Farmers should be aware that the method in which they handle inventories in arriving at taxable income could result in a tax audit by the Internal Revenue Service, a Utah State University Extension specialist said.

IRS Code 471 requires the use of inventories when necessary to clearly determine income, said Larry K. Bond, economics specialist in farm management.Bond said some taxpayers, the majority of them farmers, are including in their inventory expenses the cost of goods sold. The bulk of the cases involve the cost of feeder or breeding livestock.

The IRS has found a great many cases in which the cost of livestock sold far exceeds the gross receipts from the sale of livestock. This can happen in the normal course of business and is legitimate where records are kept on a cash rather than an accrual basis, he said.

Livestock purchased for resale may not all be sold the same year they are acquired. Yet the cost of those animals is often written off as an expense the year they are purchased. Bond said this should be offset the following year when sale receipts far exceed the cost of the animals plus the feed.

"We're not sure why the IRS has alerted us to this issue since there seems to be reason to expect situations like that explained," he said.