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Federal Register / Vol. 86, No. 2 / Tuesday, January 5, 2021 / Rules and Regulations section 471c 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 1.4711b4, under another provision of the Code.
Some comments were received on the types of direct costs required to be included as an inventory cost under the section 471c NIMS inventory method.
These commenters recommended the final regulations exclude direct labor costs from the definition of an inventory cost under proposed 1.4711b4ii.
The commenters reasoned that the preamble to the proposed regulation indicated that section 471c1Bi was generally a codification of Revenue Procedure 200110 and Revenue Procedure 200228. However, the commenters point out that this administrative guidance did not provide for direct labor or overhead costs to be included in the non-incidental materials and supplies method.
One commenter asserted that inventory treated as non-incidental materials and supplies are not inventory property but are to be characterized as a material and supply. The commenter discussed Example 1, in Section III.D of Notice 8886 19882 CB 401 to determine the treatment of nonincidental materials and supplies prior to the enactment of section 263A.
Example 1 involves an architect providing design services that include blueprints and drawings and deals with the provision of de minimis amounts of property by a service provider. This commenter cites to Notice 8886 to provide, by analogy, that inventory treated as non-incidental materials and supplies under section 471c1Bi should not include direct labor costs.
The Treasury Department and the IRS
disagree with the application by analogy to Example 1 in Section III.D of Notice 8886. That example illustrates that an individual providing services, such as an architect, is not a producer despite providing a de minimis amount of property to the client as part of the provision of services. As discussed in section 3.A of this Summary of Comments and Explanation of Revisions, the Treasury Department and the IRS believe that inventory property treated as non-incidental materials and supplies retains its character as inventory property, and so Example 1 is inapposite.
The Treasury Department and the IRS
acknowledge that there was uncertainty under Revenue Procedure 200110 and Revenue Procedure 200228 as to
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whether direct labor and overhead costs were required to be capitalized under the non-incidental materials and supplies method permitted by those revenue procedures. The Treasury Department and the IRS are also aware that tracking of direct labor costs may be burdensome, and in some cases, difficult to do for many small businesses. The Treasury Department and the IRS agree with the commenters request that direct labor costs be excluded from the inventory costs required to be included in inventory treated as non-incidental materials and supplies. As a result, these final regulations provide that inventory costs includible in the section 471c NIMS
inventory method are direct material costs of the property produced or the costs of property acquired for resale.
B. Treatment of Inventory by Taxpayers With an Applicable Financial Statement AFS
Under proposed 1.4711b5, a taxpayer other than a tax shelter, that has an AFS and that meets the Section 448c Gross Receipts Test is not required to take an inventory under section 471a, and may choose to treat its inventory as reflected in its AFS.
Proposed 1.4711b5ii defines AFS
by reference to section 451b3 and the accompanying regulations, which included the additional AFS rules provided in proposed 1.4513h.
In section 4.C.i of the preamble to the proposed regulations, the Treasury Department and the IRS requested comments on a proposed consistency rule for a taxpayer with an AFS that has a financial accounting year that differs from the taxpayers taxable year, and on other issues related to the application of proposed 1.4513h to the AFS
section 471c inventory method. The Treasury Department and the IRS
proposed to require a taxpayer with an AFS that uses the AFS section 471c inventory method to consistently apply the same mismatched reportable period method of accounting provided in proposed 1.4513h4 for its AFS
section 471c inventory method of accounting that is used for section 451
purposes. No comments were received on the consistency rule or other issues related to the application of proposed 1.4513h to the AFS section 471c inventory method.
These final regulations adopt this consistency rule. The Treasury Department and the IRS have determined that a taxpayer using an accrual method with an AFS that has a mismatched reporting period with its taxable year should apply the same mismatched reportable period method
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of accounting for revenue recognition purposes and inventory purposes because there is better matching of income and cost of goods sold by applying the same reportable period method.
C. Treatment of Inventory by Taxpayers Without an AFS
Under proposed 1.4711b6, a taxpayer, other than a tax shelter, that does not have an AFS and that meets the Section 448c Gross Receipts Test is not required to take an inventory under section 471a, and may choose to use the non-AFS section 471c inventory method to account for its inventory. The non-AFS section 471c inventory method is the method of accounting for inventory reflected in the taxpayers books and records that are prepared in accordance with the taxpayers accounting procedures and that properly reflect the taxpayers business activities for non-tax purposes. For example, a books and records method that determines ending inventory and cost of goods sold that properly reflects the taxpayers business activities for non-Federal income tax purposes is to be used under the taxpayers non-AFS
section 471c inventory method.
i Definition of Books and Records Some comments were received on the non-AFS section 471c inventory method and the standard used in proposed 1.4711b6 for books and records. One commenter reasoned that the purpose of section 471c1Bii was to provide simplification, and the reliance on the definition of books and records used in case law is too complex, creates audit risks, and uncertainties as to what books and records means. The commenter recommended using a standard in which books and records is a flexible term and something the taxpayer and his accounting professional can agree on that is consistent from year to year. For example, the commenter suggests that any financial statement reporting of inventory that is consistently applied be acceptable as books and records.
Some comments discuss the issue of work papers and physical counts of inventory, and whether either should be used if a taxpayer is expensing these items for books and records purposes.
The commenters asserted that even though a taxpayer takes a physical count of inventory, the taxpayer should be allowed to expense the inventory for Federal income tax purposes if the inventory is expensed on its books and records.
The Treasury Department and the IRS
decline to change the definition of the
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