Guide

Overhead expenses and cost of goods sold: what the IRS says

Rent, utilities, insurance and similar costs of running a place of work are called overhead. The IRS has a specific rule for when overhead counts as part of cost of goods sold. Here is what that rule says and how it differs for a seller who only buys and resells.

General information only, not legal or tax advice. I am not a CPA or an attorney. This page summarizes IRS Publication 334 and does not say how any cost applies to your return.

What the IRS says

Publication 334, Tax Guide for Small Business, lists overhead expenses under the cost of goods sold section for Schedule C (Line 39, Other costs). It gives these examples of overhead: rent, heat, light, power, insurance, depreciation, taxes, maintenance, labor and supervision.

The rule it states is that overhead expenses which are direct and necessary expenses of the manufacturing operation are included in cost of goods sold. The IRS source is Publication 334, Line 39, Overhead expenses.

For the whole path from sales to profit, including regular business expenses, see business expenses for resellers.

Why it matters

Cost of goods sold is subtracted from sales to find gross profit. A cost that belongs in cost of goods sold is handled differently from an ordinary business expense, so the category a cost falls into changes where it is reported. See supplies and equipment: how the costs are usually handled for how cost of goods sold, supplies and equipment differ.

Makers versus resellers

The rule is written about a manufacturing operation, meaning a business that makes or changes goods. That is the line to watch:

• You make, refurbish, repair or assemble the goods you sell (crafts, candles, restored furniture, repaired electronics). Part of your workshop or studio costs may be overhead of the operation that produces the goods. Whether and how much is a question for a CPA.
• You only buy finished goods and resell them as they are. Your cost of goods sold is mainly what you paid for the inventory you sold (see the formula below). Most resellers do not have a manufacturing operation, so this overhead rule often does not apply to them in the way it does to makers. Confirm with a CPA, because some activities that look like simple resale, such as repackaging or kitting, can blur the line.

Mixed businesses are common. A seller who resells most items but restores some of them has both situations in one year.

The basic formula

The IRS describes cost of goods sold as beginning inventory, plus purchases and other costs added to inventory, minus ending inventory. Because ending inventory is subtracted, overhead that belongs in cost of goods sold follows the goods. It is not simply an expense on the day you pay it.

The IRS also has rules called the uniform capitalization rules, which in some cases require certain indirect costs to be added to the cost of inventory. Publication 334 describes an exception for small business taxpayers that depends on average gross receipts, and the dollar limit is adjusted over time. I did not verify the current limit from an IRS page for this guide, so read the Uniform Capitalization Rules and Inventories sections of Publication 334 or ask a CPA whether the exception applies to you.

What to keep separate

• Do not count a cost twice. A cost reported as part of cost of goods sold should not also be listed as a separate expense.
• Selling costs have their own categories. Platform fees, postage to customers and advertising are separate categories, not overhead of making goods.
• Mixed-use space. If one room is used to make goods and also for something else, note how you divided the rent and utilities and keep the reasoning.
• Home office or home workspace. Home-related deductions have their own rules. Ask a CPA before assigning household costs to production.

Records to keep

• Rent, utility, insurance and maintenance bills, with dates and vendors
• Notes on which space and which hours were used for production
• Payroll or contractor records for any labor and supervision tied to making the goods
• Inventory counts at the start and end of the year, and a record of what you paid for each item (see the SKU guide)

Questions for your CPA

• Do I have a manufacturing operation, or only resale?
• Which of my overhead costs belong in cost of goods sold, and which are regular expenses?
• Does the small business exception to the uniform capitalization rules apply to me?
• How should I divide costs for a space I use for production and for other things?

I am not a CPA or an attorney

This page is general information, not legal or tax advice. It does not say what you can deduct or how to report any cost. Tax rules change each year and depend on your situation, so check with a CPA and the IRS. Flipfiled helps with registrations and filings from information you provide. It does not prepare tax returns.

Sources: IRS Publication 334, Tax Guide for Small Business (Line 39, Overhead expenses; Inventories; Uniform Capitalization Rules). The overhead list and the manufacturing-operation rule are from this publication as quoted to me by the site owner; I could not open that section myself, so confirm the wording on the IRS page. The statements about resellers and about repackaging are general observations, not IRS statements. Checked Oct 29, 2026.