Business Income You must report on your tax return all income you receive as adirect seller. This income includes any of the following. Income from sales--payments you receive from customersfor products they buy from you. Commissions, bonuses, or percentages you receive for salesand the sales of others who work under you. Prizes, awards, and gifts you receive for any reason fromyour selling business. Report this income regardless of whether it is reported to youon an information return. Income From Sales You have income from sales if at least some of your customers buydirectly from you and you buy the products you sell to them from acompany (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 thesetransactions. You will generally receive a commission or "bonus"for making the sale, but will have no direct income from the saleitself. If all of your sales are handled in this way, the rules inthis section do not apply to you. Report your commissions as otherbusiness income. For more information, see Other Income,later. Depending on the company with which you are affiliated and thenature of its marketing and compensation plan, you may have some saleswhich produce income from sales and some which produce onlycommissions or "bonuses." Example 1.Your customers pay you the retail price for goods they order. Yousend the orders and payments to a company. The company sends themerchandise to fill the orders. The company also sends your share ofthe retail price. You are acting as a sales agent for the company. You did notpurchase the products you sold to your customers. Your payment fromthe company is a commission, not income from sales. Include thecommissions in the gross receipts of your business. Do not include thefull amount your customers pay for the goods they order. Example 2.Your customers pay you a deposit when you take their orders. Yousend 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 (usuallycash on delivery). You are acting as a sales agent for the company. The deposit isyour commission. You have no income from sales. Example 3.Your customers pay you for the goods you sell them, either when youtake their orders or when you make deliveries. After your customersplace orders, you order the goods from a company (or from a directseller you work under). You either send the money for the goods withyour orders or you are billed later. In either case, you are able tocharge 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 incomefrom 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 payfor the goods before your customers specifically ask for them. You have purchased goods to resell to customers. The full amountreceived from your customers is income from sales. You have incomefrom sales to report on your return. Example 5.You have recruited several other direct sellers who order theproducts they sell through you. Commissions or bonuses paid to you bythe company are shared with the direct sellers in your "group"based on sales, purchases, or some other formula established by thecompany whose products you sell. You are able to keep the portion ofthe commissions you are not required to distribute to the directsellers in your group. The bonuses you receive from the company on these sales areincluded in gross receipts as commissions, not as income from sales. Gross Profit on Sales Gross receipts minus cost of goods sold equals gross profit for theyear. If you have income from sales, figure your gross profit and theincome to report by following these steps. Figure the total your customers paid you during the year forgoods you sold them. Include this in the gross business receipts youreport on your return. Next, subtract the amount (if any) your customers paid thatyou had to return in the form of refunds, rebates, or otherallowances. Show this on your tax return. Finally, subtract the cost of the goods you sold. To figurethe cost of goods sold, you must know the value of the inventory ofgoods you had at the beginning and end of the year, and your purchasesduring the year. See Cost of Goods Sold, next, andInventory, later. Cost of Goods Sold To figure the cost of goods sold during the year, follow thesesteps. Start with the value of your inventory at the beginning ofyour tax year. This is usually the same as the value of your inventoryat the end of the previous year. Valuing inventory is discussed laterunder Inventory. Add to your beginning inventory the cost of merchandise youbought during the year to sell to customers. This does not include thecost of merchandise you bought for your own use, but it can includethe cost of merchandise you use to demonstrate your product line. SeeDemonstrators under Capital Expenses,later. Subtract from this total your inventory at the end of theyear. The difference is your cost of goods sold during theyear. Example 1.Janet sells cookware on the sales-party plan. On December 31, 1998,she did not have any cookware on hand that she would sell, or hadsold, to customers. However, she did have items of cookware that sheused in demonstrations. The cost of these demonstrators was $80. Shedoes not have a beginning inventory for 1999. 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 giftsand $40 was for a set for personal use. She purchased $5,100[$5,270 - ($130 + $40)] worth of goods to sell tocustomers. On December 31, 1999, Janet had only one demonstrator set on hand.She also had several sets of cookware in boxes awaiting delivery tocustomers. The cost of these sets was $220. Her ending inventory forthe year is $220, and her cost of goods sold for 1999 is $4,880 ($0beginning inventory + $5,100 purchases - $220 ending inventory). Example 2.Lisa is a direct seller of cosmetics. She has an establishedclientele and knows what items are steady sellers. When the companyhas a special sale on these items, she buys an extra quantity forfuture sales. She had merchandise costing $200 on hand at the end of1998 (which would be her beginning inventory for 1999) and merchandisecosting $175 at the end of 1999. During the year she purchased $3,250of merchandise. Purchase returns and allowances were $50. She withdrew$200 of cosmetics for personal use. Lisa figures her cost of goodssold for 1999 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 soldfrom 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 costof all merchandise you buy to sell to customers. This costincludes any postage or freight charges to get the merchandise. Figure your purchases at the actual price you pay. Deduct acash discount or a trade discount in figuringyour purchases, not the stated purchase price. A cash discount or atrade discount is the difference between the stated purchase price andthe actual price you have to pay. Purchase returns and allowances.You must subtract purchase returns and allowances from your totalpurchases for the year when figuring cost of goods sold. This includesany rebates or refunds you received off the purchase price. It alsoincludes any credit you received for merchandise you returned. Personal withdrawals.Subtract from your purchases for the year the cost of goods in yourproduct line that you bought for personal use and the cost of goodsyou withdrew from inventory. Merchandise is considered withdrawn frominventory when it is no longer for sale to customers. For example, ifyou sell a particular kind of soap and give some as a gift or use someyourself, you must withdraw the soap from inventory because it is nolonger available for sale. Follow this procedure for all productswithdrawn for personal use, even if you are using the product only tofamiliarize 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 aconsiderable inventory of goods on hand. In either case, if you haveincome from sales, you should know how to figure your inventory at theend of each tax year. Figuring inventory involves: Taking inventory, Identifying the cost, and Valuing the inventory. You need to know your inventory at the beginning and end ofeach tax year to figure your cost of goods sold. Beginning inventorywill usually be the same as ending inventory of the year before. Anydifferences must be explained in a schedule attached to your return. Taking inventory.The first step is to identify and count all merchandise in yourinventory. Include all goods to which you have title at the end of theyear. This will generally be any goods you have on hand and have notyet sold to customers. Include merchandise you have purchased, even if you have not yetphysically received it. You may also have title to goods that wereshipped to you but not yet received. If the risk of loss duringshipment is yours, you probably have title to the goods duringshipment. If you buy merchandise that is sent C.O.D., title passeswhen payment and delivery occur. Goods not yet paid for.You may have title to goods not yet paid for. If you are billed formerchandise that is sent to you, you must usually pay the bill withina certain time, whether or not you sell the goods. In this case, youhave title to the goods and must include them in inventory if they arenot sold or delivered at the end of the year. Consignments.Merchandise you receive on consignment is not purchased by you andis never included in your inventory. You have merchandise onconsignment if you do not have to pay for what you have in stock untilthe 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 theinventory items with their costs. The specific identification methodis used when you can identify and match the actual cost of the itemsin inventory. Most direct sellers will be able to use this method. If you cannot identify specific items with their invoices, you mustmake an assumption about which items were sold during the year andwhich 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 orproduced are the first items you sold, consumed, or otherwise disposedof. The LIFO method assumes that the last items that you purchased aresold or removed from inventory first. Valuing the inventory.The third step in figuring your inventory is to value the items youhave in inventory. The two common methods to value non-LIFO inventory are thecost 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 valueof each item is usually its invoice price. Add transportation,shipping, or other necessary charges in getting the items. Subtractany discounts you received from the invoice price. If any of the goods you have on hand at the end of the year werealso in your inventory at the beginning of the year, they have thesame 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 marketmethod. New business.For a new business not using LIFO, you may choose either method tovalue your inventory. You must use the same method to value yourentire inventory, and you cannot change the method without IRSapproval. Other Income The full amount of everything you receive in your selling businessis business income. You must report all business income on your taxreturn. Take no deduction from your income before entering it on thereturn. Commissions, bonuses, and percentages.Many direct sellers receive a commission on their sales orpurchases. Your commission might be called a "bonus" or"percentage," and it might be based on both your own sales andthe sales of other direct sellers working under you, or on yourpurchases from the company with which you are affiliated. Report the full amount of any commissions you receive as businessincome, even if you pay part of it to other direct sellers workingunder you. You can usually deduct the part you pay to others as abusiness expense. For more information, see Commissionsunder Other Expenses, later. Prizes, awards, and gifts.If you receive prizes, awards,or "gifts" in your role as a direct seller, you must report theirfull value as business income. The following are examples of itemsthat must be included in income. Cash. Free merchandise. Expense-paid trips. Use of a car. Jewelry signifying your level of achievement as a directseller. Membership 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 attheir "fair market value" on your tax return. Fair market valueis the price agreed on between a buyer and a seller when both have allthe 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-salesperformance, you must include the fair market value of the use of theproperty in your business income. There are special rules for the freeuse of an automobile and certain other property. For more information,see Publications 463 and 525.