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Taxpayers with inventories may use some book reserves for tax

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October 2020


Under US generally accepted accounting principles , taxpayers that account for inventories may utilize shrinkage, lower of cost or market reserves, or revaluation reserves for financial accounting (book) inventory.  A taxpayer with these book reserves may be able to take these items into account for tax purposes and, if so, should consider changing its method of accounting under Section 471.

The takeaway

Taxpayers sometimes may apply financial accounting methods to their Section 471 tax methods to achieve savings.  A taxpayer using an inventory shrinkage reserve for book purposes but not deducting estimated shrinkage for tax purposes may consider changing its tax method of accounting to its book method.  In some cases, a taxpayer with a book LCM reserve may be able use the book LCM reserve to write down inventory from cost to net realizable value by changing its tax inventory valuation method for subnormal goods or normal goods in ending inventory.  A taxpayer with a book revaluation reserve could change its tax method of accounting from excluding to including the revaluation reserve in the tax value of ending inventory.

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Brad White

Partner, Accounting Method and Fixed Asset Services Leader, PwC US

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