When the Tax Cuts & Jobs Act of 2017 was signed into law, many pharmacy owners interpreted the new rules to mean taxpayers could write off inventory. Now that Treasury Decision 9942 has gone into effect, pharmacy owners that wrote off inventory need to be aware of the new guidance the IRS has issued and how it’s going to impact their tax returns beginning in 2022.
In this episode, The Bottom Line Pharmacy Podcast team provides an overview of TD 9942 for pharmacy owners.
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If you prefer to read this content, the video transcript is below.
Scotty: All right. Welcome to another episode of the Sykes Bottom Line Pharmacy Podcast. And today we’re going to be talking about the Employee Retention Tax Credit again. No, I’m just kidding.
Bonnie: Oh, my gracious.
Kendell: He got confused this time.
Bonnie: Wait, I thought that was actually a pretty funny joke. I thought you were doing that for real.
Kendell: Again, round four.
Scotty: I’m kidding. Although we can, if you want, but no. Today we’re going to talk about the new inventory rules that are going to impact pharmacies for new pharmacies out there that wrote off inventory after the Tax Cuts and Jobs Act. There’s been some updates with that. New IRS guidance. So, you need to be aware of that. And I know there’s a lot of pharmacies out there that wrote off their inventory after the Tax Cuts and Jobs Act. So, we’re going to get into that today.
Bonnie: Yeah, that was a big write-off that particular year for a lot of people.
Kendell: And I think it all starts with, with the Tax Cuts and Jobs Act. One thing that was a big win was moving to cash accounting for a lot of pharmacies. Meaning, the amount that you could go to cash used to be $10 million and then of gross revenues. And that got bumped up to 25 and then $26 million. So that means a lot of pharmacies could move to the cash. So that was a huge win.
Kendell: And then, um,
Bonnie: How many returns did we do that year?
Kendell: Yes. We had to make the adjustments from accrual to cash.
Scotty: And then filing the form 3115 to change the accounting method with the IRS.
Kendell: And I think…so, that was a huge shot in the arm and most pharmacies are now on cash basis that we deal with those who are under the I believe it’s 25 million, it’s 26 million this year. Those receipts.
Scotty: Yeah. Next year for 2023, it’s going to be $29 million. So essentially,
Kendell: Yeah, go ahead.
Scotty: Pharmacies can go to the cash method of accounting if their gross receipts back in, we’re going to say 2018, was $25 million dollars or less. That’s the average prior three year gross receipts. So, if you are under that, you can go… you are eligible, you’re not required to go to the cash method of accounting. If you do own multiple pharmacies, you do, and you have a controlled group situation, which you need to speak to your tax advisor on that. But, if you are generally, greater than 51% owner of those entities, you have to combine those entities, in determining that gross receipts test.
Bonnie: Yeah, that’s a big point.
Kendell: So now wrapped up in that, that threshold was increased a lot. A lot of people go to cash and there were some other treatments. For just kind of a history to break it down… you could choose to treat your inventory in separate ways and that’s when the whole, where you can write off inventory kind of reared its head for pharmacies. That was the craze. Like you can 100% write off inventory, you can, you know. It’s going to be a huge deduction, no questions asked.
Scotty: Inventory had its own set of rules under the cash method of accounting. So, if you switch to cash, you had essentially four ways of handling inventory. You can keep inventory as inventory, it stays on your balance sheet. You could change your inventory to non-incidental materials and supplies. Which we’re going to get into. You could, or you could treat your inventory according to your books and records. The most common was keep inventory or we’re going to change inventory to non-incidental materials and supplies. And when you switch to non-incidental materials and supplies it’s written off when used and consumed by the patient. So, essentially it retains the characteristics of inventory. So, you wouldn’t just change to non incidental materials and supplies and then write it off. It didn’t work like that. So, it retained that characteristic of inventory. And a lot of, back in 2018, there was a lot of groups out there in the pharmacy industry pushing what they call the de minimus election. Which said for inventory for non-incidental material items that are under $2,500 each you can make this election and then expense those items. So, there was a lot out there that were taking this election and writing off inventory, for the most part. And if you read the statute and the regulations at that time you would’ve seen that inventory was probably not, inventory items were probably not eligible for that de minimus. But it wasn’t very clear. So that’s where we are today because the IRS issued Treasury Decision 9942, I believe it is.
Bonnie: They finally cleared it up.
Scotty: And they said that Treasury decision, that guidance said de minimis election is not eligible for “inventoriable” items. And de minimis is, is not eligible for, for writing that off. So, if you’ve been writing off inventory using that election with the non-incidental materials and supplies, you’re going to need to look at making a correction there. You need to talk to your tax advisors. And that’s going for calendar year taxpayers. This new Treasury Decision 9942 is effective for 2022 tax year. So, be mindful of that.
Kendell: Yeah. And I’m a simple guy so, just to kind of come up with like a little bit of a simple example. Correct me. The way I like to think about it is first just thinking about incidental versus non incidental materials and supplies and the tax law. So, for example, if you were to purchase a stapler that’s something that’s incidental, something small, you’re not going to track that on your balance sheet. So, it’s expensed immediately. So, then non- incidental are things like if you were to maybe purchase, something much larger, let’s say a new piece of equipment. That’s something that’s non incidental, you’re actually going to keep track of, it’s going to be on your, on your books. So, basically inventory is non-incidental. Generally speaking, you would track it. It’s non incidental. You track your inventory and then what was said was that if it’s under 2,500, we’ll just write it off. Like if you were to buy a printer.
Scotty: With that election.
Kendell: Yeah. With that election, if you were to buy a printer that costs $2,000, it’s non incidental, but you’re going to choose to immediately write it off as an expense. So, basically what was going around, this is my understanding, correct me if I’m wrong, was that inventory is non-incidental, but we’ll just choose to immediately write it off because we pay less than 2,500 for one pill or one container of pills.
Bonnie: Because normally most when they’re separated separately would be less. Even though you make a huge payment to a wholesaler that’s many different drugs. So, that’s the thought.
Kendell: Okay. And now the IRS basically comes out with the Treasury decision, that you mentioned, 9942, and says clearly. No. Inventory is non incidental and it’s not a supply that can be immediately written off. No. Like good try, but no.
Scotty: Yeah. De minimis was not intended for inventoriable items. And the IRS clarified that in that decision, so, yeah.
Bonnie: And I think, you know, we had a few clients that did this. We were very upfront with our clients about the risk of it, that it was a gray area. And you know, clients, they made the decision to move forward, with the facts in front of them. So, we knew that this was a possibility. And so, this is actually now, you know, it’s happened. Shouldn’t be any shock to clients that we work with.
Scotty: We gave, we were very clear because obviously in the industry there was a lot of heat going around that, “Hey, I’m writing off inventory.” So, we gave the clients the options saying, you know, this is the way we interpret the law, that it’s going to, that this is what’s going to happen. Which most of our pharmacies just kept inventory on the books. Some made the decision that they wanted to write it off. Now we’re in the position where the IRS has clarified that and saying, you know, that inventories have to get on the books, back on the books and what that means is when you wrote off that inventory, you got a big expense for doing that because you’re writing it off. Now when you have to bring that inventory back on the books for tax purposes, you’re looking at income, picking up income. So, let’s say your inventory is $300,000. You know you’re going to have to pick that back up on the books, and that’s going to be income of $300,000. Now the catch here, is that the IRS allows you to spread out that income up to four years. So, if you wrote it off in 2018, you would be in the four year bucket, where you could take that 300 divided by four and pick up one fourth each year. If you wrote off inventory, let’s just say you switched last year and you wrote it off last year. You have to pick it up in one year. So, you only get the one year, you know. You don’t get the four years for that.
Bonnie: The four year thing is definitely helpful. I mean, that makes it a little easier.
Scotty: Oh, it’s a huge gift from the IRS there. And when you’re thinking about this DIR fee issue coming up down the pipe and how cash flow is going to be vital in 2023, I think that’s the theme really across the board from everything I’m hearing. And I would agree with that. You know, this is kind of a little, little blow to that for some pharmacies out there that are going to have to be looking to pick up this inventory back into income.
Kendell: And one thing I think we should mention, I don’t think it’s something that I would advise, but just to mention, is the conformity with books and records. Meaning that’s the, the last option outside of the non-incidental materials and supplies in the de minimis is to conformity with books and records. And meaning if you don’t track inventory for anything, you’re not counting it. You’re not, you don’t have the number on the back of your napkin in the drawer, and you’re not keeping track of inventory or in your books and records. Inventory is not being used at all. In that instance, the inventory would not be required to be on the tax return. However, for pharmacies, how do you track your performance if you don’t know what your inventory is?
Scotty: I think that, that’s a good point. And I just don’t see where pharmacies are generally going to be able to utilize that strategy. Somewhere in your script system, you’re tracking inventory. There’s somehow, some way you’ve got inventory going on in your pharmacy. And you’re using that inventory to manage or understand something going on in your pharmacy. What you need to reorder and all this stuff. So, the IRS in that Treasury decision has a few examples. And it’s going to be hard for a pharmacy to, first of all, write off inventory using the book conformity method, which is another method outside the non-incidental materials and supplies method. And then furthermore, even if you do, and you know, like you said, Kendell , you’re not going to have any clue what’s going on in your pharmacy if you don’t have any sort of inventory understanding at all.
Bonnie: That’s going to be the biggest problem that you have if you don’t have any idea about your inventory. You got bigger problems than this writing off inventory.
Scotty: So that is absolutely out of the question in terms of what I would ever suggest.
Kendell: Advise, yeah. I wouldn’t advise that. And it’s just like, you’re tracking it somehow. And if you’re not tracking it, then that’s, that’s the problem. We got a couple of videos on inventory and the importance of that. That you might want to check out. Yeah, so I think that’s it.
Scotty: Yeah. So, you know, hot topic here. I haven’t heard much about this at all going on in the industry. So, this is a pretty big thing for everyone out there that’s not showing that inventory on the books for tax purposes. You need to rethink that for 2022 and Treasury Decision 9942 is the guidance there to help you and your advisors. So, going to be a fun tax season. And luckily, we don’t have a whole lot of these to handle this year.
Kendell: No, I don’t think too many. Back in October, we started planning for those too. The ones who it does apply for we kind of looked at their inventory that’s coming back on the books and included it in the tax plan. So, it’s not a surprise.
Bonnie: Yep. Well, they finally put this to rest. On to the next thing.
Scotty: On to the next, which is the Employee Retention Tax Credit.
Kendell: No, not another one. Another episode.
Bonnie: We can never have a podcast where we don’t bring up the ERTC. If anybody has any questions with the ERTC, please call Scotty Sykes.
Scotty: No, Bonnie, that’s your favorite topic.
Bonnie: It is.
Scotty: But yeah, appreciate everybody listening and if you have any questions, feel free to reach out to us, leave a comment, subscribe, do all the good stuff for our podcast. We appreciate it. And again, if there’s any topics you want us to cover, we’ll be happy to do that as well. Reach us at Ask Sykes at sykes-cpa.com. Thank you all for listening.