Tax Tips - Manufacturing
|This section provides general tax information including fringe benefits, inventory methods, and excise taxes.
Fringe Benefits - Manufacturing Tax Tips
What is a fringe benefit and how does it affect my taxes?
A fringe benefit is a form of pay for the performance of services given by the provider of the benefit to the recipient of the benefit. For example, you provide an employee a fringe benefit when you allow the employee to use a business vehicle to commute to and from work.
Elements of a Fringe Benefit
- Performance of services. A person who performs services for you does not have to be your employee. A person may perform services for you as an independent contractor, partner, or director. Also, for fringe benefit purposes, treat a person who agrees not to perform services (such as under a covenant not to compete) as performing services
- Provider of benefit. You are the provider of a fringe benefit if it is provided for services performed for you. You may be the provider of the benefit even if it was provided by another person. For example, you are the provider of a fringe benefit your client or customer provides to your employee for services the employee performs for you
- Recipient of benefit. The person who performs services for you is the recipient of a fringe benefit provided for those services. That person may be the recipient even if the benefit is provided to someone who did not perform services for you. For example, your employee may be the recipient of a fringe benefit you provide to a member of the employee's family
Are Fringe Benefits Taxable?
Any fringe benefit you provide is taxable and must be included in the recipient's pay unless the law specifically excludes it.
Including Taxable Benefits in Pay
You must include in a recipient's pay the amount by which the value of a fringe benefit is more than the sum of the following amounts:
- Any amount the law excludes from pay
- Any amount the recipient paid for the benefit
Fringe Benefits Valuation Rules
You must use the general valuation rule to determine the value of most fringe benefits. Under this rule, the value of a fringe benefit is its fair market value.
Fair Market Value
The fair market value of a fringe benefit is the amount an employee would have to pay a third party in an arm's-length transaction to buy or lease the benefit. Determine this amount on the basis of all the facts and circumstances. Neither the amount the employee considers to be the value of the fringe benefit nor the cost you incur to provide the benefit determines its fair market value.
Fringe Benefit Exclusion Rules
There are certain fringe benefits that are not subject to federal income tax withholding. Also in some cases they are not subject to social security, Medicare or federal unemployment tax and are not reported on Form W-2. Exclusion Rules apply to the following fringe benefits:
- Accident and health benefits
- Achievement awards
- Adoption assistance
- Athletic facilities
- De minimis (minimal) benefits
- Dependent care assistance
- Educational assistance
- Employee discounts
- Employee stock options
- Group-term life insurance coverage
- Lodging on your business premises
- Moving expense reimbursements
- No-additional-cost services
- Transportation (commuting) benefits
- Tuition reduction
- Working condition benefits
Inventory - Manufacturing Tax Tips
How do I value my inventory?
An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales.
To figure taxable income, you must value your inventory at the beginning and end of each tax year. To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items.
The rules for valuing inventory cannot be the same for all kinds of businesses. The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Your inventory practices must be consistent from year to year.
Items Generally Included in Inventory
Include the following items when accounting for your inventory.
- Merchandise or stock in trade
- Raw materials
- Work in process
- Finished products
- Supplies that physically become a part of the item intended for sale
Containers such as kegs, bottles, and cases, regardless of whether they are on hand or returnable, should be included in inventory if title has not passed to the buyer of the contents. If title has passed to the buyer, exclude the containers from inventory.
The value of your inventory is a major factor in figuring your taxable income. The method you use to value the inventory is very important. Generally there are two methods for valuing inventory. These methods are cost or lower of cost or market.
To properly value your inventory using the cost method, you must include all direct and indirect costs associated with it. The following rules apply:
- For merchandise on hand at the beginning of the tax year, cost means the inventory price of the goods
- For merchandise purchased during the year, cost means the invoice price less appropriate discounts plus transportation or other charges incurred in acquiring the goods. It can include other costs that have to be capitalized under the uniform capitalization rules
- For merchandise produced during the year, cost means all direct and indirect costs that have to be capitalized under the uniform capitalization rules
- A trade discount is a discount allowed regardless of when the payment is made. Generally, it is for volume or quantity purchases. You must reduce the cost of inventory by a trade (or quantity) discount
A cash discount is a reduction in the invoice or purchase price for paying within a prescribed time period. You can choose whether or not to deduct cash discounts, but you must treat them the same from year to year. If you do not deduct cash discounts from inventory costs, you must include them in gross income.
If you cannot specifically identify the cost of your inventory, you must use either the FIFO or LIFO methods.
Lower of Cost or Market Method
Under the Lower of Cost or Market Method, compare the market value of each item on hand on the inventory date with its cost and use the lower value as its inventory value. This method applies to the following:
- Goods purchased and on hand
- The basic elements of cost (direct materials, direct labor, and an allocable share of indirect costs) of goods being manufactured and finished goods on hand
This method does not apply to the following and must be inventoried at cost:
- Goods on hand or being manufactured for delivery at a fixed price on a firm sales contract (that is, not legally subject to cancellation by either you or the buyer)
- Goods accounted for under the LIFO method
Uniform Capitalization Rules (UNICAP)
Under the Uniform Capitalization Rules, you must capitalize the direct costs and part of the indirect costs for production or resale activities subject to the rules. Include these costs in the basis of property you produce or acquire for resale, rather than claiming them as a current deduction. You recover the costs through depreciation, amortization, or cost of goods sold when you use, sell, or otherwise dispose of the property.
Excise Taxes - Manufacturing Tax Tips
Manufacturing Companies may be liable for Federal excise taxes or due a credit or refund.
Manufacturing companies may be liable for manufacturer excise taxes as well as the federal highway vehicle use tax. These companies may also be eligible to claim an income tax credit or a refund for gasoline, diesel fuel, or kerosene that is used in nontaxable uses.
Manufacturers are responsible for manufacturers taxes on the following items (for more information on each item listed, see Publication 510, Excise Taxes for 2006 (Including Fuel Tax Credits and Refunds):
- Sport fishing equipment - tax based on the sale price of the item
- Bows - tax based on the sale price of the item
- Arrow components - tax based on the sale price of the item
- Coal - tax based on either sale price of the item or weight of the item
- Tires - tax based on the weight of the item
- Gas guzzler automobiles - tax is based on the fuel economy rating of the automobile
- Vaccine - tax is based per dose
For purposes of reporting and paying manufacturers taxes, a manufacturer includes both producers and importers.
A manufacturer is any person who produces a taxable article from new or raw material, or from scrap, salvage, or junk material by processing or changing the form of an article or by combining or assembling two or more articles. If you furnish the materials and keep title to those materials, and to the finished article, you are considered a manufacturer even though another person actually manufacturers the taxable article.
An importer is the person who brings an article into the United States, or withdraws an article from a customs bonded warehouse for sale or use in the United States.
A sale is defined as the transfer of title to, or the substantial incidents of ownership in, an article distributed to a buyer for consideration which may involve the receipt of money, services, or other things. A sale can include both use and lease of an article.
A manufacturer who uses a taxable article is liable for the tax in the same manner as it were sold.
The lease of an article (including any renewal or extension of the lease) by the manufacturer is generally considered a taxable sale. However, for the gas guzzler tax, only the first lease (excluding any renewal or extensions) of the automobile by the manufacturer is considered a sale.
Credits or Refunds
A credit or refund of the manufacturers taxes may be allowable if the tax paid article is, by any person:
- Used or sold for use as supplies for vessels (except for coal and vaccines)
- Sold to a state or local government for its exclusive use (except for coal, gas guzzlers, and vaccines)
- Sold to a nonprofit educational organization for its exclusive use (except for coal, gas guzzlers, and vaccines)
In addition a credit or refund of manufacturers taxes may be allowable for the following special cases:
- Taxable articles in which the price is readjusted by reason of return or repossession of the article
- Tax paid articles for further manufacture of another article subject to the manufacturers taxes (except for coal)
Heavy Highway Use Vehicle Tax
A truck or truck tractor is subject to the highway vehicle use tax if it:
- Is a highway motor vehicle (generally, a vehicle moved by its own motor and designed to transport a load over the public highways, even if it is designed to do other things)
- Is registered or required to be registered for highway use
- Is used on a public highway, and
- Has a taxable gross weight of at least 55,000 pounds (taxable gross weight means the weight of the vehicle plus the weight of the trailers and semi-trailers customarily used in connection with vehicles of the same type, plus the weight of the maximum load customarily carried on vehicles, trailer, and semi-trailers of the same type)
The tax applies to the first use of a taxable vehicle on a public highway during the taxable period, which is each July 1st through June 30th . The person in whose name a taxable vehicle is registered or required to be registered must pay the tax on Form 2290, Heavy Highway Vehicle Use Tax Return (PDF). The tax is due by the last day of the month following the month in which the vehicle is first used during the taxable period. Thus, if you use a taxable vehicle in July, you must file Form 2290 by August 31st. See Form 2290, Heavy Highway Vehicle Use Tax Return (PDF) and Publication 510, Excise Taxes for 2006 (Including Fuel Tax Credits and Refunds).
Fuel Tax Credits and Refunds
A federal excise tax is imposed on gasoline ($.184 per gallon), clear diesel fuel ($.244 per gallon), and clear kerosene ($.244 per gallon). The amount of these taxes may be credited or refunded if these fuels are used in many types of off-road uses. Common off-road uses include use as heating oil, use in stationary engines, use in non-highway vehicles, and use in separate engines mounted on highway vehicles.
Generally, refunds of $750 or more may be claimed quarterly on Form 8849, Claim for Refund of Excise Taxes (PDF). Claims not made on Form 8849 may be claimed as income tax credit on Form 4136, Credit for Federal Tax Paid on Fuel (PDF). See the forms and their instructions for specific claim requirements.
Note that a credit or refund is not allowable for the following:
- Any use in the propulsion engine of a registered highway vehicle, even if the vehicle is used off the highway
- Any fuel that is lost or destroyed through fire, spillage, or evaporation
- Any use of dyed diesel fuel or dyed kerosene. In fact, you may be subject to a substantial penalty if you use dyed fuel as a fuel in a registered diesel-powered highway vehicle
It is important to keep records to support your claim. Keep these records at your principal place of business. These records should establish the number of gallons used during the period covered by the claim, the dates of purchase, the names and addresses of suppliers and amounts bought from each in the period covered by the claim, the purposes for which you used the fuel, and the number of gallons used for each purpose.
Environmental Cleanup Costs
This deduction provides businesses with an incentive to clean up certain sites that are contaminated with hazardous substances. Refer to the section on Environmental Cleanup Costs in Publication 535, Business Expenses.
Research and Development - Manufacturing Tax Tips
Can you deduct R&D expenditures as a current business expense?
The expenditures of research and development ("R&D") are generally capital expenses. However, you can choose to deduct these expenditures as current business expenses.
You may use one of the two following methods of accounting for R&D expenditures:
- You may deduct your R&D expenditures in the tax year, in which you paid or incurred,
- You may amortize such expenditures over a period of not less than 60 months
You must charge to a capital account any R&D expenditures that you do not deduct currently, nor defer and amortize.
You may claim the R&D credit against tax for certain qualified R&D expenditures, and combine the credit as one of the components of the general business credit. The R&D credit is a nonrefundable tax credit.
Avoiding Problems - Manufacturing
This section will assist you in choosing an accounting or depreciation method plus help on managing your payroll.
Unless you are a professional bookkeeper, you probably don't like to spend valuable business time keeping records. But keeping good records can actually help you save money.
Why should I keep records?
Good records will help you monitor the progress of your business, prepare your financial statements, identify source of receipts, keep track of deductible expenses, prepare your tax returns, and support items reported on tax returns.
Everyone in business must keep records. Keeping good records is very important to your business. Good records will help you do the following:
- Monitor the progress of your business
- Prepare your financial statements
- Identify source of receipts
- Keep track of deductible expenses
- Prepare your tax returns
- Support items reported on tax returns
Monitor the progress of your business
You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make. Good records can increase the likelihood of business success.
Prepare your financial statements
You need good records to prepare accurate financial statements. These include income (profit and loss) statements and balance sheets. These statements can help you in dealing with your bank or creditors and help you manage your business.
An income statement shows the income and expenses of the business for a given period of time.
A balance sheet shows the assets, liabilities, and your equity in the business on a given date.
Identify source of receipts
You will receive money or property from many sources. Your records can identify the source of your receipts. You need this information to separate business from nonbusiness receipts and taxable from nontaxable income.
Keep track of deductible expenses
You may forget expenses when you prepare your tax return, unless you record them when they occur.
Prepare your tax return
You need good records to prepare your tax returns. These records must support the income, expenses, and credits you report. Generally, these are the same records you use to monitor your business and prepare your financial statement.
Support items reported on tax returns
You must keep your business records available at all times for inspection by the IRS. If the IRS examines any of your tax returns, you may be asked to explain the items reported. A complete set of records will speed up the examination.
What kinds of records should I keep?
You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records. However, the business you are in affects the type of records you need to keep for federal tax purposes. Your recordkeeping system should also include a summary of your business transactions. This summary is ordinarily made in your business books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books.
Supporting Business Documents
Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents such as invoices and receipts. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense. For more detailed information refer to Publication 583, Starting a Business and Keeping Records.
The following are some of the types of records you should keep:
- Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents for gross receipts include the following:
- Cash register tapes
- Bank deposit slips
- Receipt books
- Credit card charge slips
- Forms 1099-MISC
- Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for purchases. Documents for purchases include the following:
- Canceled checks
- Cash register tape receipts
- Credit card sales slips
- Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following:
- Canceled checks
- Cash register tapes
- Account statements
- Credit card sales slips
- Petty cash slips for small cash payments
Travel, Transportation, Entertainment, and Gift Expenses
If you deduct travel, entertainment, gift or transportation expenses, you must be able to prove (substantiate) certain elements of expenses. For additional information on how to prove certain business expenses, refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Assets are the property, such as machinery and furniture, that you own and use in your business. You must keep records to verify certain information about your business assets. You need records to compute the annual depreciation and the gain or loss when you sell the assets. Documents for assets include the following:
- When and how you acquired the assets.
- Purchase price
- Cost of any improvements.
- Section 179 deduction taken.
- Deductions taken for depreciation.
- Deductions taken for casualty losses, such as losses resulting from fires or storms.
- How you used the asset.
When and how you disposed of the asset.
- Selling price.
- Expenses of sale.
The following documents may show this information.
- Purchase and sales invoices.
- Real estate closing statements.
- Canceled checks.
How long should I keep records?
The length of time you should keep a document depends on the action, expense, or event the document records. Generally, you must keep your records that support an item of income or deductions on a tax return until the period of limitations for that return runs out.
The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or that the IRS can assess additional tax. The below information contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.
Note: Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.
You owe additional tax and situations (2), (3), and (4), below, do not apply to you; keep records for 3 years.
You do not report income that you should report, and it is more than 25% of the gross income shown on your return; keep records for 6 years.
You file a fraudulent return; keep records indefinitely.
You do not file a return; keep records indefinitely.
You file a claim for credit or refund* after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
You file a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years.
Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
The following questions should be applied to each record as you decide whether to keep a document or throw it away.
Are the records connected to assets?
Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the bases of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
What should I do with my records for nontax purposes?
When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. For example, your insurance company or creditors may require you to keep them longer than the IRS does.
How long should I keep employment tax records?
You must keep all of your records as long as they may be needed; however, keep all records of employment taxes for at least four years.
Internal Revenue Service (IRS)
Keep all records of employment taxes for at least four years after filing the 4th quarter for the year. These should be available for IRS review. Records should include:
- Your employer identification number.
- Amounts and dates of all wage, annuity, and pension payments.
- Amounts of tips reported.
- The fair market value of in-kind wages paid.
- Names, addresses, social security numbers, and occupations of employees and recipients.
- Any employee copies of Form W-2 that were returned to you as undeliverable.
- Dates of employment.
- Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments you or third-party payers made to them.
- Copies of employees' and recipients' income tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V).
- Dates and amounts of tax deposits you made.
- Copies of returns filed.
- Records of allocated tips.
- Records of fringe benefits provided, including substantiation.
How should I record my business transactions?
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. These documents contain information you need to record in your books.
A good recordkeeping system includes a summary of your business transactions. Business transactions are ordinarily summarized in books called journals and ledgers. You can buy them at your local stationery or office supply store.
A journal is a book where you record each business transaction shown on your supporting documents. You may have to keep separate journals for transactions that occur frequently.
A ledger is a book that contains the totals from all of your journals. It is organized into different accounts.
Whether you keep journals and ledgers and how you keep them depends on the type of business you are in. For example, a recordkeeping system for a small business might include the following items.
Daily summary of cash receipts
Monthly summary of cash receipts
Check disbursements journal
Employee compensation records
What is the burden of proof?
The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses.
Understanding Your IRS Notice
We realize that receiving a notice from the IRS can be unnerving, but if you follow these simple steps, the process to resolving the discrepancy should be straight forward.
Do you need to see what an IRS notice or letter says, but don't have it in front of you? If you know the notice number, you can look up its purpose, basic message, possible enclosures, and other useful details. And if you have the tear-off stub from the last page, you can use the information printed on it to see some of the variable content included in that notice.
How To Identify Your Notice
The notice number prints on the top of the first page of all our notices and on the lower left-hand side of the tear-off stub included with most of them. That number identifies the message we deliver in every notice. While the contents may vary somewhat, every notice with the same number has the same basic purpose.
Understanding Your Notice or Letter
|CP or Letter Number
||Changes to Tax Return, Balance Due
||Changes to Tax Return and Earned Income Credit, Balance Due
||Changes to Tax Return, Overpayment
||Data Processing Adjustment Notice, Overpayment of $1 or more
||Data Processing Adjustment Notice, Bal Due of $5 or more, Balance Due
||Examination Adjustment Notice, Balance Due
||Estimated Tax Discrepancy, Balance Due
||Overpaid Tax Applied to Other Taxes You Owe
||Notice of Insufficient Funds
||Delinquent Return Refund Hold
|CP 90/CP 297
||Final Notice - Notice of Intent to Levy and Notice of Your Right to a Hearing
||Notice of Levy and Notice of Your Right to a Hearing
|CP 91/CP 298
||Final Notice Before Levy on Social Security Benefits
||Request for Payment or Notice of Unpaid Balance, Balance Due
||Reminder Notice - Balance Due
||Second Request Notice - Balance Due
||Final Notice - Balance Due
||Installment Agreement Reminder Notice
||Notice of Default on Installment Agreement
||Notice of Proposed Adjustment for Underpayment/Overpayment
||Collection Information Statement Requested (Form 433F/433D); Inability to Pay/Transfer
||Balance Due on Account is Paid
|Letter 668D(LP 68)
||We released the taxpayer's levy.
||Proposal to Pay Accepted
||Installment Privilege Terminated
|Letter 1058 (LT 11)
||Final Notice prior to levy; your right to a hearing
|Letter 1615 (LT 18)
||Mail us your overdue tax returns.
|Letter 1731 (LP 64)
||Please help us locate a taxpayer.
|Letter 1737 (LT 27)
||Please complete and site Form 433F, Collection Information Statement.
||Installment Agreement for Direct Debit 433-G
||Installment Agreement Reply to Taxpayer
|Letter 2050 (LT 16)
||Please call us about your overdue taxes or tax return.
||Balance Due Total to Taxpayer
||Installment Agreement for Direct Debit Revisions
||Installment Agreement Cannot be Considered
||Installment Agreement Accepted: Terms Explained
||Installment Agreement: Payroll Deduction (F2159) Incomplete
||Abatement of Penalties and Interest
||Installment Agreement Accepted - Notice of Federal Tax Lien Will be Filed
||Pre-assessed Installment Agreement
||Request for Combat Zone Service Dates
||Taxpayer Response to Reminder of Balance Due
||VRU Acceptance of Proposal to Pay (30,60,90, 120 days)
||VRU Monthly Payment Plan Confirmation
||CC IAPND Installment Agreement Confirmation
||Balance Due Explained:Tax/Interest Not Paid
||Revision to Installment Agreement
||Installment Agreement Accepted: Terms Explained
|Letter 3228 (LT 39)
|Letter 4903 (LT 26)
||We have no record of receiving your tax returns.
|Letter LP 47
||Address Information Request
|Letter LP 59
||Please contact us about the taxpayer levy.
What If My Notice Isn't Listed
You'll find useful information here about many of the notices we send, including the purpose of the notice, the reason we send it, and a list of enclosures we might include with it. There's also sample content for each. Since parts of our notices vary depending on account conditions, the samples may not exactly match the notices we mail. The basic message, though, will be the same.
- Individual Filer Notices
Notices we send about Form 1040, 1040A, or 1040EZ, or any schedules, forms, or attachments included with it are Individual Filer Notice.
- Business Filer Notices
Notices we send about business-related tax forms such as Forms 941, 1065, and 1120, are Business Filer Notices.
What To Do When You Disagree
If your notice or letter is listed above, follow the link for advice on handling disagreements with the notice. In general though, you need to contact IRS at the contact number provided on the notice to explain why you disagree. If that doesn't result in your satisfaction, the Taxpayer Advocate may be able to assist.
Tax Laws and Regulations - Manufacturing
This page provides links to recent revenue rulings and court cases, legal determination of business use of the home and other regulations for the small business.
The following is a partial list of issues solicited from Internal Revenue Agents on accounting method changes identified during examinations. This is posted for informational purposes only and does not represent any official position of the Internal Revenue Service.
Improper adjustment period:
Taxpayer has changed its method of accounting for depreciation, which resulted in a negative adjustment (in the taxpayer's favor). Taxpayer has taken this negative adjustment into account in the year 19x1. No form 3115 was filed requesting an accounting method change.
Updated Analysis: Revenue Procedure 2002-09 modified by RP 2002-19 and 2004-11 for years 2001 and subsequent: When Form 3115 is filed an automatic consent is granted. This is available if not enough or too much depreciation was claimed by using an improper method of depreciation; compliance with section 2 of the appendix necessary; one-year reporting of taxpayer favorable section 481(a) and four-year reporting of Service favorable section 481(a) adjustment.
Erroneous method becomes an accounting method:
For unknown reason, taxpayer's internal system writes up the cost of used cars (inventory) by $100. The taxpayer has done this for more than two years. Now in year 199X the taxpayer wishes to restate its inventory balance to the correct amounts and makes a large adjusting entry reducing taxable income for the amount. No form 3115 requesting an accounting method change.
According to the analysis in Revenue Ruling 90-38, 1990-1, CB 57 the "treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed tax returns represents consistent treatment of that item for purposes of section 1.446-1(e)(2)(ii)(a) of the regulations." A scenario similar to this represents the use of an erroneous accounting method. Any change would require the filing of Form 3115 and an adjustment period of 4 years, rather than 1 year.
The filing of an amended return to change an accounting method:
Taxpayer elected to use the accrual method on its initial return filing in year 19X1. In 19X3, the taxpayer decided that the use of the cash method might be more favorable.
The use of a proper method of accounting on its first return established the method of accounting. The taxpayer, therefore, is bound by its initial election. See generally in section 1.446-1(e)(1) of the regulations and Revenue Ruling 90-38, 1990-1, CB 57
Revenue Ruling 94-38 - Environmental Cleanup Cost of Land
Costs incurred to clean up land and to treat groundwater that a taxpayer contaminated with hazardous waste from its business are deductible by the taxpayer as ordinary and necessary business expenses under section 162 of the Code. Costs properly allocable to constructing groundwater treatment facilities are capital expenditures under section 263. Revenue Ruling 88-57 modified.
Environmental Cleanup Rev Ruling 2000-7
Mountain State Ford Truck Sales, Inc., 112 T.C. No. 7, March 2, 1999
LIFO - Replacement Costs
- For LIFO inventory purposes, taxpayers must use actual cost and not replacement cost
- The use of replacement cost does not clearly reflect income
- The IRS did not abuse its discretion by adding the taxpayer's LIFO reserve back to income since the taxpayer failed to keep adequate records to compute LIFO using any other method
Update: Automotive Alert (from Automotive section) on Revenue Procedure 2002-17
On March 11, 2002, the IRS released the long anticipated resolution to the replacement cost LIFO issue. Revenue Procedure 2002-17 describes a safe harbor method of accounting for vehicle parts inventory that allows automobile dealers to approximate the cost of their parts. The revenue procedure includes procedures for dealers to receive automatic consent to change to the replacement cost method.
Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979), 1979-1 C.B. 167
Lower of Cost or Market Method Ruling:
The taxpayer, who used the "lower of cost or market" method of valuing inventories, wrote down what it regarded as "excess" inventory to its net realizable value, which in most cases was determined to be scrap value. The taxpayer determined that this inventory, mostly spare parts, was "excess" inventory because it was held in excess of any reasonably foreseeable future demand, although this inventory was not scrapped or sold at reduced prices. The taxpayer physically retained the excess items in inventory and continued to sell them at original prices. The Supreme Court, in disallowing the taxpayer's write-down, held that because the taxpayer provided no objective evidence of the reduced market of its excess inventory, its write-down was plainly inconsistent with the regulations and was properly disallowed by the Commissioner. The taxpayer could not have properly taken advantage of any permitted write-down because it did not scrap its "excess" inventory nor sell or offer it for sale at prices below market (replacement cost).
IRC Section 471 - General Rule for Inventories
IRC Section 472 - Last In, First Out Inventories
IRC Section 263A - Capitalization and Inclusion in Inventory Costs of Certain Expenses.