Jeremy M. Hellman on tue 9 feb 99
Brad,
The simple answers to your questions are that, in general all costs
directly associated with the purchase of manufacturing materials (for
ceramic people this would be clay or clay ingredients, and glaze or glaze
ingredients) are part of your purchase price, and are included in cost of
goods sold (if you keep inventory). If I buy something and there is
shipping or postage on my invoice, in theory I should allocate this
shipping to each pound or kilo of material.
My supplier's catalog may say that my prepared clay costs $.35 per pound,
but if I pay $100 to ship 1,000 pounds of clay, then my real cost of clay
is $.45 per pound (the $.35 plus the $.10 per pound). However if I drive
my truck 15 miles across town to pick up my 1,000 lbs of clay and then
15 miles back, will I add the $9.75 to the cost of my clay (in 1998 the
IRS mileage allowance is $.325/mile), or $.00975 per pound of clay (less
than a penny a pound)? Probably not because that amount is so small.
Especially if I also buy other things on that trip that do not get
capitalized, I'd be even less likely to include that mileage as part of
my cost of clay.
To answer your other question, in theory a non-reimbursed shipping
expense certainly sounds like a cost of sale. In practice, you would have
to consider how you are going to track these expenses. Are you going to
include ALL the shipping you pay in cost of goods sold, including
reimbursed shipping? Do you include shipping on all sales even if it is
reimbursed as revenue? If an expense is reimbursed, you can either
classify one against the other, which should net out to zero, or you can
show both the expense and the income on separate lines.
However, your questions raise other questions about who is required to
maintain inventory (follow UNICAP rules in tax jargon), which costs go
into inventory, the method of accounting used with inventory (accrual)
and how the IRS uses the cost of goods sold.
You have to first understand that the ratio of Cost of Goods Sold to
total sales, is one of the things that the IRS scrutinizes. The IRS uses
this as one of several tests to decide whether or not to audit, and
whether or not this is a business or a hobby. (Remember that a hobby can
deduct expenses equal to income but cannot deduct a net loss.)
Also remember that the purchases included in ending inventory (which is
subtracted from your cost of goods sold) are NOT deducted in that tax
year. So if you are looking to minimize taxable income, you will not want
to unnecessarily include expenses in inventory.
One other thing to notice is that artists in general are not required to
maintain inventory. The issue is whether any given clay person will
qualify as an artist. This is an issue which I am currently researching
by discussing with preparers and artists who have been audited. I don't
have a definitive answer at this time. What little data I have indicates
that the clay person who wants to qualify as an artist, needs to provide
"proof" that he or she is creating art, rather than making functional
cups and plates. I've known of one situation where the taxpayer provided
photographs of her work, artfully arranged, showing that she was creating
a unified, unique, creative "look". The auditor looked at the
photographs and agreed that the taxpayer was an artist. I'd certainly be
interested to hear from anyone who went through an IRS audit as a ceramic
artist.
One of my books says, "Expenses paid or incurred by a self-employed
individual (including expenses of a corporation owned by a free-lancer
and directly related to the activities of a qualified employee-owner) in
the business of being a writer, photogrpaher, or artist whose personal
efforts create or may reasonably be expect to create the product are
exempt from uniform capitalization (code Sec 263.A(h)). Generally expense
for producing jewelry, silverware, pottery, furniture and similar
household items are not exempt."
To me, the above paragraph means that it is the clay person-taxpayer's
burden to prove that he or she IS an artist. I have not been able to find
a further legal definition of what is art. (Maybe we should all be
relieved that the IRS has not defined art!)
In the United States, once you determine that the uniform capitalization
rules (UNICAP) apply to your business and you are required to maintain
inventory, you are required to include all direct costs in your cost of
goods sold. Direct costs include material costs that become an integral
part of your pots, material costs that are used in the ordinary course of
producing those pots, and the cost of labor (including payroll taxes)
that can be identified or associated with the production of your pots. If
you are self-employed and file a Schedule C, and have no employees, then
you have no payroll, and direct costs tend to be relatively self-evident.
Larger businesses (defined as those incurring more than $200,000 of total
indirect costs in a taxale year) MUST include indirect costs in cost of
goods sold. Indirect costs under UNICAP, include an allocable portion of
such costs as: repair & maintenance of equipment or facilities, utilities
relating to requipment or facilities, tools & equipment that are not
otherwise capitalized, depreciaton on equipment or facilities, insurance
on the plant, machinery & equipment, indirect materials and supplies, and
so on. Smaller businesses (less than $200,000 of total indirect costs in
a taxable year) are exempt from the need to capitalize these indirect
costs.
Since all costs in ending inventory are not deductible in that tax year
(and the schedule of cost of goods sold does this computation), most
businesses would prefer to keep their ending inventory as low as legally
possible. Because record keeping can become onerous (and does not
directly contribute to cash in your pocket) most small businesses would
prefer to keep their cost of goods sold as simple to compute as legally
possible.
To further confuse this issue of cost of goods sold and inventory, I'd
again remind everyone (who hasn't fallen asleep) that any business that
is required to maintain inventory, is also required to use the accrual
method of accounting. This means that you must add all accounts
receivable to income, even though payment was not received at year end,
and you can deduct all accounts payable, even though they were not
actually paid at year end. Note that even for cash basis taxpayers,
credit card purchases are considered to have been made on the date that
those transactions take place, as long as the merchandise has been
received. So if I go out and buy widgets for my business (assuming that
widgets are an ordinary and necessary business
expense, and are not part of my inventory costs) on December 31st and
have them in my possession on Dec 31st and I pay for them using a credit
card, I'm allowed to deduct the cost of the widgets. It doesn't matter
when I actually pay my credit card bill.
One further note is that for 1998, the IRS has completely changed those
business codes required on business tax returns. Those 4 digit numbers
are now 6 digit numbers. I understand from informal sources that the IRS
will use these to compare ratios of expenses in similar businesses.
Having said all of the above, for those of you still reading this, the
following is my disclaimer. I am not intending this to be tax advice
which I would not give without a thorough understand of someone's
complete tax situation. This is just a general discussion of some of the
issues.
Bonnie
Bonnie D. Hellman, CPA in PA and CO
Pittsburgh, PA
work email: bdh@firstcaptl.com or oliviatcavy@juno.com
home email: mou10man@sgi.net
>----------------------------Original message----------------------------
>Where on the 1040 does one keep track of nonreimbursed shipping
>expenses, like UPS, (which I occasionally do for customers), and costs
>of freight for clay shipments. My instincts tell me they are part of the
>"cost of goods sold" section, probably "other costs." Would this be
>where they both would go? Thanks!
>
>--
>Brad Sondahl
>http://www.camasnet.com/~asondahl/bradindex.html
>Sondahl homepage http://www.camasnet.com/~asondahl
>Original literature, music, pottery, and art
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