MEDOWS CPA, PLLC offers expert tax advice for self-employed individuals, freelancers and retail businesses. Retail businesses face the federal tax issues highlighted below. It is easy in the daily rush of running a business to overlook or postpone reviewing tax laws that could, in some cases, generate savings. Please contact our New York City tax advisors for additional information.
Coupons and trading stamps. Merchants that issue trading stamps or premium coupons (redeemable in merchandise or cash) in connection with a sale of merchandise, may take a deduction for the merchandise or cash in the year the stamps or coupons are issued, rather than waiting until the year of redemption. This deduction is not available for coupons that provide a discount from the sales price of specified products.
An accrual-basis taxpayer engaged in the business of selling trading stamps or premium coupons may also establish a redemption reserve and subtract from gross receipts the expenses relating to the stamps or coupons, including an amount that represents the net addition to the reserve. This amount is determined at the end of the year by multiplying estimated future redemptions by the average cost of redeeming each stamp or coupon. Coupons that are distributed without charge to promote a manufacturer’s products cannot use this special reserve treatment.
Gift certificates and gift cards. Payments received for gift certificates are taxable on receipt as advance payments for goods. The amount received can be deferred to the year the sale is reported for financial accounting purposes, and to the second year after receipt, if earlier. This treatment also applies to payments for gift card sales. A taxpayer that issues a gift card in exchange for returned merchandise may apply a safe harbor by treating the gift card as the payment of a cash refund accompanied by the sale of the gift card.
Inventory accounting. Taxpayers must use inventories at the beginning and end of the tax year to compute income when the purchase or sale of merchandise is an income-producing factory. The Tax Code does not define merchandise; courts have applied various accounting definitions of the term. An item must be held for sale to be considered merchandise and to be includable in inventory. When a taxpayer takes title to tangible property for resale at the taxpayer’s risk, and the resale is a significant source of revenue, the taxpayer must use inventories. Taxpayers with inventories must use the accrual method of accounting. Inventories must include goods and supplies acquired for sale. Various valuation methods may be used; the method must reflect the best accounting practices of the taxpayer’s trade or business, and must clearly reflect income. Common methods include cost and lower of cost or market. A taxpayer may change its inventory method only with the IRS’s consent.
Inventory storage. A home office deduction is available for a taxpayer who is in the trade or business of selling products at wholesale or retail, and who regularly stores inventory or product samples at home. The taxpayer’s home must be the sole fixed location for the trade or business. The taxpayer must use the particular space for storage on a regular basis, but may also use the space for other purposes, unlike the usual home office deduction.
Advertising, displays, catalogs. Advertising and other selling expenses are generally deductible, even though the advertising may have some future benefit to the business. Courts have allowed a deduction for advertising that may provide benefits over several years, if the benefit period is not definitely ascertainable. The courts have treated a variety of expenses as deductible advertising expenses. However, some advertising expenses are treated as capital expenditures.
A business must capitalize the cost of advertising displays and signs that have a useful life greater than one year. While the IRS requires the costs of trade catalogs to be capitalized if they have a useful life greater than a year, some courts have allowed businesses to deduct these costs in the year that production costs are incurred. A taxpayer can treat outdoor advertising displays as real property under the rules for involuntary conversions, like-kind exchanges, and depreciation.
Depreciation. Ordinarily, real property used in a trade or business must be capitalized over 39 years. However, “qualified retail improvement property” placed in service before 2014 may be depreciated over 15 years. For tax years 2010-2013, taxpayers can take a Code Sec. 179 deduction for up to $250,000 of the cost of qualified retail improvement property. However, bonus depreciation is not available. Qualified retail improvement property is an improvement to an interior portion of a building that is open to the public and used in the retail business of selling tangible personal property, provided the improvement is placed in service more than three years after the building was first placed in service. This treatment is not available for elevators and escalators; the internal structural framework; structures that benefit a common area; and enlargements to the building.
Another potential depreciation benefit involves cost segregation. Certain building components and other assets can be depreciated over a shorter period than the normal 39 year period that applies to the structural components of a commercial building. The IRS has issued a directive on cost segregation in the retail industry. This directive identifies various property categories and indicates the period over which the property can be depreciated. Taxpayers must conduct a cost segregation study to identify property eligible for a shorter recovery period.
We have highlighted only some of the many federal tax laws that impact retail companies. Every business is unique and has particular state and federal tax considerations. Please contact our NYC tax office so that we can set a time to discuss your business in more detail.