hey it's patti scharf CPA and co-founder of catching clouds the leader in
e-commerce accounting today I want to talk about whether or not the 2018 tax
law changes effect when you can deduct your inventory I've been asked this
question over and over and over this year and I think there's a lot of
confusion around the topic in fact I've even talked to other CPAs and there are
mixed answers so I'm gonna give you my opinion and kind of walk you through the
my thought process and stuff and hopefully it will will help clear some
of the confusion okay but before we get started I want to say that I have done
taxes for years but I also have not done taxes in years so make sure that for
your own personal situation you go talk to your own tax adviser
okay so let's get started why do you even care about this like what's what's
the whole point of knowing when you deduct your inventory so let's say
you're selling online and use you sold a million dollars this year and this year
you also went and spent four hundred thousand dollars on product so you
bought a whole bunch of product you went online you sold it you might have some
left over chances are if you're selling that much you probably have some left
over so knowing how much you can deduct it means like if you can deduct the
whole thing then your taxable income is six hundred thousand dollars just for an
oversimplification for this example taxable income would be
six hundred thousand dollars if you can't deduct any of it your
taxable income is a million dollars so that four hundred thousand dollars of
income that you get taxed on is a pretty big deal
the other reason you want to know is when you have a good handle on how much
inventory you're able to deduct you can start paying attention to whether you're
making profit on your specific sales because you don't want to be in a
position where you are losing $1.00 per sale because you know you can't make
that up on volume it just like drowns you faster okay so so that's why you
care about when you can deduct your inventory so what is inventory and I
feel like you can't really talk about inventory without talking about cost of
goods sold those two go hand-in-hand inventory are those product purchases I
was just talking about so if you bought 400 thousand dollars worth of product
that becomes inventory it stays inventory until you sell it when you
sell it that's called writing it off it's called
expensing it it's called a deduction it is your expense so the four hundred
thousand dollars becomes cost of goods sold inventory and cost of goods sold
are seasaw amounts you spent four hundred thousand dollars no matter which
way you look at it but maybe you have three hundred thousand dollars still in
inventory and you sold a hundred thousand or maybe you sold three hundred
thousand and you still have a hundred thousand left in inventory these two
amounts always balance out and match the amount
that you spent in cash the next concept you need to know about us cash versus
accrual these are two different accounting methods I did a whole video
on how to determine cash versus accrual so go check that out if you aren't
familiar with it now let's go on to the 2018 tax law changes now the biggest
change and this is what has everybody kind of in an uproar is the gross
receipts test now what this is is it says hey here's what it used to be hey
if you have five million dollars in gross receipts so basically you've
collected five million dollars from your customers or more then you have to be
accrual basis which means you have to record everything on the accrual method
if you're under that if you're a small business you can use the cash method
it's easier you don't need to worry you're pretty look pretty little head
about it okay it was actually the limit was 1 million if you're an inventory
based retail business so there are a lot of people that were like right at that
million mark or just above and they were having to file using accrual based
method and they're kind of grumpy about it ok so what happened with the tax law
changes is that the limit got bumped up to 25 million dollars so that's a pretty
big jump and a lot of people who are right in between that million and 25
million when yeh now I can be cash basis and so everybody's thinking yay I can
now deduct my inventory when I buy it not as products are sold because I'm on
cash basis and so that's how that works the problem is in this in this new law
it says if you have non incidental materials and supplies so things that
aren't really your core product that you're selling maybe it's a sleeve that
you know you include for packaging or you know it's not really what the person
is what your customers buying it's just part of the fluff around it
that stuff yes you can deduct it or it says it follows the taxpayers method for
financial statement purposes so what does this mean
when I first heard this and people were like yeah I get to just deduct whatever
I want to when I buy it just in my gut it just doesn't feel right because the
nature of cost of goods sold is it is literally cost of goods that are sold so
if you don't sell the goods there's no cost related to them so I really in my
heart think that this change of threshold saying above this your accrual
basis and below at your cash basis has nothing to do with the amount that you
record as cost of goods sold basically your cost of goods sold just
has to match up with whatever method you're choosing for your income so if
you're reporting your income in 2018 the costs related to those sales needs to be
included in 2018 if you are reporting income in 2019 the costs related to that
income needs to be reported in 2019 you can't like mix and match that way it's
just not what the nature of cost of goods sold is in my opinion with that
said I asked a whole bunch of accounts because I heard a lot of sellers saying
oh well I talked to my CPA and they said yeah that's legit and I'm like okay well
I'm not signing your tax return so do whatever you feel comfortable with but I
just don't think it's right I've heard that there's going to be more
clarification coming on or maybe people are just hoping that there's gonna be
more clarification about this but I think there's some confusion out there
about when inventory can really be deducted I would argue that this these
new tax laws changed nothing and you just have to report your cost of goods
sold when the goods are reported as income others may have another opinion
if you have another opinion and a good argument why go ahead and leave a
comment down below I think this is an
interesting case and I think it's weird so I think it's worth discussing I like
to discuss weird things so I guess that's it I hope you found this video
helpful if you did please like comment and share if you haven't already please
subscribe and I'll catch you later
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