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Business Income

You must report on your tax return all income you receive as a direct seller. This income includes any of the following.

• Income from sales--payments you receive from customers for products they buy from you.
• Commissions, bonuses, or percentages you receive for sales and the sales of others who work under you.
• Prizes, awards, and gifts you receive for any reason from your selling business.

Income From Sales

You have income from sales if at least some of your customers buy directly from you and you buy the products you sell to them from a company (or another direct seller).

If some of your customers buy their products from a company, you, as the sales agent, do not have any sales income from these transactions. You will generally receive a commission or "bonus" for making the sale, but will have no direct income from the sale itself. If all of your sales are handled in this way, the rules in this section do not apply to you. Report your commissions as other business income. For more information, see Other Income, later.

Depending on the company with which you are affiliated and the nature of its marketing and compensation plan, you may have some sales which produce income from sales and some which produce only commissions or "bonuses."

Example 1. Your customers pay you the retail price for goods they order. You send the orders and payments to a company. The company sends the merchandise to fill the orders. The company also sends your share of the retail price.

You are acting as a sales agent for the company. You did not purchase the products you sold to your customers. Your payment from the company is a commission, not income from sales. Include the commissions in the gross receipts of your business. Do not include the full amount your customers pay for the goods they order.

Example 2. Your customers pay you a deposit when you take their orders. You send the orders to the company, but keep the deposits for yourself. The company fills the orders by shipping the merchandise to customers. The customers pay the company the rest of the retail price (usually cash on delivery).

You are acting as a sales agent for the company. The deposit is your commission. You have no income from sales.

Example 3. Your customers pay you for the goods you sell them, either when you take their orders or when you make deliveries. After your customers place orders, you order the goods from a company (or from a direct seller you work under). You either send the money for the goods with your orders or you are billed later. In either case, you are able to charge your customers more than you pay for the goods.

You are buying products "wholesale" and selling them "retail." The full amount received from your customers is income from sales. You have income from sales to report on your return.

Example 4. You keep a supply of goods your customers regularly buy from you. This allows you to fill their orders without delay. You order and pay for the goods before your customers specifically ask for them.

You have purchased goods to resell to customers. The full amount received from your customers is income from sales. You have income from sales to report on your return.

Example 5. You have recruited several other direct sellers who order the products they sell through you. Commissions or bonuses paid to you by the company are shared with the direct sellers in your "group" based on sales, purchases, or some other formula established by the company whose products you sell. You are able to keep the portion of the commissions you are not required to distribute to the direct sellers in your group.

The bonuses you receive from the company on these sales are included in gross receipts as commissions, and not as income from sales.

Gross Profit on Sales

Gross receipts minus cost of goods sold equals gross profit for the year.

If you have income from sales, figure your gross profit and the income to report by following these steps.

1. Figure the total your customers paid you during the year for goods you sold them. Include this in the gross business receipts you report on your return.
2. Next, subtract the amount (if any) your customers paid that you had to return in the form of refunds, rebates, or other allowances. Show this on your tax return.
3. Finally, subtract the cost of the goods you sold. To figure the cost of goods sold, you must know the value of the inventory of goods you had at the beginning and end of the year, and your purchases during the year. See Cost of Goods Sold, next, and Inventory, later.

Cost of Goods Sold

To figure the cost of goods sold during the year, follow these steps.

1. Start with the value of your inventory at the beginning of your tax year. This should be the same as the value of your inventory at the end of the previous year. Valuing inventory is discussed later under Inventory.
2. Add to your beginning inventory the cost of merchandise you bought during the year to sell to customers. This does not include the cost of merchandise you bought for your own use, but it can include the cost of merchandise you use to demonstrate your product line. See Demonstrators under Capital Expenses, later.
3. Subtract from this total your inventory at the end of the year. The difference is your cost of goods sold during the year.

Example 1. Janet Smith sells cookware on the sales-party plan. On December 31, 1997, she did not have any cookware on hand that she would sell, or had sold, to customers. However, she did have items of cookware that she used in demonstrations. The cost of these demonstrators was $80. She does not have a beginning inventory for 1998.

During the year, Janet spent $5,270 on goods in her product line. Of this amount, $130 was for cookware sets she gave for personal gifts and $40 was for a set for personal use. She purchased $5,100 [$5,270 - ($130 + $40)] worth of goods to sell to customers.

On December 31, 1998, Janet had only one demonstrator set on hand. She also had several sets of cookware in boxes awaiting delivery to customers. The cost of these sets was $220. Her ending inventory for the year is $220, and her cost of goods sold for 1998 is $4,880 ($0 beginning inventory + $5,100 purchases - $220 ending inventory).

Example 2. Lisa Marie is a direct seller of cosmetics. She has an established clientele and knows what items are steady sellers. When the company has a special sale on these items, she buys an extra quantity for future sales. She had merchandise costing $200 on hand at the end of 1997 (which would be her beginning inventory for 1998) and merchandise costing $175 at the end of 1998. During the year she purchased $3,250 of merchandise. Purchase returns and allowances were $50. She withdrew $200 of cosmetics for personal use. Lisa figures her cost of goods sold for 1998 as follows:

Beginning inventory

$200

Add:

Merchandise purchased during the year

$3,250

Subtract:

Purchase returns and allowances

50

Subtract:

Goods withdrawn for personal use

       200

     3,000

Goods available for sale

$3,200

Subtract:

Ending inventory

       175

Cost of goods sold

    $3,025

Lisa figures her gross profit by subtracting the cost of goods sold from her gross receipts for the year as follows:

Gross receipts

$5,375

Minus: Cost of goods sold

     3,025

Gross profit

    $2,350

Purchases. When figuring cost of goods sold, include the full cost of all merchandise you buy to sell to customers. This cost includes any postage or freight charges to get the merchandise.

Figure your purchases at the actual price you pay. Deduct a cash discount or a trade discount in figuring your purchases, not the stated purchase price. A cash discount or a trade discount is the difference between the stated purchase price and the actual price you have to pay.

Purchase returns and allowances. You must subtract purchase returns and allowances from your total purchases for the year when figuring cost of goods sold. This includes any rebates or refunds you received off the purchase price. It also includes any credit you received for merchandise you returned.

Personal withdrawals. Subtract from your purchases for the year the cost of goods in your product line that you bought for personal use and the cost of goods you withdrew from inventory. Merchandise is considered withdrawn from inventory when it is no longer for sale to customers. For example, if you sell a particular kind of soap and give some as a gift or use some yourself, you must withdraw the soap from inventory because it is no longer available for sale.Follow this procedure for all products withdrawn for personal use, even if you are using the product only to familiarize yourself with its characteristics or to demonstrate "loyalty" to the company whose products you sell.

Inventory

Many direct sellers have little or no inventory. Others keep a considerable inventory of goods on hand. In either case, if you have income from sales, you should know how to figure your inventory at the end of each tax year. Figuring inventory involves:

1. Taking inventory,
2. Identifying the cost, and
3. Valuing the inventory.

Taking inventory. The first step is to identify and count all merchandise in your inventory. Include all goods to which you have title at the end of the year. This will generally be any goods you have on hand and have not yet sold to customers.

Include merchandise you have purchased, even if you have not yet physically received it. You may also have title to goods that were shipped to you but not yet received. If the risk of loss during shipment is yours, you probably have title to the goods during shipment. If you buy merchandise that is sent C.O.D., title passes when payment and delivery occur.

Goods not yet paid for. You may have title to goods not yet paid for. If you are billed for merchandise that is sent to you, you must usually pay the bill within a certain time, whether or not you sell the goods. In this case, you have title to the goods and must include them in inventory if they are unsold or undelivered at the end of the year.

Consignments. Merchandise you receive on consignment is not purchased by you and is never included in your inventory. You have merchandise on consignment if you do not have to pay for what you have in stock until the time you sell it and collect the retail price from the customer.

Identifying the cost. The second step in figuring your inventory is to identify the inventory items with their costs. The specific identification method is used when you can identify and match the actual cost of the items in inventory. Most direct sellers will be able to use this method.

If you cannot identify specific items with their invoices, you must make an assumption about which items were sold during the year and which remain. Make this assumption using either the first-in first-out (FIFO) method or the last-in first-out (LIFO) method.

The FIFO method assumes that the first items you purchased or produced are the first items you sold, consumed, or otherwise disposed of.

The LIFO method assumes that the last items that you purchased are sold or removed from inventory first.

Valuing the inventory. The third step in figuring your inventory is to value the items you have in inventory.

The two common methods to value non-LIFO inventory are the cost method and the lower of cost or market method. LIFO inventory must only be valued at cost.

Cost method. If you use the cost method to value your inventory items, the value of each item is usually its invoice price. Add transportation, shipping, or other necessary charges in getting the items. Subtract any discounts you received from the invoice price.

If any of the goods you have on hand at the end of the year were also in your inventory at the beginning of the year, they have the same value at the end of the year as they had at the beginning.

Lower of cost or market method. See Publication 538 for a discussion of the lower of cost or market method.

New business. For a new business not using LIFO, you may choose either method to value your inventory. You must use the same method to value your entire inventory, and you cannot change the method without IRS approval.

Other Income

The full amount of everything you receive in your selling business is business income. You must report all business income on your tax return. Take no deduction from your income before entering it on the return.

Commissions, bonuses, and percentages. Many direct sellers receive a commission on their sales. Your commission might be called a "bonus" or "percentage," and it might be based on both your own sales and the sales of other direct sellers working under you, or on your purchases from the company with which you are affiliated.

Report the full amount of any commissions you receive as business income, even if you pay part of it to other direct sellers working under you. You usually can deduct the part you pay to others as a business expense. For more information, see Commissions under Other Expenses, later.

Prizes, awards, and gifts. If you receive prizes, awards, or "gifts" in your role as a direct seller, you must report their full value as business income. The following are examples of items that must be included in income.

• Cash.
• Free merchandise.
• Expense-paid trips.
• Use of a car.
• Jewelry signifying your level of achievement as a direct seller.
• Memberships in organizations or clubs.
• Tickets to sports events, shows, or concerts.

Value of goods or services received. You must report income received in the form of goods or services at their "fair market value" on your tax return. Fair market value is the price agreed on between a buyer and a seller when both have all the necessary information and neither is forced to buy or sell.

Value of use of property. If you receive the free use of property through your direct-sales performance, you must include the fair market value of the use of the property in your business income. There are special rules for the free use of an automobile and certain other property. For more information, get Publication 463, Travel, Entertainment, Gift, and Car Expenses, and Publication 525, Taxable and Nontaxable Income.

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Thursday, 19 Nov 1998 16:59:11 EST