The IRS recently published guidance on deducting materials and supplies. The issue is whether taxpayers can immediately deduct the purchase price of materials and supplies or must capitalize the purchase price of materials and supplies and deduct them over a period of years.
The treatment of materials and supplies depends on whether they are incidental or nonincidental.
Materials and supplies include the following items:
- A unit of property that has an economic useful life of 12 months or less
- A unit of property that costs $100 or less
- A component purchased to maintain, repair, or improve a unit of property that is not acquired as part of any single unit of property
- Fuels, lubricants, water, and similar items, that are reasonable expected to be consumed in 12 months or less, beginning when used in the taxpayer’s business operations.
Incidental Materials & Supplies: These can be deducted in the year purchased (or incurred for accrual basis taxpayers). Materials and supplies are incidental if they are carried on hand and no record of consumption is kept or written inventories of these items are not maintained.
Nonincidental Materials & Supplies: These are deducted in the year they are used or consumed in the taxpayer’s business operations.
Example of Incidental Materials & Supplies
ABC Corp buys 20 bottles of window cleaner at $2 each, 50 pens at $1 each, and 10 printer toners at $60 each. ABC Corp does not inventory these items or otherwise maintain a record of these items. Once each item is used, its expected life is less than 12 months. These items are considered materials and supplies because each unit of property costs $100 or less, and their expected useful life is 12 months or less. These items are incidental materials and supplies because there is no record of consumption and no inventories are maintained. ABC Corp may deduct the purchase price of these items in the year they are purchased.
Example of Nonincidental Materials & Supplies
Same facts as above example, except that ABC Corp keeps a written record of the printer toners on hand. Since the printer toners are inventoried, they do not qualify as incidental materials and supplies. They are nonincidental materials and supplies and must be deducted in the year they are used. Thus, if ABC Corp uses 3 of the printer toners in 2011, 4 in 2012, and 3 in 2013, ABC Corp will deduct $180 in 2011 (3 toners used at $60 each), $240 in 2012, and $180 in 2013. If ABC Corp did not maintain inventories or written consumption records, the full $600 toner purchase price would have been deducted in the year of purchase. The window cleaner and pens may still be deducted in the year of purchase since these items were not inventoried.
Taxpayers may make two elections:
Election to Capitalize
Taxpayers may elect to capitalize the purchase price of materials and supplies and depreciate the purchase price over a number of years. This election will be beneficial if the depreciable life is less than the number of years over which the materials will be consumed (e.g., materials can be depreciated over 3 years, but they will be consumed over 5 years)
De Minimis Election
A diminish election allows taxpayers to immediately deduct (up to a certain limit) the purchase price of both incidental and nonincidental materials and supplies. However, most small businesses will not meet the requirements for the de minimis election. The requirements are:
The business has an Applicable Financial Statement, which is
- A financial statement filed with the SEC
- An AUDITED financial statement
- A financial statement required to be submitted to a federal or state governmental agency other than the IRS or SEC
The business has a written accounting policy in effect at the beginning of the year requiring it to expense items that cost no more than a specified dollar amount for book purposes and the policy is complied with. Since the IRS published this guidance in December 2011, it is unlikely that taxpayers had a written policy in effect on January 1, 2012.
Surprising, but the IRS has received a lot of negative feedback about the complexity of these rules. However, these rules are effective for 2012.
Comments or questions about this post? Please let us know through the comment area below!
If you need help with small business taxes,
sign up for a FREE tax consultation.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230