When completing Schedule C (Form 1040) for a sole proprietorship, inventory must be accounted for if your business involves the production, purchase, or sale of merchandise as an income-producing factor. Inventory is reported in Part III, Cost of Goods Sold, and requires valuation at both the beginning and end of the tax year to determine your cost of goods sold.
Inventory Valuation Methods
- Inventory can be valued at cost, the lower of cost or market, or any other method approved by the IRS.
- Line 33 on Schedule C asks for the method(s) used to value closing inventory. This line does not apply to filers of Form 1040-SS.
- If you are changing your method of accounting for inventory, you must file Form 3115 and may need to make a section 481(a) adjustment.
Small Business Exception
- Small business taxpayers may choose not to keep an inventory, but must still use a method that clearly reflects income.
- If you treat inventory as nonincidental materials or supplies, you may deduct the cost in the year the items are first used or consumed.
- Alternatively, if your financial accounting treatment treats inventories as nonincidental materials or supplies, you won’t be treated as failing to clearly reflect income.
Reporting Inventory on Schedule C
- Line 35: Inventory at beginning of year. If different from last year’s closing inventory, attach an explanation.
- Line 41: Inventory at end of year.
- If changing your accounting method for inventory beginning in 2025, refigure last year’s closing inventory using the new method and enter it on Line 35. Attach an explanation if there’s a difference and account for it in your section 481(a) adjustment.
Source:
Schedule C (Form 1040) Instructions - 2025
Disclaimer: Always verify details with the current IRS Form and Instructions, as well as your state’s Department of Revenue. For complex situations, consult a CPA or tax attorney.