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Are you making business taxes more complicated than they need to be?

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This content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Nobody genuinely enjoys doing taxes, whether it’s as an individual or on behalf of a business. But small business owners, especially, dread tax season. There are some good reasons for this — for starters, it’s not a fun process — but for the most part, small business owners make business taxes much more complicated than they have to be.

Are you making some of these common mistakes with business taxes?

The basics of business taxes

This guide isn’t meant to educate you on business taxes from start to finish, but for the purposes of our discussion, it’s important to give you some tax tips.

Businesses are responsible for paying and withholding taxes. Sometimes, you’ll be responsible for paying taxes on the money you make. You’ll also be responsible for withholding and paying taxes on behalf of your employees.

There are five general types of business taxes you should be aware of:

Income tax

Nearly all businesses must file an annual income tax return (partnerships must file an information return). There are different standards and procedures for this, depending on how your business is structured.

Estimated taxes

Your business may be responsible for paying taxes throughout the year in the form of “estimated tax” payments. Each quarter, you’ll make a contribution to the year-end taxes you project you’ll owe, including the income tax and the self-employment tax (if applicable).

Self-employment taxes

Self-employment taxes apply to self-employed people (i.e., entrepreneurs) to cover Medicare and Social Security. There are some special rules and exceptions here, but most self-employed people will owe this tax.

Employment taxes

Employers have specific employment-related tax obligations. For example, you’ll be responsible for withholding income taxes and withholding and contributing payments for Social Security and Medicare taxes.

Excise taxes

Some businesses will have to pay special taxes on products they sell or manufacture — alcohol and gasoline are two examples.

At the end of the year, you’ll file a tax return for your business and provide documentation to the government to make sure you’ve paid taxes properly and provide any additional payments that are owed.

Note that in addition to filing taxes on a federal level, you’ll also have to pay taxes on state and local levels — and if you do business in multiple areas, you may have to file multiple tax returns.

Related: When are business taxes due and how can you prepare now?

The 3 most difficult elements of tax season

What makes tax season difficult for business owners? These are the top three challenges they face:

1. Record keeping and reporting

calculator and folders

Most business owners start to face challenges because of poor recordkeeping and reporting. The meatiest part of “doing your taxes” is simply filling out forms. You’ll note the expenses you’ve paid, the money you’ve made, and dozens of other details and calculations. But if you’ve kept sloppy records throughout the year or if you don’t know the answers to these questions, you’re going to have a hard time filling out the forms accurately.

2. Meeting deadlines

Tax deadlines can feel tight, especially if you’re also juggling all your business operations while navigating the world of business taxes. If you’re caught off guard, or if you have trouble getting the paperwork together, you might have to scramble to meet a deadline — or face the consequences of missing one.

3. Using the correct forms

The IRS has hundreds of forms, they’re not labeled intuitively, and the instructions are often written in a clunky and disorganized fashion. It’s a pain to figure out which forms you need and how to use them.

9 mistakes small business owners make when filing business taxes

Many small business owners make some combination of the following mistakes when filing business taxes:

1. Missing deadlines

The most common mistake is the simplest to understand and the easiest to avoid: missing deadlines. Some combination of procrastination, inattention, disorganization and/or apathy ultimately leads to business owners missing important deadlines.

2. Keeping inaccurate or inconsistent payroll records

If you keep sloppy records, or if you don’t know where to find certain information, you’re going to have a hard time filling out and submitting the requisite forms.

3. Selecting the wrong business entity

Is your business a sole proprietorship? Or is it an LLC? You should know the answer to this question and know the differences between these business entities.

Every year, there are at least some business owners who file a return based on the wrong structure.

Taxes do tend to be more complicated for corporations and LLCs than they are for sole proprietorships and partnerships, but don’t let that intimidate you.

4. Confusing business and personal expenses

People sitting at restaurant

You have a client who’s also a good friend. You take him out to dinner for chit chat and laughs, and you happen to talk about business for a few minutes during this interaction. Does that technically count as a business expense since he’s a client of yours?

This is ambiguous territory. But the majority of your expenses will be very clearly business related or not business related. Delineate these categories and you’ll have a much easier time accurately reporting your expenses.

5. Deducting startup expenses incorrectly

Your business’s startup costs are (mostly) deductible, but the rules are somewhat difficult to understand.

According to Intuit QuickBooks, “The IRS allows you to deduct $5,000 in business startup costs and $5,000 in organizational costs, but only if your total startup costs are $50,000 or less. If your startup costs in either area exceed $50,000, the amount of your allowable deduction will be reduced by the overage. And if your startup costs are more than $55,000, the deduction is eliminated.”

Additionally, you can deduct startup expenses over several years. It’s easy to get things wrong here.

6. Categorizing staff members incorrectly

Modern businesses often work with a mix of full-time employees, part-time employees and independent contractors, all of whom have different tax implications. Categorizing your staff members incorrectly or accounting for them inappropriately could result in complexity (and possibly penalties) later on.

7. Glossing over small expenses

There are tons of little expenses accrued by your business, from petty cash expenditures to magazine subscriptions. If you don’t account for these when tallying up your expenses and deductions, you could end up paying more in business taxes than required.

8. Ignoring deduction limits

Not all deductions are treated equally. For example, talk to your tax professional about .

If you try to deduct too much, you’ll run into major issues.

9. Neglecting some tax expenses

Businesses have many different types of taxes to consider, such as property taxes, payroll taxes, local taxes, excise taxes and self-employment taxes.

Yes, it’s a lot to keep track of, but each tax is important.

5 ways you’re overcomplicating things

As we’ve seen, there are some elements of business taxes that are truly complex. But many business owners end up exaggerating these complexities and overestimating how difficult doing business taxes truly is.

Why are you making business taxes overly complicated?

Chances are, you’re getting tripped up by one or more of the following tendencies:

1. You assume this is unfamiliar territory

Are you one of those people who “just isn’t good with numbers”? Do you believe yourself to be bad with money? If so, you may instantly underestimate your ability to handle taxes.

You don’t have to be a math genius or a personal finance guru to handle business taxes, so don’t sell yourself short.

2. You’re learning from the wrong sources

The IRS isn’t known for its approachability or clarity. In fact, many online sources are notoriously bad at communicating how taxes work. If you read an article that doesn’t make sense, don’t blame yourself and don’t blame the complexity of taxes. Just move on to an article that phrases things in different, easier-to-understand terms (or hire an expert).

3. You’re lost in the “big picture”

Businesses have many tax obligations and a cluster of responsibilities come tax season. If you try to contemplate and plan for all of them at once, you’re going to feel overwhelmed. Instead, try to focus on one step at a time and one form at a time. No individual step in the business tax world is unconquerable.

4. You’ve heard horror stories

We’ve all heard about businesses that have made mistakes and faced massive penalties but these are often exaggerated.

If you plan ahead, you shouldn’t miss any deadlines, and if you miss a filing or payment deadline, the penalties are pretty reasonable.

As long as you’re not committing tax fraud, there’s no reason to add extra anxiety to an already-stressful responsibility.

5. You have too many other responsibilities

Many business owners who worry excessively about business taxes are simply distracted by other responsibilities. Running a business and taking care of a family is a lot of work, so, of course, the temporary addition of business tax planning seems like an obtrusive and unnecessarily complicated burden.

4 ways small business owners can make tax season easier

How do you make business taxes easier?

There are some important strategies you can use to make tax season much less complicated for your business:

1. Start early

2022 calendar

The best thing you can do is start early. The deadline problem disappears if you start working on your taxes a few weeks, or ideally, a few months ahead of when you would normally start.

You’ll have much more time to gather records, check your numbers, find the right forms and assemble everything for delivery.

You’ll also be less stressed — and you won’t be as weighed down by other priorities and responsibilities.

2. Hire the right people

The right team can make a huge difference in how you prepare your taxes.

Hiring a professional accountant, or for larger businesses, an entire team of bookkeepers and accountants, can spare you the headache of trying to solve all your financial challenges on your own.

If you’re committed to doing the work yourself or if you can’t afford an accountant, make sure the people you work with — including contractors, vendors and clients — are open and transparent with their recordkeeping.

3. Keep consistent, accurate records

Accurate and consistent recordkeeping will make business taxes a breeze. The trouble is, you have to stay organized throughout the year.

Certain types of software, like Microsoft 365, can make it much easier to store your records in one place (and keep them properly organized so you can always find what you’re looking for). Just make sure you track all your financial information consistently, and back up your records in the cloud for security reasons.

4. Stick to a schedule

When tax season starts getting nearer, set a schedule for yourself. For example, if you know the deadline to send out W-2s is January 31, make it a point to send them by the 24th at the latest. Use mini-deadlines leading up to the 24th to keep yourself on track for that long-term goal. This will also force you to break each responsibility down into smaller, more easily digestible steps.

Business taxes don’t have to be taxing

There are some challenging elements of business taxes, but in reality, business taxes are simpler and more accessible than we make them out to be.

If you take your time, start early, hire the right people and prioritize keeping accurate, organized records, you’ll find yourself completing your tax obligations in record time — with minimal stress.



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Law & Legal

Essential Legal Documents You Need for Your Small Business

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Entrepreneurs from Mississauga to Montreal put all of their effort and attention into growing a business, making it important to protect what has been built. If you don’t have the right standard legal documents for your business, you could be leaving yourself open for litigation that could cost you everything.

As a business owner, you are an expert in your field but that doesn’t mean that you know how to protect yourself and your business from a legal standpoint. It’s crucial that you have the minimum of legal documents prepared for your company to make sure that you are protected from lawsuits.

photo credit: Pixabay

You can work with business lawyers in Mississauga, On, or print off some legal templates that are available online to protect your interests at a minimum. Let’s take a closer look at a few of the essential legal documents that you need for your small business.

Owner’s Agreement

To help solidify trust and cooperation in your business, it’s important to have an owner’s agreement in place. With the right amendments in place, you minimize disagreements and can work towards common goals. Your ownership agreement should clearly outline the roles and responsibilities of each of the partners including decision-making power. Your agreement should include a specified breakdown of your equity ownership agreement, and assignment of your intellectual property to the business and not the partners.

Independent Contractor Agreement

When operating your small business, it can be cost-effective to bring in independent contractors to do certain work. Your independent contractor agreement should be in place to specifically designate that your workers are responsible for paying their own taxes and they are not part of your payroll or in your direct employment.

Vendor Agreement

One of the most important aspects of a successful business is ensuring that you can supply your products quickly to customers. A vendor agreement for your suppliers will provide the terms and conditions under which they will deliver the goods that you need on time.

Employee agreement

Non-Disclosure Agreement

Before you allow any vendors, contractors, or employees into the heart of your business operations, you need to have them sign a non-disclosure agreement. This ensures that outsiders will not be able to disclose any confidential information about your business. Your agreement should clearly outline what is considered to be confidential information, specific information formats, how confidential information should be handled, and a statute of limitations.

Company Bylaws

ovinces and states require that companies create a set of governing bylaws. Within your bylaws, you should clearly outline how your business will be structured, dispute resolution, hiring practices, and powers of shareholders.

Meeting Minutes

While it may not be legally mandated in your area to keep a copy of any executive meeting minutes, it’s still a good idea to keep this type of documentation. Meeting minutes that record everything that is said in major meetings is an excellent company resource for information to resolve potential disputes.

If you are starting a new business, it’s recommended that you have these essential legal documents ready to ensure that you and your venture are protected.

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Should you trademark your domain name?

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This content should not be construed as legal advice. Always consult an attorney or legal professional regarding your specific legal situation.

In a recent post, I shared all I’ve learned about purchasing multiple domain name variations. Copyright and trademarks have been on my mind a lot lately. This got me thinking about whether a brand or business should trademark a domain name.

Now, because I’m not a lawyer and don’t pretend to be one, I went in search of people much smarter than me who could answer my simple question. Should you trademark your domain name?

Below, I’m sharing what they told me to help you decide when to consider seeing a trademark attorney for yourself.

Marc P. Misthal, Principal, GRR

Trademark Domain Name Marc P. Misthal
Image courtesy of Marc P. Misthal

Marc P. Misthal is a trademark attorney with Gottlieb, Rackman & Reisman, P.C. in Manhattan, New York. He told me that in short, yes, business owners should trademark their website domain names. The longer answer is a little more complicated. Here’s what he had to say:

“In the U.S., trademark rights are acquired by using a mark, not by registering it. So applying a mark on a hangtag, label, packaging, sign, etc. would create rights in the mark—registration is not necessary.

“The question here seems to be whether a business owner should register their domain name as a trademark. If they are using it as a trademark then yes, they should. What does that mean? Simply using a domain name as part of a URL is not going to be enough to secure a trademark registration. The Trademark Office requires proof that a mark is in use before it will issue a registration, and it will not accept a screenshot showing a URL with the domain as proof of use. If the domain name is being used as the brand, then there will likely be additional use, such as prominent use on a website selling products or services, that the Trademark Office will accept. 

“Having a trademark registration is very valuable. A registration makes notice letters more impactful, and is helpful in taking action against infringing uses that appear on online platforms; many platforms will not take action to stop an infringement without proof of a trademark registration.”

David Reischer, Esq., LegalAdvice.com

David Reischer is an attorney and CEO of LegalAdvice.com. He says that trademarks are imperative for businesses that want to protect their brand names. But you need to go beyond trying to trademark just the domain name. Here’s what he had to say:

“Domain trademarking a mark that consists of a domain name may be possible. It would be registered as a trademark or service mark in the U.S. Patent and Trademark Office (U.S.P.T.O). However, just like any other mark that comes before the U.S.P.T.O, the domain name may only be approved on the Principle Register if it functions to identify the particular source of goods or services offered. That is to say, the mark must be distinctive so as to be capable of distinguishing the applicant’s goods or services from others.

“The main benefit of acquiring trademark protection is for the legal benefit of stopping other third parties from infringing on the brand’s trademark. A business needs to trademark all corporate and product brands that are inherently distinctive to the identity of the business. Typically a business will trademark a corporate logo, product line identifiers, slogans, and any other attributes that are source identifiers of the business—including a domain name.”

Laura Winston, Principal, Offit Kurman

Trademark Domain Name Laura Winston
Image courtesy of Laura Winston

Laura Winston is a trademark attorney with more than 25 years of experience and a principal in the AmLaw 200 law firm Offit Kurman. Here’s what she had to say:

“Securing trademark rights and registering a trademark used on one’s website has always been important and highly recommended. As we move into the realm of the metaverse, NFTs, and other new digital assets, it will be even more important to secure brands that are used digitally. There are tips and tricks for claiming trademark rights and obtaining a trademark registration for a domain name. Most significantly, it needs to be used as a trademark on the website, not just as the URL that directs to the website.”

James Yang, OC Patent Lawyer

James Yang is a patent attorney and a partner with the firm of Klein, O’Neill & Singh LLP in Orange County, California. Here’s what he had to say:

“The name of the domain should be trademarked because that is typically their main brand. You don’t want others to take away your ability to use your own trademark. Also, before investing a lot of time and money into your main brand, you would want to get a trademark search done. The trademark search [sometimes] mitigates the need to rebrand after a product launch.”

Jeremy Peter Green Eche, JPG Legal

Trademark Domain Name Jeremy Peter Green Eche
Image courtesy of Jeremy Peter Green Eche

Jeremy Peter Green Eche is a trademark broker and attorney with JPG Legal. He says you only want to trademark your domain name if it matches your brand name. Here’s what he had to say:

“I’m a trademark attorney running a four-lawyer trademark-focused law firm based in Brooklyn, New York. I also run a trademark marketplace called Communer where people can buy and sell trademarks, often with domain names attached.

Business owners should always strive to own a federal trademark registration for their brand name. But they should only register their full domain name as a trademark if that’s the name they use in their branding.

For example, if somebody uses the domain name Google.com, they should only register Google.com as a trademark if they present themselves in their branding as Google.com. If it just says Google at the top of the website, then they should register Google as a trademark.

If their domain name is generic, e.g. Petfood.com, then they are not going to be able to register their name as a trademark without including the top-level domain. Generic terms ordinarily cannot be registered as trademarks. So in this example, the company absolutely should try to register Petfood.com as a trademark, and not just Pet Food or Petfood. Before a U.S. Supreme Court decision in 2020 called *Bookings.com*, you could not even register a generic name with a .com top-level domain added, but now it’s actually allowed.”

Key takeaways

Many of the other attorneys I spoke with had the same general words of wisdom. Pretty much all agreed that trademarks are a good idea for brand preservation and protection. How you go about your trademark is where things get tricky.

Domain name trademarking requirements and who it will work for:

Based on my research and feedback from attorneys, to trademark a domain name, it needs to be your brand identifier. Otherwise, you will be better off trademarking your brand name, logo, and other elements of your brand identity.

Why does someone need to trademark a domain name?

If it is your brand identifier, trademarking it will protect your brand and prevent others from using your brand name. This can help potential customers avoid being confused about who they are working with/buying from.

What can happen if you don’t trademark?

The Reader’s Digest version is that if you don’t trademark, you might not be legally protected from someone else attempting to use your brand/company name. That’s not to say they would be able to use your name, but a lawsuit could prove quite costly.

Next steps to trademark your domain name

So, where do you go from here? Seek out legal counsel. Always consult an attorney to better understand your specific situation. Attorneys offer free consultations to at least help point you in the right direction. It’s no secret that working with a lawyer isn’t cheap. But the amount of money and headache it can save you, in the long run, might be worth it. After chatting with all these lawyers I know I’m in the market for a trademark attorney for a business idea I’ve been considering. Based on everything they shared with me, I think trademarks are a necessary business expense. If nothing else, it gives you peace of mind that your brand/company identity is better protected.

This content should not be construed as legal advice. Always consult an attorney or legal professional regarding your specific legal situation.



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What is Cost of Goods Sold? (COGS)

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This content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

This article was originally published on Feb. 22, 2016, and was updated on Jan. 20, 2022. 

Table of contents:

Managing cash flow is critical to the ongoing health of your small business. Unfortunately, many entrepreneurs struggle to do so effectively.

Lending Tree reports that almost 30% of small businesses blame “running out of cash” as a major contributor to their startup failure. Almost 20% say they went under due to pricing or cost issues.

Calculating and understanding your cost of goods sold (COGS) will help you to better understand your small business cash flow, and set you up for long-term success.

In this post, we’ll explain what the cost of goods sold is, how to calculate it, and how to report it during tax season.

What is cost of goods sold (COGS)?

retail store

Your cost of goods sold includes the direct costs associated with the production of the products your small business sells.

Your direct costs are most often the inventory purchased to make or sell products to customers. But there are other purchased items and indirect costs (like overhead costs) that can be included in your COGS calculations, which we’ll get into shortly.

What counts under COGS?

If you own a donut franchise, for example, you’d include the following in your COGS calculation:

  • The direct inventory cost of manufacturing the donuts, including the regular purchase of baking soda, flour, sugar, and yeast.
  • Any tools you need to operate while making a donut — from pots and pans to fryers and stand mixers.
  • Indirect costs like employee wages to make the donuts, utility bills for things like water (if it’s in the recipe), or rent paid for a manufacturing facility.

What’s not included in COGS

If you are a small business owner who doesn’t manufacture your own products, your cost of goods sold typically would not factor in your indirect overhead costs (or operating expenses) incurred to run your business.

For example, when you purchase inventory from other vendors for resale, your indirect costs might include the monthly cost to rent your storefront or to keep the lights on.

Likewise, you do not need to include anything in your COGS calculations that goes into your cost of revenue, meaning the total amount you invest to sell products to customers. These costs include line items like your marketing and product distribution expenditures.

It’s always best to check with an accountant or tax expert to learn what direct and indirect costs should or shouldn’t be included in your COGS calculation.

Why service-based small businesses don’t use COGS

When doing COGS calculations, business owners must itemize the inventory they purchased (within a set time period) to manufacture or sell their products to customers.

That’s why most service-based businesses, like freelancers, consultants, and service-based software do not typically use COGS when preparing financial statements.

Of course, there are some exceptions, like a hairdresser who might sell items in-store such as shampoo, hairstyling products, and anything else that is part of their inventory as a good to be sold.

Why small businesses should care about COGS

From a tax perspective, you need to know your cost of goods sold — broken down into different line items on your business income tax form — so you can report it to the government. We’ll get into income tax reporting for COGS later in this post.

From an accounting and finance perspective, small business owners must also understand your break-even point and determine the lowest price you can set for your products to keep your business running smoothly.

COGS plays a crucial role in determining those factors, as well as in managing cash flow and finding cost savings.

For help with calculating your break-even point, read: “What is break-even analysis.” You might also want to learn more about cash flow forecasting for small businesses, and understand how to avoid cash flow problems.

How to calculate cost of goods sold

To calculate your cost of goods sold, you first need to understand the total amount of inventory and other relevant costs (if you’re a manufacturer) you regularly spend for the products you sell on a monthly, quarterly, and annual basis.

The time period for calculating COGS depends on the type of business you run and how you do your accounting.

Likewise, there are different ways to do the COGS calculations, including:

  • First in, first out (FIFO)
  • Last in, first out (LIFO)
  • Average cost
  • Special ID method

It’s crucial to have all of this information ready for your accountant — or for a tax professional to help you understand what you need to do if you manage your own books.

COGS calculation formula

For each relevant COGS reporting time period, start with the total value of your beginning inventory (i.e. the materials you already have on-hand) before you make any new purchases. Then, add on the total value of any new materials you purchased over the same time period.

For simplicity, let’s say you want to measure COGS over one month, and your total value for existing inventory is 5,000 units at a cost of $1.00 each. Your beginning inventory is, therefore, worth $5,000.

Next, you buy an additional 5,000 units at the same cost. You now have $10,000 worth of inventory ($5,000 + $5,000) to sell.

Over the course of that month, you sell 7,500 units. At the end of the month, you’re now left with 2,500 units in your inventory (at a cost of $1.00 each = $2,500).

Here’s the formula you’d use to calculate your cost of goods sold for the month:

Beginning inventory = $5,000

  • Purchases = $5,000

– Ending inventory = $2,500

________________________

Cost of goods sold = $7,500 for one month

As your business grows, and as you start to measure your cost of goods sold over longer periods, you might use more sophisticated ways to calculate these numbers.

Let’s assume you’re looking at your COGS on a quarterly basis, and the cost to purchase your inventory changes each month. The first month, the cost per unit is $1.00, the second month it goes up to $1.50, and in the third month, it costs $1.25 per unit.

First in, First Out (FIFO) method

This COGS accounting method assumes you’ll sell the inventory worth $1.00 per unit first, before selling items sold in later months. Let’s assume that over the 2nd quarter of 2022, you sell a total of 325 units. In April, you had 100 units left in stock (worth $1.00 each) and you sold all of them.

In May, you purchased an additional 200 units at $1.50 each and sold all of them. Finally, you purchased another 200 in June and sold only 25.

Let’s do the COGS calculation, starting with the cost per unit sold each month.

  • April = $1.00 x 100 units = $100
  • May = $1.50 x 200 units = $300
  • June = $2.00 x 200 units = $400

Your cost per goods sold is, therefore:

$100 (for the existing inventory in April)
+ Purchases in May and June worth $700 ($300 + $400)

– Ending inventory of 175 units (@ $2.00 each) = $350

________________________________

$450 is your quarterly FIFO COGS ($100 + $700 – $350)

Last in, Last Out (LIFO) method

In this scenario, you calculate COGS by using the value of your inventory in the last month of the quarter first.

Some businesses use this method to get a tax break when their cost per unit goes up significantly over a set time period.

Using the numbers illustrated above in the FIFO COGS calculation, you’d use the value of your goods purchased in June as your starting point. Let’s say you sold a total of 300 units in the quarter. You’d take the value of the 200 units sold in June (at $400), add 100 units at the May rate (100 x $1.50 = $150), and calculate your COGS like this:

$400 (for all units bought in June)
+ $400 (for units purchased in April and May)

– $250 (inventory left from April and May = 100 @ $1.50 + 100 @ $1.00)

____________________

$550 is your quarterly LIFO COGS ($400 + $400 – $250)

Keep in mind that using the LIFO method for COGS will eat into your profits. Therefore, you need to weigh the value of reporting losses for tax breaks versus reporting higher revenue, which might raise concerns with your bank when you need financing, or if you have any business investors or shareholders (as your business grows).

Average cost method

This is a simple COGS method that uses the average cost of the inventory purchased over a three-month or annual reporting period in the COGS calculation.

Using the example above, you’d add all three unit prices up and apply the average cost against all units sold during that time period. You may want to start out using the average cost method to manage cash flow, especially if you don’t manufacture your own products.

Special ID method

This COGS method is used when you sell multiple products that vary in manufacturing costs over a set time period. For example, an automobile manufacturer will sell different car models with different product identification numbers. In this instance, it would be wise to work with an accountant to properly calculate your COGS.

What do I need to know about COGS and taxes?

Regardless of whether you calculate your COGS monthly or quarterly, you’ll need to do so during tax season. Your COGS calculations must be completed in Part III (Schedule C) of your small business income tax statement.

You can use the cost of goods sold worksheet on lines 35 to 42 of page two.

This content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. Check the IRS website for up-to-date instructions and requirements.

Cogs taxes calculation

Cogs taxes calculation

Let’s take a closer look at each of the line items that go into the COGS calculation.

Line 35: Inventory at the beginning of the year

If you’re an online or physical retailer, and simply re-sell the inventory you purchase from someone else, the amount on this line is the cost of the merchandise you had on hand at the beginning of the year.

It’s different if you manufacture your own products. The amount on this line would be the cost of any items you produced, plus the cost of the supplies you purchased in the reporting tax year and still have on hand to make products you’ll sell in the future.

Note: If there is any difference between the previous year’s ending inventory and this year’s beginning inventory, you will need to explain why.

Line 36: Purchases less cost of items withdrawn for personal use

For re-sellers, the amount you input on this line should be the inventory you bought during the tax year.

If you manufacture your own items to sell, the amount should include the materials and parts you purchased during the year from vendors (including any discounts they gave you).

Always be sure to remove the cost of any items you returned, as well as any items you pulled out of your inventory for your own personal use.

Line 37: Cost of labor (minus your own paid labor)

Your cost of labor consists of three elements:

  1. Direct labor: Wages you paid to employees who made the products to be sold.
  2. Indirect labor: What you paid to employees who performed general factory functions, such as a foreman, and whose work does not have a direct connection with the making of the product.
  3. Other labor: Wages for selling or administrative personnel.

If you run a manufacturing business, the labor costs you input on line 37 for COGS should be relevant to each product produced during the period. A tax account should be able to help you identify which costs to use in your COGS calculation.

Re-sellers won’t likely have many labor costs, and you must not include your own paid labor (as the business owner) in your cost of goods sold.

Line 38: Materials and supplies

The number inputted on this line for COGS should include the cost of the items that are separate from the main materials used in the manufacturing of your product — but are still an important part of producing it.

For example, these materials might include glue or buttons that a fashion retailer sews onto their garments.

Line 39: Other costs

Additional costs can be added to your cost of goods sold, depending on the type of business your run.

Manufacturers can use this line to record any additional costs of creating your product — such as packaging and shipping costs to bring in supplies and materials — as well as the overhead costs for running your factory (but not the costs to sell or distribute products).

Line 40: Cost of goods available for sale

On this line, you should add up the amounts on lines 35 through 39 to get the total cost of goods available for sale.

Line 41: Inventory at end of the year

On this line, you should include the value of the items you have in your inventory that have not yet been sold as of year-end.

Like most businesses, you may need to do a physical inventory count of what you have in stock on December 31, and determine the cost to produce the items in that count.

When placing a value on your end-of-year inventory, be sure to use the cost to produce the items in your COGS calculation and not the price you charged customers for these items.

Now you have everything you need to calculate your cost of goods sold for the tax year. On line 42, subtract the amount on line 41 from line 40. You’ll input this final number on line 4 of page 1 of Schedule C – Cost of Goods Sold.

For additional help when completing your small business taxes, read: How to organize your financial statements to make tax season smooth sailing.

Planning for long-term growth with COGS

charts showing growth

charts showing growth

Once you calculate your cost of goods sold, you’ll gain a better understanding of your monthly, quarterly, and annual cash flow.

Your COGS calculations can also help you to price your products accordingly, complete your business income taxes, and plan for the long-term growth and success of your small business.

Keep in mind, the above content provides a general explanation, and how you calculate COGS will depend on many factors. For example, manufacturing businesses will have more sophisticated requirements for tracking inventory and calculating the cost of goods sold.

Always consult an accountant or tax professional for specific COGS reporting or tax requirements for your small business.

This article includes content originally published on the GoDaddy Blog by Chris Peden.



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