Hello and thank you for your question.
The tax concept that matters here is the cash method of accounting
versus the accrual method.
On the cash method, you've spent 9,050 and you've taken in 9,100 so
your taxable profit is 50.
On the accrual method, you have cash receipts of 9,100 and even
ignoring any other accounts receivable (money owed to you for goods
already delivered) that would also have to be counted as receipts on
the accrual method, your receipts are at least the 9,100. And your
accrued expenses are 9,050 minus the 4,000 that you're still holding
for sale to future customers, leaving only about 5,050 of accrued
expenses and taxable profit of 9,100 - 5,050 = 4,050 of taxable
profit.
So your question is whether you are permitted to use the cash method,
or will the IRS require you to use the accrual method.
Good news!
SMALL BUSINESS EXEMPT FROM ACCRUAL!
BUSINESS WITH RECEIPTS LESS THAN $1 MILLION CAN USE CASH METHOD
http://www.hoven.com/praccrual.htm
Significant Court Cases, Revenue Rulings, Internal Revenue Codes, and
Treasury Regulations
http://www.irs.gov/businesses/small/industries/article/0,,id=99470,00.html
Revenue Procedure 2001-10, 2001-2 I.R.B.
This procedure provides that the Commissioner of Internal Revenue will
exercise his discretion to except a qualifying taxpayer with average
annual gross receipts of $1 million or less from the requirements to
account for inventories. This revenue procedure also provides the
procedures by which a qualifying taxpayer may obtain automatic consent
to change to the cash receipts and disbursements method of accounting
(the cash method) and to a method of accounting for inventory as
materials and supplies that are not incidental.
Revenue Procedure 2000-22, 2000-20 I.R.B.
This revenue procedure provides that the Commissioner of Internal
Revenue will exercise his discretion to except a qualifying taxpayer
with average annual gross receipts of $1 million or less from the
requirements to account for inventories and to use an accrual method
of accounting for purchases and sales of merchandise. This revenue
procedure also provides the procedures by which a qualifying taxpayer
may obtain automatic consent to change to the cash receipts and
disbursements method of accounting (the cash method).
As far as reporting that $50 of income to the IRS (or zero or a loss
if you pay out or spend that $50 or more in the business), you will
have to attach Schedule C to your income tax return.
http://www.irs.gov/pub/irs-fill/f1040sc.pdf
Incorporating and making an S election, or forming an LLC, will
protect your personal assets from lawsuits, but you already have the
tax result you were looking for, unless and until your annual receipts
exceed $1 million.
Search terms used:
2000-22 cash method inventory
"Schedule C"
Sincerely,
Richard-ga |
Request for Answer Clarification by
miketx-ga
on
17 Dec 2003 19:24 PST
Thanks, Richard. Quick clarification: Is my following logic correct?:
--- year 2003 ---
I buy a CD player wholesale for $50. I sell for $100 net.
I buy two CD players for the $100. I sell for $200 net.
I buy four CD players for the $200. I sell for $400 net.
I buy eight CD players for $400.
No taxes paid ($50 loss, too?), under cash method of accounting.
--- year 2004 ---
I sell eight CD players for $800 net.
I buy sixteen CD players for $800. I sell for $1600 net.
I buy thirty-two CD players for $1600. I sell for $3200 net.
I buy sixty-four CD players.
No taxes paid ($0 loss, $0 profit?), under cash method of accounting.
--- year 2005 ---
I sell the sixty-four CD players for $6400.
I pay taxes on $6400 (?).
Is this strategy legal? And are my figures (especially the end taxes) correct?
I'll provide a tip if you can answer this, as I know it's more work.
Thanks,
Mike
|
Clarification of Answer by
richard-ga
on
17 Dec 2003 21:15 PST
Hello again:
Unfortunately, the pyramid approach that you describe will not work.
Google Cache of IRS Topic 408 - Sole Proprietorship
http://216.239.41.104/search?q=cache:QHOdMkIvt60J:www.irs.gov/taxtopics/page/0,,id%253D16200,00.html+%22topic+408+-+sole+proprietorship%22&hl=en&ie=UTF-8
"Be aware that Revenue Procedure 2001?10 specifically states when you
can deduct the costs for the inventoriable items that are being
treated as materials and supplies that are not incidental within the
meaning of Treasury Regulation #1.162?3. In the case of a cash method
taxpayer, the cost for these items cannot be deducted until the year
in which (1) you sell the items or (2) you pay for them, whichever is
later.
Rev. Proc. 2001?10 provides detailed procedures for determining
whether you satisfy the average annual gross receipts test. Review
section 5 of Revenue Procedure 2001?10 for these procedures."
So in your example, in year 1, there is no immediate deduction for the
eight CD players bought at the end of the year. The year 1 taxable
income is $350.
Then in year 2 the 8 CD players carried over from the prior year are
now deducted, but again there's only a deferral of deduction for the
players unsold at the end of the year.
Sorry if this comes as bad news. You'll want to read section 5 of
Revenue Procedure 2000-22 (or just show it to your accountant).
-R
|
Request for Answer Clarification by
miketx-ga
on
17 Dec 2003 22:51 PST
Thanks, Richard. I've just researched it as well to try to gain more
understanding. In other words, anything I buy this year but I don't
sell until next year isn't deducted until that year, thus making it as
if I had bought the product next year? Back to my fictional example:
--- year 2003 ---
I buy a CD player wholesale for $50. I sell for $100 net.
I buy two CD players for the $100. I sell for $200 net.
I buy four CD players for the $200. I sell for $400 net.
I buy eight CD players for $400.
I started with $50, at $400 in inventory. Pay taxes on $350.
--- year 2004 ---
I sell eight CD players for $800 net.
I buy sixteen CD players for $800. I sell for $1600 net.
I buy thirty-two CD players for $1600. I sell for $3200 net.
I buy sixty-four CD players for $3200.
$3200 worth of inventory. Deduct $350 from previous year. Pay taxes on $2850.
--- year 2005 ---
I sell the sixty-four CD players for $6400 net.
$6400 in cash. Deduct $2850 from previous year. Pay taxes on $3550.
Is that right, or do I have this all wrong? I guess I'm just trying to
figure out what my tax hit will be this year. In my situation, with
$50 cash profit and ~$4000 in inventory, I'll be paying taxes on
$4050? And that's self-employment tax, which means like 15.3% alone
between Social Security and Medicare, right? Plus federal income tax
rate?
Any advice would be appreciated. I know I'll probably need to get a
tax accountant, but I'm just trying to figure out roughly how much
I'll lose...
-Mike
...18-years old, and already needing a tax accountant! arg...
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