Quatloos!

Hi, I have a very small business ($5K/year gross) besides my day job. It's a media business and till now has mostly involved services such as Web development. I have started manufacturing audio CDs, though, so I need to know how to account for inventory in my federal income tax filing. This year, it's only about a dozen CDs left over to report, but next year it will probably be a significant number. With such low revenues I can't afford a CPA so I laboriously file my own taxes.

Here's my question: How do I value the unsold CDs as inventory? Is it the retail price? I've sold them at several different price points, both wholesale and retail, so what price do I use? Or are they valued at the cost of producing them?

Thanks,

LDE

LDE wrote:Hi, I have a very small business ($5K/year gross) besides my day job. It's a media business and till now has mostly involved services such as Web development. I have started manufacturing audio CDs, though, so I need to know how to account for inventory in my federal income tax filing. This year, it's only about a dozen CDs left over to report, but next year it will probably be a significant number. With such low revenues I can't afford a CPA so I laboriously file my own taxes.

Here's my question: How do I value the unsold CDs as inventory? Is it the retail price? I've sold them at several different price points, both wholesale and retail, so what price do I use? Or are they valued at the cost of producing them?

Thanks,

LDE

You value the unsold inventory - the merchandise inventory of CDs -- at your cost of producing them, not the retail price you would be charging to sell them. Cost generally means your purchase cost. The total cost of all the CDs you still held at the end of the tax year 2009 would generally NOT be a deductible expense for 2009. Instead, that cost is "capitalized", and the cost amount is your "tax basis" in the unsold merchandise inventory.

If your business is simply an unincorporated sole proprietorship, there's really no place to "report" the cost of the unsold merchandise inventory of CDs. You would include a Schedule C with your Form 1040 return, and the cost of the unsold items would simply not be deducted.

However, if you have incorporated your business, you might have to report the cost on a balance sheet as part of the return, but it doesn't sound like you are doing enough business to worry about that yet.

I should note that unless you start accumulating huge amounts of merchandise inventory that would remain on hand at the end of the tax year, the effect of "expensing" that cost (while theoretically incorrect) and deducting the cost on your federal income tax return (again theoretically incorrect) might not result in a material mis-statement of your income tax liability for that year. In such a case, the unwritten "materiality rule" could apply. This sounds like it could be your situation for 2009 -- the cost of having produced a dozen CDs could be insignificant.

EDIT: If your business is in the form of a corporation, the corporation would generally file a 2009 Form 1120, which is due March 15, 2010. However, if you elect what is called "subchapter S" status (by filing a Form 2553), the return would be a Form 1120S. Even if you have to file one of these forms, you might not be doing enough business to have to include a balance sheet and report your unsold inventory.

LDE wrote:... so I need to know how to account for inventory in my federal income tax filing. ...

There is no federal inventory/property tax. IMHO the only implications would be if you depreciated them for some reason or sold them at a loss and used that loss to offset income on your balance sheet.

LDE wrote: ...
Here's my question: How do I value the unsold CDs as inventory? Is it the retail price? I've sold them at several different price points, both wholesale and retail, so what price do I use? Or are they valued at the cost of producing them?

Thanks,

LDE

The people you need to worry about are the State tax vultures. I would suggest that because of the state you're in, you get some professional guidance.

(DRUM ROLL) I think CKB is correct. (ROCKETS, FIREWORKS, STOPPED CLOCK ANALOGIES).

LDE needs to worry about the ad valorem tax on inventory imposed by the taxing authorities in Texas. However, if the value of the CD's is minimal his franchise tax will be minimal. Contact the Tax Assessor Collector for your county for help.

By the way, the State likes its sales taxes, too, so you might check in with the Controller on those obligations. Those attach to you, personally; the ad valorem only attaches to the asset.

If your business is simply an unincorporated sole proprietorship, there's really no place to "report" the cost of the unsold merchandise inventory of CDs. You would include a Schedule C with your Form 1040 return, and the cost of the unsold items would simply not be deducted.

Actually there is a section on page 2 of the Schedule C to account for inventory.
See http://www.irs.gov/pub/irs-pdf/f1040sc.pdf for the form and http://www.irs.gov/instructions/i1040sc ... ml#d0e1054 for instructions.

Line 33
Your inventories can be valued at cost; the lower of cost or market; or any other method approved by the IRS. However, you are required to use cost if you are using the cash method of accounting.

Cost is obviously the most simple method to value inventory.

Publication 538 (3/2008), Accounting Periods and Methods, is at http://www.irs.gov/publications/p538/index.html

I hope this helps for recording inventory on Schedule C.

Thanks so much to all of you. My business is a sole proprietorship but it is registered with both the state and county (DBA) and has its own bank account. I do file annual state sales tax returns (more on that below). I'm pretty sure the franchise tax is only imposed on businesses with much greater sales than mine but I'll double-check that.

In filing the federal Schedule C, Part III (Cost of Goods Sold), line 33 is "Inventory at beginning of year," while line 41 is "Inventory at end of year." For the sake of simplicity assume that at the beginning of the year I've got $100 of blank CDs, $20 of ink, $15 of paper for the outer label, and $50 worth of jewel cases, and there's no other inventory. By the end of the year I still have no other inventory, but I've turned that $185 of materials into 200 finished CDs I will eventually sell for $12 each but I don't sell any by year's end. So both line 41 and 33 will say "$185," right? (This is not a deduction but rather a reduction of a writeoff, if you follow me, since it's subtracted from cost of goods sold.)

OK, for those of you who are based in Texas, here's another question, this one on sales tax. I've had this explained several times by people from the comptroller's office, but it's still confusing to me and they didn't do such a hot job of explaining it. Here's how I understand it:

1. I perform a taxable service (say, prepress on a self-published book) in the rural county where I live. Let's call it Chupacabras County. I live in an unincorporated area where's no municipal tax; I collect and forward a total of 6.75% (state + county). The client lives in Round Rock where the municipality charges the maximum for a total of 8.25%. So long as I never "do business" (as defined, let's not go into the details) in Round Rock and my contacts with the client are only at my office or electronic, the tax rate is 6.75%.

2. I wind up doing business at the location of another client in Round Rock. Now I'm considered to be doing business in Round Rock so even in the case of the first client I must charge 8.25%, of which Round Rock gets the difference between the Chupacabras County rate and the Round Rock rate, or 1.5%.

3. Now here's where it's tricky. I subsequently play a gig in Round Rock (note, I didn't say Austin because its tax is split between city and districts) and sell CDs at retail there. Obviously they're subject to the Round Rock sales tax rate of 8.25%. But in this case, Round Rock gets all of the tax above the state rate (which I think is 6.25%, with 0.5% to Chupacabras County), right? I.e. 6.25% to the state, 2% to Round Rock, and 0 to Chupacabras County, right? Or is it still 1.5% to Round Rock and 0.5% to Chupacabras County?

Thanks again for your help,

LDE

P.S. For those who think a national sales tax will simplify your tax filing, please read through those last three paragraphs for just a small taste of what is involved. I wouldn't relish having to figure this out at both the state and federal levels.

As a partial answer to your sales tax questions, my wife and I have some experience dealing with the Texas Comptroller's office because we operate a (very) small mail order business and occassionally set up tables at different venues around the state to sell things.

It sounds like we got a better explanation than you did. What we were told was that anything we sold in Texas, we collect the sales tax at the rate charged where our business is located (meaning Austin). Since all sales tax gets sent to the Comptrollers office for distribution to the local entities, we were told we were not responsible for dividing up the tax ourselves. The good news was that anything we sold out of state by mail was not subject to sales tax but if we sold anything in person, we would be responsible for remitting tax at the local rate there and submitting it to that state's version of the Comptroller's office.

Take it with a grain of salt, it was a few years back (less than ten). Since I am selling it to you for the same price we paid, you may want to check back with the Comptroller's office for verification.

In filing the federal Schedule C, Part III (Cost of Goods Sold), line 33 is "Inventory at beginning of year," while line 41 is "Inventory at end of year." For the sake of simplicity assume that at the beginning of the year I've got $100 of blank CDs, $20 of ink, $15 of paper for the outer label, and $50 worth of jewel cases, and there's no other inventory. By the end of the year I still have no other inventory, but I've turned that $185 of materials into 200 finished CDs I will eventually sell for $12 each but I don't sell any by year's end. So both line 41 and 33 will say "$185," right?

That is correct.

jg wrote:

If your business is simply an unincorporated sole proprietorship, there's really no place to "report" the cost of the unsold merchandise inventory of CDs. You would include a Schedule C with your Form 1040 return, and the cost of the unsold items would simply not be deducted.

Actually there is a section on page 2 of the Schedule C to account for inventory.
See http://www.irs.gov/pub/irs-pdf/f1040sc.pdf for the form and http://www.irs.gov/instructions/i1040sc ... ml#d0e1054 for instructions.

Oops, I forgot all about that. I was thinking of the fact that there is no Schedule L balance sheet for a Form 1040 (as compared to a Form 1120 or Form 1120S, which do include a Schedule L).