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US Tax question- valuing inventory


#1

Folks, I’m trying to do my (jewelry) business-related US income taxes
and have a thorny question. I know several of you must be in the
same boat so I’m tossing it out to you.

If I did NOT pay myself a salary last year, should I take my hours
creating each piece into account when valuing my end-of-year
inventory for tax purposes? Of course, I take the hours into
account when pricing the pieces, but that’s a different beast.

I’m conflicted on what I read. Tax code says to account for all
vosts including labor costs in the value of the inventory … but if
my labor was “free” (i.e. nothing taken out of the business), then
do I count it? And if so, at what rate?

What do you do in this case?

Many thanks for any help you can give.

Karen Goeller
@Karen_Goeller


#2

Karen, A year or two ago, Metalwerx had an accountant and an attorney
come in for a seminar on issues like these. I understood them to
say that year end inventory (both finished and unfinished goods)
were calculated by what expense dollars had actually been expended
only - no markup, no personal labor. If you had paid for someone
else’s labor (a caster?) to produce the piece, then you include that
cost. Linda


#3
  I'm conflicted on what I read.  Tax code says to account for all
vosts including labor costs in the value of the inventory ... but
if my labor was "free" (i.e. nothing taken out of the business),
then do I count it? And if so, at what rate? 

Hello Karen. I’ll begin by saying that I am not a tax expert and the
opinions I express are just that. You should research and evaluate
any comments on an individual basis to determine if there is any
application to your situation.

Try the IRS website www.irs.gov and research the instructions
concerning inventory for Schedule C. (profit or loss from business).

If I understand the instructions correctly you may value your
inventory by either cost of the raw materials used in items for sale
or by the value of inventoriable items taking into account the value
added by your work on the items for sale.

As artists, we may be exempt from adding such value to our unsold
inventory until the year in which an item is sold. Using this
accounting method, I add the cost of raw materials purchased in any
given year to my inventory that year and deduct from my inventory
(in “cost of goods sold”) the cost of whatever raw materials were
used in producing the items sold that year. Your labor - the value
added to the raw materials you used - is not computed in your
inventory. If you paid for someone else’s labor to produce the items
sold those labor costs would be included in your “cost of goods
sold”.

There is a place on Schedule C under cost of goods sold where you
may indicate any “change” in the way you valued your inventory. You
may be required to file a statement with your return indicating how
you changed the way in which you valued your inventory during this
tax year.

Hope this helps.
Pam Chott
Song of the Phoenix


#4

Karen - The way our accountant explained it to us is: if you didn’t
spend money for it, you cannot claim it on your taxes. Disappointing
to us, but there it is. We just spent thousands moving our inventory
hundreds of miles, and are working out the details of that, and the
unpaid labor component came up in the discussion. I hope that helps
clarify your situation.

Jim Small
Small Wonders


#5
 The way our accountant explained it to us is: if you didn't spend
money for it, you cannot claim it on your taxes 

The only exception I know of to this is that if you paid yourself a
salary from the company, then you can claim that on your schedule C
, BUT, and a big BUT here, you must then claim the salary as an
income and pay taxes on it. If you can figure a way to make this
work for you, go for it. This is a double edged sword though. If
you end up with a profit from the business, and have paid yourself a
salary, you are exposed to paying taxed twice on the same earnings,
unless you have given yourself a bonus at the end of the year to
offset the profits. You will still need to pay taxes on the
earnings. Just figure which way makes the best deal for you. One
thing to remember, this profit on the business side, The schedule C,
is what makes your business a “Business” vs a Hobby. It is also
what makes your contributions to your Social Security worth while
(for now any way). The real answer is to set down with a CPA and go
over your books and follow their recommendations. There are just
too many twist and turns to keep up with and your business is making
jewelry, not interpreting the tax laws. My first year in business
resulted in a big loss, both on the schedule C, and my personal
taxes. I got to spend around 80 hours of time gathering records for
my CPA to take to the IRS and defend my return. In the end, the IRS
got $nothing more in taxes, and it cost me the 80 hrs of time
gathering records and $350 for my CPA to represent me. I grumble
over this, but it could have come out worse as the case was closed,
and I didn’t have to spend anymore of my time on it.

Don


#6

Your advice to see a CPA is wise. But your comment on paying twice
on your earnings is not accurate. If you pay yourself salary, its
deductible as a business expense for your company. If you still have
profit after deducting salary, you do pay tax on the profit, but you
are not paying twice.

Linda Holmes-Rubin
ForCapital Associates of Atlanta
Phone: 770-479-7837
Fax: 770-720-7555
Email: lindahr @ mindspring.com


#7
    salary, you are exposed to paying taxed twice on the same
earnings, unless you have given yourself a bonus at the end of the
year to offset the profits. 

This is total hogwash with regard to Schedule C. If you create an
Inc. which must pay taxes (NOT an “S” corp. Inc.) then you’re on form
1120 and do get into “double taxation” when there are dividend
distributions.

    The schedule C, is what makes your business a "Business" vs a
Hobby. 

This is hogwash too. The IRS has a whole host of questions none of
which is “Did this individual file a Schedule C?” and for which NO
SINGLE ANSWER is ever definitive that are used to determine when
deductions are legitimately business deductions. And what’s worse,
the rules allow any answers this year (or, I think it’s for the last
5 years, 3 for certain, but don’t quote me) to be answered
differently for THIS year when the same question is asked for THIS
year NEXT year or the next year, etc. In other words the IRS can let
you pass as a business for several years then decide you were only a
hobbyist for those years and DO owe taxes on what you previously
declared as deductible expenses.

      The real answer is to set down with a CPA and go over your
books and follow their recommendations. 

Yes, IF they are competent tax advisors too.

I’m not a CPA or tax advisor either but I have read the IRS
publications and that is where I got the above not from
simplified “sound bites” fed to someone not willing to read and
understand the tax rules.

James E. White
Inventor, Marketer, and Author of "Will It Sell?