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The Florists* Review 



39 



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DON'T USE INVENTORY 



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GROWERS' INCOME TAX. 



Inventory Not Needed. 



Since the inception of tlie federal in- 

 ('i)iiie tax one of the questions most fre- 

 ((uently raised by florists and nursery- 

 iiion is whether the use of an inventory 

 is necessary. In an article coverinjjf this 

 subject, prepared after consultation 

 with income tax officials at Washington, 

 it was definitely stated in The Eeview 

 of February 10, 1921, that an inventory 

 was not needed. It was explained at 

 iliat time that the status of those who 

 prow plants under glass or trees, shrubs 

 and plants in nurseries is looked upon 

 as similar to that of the farmer, a ge- 

 neric classification used in a liroad way 

 in the income tax regulations. 



But the question which subsecpiently 

 occurred with frequency was whether 

 tlie florist or nurseryman who had here- 

 tofore included an inventory with his 

 tax return might change his method. Re- 

 garding the method of computing in- 

 come, section 212b of the revenue act of 

 1918, which appears in the same form 

 in tlie same section of the revenue act 

 of 1921 just jiassed, says: 



The not iiicnnip slinll lip coniiintcd upon tlie basiH 

 of tlip taxpuypr's ininiuil incoinp aiiountiiiK pe- 

 riod in iici'onlHncp with the inpthod of iipconntinB 

 rPRiiIiirly employed iu kecpini; liooks of such tax- 

 payer; that if no mikIi nipthod of accounting has 

 lippn He. pniploypd, or if the method emplovpd 

 does not clearly reflett the income, the compu 

 tation shall be made upon siic'h basis and in such 

 manner a« iu the opinion of the commissioner 

 does clearly reflect the Income. 



Regarding inventories, section 203, 

 which is exactly the same in the new 

 and old laws, reads as follows: 



That whenever, in the opinion of the commiR- 

 sioner, the use of inventories is necessary in 

 order clearly to determine the income of any' tax- 

 payer, inventories shall lie taken bv sucli tax- 

 payer upon such basis as the commissioner, with 

 the approval of the secretary, may prescribe as 

 fonformlnK as nearly as may be to the best ac- 

 connlniB practice in the trade or business and 

 as most clearly reflecting the Income. 



It is, therefore, left to the discretion 

 of the commissioner of internal revenue 

 to demand inventories if he believes the 

 business is such that the true net income 

 <'.'ui only be determined by the use of an 

 inventory. Although the commissioner 

 lias issijod, from time to time, numerous 

 regulations, rulings and opinions regard- 

 ing inventories and affecting different 

 industries, it was not until the Cali- 

 fornia A.ssociation of Nurserymen 

 placed the matter before the commis- 

 ■^'oncr, through attorneys, tliat a ruling 

 specifically covering the nursery indus- 

 try and florists was made. 



Two Methods of Accounting. 



ilie 'otiiinis^ioner had, however, sup- 

 H'Pd a statement expl.-uu'tory of what 

 'le considered the jiroper .accounting 

 i^'iethods. Bt-fore quoting this it may he 

 •■■'itcd that two ])rincipal methods arc 

 'yoornized, that of cash basis and that 

 ""'.1 ••iccriiid basis. If income is not con- 

 sidered until it is received in money, and 

 '■xiunses ;irc not considered until jiaid, 

 the accounting svstcm is said to be upon 

 f" ensh basis. When income is taken into 

 ' onsideration when earned, even thougli 

 "^ has not been paid in cash, and ex- 

 penses are considered wlien they are in- 

 "rrod, wheth.T pai.l or not, the account- 



ing }s said to be on the accrual basis. 

 Generally the courts have lield that 

 the cash basis clearly reflects the in- 

 come. Congress, however, considered 

 that tlie cash basis is not always the 

 test, and gave power to the commis- 

 sioner to require the use of a different 

 method whenever he considered it neces- 

 sary. The commissioner has taken into 

 consideration the difficulty of applying 

 an arbitrary method of accounting for 

 all taxpayers, and on this point he has 

 issued rulings, in regulation 4'), article 

 24, reading as follows: 



It is recognized that no uniform method of ac- 

 counting can be prescribed for all taxpayers, and 

 the law contemplates that each taxpayer shall 

 adopt such forms and systems of accounting us 

 are, In his judgment, best suited to his purpose. 

 Each taxpayer Is required by law to make a re- 

 turn of his true income. He must, therefore, 

 maintain such accounting records as will enable 

 him to do so. Among the essentials are the fol- 

 lowing: 



(1) In all cases In which the production, pur- 

 chase, or sale of merchandise of any kind is an 

 income-producing factor. Inventories of the mer- 



Official 



"It is held, therefore, that 

 where the selling of orna- 

 mental plants and trees, as well 

 as fruit trees, is the chief in- 

 come-producing factor of a tax^ 

 payer, an inventory of such 

 trees and plants at the begin- 

 ning and end of the taxable 

 year, should not be used in cal- 

 culating net income for income 

 tax purposes." 



chandise on hand (including flnished goods, work 

 in process, raw material and suiiplics) should be 

 taken at the beginning and end of the year and 

 used in computing the net income of the year. 



CM Kxppn<liturcs made during the ye:ir should 

 be projiprly classitipd as bctwei'n capital and in- 

 come: tiiat is to sa.v, that expenditures for items 

 of idiint. e(iuli)mpnt, etc., which have a useful 

 life extending substantially bpyoml the year, 

 shoulil be charged to a capital account and not 

 to an expense account; ami 



i'.i) In any case in which the cost of capital 

 assets is being recovered through deductions for 

 wear and tear, depletion or obsolescence an ex- 

 penditure (other than ordinary repairs) made to 

 restore the property or jirolong its useful life 

 should be charged against Ihe property account or 

 the appropriate reserve and not against current 

 expenses. 



Either the cash basis or the accrw.al 

 basis may be used by those engaged in 

 agricultural industries, but more gener- 

 ally tlie first lias been used, with the 

 coiiiniissioner 's sanction, because tlieic 

 is (lifliculty in correctly coni]iiiting tlic 

 valu(> of a crop in process of growing, it 

 may turn out splendidly or it may jirove 

 a failure. 



Before The Review published the 

 article on florists' income tax procedure, 

 many of them liad used the invcmtory 

 merely because the crops in their green 

 houses seemed to be merchandise oi 



hand. After The Review had presented 

 the commissioner's attitude in the mat- 

 ter the question arose whether a florist 

 might change from one method to the 

 other, from the accruttl basis to the cash 

 basis, and cease filling out the inventory 

 blank. Florists and nurserymen found 

 in many cases that they had paid the 

 government more on the accrual basis 

 than they would have paid on the cash 

 basis, without an inventory. The Cali- 

 fornia Association of Nurserymen put 

 the question before a San Francisco at- 

 torney, "May nurserymen who have 

 been reporting inventories discontinue 

 that method and make income tax re- 

 turns on the basis of receipts and dis- 

 bursements?" The attorney's opinion, 

 which has just been published in a bul- 

 letin of the association, after referring 

 to the same articles of the tax law and 

 regulations as are quoted above, stated 

 that while nurserymen who were not 

 using an inventory might safely con- 

 tinue to do without it, those nurserymen 

 who had heretofore used inventories 

 should obtain permission from the com- 

 missioner before changing their method. 



Here Is the Ruling We Want. 

 At the request of Roy F. Wilcox, 

 president of the California Association 

 of Nurserymen, the attorney wrote for 

 a ruling of the commissioner of internal 

 revenue on the subject, the reply to 

 which is as follows: 



TRE.\SURY DEPARTMENT. 

 WASHINGTO.N. 

 Office of 

 Commissioner of Internal Revenue. 

 Cornish & Moore, 

 017 Inderwood Kuilding, 

 .San Francisco, (;al. 



.Sirs: l{eceii)t is acknowledged of your letter 

 dated April 1. 1921. in which you in(|uire 

 "whether the department requires one engaged 

 in the producing and selling of nursery stock, 

 that is, ornamental plants and trees, as well as 

 fruit trees, to submit an inventory with his an- 

 nual income tax returns." You state tliat the 

 Iieculiar character of this business is most dif- 

 ficult to prepare inventories and tliat there is u 

 (piestion as to whether "the requirpinpnts of in- 

 ventories might not makp it most diflicult to 

 deterinine tile actual income of the taxpayer." 



In reply, you are advised that the use of In- 

 vi-ntories for the puri>ose of determining the cost 

 of goods sold by a taxpayer Is reipiired where 

 the maiMifacture or the jiurchase and sale of 

 mcrcliai]i|isp is the chief income producing fac- 

 tor. Wliere, owing to the peculiar nature of an 

 industry or business, it is impossible to value 

 the articles dealt in and on hand at the end of 

 the taxable year. Inventories should not be used 

 for the purpose of arriving at the cost of mer- 

 chandise sold during the year. 



It is held, therefore, that where the selling of 

 ornamental plants and trees, as well as fruit 

 trees, is th<^ chief income producing factor of a 

 taxpayer, an inventory of such trei'S and plants 

 at the beginning and end of the taxable .year 

 should not be used in calculating net income for 

 income tax inirposes. Respectfully, 



Signed K. H. Rats(m. 

 Acting Deputy Commissioner. 

 I!y M. K. Stickley, 

 Head of Division. 



Florists on the Pacific coast who are 

 members of tln> Xurserymen's Associa- 

 tion are jireparing to file their tax re- 

 turns on a b.'isis of cash sales less ex- 

 penses, instead of using the inventory 

 as li(M-etofore. The collector at Los 

 Angeles has stated that the letter from 

 W.'isliington above (|uoteil is ])lenty of 

 authority to make the change. One 

 large firm of florists near I..os Angeles 

 ])lans t(( file a claim of overpayments 

 made in tlie last two years, ho))ing to 

 get back ]);irt of the taxes it has ])aid 

 en the iiiveiitorv basis. 



