Zero Beginning Inventory on Past Schedule C: Amend or Form 3115?

Do I have to track inventory, or can a small seller skip it?

Inventory is generally required when producing, buying or selling goods is an income-producing factor in the business: stock is valued at the start and end of every year (26 CFR 1.471-1; Publication 538). Sellers who keep an inventory report cost of goods sold (COGS) in Schedule C Part III, online sellers included. A small business taxpayer may skip a formal inventory, but it still needs a method that clearly reflects income. That does not by itself allow deducting stock when you buy it.

If the old treatment was not permitted, one filed return left out is usually amended. Two or more consecutive returns with the same treatment are generally an accounting method, changed with Form 3115 and a section 481(a) adjustment, a catch-up amount added to income. Starting this year at zero is no substitute for either.

A small business taxpayer has average annual gross receipts of $32,000,000 or less over the three prior tax years and is not a tax shelter (Schedule C instructions). The limit changes each year, so an earlier return uses that year's figure (Rev. Proc. 2025-23, section 22.18). An individual counts every business plus a share of any partnership or S corporation, related businesses are combined, and a business under three years old uses the time it has existed (26 CFR 1.471-1; 26 U.S.C. 448(c)).

Such a business has two simplified options: treating stock as non-incidental materials and supplies, deducted in the later of the year the goods go to a customer and the year paid; or following its financial records, meaning its applicable financial statement (such as an audited one used for credit) if it has one and otherwise its books and records. Deducting purchases when paid can be permitted under the second option if the books never carried stock; books that carry stock, or a stock figure given to a lender, another outside party or the shareholders, point the other way (the examples in 26 CFR 1.471-1). A business that is not a small business taxpayer has no simplified option. Both options are in inventory or supplies for small sellers.

What makes a case less simple, and a reason to have the returns read before anything is filed:

• Two or more filed returns handled stock the same way.
• Some years show stock and some do not, or the opening count does not tie to the invoices or to what earlier returns deducted.
• An IRS notice or examination is open.
• Years were never filed.
• The business ended or changed form, such as a sole proprietorship that incorporated: a method change generally cannot be requested for the year a business ceases, which includes incorporating (Rev. Proc. 2015-13, sections 3.04 and 5.03; Instructions for Form 3115).

Gather the last three returns (the Part III pages, or Form 1125-A), purchase invoices, year-end counts, sales by item and any platform reports.

What did my old returns do with stock when ending inventory was zero?

Usually, old returns with no beginning or ending inventory deducted the stock in the year it was bought instead of the year it sold. On Schedule C, cost of goods sold (line 42) is line 40 minus ending inventory (line 41), and line 40 adds beginning inventory (line 35) to the year's purchases and other costs (Schedule C). With nothing on lines 35 and 41, line 42 equals everything bought in the year, shelf stock included.

The difference matters. A deduction taken early changes only the year a cost is taken, and the IRS treats a practice that changes only timing as a method of accounting. A practice that permanently changes lifetime income generally is not one (Rev. Proc. 2015-13, section 2.01; 26 CFR 1.446-1). Counting the same stock again as beginning inventory in a later year would deduct its cost twice.

Do I need to put zero as beginning inventory so it matches?

Not if stock was on hand on the first day and the old treatment was not permitted. A small business whose books never carried stock may be allowed to expense it, and zero is then its method (see the first section). Where it was not permitted, Schedule C line 35 is the cost of the merchandise on hand at the start of the year, and it requires an explanation only when that differs from last year's ending figure (Schedule C; Publication 334). Zero matches the old return but not the shelf.

Starting at zero avoids a second deduction only if earlier returns already deducted that stock. Even then it is not a clean fix:

• If you count stock at year end but start at zero, this year's cost of goods sold leaves out the opening stock, so this year's income is higher by that cost, all at once. A Form 3115 makes the same catch-up under the IRS's procedures and spreads a positive adjustment over 4 tax years.
• If earlier returns never deducted the stock, a zero opening figure means its cost is not deducted when the stock sells.
• If the earlier treatment was an established method, a different method in this year's return is a change made without consent, however it is labeled (Rev. Proc. 2015-13, section 2.03).

When is skipped inventory my accounting method, and when is it a one-year mistake?

Generally, one filed return is a mistake and two or more consecutive returns with the same treatment are a method. Treating a material item the same way on two or more consecutively filed returns is consistent treatment, whether or not the treatment was permitted. In most instances a method is not adopted without that consistency (Rev. Proc. 2015-13, section 2.01; 26 CFR 1.446-1).

The sources say "in most instances," so the facts decide. A year with no return, a different treatment in one of the years, or a change of entity can move a case from one row to another.

Do I amend the old returns, file Form 3115, or fix it only going forward?

Whether to amend or file Form 3115 depends on whether the old treatment was permitted and, if not, which row of the last table the facts fit:

The consent rules are in Rev. Proc. 2015-13, sections 2.03 and 2.05. A change of inventory method is made on Form 3115 (Schedule C instructions).

The year of change is the first year the corrected method is used. For an automatic change, the Form 3115 goes with that year's return, so it is usually a year not yet filed (Instructions for Form 3115).

Form 3115. Rev. Proc. 2025-23 lists the automatic changes. Section 22.17 covers a taxpayer changing from deducting inventory to a permitted inventory method, unless it uses or proposes a small business method. Section 22.18 covers a small business taxpayer moving to one of those methods. Section 22.19 covers changes within a small business method; a business on the financial-record option that changes how its own records treat stock gets no audit protection. Section 22.20 covers a switch from a small business method to formal inventory. A preparer picks the one that fits.

• A partnership or corporation files its own Form 3115, signed by an authorized partner, LLC member or officer (Instructions for Form 3115).
• An automatic change has no user fee. Attach the original Form 3115 to the return for the year of change, filed on time including extensions, and send a signed copy to the IRS address in the instructions by the same date. The IRS does not acknowledge receipt (Instructions for Form 3115).
• The automatic route is generally closed if the same item was changed in any of the 5 tax years ending with the year of change, with listed exceptions (Rev. Proc. 2015-13, section 5). Outside it, a non-automatic request goes to the IRS National Office with a user fee and must be filed during the year of change itself, not afterward with the return (Instructions for Form 3115).
• A timely filing generally keeps the IRS from requiring the same change for earlier years; the exceptions, such as an open examination, are under the notice section below (Rev. Proc. 2015-13, section 8).

Form 1040-X. File a separate Form 1040-X for each year, with a corrected Schedule C. Removing a deduction means more tax, with interest from the original due date, and other penalties can apply for negligence or a substantial understatement. A federal change may also change the state return (Instructions for Form 1040-X). A claim for a refund, such as for a deduction an earlier return missed, must generally be filed within 3 years after filing the original return or 2 years after paying the tax, whichever is later.

What is a section 481(a) adjustment, and how is it spread?

A section 481(a) adjustment is a catch-up that keeps a cost from being counted twice or missed when the method changes (26 U.S.C. 481). For a seller who deducted stock early, it is usually positive: the stock's cost was already deducted and, under the new method, would not have been. The adjustment is computed even for earlier years that are otherwise closed (Rev. Proc. 2015-13, section 2.06).

Sources: Rev. Proc. 2015-13, section 7.03; Instructions for Form 3115. A net positive adjustment goes on Schedule C line 6. A net negative one goes in Part V (Schedule C instructions).

If the business ceases, for example by incorporating, selling out or contributing its assets to a partnership, the unspent balance of a positive adjustment is taken into income in that year (Rev. Proc. 2015-13, sections 3.04 and 7.03(4)(a)).

How do I work out beginning inventory now if I do not know it?

Leaving beginning and ending inventory blank reports zero, and zero usually deducts the cost of stock on hand too early. Beginning inventory for the first year of the corrected method is the cost of the goods on hand on that year's first day.

1. Count the stock now, by item, including goods you own that are in transit or out on consignment, and price it at cost: invoice price less trade discounts plus freight to get it to you (Publication 538; landed cost). Tie each cost to an invoice, canceled check or card slip (Publication 583).
2. Roll the count back to the opening date. Reverse every movement since then, at cost: add back units sold, returned to suppliers, lost or taken for personal use, and take out units bought or returned by customers. The result is only as good as the records behind it.
3. Compare the result with the old Part III pages. They show whether the opening stock was already deducted, which puts it in the adjustment, or never deducted, in which case its cost is still waiting to be deducted when the stock sells.

With no records at all, see inventory and cost of goods without records. For stock you bought personally before opening, see starting inventory you already owned.

What changes on this year's Schedule C Part III?

Lines 35 and 41 hold real figures, and any difference from last year is explained. If you are changing method, the instructions say to refigure last year's closing inventory under the new method, enter it on line 35, attach an explanation and use the difference in the section 481(a) adjustment (Schedule C instructions).

A partnership or corporation reports the same figures on Form 1125-A: beginning inventory on line 1, ending inventory on line 7 and cost of goods sold on line 8 (Form 1125-A). To fill Part III each year, see Schedule C cost of goods sold. To correct a filed partnership or S corporation return, see correcting a filed business return.

What if I have a notice, an audit or unfiled years?

A notice, an examination or an unfiled year each changes the route, and the rules below differ for each.

• An IRS contact about a return. A taxpayer is under examination once the IRS contacts it to schedule or conduct any type of examination of a return. Whether a given notice counts depends on that definition (Rev. Proc. 2015-13, section 3.18).
• While under examination, a copy of Form 3115 goes to the examining agent no later than the filing date, the positive adjustment period is shorter, and audit protection for earlier years is generally unavailable, with listed windows (Instructions for Form 3115; Rev. Proc. 2015-13, sections 7.03 and 8.02).
• The IRS can change the method itself if the one used does not clearly reflect income. A resulting positive adjustment is ordinarily made in the earliest year under examination, in one year (Rev. Proc. 2015-13, section 2.09).
• Years never filed have no earlier treatment on file, so which return is the first to reflect stock can change when late returns are filed. A method is adopted at once if stock is treated properly in the first return that reflects it, and otherwise generally only after two or more consecutively filed returns (Rev. Proc. 2015-13, section 2.01). The period for the IRS to assess tax for a year with no return filed is not limited (Publication 583). See catching up on unfiled business returns.
• Some years filed, some not is a mixed case that needs a preparer.

What inventory records should I keep from now on?

Keep what lets someone rebuild each year's opening and closing figure: the year-end count sheet (item, quantity, unit cost, and who counted and priced it) (Publication 334), the invoices, canceled checks and card slips behind it (Publication 583), sales by item and platform reports, and each filed return with any Form 3115 and its statements. Book inventory must be adjusted to a physical count at reasonable intervals (Publication 538).

Keep supporting records until the period of limitations for that return runs out (Publication 583), but a section 481(a) adjustment reaches back past that point, so keep the oldest invoices and counts you have. See how long to keep business records.

Example

These examples are illustrative. All figures are in US dollars.

Two years deducted all purchases

A reseller opened two years ago. Each year it bought US$40,000 of goods and deducted all of it, showing no ending inventory, while US$12,000 of stock sat on the shelf at each year end. Its books carry that stock, so the books-based method for small sellers is not open to it. It has not changed this item before and is not under examination.

Year 1 deducted US$12,000 too early. Year 2 repeated the treatment, which left the same US$12,000 deducted early: US$80,000 deducted over the two years against US$68,000 with a count. Same treatment on two consecutive returns is generally a method, which points to a Form 3115 for year 3 rather than two amended returns. Line 35 shows US$12,000 and the section 481(a) adjustment is US$12,000, positive. Below the US$50,000 threshold the election to take it all in year 3 is available; without it, the adjustment is spread at US$3,000 a year over four years.

One first-year error

A new seller's books carry its stock, so deducting purchases when paid was not permitted. Its first return deducted US$15,000 of purchases while US$4,000 was still unsold. Only one return shows the item, so it is generally a mistake, not a method. Amending that return makes cost of goods sold US$11,000, which raises income by US$4,000, so tax on it is due with interest from the original due date. The next return opens with US$4,000. If the second return was already filed the same way, a preparer decides which example this is.

A preparer asks for beginning inventory

A seller has US$9,000 of invoices, all dated before the year of change began, for stock still on the shelf, and no counts from past years. A shelf count priced at invoice cost and tied to the invoices gives an opening figure of US$9,000. The earlier returns decide the rest. If an established method already deducted that cost, the US$9,000 sits in the adjustment. If the deduction was one return's mistake, that return is amended instead. If it was never deducted, its cost is still waiting to be deducted when the stock sells.

Different for you?

• Two or more filed returns left stock out: whether to amend, file Form 3115 or fix it going forward, and the opening figure and adjustment, depend on each year's facts. Get bookkeeping help to rebuild stock and cost by year before the return is prepared.
• An IRS letter about a return, or years never filed: the rules differ for each, as set out under the notice section above. For years with no return, see catching up on unfiled business returns, and get bookkeeping help to rebuild each year's stock.
• The business is closing, being sold or incorporating: any unspent adjustment comes into income that year. Get bookkeeping help to rebuild stock and cost before the final return.
• You have no counts or receipts for past years: see inventory and cost of goods without records.
• You bought the stock personally before opening: see starting inventory you already owned.
• You are a partnership or S corporation and the return needs correcting: see correcting a filed business return.
• Your stock will not sell: see writing off unsold or obsolete inventory.