How to Include Cost of Goods Sold on a Business Tax Return
COGS Schedule C, Partnership Returns, and Corporate Tax Forms
Cost of goods sold (COGS) is a calculation of the value of a company's inventory, both that which has already been sold and that which remains to be sold.
COGS is shown in a similar way on each type of business tax return. Cost of goods sold is a reduction in business income so the higher your cost of goods sold, the less income you'll have left to pay taxes on.
Calculating Cost of Goods Sold
The process of calculating the cost of goods sold is the same for all business types. Begin by gathering the necessary information. You'll need to know the valuation method you should use as well as your beginning and ending inventory. You'll need the cost of all associated labor and purchases.
Now you'll do the cost of goods sold calculation. It starts with beginning inventory and adds in the costs of materials and labor. It then calculates your ending inventory.
The Internal Revenue Service provides worksheets for calculating COGS. The one you would use depends on the type of tax return you're filing. The calculation is done in Part III of Schedule C, the form submitted by sole proprietors and single-member LLC's to determine their taxable incomes.
For all other business types, the calculation is done on Form 1125-A.
What's Included in COGS?
Cost of goods sold typically includes goods you purchase for resale, such as if you have a retail business, as well as freight or shipping costs to get them to your location. It includes your costs incurred in storing these items until a point of sale and the labor involved in doing so.
If you manufacturer or create items for eventual sale, COGS includes all the above costs as well as the components you must purchase to assemble your product.
You can also include indirect costs such as rent and administrative costs.
Schedule C—Profit or Loss from Business
Schedule C is used to calculate the net income, either profit or loss, of a small business over the course of the tax year. The result of your calculations in Part III of Schedule C appears on line 4 of Part I.
Form 1120 is the U.S. corporate income tax return. Form 1120-S is used to calculate the net income, profit or loss, of all incorporated businesses. The result of the calculation of the cost of goods sold is shown on line 2 of Part I under "Income."
Form 1065, the U.S. Return of Partnership Income, is used to calculate the net income, profit or loss, of partnerships. The result of the calculation of the cost of goods sold is shown on line 2 of Part I under "Income." The COGS calculation is detailed on Schedule A.
Limited Liability Companies
A single member LLC (SMLLC) files a business tax return as a sole proprietor using Schedule C. A multiple-member LLC files a business tax return as a partnership using Form 1065.
Doing the Cost of Goods Sold Calculation Yourself
If you have a very simple business and the COGS calculation is fairly straightforward, you might be able to do this yourself. The most difficult part is typically the inventory valuation method—LIFO, FIFO, actual, or average—which can be quite complicated.
It's always worthwhile to have a tax preparer do at least this part of the calculation and perhaps even to review everything when you've finished.
You Can't Double Dip
Keep in mind that you can't also use an expense as a separate business expense tax deduction if you include in your calculations of your cost of goods sold.
COGS is predominantly a consideration for businesses that engage in manufacturing items or purchasing stock for resale. If you're a consultant or a service provider, it's unlikely that you'd ever have to deal with this aspect of your tax return.