Required to report inventory?

[Judys4800]

This question is being asked by soooo many people, and the answer has really not been given.  This is confusing to all of us VERY small business owners who are trying to do the right thing.  We really are.  The person asked, can they take all the units they purchased in 2011 and use that as expense?????  Can they take all the income they received in 2011 and use that as income??????  
It is a very simple question and no one has answered it.  If no, then say no, you can't do that.  It's wrong.  If yes, then say yes, that is ok.  We are trying to follow the rules but we don't understand them and our businesses are so small we can't afford accountants.   One example would help so many people.

[MaryEllen]

There are multiple sets of rules for when to claim income and expenses on your tax return.

Most common - small businesses are cash basis taxpayers and report their business income in the year they receive it and their business expenses in the year they pay it, whether it is paid by cash, check or credit card. They would not deduct their credit card payments in later years, because they have already deducted the expense.

Less common - accrual basis taxpayers who report their income in the year they earn it (bill it) and report their expenses in the year they incur the expense, even if they pay for it in a later year.

There are exceptions to these rules and inventory is one exception. Businesses that have sales of less than $1 million are exempt from accrual basis reporting requirements, but no business can deduct inventory (cost of goods sold) that is not sold by the end of the year. Whether the business is cash basis or accrual basis, cost of goods sold must be adjusted for beginning and ending inventory.

Example - I started a business last year, and purchased 600 $1 items to sell. I sell 300 items for a total income of $900 by the end of the year. I will report $900 income and $300 of cost of goods sold for the year. (For cost of goods sold calculation I report purchases of $600 less ending inventory of $300).

[lchutton]

@MaryEllen-Your answer is opposite of that posted by TurboTaxfredL.  He says if you meet certain rules (business is under $10,000,000 in sales or Personal is under $1,000,000, plus a couple of other restrictions), you can expense the purchased inventory.  That would have the effect of reducing current profit in the the items were purchased and increasing the profit in the year the items are sold.  For you example, it would appear to allow you to use $600 as the COGS.

It doesn't sound like the IRS to allow you to defer profit, but the "Cost of Goods Sold" section of the Schedule C Instructions refer you to Pub. 538 along with other bulletins appear to me to agree with Fred.  However, I would not be surprised if you were both correct because the businesses might be different.

Your comments?

[Judys4800]

I ended up going to HR block and they said all the business they've worked with report inventory and calculate cost of goods sold.  They said if I wanted to change that, I would need to go to a CPA because they would not feel comfortable doing it.  I ended up reporting inventory, like I've done for the previous 2 years.  But if the method of reporting inventory as an expense the year you buy it is an acceptable method, I would want to do that in the future.  Its MUCH easier and in the end it all balances out.  I would have more profit in the following years because I would already have the inventory.  So I would have less expense in making the sale and then I would start paying more taxes.

[elj23]

This inventory issue as presented in 2011 turbo tax is very confusing and misleading. Please address this clearly: What is the definition of Inventory, and if we do not need to report it as a small business (particularly one that converts purchased raw materials into a finished product), would we still need to list a value for ending inventory, and if so, where, and how? This would significantly change the tax due if ending inventory was no longer necessary to claim. Please clarify!

[crystalsdestiny]

Publication 334 straight from the IRS.gov website! Hope this helps! 

Inventories

Generally, if you produce, purchase, or sell merchandise in your business, you must keep an inventory and use the accrual method for purchases and sales of merchandise. However, the following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later).

1. A qualifying taxpayer under Revenue Procedure 2001-10 in Internal Revenue Bulletin 2001-2.

2. A qualifying small business taxpayer under Revenue Procedure 2002-28 in Internal Revenue Bulletin 2002-18.

Qualifying taxpayer.   You are a qualifying taxpayer if:

• Your average annual gross receipts for each prior tax year ending on or after December 17, 1998, is $1 million or less. (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing by 3.)

• Your business is not a tax shelter, as defined under section 448(d)(3) of the Internal Revenue Code.

Qualifying small business taxpayer.   You are a qualifying small business taxpayer if:

• Your average annual gross receipts for each prior tax year ending on or after December 31, 2000, is more than $1 million but not more than $10 million. (Your average annual gross receipts for a tax year is figured by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3.)

• You are not prohibited from using the cash method under section 448 of the Internal Revenue Code.

• Your principal business activity is an eligible business (described in Publication 538 and Revenue Procedure 2002-28).

Business not owned or not in existence for 3 years.   If you did not own your business for all of the 3-tax-year period used in figuring your average annual gross receipts, include the period of any predecessor. If your business has not been in existence for the 3-tax-year period, base your average on the period it has existed including any short tax years, annualizing the short tax year's gross receipts.

Materials and supplies that are not incidental.   If you account for inventoriable items as materials and supplies that are not incidental, you will deduct the cost of the items you would otherwise include in inventory in the year you sell the items, or the year you pay for them, whichever is later. If you are a producer, you can use any reasonable method to estimate the raw material in your work in process and finished goods on hand at the end of the year to determine the raw material used to produce finished goods that were sold during the year.

[kellycwallace]

Here is an article that explains in detail  the reporting of inventory and Cost of Goods Sold (COGs) on your return.  Although you are not required to report inventory if your receipts are 1 million or less as a Qualifying Taxpayer, the costs for what would otherwise be inventoriable items are considered to be NON-incidental materials and supplies to be listed on line 36 (purchases on Sch C).   These non incidental costs however are deducted the year you sell the items, or the year you pay for them, whichever is later. Therefore, you do NOT deduct every raw material or wholesale product you purchased in the year even if you have inventory on hand.  You only deduct the cost of materials associated with the finished product sold.  If you are a producer, you can use any reasonable method to estimate the raw material in your work in process and finished goods on hand at the end of the year to determine the raw material used to produce finished goods that were sold during the year.  

So you may not have to record inventory as a qualifying taxpayer, but you still need to include in COGs only those costs related to the finished goods sold.  Therefore, it may be easier to record inventory to track these expenses anyway. 

https://www.etsy.com/teams/7744/etsy-us-tax-bookkeeping-quickbooks-and/discuss/12057040/

[colcla]

Eventually, I discovered in discussion with a Help service on-line that when I bought the store version the problem disappeared. Unfortunately, I had originally selected to use an on-line version which apparently misused my previous data and I was unable to proceed.

[colcla]

I think TurboTax has a defect!