Deductions & credits

Here's a little something I put together a few years ago. Maybe it will help you understand this stuff?

What you pay for inventory is not deductible until the tax year you actually sell that inventory. The TurboTax program will figure this for you by asking you for the information below. The math used by the program is basically what you paid for the inventory in your possession on Jan 1 of the tax year, plus what you paid for inventory purchased in the tax year, minus what you paid for inventory in your possession on Dec 31 of the tax year.

Take special note that in your first tax year dealing with inventory, the Beginning Of Year (BOY) inventory balance has to be zero. This is because your BOY balance must match exactly your prior year End of Year (EOY) inventory balance. So if this is your first year dealing with inventory and you already had inventory in your possession at the start of the tax year, you will include what you paid for that inventory in the “Cost of Purchases” box in that first year only.

Beginning of Year (BOY) Inventory Balance - This is what 'YOU" paid for the inventory in your physical possession on Jan 1 of the tax year. it does not matter in what year you paid for it either. Note that in your first year of business or first year of dealing with inventory, the BOY Inventory Balance *MUST* be zero, with no exceptions. This is because your BOY Inventory balance must match your prior year's End of Year (EOY) Inventory balance. If this is your first year dealing with this, then the only possible way for these two to match, is if the BOY Inventory balance is ZERO. There are no exceptions.

End of Year (EOY) Inventory Balance - This is what *YOU* paid for the inventory in your physical possession on Dec 31 of the tax year. It does not matter what tax year you paid for it.

Cost of Purchases - What 'YOU" paid for inventory you actually purchased during the tax year. (do not include costs for those things in other categories here)

Purchases withdrawn for personal use - What "YOU" Paid for inventory you pulled from your salable inventory for your personal use.

Labor Costs - What "you" paid for the labor to manufacture the product you sold. Typically this will be zero because if you have employees, you've already reported what you paid those employees as such, on their W-2 forms. If you paid a 3rd party contractor to manufacture the product, then you've already reported what you paid that contractor on a 1099-MISC or 1099-NEC if applicable. (The point is, you can't claim your labor costs twice.)

Materials & Supplies - What "YOU" paid for those items that may or may not become "a material part of" the product you sell. These items may or may not be "consumed" during the manufacturing process. For example, sand paper, jigsaw blades and the such are "consumed" during the manufacturing process and do not become a material part of the product you sell. Whereas nails do become a part of the product you sell. But trying to figure and enter the cost per nail and keeping track of the number of nails used on a product is just a PITA. So if you purchased 6 boxes of nails to build 50 items and only used 5 1/2 boxes, you include here what you paid for the full 6 boxes. Just don't claim that 1/2 box again next year. Typically you'll enter zero here, as it's more common for materials and supply costs to be included in the Business Expenses section outside of the inventory section.

Other Costs to prepare for sales - This would be things like boxes, packing materials, shipping costs, etc. But again, it's more typical for these costs to be claimed in the Business Expenses section outside of the Inventory section.

Example:

Year 1

BOY Inventory Balance - $0

Cost of Purchases - $5000 ($2000 of this is what you already had prior to starting your business)

EOY Inventory - $2500

The above indicates you started the tax year with no inventory, purchased $5000 of inventory during the tax year, and ended the tax year with $2500 of inventory. The program will “do the math” and “know” that you sold $2500 of that inventory. That $2500 will be deductible from your gross business income for that tax year and will not be taxed.

Year 2

BOY Inventory Balance - $2500 (Take note this matches exactly the year 1 EOY balance)

Cost of Purchases - $5000

EOY Inventory Balance - $1500

The above indicates you started the tax year with $2500 of inventory. Then during the tax year you purchased an additional $5000 of inventory and ended the tax year with $1500 of inventory. The program will “do the math” and “know” that you sold $6000 of that inventory during the tax year. That $6000 will be deducted from your gross business income for the tax year and will not be taxed.