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April 2010

Manufacturers & Distributors May Have Opportunity to Deduct for
Subnormal Inventory Items

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Melissa Buschmann
Many manufacturers and distributors are not taking tax deductions for subnormal inventory items. Subnormal inventory items are any goods that cannot be sold at normal prices or in the normal way because of damage, imperfections, shop wear, changes in style, odd or broken lots or other similar issues. In many cases, however, taxpayers may deduct write-downs for qualifying subnormal goods against taxable income. In 2009, the IRS made it easier to use this deduction by adding it to the list of approved automatic accounting method changes.

To take the deduction, the taxpayer must identify specific finished, subnormal inventory items. Excess inventory does not qualify as subnormal. The taxpayer must offer subnormal inventory items for sale to the public at a reduced price within 30 days of the tax year-end. The taxpayer does not need to sell the finished goods; offering them for sale at a discount is sufficient to support the reduction in the value of the inventory.

In the case of a manufacturer with subnormal raw material or partially finished goods held for use or consumption, this 30-day rule does not apply. Considering the usability and the condition of the goods, a reasonable deduction may be available, but it will not be less than scrap value.

The tax deduction is calculated as the difference between the carrying value of each subnormal inventory item and the reduced sales price, including expenses associated with offering the goods for sale. More simply put, the deduction is book cost less net realizable value of each subnormal inventory item.

Certain other inventory write-downs may also be deducted against taxable income.

It is not too late to qualify for the deduction on your 2009 tax return. If you think your company may qualify, please contact your BKD advisor.

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