Tax Tips for Entrepreneurs

Tax Deductions for Cost of Goods Sold

When calculating business taxes, make sure you correctly deduct the cost of goods sold from your gross receipts to figure your gross profit for the year. Simple, right? Maybe not!

As a small business owner, you're entitled to tax deductions related to the cost of doing business.

If the expense is necessary for the regular operation of your company, you can probably deduct it in one way or another on your federal and state income tax returns.

The cost of goods sold is a common expense category for small businesses. Although the government is eager to tax your resale profits, they recognize the amount you spend on acquiring those products as a legitimate and deductible business expense.

However, tax deductions for the cost of goods sold are subject to special tax requirements. You will still be allowed to deduct the amount you spend on wholesale merchandise, but you need to be careful how you calculate the cost of goods sold for the current tax year and how you deduct the expenses related to resale.

Calculating the Cost of Goods Sold

In a retail business, the cost of goods sold is a key factor in determining your company's annual gross profit. By deducting total costs from total sales revenues, you get the amount of gross income you received from the resale of your products. The problem is assigning a value to the cost of goods sold since your product levels are in a constant state of flux. To arrive at an accurate figure, you'll need to conduct inventories at the beginning and the end of each tax year, and maintain accurate records about the merchandise you purchase for resale. Once you have that information, all that remains is to apply a simple formula: Beginning Inventory + Inventory Purchases - Ending Inventory = Cost of Goods Sold.

Other Requirements

You may also be allowed to deduct other expenses in the cost of goods sold category. In addition to the direct costs of products or raw materials, it might be possible to deduct freight, storage, factory overhead and the labor costs directly related to the workers who product the products.

You should know that in some cases, uniform capitalization rules can require you to capitalize the direct and indirect costs (e.g. rent, processing, administrative expenses, etc.) associated with specific production or resale activities.

Also, it's important to keep in mind that any expenses you include in the calculation of the cost of goods sold cannot be deducted again as a normal business expense. Double dipping is a big red flag that triggers audits and other negative tax consequences.

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