When you hear about the Tax Cuts and Jobs Act (TCJA), typically people are speculating about the future of the tax laws that expire this year. What we hear less about are the tax provisions that were made permanent—and that could be beneficial to your business.
For instance, when you established your business, you selected a method of accounting. If you have a C corporation or a larger business, that decision may have been made for you, since most of these entities are required to use the accrual method. However, TCJA expanded the range of businesses that are allowed to use the cash method by shifting the definition of a “small business taxpayer” to those with less than $25 million in annual gross receipts.
This is exciting news for many small businesses, since the cash method of accounting comes with significant tax benefits. With the cash method, small businesses can report income in the year they receive it and deduct expenses in the year they pay for them. Overall, this is a simpler and less expensive process than the accrual method.
TCJA also shifted the requirements for which companies have to account for their inventories. This can provide tax savings to small businesses that understand how to leverage it. Today, we’ll be looking at one of the two options for treating inventory known as the “non-incidental material and supplies” (NIMS) method.
Doing it the “NIMS” Way
The NIMS method treats inventory as supplies used in business. This means that the small business will now deduct their inventory either in the year that inventory is paid for or when that inventory is “used or consumed”—whichever comes later. For example, if a customer purchases an item in December 2024, but your business is not able to actually deliver it to the customer until January 2025, you will receive the deduction for tax year 2025—the later of the two dates.
A major benefit of the NIMS method is that small businesses can deduct labor and overhead expenses as they are incurred. Before TCJA, these expenses would need to be capitalized, or recognized in smaller amounts over time. Now small businesses are allowed to deduct the full amount in a single tax year.
The Top Three Benefits of NIMS
When the U.S. Treasury and the IRS provided the final regulations for the NIMS method, they highlighted these three reasons the method benefits small businesses:
1. The More The Merrier
First, TCJA allowed more businesses to use the NIMS method. Previously, the type of industry you were in could bar you from treating your inventory as non-incidental materials and supplies. Producers and resellers were usually not allowed to use this method, for instance. Income was another limiting factor. Before TCJA, only businesses with less than $1 million in gross receipts could use the NIMS method (except for certain contractors). Now that cap has been raised to $25 million in gross receipts.
2. A Lighter Lift
The NIMS method is much more straightforward for the accounting process, which can save small businesses both money and headaches. With this method, businesses also gain the potential for more deductions and a lower tax bill. This is especially true when it comes to those expenses that no longer have to be capitalized, such as direct labor costs or indirect costs like overhead. Instead of tracking these expenses year after year and deducting the cost slowly, small businesses can receive a tax deduction all at once.
3. Time to “Cash” In
Lastly, new regulations allow small businesses to use the cash method of accounting and benefit from more immediate tax deductions. However, you will need to be diligent about tracking the progress of your inventory: when did the customer pay versus when was the product actually delivered to the customer? Under the NIMS method, you will not be able to take that tax deduction until the later of those two dates—either when the inventory was purchased or when the inventory was provided to the customer.
How NIMS Affects Other Tax Deductions
One tax rule that many businesses take advantage of applies to expenditures under $2,500. Known as the “de minimis safe harbor” rule, these small expenses can be deducted right away instead of being capitalized. However, this changes when you opt for the NIMS method. Because you are now recategorizing your inventory as “business supplies,” these items cannot be expensed without an applicable financial statement.
Summary
Many tax strategies come with trade-offs, and the NIMS method is no different. By treating your business inventory as non-incidental material and supplies, you open up the pathway to new tax savings, while also introducing new limitations regarding rules like the de minimis safe harbor. However, if your business could benefit from using the cash method of accounting and deducting certain costs sooner, this could be the right option for you.
To learn more about the TCJA provisions that could impact your business, reach out to a Certified Tax Planner today.
