Method of Accounting

This discussion provides some great insight into my question, but isn't quite on point.

viewtopic.php?f=8&t=9942&p=91401&hilit=change+of+accounting+method+inventory#p91401

I have a medical practice with significant inventory (~$100K) and significant revenue from the sales of those items (~50% of total revenue). Overall gross receipts is less than $3M.

I understand, from a CPE I attended, that the rules around cash basis and 'ignoring' inventory are much more liberal in 2018. Based on the fact above, can I make an accounting method change for 2017 and write off inventory to zero (incidental materials and supplies)? I found an article from 2010 discussing RP 2009-39 stating an automatic change to incidental materials and supplies is not available. Does anyone know if anything has changed on this?

To my understanding, if inventory is a material income-producing factor, then the higher gross receipts limits allow you to account for inventory as non-incidental materials and supplies.

If I'm wrong, I'm sure Coddington will correct me given that you provided the perfect thread title to catch his attention

This is often misunderstood. It is my understanding that you still do not get the write-off until the "inventory" or "non-incidental supplies" are sold. There are some differences in treatment (fifo perhaps?) but it is not the case that treating it as not inventory will allow you the full write-off.

I have always understood it to mean that you don't have to follow the UNICAP rules of inventory in Sec 263. That section has includes icky stuff about indirect costs, mixed service costs, allocation of all the direct costs of producing that inventory, etc. (I used to be in the Cost Accounting Dept of a major manufacturer and I hated it!! Never again!)

But it is still "inventory" in that it resides on the balance sheet until sold or disposed.

To my understanding, if inventory is a material income-producing factor, then the higher gross receipts limits allow you to account for inventory as non-incidental materials and supplies.

If I'm wrong, I'm sure Coddington will correct me given that you provided the perfect thread title to catch his attention

Thanks. This is my exact question. I've been treating inventory for this client as non-incidental M&S, but I was under the impression that we could make a change in 2018 to treat them as incidental. I couldn't find any guidance on the thresholds around 'material income-producing factor' and whether that actually changed or maybe the instructor ignored that in their analysis.

I just researched this issue and put together a memo for my client, which Brian reviewed for me. We have a uniform definition of a small business under the new law. If the taxpayer is under $25M gross receipts, he may treat inventory as non-incidental material and supplies. The items stay on the balance sheet until used or sold, but we only account for the cost of the materials. No capitalization of direct costs, and most fabulously, no 263A.

If the taxpayer is not required to use inventory, then he also does not have to use the accrual method. The book/tax conformity requirement remains. Consider whether your state conforms to the new law. In CA, we have no idea what we're supposed to do for state purposes since CA conforms to the IRC at 1/1/2015. We could be in a situation where for fed we don't use inventory, don't deal with 263A, and change to cash method but must retain the old methods for CA. In that case, CA would be out of compliance with the book/tax conformity requirement.

We don't know what the IRS is going to require for the changes in accounting method. Remember TPR...first the IRS said everyone had to file the 3115, and then at the beginning of tax season, it streamlined its procedures. Of course, there will be a 481 adjustment.

The law says that the taxpayer can treat inventory as non-incidental materials & supplies or in accordance with the books and records prepared according to the taxpayer's accounting procedures. Ponder that for a moment. I wonder how that last part made it into the bill and whether it will be addressed when there is a technical corrections.

I'm doing a free webinar on this topic this Friday at 1:00 PM Central time.

In short, Congress will allow non-tax shelter taxpayers that meet the $25 million gross receipts test at the single employer level to either: 1) treat inventory as non-incidental materials and supplies (presumably following the guidance in Rev. Procs. 2001-10 and 2002-28), 2) follow their financial accounting method (or book if they don't have financials). The second method opens up the door to abuse. Taxpayers might expense their inventory for book purposes.

In short, Congress will allow non-tax shelter taxpayers that meet the $25 million gross receipts test at the single employer level to either: 1) treat inventory as non-incidental materials and supplies (presumably following the guidance in Rev. Procs. 2001-10 and 2002-28), 2) follow their financial accounting method (or book if they don't have financials). The second method opens up the door to abuse. Taxpayers might expense their inventory for book purposes.

Thanks for the thoughtful replies Coddington and Jessica. It was #2 described above that was presented in the CPE. The answer to my question for 2017 is pretty clear. I guess 2018 will remain the Wild West.

Hijaking this old thread.

I have a client who wants to know the cost of changing his cash method tax return to accrual method tax return. Their books are already run on accrual method. Client does not exceed 10 MM in average annual sales. Construction industry. No long term contracts.

We need to find the difference in taxes and fees.

We would take the option of spreading the additional tax over 3 years, since the difference in tax is estimated at 180k+.

How would you go about figuring the difference?

Thank you for your time.

The difference in income between the cash and accural methods is taken into account ratably over four years under section 481(a), starting with the year of change. (The three-year option you mentioned won't apply.)

It is an automatic change in almost all situations, so you have the cost of the Form 3115 itself, plus the ongoing costs of any M-1 adjustments for differences between the book and tax accrual methods and submethods.

I am looking at the difference in taxes between cash basis and accrual.

Would the difference be about 5% of the additional taxable income (lets say 600k) from the conversion that will be spread over the 4 year period? So, would 30k in additional tax be correct? 5% is a guess of the additional tax bracket that the income will be taxed at when the owner's tax bracket gets a bump from the additional income.

Noobie-the income is spread over 4 years, not the tax. The tax will be computed each year on the taxable income, after the inclusion of the 481(a) adjustment.