Inventory and Cost of Goods Sold for Self-Employed Taxpayers
In short: Cost of goods sold (COGS) represents the direct costs of producing or purchasing the products you sell, which you calculate in Part III of Schedule C to reduce your gross receipts.
What is Cost of Goods Sold?
Cost of goods sold encompasses all direct expenses required to create, acquire, or prepare your products for sale. For self-employed individuals, this primarily includes wholesale purchases of merchandise, raw materials, manufacturing supplies, and direct labor costs associated with production. You cannot deduct these inventory expenses immediately when you buy them; instead, you track them and deduct them only when the corresponding product sells. This matching principle ensures your business deductions align accurately with your sales revenue throughout the tax year.
Calculating COGS on Schedule C Part III
You calculate your total Cost of Goods Sold on IRS Schedule C, specifically in Part III on lines 33 through 42. The process involves taking your beginning inventory at the start of the year, adding the cost of purchases, labor, and additional materials, and then subtracting your ending inventory at the close of the year. The final resulting figure from line 42 transfers directly to line 4 on the front page of Schedule C. This amount is subtracted from your gross receipts to arrive at your official gross profit for the tax year.
Inventory Tracking and Small Business Rules
Maintaining accurate records of your inventory is essential for substantiating your deductions if the IRS reviews your return. You must count your physical stock at the beginning and end of the tax year to determine inventory values. Many small 1099 businesses qualify for simplified inventory accounting methods, allowing them to treat inventory as non-incidental materials and supplies or follow cash-method rules. Regardless of the method you choose, keeping detailed receipts and purchase logs prevents calculation errors and supports your claimed deductions.
Related
What the Proofly receipt scanner does — and doesn’t
Does
- Reads merchant, date, line items, tax and payment method from a photo, with a confidence meter so you can correct it before saving
- Keeps personal and per-company receipts separate
- Maps business expenses to Schedule C lines (meals already at 50%)
- Exports an audit pack: every receipt image plus a ledger, as PDF, and CSV for QuickBooks or Xero
- Has a manual mileage log priced at the IRS rate for each trip’s date
Doesn’t
- File your taxes or give tax advice
- Sync live with QuickBooks or Xero (it’s CSV export)
- Pull transactions from your bank automatically
- Track your drives by GPS
- Guarantee how an audit turns out
Frequently asked questions
Where do I report Cost of Goods Sold on my tax return?
You report your calculation on Schedule C, Part III, lines 33 through 42, and transfer the final result to line 4 of Part I.
What expenses are included in COGS?
COGS includes the cost of products purchased for resale, raw materials, supplies used in manufacturing, and direct labor tied to producing the goods sold.
Can all self-employed businesses deduct COGS?
No, COGS applies strictly to businesses that sell physical products. Service-based 1099 providers generally do not track inventory or calculate COGS.
How does COGS affect my taxable income?
COGS is subtracted directly from your gross receipts to calculate your gross profit, which lowers your overall taxable business income.
Sources
This guide summarizes IRS guidance as of October 28, 2026 for planning purposes. It isn’t tax advice — confirm your situation with IRS.gov or a qualified tax professional.