Not all monetary increases in your business are treated as income for tax purposes. Separating what you feel as more wealth from what is actually taxable income can help you make tax savvy decisions for your business.
Here’s a rundown of some items to note.
Gross receipts. The sales proceeds you receive for your merchandise is not entirely income. The proceeds (gross receipts) must be reduced by the cost of goods sold (what it cost you for inventory) to arrive at the amount of income that’s taxed.
Consignments. Consignments of merchandise to others to sell for you are not sales. This is because the title to the merchandise remains with you (the consignor), even after the other party (the consignee) possesses the merchandise. If you ship goods on consignment, you have no profit or loss until the consignee sells the merchandise. The merchandise you shipped out on consignment is included in your inventory until it is actually sold.
Sales taxes. While you may be required to collect sales tax from customers and remit it to the state, you’re just the state’s agent. The amount of this sales tax is not income to you.
Getting back your own money. It is not “income” for tax purposes when you get back your own money. This can occur when what you receive is a return of capital (i.e., your investment in property). This is your basis in property, which is subtracted from the sales proceeds to determine your gain (or loss). Similarly, when you receive proceeds from a loan you made to someone, you’re merely getting back the principal. It’s not income.
Paper profits. The value of your property may go up or down. When the value of your property appreciates, it is not income until there’s a sale. For example, your business owns a strip mall in a city that’s booming. The value of your property may increase substantially, giving you potential profit (income)…but your gain only becomes taxable if you sell.
The law makes it tax free. Some types of income are tax free because the law says so. Examples of tax-free income include:
- Frequent flyer miles and other rewards programs (e.g., cash backs). But there are some things to watch out for. Although the receipt of frequent flyer miles isn’t taxed, a deduction for business travel financed with them needs to be reduced accordingly. And certain credit card reward bonuses are taxable.
- Insurance proceeds
- Municipal bond interest
- Rebates on product purchases
Deferred income. Even income that you may have had to report now can be deferred in certain situations:
- Advance payments. If you are on an accrual basis for tax accounting purposes, you can elect to postpone including an advance payment in income until the next year. The IRS has guidance on this deferral election.
- Installment sales. If you sell property (not inventory) and receive payment over more than one year, you can spread your gain over the period in which payments are received.
- Like-kind exchanges. If you exchange realty solely for other realty that is “like kind,” no gain is recognized on the exchange. The unrecognized gain is effectively preserved in the tax basis of the replacement property so that the original gain, plus gain from any additional appreciation in the property, is recognized when it is ultimately sold.
Final thought
“Not everything that can be counted counts, and not everything that counts can be counted.” — Albert Einstein
Work with your CPA or other tax adviser to check on the tax status of your “income.”
