Whether a taxpayer may “write-down” year-end inventory depends upon 1) the inventory method chosen and, 2) the type of inventory involved.  With respect to inventory methods, a taxpayer generally will have chosen to value ending inventory either at cost, or at lower of cost or market (LCM).  And with respect to inventory type, a taxpayer will generally be sitting on either “normal” or “subnormal” goods.  Normal goods in inventory may generally not be written down below cost unless the taxpayer has elected to use LCM, and the current bid price (replacement or reproduction cost) of all inventoriable costs is lower than cost reflected on taxpayer’s books, or the goods had in fact been offered for sale prior to the inventory date at a net realizable value lower than cost.  Subnormal goods, on the other hand, may be valued at net realizable value regardless of whether the taxpayer has elected to use LCM.

The term “cost” is generally defined as the invoice price less trade or other discounts.  To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.  For taxpayers acquiring merchandise for resale that are subject to the uniform capitalization rules of §263A, additional amounts may be required to be included in inventory costs.  For merchandise purchased for resale by taxpayers with average 3-year annual gross receipts over $10 million, cost also includes purchasing, handling, storage, and a portion of general administrative costs.  In the case of merchandise produced by the taxpayer, cost is generally defined to include the cost of raw materials and supplies consumed in connection with the product, expenditures for direct labor, and indirect production costs incident to and necessary for the production of the particular article.

For purposes of the LCM, “market” is generally based on the current bid price (replacement or reproduction cost), not the price at which the goods can be sold.  The concept of net realizable value, although acceptable for financial reporting purposes, is only acceptable for tax purposes if the merchandise has been offered for sale prior to the inventory date at a price lower than its replacement cost.  The final income tax regulations issued under §263A made revisions to the definition of market.  The regulations now state that under ordinary circumstances and for normal goods in an inventory, market means the aggregate of the current bid prices prevailing at the date of the inventory.  The basic elements of cost include direct materials, direct labor, and certain indirect costs.  Thus, for taxpayers to which §263A applies, the basic elements of cost must reflect all direct costs and all indirect costs properly allocable to goods on hand as of the inventory date at the current bid price of those costs, including but not limited to the cost of purchasing, handling, and storage activities conducted by the taxpayer, both before and subsequent to acquisition or production of the goods.

For financial reporting purposes, a taxpayer has the option of performing an LCM analysis on the basis of item-by-item, group of items, category of inventory, business segment, or for inventory as a whole depending on the particular facts and circumstances.  For tax purposes, however, the market value of each article on hand must be compared with the cost of the article to determine each article’s lower of cost or market value.  The requirement of valuing each item separately prevents a taxpayer from using a percentage write-down approach even though it would be permitted for accounting purposes.

Regardless of the inventory valuation method employed by the taxpayer (cost or LCM), “subnormal” goods should be valued at net realizable value.  Subnormal goods are any goods that are unsalable at normal prices or in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including second-hand goods taken in exchange.  Subnormal goods originally acquired for resale, or produced finished goods should be valued at bona fide selling prices less direct costs of disposition.  Bona fide selling price means the price at which such subnormal goods are actually offered for sale during the tax year or within 30 days after the tax year.  The “30-day rule” has been strictly applied by the IRS in cases involving goods acquired for resale and finished produced goods.  Thus, even where subnormal goods exist, the taxpayer must be able to prove the actual offering at less than cost.  Verification must be made through contemporaneous recordkeeping.

Mark R. Giallonardo, JD, LLM is a Principal in HbK’s Tax Department and currently supports HbK’s Florida offices. Mark has been developing tax planning strategies for owner-operated companies for more than 20 years and may be reached at (239) 263-2111 or mgiallonardo@hbkcpa.com.

One of the most commonly missed tax credits for construction and warehouse activities is the Alternative Fuel Tax Credit for taxpayers that use propane powered forklifts. The forklift use qualifies for a 50 cent per gallon credit for both “C” corporations and pass-thru entities. To be eligible for the credit, a taxpayer must first register with the IRS. This is accomplished on Form 637, Application for Registration (For Certain Excise Tax Activities). This credit could be a significant benefit to any construction or warehousing operation. For Example, four forklifts that consume approximately 5 gallons per day for 250 days in a year, would typically consume approximately 5,000 gallons of propane. That equates to a $2,500 tax credit per year.

Form 637 is completed only one time to obtain the initial registration number. Once registered, the
company simply keeps track of the gallons of propane used and claims the credit on Form 4136 –
Credit for Federal Tax Paid on Fuels. Please contact a professional at Hill, Barth & King LLC if you
have any questions or would like assistance in preparing Form 637.

William E. North, II, CPA, CCIFP is a Principal in the Sarasota, Florida office of Hill, Barth & King LLC and is a member of HBK’s Construction Industry Group.

The Treasury Department has announced that, as a part of a three-pronged initiative to reduce the amount of paper transactions it handles, most employers that are now allowed to use Federal Tax Deposit Coupons and checks to make payroll tax deposits will have to make those deposits electronically through the Electronic Federal Tax Payment System (EFTPS) beginning in 2011.  The primary exemption will be for employers that have $2,500 or less in quarterly payroll tax liability and that pay their liability when filing their employment tax returns (e.g. Forms 941 or 944).

Currently, employers are required to use EFTPS at the beginning of the second calendar year after their total federal tax deposits (e.g., payroll, income, excise, etc.) exceed $200,000 in a calendar year.  Once they meet the threshold, they must use EFTPS even if their total tax deposits dip below $200,000 in a future year.

What does this mean for you?  Starting in 2011, if you make your payroll tax liability deposits in any manner other than paying them with the quarterly return, you will be required to deposit them electronically through EFTPS.  You will no longer be allowed to pay them at your bank with a coupon.

As soon as possible, you will need to sign up for EFTPS.  It is easy and it is free.  Just go to www.irs.gov and on the right hand side of the page, you will see the EFTPS logo.  Click on this and it will take you to a page that contains a brief description of the program and a link which allows you to register for the program.  Some of the items that you will need to complete the registration besides the company name and address include your company’s Federal I.D. number and banking information.  You will also need to assign a designated individual as the primary contact.

Once your company is enrolled, you can make any of your federal tax deposits via the internet or telephone.  By 8:00 p.m.(ET) at least one calendar day in advance of the due date, you access EFTPS directly to report your tax information. You will instruct  EFTPS to move the funds from your account to the Treasury’s account for payment of your federal taxes. Funds will not move from your account until the date you indicate. You receive an immediate acknowledgement of your payment instructions, and your bank statement will confirm the payment was made.  You can initiate your tax payment 24 hours a day, seven days a week.

As an added convenience,  EFTPS allows taxpayers to schedule tax payments in advance. Businesses can schedule payments up to 120 days in advance of their tax due date. Individuals can schedule payments up to 365 days in advance of their tax due date. EFTPS will automatically make your payments for you on the due date you indicate. Scheduled payments can be changed or cancelled up to 2 business days in advance of the scheduled payment date.

If you have any questions regarding this program or anything else regarding your payroll or business, please contact the CPA professionals at Hill, Barth & King’s Fort Myers office at 239-482-5522 and we will be glad to help.