263A is shorthand for IRS Code Section 263A, and it details the rules used by business taxpayers to account for and capitalize their costs. Also known as UNICAP, or uniform capitalization, Section 263A often befuddles even the most seasoned business professionals. It is highly advised to consult with an accountant for accurate calculation of 263A, as the IRS can and will audit for your compliance with this regulation.
Who Needs To Calculate 263A
This difficult section of the IRS Code applies to retailers, wholesalers, and manufacturers who bring in average gross receipts of at least $10 million per year. Regulations vary depending on your class or category of business such as:
- If you provide a service
- Manufacture goods
- Produce property
- Is a retailer
Basics for 263A Calculation
263A calculations begin by determining all of your indirect purchasing costs. Any purchase you make, warehousing fees, processing fees, repacking and assembly costs and support payroll costs count as indirect purchasing costs. These costs do not include marketing, advertising, distribution, or research and development.
You must then allocate these costs between inventory and the cost of goods sold. An example of costs of goods sold would be the materials used to make a particular product; inventory would be the machine used to make the product.
Once you allocate costs, all costs must be classified into three categories: production, administrative and mixed services. Production costs and administrative costs require no further explanation, and mixed services include anything that may be defined as both a production and an administrative cost. These may include purchasing, data processing, or your personnel department. Then you have to allocate mixed services costs between production and administrative.
While the process of classifying your costs is a lot of busy work, cost accounting is where accounting and mathematics come in.
There are a variety of different methods for cost accounting, and different methods may be preferred in different industries. Consult with a tax professional to figure out the preferred method for your industry. Examples of common cost accounting methods include production labor as a percentage of total labor costs or average cost per unit. Preferred accounting methods often change from year to year.
It can’t be stressed enough the importance of getting a tax professional to check your figures. This guide gives you a basic understanding of how 263A works, but it is nowhere near long enough to provide a full breakdown of how it’s done. It requires tables and figures for how to do cost accounting in your particular business for each of the different categories as well as what sorts of costs qualify for each category.