9058 / What is inventory accounting? What methods are generally used by taxpayers to account for inventory?

Editor’s Note: Under the 2017 tax reform legislation, taxpayers that meet the gross receipts test (see Q 9044) are no longer required to account for inventory under IRC Section 471 and can instead use a method of accounting for inventory that either (1) treats inventory as non-incidental materials and supplies or (2) matches the taxpayer’s method of inventory accounting as used for financial accounting purposes.¹ Under prior law, taxpayers were only permitted to account for inventory as materials and supplies that are non-incidental if they had average gross receipts of less than $10 million.²

Taxpayers that fail the gross receipts test are not eligible for the new rules governing inventory accounting. The $25 million threshold will be indexed annually for inflation; the 2025 amount is $31 million. The new rules governing inventory accounting are effective for tax years beginning after December 31, 2017.

Inventory accounting is generally required in any case where the IRS feels it is necessary in order to accurately reflect a taxpayer’s income (but see Editor’s Note, above). Inventory accounting usually becomes important in cases where the taxpayer’s business involves the production and sale of goods or the purchase and resale of goods.