CL.-9bir

*f-e-.

the mismatching that would occur d
section 263A costs were not jnclud6din determining the market value d

item. The item, which remains on
at the end of X's taxable year, cou
sold to a customer for $100 at

mining market at year end, the

Section 26311

Id only be valued at $80. Thus, the
263A costs that
to be marched

t
k
9100 af W
mrhtdtdrhtimnddbe
jtducted in a year prior to the year X
srlls the

item.

,I.Ownership oj Property Produced

Commentators questioned whether a
ldxpdyer that does not have fonnal or
I ~ g a ltitle to the property it is producrrig is considered a producer for
I'urposes of section 263A. The final
tcgulations generally provide that a
lanpayor tbrY Pws noL bkb k@ tiLle
I

t

r

W

-

administrative expenses to items acquired under routine business arrangements. The Service and the Treasury

Several commentators inquired
whether the enactment of section 263A
has affected the Service's administraiP BeY. Roc. 69-2L
a c e ~ ~ ~ ( b i S i s w r etive~ M4Lf;M
i n
~ r * i m n p r D j c e t m M m -2
C.B.
(w
proposed regulations under section (2)(ii)(b) of this chapter), that computer
263A(f) and intend to issue final software development costs so closely
regulations defining contract under sec- resemble the kind of research and
tion 263A(g)(2) when those proposed experimental expenditures that fall
regulations are finalized. Therefore, the within the purview of section 174 as to
final regulations reserve the paragraph warrant accounting treatment similar to
regarding the definition of a contract. that accorded such costs under section
The Service is requesting comments 174. The Service has no uresent infrom taxpayers for a 60-day period tention of changing its administrative
after the publication of these final position contained in Rev. Prw. 69-2 1.
regulations in the Federal Register but continues to study i t s viability.
regarding the definition of a contract Thus. as long as Rev. Proc. 69-21
remains in effect. taxpayers are not
for these purposes.
rsgrvsP lo
(dlsoy w-

m,

rnt.rn[d)-

r c r e Z l r - ~ - b

U

c - i 4 m C Q Q l i g t b

---*--

t * x p l p r i s ~ I b ~ d t i r

-=MBw--

' t - m

-*-It-N
U
5
d
~
v
i
P
b
o ..-rr.t---*ra,dllt
~
.
mwregdabS-m&
r r + r b . r c l r o d u q t h r a r
hmk, ar s i r n i b paprtgr.A&
\tatm this gm- tionatly, the C o n f e m c e Report to - o f I b t M R w - C o d e
era1 ruk F h , d m 460(e)(l) section 263A defines tangible personal
are mated PS mgiblc
p p provides dm# se263A applies to a property, for purposes d section 263A, erty under seftion m A (#.g., fib%
home construction cmtm3 unless that as including "films,
mordings, s o d recordiqs, i p s 0 fqm, md
contract will be
within two video tapes, books, and other similarly b&L
One cmmwggyears of the cocommencement [sic] property embodying words, ideas, that tho final regulaEioPs d e b tke
Jate and the taxpayer's average annual
concepts, images, or sounds, by the reference to licenses. However. the
gross receipts for the three preceding creator thereof." 2 H.R. Conf. Rep. final regulations retain the reference to
taxable y e a r s d o not e x c e e d No. 841 n.1, 99th Cong., 2d Sess. II- licenses because licenses are commonly
6 10,000,000. Because sedion 460(e)(1) 308 (19861, 1986-3 C.B. (Vol. 4) 308 used in the publishing, sound recordprovides that section 263A applies to n.1.
ing, and film industries and are approthese home construction contracts (even
priate]y considered a cost of publishing
The final regulations generally incor~ t ' the contractor does not own the
a book or producing a sound recording
porate the definition of tangible perunderlying property), the Service and
or film. The final regulations also add
sonal property used in the Conference
the Treasury believe that ownership is
licensing
and franchising fees (or amorReport. The final regulations clarify the
not a prerequisite to capitalization
tization thereof) to the examples of
definition in the Conference Report by
under section 263A with respect to
indirect costs that are capitalized to the
providing further guidance as to what
extent properly allocable to property
such contracts. Thus, the final regulaconstitutes other similar property for
tions adopt the position in Q & A 4 of purposes of the tangible personal prop- produced or acquired for resale.
Notice 89-15. 1989-L C.B. 634. (See
erty definition. In general, the final
$601.601(d)(2)(ii)(b)of this chapter.)
regulations provide that other similar. C. Definition of Produce
Second, seulion 263A(g)(2) provides properry is intellectual or creative
Many commentators suggested that
that, with respect lo certain costs. a property for which. as costs are intaxpayer is treated as producing any curred in producing the property, t t is produce be defined more precisely in
property that i s produced for rhe intended (or is reasonably likely) that the final regulations and that the final
taxpayer under conlract. Therefore. a any tangible medium in which the regulations include a complete list of
taxpayer that has property produced for property is embodied w i l l be mass all types of production activities. Other
it under contract is subject to section distributed by the creator or any one or commentators requested that produce
263A even though it does not own the more third parties in a form that is not be defined more narrowly in the final
underlying properly being produced.
substantially altered. However, the final regulations.
The final regulations do not adopt
Commentators suggested that con- regula~ionsprovide an exception to this
tract be defined for this purpose in a general rule. Any intellectual or cre- these suggestions. The Service and the
manner that would n~inin~ize
taxpayer ative property that is embodied in a Treasury believe that the determination
:ompliance burdens. They noled that a tangible medium that i s mass dis- of whether a taxpayer is a producer is
broad interpretation of contract could tributed merely incident to the distribu- generally a facts-and-circumstances dtinclude routine purchase orders. which tion of a principal product or good of termination that must take into account
would require taxpayers to allocate and the creator is not other similar property the nature of the taxpayer's trade or
zapitalize a portion of their general and for these purposes.
business activities. Further, the Service

a
#

Section 263A
and the Treasury believe that many of
the curnmentarors' concerns regarding
the scope of produce have been allevi- A. Resellers with Prod~rction
ared in the final regulations through the Aciiviiies
adoption of various de minimis d c s .
These rules include de minimis rules
Cornmenlators questioned whether
for property provided to customers personal property acquired by a small
incident to the provision of services. de reseller becomes subjec~to the uniform
ntinimjs rules for propetty produced capitalization rules under section
incident to resale activities, and rules 263A(g)(2) because the property is
treating producers using the simplified produced for the small reseller under
production methd as having no addi- contract (e-g., private label goods). In
tional section 263A costs if they incur response, the final regulations provide
de minrnzis indirect costs.
that a small reseller is not required to

D. Pre-production

Costs

Conlrnentators questioned whether
costs incurred pnor to the comnrencrment of production (pre-production
costs) must be capitalized. Under the
rxieridcd-period long-tem contract regulations. pre-production costs (e.p., bid-

ding expenses) are capitahzed. Accordingly, the final regulations, which are
patterned after the extended-period
long-term rontract regulations, clarify
that pre-production costs must be capitalized if it is reasonably likely that
they relate to production that will take
place in the h u e . Eor example, a

---

mmmfauiu~,rrmust c e i z e the costs
of aoring and haadling raw materials
Wore tbc raw merials arc committed
to p r n d d a n .

Further. r real

estate

M o p e r must capitaiize hues inc
d w&
m propmy ifit is
reawnably likely tbc p p l y win be
-IY
auteloped

ooot~iDwzed&mqlm--

d w - - f
must be cayitalizcd. The lcgislntive
history explains thar section 263A was
intend& to provide a uniform. comprehensive set nf capitalization ruler
governrng the cost of both producing
and reselling property. S. Rep. No. 313,
99th Cong., 26 Sess. 140 (1986). 1 9 8 6
3 C.B. (VoI. 3) 140. Because the
legislative history specifically states
that costs incurred by resellers incident
to purchasing property, huch as storagc
costs, must be capitalized. the final
reguIations clarify that similar costs
iwurred by producers (such as the cost
dflp'lBr;a;nkdHPYrI&

capitalized as well. However, as indicated in Notice 88-86, the final regulations provide that producers may deduct the costs of an on-site storage
facilit} to the same extent as wseIlers.

clear on wh~chindirect costs resellers
are required to capitalize. The final
regulations clarify that in addition to
purchasing, storage, and handling costs,
resellers must also capitalize other
indirect costs that are properly allocable to property acquired for resale.
C. Slorage Costs

Under the temporary regulations,
resellers must capitalize their stornge
costs attributable to their off-site storage facilities but not their on-site
cap~lalizeadditional scction 263A costs storage facilities The temporary reEto personal property produced for it uIations provide that an on-site storage
under contract if the contract is entered facility is a facility which is physically
into with an unrelated person incident attached to, and an integral part of, a
to its resale activities and the property retail sales facility where the taxpayer
is sold to its customers.
sells merchandise stored at rhe facilily
tn addition, commentators questioned to retail customers physically present at
whether a reseller otherwise subject to the facility. Cornrnentalvrs suggested
section 263A (e.g., a reseller with gross that the physically attached to and
receipts of greater than $10,000,000) integral part of standards be modified
that acquires propeny for resale is lo provide a broader definitinn of an
prohibited from using the simplified on-site storage facility.
resale method merely because the
The final regula~ionsretain both the
res~ller is considered a producer wilh physically attached to and integral part
respect to the property produced for it of standards. The Service and tk
under contra= The find regulations Trrasury b e l m that these standards
cIanfy that smh a reseller is not arr nundated by & legislative history
indigible to use tbe w f k d resale of
263A. This legislative hisd mcdy bccanse i& m n a l tory -dm
d€-site storage mts
pmpaty qlriesd for resale is pdtlced are t
k "costs of woring goods in a
under -ct
with an unrtlated third facility distinct from the facaity
wbarin tBt taxpayer mdum rerail
F-'.
S- Uep. Ma 313.
The final tegulatiar aiso m l y nb of ...
kc
142 <1986),19%
~ 4 u a - - L o o r
3 CB
3) 142 The fid regub-a-rsOlir
drify. *1IClt a A t
a m c n a r - * ~ ~

-

wbw'

ria---P*litWLoi

m m k d a k 5 i f * ~ X r
rivitieE#&-*wm
pose, a ~ s e l h ' sproaaivitlFs
are presumed tie mininrmis if: ( 1 ) he
gross receipts from the sale of property
produced by the reseller are less than
10 percent of the total gross recelpts of
the trade or business; and (2) the labor
cosls allocable to the production activities of the trade or business are less
than 10 percent of the total labor costs
of the trade or business. Further, the
final regulations generally provide that
resellers are no! precluded from using
the simpl~fiedresale method solely by
reason of a d~ minimit amount of
activilj-

B.

Costs Capi~alizedby Resellers

Commentators expressed concern
that the temporary regulations were not

- y q d k m * - m
~ w i p h d p l t a

iwpmuftbt-afthl
retail site; which art generdly opcr
each business day exclusively to retai

customers; on or in which reral
customers normally and routinely

shor

to select specific items of merchandise
and which are adjacent lo or ir
immediate proximity to other portion:
of the specific relail site.
Based on several comments received
the Final regulations permit certain non
retaiI customers to bz treated as retai
customers for purposes of determininj
w h e k a facility is a retail sale

aFm a
s purpme, a non-mi
mmmiarrtaredwamif the following requirements are satla
fied; the nun-retail customer purchase
goods at the facility under the sam
terms and conditions as are available O

Section 263A
retail customers (e.g., no special discounts); the non-retail customer purchases goods in the same manner as a
retail customer (e.g., the non-retail

function storage facility with respect to
property sold to customers from the
facility are not required to be c a p
italized to the extent that the costs are

advance and mmt come to the facitity
ro examine and select goods); retail
customers shop at the facility on a
routine basis (i.e.. on most business
Jays) and no special days or hours are
reserved for non-retail customers; and
taore than 50 percent of the gross sales
the facility are made to retail
iusiomers.
The temporary regulations provide
that a dual-function storage facility is a
>torage facility that serves as both an
tin-site storage facility and an off-site
vtonpe f d t y . T h y also provide that

in on-site sales. HandIing costs attribu-

- * m m r w *

a P P r t d P d b r v - i
t

r

e

U

r

~

~

&

~

h

the-d*mbd-d

h

g

v f l * t k ~ i m , * d

w*

table to property sold to customers
from a dual-function storage facility in
on-site sales are determined generally
by comparing the gross on-site sales of
the facility to the total gross sales of
the facility.

E. Exception for Repackngilig

grasp sale& of tb
'lht
rek h i e ths d d o n ratio
and d g ~p v i & t
b
t F o r to its
computation a taxpayar mnst maLe ap
yropriate adj-ts
h&T uscs d
J dual-function stor*
facilty .
D. Handling Cars
Hnndling cos& arc Wnd ip tbe
temporary regulations as the costs
attributable to handling, processing,
assembling. repackaging, and transporting property acquired for resale. For
purposes of clarification, the final
regulations provide definitions of each
of the above terms associated with
handling costs so that taxpayers can
tnore easily distinguish handling ac-

tivities from other activities not subject
to section 263A.
In addition, commentators requested
clarification regarding the types of
handling costs that must be capitalized
under section 263A. In respnse. the
tlnal regulations provide a bright-line
test for determining which handling
costs must be capitalized. Under this
test, handling costs incurred at s retail
sales facility with respect to property
sold to retail customers at the facility
are not required to be capitalized. Thus,
for exampie, handling costs incurred at
a retail sales facility to unload, unpack,
mark, and tag goods sold to retail
customers at the facility are not required to be capitalized. In addition,
handling costs incurred at a dual-

Costs

Under the temporary regulations, the
costs of repackaging goods in preparation for immediate delivery to particular customers are excepted from hand-

h

n

g

c

a

m

t

h

a

t

~ ~ ~
irg&k1~~--41Yb i .Horrzvler, d

i#f---**

sidic a

- - - J J b e

* W d ~ r n , t g L
Wtk-iah-

R-Lb-mCa,

.

5 a i a d h M W f k p r d
them&m.-

W l j d t - m m d

The temporary regulations also exclude from capitalization under section
263A the costs of delivenng certain
items from an off-site storage facility
(bx&glJeS--dksalit
takes place, provided the i m s m
specifically ordered by customers
(custom order exception). The final
regulations reserve the paragraph regarding the custom order exception and
the distribution cost exception (induding a provision regarding costs incurred
transporting goods to a related person).
As provided therein, the separate
Notice of Proposed Rulemaking prov~desthat these exceptions pertain only
to transportation costs that are incurred
generally outside a storage facility. For
this purpose, costs incurred on a load-

jq-w-rn-

8

I_,--Th&J

rcgukhs m
e the p q r a p 4 rcgarding the repackaging exception. Under a separate Notice of Proposed
W
e in *** m-6491, page
621, r h s Wllletiah irk p
r
m bat
the -g
be h i nated far t
k
-n.
m,
PariI the N&ke of Proposed
Rutmtakrng is finalized. the paragraph
in the temporary regulations providing
the repackaging exception continues to
apply.

--

F. Exceptions for Distribution Casrs
and Costs of Delivering CustomOrdered Items

Under the temporary regulations, dis-

tribution costs are a type of handling
costs that are not required to be
capitalized (distribution cost exception).
Distribution costs are defined in the
temporary regulations as the cost of
delivering g o d s directly to an unrzlated customer.
Some commentators suggested that
the cost of delivering goods to a related
customer should be deductible just as
the cost of delivering goods to an
unrelated customer are deductible. Another commentator suggested that the
cost of delivering goods to a related
customer should be deductible unless
the related persons are members of a
consolidated group. As explained in the
accompanying Notice of Proposed
Rulemaking, these suggestions have not
been adopted.

-

&

-

tp.gprrta?.*ar,dIbeCpFopa
&
coatinae to appty.

The finor regvZatioa prorids several
simplifikd
fw allocating
and
cosh to
property proacquired far t&.
la
tkese
simplified methods dzPermiPe -we
amounts of additional section 263A
costs allocable to ending inventory.
Additional section 263A costs are those
costs, other than interest, that were not
capitalized under the taxpayer's method
of accounting immediately prior to the
effective date of section 263A, but that
are required to be capitahzed under
section 263A. In addition, the final
regulations provide a simplified method
for allocating costs incurred in a
service department (i.e.. service costs)
to property produced and property
acquired for resale.

w,

A. Simplified Production Method
The final replations provide a simplified production method for purposes
of determining the aggregate amount of
additional section 263A costs that must
be added to eligible property held by
producers at the close of the taxable
year. Under lhis method. producers
determine additional section 263A costs
by multiplying their section 471 costs
remaining on hand at year end by an
absorption ratio consisting of their
additional section 263A costs incurred

Section 26311
during the taxable year over their
section 471 costs rncurred during the
taxable year.
The temporay rcgulntions limit the
availability of the stmplified production
methcld to rwo typrs o f property: stock
in trade of the taxpayer properly
includible in inventory; and noninventory propeny held by the laxpayer
primarily for sale to customers in rhe
ordinary course of the taxpayer's trade
or business. The final regulat~onsfoilow Notice XS-Oh and ~ x p a n d lhe
categories of produced property eligible
fur tb simplified production method to
include; self-cortstmcted assets substantially identical iu nature to, and produced in the same manner as. ~nventory
property or other prvpelty held pnmarily for sale 10 cuslorners in the
ordinary course of the taxpayer's !ride

or business; and self-constructed assets
prodtrccd by the taxpayer on a routine
and reprtitive basis in the ordinary
c~lrse of the taxpayer's produaion
activities.

A number oi commenrators requesied
that the simp3iRed -ion
method
in the tempwary rtgulations be revised
to
rke ~raonmof $ ~ ; l i u ~263A
i
cosu aU~~able
to raw materials invento&.
b -ms
suggested
that d d v m b e d on this neth hod
may rcrult in an excessivt mount of
sect&
263A cnsts k h g allocated to
raw mYrrLls inwntories. They argue
&au fhis result m u m fi l
k

~ p r o d a h a n ~ & e o
*--dramas-

the inventvriablc cost of t h z ~mate-

lion methoi be~ng used by reseilers.

rials. Second, incorporaring these suggestions in the iilliil regularions would
reduce the sirnpIicity that the sirnpiified
prodllcrion mcthod i s intrrlded to provide. If the simplified production
method produces inappropriate rcbults,
a taxpaytr may request to change ~ t s
merhod of accounting to a facts-ondcircumstances allocation method.
Commentators requested clarification
otl detern~~nirig
section 471 costs. They
ques~innedwhether a cnange t n finnncia1 rep~rtingpractices with rtspcct in
category iii costs jciescribed in the full

The simplified resale m e t h ~ di s esserl-

absorptio~ rcgulatrons of
i ,471I l ( c j ( 7 ) i for years afrer the effccti;e
date of section 2634, would auromaiically cllangrl the costs ~ncludeu in
section 471 costs for purposes cf the
simplified production methcrd. The fina;
regulations clarify that in order for a
taxpayer to change ~ t scosts included in
section 471 costs, t h t taxpayer mast
first change its 111rthod of accounting
used in determining section 471 costs
for federal income lax purposes. Thciefore, a change in the treatment of
section 47 1 costs for financial repofling
purposes does noi autrlmaticalij' result
i n s c h a n g m the treament of sectior!
471 costs for federal income !ax
purposes.
Finallq. commentators sugpestrn ?hat
the final regulations ptov~deall excep
tion tor producers similar to thc gross
rcoeipts -e
avaiiabk to reselks.
Aibngh
#
tbt fim rc@amns do not
lslrpClriE-tbCydop&.
-.a&rriaiarir-fu

lain taxpayers engaged In horn resaIe
and produstion actj~~ilie?
to tizcl the
simphl'ied resalc mcrhod in ~ W G~ i f l 1 ~ tions. Firs!, the finai rzguiat~onsgcccl-ally permit a resc~ier ~ i t h 9c-sv;ifi:'
property produced under contrac: tc.
elect rhe simplified resale ir~cthod.
Second, the final rrguia!iohs permit a
taxpayer with d t ; ? I ~ J : ~~rIe~d uJ cs: i ~ u :
activities to elect the simplified rcsa!?
method. For this purpose. s rese!!er'~
production activitie: arz presulxii ilk
mirlin~isif: ( I ) the gros5 receip~sfron:
thc sale of proper!y prnduced b:: the
rcselle~are less ihan i G peicsr,; of t!lc
lord grubs receipts of the rra& 3 .
bcsiness; and (2) the labrv costs R;iocable to the prductior, activities o:
the trade or business are Ie>s they! 1 ; '
perccnt of the ro?aI Iabvr ~ ~ l s r;i
r s ihb
rradc cr business. If the slmplificl
resale method is e k t d , I! rnusr. hl
trned lo capitalize all cosls allorable
+li$ibic praeafjl pcPhrced w.d p q n
Ax@&*&.

r o r m r - W k U a l y n
pdums-W*ireplifibd~
pbonpcriada!ftirHcthansrcinarmd -mcr)ladUlllertbifw i c h ~ r n o i b e r & m di ~ f
P
~
~
f
h
~
-hod
has i n d i m costs of
held longer. For example, a taxpyer prd~aim
that buys additional raw marerials on $200,000 ur l e s ~ i n a taxable year
Ihe ]as! day of the year would be (excluding certain indirecr cars specifrequired to allocate significantly more ically nut rcqulred to be capitalized).
additional section 263A costs (such as the producer is deemed to have no
storage, handlrng, and carrying costs) addrtronal x c t i o n 263A cobts in thar
ro those materials under the simplified vear.
production method than it would under
a facts-and-circumstances allocation
rnelhod.
Prior ro issuance of the final regulaThe final regulations du not adopt
these recommendations. The Service tions. resellers were permitted to
and the Treasury believe thar the cl~ooscfrom three simplified allocation
simplified praduciion method formula methods to &[ermine the aggrzgate
nrrvvlor af asldrtiml seaion ?h3A
&-*-drew
materials that are purchased on the last costs anoc-dbllc ID rn.
day of the )'ear. First, the taxpayer will The final regulations provide only one
have likely incurred pwrchasing costs simplified allocaiiun mer11od for reand handling costs in obtaining these sellers, the simplified resale method.
materials, whish should be included in which is the principal simplified alloca84

1993-2 C.B.

tially the same as the modified resalt
method set fonh in Notice 59-67. ?'he
final regulations permlr reseilers tc

rncdify the formulas provided u:,der the
simplified resale method to y l e l ~a!locations equivajent tc the orher rwc.
simplified allocation methods nc-r spe-

cifically

retained

in the

final

regulations.

fiefierally. the sirnplif~ed resale
merho3 may no! be elected 3:j raxpayers with praductio~activitie?. however. the final reguiations pernit zer-

r b s

l

e

d

ThE

ugulatians provide
simplified service cost method pr.

ducers may use to aIIocate mi;;,
service r:osts among thrir various bu
nezs activities. Under this mcthod. 111.
portion of a taxpayer's mixed s e T w
costs rcquired io bc capitalized
dcrcr~nined by multiplying th? i ,I
paver's total mixed service cosrs I .
curred duri~lg the taxable yEdT by
ratio of its tordl pr~duc:ion P , .
(e-xcludlng mixed Y C I V ~ L C costs
inrerest) incurred durinz the tax,ll
year ra its [oral costs incurred J!:II
the taxable year (excluding 1;:.
I!

$ 1 1

&--apdLaXe>
sessed hased on income). Resellers
use n similar simplified servix

merhod provided they clecr thr

plified resale method. Comn:.etl~

I

Section 263A
l-r.\~cd that all resellers, not just
using the simplified resale
,
be perm~tted to use the simi .:I ~t.tiservice cost method. In response
,, -

8,jl\.r.\

Simplification for Both Produ~-ersand
Resellers

rl1111l.

rtrtc

,

A. Historic Absorption Ratio Election

tbt i i d

one simplified service cost
Commentators expressed concern
[nay be used by all re- that computations under the simplified
. I 1 , r 5 and producers, regardless of production method and the simptified
: ! b l r11r.r they
elect another simplified resale method are costly and time
, 111,111.
consuming because a taxpayer must
I 1 1 .~ddition.commentalors suggested determine its absorption ratio annually.
11 11
rhe allocation ratio under the In response, the final regulations permit
,111~l11fied
service cost method in tk producers and resellers to elect to use a
I I i l l r lrary
regulations results in the historic absorption ratio in conjunction
. . ~ . r capitalization of mixed service with the simplified production method
or the simplified resate method.
( > , . I , because the cost of raw materials
,
111~luded
in both the numerator and
In general. if n taxpayer elects to use
. ~ ~ - ~ ~ r l ~ u iof
n a tthe
o r ratio. They also a h~storic absorption ratio, the addiI ~ ! - ? c + t e dthat p r o k c r s be permitted tional section 163A costs allocable to a
kt.=
a
tslio m p y & s - - = a D m IIIIIJX
W tbt ow in tbt
pltod
h -a's
I

%

I I 11.

, r t l # ~that
l

1

r 8

<.,,,I:-It.c~tbt

*
WW &

-

w

Ab
I t ~ l * l l l a a dio M
lbt m
: G . ~ t r l i ~
@
r h
-lo
W 1+
either a lak-based f i a t i o n ratio
. # I the pdmim cost allocation ratio
>lt.%crikd
above.
! 'ommentatonalso ~ s t e that
d the
.,I ~,goriesof p d u c e d property eligible
t t l r . the simplified service cost method
1 ) ~ . expanded. Consistern with Notice
5s - 86. the final regulations provide
r1l.11 the sinlplified rervice cost method
I < ;dso available for: self-constructed
.t\\cts substantially ~dentical in nature
11).and produced in the same manner
. I \ , rnventory propeny or other property
11~.1dprimarily for sale to customers in
I llc ordinary course of the taxpayer's
11~13iness;and self-constructed assets
114 oduced by the taxpayer on a routine
. 1 1 1 c l repetitive basis
in the ordinary
,i lime of the taxpayer's production
.~<,tlvities.
In determining total mixed service
.tbsts under the simplified service cost
1 1 lethod, the temporary regulations require that a taxpayer include the total
~ o \ t sof any department or function
\lzrforming mixed service activities.
I.t)r example, a reseller i s not permitted
lo segregate non-resale activities perlbrined in a mixed service department
l'rom the department's other costs.
C'ommentaturs requested that this
restriction br removed in the final
r,egulations. The Service and the Treasury, however. believe this restriction IS
appropriate to prevenl distortions in the
;illocation of inixed service casts to
production and resale activities.
(

lar taxpayer's operations. with the same
degree of specificity as required of
manufacturers capitalizing costs prior
to the enactment of section 263A.

-

m - h b y i a h
471

--ma-

w,

my. A
rbwepdar
ntiPi6mBaedarthpreernage of additiolmI section 263A cow
capitalized by the taxpayer during a
three-year test period Taxpayers are
required to test the accuracy of the
historic absorption ratio by comput~ng
an actual absorption ratio once every
six years. If the tmt of the ratio
indicates a more than oae-half of one
percentage point difference (plus or
minus) from the taxpayer's actual
absorption ratio, the taxpayer must
redetermine its historic absorption rario
using an updated test period.
For the following reasons. the historic absorption ratio is on1y available
to taxpayers that use one of the
s~mpliriedmethods. First, i t is difficult
for taxpayers that do not use a
simplified pmduct~on ~r~cthodor simplified resale method to identify additional section 263A costs. Second. the
histor~c absorption ratio rtsults in
certain con~plexit~esfor dollar-value
LEE0 taxpayen that n ~ u s t allocate
a d d ~ t ~ o n asection
l
263A costs to specific items of property.
Taxpayers will be permitted to elzct
a historic absorption ratio in their first.
second, or third taxable year beginning
after D e c e m k r 31, 1993.

B. Taxpavers Not Electing Simplified
Merhods
Taxpayers that d o not use a simplified method must capitalize their
costs under section 263A based on the
facts and circumstances of the particu-

C.

Trade or Business

Requirement

A number of commentators suggested thal taxpayers should be Permitted to apply the simplified methods to
more discrete business units than a
separate and distinct trade or business
(e:g., a product line). The final regulations have not adopted this suggestion.
Applying the simplified methods to
business units smaller than a trade or
business is not consistent with the
legislative history, which intended that
the simplified methods would be ap-

plied-meactrrrpdta
Sa Z W B .
bmifiegs d a .-

Cd-EbC:I&:w*--a
-3
C.B. tvd.

SIlsa &-

Wrnkrirrre-cbr
a arde or
is contray to lk
goals d adrninistrdue -ience
and simplicity for h h taxpaythe Service.

D. Add-on Perrettmgc M

and

a

Some c o m r a O a r s s u g g f f e that
the final mgallnions pmnit pmdrsam
and resellers to capitalize additiod
section 263A costs based on average
absorption percentages experienced
within various ~ndustries.The Service
generally believes that, for small taxpayers for which the costs of compliance with section 263A might outweigh the benefits to the government
of compliance, the use of industryspecific safe harbor absorption percentages would be a reasonable simplifying
assumption under the Secretary's section 263A(i) authority. The Service has.
however. encountered difficulty in cotIecting the necessary industry-specific
data (e.g., by Standard Industry Code
grouping) to facilitate the development
of safe harbor absorption percentages.
Thus, the final regulations do not
permit the use of an add-on percentage
method as requested by commentators,
The regulations do provide, however,
a significant simplification through the
availability of the historic ratio election
and the rule under which producers
with de minimis indirect costs and
using Ihe simplified producrion method
are deemed to have ncl additional
capitalizable costs under section 263A.
In addition. the Service is willing to

1993-2 C.B.

85