As a small business I am aware that I can use the cash method of accounting and claim my inventory (fabric, threads, beads, etc) as non incidental materials and supplies and not have to place a beginning and ending inventory on my schedule c. But what dies this mean? I have read every publication the IRS posted and they all seem to blend into this huge blob in my brain and never quite answer my question as to how I claim my inventorable supplies as non incidental materials and supplies.
I have always kept very good records of my business. I have spreadsheets of all my fabrics which include giving each fabric an item number, date of purchases, purchase amounts in square inches, and price per square inch. Receipts are also scanned and kept in a computer file by order of date to refer to. Each fabric also has another file to refer to which has a picture of the design of the fabric, all purchase dates , amounts purchased, and fabric numbers. All my patterns are measured so I know exactly how many square inches I use in each of my items. All waste fabric is measured and posted to my spreadsheet before it is thrown out. At the end of the year I list all of my sales on a spreadsheet and figure out how many square inches of each of the fabric sold in items and list those amounts on my fabric spreadsheets to deduct from the amounts of every fabric. Then with those amounts I calculate the cost used of every fabric sold in items to customers. Then I refer to my hardware and thread spreadsheet and add that total to the COGS total, and refer to my bead spreadsheet and again add that total. All COGS numbers are only of supplies used in my sold items.
Even though I did not need to post inventory with the cash method, I wanted to cover myself if any questions were ever asked. I have spreadsheets of my mileage, supplies, expenses, everything for my business.
This weekend I began filling out my schedule c and I had the same questions about the correct line on the schedule c to place the amount deducted for my non incidental materials and supplies ( fabrics, etc used in sold items). I always placed this number on line 38 without beginning and ending inventory. So I bit the bullet today and called the IRS to double check. Here is what the extremely nice woman told me......
1- if a small business makes less than 1,000,000 dollars a year in gross receipts they are automatically exempt from posting inventory on schedule c and are allowed to use cash method of accounting claiming inventory sold as non incidental materials and supplies. BUT......you must only claim what you have sold. You cannot just take all your receipts from supply purchases used in your finished goods and deduct them. This is a huge no no. So basically what I have done keeping track of my inventory was correct.
2- The nice woman told me that the IRS has never updated their schedule c forms to add the line to place the total of your non incidental materials and supplies used in your item sales. So she said that you are allowed to place this total either in line 38 on schedule c without a beginning and ending inventory amount and carry this number to your COGS total line. OR, you can add this total in with your supplies in the expense section. The only thing to remember with all of this is to only deduct the amount that was sold to customers. She said if you are ever audited they will want to know how you came up with the deduction and will be looking to see if you just deducted all fabric, etc supplies regardless if you sold them or not.
3- I also had read IRS publications that stated that if your business code ( NCAIS ) is certain numbers you cannot use cash accounting. The woman told me this is not true and it did not matter what business code your business was. Making less than 1,000,000 dollars is the only factor in allowing a small business to use cash method of accounting with no beginning and ending inventory and posting supplies sold as non incidental materials and supplies.
I am happy to say that I have been filling my taxes out exactly correct. It takes alot of time to do all the calculations but there is no way out of it. I love math so I don't mind. But I truely feel sorry for anyone who is just deducting all supplies whether they are used in sold goods or not.