Getting completely damaged inventory always sucks. There’s never a time when you get a broken item and celebrate. Ever. BUT you should NOT be throwing away your damaged pieces! Here’s what you need to do:
Damaged inventory is a TAX WRITEOFF. It goes in the “Loss” Category. Here’s a really super quick, simple explanation of how important it is to write-off your losses.
Let’s say you pay $1,000 for 100 pieces of clothing. This means you paid $10 per piece.
Let’s say 20 pieces are totally unsellable. This means $200 of the $1,000 you spent is a write-off.
Now let’s say you sell the remaining 80 perfect pieces for $40 each and make $3,200 total (AKA “Gross Profit”.)
After you deduct the money you spent on the merchandise, (sold for $3,200 - $1,000 cost) you end up with $2,200 adjusted profit (AKA: “Net Profit”).
This means you would owe the government taxes on $2,200.
But wait… you need to deduct your write off! You had the 20 unsellable pieces that cost you $200, so the government lets you take $200 “Loss” off of the $2,200 you owe taxes on….
So now you only owe taxes on $2,000 instead of $2,200!
Taxes are roughly 20% of your net profit, so if you did NOT “write off” your $200 loss, you would be giving the government an additional $40 for no reason at all!
Maybe $40 doesn’t sound like enough money to make the writeoff worth your time, but in 1 years time, once you add up all of your damages, breakage, expired products, customer returns that are totally unsellable, etc you’ll be amazed at what the number comes to! We have about $35,000 of totally legitimate loss every year just from products we were shipped by Big Brand Stores that are utterly unsellable to our buyers. If we did not save all of our damages to write them off, we would be giving Uncle Sam at least $7,000 for nothing! That's a lot of money to throw away on top of literally throwing away the extreme damages!
HOW TO DO IT
NO INVENTORY EVER GOES IN THE TRASH! If you have employees, this also helps prevent dishonesty. Unfortunately, you may end up with a “bad apple” who tries to steal merchandise by claiming “Oops! I thought it was damaged. Instead of throwing it away I put it in my purse. But now that you see it in my purse, I realize this piece isn't actually damaged at all. My bad!”...Like I said, NO INVENTORY EVER GOES IN THE TRASH. Remember that!
What we do is throw all of our damages in a big pile. We label the exterior boxes “DAMAGES” and take a couple photos. My accountant has always explained that anytime you are claiming a large writeoff for loss, it is important to be able to PROVE it, just in case the government decides they want evidence that the writeoff is legitimate.
Anyways, once the pile is sky-high, count it or do some “eye balling” to determine how much loss you have. If you utilize scanners and spreadsheets, you are already way ahead of the game.
Then, before you discard the damages, make accurate notes of what you are throwing out and cost. For example:
- 30 sweaters, $5 cost each = $150
- 58 shirts, $3.99 each = $231.42
- 150 high-end jewelry, $4.21 each = $631.50
- 25 low-end jewelry, $1 each = $25
And so on. You could be able to come up with a total of how much money you are going to be losing on. Be sure to notate the date you are discarding it. I even get pictures of it literally in the dumpster because, personally, the government terrifies me. I had a bad experience with them in 2008 - 2012 where they kept cashing my sales tax payment checks but not logging the payments. Then they would send me huge bills for “past due + compounded interest” for all these payments that clearly show as “cashed” months prior. It took me all the way until 2019 to FINALLY resolve this mess with them. Calling it a “nightmare” is an understatement. The day they sent me the “$0 Past Due” Letter I framed it. Point being, ALWAYS HAVE RECORDS… of EVERYTHING.
TIPS: I strongly suggest backing up your records. You can use services like Google Drive, Microsoft Drive, or if you're on a mega-budget, take a screenshot or photo of it and upload it to Google Photos then make a photo album for "Tax Stuff".
Also, don't fudge writeoffs. It is tempting to double or triple the number. Nobody enjoys paying taxes BUT if the amount of loss you are claiming doesn't make sense with the amount of profit you are claiming, you run a very high risk of an audit... and an audit is far worse than paying an additional $300 in taxes. Play the game correctly and you'll be in business forever! Just make sure you claim that loss!