Inventoriable Items Treated as Nonincidental Materials and Supplies
Under Revenue Procedure 2002-28, if your principal business activity is an eligible activity and has average annual gross receipts of $10 million or less for the previous three years, you can use the cash method even if inventory is an income-producing factor.
Moreover, an eligible business may choose not to keep an inventory.
If you choose not to account for inventory, you may treat inventoriable items as nonincidental materials and supplies under Reg. Section 1.162-3.
This means, the cost of inventoriable items...
- Purchased for resale to customers or
- For use as raw materials for producing finished goods for resale, or
- For use in the performance of a service (e.g., a roofing contractor that installs roofing) -
Must be deducted...
- In the year provided to customers, or
- In the year you pay for such items
- Whichever is later.
Incidental vs nonincidental
Incidental materials and supplies (i.e. basic office supplies, such a s pens, paper clips, rubber bands, etc.) are deductible currently. No record of consumption is kept and no physical inventory is taken either at the beginning and end of the year. For a cash basis taxpayer, nonincidental materials and supplies (i.e. spare parts are deductible in the year they are used or paid, whichever is later per IRS Reg. Section 1.162-3.
Valuing Inventoriable Items
A qualifying small business taxpayer may determine the amount of the allowable deduction for inventoriable items treated as nonincidental materials and supplies by using one of the following methods:
- A first-in-first-out (FIFO) method
- An average cost method
- A specific identification method
Whatever method is used, it must be used consistently.
LIFO (last-in-first-out) method may not be used.
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