It is that time of the year where we as tax and consulting professionals are in the thick of tax season. At this point there are only a few adjustments that can be made in 2019 to have an impact on 2018 taxes. Contributions to retirement accounts and profit-sharing plans are typical. However, with the new tax law, there are significant changes that can be made now to 2018 business tax returns that may lead to substantial tax savings and increase cash flows to businesses and business owners. The new law allows many businesses to simplify how they report their revenues and expenses (otherwise known as their accounting methods) now and going forward to realize these savings.
Simplified Accounting for Small Business Inventory
Businesses that carry inventory have been required to follow extensive rules to account for their inventory costs. However, these accounting and reporting burdens have been reduced for businesses that have average annual gross receipts for the prior three years that are less than $25 million. These eligible businesses can now make an accounting method change for tax purposes to be exempt from two separate rules:
- UNICAP (requiring additional costs to be capitalized into inventory under IRC Section 263A). Previously, UNICAP adjustments were required for companies with average annual gross receipts of $10 million or more, so there are many more businesses that now fall under the higher threshold.
- General tax rules for inventory (under IRC Section 471). A business that elects to be exempt from the inventory rules may either treat inventories as non-incidental materials and supplies or conform to their financial accounting treatment (see below).
What Does This Accounting Method Mean to My Business?
Under the new rules for Section 471, rather than tracking inventory, eligible companies will only track purchases of materials (whether raw materials used in manufacturing or purchased goods for resale, for example). The business may deduct the cost of these materials in the year they are first used or consumed. This is what is meant by “non-incidental materials and supplies”. The most favorable impact will be to manufacturers that will now deduct the cost of purchased raw materials when the materials move out of storage into the work-in-process phase. Direct labor and direct overhead will be immediately deductible under this method. For resellers and distributors there is much less of an impact since it will be likely that their material purchases will be used or consumed when the product is sold to customers. Still, eligible businesses will no longer be subject to UNICAP and will be able to deduct these costs in the year the method change is made.
The other alternative is that eligible companies can follow their book treatment of accounting for these costs.
The new tax law brought about many new changes and possibilities to reduce taxes and increase cash flows. Analyzing how to properly take advantage of these changes and measuring the impact can be complex—but worthwhile when you see the savings in your bottom line.