The Thor Power Tool Rule stems from a landmark 1979 court case between Thor Power Tool Company and the IRS. This rule controls how businesses can write down inventory for tax purposes, limiting deductions to cases where inventory value has permanently fallen below cost. It prevents companies from manipulating taxable income by writing down inventory based on temporary dips or anticipated drops in sales.
When a business purchases inventory, it records the inventory at cost. If the inventory becomes obsolete, damaged, or otherwise declines in value, businesses might want to write down its value to the lower market price to reduce taxable income. However, under the Thor Power Tool Rule, this write-down is allowed only if the drop in market value is permanent.
“Permanent” in this context means the inventory’s market value is substantially and demonstrably below cost, and there is no reasonable expectation of a recovery. Temporary market fluctuations or seasonal sales slumps do not qualify for inventory write-down under this rule. Businesses must have concrete evidence such as damaged goods, obsolete stock, or a clear and sustained market price decline.
For example, if a retailer buys power tools at $100 each, and due to new technology, the tools can only be sold for $60 permanently, then the business may write down the inventory value to $60 for tax purposes. But if the lower price is due to a short-term market softness expected to rebound, the write-down is not allowed for tax deduction.
This rule mainly affects businesses using accrual accounting methods that maintain a physical inventory, including retailers, manufacturers, and wholesalers. Small businesses using cash accounting generally do not handle inventory the same way for tax purposes and may be less impacted.
To comply with the Thor Power Tool Rule, companies should:
- Keep thorough documentation supporting the permanent reduction in inventory value, such as appraisals, market analyses, or evidence of obsolescence.
- Avoid relying on forecasts or temporary market trends for write-down decisions.
- Regularly review inventory values to identify permanent declines promptly.
- Seek advice from tax professionals to ensure write-downs meet IRS standards.
Common mistakes include prematurely writing down inventory based on temporary market conditions, failing to document reasons for write-downs adequately, and confusing tax write-down rules with financial accounting standards, which may be more flexible. Incorrect application can trigger IRS audits, disallowed deductions, penalties, and interest.
Below is a summary table highlighting key points of the Thor Power Tool Rule:
| Aspect | Details |
|---|---|
| Origin | 1979 Thor Power Tool Co. vs. IRS court case |
| Purpose | Limit tax deductions to permanent inventory value declines |
| Key Requirement | Write-down only for permanent value loss |
| Applies to | Businesses using accrual accounting with physical inventory |
| Common Errors | Writing down on temporary declines without evidence |
| Tax Impact | Reduces taxable income if criteria are met |
| Recommended Action | Keep records, consult tax pros, review regularly |
For businesses needing to understand inventory write-down tax rules more broadly, see our detailed articles on Inventory and Loss from Obsolete Inventory Deduction.
Sources:
- IRS. (n.d.). Inventory Valuation. Retrieved from https://www.irs.gov/publications/p538#enUS2023_publink1000203604
- Treasury Regulations, 26 CFR §1.471-2 Inventories: Valuation.
- Investopedia. Thor Power Tool Co. Tax Case. Retrieved from https://www.investopedia.com/terms/t/thorpowertoolrule.asp
- Tax Foundation. Inventory Tax Accounting Rules. Retrieved from https://taxfoundation.org/inventory-accounting-rules/
For further details on IRS inventory valuation rules, visit the official IRS resource linked above.