It’s coming up on the end of the year! Do you do inventory every year? Some small businesses do inventory as often as every week, month or quarter. If you aren’t doing inventory at least once a year, you need to!
In one of our past blogs, we talked about taxes as a small business owner and how it is important to find every type of expense that can be taken off of your business’s bottom line so you can pay less in taxes. In this blog we will talk about the Safe Harbor Exception for inventory and how it might apply to your small business.
What is Safe Harbor?
There are many definitions and applications for the term “Safe Harbor” but for the purpose of this blog, we will talk about Safe Harbor as an accounting method to simplify your business tax returns. Safe harbor accounting is not intended to avoid taxes, but to minimize what you have to pay within the rules or laws outlined by the IRS.
What is Safe Harbor for Inventory?
Remember Aunt Lucy from our earlier blog who knits magical unicorns? Well Aunt Lucy’s business has exploded, and she is now selling her knitted unicorns, along with 50 kinds of massive stuffed jungle animals. Each year, when she counts her inventory of gigantic creatures, she compares it to her sales receipts and (before Safe Harbor) could finally count the sold inventory expense on her business taxes. Before 2018, Aunt Lucy was not allowed to claim a deduction for inventory, until the inventory was sold.
Congress has since then implemented the Tax Cuts and Jobs Act that provided a (potentially) huge tax-write off for small businesses that carry inventory. Aunt Lucy, being the savvy small business owner that she is, decided to take advantage of the new ruling and claim her inventory expense the same year that she purchased the items, instead of when she sold them.
How do I change to Safe Harbor Accounting for Inventory?
Changing the method of accounting provided a large tax windfall for Aunt Lucy, and it can for your business too. There are a few rules (of course) to be able to take advantage of Safe Harbor for Inventory:
- Small businesses with gross receipts under $25 million qualify
- You (or your accountant) will need to notify the IRS that you are changing to a cash method of inventory. (Form 3115)
- Each inventory item needs to be under $2500 per unit.
- If your small business has no requirements to issue GAAP basis financial statements (audit, review, compilation) there may be an opportunity to implement this strategy.
What about safe harbor for restaurants?
Safe Harbor rules can also apply to restaurants who make improvements to their property. In the past, if a restaurant remodeled, or updated their “look” the expenses were required to be capitalized and depreciated. With the Safe Harbor rules, small businesses can now count the remodeling as “repairs” and write them off in the same tax year.
Talk to your tax expert!
I’m not a CPA, nor do I play one in business blogs! There are a lot of rules and red tape to work through with Safe Harbor, so make sure you talk to an expert to see if your small business is eligible for the deductions, and if it would help you when tax season rolls around.
For additional information on Safe Harbor and how it can help your small business save on taxes, (Check with your accountant) and then feel free to reach out to us at the Small Business Development Center – SBDC – Serving Paris area: Lamar, Hunt, Hopkins, Delta, and Red River counties.