An unexpected inventory deduction in the TCJA?
Both online retailers and stores now have the opportunity for a new inventory deduction when buying goods, according to Tom Wheelwright, a CPA and CEO of WealthAbility. Under the previous rules, products could only be deducted when they were sold.
“The potential savings are significant, and we’ve seen this new deduction literally save a business. It can mean the difference between a business surviving and thriving or going under. For example, if someone is carrying $300,000 of inventory at the end of 2019, the business could get a $300,000 deduction in 2020,” he said. “In the first year of applying this new law inventory deduction, this change can result in major tax savings for retailers.”
Previously, the requirement was to use after-tax dollars for building inventory, Wheelwright noted, “so this change may well have significant, positive impacts on retailers. As a result, inventory is becoming a tax-beneficial purchase instead of a tax liability.”
Under the Tax Cuts and Jobs Act, a retail owner can write off inventory for the year it is purchased, as long as the item is under $2,500 and their average annual gross receipts for the past three years are under $25 million. “The TCJA allows small businesses to treat inventory as ‘non-incidental materials and supplies,’ the cost of which can be deducted when paid,” Wheelwright explained.
“Instead of only those with sales under $10 million being able to use the cash method, now that limit is $26 million,” he added. “This change gives a lot more businesses the opportunity to use the cash method of accounting, so they don’t have to pick up receivables and payables in income and expense.”
“Suppose you have a client with $500,000 inventory on the books,” he posited. “If you make a change to the cash method of accounting, then you would likely end up with an additional deduction in that amount for the year you make the change.”
Wheelwright cites as authority the explanation of the law by the staff of the Joint Committee on Taxation — the so-called Blue Book.
“On page 113, footnote 465, it states that if you elect to treat inventory as non-incidental materials and supplies, then anything under $2,500 can be deducted. That’s the only place that says this,” he said. “It doesn’t say it in the law itself, and there are no regulations on it. Although the Blue Book is technically not the law, it is the explanation of the law by the people who wrote the law, so it is usually pretty reliable.”
The inventory deduction on purchases versus sales is an example of moving toward a consumption tax approach for small business, according to Wheelwright. "For inventory, historically, you did not get to deduct it until you sold it. Under the new law, the provision effectively says that you can deduct it when you buy it instead of waiting until you sell it.”
“Income tax has traditionally been thought of as a tax on all of the net income of a business owner. The new tax law radically changes this. Now, any money reinvested into a business, including into inventory, is tax-free,” he said. “It doesn’t matter whether the business belongs to the retail, service, manufacturing, real estate, energy or agricultural sector. Business owners now have greater incentives than they previously had to increase investments in many areas, including inventory.”
“The new law encourages production and punishes consumption by rewarding business investments that fuel the economy,” he said.