What this line means
The value of all inventory you had on hand at the end of the tax year (December 31 for calendar-year filers). This includes finished goods, raw materials, and work in progress. You subtract this from line 40 to determine the cost of goods actually sold during the year. This number becomes next year’s beginning inventory on line 35.
Does this apply to you?
- You sell physical products and had unsold inventory on December 31
- You manufacture goods and had raw materials, work in progress, or finished goods remaining
- You carry seasonal inventory that was not fully sold by year-end
- You stocked up on materials or products in anticipation of future sales
Easy to overlook
A physical count is the most reliable way to value ending inventory The IRS expects your ending inventory to reflect what you actually have, not an estimate. Conducting a physical count at or near year-end and valuing each item using your chosen method (line 33) gives you the most defensible number. Relying solely on software estimates without periodic physical verification can lead to discrepancies. 1 IRS Publication 334 — Tax Guide for Small Business
Damaged or obsolete inventory can be written down If you use the lower of cost or market method (line 33), inventory that has lost value can be written down to its current fair market value. Holiday merchandise after the season, spoiled perishables, or outdated electronics may be worth less than what you paid. Writing down damaged goods reduces ending inventory and increases your cost of goods sold deduction. 2 IRS Schedule C instructions — Part III, Line 41
Watch out for this
Forgetting to include work-in-progress inventory in the ending count. If you manufacture products and have partially completed items at year-end, their accumulated cost (materials and labor invested so far) must be included in ending inventory. Leaving them out understates ending inventory and overstates cost of goods sold.
Footnotes
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IRS Publication 334, Tax Guide for Small Business. https://www.irs.gov/pub/irs-pdf/p334.pdf ↩
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IRS Schedule C (Form 1040) Instructions, Part III, Line 41. https://www.irs.gov/instructions/i1040sc ↩