You sell a $50.00 item on eBay. Your supplier charges you $28.00 for it, plus $4.00 to deliver it to your buyer. eBay takes its fees. You pay for a promoted listing. At the end of the year, which of those amounts is "cost of goods sold", which is an ordinary business expense, and does it change how much tax you owe?
For a dropshipper the answer is less obvious than for a shop with a stockroom, because you may never hold a single unit. The IRS publications never mention dropshipping by name. What they do contain is a clear definition of cost of goods sold, a line-by-line layout on Schedule C, and rules on inventory that you can apply to your own facts. This guide walks through them and marks the places where the published guidance stops and a preparer's judgment starts.
The short version
- Cost of goods sold (COGS) is the cost of the merchandise you sold. For a reseller, Publication 334 says to use the cost of all merchandise you bought for sale, and it counts freight-in on that merchandise as part of COGS.
- COGS is worked out in Part III of Schedule C (lines 35 to 42) and is subtracted from your net receipts to give gross profit. Selling and administrative costs are business expenses, deducted separately.
- Many small businesses do not have to keep a formal inventory: the IRS "small business taxpayer" exception applies to average annual gross receipts of $31 million or less over the 3 prior years (checked October 2026 in Publication 334 for 2025).
- Where a cost lands (COGS or expense) changes gross profit but, for most small sellers, does not change net profit, as long as the cost is deducted somewhere and the treatment is consistent.
- Returns, supplier credits, discounts, sales tax you pay on goods and items you take for personal use all have specific treatments, covered below.
1. What the IRS means by cost of goods sold
Publication 334 (Tax Guide for Small Business) says that if you make or buy goods to sell, you can deduct the cost of goods sold from your gross receipts on Schedule C. It applies to manufacturers, wholesalers and retailers, and to any business that makes, buys or sells goods to produce income. A business that only sells services does not figure COGS. Publication 583 (Starting a Business and Keeping Records) uses an even simpler definition of inventory: any item you buy and resell to customers.
For a merchant, line 36 of Schedule C is where purchases go: Publication 334 says to use the cost of all merchandise you bought for sale. That is the heart of COGS for a dropshipper. The unit you bought from the supplier to fill a buyer's order is merchandise bought for sale, whether it sat in your house or went straight from a supplier's warehouse to your customer's door.
Gross profit is then net receipts minus COGS. Publication 334 sets this out in order: gross receipts, less returns and allowances, gives net receipts; net receipts less COGS gives gross profit; business expenses come after that.
2. How Part III of Schedule C works
Part III of Schedule C, as reproduced in Publication 334, works like this:
| Line | What goes there |
|---|---|
| 35 | Inventory at the beginning of the year |
| 36 | Purchases, less the cost of items withdrawn for personal use |
| 37 | Cost of labor (not amounts paid to yourself) |
| 38 | Materials and supplies |
| 39 | Other costs |
| 40 | Add lines 35 through 39 |
| 41 | Inventory at the end of the year |
| 42 | Cost of goods sold: line 40 minus line 41 |
For a reseller, the lines that matter are 35, 36, 39 (freight-in) and 41. Publication 334 notes that labor on line 37 is usually a manufacturing item, and line 38 is for materials used in manufacturing goods.
What you had available to sell, minus what is still unsold at year end, is what you sold, and the cost of that is COGS.
3. What counts, and what does not
Counts as COGS (per Publication 334)
- The price you paid for merchandise you bought to resell. Use the price you actually paid, not the supplier's list price. Publication 334 says trade discounts reduce the cost of purchases.
- Freight-in. Freight-in, express-in and cartage-in on merchandise you purchase for sale are part of COGS.
- Sales tax you paid on the goods. Publication 334 says that if the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise.
- Opening inventory, and the value of closing inventory as the offset.
Reduces what you count
- Purchase returns and allowances. Publication 334 says you must deduct all returns and allowances from your total purchases during the year. If a supplier credits you for a faulty unit, it comes off purchases.
- Cash discounts. Amounts a supplier lets you deduct for prompt payment can be deducted from purchases or credited to a discount income account. Choose one method and use it every year.
- Merchandise taken for personal use. If you take an item for yourself or your family, remove its cost from purchases.
Does not count as COGS
- Selling and administrative costs. Publication 334 says business expenses are costs you do not have to capitalize or include in COGS but can deduct in the current year. Its list of other deductible expenses includes advertising, bank fees, supplies and materials, and utilities.
- Packaging that is not part of the product. The publication says containers and packages that are an integral part of a manufactured product belong in COGS, and if they are not, their cost is a shipping or selling expense.
- Sales tax you collect from buyers. Publication 334 says taxes imposed on the buyer that you collect and pay over are not deductions and not part of gross receipts when you are required to collect them.
4. Where dropshipping makes it fuzzy
None of the IRS pages we reviewed discuss dropshipping, so the following is how the published rules apply, not a special dropship rule.
The supplier's delivery charge
If your supplier's invoice has a separate delivery charge for sending the item to your buyer, is that "freight-in"? Publication 334 defines freight-in as freight on merchandise you purchase for sale. A charge for sending the goods to your customer is a delivery cost on goods you bought for sale, so it may reasonably be treated as part of the purchase cost. But the publications do not address direct-to-customer delivery, so ask your preparer which treatment they use and keep it consistent.
Using the opening example: sale $50.00, supplier price $28.00, supplier delivery $4.00, eBay fees $6.50 and promoted listing ads $2.50 (all illustrative figures, not real rates).
| Delivery in COGS | Delivery as an expense | |
|---|---|---|
| Sale price | $50.00 | $50.00 |
| COGS | $32.00 | $28.00 |
| Gross profit | $18.00 | $22.00 |
| Delivery, eBay fees and ads as expenses | $9.00 | $13.00 |
| Net profit | $9.00 | $9.00 |
Left column: $50.00 - $32.00 = $18.00, then $6.50 + $2.50 = $9.00, and $18.00 - $9.00 = $9.00. Right column: $50.00 - $28.00 = $22.00, then $4.00 + $6.50 + $2.50 = $13.00, and $22.00 - $13.00 = $9.00. Same net profit. The difference shows up in gross profit, which matters if you use gross margin to judge your pricing.
eBay fees and ad fees
eBay's selling fees are not the cost of the merchandise, so they are not COGS. The Schedule C instructions for line 10 say that a dealer in property, meaning someone who regularly sells property in the ordinary course of business, enters the commissions and fees paid to facilitate those sales on that line, and the Publication 334 list of other expenses includes advertising. How to label a particular eBay fee is a question for your preparer, but both routes lead to an expense deduction and neither belongs on line 36. Our guide to eBay fees for dropshippers lists what each fee is.
Outbound postage when you ship yourself
Postage to the buyer is not freight-in, because freight-in is the cost of getting goods to you. The pages we reviewed do not name outbound postage, so ask your preparer where they put it.
Inventory you hold
If you buy goods in advance (a bulk deal, a hold-for-pickup order, a few units kept to ship fast), those units are inventory. Publication 538 says purchased merchandise is included in inventory if title has passed to you, even if it is in transit, and goods ordered for future delivery are not included if you do not yet have title.
5. Do you have to keep inventory?
Generally, Publication 334 says that if you produce, purchase or sell merchandise you must keep an inventory and use an accrual method for purchases and sales. There is an exception for a small business taxpayer: one with average annual gross receipts of $31 million or less for the 3 prior tax years (indexed for inflation) that is not a tax shelter. Publication 334 for 2025 and the 2025 Schedule C instructions both give that figure. Publication 538, in its 2022 edition, gives an older $26 million figure, which is a reminder to read the current-year pages.
A small business taxpayer can choose not to keep an inventory, but must still use a method that clearly reflects income. One accepted route is to treat inventory as non-incidental materials and supplies, which means you deduct the cost in the year the goods are used or consumed, and Publication 334 says inventory is used or consumed in the year you provide it to your customers. The other is to follow your financial accounting treatment, which for a business without a formal financial statement means the method in your books and records.
For a pure dropshipper, who buys after the customer pays, year-end inventory is often zero or very small, so the practical difference between methods may be minor. Switching methods requires Form 3115, per Publication 334, so choose with a preparer's input.
Worth remembering: whichever method you use, Publication 334 says inventory practices must be consistent from year to year and must clearly reflect income. Consistency is the thing to protect.
6. A year of COGS on Schedule C (illustrative)
Here is a made-up year for a seller who ends the year with a little stock. All figures are invented to show the arithmetic.
| Item | Amount |
|---|---|
| Gross receipts (line 1) | $62,000 |
| Returns and allowances (line 2) | $1,500 |
| Net receipts (line 3) | $60,500 |
| Inventory at start of year (line 35) | $0 |
| Purchases from suppliers | $41,800 |
| Less supplier credits for returned goods | $600 |
| Less cost of items taken for personal use | $120 |
| Purchases net (line 36) | $41,080 |
| Add lines 35 to 39 (line 40) | $41,080 |
| Inventory at end of year (line 41) | $900 |
| Cost of goods sold (line 42, line 4 on Schedule C) | $40,180 |
| Gross profit | $20,320 |
The sums: $62,000 - $1,500 = $60,500. $41,800 - $600 - $120 = $41,080. $41,080 - $900 = $40,180. $60,500 - $40,180 = $20,320. Business expenses such as advertising and fees come off the $20,320 afterwards.
The Schedule C instructions say line 2 returns are cash or credit refunds to customers for defective, damaged or unwanted products, and allowances are price reductions given instead of a refund. Refunds you pay to buyers are therefore not part of COGS; the matching supplier credit, if you receive one, is. Our guide to returns and refunds for dropshippers covers the operational side.
Publication 334 notes that a Form 1099-K may not be the amount you should report as income, because it may not include all your receipts and may include items, such as sales tax, that are not receipts. Reconcile your own sales records to your return. More in our guide to eBay seller taxes in the US.
7. Records that make COGS defensible
Publication 583 says supporting documents for inventory should show the amount paid and that it was for inventory, and lists documents such as invoices and credit card sales slips. For a dropshipper, a practical set is:
- Every supplier invoice or order confirmation, saved with the eBay order number it fulfilled.
- Supplier credit notes for returns and allowances.
- A count of any stock on hand at year end, with unit costs. Publication 334 recommends inventory forms or count sheets recording description, quantity, unit price and value.
A sanity check from Publication 334: compare your gross profit percentage with your usual markup. A large gap may mean sales, purchases or inventory were mis-recorded. The US eBay fee calculator and our guide to pricing listings for profit help you set that markup.
8. Common mistakes
- Putting eBay fees or ads into purchases. They are selling costs, not the cost of the goods.
- Ignoring supplier credits. Refunds from the supplier reduce purchases; leaving them out overstates COGS.
- Treating sales tax you collected as income or as a cost. Collected tax you must pay over is not gross receipts, and sales tax you pay on goods you resell is part of their cost.
Sellhelm, the eBay dropshipping software this blog belongs to, prices every listing from your real fees, which gives you a gross margin to test your books against.
Sources and how we checked
Facts in this guide were checked against these official pages in October 2026. Rules and figures change, so confirm anything that affects a decision. This is general information, not legal or tax advice.
- Publication 334, Tax Guide for Small Business (Internal Revenue Service)
- Instructions for Schedule C (Internal Revenue Service)
- About Schedule C (Form 1040) (Internal Revenue Service)
- Publication 538, Accounting Periods and Methods, January 2022 edition (Internal Revenue Service)
- Publication 583, Starting a Business and Keeping Records (Internal Revenue Service)
- Topic no. 305, Recordkeeping (Internal Revenue Service)
Questions people ask
What is cost of goods sold for a dropshipper?
For a reseller, Publication 334 says to use the cost of all merchandise bought for sale, plus freight-in on it. Part III of Schedule C turns that into a figure that is subtracted from net receipts to give gross profit.
Are eBay fees part of cost of goods sold?
No. eBay fees and advertising are selling costs, not the cost of the merchandise. They are deducted as business expenses. Where a specific eBay fee is labelled on Schedule C is a question for your tax preparer.
Do I have to keep inventory if my supplier ships directly?
Not necessarily. A small business taxpayer, with average annual gross receipts of $31 million or less over the 3 prior years, can choose not to keep a formal inventory. You must still use a method that clearly reflects income and apply it consistently.
Does the supplier delivery charge count as cost of goods sold?
Publication 334 counts freight-in on merchandise bought for sale as COGS, but the IRS pages we reviewed do not address direct-to-customer delivery. Ask your preparer, and stay consistent.
How do refunds to buyers and credits from suppliers appear?
Refunds you give buyers are returns and allowances on line 2 of Schedule C. Credits from your supplier for returned goods reduce purchases, per Publication 334. They are separate entries, so record both.