TCJA-Inventory

[Sean]

A small retail client keeps their books on the cash basis except on 12/31 they record inventory and adjust purchases.  Under the new tax law I think they can be cash basis totally and not record inventory.  Am I wrong on this?  If correct how do I expense opening inventory on 1/1/2018?  It is about $100,000.00.

[IntuitJim · Accepted solution]

Sean, Thanks for joining Community.

If you are a small business taxpayer (average annual gross receipts of less than $25 million), you can choose not to keep an inventory, but you must still use a method of accounting for inventory that clearly reflects income. If you choose not to keep an inventory, you will not be treated as failing to clearly reflect income if your method of accounting for inventory treats inventory as non-incidental material or supplies, or conforms to your financial accounting treatment for inventories. If, however, you choose to keep an inventory, you generally must use an accrual method of accounting and value the inventory each year to determine your cost of goods sold.

If you choose not to keep inventory on the books, you would simply include / debit  the $100K in COGS (purchases) for the year of change and credit inventory to zero it out.

Be sure to discuss the change with your client so they understand the multi-year impact of the change and aren’t surprised when profit pops back up the next year.

[catman]

Hi, is this still applicable? And if so, what happens on the tax returns under end of year inventory? It should be zero right, if all inventory is now expensed during purchase? This whole thing is extremely confusing and I have read conflicting articles constantly regarding this. From my understanding the TCJA allows small business to deduct inventory during purchase, but others say that you can only deduct sold items and must calculate COGS to reflect accurate income... So which one is it? Thanks,

Kevin

[StacyHauserAccounting]

This is still applicable although the IRS has become stricter on the rules.  If a small business qualifies to treat inventories as non-incidental materials and supplies, they can deduct incidental costs in the current tax year.  Incidental costs included in ending inventory the prior year gets deducted over the next 4 years.  Form 3115 must be completed to change the accounting method with the IRS and the books and records of the taxpayer must reflect the election.  If a business keeps up with inventory on their books, they cannot take the election.

Incidental materials and supplies can be deducted the year paid. 

Non-Incidental materials and supplies include inventory and can be deducted in the year paid or the year they were provided to the customer, whichever is later.

This is directly from the IRS instructions for schedule C 2019:

"To change your accounting method, you generally must file Form 3115. You also may have to make an adjustment to prevent amounts of income or expense from being duplicated or omitted. This is called a section 481(a) adjustment.

Example.

 

You change to the cash method of accounting and choose to account for inventoriable items in the same manner as non-incidental materials and supplies for the 2019 tax year. You accrued sales in 2018 for which you received payment in 2019. You must report those sales in both years as a result of changing your accounting method and must make a section 481(a) adjustment to prevent duplication of income.

 

A net negative section 481 adjustment is generally taken into account in the year of change. A net positive section 481(a) adjustment is generally taken into account over a period of 4 years. Include any net positive section 481(a) adjustments on line 6. If the net section 481(a) adjustment is negative, report it in Part V."

Stacy Hauser, CPA  

[CS2]

Will Turbo Tax ask these inventory questions and walk me through this or is this all done prior to starting taxes on Turbo Tax for the 2020 tax year?

[qbteachmt]

You seem to be lost on the internet.

You’ve come to a Peer User community for Intuit Tax Preparation products supporting tax preparation professionals for Lacerte, ProSeries and ProConnect programs/tools, and you may be looking for support as an individual taxpayer. Please visit the TurboTax Help site for support.

Thanks.

[swongtax]

Hello community of tax professionals!

I have a follow up question along the same lines regarding a "small business taxpayer" who sells T-shirts and sneakers on consignment.  We are filing his self-employed small business on Schedule C and he chooses not to keep track of inventory.  2021 is his first year of running this business, and he would like to "write-off" all of his ending inventory purchased in 2021 but not sold in 2021. 

According to the IRS updated rules, it sounds like I can expense/deduct this amount as "non-incidental material and supplies".  

1.  Is this a correct assumption?

2. What line number on Schedule C should this "non-incidental material and supplies" go on?

*Would it be Schedule C Line 38 "Materials and Supplies" or Line 36 "Purchases"?

3.How would this make sense if reporting it this way, in fact, would increase the Cost of Goods Sold (COGS) when the inventory have not yet been sold?  This would also affect numbers in the following tax year.

THANK YOU FOR YOUR HELP!

SW

[qbteachmt]

"and he chooses not to keep track of inventory."

A Consignment operation means there is no Purchased inventory. They sell first, then pay the consignor the sales amount minus a commission for selling. Your client has not purchased anything at the time it is put on hand and made available to sell.

Inventory is not "non-incidental materials and supplies." While you might be thinking that "stuff = stuff" there are different types of Stuff. Here is an example of material and supplies: I run a water district and buy a few meters and a spare pump/motor to keep on hand at all times. I "restock" as they get used. They are not on hand for sale. They are a supply item.

"would increase the Cost of Goods Sold (COGS)"

Well, it cannot do Both. It cannot be COGS (a direct expense of what got sold) as well as Expense as Supply (an indirect expense). Supplies and materials might be used in the course of making goods or providing services. In this example, if I buy various wood products to make furniture to sell, that furniture has the invested cost of goods still right there, on my shelf, ready to sell. I also might have a bunch of leftover scrap materials that I consider can be useful, but I want to write off all of the material that was purchased this year, even the part not used to make furniture, yet.

[swongtax]

Thank you so much for your reply!

A few more details:

Taxpayer buys T-shirts and sneakers for the sole purpose of RESALE.  He sells items both online (Ebay) and at consignment shops.  Items submitted to consignments do not necessarily get sold and paid.  If items are not sold, he will take them back and try to sell via another method.  He does not collect any revenue from consignment shops until the item is sold.  So, I guess the questions I still have are:

1.Since he buys goods to resell, I assume that he should a "cost of goods sold" when the goods are sold during the year, I would report that under "Purchases  Line 36" Schedule C?  

2.He purchases items (T-shirts and sneakers) for the sole purpose of resale.  So, does this mean he has an inventory for the goods that he purchased during the year but did not yet sell by year end?  According to your explanation, are you saying that he does not have an inventory (due to consignment sales) and so this means his items/goods would be considered "supplies" and not "cost of goods sold".

3.I understand what you mean by the items are not considered "non-incidental material and supplies", thank you for the explanation, but does that also mean there is no way to report the unsold items on Schedule C of the current tax year?

THANK YOU!

SW

[swongtax]

I am all set on this topic after researching "Consignor" info.

Thank you for your help!

[qbteachmt]

Okay, so he is the owner that puts the items for sale on consignment = those items are still his inventory asset. If they don't sell, he gets them returned to him, for instance. While that is on hand, it is his inventory, even if not in his possession, similar to placing goods for sale for fulfillment through Amazon.

Perspective matters with consigned goods, and sometimes there is some of both "this is for sale and I keep a commission" and "this is for sale and then I pay you for them later." It depends on the terms with the end seller.

Purchases in that year are not COGs, but the expenditure to refill what gets sold.

Inventory cost on hand at beginning of the year

Purchases of same + Any other costs this year that got invested in products

minus

Inventory cost on hand at the end of the year

=

COGS

Example:

0 on hand Year one

$5000 purchased

$2000 left at end of year

= $3000 COGS year one

$6000 purchased in the new year two

$500 left at end of year two

=

$7500 COGS year two

You had a total of $8000 of stuff in that second year, and ended with $500 of it = $7500 COGS.