TCJA Company being on cash basis if revenue is under 25MM

Pros, I hope everyone is well. I wanted to ask if a company making around 8 MM a year could go back to cash basis and therefore report is inventory which is around 1.5MM as an expense with the new TCJA rules? I thought inventory was one of those expenses it does not matter if they are allowed to be on cash basis, a company has to show inventory as an asset for tax purposes. Maybe, the new laws have changed this to show inventory as an expense. Any insight would be great. Thank you.

Inventory remains accrual.

Inventory must be accounted for according to the method used in preparing the financial statements or as non-incidental materials and supplies. That means that you have the assets on the balance sheet, but you don't have to capitalize costs. It is much simpler and is going to be a huge benefit for a couple of my clients. I don't yet know what happens to the $1.5M on the current balance sheet because I am swamped with 9/15 and 10/15 work, fully immersed in old law, and I will figure out the details later.

Inventory that is treated as non-incidental supplies, following the prior law rev procs, would consist just of the direct material costs. L&OH gets expensed as it is paid. The direct material cost is deducted under a cash basis procedure. When the direct material cost is paid (not accrued), it becomes available for expensing through COGS. So if something is sold prior to payment to the underlying vendor, there is no deduction until the vendor is paid. If the vendor is paid before the goods are re-sold, then they get deducted upon sale.

Inventory must be accounted for according to the method used in preparing the financial statements or as non-incidental materials and supplies. That means that you have the assets on the balance sheet, but you don't have to capitalize costs. It is much simpler and is going to be a huge benefit for a couple of my clients. I don't yet know what happens to the $1.5M on the current balance sheet because I am swamped with 9/15 and 10/15 work, fully immersed in old law, and I will figure out the details later.

It would likely be deducted pursuant to filing of the 3115 wouldn't it?

Sure, there is a deduction at some point. I believe that there is something called a cut off method, and of course, there is a 481(a) adjustment. Perhaps one method says you can deduct the whole previously capitalized inventory balance at once and the other says that you deduct it over 4 years. I'm pulling this out of deep memory from thousands of years ago. Perhaps Brian will clarify.

Jessica, I just recently had this question. Coddington (Brian) provided guidance. It is a 1-year 481(a) adjustment.

I wish there were a way to elect a 4-year 481(a) adjustment for a negative adjustment.

I was going to ask this question under a different thread but opened this one in error, I think it applies more to my clients and my questions though. I have two small factory clients - making chocolate and making potato chips. Both have incomes well below $25 million. Every year we go through the time consuming 263-A adjustment, both are on accrual basis.

Under TCJA, it looks like we can make an election on 3115 to change the 263-A requirement of account for inventory and costs, eliminating that journal entry. How will the adjustment on the balance sheet be treated in making that conversion? I think that might be similar to JAD's question. And if we change that part of their accounting, can they stay on accrual basis? Ultimately the only change I'd like to recommend is to curtail the 263-A adjustment. Can we do that?

Yes. It seems we have two concurrent discussions. See: viewtopic.php?f=8&t=13046

For the section 263A adjustment, you would just need to eliminate the schedule M adjustment (following the filing of a Form 3115). If this is all you want to change, this is all you need to do.

There is a separate method change to change the treatment of inventory from the current tax method to either non-incidental materials & supplies treatment or book inventory treatment. The latter would involve the elimination of any schedule M adjustments related to inventory. For manufacturers, the former would involve journal entries to capitalize only raw materials and the raw material content of WIP and FG.

Clarified rules for the treatment of materials and supplies costs
How do the final tangibles regulations governing deductions for materials and supplies differ from previous rules?
In most cases, the final tangibles regulations don't change the general rules for deducting materials and supplies. The final tangibles regulations merely incorporate pre-existing precedents on the definition and treatment of materials and supplies and add some safe harbors to provide you with additional certainty. The final tangibles regulations also provide additional elections and methods for those using rotable spare parts.

What is included in the definition of materials and supplies?
Materials and supplies are tangible, non-inventory property used and consumed in your operations including:

Acquired components – Costs of components acquired to maintain, repair, or improve tangible property owned, leased, or serviced by you and that's not acquired as part of a larger item of tangible property; or
Consumables – Costs of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less, beginning when used in operations; or
12 month property – Costs of tangible property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in your operations; or
$200 property – Costs of tangible property that has an acquisition cost or production cost of $200 or less.
The property need only fit into one of the above categories to qualify as a material or supply.

When can you deduct the costs of materials and supplies?
As under prior rules, you may deduct the costs of incidental and non-incidental materials and supplies in the following manner:

Incidental materials and supplies – If the materials and supplies are incidental, i.e., of minor or secondary importance, carried on hand without keeping a record of consumption, and no beginning and ending inventories are recorded, e.g., pens, paper, staplers, toner, trash baskets, then you deduct the materials and supplies costs in the taxable year in which the amounts are paid or incurred, provided taxable income is clearly reflected.
Non-incidental materials and supplies – If the materials and supplies are not incidental, then you deduct the materials and supplies costs in the taxable year in which the materials and supplies are first used or consumed in your operations. For example, deduct certain expendable spare parts in a trucking business for which records of consumption are kept and inventories are recorded in the taxable year the part is removed from your storage area and installed in one of your trucks. However, an otherwise deductible material or supply cost could be subject to capitalization under § 263(a) if you use the material or supply to improve property or under § 263A if you incorporate the material or supply into property you produce or acquire for resale.
Application with de minimis safe harbor – If you elect to use the de minimis safe harbor and any materials and supplies also qualify for the safe harbor, you must deduct amounts paid for these materials or supplies under the safe harbor in the taxable year the amounts are paid or incurred. Such amounts are not treated as amounts paid for materials and supplies and may be deducted as business expenses in the taxable year they are paid or incurred.
What must you do to apply the final tangibles regulations to materials and supplies?
Because the final tangibles regulations governing the treatment of materials and supplies are based primarily on prior law, if you were previously in compliance with the rules you generally will still be in compliance and generally no action will be required to continue to apply these rules on a prospective basis.

Also, the final tangibles regulations governing the treatment of material and supplies apply to amounts paid or incurred in taxable years beginning on or after 1-1-2014. Therefore, for your first taxable year beginning 1-1-2014, most of you will not have a change in accounting method for your materials and supplies. If you desire to change your method of accounting for materials and supplies in a subsequent taxable year, you would file Form 3115 and compute a section 481(a) adjustment taking into account only amounts paid after 1-1-2014.

For more information, including simplified procedures for accounting method changes for certain small business taxpayers, see When and how do you change a method of accounting to use the final tangibles regulations?

Source: https://www.irs.gov/businesses/small-bu ... egulations

Noobie,

The final TPR regs do not help much with the TCJA inventory issues. When the TPR came out, the Branch 3 Chief Counsel attorney in charge of this section informally commented that the DMSH would not apply to inventory "treated as non-incidental materials and supplies" because they are not actually non-incidental M&S. The Branch 6 attorneys, post-TCJA, seem to have a more open mind, but there are interpretive issues that must be settled. It seems safe to say that taxpayers will at least be able to use the old rev procs for guidance on inventory treated as non-incidental M&S, but more aggressive positions may become possible.

The JCT released the Blue Book yesterday. The DMSH is available for inventory treated as non-incidental materials or supplies but only if it meets the requirements of the DMSH. If the taxpayer treats the inventory as inventory for book/financial purposes, it cannot expense it under the DMSH.

Can we stop capitalizing labor and overhead via 263A, continue to account for inventory in the same manner as the client has historically done so, retain accrual basis and write off the existing labor and overhead adjustment from the balance sheet? And do we need to file 3115 to do any of that?

Brian, then is this correct: Taxpayer makes and sells beer. Taxpayer buys ingredients and bottles. Taxpayer pays $2 million for 2 million bottles. Each bottle costs $1. Ingredients and bottles are treated as non-incidental materials and supplies. All costs may be expensed under DMSH?

If taxpayer spends $10,000 on 5,000 pounds of sugar, how is the unit of sugar measured for purposes of the $2,500 DMSH limit? $10,000 is obviously more than $2,500. Is it measured by pound, by grain, etc?

To echo Action's question, do we have clarity yet re whether 471 costs are not capitalizable to non-incidental M&S?

Thank you.....

Coddington, wouldn't you file 3115 to treat inventory as non-incidental M&S, to remove it from books both tax and financial?

bump

Noobie, that would be a method change under Rev Proc 2018-40, DCN 235.

Why wouldn't everyone just show COGS, and not report it is as inventory to get the write off as COGS? Is it because the taxpayer may need to track it like inventory to manage the business or report to third parties?

Most businesses of any size would have to check with their lenders to see if that kind of reporting is permissible.

Action,

1. Can we stop capitalizing labor and overhead via 263A? Yes, if it is capitalized under section 263A.

2. continue to account for inventory in the same manner as the client has historically done so? Yes.

3. retain accrual basis? Yes

4. and write off the existing labor and overhead adjustment from the balance sheet? No, not if they continue to account for inventory in their historical manner. They'd need to switch to non-incidental material and supply treatment.

5. And do we need to file 3115 to do any of that? Yes for (1) and (4) if switching to non-incidental treatment. No for (2) and (3) since there is no change (assuming they don't have tax-only adjustments to their section 471 costs).