3 Essential Ways to Prepare Your CPG Business for 2021 Tax Filing

 In Bookkeeping, Taxes

Consumer product goods (CPG) businesses have weathered a lot over the last two years: the COVID-19 pandemic, unprecedented supply chain issues, labor shortages, and rapidly increasing inflation. With tax season upon us, it’s more critical than ever to ensure your 2021 tax filing is not only done correctly but also positions you to keep more money in the business by reducing your tax liability.

The unique nature of CPG businesses makes your company’s tax filing complex, with various deductions and credits to consider. The following three approaches can help you prepare for tax filing, reduce your tax liability, and keep more resources to invest in growing the company.  

Maximize Deductions Through Good Inventory Accounting

The inventory you maintain—whether it’s raw materials, component parts, or finished goods—is a highly valuable asset. But those inventory items can lose value for many reasons, including:

  • Damage resulting from improper storage or handling

  • Spoilage

  • Theft, both internal and external
  • Obsolescence due to product advancements or changes in market demand

  • Failing to maintain the right mix of finished goods (e.g., running out of stock on fast sellers and carrying too much stock on slow sellers), which can be especially difficult to manage now due to supply chain constraints 

Writing off inventory that has lost its value is an effective way to reduce your gross profit and your resulting tax liability. However, it requires proper inventory accounting to obtain the maximum tax deductions and ensure you stay compliant with tax laws and regulations. Navigating the complexities and nuances of inventory accounting for CPG businesses is essential—and something a professional advisor is well-suited to help with.  

For example, there are various approaches to writing off inventory, depending on how significant the loss is. When the write-off isn’t enough to make a material difference to the business, it’s typically done by deducting the value of the inventory from your Cost of Goods Sold, or COGS (which is why proper calculation of COGS is so vital, as explained below!). If the inventory loss is more significant, it’s usually debited from a separate account. 

If you follow Generally Accepted Accounting Principles (GAAP), you must write off inventory as soon as you’ve determined it has lost its value. Unlike assets like equipment, which you can depreciate over time, you can’t wait to write off inventory or spread the write-off over time. Some CPG businesses calculate their inventory write-off at year end, but if you maintain a large volume of inventory you may want to calculate the write-off more often, so you always have an accurate idea of the value of the inventory you’re carrying.

What makes an inventory write-off especially valuable is that it’s tax deductible in some cases. To qualify for this tax deduction, you must be able to prove to the IRS that you didn’t sell the written-off inventory to your customers. If you donate the inventory to a charity, sell it to a salvage yard or liquidator, or destroy it, then you’re allowed to take the tax deduction. Whatever approach you take to disposing of inventory you write off, be sure to keep receipts and take photos to provide to the IRS in the event of an audit.

Calculate Your COGS Accurately

COGS represents all the direct costs your CPG business incurs in creating or obtaining the products you sell to your customers. GAAP requires CPG companies to adhere to very specific guidelines about which costs to include in COGS and how to calculate it (which is why many CPG businesses partner with outsourced tax and accounting specialists for guidance and support). Since this figure impacts your gross profit and gross margin, it’s vital that you calculate your COGS accurately before filing your 2021 taxes.

The costs that go into your COGS include a mix of:

  • Variable costs, such as ingredients and other raw materials, parts, packaging, in-bound freight, storage, and labor

  • Fixed costs, such as the overhead to run a production facility

Any expenses associated with selling or administration—like your office rent or your sales team’s salaries and commissions, for example—are not included in COGS. And while chargebacks or deductions from a distributor or retailer will certainly affect your bottom line, they don’t fall under COGS. (Check out this blog for helpful information on the complex subject of how to handle chargeback fees, trade spending, and other deductions appropriately in your accounting records.)

When you calculate COGS for tax filing purposes, you also exclude the costs associated with products you haven’t sold during the period you’re reporting on (like the 2021 tax year), since those will be accounted for in your inventory on-hand. That makes it vital to accurately calculate the value of your inventory at the beginning and end of each reporting period.

If you do physical inventory counts to compare the value of the inventory counted to the records in your accounting system for tax purposes, it’s important that those counts are done accurately and consistently. An accurate physical count also helps you identify damaged inventory or determine if there are items missing due to internal or external theft, both of which are write-off opportunities.

Calculating COGS accurately isn’t just helpful for tax filing purposes; it also ensures you have a good handle on what it truly takes to produce a product, which directly impacts your margins. Whether it’s a small change in raw material costs or the need to switch to different packaging because of supply chain constraints, everyday decisions can easily impact your COGS incrementally—especially at a time of rising inflation. Your COGS could be slowly creeping up, but unless you calculate it periodically and accurately, you won’t have full visibility into how your costs are rising and the impact on your profitability. 

Take Advantage of the R&D Investment Credit

As a CPG business, you’re likely investing in innovations that can advance your products and increase your operating efficiencies. When you engage in research and development (R&D) efforts like these, you may qualify for an R&D tax credit.

R&D-related tax laws are changing beginning with the 2022 tax year, but the good news is the R&D tax credit is still allowable for the 2021 tax year. Though the associated tax laws make it complex to calculate—which is where the services of a professional advisor are especially helpful—it’s worth using this credit to reduce your tax liability where possible.

When you enhance your production processes through improved automation or implement efficiency-improving technologies or processes, for example, you’re engaging in activities that may qualify for the R&D tax credit. Generally, R&D-related expenses like these qualify for the tax credit:

  • Wages
  • Materials
  • Supplies
  • Equipment
  • Third-party services

As with any tax credit, the R&D tax credit can have a significant financial impact because it can directly offset your federal tax liability, your payroll tax liability in some cases, and even your state income taxes depending on where you’re located. Not all R&D-related expenses qualify for the tax credit though, so it’s best to consult a professional tax advisor like the experts at Simple Startup. We can help you determine the best way to maximize your qualified research expenses (QREs) to optimize the R&D tax credit for the 2021 tax year.

In addition to the R&D tax credit, some research expenses qualify as tax deductions. These are more along the lines of experimental or lab activities, which may or may not be applicable to your CPG business. Since you can’t take the R&D tax credit and the R&D deduction for the same expenditures, it’s best to talk with a professional advisor about how to gain the maximum benefit from these two opportunities.

As you prepare for your 2021 tax filing, these three approaches can help you maximize any tax deductions or credits you qualify for, report an accurate gross margin number, and reduce your tax liability. To ensure you’re optimizing tax strategies like these, turn to Simple Startup! We’re highly experienced in helping C-suite professionals and other business leaders navigate the nuances of tax filing for CPG businesses, file their taxes properly, and keep more funds in the business to invest in growth and expansion.

Need help getting your CPG business’s 2021 tax filing right? Book a call with Simple Startup and find out how our tax and accounting specialists can assist!

And as you look ahead, don’t forget to make note of key tax dates for 2022 to avoid late filings or payments and the associated penalties.  

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