Treasury Reg. Sec. 1.162-3: Deducting Materials and Supplies
Treasury Reg. Sec. 1.162-3 prescribes when materials and supplies may be deducted.
Here's the text of Sec 1.162-3:
Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only in the amount that they are actually consumed and used in operation during the taxable year for which the return is made, provided that the cost of such materials and supplies have not been deducted in determining the net income or loss or taxable income for any previous year.
If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and to deduct from gross income the total cost of such supplies and materials as were purchased during the taxable year for which the return is made, provided the taxable income is clearly reflected by this method.
When to Deduct Nonincidental Materials and Supplies
When inventoriable items are treated as nonincidental materials and supplies, you deduct their cost in the year you pay for them OR in the year such items were consumed (or provided to customers), whichever is later.
Inventoriable Item Defined in Revenue Procedure 2002-28
An inventoriable item is any item either purchased for resale to customers or used as a raw material in producing finished goods. For cash method taxpayers, inventoriable items may be treated as nonincidental materials and supplies. This means, you deduct the cost of such item either in the year you pay for them or in the year such items were provided to the customer, whichever is later.
Incidental Material and Supplies vs Nonincidental
Incidental materials and supplies for which no inventory is maintained may be deducted in the year purchased by a cash method taxpayer.
However, as previously stated, nonincidental materials and supplies are deducted in the year you paid for them or in the year they are consumed (or provided to a customer), whichever is later.
The second part of Section 1.162-3 deals with when the cost of incidental materials and supplies that are kept on hand may be deducted. Incidental materials and supplies may be deducted in the year of purchase when:
- No records are maintained indicating when supplies are actually used.
- No inventory is taken of the amount of supplies on hand at the beginning and end of the year, and
- Income is clearly reflected for the year.
- Return to the Tax Basics for Startups Table of Contents to find related links.