What Online Sellers Need to Know about Inventory and Taxes

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At Outright, we get that the crafting part of your business is the fun part. We also get that things like taxes and bookkeeping are not quite as fun. We strive to make that part of your business a little less taxing, so here’s everything you need to know about tracking your inventory for tax-purposes, in a nutshell:

Value Inventory

The first thing you need to be aware of when tracking inventory for tax purposes is that you do need to have a value for your inventory at the beginning and end of the year. Sounds obvious, but getting the value at these two points may be a bit involved. If this is your first year as a crafter, the beginning balance in your inventory is $0.

So, what should be included in your inventory calculation? You want to be sure to include the following:

1. Items that you have finished making
2. Items that you are in the process of making
3. The materials you have purchased to make what you sell (also called raw materials).
4. The supplies you purchase that are incidental to what you making (glue, rivets, etc.) but become a part of the product you are making.

However, there are a few things you do not include:

1. Items that a customer has agreed to buy, but you have not delivered it to the customer and they have not made payment.
2. Items that someone has consigned to you.
3. Items that you have ordered, but you have not made payment and they have not been delivered to you.

Now the question becomes how do to assign a value to what you have in your inventory.

There are three methods to do this:

1. The cost method – the cost to purchase the materials that will go into what is being made, including shipping and discounts.
2. The retail method – the retail selling price. This is a little more complicated, and involves markup percentages and the like.
3. The lower of cost or market method – you would compare the cost you paid versus the market value of each individual item, and select the lower value. This one is like the retail method in that is usually more suited for someone with an accounting degree!

Prepare Tax Forms

Once you have figured out the items to include in inventory and their values, you are ready to prepare your tax forms for the year. Here are the steps you take:

1. Determine your inventory at the beginning of the year.
2. Add the costs of all the items purchased to make a product or products to be sold, less the value of any items withdrawn for personal use.
3. Add any labor costs you paid to have others make the products.
4. Add in the costs for materials and supplies, which can be things like glue and hardware.
5. Add in other costs incurred, such as containers and costs to have items shipped in, if not included in the cost of the products ordered.
6. You now have total costs of goods available for sale.
7. From this cost of goods available for sale, subtract the value of your ending inventory. This will give you your cost of goods sold. This cost of goods sold will be subtracted from your sales to help you arrive at your taxable income.

While determining inventory costs and how to classify the costs can be complicated, the best thing to do is get started now in determining your costs so you can get a jump on the year end, and take the calculations and steps one at a time. If you still have questions, find a local accountant to give you a hand. We love to help small business owners meet the goals they set for their business.

Chris Peden, CPA, CMA, CFM has over 15 years in the corporate world helping companies meet their regulatory compliance requirements. He also assists small business owners with organizing and making sense of their finance information. You can reach him at chrispedencpa@yahoo.com. In accordance with Circular 230 Treasury Department Regulations, we are required to advise you that any tax advice contained in this article may not be relied upon to avoid penalties under the Internal Revenue Code. If you are interested in a written opinion that can be relied upon to prevent the imposition of tax-related penalties, please contact the author.

Stitch Team

This post was written by a Stitch team member. Stitch helps retailers simplify inventory management and multichannel selling. Check out more about Stitch in the links below!
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