New automatic method change for nonincidental materials and supplies.

• Author: Klahsen, Rick

With the release of Rev. Proc. 2009-39, taxpayers may now obtain automatic IRS consent to change their method of accounting for nonincidental materials and supplies to comply with the rules in Regs. Sec. 1.162-3. Prior to the release, taxpayers were required to file an advance consent request and submit a user fee in order to obtain explicit permission from the IRS to make a change to properly account for nonincidental materials and supplies.

Background

Many taxpayers face the issue of how to treat materials and supplies used in their trade or business. Depending on their book treatment, for tax purposes the cost of supplies may either be deducted upon purchase as an ordinary and necessary business expense (i.e., in the case of incidental materials and supplies) or be capitalized under Regs. Sec. 1.162-3 and expensed as consumed (i.e., in the case of nonincidental materials and supplies). Specifically, incidental materials and supplies on hand at the end of the year may be deducted in the year of purchase as long as no record of consumption is kept or no physical inventories are taken, provided the taxpayer's taxable income is clearly reflected by this method.

When a taxpayer takes a physical inventory or keeps a record of consumption, the materials and supplies are generally nonincidental. If a taxpayer does not take a physical inventory or keep a record of consumption, the materials and supplies are generally incidental. Typically, the taxpayer's treatment of materials and supplies for financial reporting purposes will dictate the tax treatment. The capitalization of materials and supplies on hand at the end of the year for book purposes most likely means that a physical inventory was taken or a record of consumption was kept, in which case the taxpayer generally must capitalize the materials and supplies for tax purposes as well.

Supplies Are Not Inventory

While nonincidental materials and supplies on hand at the end of the year generally must be capitalized, they are not capitalized as inventory if they:

* Were not acquired for sale to customers; and

* Will not physically become a part of merchandise held for sale (Regs. Sec. 1.471-1).

Therefore, by escaping inventory classification, supplies generally do not have to be included in uniform capitalization calculations under Sec. 263A unless it is appropriate to include them as an inventoriable overhead cost under Sec. 263A and the regulations there under. It also means, however, that the...