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I have a client who is selling products on a payment- plan.

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how do I handle this...
I have a client who is selling products on a payment- plan. how do I handle this tax wise? Supposed he paid 5000 for a car or trailer, and he sells it for 10,000 total, $100 a month for 100 month. He is not getting financing. I know if it were real estate I could do it as an installment plan and each month would be $50 profit and thus $600 in taxable income. Can I do the same thing with this car/trailer? Or do I start taking profit once he makes a profit in 50 payments, or what?
Submitted: 8 months ago.Category: Tax
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11/12/2017
Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago
Chad EA, CDFA®, CFP®
Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional
Category: Tax
Satisfied Customers: 2,606
Experience: IRS Licensed Enrolled Agent, CDFA ® CFP ®, MBA
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Hi Dave, My name is ***** ***** I will be able to assist you today.

How you account for the sale of inventory, such as vehicles or trailers when you are in the business of selling cars and vehicles, with payments would depend in part on the accounting method the client is using. The cash or accrual method.

In accrual method, you record income when you complete a service or when goods are shipped and delivered.

Although most small businesses, particularly sole proprietorships and partnerships, use the cash method, the IRS states, “If an inventory is necessary to account for your income, you must generally use an accrual method of accounting for sales and purchases.”

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Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

According to the IRS, companies can use either the cash method or accrual method to figure taxable income and keep their books for the tax year. However, certain businesses that produce, purchase or sell merchandise, or that earn gross sales over $5 million, must use the accrual method in their accounting.

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Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

For example, if your customer sells merchandise to a customer on store credit during the month of October, the accrual method dictates that you record the transaction immediately as an item in accounts receivable until you receive payment. Even if the customer doesn’t make a cash payment on the merchandise until January, the transaction should be recorded as income for the month of October.

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Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

If your client has inventory and sells merchandise with payment plans then the client should inform if they use the cash or accrual method of accounting. T

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Then you report the income as you are required by the accounting method the tax payer has chosen or is required to use.

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Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago
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Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

If you have any follow up questions or would like for me to expand on my answer above please let me know!

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At the conclusion of our conversation please take a moment to accept the answer by rating the answer with three stars or more.

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A positive rating of five stars is always appreciated.

Thank you!

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Customer reply replied 8 months ago
OK. The client is way less than $6 Million. Does that mean he can do the cash method? If so, how does he do it? Do I keep the purchase price of all property as inventory for COGS until sold? When money is i spent on renovating /reparing vehicles or trailer, do I count that as an expense and also add it to the inventory value? E.G. He spends $5000 repair or renovating a vehcile or trailer, do I count this as an expense/purchase and increase the inventory by $5000. And THEN he sells the property. Say he bought it for 10,000, spend 5000 renovating it, and then collected $5000 down and 5000 per year for five additional years for a total sale price of 30,000. My first impulse is to take $5000 cash paid as income/gross receipts and reduce his inventory by 2500 (the cost value of 1/6 of property) the first year, producing the net effect of an installment agreement. Naturally, the docs woudl have to reflect his somehow. This seems to me the only reasonable way to handle it. If there is more than one property, this would wind up as totals for receipts, COGS, etc. One tax pro told me I would have to take the total sale price as first year income, but this seems unrealistic to me and unfair to the client. Basically, the client would have to stop allowing clients to make payments and would have to only sell to clients who could get a bank loan and pay off the bank. He was telling me this is mandatory. Do you agree? Or is this approach legitimate? Or do you have a more sensible way?
Customer reply replied 8 months ago
OK. Help me out here. The situation is I have a client who has a small business buying, renovating and selling vehicles. Now, in some cases, he is selling a vehicle or a trailer and agreeing to accept payments without going to the bank or getting financing. I have one tax pro tell me he has to take the full sales price as income and pay tax on it less basis and expenses, and that he has to use accrual accounting. This would create a problem for the client. It is one thing to let a customer make payments. It is another to pay tax on entire sales price when you have not received it. I understand that in real estate I could set up an installment plan and split out payment over years, Sales are WELL LESS than $6 million dollars. Does this mean I can use the cash method of accounting? Lets say the client has borrowed money to purchase the trailer. This is obviously not income. Money paid back to a lender/investor as interest or whatever would be business expenses. Principal or investment paid back would have no tax consequence. Now, as the income comes in, how is profit taken? Do I do it like an installment plan, taking a ratio of projected profit? Do I wait till the cost is paid off of the initial investment for each vehicle and take profit then. Or do I just take the cash income off all sales, minus all expenses including the cost of loan interest and have a starting and closing inventory based on cost.
Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

Hi Dave,

In my opinion, the client brought you an accounting issue that is generally completed as a separate billable service from completing the taxes.

"If any business that carries, produces or sells inventory, must use the accrual method of accounting unless the business has average annual gross receipts of $1 Million dollars or less."

___

For installment sales you are able to use IRS Form 6252 Installment Sale Income

____

Each payment on an installment sale usually consists of the following three parts, almost like real estate installment payments.

  1. Interest income.
  2. Return of your adjusted basis in the property.
  3. Gain on the sale.

In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property such as borrowed funds to purchase the inventory.

___

More information on how to figure income is on page 3 of publication 537. https://www.irs.gov/pub/irs-pdf/p537.pdf

_____

There is also a work sheet contained in the publication that is helpful to determining how the installment payment is applied to return of basis, interest and gain.

Publication 537 should be very helpful, but please let me know after you skim through the publication, if you do have any further questions.

Please let me know if my reply cleared up your questions above or if you do have any follow up questions please do let me know.

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Customer reply replied 8 months ago
Dear Chad,Thank you for this. Maybe I have mis-understood something.Publication 537 is about INSTALLMENT SALES. And the client is not eligible to do an instalment sale on vehicles/trailers, correct? So reading about installment sales does not really help me.And I agree this is a separate matter from taxes. I just want to make sure I steer the bookkeeper (who seems to think he has to pay tax on entire sale price even if not collected) in the right direction.I BELIEVE the client can do cash method accounting, and achieve a similar effect. He cannot pay tax on income he has not received. Please see my last follow up question. At this point,I just want to help the bookkeeper does it right. If you could answer my last addendum kind of question more direclty, that would be very helpful. Also, where does $1 Million come from? I did find a reference to $5 million in IRS materials. I believe you know the answer to the question I am asking in my addendum question, and would appreciate it if you could address it directly. Maybe I am wrong, but I get the idea you are trying to get me to read between the lines, and I am not quite getting what you mean. I understand there can be fine print and exceptions. I have a client and his bookkeeper,and would like to steer them in the right direction. I had an idea I proposed to you on using cash basis, that I think is correct, and your answer refers me elsewhere, and makes me think I got it wrong! Please help me out here.
Customer reply replied 8 months ago
Dear Chad,
Have not heard back from you. Not sure if you got my last question. If you do not know the answer to the question or it is too much, please let me know. I got a nudge to rate you, but I had a query so maybe you did not get the query. If you read my question above and the prior one, I think you will understand what I am asking.
Tax Professional: Chad EA, CDFA®, CFP®, CERTIFIED FINANCIAL PLANNER ®, Professional replied 8 months ago

The sales are installment sales when the sale consists of more than one payment.

The book keeper should report the sale gain, lost and capital accounts under the accounting method they are either required to use or have the option to use.

Depending on inventory and gross sales will dictate is the client is required to use the accrual or cash method of account.

"I BELIEVE the client can do cash method accounting" - The IRS has created guidelines for businesses to determine what methods are available to them for accounting purposes.

"At this point,I just want to help the bookkeeper does it right" - The book keeper should be following IRS regulations. Publication 538 covers this topic www.irs.gov/pub538.

In my opinion, this issue is best handled between the book keeper, tax account and owner of the business. I don't have access to the factual information, just ranges of prices and examples of expenses.

You have asked multiple questions that have multiple variables which depend on the accounting method used by the book keeper.

"How you account for the sale of inventory, such as vehicles or trailers when you are in the business of selling cars and vehicles, with payments would depend in part on the accounting method the client is using. The cash or accrual method"

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