If you are self-employed and manufacture or purchase items for resale, under current IRS rules, you must report inventory expenses. All business owners must report those expenses on the back of their Schedule C tax form because inventory costs are not deducted in the same way as other normal business expenses.
Because of this, the IRS requires all businesses, no matter how small, to track inventory expenses separately from all other business costs. Your inventory expenses not only include the cost you pay for those resale items, or all the parts needed to put the items together, but it also includes all shipping costs and wages paid for assembly.
You are not allowed to deduct inventory expenses until an item is sold or permanently removed from your business inventory. All unsold inventory costs must be carried over to the next fiscal year. Unsold inventory includes everything you haven’t sold, traded, scrapped, given away, or donated. It also includes all inventory items found in stores and warehouses that have been sold on consignment.
There is a small section on the back of the Schedule C small business tax form where you fill in the value of your beginning inventory, the cost of all inventory added during the current tax year, any inventory disposed of for personal use, and your purpose. inventory value for the year.
For IRS inventory records that will survive a tax audit, I’ve devised a formula called LATER: Lit is, HAStell, Ttotal, mevalue and Rreport. Is that how it works:
STL – List all items purchased for resale as those items arrive. Make a simple six vertical column chart on lined paper; I use a spiral notebook. Title those six columns as follows:
- Article name
- Total cost
- Number of salable items
- Cost per item
- remaining inventory
- year end value
Fill in the first three columns as items arrive. To get the cost per item, divide the total cost of each item by the number of salable items and write that amount in column four. You will complete the last two columns on the last business day of the fiscal year.
BILL – On the last day of the fiscal year account of all unsold inventory; both on their shelves and for sale on consignment. Enter this count for each item as remaining inventory.
TOTAL – Multiply your remaining inventory count by your cost per item for each item and enter that value in the final column. Add up everything that is in the second and last column. The first figure is the total spent to add merchandise and the second is the year-end inventory value.
ASSESS – Review all remaining inventory to assess quality and shelf life. Remove all unsaleable merchandise to throw away, donate, or set aside to use for future promotions. Deduct the value of any discarded or donated inventory. Items used for future promotions will be deducted when used.
POSTPONEMENT – On the back of your Schedule C tax form, you’ll find a place to enter the total of all added merchandise and your year-end inventory. Add the fiscal year opening inventory and merchandise added together, and subtract the remaining value of your inventory to complete the cost of goods sold.
This year’s year-end inventory value becomes the opening inventory value of the next fiscal year.
Take the time to make this simple six-column inventory chart at the beginning of the fiscal year, follow the formula LATER, and you’ll get those inventory deductions right every time.
