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Income Tax Regs. In the first level allocation, “Indirect
costs may be allocable to both production and resale
activities, as well as to other activities that are not
subject to section 263A. Taxpayers subject to section 263A
must make a reasonable allocation of indirect costs between
production, resale, and other activities.” Sec. 1.263A-
1(e)(3)(i), Income Tax Regs. If the indirect costs need
only to be allocated between one item of taxpayer-produced
property and the taxpayer’s other activities, or between one
item of property acquired for resale by the taxpayer and the
taxpayer’s other activities, the allocation stops at the
first level.
If indirect costs must be allocated among different
items of property subject to section 263A, the regulations
provide for a second level allocation. See sec. 1.263A-
1(f), Income Tax Regs. The cost allocation method used at
the second level must be reasonable under section 1.263A-
1(f)(4), Income Tax Regs. Sec. 1.263A-1(g)(3), Income Tax
Regs. For the second level allocation, the regulations
provide:
A taxpayer may use the methods described in paragraph
(f)(2) [specific identification method] or (3) [burden
rate and standard costs methods] of this section if
they are reasonable allocation methods within the
meaning of this paragraph (f)(4). In addition, a
taxpayer may use any other reasonable method to
properly allocate direct and indirect costs among units
of property produced or property acquired for resale
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