cash basis carrying inventory

IRS Pub 538 pages 14 to 16 talks about cases when a cash basis taxpayer can carry inventory. Exclude the easy case which is revenue procedure

2001-10, for taxpayers with under one million in gross receipts. The only other exception is revenue procedure 2002-28, which talks about taxpayers that meet these tests:

  • Under 10 million gross receipts (using a specific test)

  • Not prohibited by section 448 from using cash basis (so that would be C Corporations and Partnerships with > 5 million gross receipts)

  • Eligible business type (there is a list of NAICS codes that are prohibited for the principal activity of the business)

The general impression one gets from reading the rules for 2002-28 and other articles online is that the IRS really really does not like any business that carries inventory to be on the cash basis. My question is can someone give me a sense of audit risk from carrying inventory and being on cash basis, even if you pass the 2002-28 tests? You get the feeling that even if you follow 2002-28 strictly, that just being a cash basis taxpayer with inventory will elevate audit risk a lot.

One article I read online contained the generalization that IRS will test value of inventory against gross receipts, and if they see inventory >= 15% of gross receipts then they will change you to the accrual method for the years under audit. Is that a fair statement, and are there other tests and generalizations that can be made to help a cash basis taxpayer that carries inventory understand whether IRS will require transition to accrual basis for other reasons than what is in procedure 2002-28 alone?

nish

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nish
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