If you work for yourself and make or buy items for resale, according to current IRS rules you have inventory expenses to report. Every business owner is required to report those expenses on the back of their Schedule C tax form because inventory costs are not deducted in the same manner as other normal business expenses.
Because of this, the IRS requires that every business, no matter how small, track inventory expenses separate from all other business costs. Your inventory expenses not only includes the cost you pay for those resale items, or all of the pieces needed to assemble the items, but it also includes all shipping charges and wages paid for assembly.
You are not allowed to deduct inventory expenses until an item is sold or otherwise permanently removed from your business inventory. All unsold inventory costs must be carried forward into the following tax year. Unsold inventory includes everything you have not sold, traded, trashed, given away or donated. It also includes all inventory items sitting 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 opening inventory, the cost of all inventory added during the current tax year, any inventory removed for personal use, and your end of year inventory value.
For IRS inventory records that will survive a tax audit I have devised a formula called LATER – List, Account, Total, Evaluate and Report. Here’s how it works:
LIST – Write down 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:
- Item Name
- Total Cost
- Number of Sellable Items
- Per Item Cost
- Remaining Inventory
- End of Year Value
Fill out the first three columns as items arrive. To get the per item cost divide the total cost of each item by the number of sellable items and write that amount in column four. You will fill in the last two columns on the last business day of the tax year.
ACCOUNT – On the last day of the tax year account for all unsold inventory; both on your shelves and out for sale on consignment. Enter this count for each item as remaining inventory.
TOTAL – Multiply your remaining inventory count by your per item cost for each item and enter that value in the final column. Total everything in the second and last columns. The first figure is the total spent to add merchandise and the second your end of year inventory value.
EVALUATE – Look over all remaining inventory to evaluate its quality and shelf life. Remove all unsellable merchandise to be trashed, donated or reserved for use in future promotions. Deduct the value of any inventory trashed or donated. Items used for future promotions will be deducted when used.
REPORT – On the back of your Schedule C tax form you will find a place to enter the total of all merchandise added and your end of year inventory. Add the tax year’s opening inventory and merchandise added together, and subtract your remaining inventory value to fill in the cost of goods sold.
This year’s end of year inventory value becomes the following tax year’s opening inventory value.
Take the time to make this simple six column inventory chart at the start of the tax year, follow the LATER formula, and you’ll get those inventory deductions right every time.