Changes to Inventory Methods for Manufacturers

It’s no secret that the Tax Cuts and Jobs Act (TCJA) of 2017 dramatically changed how businesses operate, including how they account for inventory. These changes particularly impacted manufacturers, creating questions and complexities that did not previously exist.

Thankfully, the IRS recently released regulations that provide further guidance. The regulations define what constitutes a taxpayer’s accounting records and procedures as well as provide guidance on accounting method options available. One of the most beneficial methods available for manufacturers is the non-incidental materials and supplies (NIMS) method.

What Is NIMS and Why Is It Important?

Manufacturers that use the NIMS method are only required to capitalize the direct material cost of their inventory and are not required to capitalize the cost of labor or overhead. A typical manufacturer capitalizes the cost of its direct material, labor, and overhead costs such as depreciation, utilities, repairs and maintenance. The NIMS method allows manufacturers to deduct labor and overhead as they are incurred rather than including it in the cost of inventory, providing a significant opportunity to accelerate deductions for tax purposes.

For example, consider a company that has $2 million of inventory, and 50% of the cost of the inventory is labor and overhead. The NIMS method allows the company to accelerate $1 million of deductions compared to the book accounting method.

Who Could Be Eligible?

To be eligible to use the NIMS method, a manufacturer must be a small business taxpayer, which means annualized gross receipts averaged less than $26 million for the prior three tax years. The rules require that companies under common control be treated as one. To the extent a business owner has multiple businesses, they may have to consider whether these would be treated as one for purposes of the gross receipts test.

Determining Eligibility

Determining to what extent this would be beneficial and whether a business is eligible requires some analysis and consideration of your current tax position. For assistance with this, please reach out to your KSM advisor or complete this form.