Post a new topic
    10 Replies Latest reply on Apr 28, 2008 3:54 PM by nytaxguy

    Accrual vs. cash basis tax ?

    twistedjules Wayfarer
      Hi all, I've just started a home-based jewelry business where I design and make jewelry to sell. I've just started a website also. So I'm doing my taxes on Turbo Tax and come to the business portion where they ask "accrual or cash" pick one. From what I understand, if I have any inventory (no matter how small?) I have to use the accrual method. Since one of my favorite things is buying jewelry components, I'm wondering how this will work for the accrual method. Do I end up being taxed on any unused inventory at the end of the year? I also use the "inventory" to make pieces for myself, my mom, friends, etc., where they are gifts. It seems like it would be better for me to use the "Cash" basis where taxes are figured on a piece by piece basis. Soooo what do I do? Also, are my unsold pieces considered inventory? Boy, oh boy, I think I should have stuck with selling informally vs. starting a business. I don't know that I will make enough to justify it. Any help or advice will be greatly appreciated!

      jules
        • Re: Accrual vs. cash basis tax ?
          Lighthouse24 Ranger
          Welcome to the community. No, having inventory doesn't require you to use the accrual method. You're correct in thinking that cash accounting would be much simpler for you, and I don't see any reason why you couldn't use it. Likewise, using the cost method to value your inventory would be simpler than using the lower-of-cost-or-market method.

          With these methods, your Cost of Goods Sold (which you subtract from your gross receipts to calculate your gross income) is: your Starting Inventory (the cost of the components you already had on hand when the year began) PLUS the cost of the components you bought during the year (including materials, supplies, and outside labor used to create the products you sold) MINUS your Ending Inventory (the cost of all the components you still have left at the end of the year).

          Most so-called "inventory tax" is actually a state and/or local property tax -- so if you are in a jurisdiction that requires you to include your Ending Inventory as business property on which you pay taxes, then yes, you pay state/local property taxes on that amount. I don't think a small business like yours would be eligible for anything like federal warehouse tax exemptions, but that's getting into tax pro territory (I'm just a business owner).

          Hope this helps. Best wishes.
          1 of 1 people found this helpful
            • Re: Accrual vs. cash basis tax ?
              twistedjules Wayfarer
              Thank you for the very informative answer. It's a lot to take in, but I think I understand what you're saying. You must have read my mind with the Cost of Goods, because I didn't understand that one at all in the tax questions. Also, before that, they ask for Income; would this be my gross sales, do you know, or possibly a negative number; my net sales? Since I just got official in Nov-Dec, do I start from there as far as inventory, etc.?

              Thanks!

              jules
                • Re: Accrual vs. cash basis tax ?
                  Lighthouse24 Ranger

                  Gross Income = Total Sales (receipts) MINUS Cost of Goods Sold MINUS Returns.

                  So your gross income should be a positive number (if it isn't, it means you're selling your product for less than the cost of all the components you buy to make it, or that you have a lot defects/returns -- neither of which is good business). You deduct your total business expenses from your gross income to get your net profit or loss. Obviously, that can be a negative number, but to qualify as a business (as opposed to a hobby), you have to show a profit periodically -- you can't show a net loss year after year.

                  You tax return will have a box to indicate that it's the business' first filing, so you can assume on your first "official" day that the business had no inventory. If you (personally) did have inventory (supplies and materials that were used to make the products you sold), then you need to account for how you transferred them to the business (the easiest way is if the business bought them from you at actual cost on the second "official" day).

                  Note that any tools or equipment you owned personally and transferred to the business also have to be accounted for (not as part of Cost of Goods Sold, but as capital expenses or deductible start-up costs). If any of these assets is depreciable, things get more complicated -- back into tax pro territory (at least, for me) . . . A lot of "craft" type small business owners elect not to do this because such tools are not usually subject to property tax when they are personal possessions, but may be assessed as taxable property by state/local jurisdictions if they are part of the business' assets.

                  I hope all that was clear and useful.
              • Re: Accrual vs. cash basis tax ?
                LUCKIEST Guide
                Welcome to this web site. Lighthouse always gives good answers.
                Do you have an Accountant??

                There are two methods of accounting. One is Cash, the other Accrual.
                In the Cash method, Income and Expenses happen when the Cash is received and the Expense is paid.
                The Accrual method. Income is recorded the day the invoice is prepared. It then becomes a Receivable
                until paid. Expenses are recorded in the month they happen and become a payable until paid.
                You can choose between Cash and Accrual the in first year of operations. Choose wisely.
                LUCKIEST
                1 of 1 people found this helpful
                  • Re: Accrual vs. cash basis tax ?
                    twistedjules Wayfarer
                    Hi, and thank you for your response. I do not have an accountant yet. I just started my business in Nov-Dec of '07 so I'm trying to do this on my own and then maybe next year I could justify the expense.

                    I'm mainly just trying to figure which is the best way to go for me; accrual vs. cash and I know I need to choose wisely. I have read that if you have inventory, you must do it the accrual way but my inventory amts. to less than 200.00.

                    jules
                  • Re: Accrual vs. cash basis tax ?
                    nMoncrief Adventurer
                    I agree with Lighthouse 24 that the cash basis would be best for you. In my last business, I had large accounts payable, accounts receivable, and depreciable assets (2 company vehicles.) Our CPA told us that had to use the accrual method, and we ended up paying him > $1,000/year to do our taxes. Now, I have another LLC business, but this time I researched it myself first. The informatin I found confirmed that accrual accounting is primarily for businesses with large inventories (payables), in-house accounts (receivables), and depreciable assets. Since I have none of that now, I'm using the cash basis and it's working fine for me. I'm finally able to do my own taxes again. I'm not a CPA, so please ask an expert before taking any advice from this forum.

                    If/When you're ready to start accepting credit cards for your online business, I would love to give you a quote. My rates and fees are very low, and my service is the best anywhere. You can see my contact info by clicking on my profile to the left. Good luck in your business!

                    Neil Moncrief
                    www.CreekFinancial.com
                    1 of 1 people found this helpful
                      • Re: Accrual vs. cash basis tax ?
                        twistedjules Wayfarer
                        Thank you, Neil. I do accept credit cards through propay. I signed up in November, but if your rates are better, I would consider that in the future. Also, thanks for the info on the accrual vs. cash. I wondered about the inventory thing. I will check with an accountant.

                        jules
                          • Re: Accrual vs. cash basis tax ?
                            nytaxguy Wayfarer
                            I am a CPA in NY. The easiest method for you would be to elect cash basis and then not to elect to account for inventory. Just expense all of your "inventory" items as paid for call them supllies or whatever else is appropriate. You are allowed to not account for inventory if you are a small business with gross receipts under $1 million.