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Of particular concern for examin- taxpayers may elect the one-third/
ing agents are vendor rebates. This can two-thirds rule for allocating labor
be an area of additional scrutiny upon For calendar-year between purchasing and nonpurchasing
review, as taxpayers reduce the cost taxpayers, the activities. An audit technique described
of inventory for vendor rebates to the three-year period in the practice unit instructs examining
extent they qualify as “trade or other agents to look to the specific functions
discounts” (see Regs. Sec. 1.471-3(b)). granted to comply that an individual performs rather than
Taxpayers should take note that the with the final an individual’s job title when determin-
term “trade or other discounts” is not ing how to treat costs. This may some-
limited to discounts based solely upon Sec. 263A times benefit the taxpayer. For example,
regulations closed
the purchases of a particular volume individuals with a title of “buyer” or
of merchandise to which the discount with the tax year “merchant” often spend a significant
relates but is broader in scope. For ex- amount of time engaging in marketing
ended Dec. 31, 2020.
ample, TAM 200605010 provides that and selling activities, the costs of which
amounts received from vendors pursu- are not required to be capitalized.
ant to certain agreements may consti- The practice unit indicates resell-
tute discounts allowable as a reduction to inventory. Categorizing these dis- ers must capitalize handling costs and
to the cost of inventory, provided the counts as an additional Sec. 263A cost off-site storage and warehousing costs
agreements do not require the taxpayer can generate a favorable Sec. 263A under Sec. 263A. As defined in Regs.
to perform services for the vendor and adjustment without the administrative Sec. 1.263A-3(c)(4), handling costs
the vendor is neither entitled to receive, burdens associated with adjusting Sec. are costs attributable to processing,
expects to receive, nor has received the 471 costs. assembling, repackaging, transporting,
performance of services in exchange for and other similar activities that do not
the rebate or allowance. Thus, resell- Identification and allocation of constitute production with respect to
ers may want to analyze the nature of additional Sec. 263A costs property acquired for resale. Further,
their vendor rebates in the context of The LB&I practice unit instructs Regs. Sec. 1.263A-3(c)(5) provides that
this TAM to determine whether such examining agents to identify and de- storage costs are capitalizable to the ex-
discounts are considered a “trade or termine the additional Sec. 263A costs tent they are attributable to an off-site
other discount” and therefore treated as allocable to resale activities as part of storage or warehousing facility.
a reduction to the cost of inventory. examining a reseller’s Sec. 263A com- Interestingly, the practice unit does
In addition, with respect to Sec. 471 putation. Regs. Sec. 1.263A-1(d)(3) not discuss pick-and-pack costs, which
costs, the final regulations provide a describes additional Sec. 263A costs as resellers may generally deduct in accor-
de minimis rule for certain uncapital- costs, other than interest, that are not dance with Regs. Sec. 1.263A-3(c)(4)
ized direct material costs under Regs. generally capitalized into inventory for (vi)(C). Resellers commonly generate a
Sec. 1.263A-1(d)(2)(iv)(C). Under the financial statement purposes but that significant benefit by properly analyz-
direct material de minimis rule, resell- are required to be capitalized under Sec. ing handling and off-site storage costs
ers are not required to adjust Sec. 471 263A. As described in the practice unit, to identify pick-and-pack costs. While
costs for uncapitalized direct materials these include purchasing costs, han- many resellers perform a pick-and-pack
(e.g., discounts), provided the absolute dling costs, storage costs, and service analysis for labor and labor-related
value of the uncapitalized direct mate- costs, including mixed-service costs. costs, the ability to include nonlabor
rial costs does not exceed 5% of total In accordance with Regs. Sec. costs in the pick-and-pack analysis is
direct material costs. Rather, these 1.263A-3(c)(3), resellers are required often overlooked. For example, depre-
uncapitalized direct material costs can to capitalize purchasing costs, which ciation on machinery and equipment
be included in the numerator of the include personnel costs (e.g., those of dedicated to the pick-and-pack func-
simplified method absorption ratio buyers and assistant buyers) related tion may qualify as a deductible pick-
computation as an additional Sec. 263A to purchasing activities. Purchasing and-pack cost.
cost. This has proven to be a beneficial activities are defined in Regs. Sec. Service costs are another area of
provision for resellers with trade or 1.263A-3(c)(3)(i) and include selection concern in the practice unit. Service
other discounts that are not being capi- of merchandise and placement of pur- costs are indirect costs associated with
talized for financial statement purposes chase orders, for example. As provided a service department or function that
and are otherwise treated as a reduction in Regs. Sec. 1.263A-3(c)(3)(ii)(A), are generally required to be capitalized

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