Tax write-offs are a business’s best friend. Tax deductions improve the company’s bottom line and long-term business outcomes. The Internal Revenue Service (IRS) provides Form 1125-A to legally deduct the taxable income by including the cost of goods sold (COGS). Filling the form for tax deductions requires accurate inventory valuation metrics, accounting prowess, and instructions. Assuming you are a top-line accountant, let’s dive into the tax aspects of form 1125-A.
What Is a Form 1125-A?
A Form 1125-A is a fillable IRS form to document the cost of goods sold by a corporation or partnership for tax deductions. However, to use the form, a business must meet particular requirements that are generally entities that create goods to sell them. Form 1125-A like many other tax forms is attached to other forms such as the IRS form 1120. The form is available on the IRS website and template providers’ websites.
When to Use IRS Form 1125-A
Business entities file form 1125-A to reduce the taxable income based on the cost of goods sold. The cost of goods is a financial metric in a company that is the difference of the cost of goods for sale minus the ending inventory. Cost of goods uses the cumulative total of costs incurred in manufacturing or acquiring resale goods. Direct costs in manufacturing such as labor and raw materials purchase are factored in.
Important: The accounting perspective of a business dictates the cost of goods to be included in the expenses section in a financial statement. However, when filling 1125-A, do not include COGS in the expenses section.
After calculating your COGS, document it in form 1125-A. Attach it to Form 1120 when filing your tax returns. COGS reduces the taxable income; therefore, you’ll pay less to the IRS and improve profitability. It’s important to provide accurate calculations for the cost of goods and file the form within the due date stated, typically before the 15th of the fourth month. However, sometimes extensions are approved for filing Form 1125-A.
Tip: Use standard inventory valuation methods to avoid providing lengthy explanations for your unique method. However, if standard valuation tools do not present the true picture of COGS, then use other ways and attach an explanation of the technique.
Essential Elements of Form 1125-A
Standard IRS provided form 1225-A contains the essential elements of a good template. However, you may find some lacking the important elements for online sourced templates. The following are must-haves of form 1125-A:
- Inventory at the beginning of the fiscal year
- Coat of labor
- The total cost of goods
- Additional section 263 A costs
- Inventory at the end of the year
- Methods for valuing closing inventory
- Amount of closing inventory computed through LIFO if you use LIFO
- Acquisition of property for resale section
- Change in determining valuations between opening and closing inventory.
Overhead costs are not included in the form when detailing the cost of goods. However, in an accounting statement, you would include overhead costs such as purchasing new machinery in the expenses section in an income statement.
Note: Valuing inventory is unique to each business. However, the accrual method is the best for small businesses to determine the cost of goods for tax write-offs.
Form 1125-A instructions
Alongside form 1125-A, the IRS issues specific filling instructions you must employ to fill the form correctly. We present a simple breakdown of the form’s specific instructions that you will keep in mind when entering the cost of good values and other valuations.
- Inline one, which is the inventory at the beginning of the year, you need to state the opening inventory or refigured amount if there is a change in the valuation method. Attach an explanation to the form to indicate the difference between the preceding years’ closing inventory and the refigured amount.
- Purchases for personal use under the purchases section should be kept to a minimum. If you are a corporation, state the purchases as distribution to colleagues.
- As previously stated, form 1125-A has a property acquired for the resale section. Section 263 A rules regulate the said section, and you may tick yes or no in the checkboxes. Also, if you choose a simplified production method, then the revised section 263 A requires additional costs other than an interest to be capitalized. Conversely, for simplified resale, such as off-site storage, processing tasks, and administrative costs are the additional section 263 A costs.
- Line 5 is designated for other costs not included in lines 2 to 4. Attach a statement for the additional costs. For cooperatives, the rules prohibit them from deducting specific per unit allocations. Per unit retain allocations such as qualified per-unit retain certificates require an attached statement detailing them when you fill other costs as a cooperative.
- End-of-year inventory is the closing inventory based on your valuation. For additional section 263 costs, check the regulations on 1.263A-1 through 1.263A-3 on including the costs in closing inventory.
- Enter the costs of goods sold in line 8 of Form 1125-A, reading the values from form 1120 if you file 1120, 1065, 1120-C, and 1120-S. See the appropriate section the COGS is stated on for each form.
- You can use cost or market value or other IRS-approved methods under the inventory valuation methods. If you are using the LIFO method for the first time, attach a form 970 if you changed to LIFO detail the write-up effect as income over the three years from first using LIFO.
Note: Inventory may be valued lower if the goods are unsalable at current market prices or due to defects. In such cases, the value of the goods is the bona fide price minus the direct deposit on cost not below the items’ scrap value.
Accurately filling form 1125-A is essential to seeking tax write-offs based on COGS. Pay attention to instruction when filling out the form. You can appoint a certified accountant to determine the best inventory valuation metric that determines the cost of goods. However, you may go it alone for small businesses without incurring hiring expenses. Importantly remember to file Form 1125-A with the IRS before the due date.