question regarding inventory on 1040 schedule C

[wasatchm]

I realize that it asks for beginning and end of year inventory for the schedule C.

I always put 0 even if I have inventory.  can someone tell me why the IRS want's to know the beginning and ending inventory?

and is there an real benefit for someone like me who doesn't have a lot of inventory at the lest of the year (probably less than 10K worth) the put the actual inventory on my schedule C instead of just putting 0.  I just like to keep things simple.  

thanks

[thenobletuckylife]

Hi There...a quick answer is that if you have inventory they want to know how much you still have after the tax year.

In other words if you started out with $10,000 and ended up with $6,000 there is a possible tax liability on the difference.

This is just a general answer because there are many issues and scenarios for folks in business that really requires the need for an accountant at minimum.

Mr C

[mr_lincoln]

@thenobletuckylife, @wasatchm 

I believe the "tax liability" has more to do with how much profit you made as taxable income.  I suspect that the IRS may have some computer bots that flag inventory values o "0" ... in other words, what you are saying with value as the beginning balance is you sold all o fyour inventory which is not the case.  If you end one year with "X" amount of inventory then THAT is the beginning amount for the following year.  Then lets say hypothetically you buy 5K of inventory in the new year but sell none of it ... technically you would be claiming a loss for the business, meaning the inventory expense exceeded sales - i.e. Taxable Income.  Businesses can show a loss for I belive 5 years before they have to report a profit.  You should really sit with a CPA and go ver what you need to report ... that's their business and their advice will 1) keep you legal and 2) possibly help with good deductions for your business. 

[copper.boom]

This is your second post with tax inquiries. I highly suggest you consult a CPA to make sure you have your ducks in a row.

[wasatchm]

"In other words if you started out with $10,000 and ended up with $6,000 there is a possible tax liability on the difference."

YES, there is a $4,000 difference between the 2 numbers.   that would mean I sold $4000 in products that year.  but I don't see that effecting my tax liablity.  all that would mean is that my COST OF GOODS SOLD  for the year is $4,000 right?  and I do report the profit on those COST OF GOODS SOLD (gross receipts minus expenses).  that is all reported on my schedule C.

I am performing and inventory check (I track my inventory and sales in an excel spreedsheet)  right now.   it will probably take me a few hours to complete.  and then I will do this same inventory check again on DEC 31.   so my inventory will be spot on (or within 1 percent).  I just started an LLC a few days ago (and will be taxed as an S CORP), so I will definetly be putting the correct inventory for BEGINNING and END OF YEAR.    I just want to know why the IRS wants it.  I can see that the COST OF GOODS SOLD can be checked against the beginning and end of year inventory for accuracy.  is that the reason?   or one of the reasons.  

I very well may be going to a CPA with some more complex questions.  however, I thought this was a fairly simple question that some sellers may very well know the answer to.  maybe I will try to get an APPT with a CPA (for small business) that will go over all the lines on the 1120S (S corp ) tax form.  that seems like a smart idea.

thanks

[thenobletuckylife]

In some circumstances the inventory you still have on hand is considered a taxable asset.

The IRS expects the gross income and expenses along with the net expenses and final taxable income to be provided. In some situations if you have already expensed out your inventory but still have it on hand it can be considered taxable.

So in the previous example...if you started with $10,000 and ended with $4000 that 4 grand could be considered taxable...this is why you need a CPA.

He will determine your start up investment you brought to the table and work from there.

The time where inventory starts to have an affect is over several years not typically in your first start up year but once again there are many many variables. Your S corp simply roles over any taxable profits into your personal tax bracket.

Mr C

[candles18]

Note: Business with less than $1,000,000 in annual gross receipts are exempt from having to use the accural method of accounting and accounting for inventories.  So, I assume, that most of us here can use the simpler cash method of accounting. See:

https://www.irs.gov/pub/irs-irbs/irb01-02.pdf

Other than being simplier, though, I'm not sure of the pros or cons of using cash over accural.  This may be one of thos cases where it's best to work with a tax expert.

[myboardid]

nobletucky has hit the jackpot - any inventory that remains on Dec 31st over the value of what you had on the previous Jan 1st is TAXABLE (in the simplest of terms).   That is why you need to record and report the numbers. 

I STRONGLY suggest working with a tax specialist, especially when changing the type of business entity you are using.  Money spent consulting with them could possibly save you 10 times as much in taxes, if only by preventing making a bad mistake.  No one here is a tax accountant. 

[wasatchm]

"So in the previous example...if you started with $10,000 and ended with $4000 that 4 grand could be considered taxable...this is why you need a CPA."

so what if it was reversed.....I started jan 1 with 4K inventory and ended dec 31 with 10K inventory.     is there a situation in which my tax burden would be lessened versus just putting 0 as the beginning and end inventory date?

my net income is about 30-40K/yr so a 10K in inventory is about 25 percent of what I made for the year.

I will definetly consult a tax professional.  if I start putting a lot of time into tracking software (highing CPA, buying expensive software, etc),  it would probably kill my income a bit more.  so I will do it....but only if it's neccessary.

if I had 100K in inventory, it would probably be smart to keep very close track of inventory as I think if you didn't, then over time it would hurt your bottom line.

[luckythewinner]

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@candles18 wrote:

Note: Business with less than $1,000,000 in annual gross receipts are exempt from having to use the accural method of accounting and accounting for inventories.  So, I assume, that most of us here can use the simpler cash method of accounting. See:

https://www.irs.gov/pub/irs-irbs/irb01-02.pdf

Other than being simplier, though, I'm not sure of the pros or cons of using cash over accural.  This may be one of thos cases where it's best to work with a tax expert.

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IMHO this is excellent advice.

If you are a qualifying taxpayer (less that $1 million in sales and not a tax shelter)  you can generally ignore accounting for inventory for tax purposes as long you pay for it out of pocket and do not expense it until the year in which it is actually sold.

So if you bought an item in 2014 for $50 and sold it in 2016 for $150, then in 2016 you would report both the $150 in sales and expense the $50 in cost by treating them as "materials and supplies that are not incidental": 

"If you account for inventoriable items as materials and supplies that are not incidental, you will deduct the cost of the items you would otherwise include in inventory in the year you sell the items, or the year you pay for them, whichever is later."

 ( https://www.irs.gov/publications/p334/ch02.html#en_US_2016_publink1000313270 )

For many small sellers, this is the simplest way to handle inventory.

[candles18]

A few states tax inventory, but you don't pay federal taxes on inventory (at least not directly -see below).

But, it's not good tax-wise to have a large inventory because it's money you've spent (an expense) that you cannot deduct until you sell the products.

For example, in a year you sell $100 worth of merchandise that cost you $80. You would report your gross income as $100 and your Cost of Goods Sold as $80 for a profit of $20. You would be taxed on that $20.

If during that year, you actually spent $100 buying products to add to your inventory, then you would have really made no profit (even though you still have to pay taxes on the $20 "profit" recorded on your taxes).

If you had spent just $80 on the inventory and spent $20 more on something like advertising, you would have spent the same amount, but could write off the cost of the advertising. This would reduce your profit to $0 and you would pay no taxes.

So, even though you don't directly pay taxes on extra inventory purchased during the year, in effect you are because you're missing an opportunity to reduce your reported profit.

Of course, if you buy more inventory in a year than you sell, you still have the inventory on-hand and it has value (it's an asset). You can sell it during the next year. When you sell items from your inventory, you can then write off the cost you paid for it (Cost of Goods Sold).

Even though the cash method of accounting is simpler, you still have to keep track of the Cost of Goods Sold because you are not allow to write off expenses for buying merchandise until you have sold it.

[7606dennis]

As already mentioned, you need to consult a qualified tax professional regarding this issue.

Frankly, if you are not handling the costing and recording of your inventory correctly, your Schedule C is inaccurate.  If you're maintaining an inventory you need to maintain records to accurately figure cost of goods sold which you will need to determine your net income from your business.

I believe that the IRS places restrictions upon what they consider acceptable accounting practices.  You, if memory serves, are required to use the accrual method as opposed to the cash method.  There is also the matter of accounting for inventory such as first in, first out etc.  I highly recommend consulting a good CPA.  It could possibly save you a whole lot of grief if you're ever audited.

[jashina1]

Zero is not correct, you need to input the correct inventory and it should be place on Schedule C not on our 1040. You should seek the assistance of an accountant . Putting zero may increase your chances of an audit as it is not a true reflection of your inventory.

[wasatchm]

thanks.  I have posted some of these questions on some accounting forums also

and gotten some good responses.  but sometimes their just to technical to explain something in lay mans terms.  

I just bought a book 

"How To Start And Run Your Own Corporation: S-Corporations For Small Business kit".   

I hope it's provides some useful insight on running a single member LLC S corp.

I will certainly be putting together a list of questions  to ask a CPA.   I am going to give myself about a week to get all the questions together and then hopefully I won't realize after I have visited with the CPA that I forgot to ask him some very important questions.

[luckythewinner]

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@7606dennis wrote:

if memory serves, are required to use the accrual method as opposed to the cash method.  There is also the matter of accounting for inventory such as first in, first out etc.

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Your memory does not serve. 

The publication 334 link I posted above explains that qualifying taxpayers (under $1 million in sales and not tax shelters) can:

"use the cash method of accounting even if they produce, purchase, or sell merchandise. These taxpayers can also account for inventoriable items as materials and supplies that are not incidental"

This means they can choose NOT to use the accrual method, and they do not have to account for inventory other than by expensing the cost of an item in the year it is sold.