The TCJA provides small manufacturers exemptions from the use of full absorption method of inventory costing (§471) and uniform capitalization (§263A). A small manufacturer is any manufacturer with average annual gross receipts for the three prior tax years under $25 million.
Inventory Costing Under TCJA
Qualifying taxpayers can elect out of §263A by following the automatic change of accounting procedures. Details of the election out of §263A are explained in REV PROC 2018-31. The change is made by filing Form 3115 with a timely filed tax return. The designated automatic accounting method change number is “234”. The amount of the favorable §481 adjustment will be the §263A amount included in beginning of the year inventory.
Small manufacturers as defined above can also elect out of the full absorption method of inventory costing (§471). However, a taxpayer with “Applicable Financial Statements” must adhere to the method of inventory costs used in those financial statements for tax purposes. “Applicable Financial Statements” include audited financial statements. Reviews and Compilations are not “Applicable Financial Statements”. Taxpayers without “Applicable Financial Statements” must use the same method of accounting for inventory for tax as they use for books.
Non-incidental Materials
Under TCJA small manufacturers without “Applicable Financial Statements” can account for inventory as nonincidental materials and supplies if they use the same method for books. The use of full absorption method of inventory accounting under §471 is not required. Under §471 a manufacturer must include both direct and indirect production costs in the computation of inventoriable costs. Examples of §471 costs include direct labor, repairs, utilities, rent, tools and equipment not capitalized and costs of quality control.
Inventory that is treated as nonincidental materials and supplies is deducted in the taxable year in which it is first used or consumed in the taxpayer’s operations, which is generally when the taxpayer provides the goods to the customer.
Qualifying taxpayers can elect to treat inventory as nonincidental materials and supplies by following the automatic change of accounting procedures. Details of the election are explained in REV PROC 2018-31. The change is made by filing Form 3115 with a timely filed tax return. The designated automatic accounting method change number is “235”. The amount of the favorable §481 adjustment will be the §471 costs included in beginning of the year inventory.
Both of the above changes of accounting methods can be made on one Form 3115.
Principal
may@hwco.com
