Tax strategist and CPA, Tom Wheelwright, comes bearing good news about an inventory deduction that can decrease your tax bill.
Here’s what Tom says about this inventory deduction:
At the CapCon event in January, 2019, I explained from stage that it appeared that most inventory with a cost of under $2,500 would be deductible under the new law enacted in December, 2017. After leaving the stage, several people in the audience came to me to point out that the IRS website said that inventory was NOT deductible.
My research at the time led me to the Explanation by the Staff of the Joint Committee on Taxation for the 2017 Tax Cuts and Jobs Act (TCJA) (commonly referred to as the “Blue Book.”) Footnote 465 in the Blue Book explained that under certain circumstances, a taxpayer would be able to use the cash method of accounting for inventory, effectively deducting the cost of inventory when purchased instead of waiting until it is sold.
You can watch Tom’s CapCon presentation here:
The Blue Book went on to say that the following needs to occur:
1. The taxpayer must have average annual sales of less than $25 million
2. The taxpayer elects to use the cash method of accounting
3. The inventory has a cost of less than $2,500 per line item
4. The taxpayer uses the cash method of all books and records
Many of us wondered whether the IRS was just slow or whether the IRS was taking a position contrary to the explanation in the Blue Book.
The good news is that the IRS recently released its proposed regulations on this issue (See Regs. Section 1.471-1(b)(6) and gave specific instructions on how to deduct inventory when it’s purchased, as allowed by the TCJA.
The IRS said the following must occur:
1. The taxpayer must have average annual sales of less than $25 million
2. The taxpayer elects to use the cash method of accounting
3. The inventory has a cost of less than $2,500 per line item
4. The taxpayer uses the cash method of all books and records
5. The taxpayer cannot report inventory to the bank or other creditors
Note that the IRS merely added a fifth requirement/clarification to those listed in the Blue Book. The downside to this, of course, is that retailers who have loans with a bank will always have to report their inventory to the bank. This provision really will not apply to those who use banks and other lending institutions for business borrowing if the lending institution requires them to maintain inventory.
The great news is that many online entrepreneurs truly operate on a cash basis and never use a bank except for a normal line of credit such as a credit card. And most Amazon resellers don’t sell any items that cost more than $2,500.
Inventory Deduction Action Steps
If you want to take advantage of this provision and currently are not using the cash method of accounting, you should take the following steps on your 2020 business tax return to make this change.
1. Change your books to the cash method of accounting, deducting currently all of your inventory purchases
2. File form 3115, change in accounting method, with your 2020 tax return. You must make two different elections on this form. First, you must elect to change from the accrual or hybrid method of accounting to the cash method of accounting. Second, you must elect to deduct inventory under the de minimis exception. There are code numbers to use for each of these elections on the 3115. Your accountant should be able to do this for you when they prepare the business tax return.
3. Calculate the two additional tax deductions created by changing to these methods of accounting. This includes the deduction for not picking up accounts receivable or accounts payable and the deduction for your inventory on hand at the beginning of the year.
4. Enjoy the massive tax savings from making these changes.
For your accountant, this inventory deduction should be pretty simple. If they don’t understand it, you may want to consider upgrading your accountant. Feel free to contact WealthAbility if you need to upgrade to accountants who understand how to reduce your taxes on a daily basis, including this massive tax deduction for inventory.
Contributed by the only tax strategist we know who can bring a roomful of entrepreneurs to their feet, cheering, hooting, and hollering at the end of a discussion on taxes. Tom Wheelwright, CPA and the author of Tax-Free Wealth (part of the Rich Dad, Poor Dad series) , of WealthAbility.com has a lot of fans inside The One Percent.
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