Freight, Duty and Sales Tax in COGS: Landed Cost on Inventory

Do I include shipping, duty and sales tax in the cost of my inventory?

Yes, for goods you buy to resell. The cost of purchased stock is the invoice price less trade discounts, plus "transportation or other necessary charges incurred in acquiring possession of the goods" (26 CFR 1.471-3(b)). Bookkeepers call that total landed cost. Each item's landed cost reaches cost of goods sold (COGS) when the item sells, and items still on hand carry theirs into ending inventory.

For a business that keeps a formal inventory, booking a stock cost as an ordinary expense moves its deduction to an earlier year than the one the goods sell in. It makes gross profit look larger than it is and leaves the stock on hand worth less than it cost. A small business may use a different permitted method, covered below.

A case is not simple when:

• freight, duty or sales tax on stock were expensed in earlier years;
• stock arrives from several suppliers or in partial shipments;
• a customs broker pays duty for you;
• goods are in transit or unsold at year end;
• gross receipts are near or above the small-business limit, or you are not sure which side you are on.

If earlier returns expensed these costs, or gross margin looks higher than it should, the fix can reach past this year. The last section says when to get bookkeeping help.

Gather supplier invoices and shipping terms, freight and broker bills, the customs paperwork showing duty, receipts showing sales tax paid, units received and sold, a count of units on hand and in transit at year end, and last year's ending inventory.

Do I factor shipping costs into COGS?

Inbound shipping, yes. Shipping to your customers, no.

Publication 334 says freight-in, express-in and cartage-in on merchandise you buy for sale are all part of cost of goods sold (chapter 6). That covers freight the supplier adds to the invoice and freight you pay a carrier yourself. Publication 334 lists it under Part III, line 39, "Other costs"; the Schedule C cost of goods sold guide walks through the lines. A partnership or corporation enters the same cost on Form 1125-A, line 5.

Delivery to a customer is a cost of making the sale, not of acquiring the goods. The capitalization regulations list distribution costs among those not added to inventory (26 CFR 1.263A-1(e)(3)(iii)(A)). It is a selling expense, deducted as an operating expense. The exception is delivery to a related person: for a business under the capitalization rules (above the small-business limit, below), that transport cost joins the cost of the goods sold (26 CFR 1.263A-3(c)(4)(vi)(A)).

Do import duties, tariffs and customs broker fees go into inventory cost?

Yes, for goods you import to resell. The cost regulation does not name duty. It covers other necessary charges to acquire possession of the goods, and duty, customs fees and a broker's clearance fee are what an importer pays to take possession (26 CFR 1.471-3(b); Publication 538).

• You pay the duty or a broker bill: add it to the cost of the goods on that shipment.
• The supplier ships duty-paid and bills one price: the duty is already inside the price. If the invoice shows duty as its own line, it is part of the cost like any other line.

Keep the customs paperwork that shows the duty on each product so you can charge it to the right item.

Tariffs on equipment you keep and use follow a different rule: see tariffs and duties on imported equipment. A Canadian corporation shipping duty-paid to US customers is covered in tariffs and duties when shipping to US customers.

What about packaging and containers?

Packaging sold with the product, which the buyer keeps, is part of its cost. Packaging used only to ship an order is not.

The regulation counts as stock the supplies that become part of what is sold, including containers such as bottles and cases when title passes to the buyer with the contents. Publication 538 leaves out supplies that do not become part of the item for sale. When to deduct shipping supplies bought in bulk is covered in inventory or supplies.

Do I need to include the sales tax in the cost of this inventory?

Yes, if you paid it. Publication 334 says sales tax on merchandise bought for resale is part of the merchandise's cost (chapter 8). The Schedule C instructions say not to deduct sales tax on business purchases as a tax and to treat it as part of the cost of the property. The tax joins the invoice price and reaches COGS with the goods.

Keep two taxes apart:

• Tax you paid a supplier on stock: part of the stock's cost.
• Tax imposed on the buyer that you collect and pay over to the state: not income and not an expense, except any part the state lets you keep, which is income (Publication 334, chapters 5 and 8; Schedule C instructions).

Whether a state taxes stock bought for resale, and how a buyer documents that it is for resale, are state rules. For using a resale certificate or recovering tax a supplier charged by mistake, see resale certificates and sales tax refunds.

What else stays out of landed cost?

Delivery to unrelated customers and other selling costs stay out for everyone. Off-site storage, purchasing and handling costs stay out for a small business.

• Advertising, marketing, other selling costs and delivery to unrelated customers are not added to inventory (26 CFR 1.263A-1(e)(3)(iii)(A)).
• Off-site storage, purchasing and handling (such as repackaging) costs are not required in stock cost for a taxpayer whose average annual gross receipts for the three prior years are no more than $32,000,000 and that is not a tax shelter (26 U.S.C. 263A(i); 26 CFR 1.263A-1(j)). Above the limit, a reseller generally must add part of them to stock, with exceptions for on-site storage and for handling at a retail store for goods sold there (26 CFR 1.263A-3(c)).

How do I record shipping costs for inventory purchases and spread them across items?

If you carry stock in your books, charge each cost to the stock it belongs to: directly when the bill names the item, by a steady spread when one bill covers several.

1. Record each supplier invoice by item and quantity.
2. Post freight, duty, broker and sales tax bills to the stock they relate to, not to an expense account. A holding account works until you allocate them.
3. Charge a cost directly to an item when the bill names it, such as duty on one product.
4. Spread a shared cost, such as one freight bill for several products, on one basis.
5. Divide each item's total cost by the units received. That is its landed cost per unit.
6. When units sell, move their landed cost to COGS.

The entries:

Bases for spreading a shared bill:

The rules name no formula for spreading a shared bill. For stock a small business treats as non-incidental materials and supplies, the regulation allows "specific identification or any other reasonable method" (26 CFR 1.471-1(b)(4)(iii)), and Publication 538 requires an inventory method that clearly reflects income and is used the same way every year. Pick the basis that matches what drove the charge, write it down and keep it.

To say which units sold, use specific identification when you can match costs to items; otherwise a flow assumption such as first-in first-out applies (Publication 538).

What happens to freight and duty on stock I have not sold by year end?

Freight and duty on stock you have not sold stay in ending inventory and reach COGS in the year the units sell.

COGS is beginning inventory plus purchases and other costs, minus ending inventory (Publication 334, chapter 6). Inventory valued at cost uses the invoice price plus transportation and other charges to acquire the goods (Publication 538), so each unsold unit is counted at its landed cost. Counting it at the invoice price alone overstates COGS for the year. Next year's opening inventory is this year's ending figure, so those costs come out when the units sell. A small business that skips a formal inventory has different timing, covered next.

Two year-end traps:

• Stock in transit. A business that keeps a formal inventory includes purchased goods once title (ownership) has passed to it, even if they have not arrived (26 CFR 1.471-1(a)). The freight and duty on those goods go with them. Keep the supplier's shipping terms to show when title passed.
• Late bills. A freight or broker bill that arrives after year end can belong to goods already received. Collect them before closing the year.

Can a small business just expense freight and duty?

Only under a permitted method. A small business taxpayer, with average annual gross receipts no more than $32,000,000 for the three prior years and not a tax shelter, may skip a formal inventory, but it must still use a method that clearly reflects income (Publication 334, chapter 2; 26 CFR 1.471-1(b)). The limit is indexed each year, so IRS publications printed for an earlier year show a smaller figure (IRB 2025-45). How receipts are counted is in inventory or supplies.

Only the last method can let freight and duty be deducted when paid or incurred, and only if the books expense them. It works cost by cost: books can hold invoice cost in stock and still expense freight. But books that use a stock count to allocate cost, or that report a stock figure drawn from it to a lender or to shareholders, can be read as capitalizing those costs, and the return must then follow (26 CFR 1.471-1(b)(6)(i) and (iii)). See inventory or supplies for the choice. Changing from one method to another generally needs Form 3115, the IRS form for a change in accounting method (Publication 334).

When does landed cost need a professional?

When freight, duty or tax were expensed in earlier years, when receipts pass the small-business limit, or when one bill covers many orders.

• Freight, duty or tax were expensed in earlier years. If the same costs were expensed on two or more filed returns, that treatment is usually the business's accounting method, and moving them into stock is a method change filed on Form 3115 with a section 481(a) catch-up adjustment. An automatic change goes with the return for the year of change, filed on time including extensions, and a signed copy goes to the IRS National Office by the same date (Instructions for Form 3115; Publication 334; 26 CFR 1.446-1(e)(2)(ii)(a)). A single year's slip is generally corrected differently, so the number of returns matters; see fixing inventory missing from past returns. If past returns deducted costs that this year's opening stock also includes, the same cost is deducted twice.
• Receipts above the small-business limit. The capitalization rules add purchasing, handling and off-site storage costs, and allocating them takes a method (26 CFR 1.263A-3).
• Many suppliers and partial shipments. One freight bill, duty entry or broker statement can cover several orders. Each cost must follow the units it relates to, not the date of the bill.
• Imports from a related company. Costs counted in both the stock's cost and its customs value cannot be higher for tax than for customs (26 U.S.C. 1059A); see the imported goods and equipment guide.
• Supplier credits and duty refunds. Trade discounts must reduce cost (Publication 538). A refund of duty reduces the cost of goods still on hand. For goods already sold, the IRS has published no guidance on tariff refunds, but its ruling on floor-stock payments treats payments tied to goods whose cost was already in cost of goods sold as income under the tax benefit rule (Rev. Rul. 2001-8), and the part of the earlier cost that gave no tax benefit is excluded (26 U.S.C. 111). CBP explains how importers claim IEEPA duty refunds; the imported goods and equipment guide covers how a tariff refund is booked.

Example

All figures are in US dollars and are illustrative.

A 2,000-unit import

A seller that keeps a formal inventory imports 2,000 units to resell.

By year end 1,500 units have sold. COGS is 1,500 × $11.70 = $17,550, and the 500 units on hand carry $5,850 into ending inventory.

If a business that keeps a formal inventory had expensed the $3,400 of freight, duty and broker fees and only the $20,000 invoice held as stock, COGS would be $15,000 plus the $3,400 expense, an $18,400 deduction, and ending inventory would be $5,000. This year's deduction is $850 too high; the difference reverses when the 500 units sell.

Sales tax on stock

A retailer buys $10,000 of stock and pays $800 of sales tax because it gave the seller no resale certificate. The stock's cost is $10,800, not $10,000. If 60% of it sells, COGS is $6,480 and $4,320 stays in ending inventory. The $800 is not deducted on its own as a tax.

One freight bill, two products

One $2,000 freight bill covers product A (1,000 units, $30,000 of invoices) and product B (500 units, $10,000 of invoices). Spread by invoice value, A takes $1,500 ($1.50 a unit) and B takes $500 ($1.00 a unit), so landed costs are $31.50 and $21.00 a unit. If the carrier billed by weight and B is bulky, weight may be the more reasonable basis.

Different for you?

• You import or buy in bulk, freight, duty or sales tax were expensed for years, or the margin on a return looks too good: each product's cost, the spreading method, the year-end stock value and any correction to earlier returns depend on records that may need rebuilding. Get bookkeeping help. If past returns showed no inventory at all, see fixing inventory missing from past returns.
• You paid duty on stock and expect a refund: which units the refund relates to, and the year it belongs in, depend on your entry records. Get bookkeeping help.
• Your gross receipts are above the small-business limit, or stock comes from many suppliers in partial shipments: the capitalization rules and the cost spread need a method set once and used every year. Get bookkeeping help.
• You import equipment you keep, or buy from a related company abroad: see tariffs and duties on imported equipment.
• You are a Canadian corporation shipping duty-paid to US customers: see tariffs and duties when shipping to US customers.
• Your stock sits at a marketplace fulfillment center: see fulfillment fees and inventory.
• A supplier charged sales tax on stock you could have bought for resale: see resale certificates and sales tax refunds.
• You make what you sell: see cost of goods sold for handmade products.
• You are choosing between expensing stock and holding inventory, or entering the result on Schedule C: see inventory or supplies and Schedule C cost of goods sold.
• Your business files in Canada, or you buy stock in US dollars for a Canadian business: see cost of goods sold and inventory for a sole proprietor and US-dollar inventory cost in Canadian books.