1099-K and Cost of Goods Sold: Why Gross Sales Isn't Profit

Why does my 1099-K show far more than I made?

Form 1099-K reports gross payments, not profit. Box 1a adds up each transaction at its full amount, with no reduction for fees, credits, refunds, shipping or discounts (Instructions for Form 1099-K; 26 CFR 1.6050W-1).

The form also knows nothing about what you paid for the goods, and it can include money that was never sales income, such as sales tax collected from buyers (Publication 334). The gap to profit is usually ordinary. In order: report the sales, subtract refunds, subtract the cost of the goods you sold, subtract fees, postage and other business costs, and what is left is net profit.

A case needs more than subtraction when forms came from several platforms for the same sales, you never counted stock or kept supplier invoices, earlier returns reported the gross with no cost of goods sold, or the IRS has already proposed tax on the gross. Selling as a hobby rather than a business changes the bridge: cost of goods sold can still reduce hobby income, but most hobby expenses, such as fees and postage, cannot be deducted, and self-employment tax does not apply (26 U.S.C. 67(h); 26 CFR 1.183-1(e); 26 U.S.C. 1402(a); hobby or business).

Gather first:

• every Form 1099-K, and each platform's order-level reports;
• supplier invoices, receipts for materials if you make what you sell, and bank or card statements for what you bought to sell;
• last year's closing stock and a count of what you hold now;
• records of refunds, fees and postage.

Do I report the 1099-K amount, and where does it go on Schedule C?

Yes: report the sales on Schedule C, line 1 (gross receipts). That is what the form shows for goods sold, plus any sales no form reported (IRS: What to do with Form 1099-K; Instructions for Schedule C). A single-member LLC owner is a sole proprietor for this purpose unless the LLC elected corporate treatment (Publication 334). Partnerships and corporations report on their own returns; see income tax for online sellers.

Do not skip the form: the IRS gets its own copy and compares it with returns (IRS: CP2000 notice). Do not enter only profit or payouts either, because line 1 asks for gross receipts. The IRS generally has 3 years after a return is filed to assess more tax. Leaving out more than 25% of the gross income stated on a return can extend that to 6 years, and for a business that gross income is receipts before cost of goods sold (26 U.S.C. 6501(a) and (e)).

Remove an amount from line 1 only when a record shows it was not business sales: gifts, reimbursements, cash back given at checkout, sales tax imposed on the buyer, or personal items you sold (IRS: What to do with Form 1099-K; Publication 334). The Form 1040 instructions send gifts, reimbursements and personal items sold at a loss to the entry space at the top of Schedule 1, and a personal item sold at a gain to Form 8949 and Schedule D (Instructions for Form 1040). See personal items sold at a loss and hobby or business.

How do I get from the 1099-K to my real profit?

Start with true sales, then work down Schedule C in this order. Each step needs a record you can produce.

A business that sells only services generally has no cost of goods sold (Publication 334). Line numbers come from the latest published Schedule C; check them on the form for the year you file.

Where do platform fees, shipping costs and refunds go?

Refunds reduce sales on line 2, platform fees and postage are expenses, shipping you charge stays in sales, and freight to bring goods in is part of cost of goods sold. The IRS lists fees, refunds and shipping among the amounts you can deduct from the form's gross amount (IRS: What to do with Form 1099-K); the table shows where each lands on Schedule C.

Duties and packaging are in landed cost in cost of goods sold. Matching payouts to sales in the books is in reconciling sales and payouts.

What is cost of goods sold, and where does it sit on Schedule C?

Cost of goods sold is what you paid for the goods you sold during the year, not for everything you bought. It goes in Part III of Schedule C, and line 42 carries to line 4 (Schedule C). For a business that sells goods, gross income is total sales less cost of goods sold, and selling expenses are not part of that subtraction (26 CFR 1.61-3), so fees and postage stay in Part II.

When buying, making or selling goods is how you earn income, you must generally account for inventory at the start and end of the year. A small business taxpayer (average annual gross receipts of $32,000,000 or less over the three prior years, and not a tax shelter) may skip the formal inventory but must still use a method that clearly reflects income (Instructions for Schedule C; Publication 334). The methods that qualify, Part III line by line and how to count stock are in cost of goods sold on Schedule C.

How do I work out cost of goods sold for the year?

Add the stock you started with to what you bought, then subtract the stock you still hold (Publication 334).

Beginning stock usually equals last year's ending stock; explain any difference. Purchases and freight-in come from supplier invoices. Ending stock comes from a count at year-end. If you make what you sell, materials and the labor of people you pay count too, but not amounts paid to yourself (Schedule C). The cost is what you paid, never the sale price or the form's gross amount.

Count on written lists of each item's description, quantity, unit price and value, kept as a permanent record (Publication 334). Part III line by line and valuing stock are in cost of goods sold on Schedule C; Example 2 shows the arithmetic.

What if I never tracked stock or kept receipts?

Cost of goods sold still has to be supported, by records or by a reconstruction you can explain. The regulations require records, including inventories, enough to establish gross income and deductions (26 CFR 1.6001-1), and the IRS lists canceled checks, receipts, card slips and invoices as support for inventory cost (Publication 583).

When those are missing, rebuild from what exists:

• supplier and platform order histories;
• bank and card statements that show supplier payments;
• a count of what you hold today, valued at cost; add the cost of what you sold since year-end and subtract the cost of what you bought since, to estimate year-end stock;
• the platform's sales by item.

Then test the result: divide gross profit by net receipts and compare it with your usual markup, since a large gap points to an error in sales, purchases or stock (Publication 334). Write down how each year's figure was built.

The IRS pages above set no method for reconstructing missing cost, so what an examiner accepts depends on the facts. Years of resale without stock records are in cost of goods sold without records.

What if I got 1099-Ks from several platforms for the same sales?

Count each sale once. A seller can hold a form from a card processor, which reports at any amount, and one from each marketplace or payment app over $20,000 in more than 200 transactions; a platform may send one below that (IRS: Understanding your Form 1099-K). For forms that cover different transactions, the IRS says to use all of them and your own records to work out your actual tax (IRS: Form 1099-K FAQs).

One transaction should appear on one form only: when more than one entity could report it, the one that sends the instruction to transfer the funds to the seller's account files, unless the parties agree in writing that another files for it (26 CFR 1.6050W-1; Instructions for Form 1099-K). If the same orders show on two forms, the form totals overstate sales.

1. List each form's issuer, box 1a, box 3 (transactions), box 4 (backup withholding, claimed on your return as tax paid) and monthly boxes 5a to 5l (Instructions for Form 1099-K; Instructions for Form 1040, line 25b).
2. Match each to the platform's order-level report and mark orders that appear on more than one form.
3. Report each sale once on line 1.
4. Ask the issuer of the form that should not have included the repeated orders for a corrected form. The IRS cannot correct it (IRS: What to do with Form 1099-K). If none arrives, file anyway. The Form 1040 instructions put an amount a form included in error in the entry space at the top of Schedule 1, and only the part in error when the rest of the form is right; the true sales stay on Schedule C (Instructions for Form 1040; IRS: What to do with Form 1099-K). Check that the form for your year has the entry space, and keep the order-by-order match as your answer if the IRS asks.

Other form errors are in wrong or corrected platform forms.

Is self-employment tax figured on gross sales or on profit?

Self-employment tax is figured on net profit, not gross sales: the business's gross income minus ordinary and necessary business expenses (IRS Topic 554). The rate is 15.3% on 92.35% of that profit, with the Social Security part capped each year, and it generally applies once the result reaches $400 (Schedule SE, line 4c). Schedule C line 31 carries to Schedule SE (Schedule C).

A return that shows the gross with no cost of goods sold would overstate this tax as well as income tax if the business had supported costs. A cost the IRS cannot verify may be disallowed, which is why the records above matter.

What if the IRS notice shows more income than my return?

Answer a CP2000 notice with records that tie the form to profit. It means income that third parties reported does not match the return; it proposes changes, is not a bill, and may need a response (IRS: CP2000 notice). A 1099-K gross larger than the sales on the return can cause one, for example when a seller entered net payouts or profit on line 1. Any other letter, such as an examination letter, has a different reply, so bring it to individual tax help before answering.

Reply by the date printed on the notice; the IRS manual sets it at 30 days from the notice date, and staff can give 30 days more on request. If the return already claimed returns, cost of goods sold and expenses, disagree on the response form and send the bridge from form to profit: forms, platform reports, invoices and the stock count. If the return left costs unclaimed and the notice is otherwise correct, the IRS says to file Form 1040-X with "CP2000" written on top and send it with your reply. How to agree, disagree or amend, and what a missed date means, is in answering an IRS underreporter notice.

Can I fix a return I already filed on the gross?

You may be able to: Form 1040-X corrects a filed return (IRS: About Form 1040-X), and a return that reported the gross with no cost of goods sold can be corrected when each cost is supported by records. If the earlier returns deducted the purchases somewhere else, such as supplies, two or more consecutive years of that can be an accounting method, and a method is changed with Form 3115, not by amending (Rev. Proc. 2015-13, section 2.01; fixing inventory missing from past returns). A refund claim generally has to be filed within 3 years after filing the original return or 2 years after paying the tax, whichever is later (IRS: Time you can claim a credit or refund).

Each year has its own sales, purchases and stock count, so each year's cost needs its own support. Whether to amend, which years and by how much is in amending a return for business expense mistakes.

Example

Figures are in US dollars and are illustrative. Minus signs show what is subtracted; the form takes each amount as a positive number.

An online craft seller

The form shows $60,000, and the seller's records confirm all of it is real sales, including shipping buyers paid. The seller gave $4,000 of refunds, paid $20,000 for the goods sold, and paid $7,000 in platform fees and $4,000 in postage.

Self-employment tax follows the $25,000 profit, not the form's $60,000: about $3,500 (92.35% of the profit at 15.3%), before income tax and any other income.

A reseller with a stock count

The reseller sold $30,000 of goods with no refunds. Beginning stock cost $5,000, purchases were $22,000 and ending stock cost $7,000, so cost of goods sold is $5,000 + $22,000 - $7,000 = $20,000. Gross profit is $10,000, and $3,000 of platform fees leave $7,000 of net profit.

The same sales on two forms

A seller gets a marketplace form for $18,000 and a payment-app form for $12,000. The order reports show $12,000 of the marketplace orders were paid through the payment app, so those orders appear on both forms. True sales are $18,000, not $30,000.

Line 1 shows $18,000, followed by returns, cost of goods sold and expenses. The seller asks the issuer that should not have reported the repeated orders for a corrected form and keeps the order-by-order match. If no correction arrives, the $12,000 goes in the entry space at the top of Schedule 1, so the forms' $30,000 ties to the $18,000 on line 1.

Different for you?

• Filed returns show the gross with no cost of goods sold, or the IRS has proposed tax on the gross: each year's cost has to be supported before anything is amended or answered. Bring the notice, forms and records to individual tax help. Years never filed are in Schedule C expenses for unfiled years.
• You have no stock records, or years of resale: see cost of goods sold without records, then get individual tax help to settle each year's figure. To keep purchase, fee and stock records current, see bookkeeping.
• Forms came from several platforms, or the numbers will not reconcile: see wrong or corrected platform forms and reconciling sales and payouts. If the books are behind, see bookkeeping.
• Your shop runs on one handmade-goods marketplace: see bookkeeping for a handmade-goods shop.
• You may be a hobby seller, or sold personal items: see hobby or business and personal items sold at a loss.
• You sell through a partnership or corporation, or owe state or sales tax: see income tax for online sellers.