IRS Form 1125-A – In the world of business taxation, accurately calculating and deducting the cost of goods sold (COGS) is essential for reflecting your true income and minimizing tax liabilities. If your business manufactures, purchases, or sells merchandise, IRS Form 1125-A plays a pivotal role. This form helps corporations, cooperatives, S corporations, and partnerships compute COGS, which directly impacts your taxable income on returns like Form 1120 or 1065.
As tax laws evolve, staying compliant with the latest requirements is crucial. For the 2025 tax year, Form 1125-A (revised November 2024) introduces nuances for small businesses, including simplified inventory methods. In this comprehensive guide, we’ll break down everything you need to know about IRS Form 1125-A, from eligibility to line-by-line instructions, inventory valuation, and best practices. Whether you’re a seasoned accountant or a small business owner, this resource will help you file confidently.
Download the official Form 1125-A PDF here: IRS.gov.
Who Must File IRS Form 1125-A?
Not every business needs to file Form 1125-A—it’s specifically for those claiming a COGS deduction. According to the IRS, you must complete and attach this form to your tax return if you’re filing:
- Form 1120 (U.S. Corporation Income Tax Return)
- Form 1120-C (U.S. Income Tax Return for Cooperative Associations)
- Form 1120-F (U.S. Income Tax Return of a Foreign Corporation)
- Form 1120-S (U.S. Income Tax Return for an S Corporation)
- Form 1065 (U.S. Return of Partnership Income)
- Form 1065-B (U.S. Return of Partnership Income, for certain older filers)
The key trigger? If the production, purchase, or sale of merchandise is an “income-producing factor” in your business, inventories are required at the beginning and end of the tax year. This applies under Regulations section 1.471-1(a). Exceptions exist for small business taxpayers (average annual gross receipts of $26 million or less over the prior three tax years), who can use simplified methods like treating inventory as non-incidental materials and supplies.
Failing to attach Form 1125-A when required can lead to IRS scrutiny, penalties, or disallowed deductions. Always cross-reference with your main return’s instructions—for example, Form 1120 filers enter the COGS amount from line 8 of Form 1125-A on line 2 of their return.
What Is Cost of Goods Sold (COGS) and Why Does It Matter?
Cost of goods sold represents the direct costs attributable to the production or purchase of goods you sell during the tax year. It includes inventory costs, labor, materials, and certain indirect expenses. Subtracting COGS from your gross receipts gives you gross profit, a foundational metric for your income statement and tax return.
For tax purposes, COGS isn’t just an expense—it’s a deduction that lowers your taxable income. Accurate reporting ensures compliance with accrual accounting rules, where sales and purchases must match to “clearly reflect income.” Miscalculating COGS can inflate your tax bill or trigger audits, especially if inventory methods change without proper adjustments.
Under the uniform capitalization rules (UNICAP) of section 263A, many businesses must capitalize additional costs (like indirect labor or overhead) into inventory, deferring deductions until goods are sold. Small businesses are exempt from full UNICAP if they meet the gross receipts test (section 263A(i)).
Step-by-Step Guide: How to Fill Out IRS Form 1125-A?
Form 1125-A is straightforward but requires precise calculations. Use accounting software or spreadsheets for accuracy, and retain supporting records like invoices and inventory logs. Here’s a line-by-line breakdown based on the November 2024 revision.
Part I: Cost of Goods Sold
This core section computes your deductible COGS. Gather your beginning inventory, purchase records, labor costs, and ending inventory valuation.
| Line | Description | How to Calculate/Fill |
|---|---|---|
| 1 | Inventory at Beginning of Year | Enter your opening inventory value. If changing accounting methods (e.g., from cash to accrual), refigure last year’s closing inventory and note any section 481(a) adjustment. |
| 2 | Purchases | Total cost of merchandise bought for resale, minus personal withdrawals. For partnerships, report partner distributions on Schedule K/K-1. |
| 3 | Cost of Labor | Direct labor costs for producing goods (e.g., assembly line wages). Exclude indirect or administrative labor. |
| 4 | Additional Section 263A Costs | Capitalizable costs under UNICAP not on lines 2–3 or 5 (attach schedule). For simplified methods, include off-site storage, handling, or admin costs (see Regs. 1.263A-1–3). |
| 5 | Other Costs | Any remaining direct costs (attach schedule). Cooperatives: Include deductible per-unit retain allocations (section 1383). |
| 6 | Total (Lines 1–5) | Simple addition. |
| 7 | Inventory at End of Year | Closing inventory value, including UNICAP adjustments. |
| 8 | Cost of Goods Sold | Subtract line 7 from line 6. Transfer to your main return (e.g., Form 1120, line 2). |
Tip: Attach schedules for lines 4 and 5 if costs exceed basic entries. For cooperatives, detail per-unit retains separately.
Part III: Additional Information
Part II (Inventories) is integrated here—no separate section. Answer these yes/no questions to disclose methods and changes:
- Line 9a: Check your closing inventory valuation: (i) Cost, (ii) Lower of cost or market, (iii) Other (explain), or small business options (iv)–(vi) like non-incidental supplies or book method.
- Line 9b: Writedown of subnormal goods? (E.g., damaged items valued below cost.)
- Line 9c: Adopted LIFO this year? Attach Form 970.
- Line 9d: LIFO users: Report LIFO inventory and reserve (FIFO minus LIFO value).
- Line 9e: Subject to section 263A? (Yes/No—most producers/resellers are.)
- Line 9f: Change in inventory determination? Explain if yes.
What’s New for 2025: Small businesses must now specify alternative methods on line 9a(iv)–(vi) for tax years after December 31, 2023.
Inventory Valuation Methods: Choosing the Right Approach
Valuing inventory correctly is the backbone of COGS. The IRS requires methods that conform to GAAP and clearly reflect income. Common options include:
- Cost Method: Invoice price + freight – discounts. Includes all direct/indirect production costs under UNICAP.
- Lower of Cost or Market (LCM): Use the lower value to avoid overstating assets. Market = replacement cost or net realizable value.
- LIFO (Last-In, First-Out): Matches recent costs to sales; ideal for inflation. Requires IRS election via Form 970. Watch for LIFO recapture on S corp conversions.
- FIFO (First-In, First-Out): Assumes oldest costs sold first; ending inventory reflects current prices.
- Retail Method: For retailers—estimates cost via markup percentages on retail values.
Small businesses can opt for simpler treatments, like cash method conformity. Changes require Form 3115 approval and may trigger a section 481(a) adjustment to spread income/deductions over four years.
For subnormal goods (e.g., obsolete stock), writedown to net selling price minus disposal costs. Always perform physical counts periodically.
Uniform Capitalization Rules (UNICAP): What You Need to Know?
Section 263A mandates capitalizing costs like indirect labor, utilities, and depreciation into inventory for producers or resellers. This prevents immediate expensing. Exemptions apply to:
- Small businesses (gross receipts ≤ $26M).
- Personal-use property.
- Certain farming or research costs.
Simplified methods (production or resale) allocate costs via formulas—see Regulations 1.263A-1 through -3. Track these in lines 4 and 7 of Form 1125-A.
Common Mistakes to Avoid When Filing Form 1125-A?
- Inconsistent Methods: Switching without Form 3115 can lead to recharacterization.
- Forgetting UNICAP: Non-exempt businesses risk understating COGS and overpaying taxes.
- Poor Documentation: No schedules for “other costs” invites audits.
- LIFO Errors: Failing to report reserves or recapture tax on conversions.
- Small Business Oversight: Not checking simplified boxes on line 9a post-2023.
Consult Pub. 538 for deeper dives on accounting periods and methods.
Frequently Asked Questions (FAQs) About IRS Form 1125-A
1. Can small businesses skip inventory altogether?
Yes, if gross receipts ≤ $26M, treat as materials/supplies or use book methods (line 9a(iv)–(vi)).
2. What’s the deadline for attaching Form 1125-A?
Same as your main return—e.g., March 15 for calendar-year S corps (extendable to September 15).
3. How does COGS affect my tax return?
It reduces gross income on line 2 of Forms 1120/1065, lowering overall tax.
4. Need help with LIFO adoption?
File Form 970 with your return; include inventory details.
5. Where can I find more resources?
- IRS About Page: Form 1125-A Overview
- Pub. 538: Accounting Periods and Methods
Final Thoughts: Streamline Your COGS Reporting Today
Mastering IRS Form 1125-A ensures accurate COGS deductions and audit-proof filings. With options for small businesses and clear UNICAP guidance, the 2025 form simplifies compliance for most. Review your records early, consider professional advice for complex inventories, and download the latest version to stay current.
For personalized tax strategy, consult a CPA. Questions? The IRS resources above are your best starting point.
This article is for informational purposes only and not tax advice. Tax laws change; verify with IRS.gov for your situation.