Cost of goods sold on Schedule C, for a handmade shop

Last updated July 2026 · For US-based handmade sellers

Schedule C has a section called Part III, Cost of Goods Sold. If you make what you sell, that section is the whole reason your tax return is more annoying than a reseller's. A reseller buys a thing for $8 and sells it for $20; their cost of goods sold is $8 and the arithmetic is over. You bought a 20-yard bolt of fabric in March, used part of it across nine different products, still have some of it, and sold six of those products in a year that also had a batch you scrapped.

Part III wants one number out of that. Here is what it is actually asking.

The structure, in plain terms

Part III works out what the goods you sold cost you, by starting from everything you had and had bought, then subtracting what you still have left:

The logic is not accounting trickery, it is a physical statement: what I had, plus what I got, minus what I still have, is what went out the door. Everything difficult about it comes from needing to know what you still have, and what it cost.

The part that surprises handmade sellers: your own hours are not in there

The cost of labor line is for wages and compensation paid to employees. The IRS instructions state it directly: do not include amounts paid to yourself. As a sole proprietor you are not your own employee, so the 40 hours you spent making inventory last month is not a deductible cost of goods sold.

Why "just add up the receipts" does not work

Three specific reasons, all of them structural rather than a matter of being disorganised.

1. A purchase is not a cost until it is sold

If you spent $600 on materials in December for a January product run, most of that $600 is not cost of goods sold for the year you spent it — it is inventory you are still holding. Treating purchases as costs in the year you bought them overstates your expenses in a heavy buying year and understates them in the year you actually sell.

2. One purchase splits across many products, unevenly

The bolt of fabric becomes part of nine products at different consumption rates. To know what the six you sold cost, you need a per-unit material cost for each product — effectively a recipe. Nobody can reconstruct that in April from a shoebox of receipts, because the information needed (how much of what went into which) was never written down at the time.

3. Ending inventory is a physical count you have to actually do

The figure for what you were holding on 31 December is not derivable from receipts. It comes from counting what is on your shelves and valuing it. If you have never done this, the first year is the hard one, because the beginning-of-year figure has to come from somewhere too.

What to track during the year so January is not a reconstruction project

The whole problem collapses if four things are recorded as they happen instead of remembered afterwards.

1. Every material purchase, with quantity and unit. Not "$47 at the craft store" — "4 yards linen at $11.75/yd". Without a unit cost you cannot cost a product later.
2. A recipe per product. How much of each material one unit consumes. Write it once, when you design the product. It changes rarely.
3. What you made, and when. Finishing 12 candles converts materials into inventory. That event is what the form is tracking.
4. What you sold. Your Etsy order export already has this. Combined with the recipes, it tells you what the sold items cost.

With those four, the year-end figure is arithmetic. Without them, it is archaeology.

The other section: fees are expenses, not COGS

Etsy's transaction fee, payment processing, listing fees, and Offsite Ads are generally business expenses reported elsewhere on Schedule C — not part of cost of goods sold, which is about what the goods themselves cost to produce. This matters because it means your Etsy fee total and your COGS total are two separate figures you need, and mixing them produces a return that is wrong in both places.

If you want to see what those fees actually take from a sale, we worked three products out to the cent here: Etsy fees in 2026 and what you actually keep.

The honest summary

Cost of goods sold is not difficult conceptually. It is difficult because it requires information that has to be captured at the moment it happens — unit costs, recipes, production, sales — and almost nobody starts a handmade shop by setting that up. The sellers who find tax season bearable are not better at tax. They wrote down four things during the year.