Inventory vs Supplies: Can You Expense Stock When You Buy It?

Can you deduct stock the day you buy it, or only when you sell it?

Usually only when the goods are sold or used. Goods bought to resell, and materials that become part of what you sell, are inventory, and their cost reaches your profit as the goods leave (26 CFR 1.471-1). The exception: a business whose average gross receipts are no more than $32,000,000 may follow its own books, so expensing stock when paid works only if the books really expense it and carry no stock on hand. Once the books carry stock, the cost waits for the sale.

A small business may use a simpler method than a full inventory, but only these:

What makes a case less simple: earlier returns that treated the same stock in different ways, a large purchase near year end, gross receipts growing toward the limit, or a lender who has been shown an inventory figure. Gather purchase invoices, a year-end count or estimate of stock on hand wherever it sits, the cost of goods sold pages of the last returns, and gross receipts for the last three years. Mixed treatment across years, a method change and books that carry stock are the points where the return and the books both usually need a professional's review.

Cost of goods sold vs supplies: what is inventory, and what is a supply?

Inventory is what you buy to resell plus the raw materials and supplies that physically become part of what you sell. Supplies that do not become part of the product are not inventory (Publication 538; 26 CFR 1.471-1).

In the books, stock you carry is an asset until it sells, then cost of goods sold, an expense. Containers that pass to the buyer with the product, such as bottles and cases, count as stock (26 CFR 1.471-1). Packaging that is not an integral part of the product, such as cartons, mailers and tape used only to ship an order, is a shipping or selling expense (Publication 334); see landed cost in cost of goods sold.

Tangible items a business uses up are materials and supplies when they meet a test in the regulation, such as fuel and similar items used within 12 months, a useful life of 12 months or less, or a unit cost of $200 or less. Costlier items that last longer are handled in expense or capitalize small purchases. Supplies come in two kinds (26 CFR 1.162-3):

• Non-incidental materials and supplies are deducted in the year they are first used or consumed in the business.
• Incidental materials and supplies are deducted in the year paid or incurred, on the conditions in the next section.

Cost of goods sold versus supplies is a split on the return. On Schedule C, the cost of stock runs through Part III, and the Supplies line (line 22) is for supplies "not included in Part III" (Schedule C). A partnership or corporation reports cost of goods sold on Form 1125-A.

Which supplies can you expense when you pay for them?

Incidental supplies, and small purchases covered by the de minimis safe harbor election. Supplies clearly qualify as incidental when they are carried on hand, no record of their use is kept, and no physical count is taken at the start and end of the year. Their cost is then deducted in the year paid (for an accrual business, the year the liability is incurred), provided that clearly reflects taxable income, so check a large or unusual purchase first (26 CFR 1.162-3; Schedule C instructions, line 22). The regulation joins the record and count conditions with "or", but the IRS's own guidance describes supplies with neither use records nor counts (IRS: tangible property regulations). This page treats having neither as the safe case, so a business that counts supplies or tracks their use, but not both, should check the facts first. Anything you sell, or that becomes part of what you sell, is stock, however cheap.

The de minimis safe harbor is a second route, for tangible items that are not stock, supplies included. The business elects it each year with a statement on its timely filed original return, extensions included. A later amended return does not make the election unless the IRS consents to a late one, and the election cannot be revoked. It needs an expensing policy in place at the start of the year (written, if the business has an applicable financial statement) and covers purchases expensed in the books under that policy, up to $2,500 per invoice or item, and more with an applicable financial statement. A partnership or S corporation makes the election itself, not its owners. It excludes inventory (26 CFR 1.263(a)-1(f); IRS: tangible property regulations), and once elected it covers all qualifying materials and supplies that year (26 CFR 1.162-3(f)). See expense or capitalize small purchases.

Which small businesses can skip a formal inventory?

A small business taxpayer can. That is a business whose average annual gross receipts for the three prior tax years are no more than $32,000,000 and that is not a tax shelter (26 U.S.C. 471(c); 26 CFR 1.471-1; IRB 2025-45). A tax shelter here is an enterprise other than a C corporation that was ever offered in a registered securities offering, a syndicate (section 1256(e)(3)(B)), or an arrangement with a significant purpose of avoiding tax (26 U.S.C. 448(d)(3); 461(i)(3)). Skipping is a choice, not a default: the business may still keep a formal inventory (Publication 334). The limit is indexed each year, so IRS publications printed for the previous tax year show a smaller figure.

How the test counts:

• Gross receipts are total sales net of returns and allowances, amounts received for services, and other income such as interest and rent. They are not reduced by cost of goods sold. Sales tax collected is left out when the law puts it on the buyer (26 CFR 1.448-1T).
• A newer business uses the period it has existed, short years are annualized, and a predecessor's receipts are included (26 U.S.C. 448(c)).
• An individual with several businesses tests each as if it were a corporation or partnership, but adds their receipts together, plus a share of the receipts of any partnership or S corporation the individual owns (26 U.S.C. 471(c)(3); 26 CFR 1.471-1).
• A corporation or partnership counts its own receipts plus its share of the receipts of each partnership it belongs to, unless the aggregation rules apply. Those rules treat related businesses under common control as one person (26 CFR 1.471-1; 26 U.S.C. 448(c)). A single-member LLC that is disregarded is treated as part of its owner's business (26 CFR 301.7701-2).

The test runs every year on the three prior years, so a business can lose the exemption in a later year. Above the limit, a business with stock keeps a formal inventory and uses an accrual method for purchases and sales. Small business taxpayers are also exempt from the uniform capitalization rules that make a maker or reseller add extra costs to stock (26 U.S.C. 263A(i)); the handmade products guide covers what goes into each item's cost.

If you skip a formal inventory, which year does the cost reach your profit?

It depends on which of the two permitted methods the business uses.

Non-incidental materials and supplies method. The cost is recovered through cost of goods sold in the later of two years: the year the goods are used or consumed, which is the year they go to a customer, and the year the cost is paid or incurred (26 CFR 1.471-1). Stock still on the shelf at year end waits for a later year. The regulation's own example is a baker who buys ingredients in November, bakes in December and sells in January: the cost is recovered in the year of the January sale.

The business's own books. A business may instead follow how its books and records treat inventory. A business with an applicable financial statement (a certified statement under generally accepted accounting principles, such as an SEC filing or an audited statement used for credit or owner reporting) follows that statement's method or uses the non-incidental method. Reviewed or compiled statements and the owner's own reports are not audited (26 CFR 1.471-1; 26 U.S.C. 451(b)(3)). Even then, a cost cannot be recovered before it is paid or incurred under the business's overall method.

Skipping the formal inventory does not skip the arithmetic. Someone still has to work out which goods went to customers and what is left. A formal inventory counts stock by who owns it, not where it sits: goods at a marketplace warehouse or in transit count if title is yours, and goods ordered but not yet yours do not (26 CFR 1.471-1, paragraph (a), the title rule). That rule is written for formal inventories, and no source says how it applies under the small business methods, so check where each batch of stock stood at year end.

Is there a preferred method for tracking inventory?

No single method is preferred; the choice has to fit the records. A formal inventory identifies cost by specific identification, when each item matches an invoice, or by first-in first-out (last-in first-out needs its own election). The method must follow generally accepted accounting principles for similar businesses, clearly reflect income and be used the same way every year. Perpetual stock records must be adjusted to a physical count at reasonable intervals (Publication 538).

The non-incidental method allows specific identification, first-in first-out or average cost, used consistently, and not last-in first-out (26 CFR 1.471-1). Valuing year-end stock is covered in the Schedule C cost of goods sold guide. Changing the method later is a method change; see "How do you switch methods, and does the IRS have to consent?" below.

What changes on Schedule C if you keep an inventory?

Part III does the work, and the rest of the return stays on its overall method. A business that keeps an inventory generally uses an accrual method for purchases and sales and may stay on the cash method for everything else (Publication 334).

Part III shows cost of goods sold as beginning inventory plus purchases and other costs, less ending inventory. Beginning inventory should match last year's ending inventory; attach an explanation if it does not (Schedule C; Publication 334). The Schedule C cost of goods sold guide walks through each line.

What stays the same: gross receipts on line 1, the Supplies line for incidental supplies, and the cash method for other income and expenses. Schedule C has no box for the small-business methods; Form 1125-A does, at line 9a.

Do your books have to follow the same method as your return?

If the business uses the books method, yes: the return follows the books. Under the non-incidental method, no: it looks to when the goods go to customers. Either way, the records must support the return, and any difference between books and return must be reconciled (26 CFR 1.446-1(a)(4); Rev. Proc. 2015-13, section 2.01(4)). The regulation draws the line for the books method with examples (26 CFR 1.471-1):

• Books that expense stock when paid and do not allocate cost to stock on hand support deducting the cost when paid. A regular physical count does not change that by itself.
• Books that carry stock do not support that. In the examples, three things made the books carry inventory: a count used to allocate cost in the books while the stock cost is reported to a lender; a point-of-sale ledger that tracks cost and quantities; and a count used to value stock in internal reports to shareholders, which the regulation treats as part of the books. The return must then follow.
• Payment is a floor. Even under the books method, a cost cannot be recovered before it is paid or incurred. In one example, accrual books showed a cost in December, but the return recovered it in the January year the bill was paid.

A balance sheet that shows stock next to a return that expensed the same stock presents two treatments of the same goods. Under the books method the regulation looks to the books, so the two are read together.

What accounts does a small seller need for stock and supplies?

Accounts that mirror the return lines, so either method can be traced from the books (Schedule C; Form 1125-A).

A tracked inventory asset account, reconciled to year-end counts, is the kind of record the regulation's examples treat as carrying stock; see "Do your books have to follow the same method as your return?" above.

Does the method change your profit for good, or only the timing?

Only the timing, for goods that are later sold. The IRS treats a practice that changes the year a cost is taken, but not lifetime taxable income, as a method of accounting (Rev. Proc. 2015-13). Each cost is recovered once; the method decides the year. A larger deduction this year means a smaller one in the year the stock sells.

Timing still matters, because it moves profit between years. Stock that never sells is a separate question: see writing off unsold or obsolete inventory.

How do you switch methods, and does the IRS have to consent?

Changing how a business treats inventory is a change in method of accounting. It needs the IRS's consent before the new method is used, whether or not the new method is permitted (26 CFR 1.446-1; 26 CFR 1.471-1). The first return is the exception: a business picks its initial method when it files it (Publication 538).

For a small business taxpayer, consent is treated as granted under the automatic procedures when the filing is done correctly, subject to IRS review:

1. Complete Form 3115 with the right change number: 260 for the non-incidental method, 261 for the books or financial statement method, 263 to return to a formal inventory (Rev. Proc. 2025-23, sections 22.18 and 22.20). For 260 and 261, only the parts the revenue procedure names need completing; 263 has no reduced filing.
2. Attach the original to the return for the year of change, filed on time including extensions. The business files it for itself: the owner (both spouses on a joint return), a general partner or LLC member, or a corporate officer signs (Instructions for Form 3115).
3. Send a signed copy to the IRS no earlier than the first day of the year of change and no later than the day the return is filed. There is no user fee, and the IRS does not acknowledge receipt (Instructions for Form 3115).

If the IRS has contacted you about examining a return, a copy of Form 3115 must also go to the examining agent by the filing date, and the change may not carry audit protection; that is a case for professional review before filing (Instructions for Form 3115, lines 6a to 7a; Rev. Proc. 2015-13, sections 6.03(3) and 8). A later change in how the books treat inventory is also a method change, with its own change number, 262, and no audit protection (Rev. Proc. 2025-23, section 22.19).

A section 481(a) adjustment keeps costs from being counted twice or missed in the changeover; fixing inventory missing from past returns covers how it is figured and spread. In the year of change, Schedule C line 35 is last year's closing inventory refigured under the new method, with any difference explained (Schedule C instructions).

The automatic route is generally closed if the business changed, or applied to change, the same item in any of the five tax years ending with the year of change (Rev. Proc. 2015-13, section 5.05). Exceptions: a change within the books or financial-statement method, a change back to a formal inventory in the first year the business stops qualifying, and a later switch to a small business method after that one (Rev. Proc. 2025-23, sections 22.18(5), 22.19(2) and 22.20(3)). A timely return that left out Form 3115 can be amended within six months of its original due date (extensions not counted) to attach it, with a statement citing section 301.9100-2(b) (Rev. Proc. 2015-13, section 6.03(4)(a)). Outside the automatic rules, Form 3115 generally must be filed with the IRS National Office during the year of change, by December 31 for a calendar-year business; it is a request for a ruling and carries a user fee (Instructions for Form 3115; Rev. Proc. 2015-13, section 6.03(2)).

What if earlier returns mixed the two methods?

It may be an adopted method or an error, and the sources leave the line to the facts. Treating a material item the same way on two or more consecutively filed returns shows a method. In most instances a method is not adopted without that consistency, but an item treated properly on the first return is adopted at once (Rev. Proc. 2015-13, section 2.01; 26 CFR 1.446-1). A single odd year may be a mistake to correct on an amended return. The same treatment repeated on consecutive returns may be an adopted method, and changing an adopted method is done with Form 3115.

Mixed treatment can double count. If one year deducted every purchase and the next year opened with the same stock as beginning inventory, that stock's cost is deducted twice. An item treated inconsistently may not clearly reflect income, and the IRS may refigure income under a method that does (Publication 538; 26 CFR 1.471-1). See fixing inventory missing from past returns.

Example

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

A coffee roaster with beans left at year end

Assume the roaster is a small business taxpayer (average receipts for the three prior years far below the gross receipts limit, not a tax shelter, no applicable financial statement) and is already permitted to use the method in each row, so a formal inventory is a choice. It starts with no stock, pays US$60,000 for green beans and sells US$180,000 of coffee, all but US$15,000 of that bean cost sold to customers by December 31. No roasted coffee is left unsold. No count was kept, so someone must work out from invoices and the store room what is left.

The third row is available only when the books truly expense purchases and carry no stock, and the return must still clearly reflect income. A roaster whose books track the beans is in the first two rows. When the third row applies, this year's profit is US$15,000 lower than in the first two. If the remaining beans are roasted and sold next year, the difference reverses then: US$15,000 is deducted next year under the first two methods and nothing under the third, which already deducted it.

A candle maker's supplies and stock

A candle maker, a small business taxpayer with no applicable financial statement, buys US$800 of cleaning supplies and shop towels, and US$4,000 of wax and jars that go into the candles. The supplies are incidental if she keeps no use records and no counts, so the US$800 is deducted when paid. The wax and jars are stock. Under a formal inventory or the non-incidental method, their cost reaches profit as candles sell, and wax left at year end is not deducted yet; books that expense purchases and carry no stock can support deducting it when paid. If she starts both keeping use records and counting the towels, they become non-incidental and are deducted as used, unless a de minimis safe harbor election lets her deduct them when paid.

An online shop's December stock buy

An online shop buys, receives and pays for US$40,000 of spring stock in December and sells none of it until March. Assume it is a small business taxpayer with no applicable financial statement. Under a formal inventory, the US$40,000 is ending inventory, so none of it is cost of goods sold this year. Under the non-incidental method, the goods are used or consumed when they go to customers in March, so the deduction falls in the following year. Neither stock method makes it a December deduction. Only books that really expense purchases and carry no stock could support deducting it when paid; a shop whose books carry the stock is not in that position.

Different for you?

• Earlier returns treated the same stock in different ways: read fixing inventory missing from past returns, then see bookkeeping help for rebuilding each year's stock records and checking which method each return used.
• A big year-end purchase swings your profit: the method decides which year it lands in. See bookkeeping help for the year-end stock records that decide it.
• Your gross receipts are growing toward the limit, or you own several businesses: the test adds related businesses together, and a business that outgrows it changes back to a formal inventory. See bookkeeping help for tracking receipts against the limit and preparing the change.
• A lender or buyer wants inventory on the balance sheet: books that carry stock can change the tax method. See bookkeeping help for lining the books up with the return.
• A partnership or corporation files Form 1125-A from your books: the stock figures must match the books and the method. See bookkeeping help for checking them before the return is prepared.
• The IRS has contacted you about a return that includes stock: a method change during an examination has extra steps. See bookkeeping help before filing anything.
• You are incorporating, selling the business or putting it into a partnership: a method change generally cannot be requested for the year the business ceases, any unspent section 481(a) adjustment comes into income that year, and the new owner's gross receipts test includes its predecessor's (Rev. Proc. 2015-13, sections 3.04, 5.03 and 7.03; 26 U.S.C. 448(c)). See bookkeeping help for putting the stock records in order before the change.
• You make what you sell: see cost of goods sold for handmade products.
• You paid freight, duties or packaging on stock: see landed cost in cost of goods sold.
• You bought stock personally before opening: see starting inventory you already owned.
• You have no records of what stock cost: see inventory and cost of goods without records.
• Your stock will not sell: see writing off unsold or obsolete inventory.
• You are choosing between cash and accrual books: see cash or accrual for a small business.
• You sell on online marketplaces: see online seller income tax.