If I have a SaaS (software as a service) based company, and I am tracking cost of revenue in my accounting software, so that I have useful income statements and can track gross profit, how does that map onto my tax return (1065 in my case).
My company doesn't have inventory and a COGS deduction doesn't apply. So I'm assuming I don't fill that in the COGS line 2. But then gross profit on line 3 is not really accurate.
Do I just put the cost of revenue items down into regular expense categories below line 8 in the expenses section of the 1065, or should it be handled differently?
As an accountant (CPA) myself, I can think of at least two different ways to handle your situation for income tax purposes, your financial accounting statements, as well as for informal internal accounting purposes (i.e., generating monthly or quarterly profit & loss statements).
Let's start with the assumption that you actually do have some ongoing costs, even if yours is a software as a service (SaaS) business. It probably costs you something to provide the software services to others (your customers), and so that in itself could be called Purchase (or acquisition) costs, or even Cost of Goods Sold (COGS). It shouldn't matter that you are selling an intangible good.
If we take this approach, then we can briefly examine what that would look like on a Form 1065 (Partnership) tax return, by opening up screenshot #1, attached to this answer below.
Here we do consider our costs for providing the software service as a COGS. We just have no opening or closing inventory. And we would then fill out our accompanying Form 1125-A as shown in screenshot # 2 (or we could use instead Form 1125-A, Line 5 to input our costs, in lieu of what is demonstrated). No matter, because the costs will ultimately appear the same way when we take our Form 1125A data and transfer it back onto our main Form 1065.
Alternative number two would have you record your costs instead on Line 20 of your Form 1065, and then you can attach any customized statement that you like to further report and / or justify your deductible expenses for tax purposes. Please see screenshot # 3 for an example to see what this would look like.
Basically, I should think that any reasonable accountant would be comfortable with using either of these two broad methods (or an acceptable, but similar, alternative). All solutions resolve the basic accounting equation: REVENUE - EXPENSES = NET INCOME
Thanks for asking this important question, and good luck with your business!
You're very welcome. Changing revenue / expense approaches shouldn't really cause any accounting issues that I can think of, except where you might be using these figures for internal comparison purposes over time, and in which case at least one expense category wouldn't, obviously, match the dollar amount for a prior period if you change expense treatments. However, with respect to income tax reporting, again it is really the "bottom line" that the IRS is going to be monitoring, as well as seeing that all of the "flow through" items of income, gains, losses, and deductions correctly are reported by the individual 1065 Partners (via Schedules K-1). How you get to that "bottom line" though, as long as any reasonable accounting treatment results in the same Net Income, is typically a decision left up to the discretion of company management (i.e., you). In other words, you shouldn't need to amend any prior year tax returns, because there has been no actual change in taxable income. The same should be true for your financial accounting records. Simply make the accounting change "prospectively," that is, going forward.