Part III. Cost of Goods Sold

Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an income-producing factor. See Regulations section 1.471-1.

However, if the organization is a qualifying taxpayer or a qualifying small business taxpayer, it may adopt or change its accounting method to account for inventoriable items in the same manner as materials and supplies that aren’t incidental (unless its business is a tax shelter (as defined in section 448(d)(3))).

A qualifying taxpayer is a taxpayer that, for each prior tax year ending after December 16, 1998, has average annual gross receipts of $1 million or less for the 3-tax-year period ending with that prior tax year. A qualifying small business taxpayer is a taxpayer (a) that has average annual gross receipts of $31 million or less for the 3-tax-year period ending with that prior tax year, and (b) whose principal business activity isn’t an ineligible activity.

Under this accounting method, inventory cost for raw materials purchased for use in producing finished goods

and merchandise purchased for resale are deductible in the year the finished goods or merchandise are sold (but not before the year the organization paid for the raw materials or merchandise, if it is also using the cash method). For additional guidance on this method of accounting for inventoriable items, see Pub. 538 and the Instructions for Form 3115.

Enter amounts paid for all raw materials and merchandise during the tax year on Schedule A (Form 990-T), Part III, line 2. The amount the organization can deduct for the tax year is figured on Schedule A (Form 990-T), Part III, line 8.

All filers not using the cash method of accounting should see Section 263A Uniform Capitalization Rules under Limitations on Deductions , earlier, before completing Schedule A (Form 990-T). The instructions for lines 1, 4, 5, and 7, later, apply to Part III earlier, before completing Schedule A (Form 990-T).

Inventory valuation methods. Inventories can be valued at:

1. Cost, as described in Regulations section 1.471-3,

2. Lower of cost or market, as described in Regulations section 1.471-4, or

3. Any other method approved by the IRS that conforms to the requirements of the applicable regulations cited below.

However, if the organization is using the cash method of accounting, it is required to use cost.

A small producer is an organization whose average annual gross receipts are $1 million or less. Small producers that account for inventories in the same manner as materials and supplies that aren’t incidental may currently deduct expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.

The average cost (rolling average) method of valuing inventories generally doesn’t conform to the requirement of the regulations. See Rev. Rul. 71-234, 1971-1 C.B. 148.

Organizations that use erroneous valuation methods must change to a method permitted for federal income tax purposes. File Form 3115 to make this change.

Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal because of damage, imperfections, shop wear, etc., within the meaning of Regulations section 1.471-2(c). The goods may be valued at the bona fide selling price, minus direct cost of disposition (but not less than scrap value). Bona fide selling price means actual offering of goods during a period ending not later than 30 days after inventory date.

If this is the first year, the last-in first-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued under the LIFO method provided in section 472, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970.

If the organization changed or extended its inventory method to LIFO and had to write up the opening inventory to cost in the year of election, report the effect of this

28 Instructions for Form 990-T (2025)

write-up as other income (on Schedule A (Form 990-T), Part I, line 12) proportionately over a 3-year period that begins in the tax year the LIFO election was made (section 472(d)).

Inventory at Beginning of Year

Line 1. If the organization is changing its method of accounting to no longer account for inventories, it must refigure last year’s closing inventory using the new method of accounting and enter the result on Schedule A (Form 990-T), Part III, line 1. If there is a difference between last year’s closing inventory and the refigured amount, attach an explanation and take it into account when figuring the organization’s section 481(a) adjustment (explained earlier).

Additional Section 263A Costs

Line 4. An entry is required on this line only for organizations that have elected a simplified method of accounting.

For organizations that have elected the simplified production method, additional section 263A costs are generally those costs, other than interest, that are now required to be capitalized under section 263A but that weren’t capitalized under the organization’s method of accounting immediately prior to the effective date of section 263A. For details, see Regulations section 1.263A-2(b). For organizations that have elected the simplified resale method, additional section 263A costs are generally those costs incurred with respect to the following categories.

• Off-site storage or warehousing.

• Purchasing.

• Handling, such as processing, assembling, repackaging, and transporting.

• General and administrative costs (mixed service costs).

For details, see Regulations section 1.263A-3(d). Enter on Schedule A (Form 990-T), Part III, line 4, the balance of section 263A costs paid or incurred during the tax year not included on Schedule A (Form 990-T), Part III, lines 2 and 3.

Other Costs

Line 5. Enter on Schedule A (Form 990-T), Part III, line 5, any costs paid or incurred during the tax year not entered on Schedule A (Form 990-T), Part III, lines 2 through 4. Attach a statement describing the other costs.

Inventory at End of Year

Line 7. See Regulations sections 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory.

If the organization accounts for inventories in the same manner as materials and supplies that aren’t incidental, enter on Schedule A (Form 990-T), Part III, line 7, the portion of its raw materials and merchandise purchased for resale that are included on Schedule A (Form 990-T), Part III, line 6, and weren’t sold during the year.