What this line means
Any costs directly related to producing or acquiring your products that do not fit on lines 36, 37, or 38. Common entries include inbound freight charges, containers and packaging integral to the product, overhead costs allocated to production (such as rent or utilities for a workshop), and depreciation on production equipment. This is the catchall line for direct production costs.
Does this apply to you?
- You pay inbound freight or shipping to receive raw materials or inventory
- You incur overhead costs directly tied to production — rent for a workshop, utilities for a production space
- You have depreciation on equipment used exclusively in production
- You pay for third-party processing steps — plating, finishing, heat treating — on your products
Easy to overlook
Inbound freight belongs in COGS, not in general expenses Shipping costs to get materials and inventory to your location are part of cost of goods sold, not a separate business expense. Many sole proprietors put all shipping on line 27a (other expenses), but inbound freight should be on line 39. Outbound shipping to customers goes on Part V as an other expense (which flows to line 27a). 1 IRS Publication 334 — Tax Guide for Small Business
Production overhead can be allocated here If you rent a dedicated workshop or studio for manufacturing, a portion or all of that rent can be included in cost of goods sold through this line rather than on line 20b (rent). The same applies to utilities for a production facility. Allocating production overhead to COGS more accurately reflects your true gross margin. 2 IRS Schedule C instructions — Part III, Line 39
Watch out for this
Leaving this line blank when you have legitimate production overhead costs. Many sole proprietors put all rent, utilities, and freight on the expense lines (Part II) without allocating the production portion to cost of goods sold. While this does not change your total deductions, it understates cost of goods sold and overstates gross profit.
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 39. https://www.irs.gov/instructions/i1040sc ↩