What this line means
The direct cost of the products you sold during the year. This includes what you paid for raw materials, inventory purchased for resale, and direct labor to produce goods. You calculate this number in Part III of Schedule C (lines 33-42) and enter the result here. Service businesses that do not sell physical products generally leave this line blank.
Does this apply to you?
- You sell physical products — handmade goods, retail inventory, wholesale items
- You manufacture or assemble products using raw materials
- You buy products wholesale and resell them at retail
- You sell food or beverages that require ingredients you purchase
Easy to overlook
Service businesses do not use cost of goods sold If you are a freelance writer, consultant, designer, or any other service provider, your costs are business expenses (lines 8-27), not cost of goods sold. Putting service-related costs on line 4 instead of the appropriate expense lines does not change your tax bill, but it misclassifies your income and can trigger questions if the IRS reviews your return. 1 IRS Schedule C instructions — Part III
Unsold inventory is not a current-year expense If you bought $10,000 of inventory and only sold products that cost you $6,000, your cost of goods sold is $6,000 — not $10,000. The remaining $4,000 sits in ending inventory (line 41) and becomes next year’s beginning inventory. Expensing inventory you have not sold overstates your deduction. 2 IRS Publication 334 — Tax Guide for Small Business
Watch out for this
Including shipping costs to customers in cost of goods sold instead of on line 27a (other expenses). Inbound freight — what you pay to get materials to your workshop — is part of COGS. Outbound shipping — what you pay to send finished products to customers — is a separate business expense.
Footnotes
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IRS Schedule C (Form 1040) Instructions, Part III (Cost of Goods Sold). https://www.irs.gov/instructions/i1040sc ↩
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IRS Publication 334, Tax Guide for Small Business. https://www.irs.gov/pub/irs-pdf/p334.pdf ↩