Guide · Tax year 2026 · Updated October 23, 2026
Materials and cost of goods sold for Etsy sellers
Your Etsy statements show what Etsy charged you, not what you spent on clay, yarn, silver or blanks. On Schedule C those costs usually go through Part III, Cost of Goods Sold, and its Line 42 total comes off your sales on Line 4. Here is how Part III works for a small maker, the option not to keep an inventory, and how a cost per unit lets you check the result.
Schedule C Part III → Line 4 · worked example
One year of materials, from inventory to gross profit
| Part III · Cost of Goods Sold | |
|---|---|
| 35Inventory at beginning of year materials and finished pieces on hand on January 1 | $600.00 |
| 36Purchases less cost of items withdrawn for personal use finished goods bought to resell; none in this shop | $0.00 |
| 37Cost of labor paid helpers only, never yourself | $0.00 |
| 38Materials and supplies clay, glaze and other materials bought during the year | $2,900.00 |
| 39Other costs | $0.00 |
| 40Add lines 35 through 39 | $3,500.00 |
| 41Inventory at end of year counted on December 31 | ($700.00) |
| 42Cost of goods sold Line 40 less Line 41; carried to Line 4 | $2,800.00 |
| Part I · Income | |
| 1Gross receipts or sales | $14,000.00 |
| 2Returns and allowances | ($380.00) |
| 3Subtract line 2 from line 1 | $13,620.00 |
| 4Cost of goods sold from Line 42 | ($2,800.00) |
| 5Gross profit | $10,820.00 |
How Part III adds up
The IRS instructions say that when making, buying or selling merchandise produces your income, you "must take inventories into account at the beginning and end of your tax year". Part III does that in three moves:
- Start with what you had (Line 35). This should equal last year's Line 41. If it doesn't, the form asks you to attach an explanation.
- Add what you bought (Lines 36 to 39). A maker's materials go on Line 38. Line 36 is for goods bought to resell, less anything you took for personal use. Line 37 is labor you paid others; the form says "Do not include any amounts paid to yourself."
- Subtract what's left (Line 41). What you didn't use or sell by year end is next year's opening inventory. The remainder, Line 42, is the cost of what you sold, and you carry it to Line 4.
Lines 33 and 34 ask how you valued closing inventory (cost, lower of cost or market, or another method) and whether that changed during the year. If you value what's left at what you paid for it, that's the "Cost" box.
Check Line 42 with a cost per unit
ShopYear's Profit by listing table has a "Cost per unit" column: what one piece costs you to make. Units sold times that cost gives the materials in what you sold, which is what Line 42 measures from the other direction.
Profit by listing → cost of units sold
Same shop, by listing
| Listing | Units × cost | Cost of units sold |
|---|---|---|
| Speckled stoneware mug | 400 × $4.00 | $1,600.00 |
| Hanging planter | 150 × $6.00 | $900.00 |
| Coaster set of 4 | 100 × $3.00 | $300.00 |
| Total (compare: Line 42) | 650 units | $2,800.00 |
- Close is good. Here the two agree because every piece of clay ended up in something sold or on the shelf at year end.
- A gap tells you something. If Line 42 is much higher, look for waste, broken or unsold pieces you didn't count, or a cost per unit that's out of date. If it's much lower, check your year-end count.
- The cost per unit is your estimate, not a tax figure. Line 4 comes from Part III. Use the per-listing figure to price and to sanity-check, not as the number on the form.
Not keeping an inventory: the small business option
If your shop qualifies as a small business taxpayer, you don't have to count stock every December 31. The instructions say a small business taxpayer "can choose not to keep an inventory", as long as the method still clearly reflects income. You qualify if your average annual gross receipts for the 3 prior tax years were $31 million or less (indexed for inflation) and you are not a tax shelter.
- Materials as supplies. One accepted method treats inventory as "nonincidental material or supplies". You then deduct what you paid for materials "in the year in which they are first used or consumed", not the year you bought them. Clay bought in December and first used in January is deducted the following year.
- Following your books. The other accepted method follows how your own books and records treat inventory.
- Which line? The instructions say when to deduct materials under this option, not which line to use. Ask your tax software or preparer, and keep to the same line every year.
- Switching methods means filing Form 3115, according to the instructions. Publication 538 has the details.
Line 22 supplies or Part III?
The form labels Line 22 "Supplies (not included in Part III)". The instructions let you deduct materials and supplies there "only to the extent you actually consumed and used them" during the year. Incidental supplies you keep no inventory or records of use for can be deducted when bought, if that clearly reflects income.
ShopYear's suggestion, not IRS text: what becomes part of the product goes in Part III; what the shop uses up without it ending up in the product goes on Line 22. The IRS text doesn't name packaging, tags or tape. Pick a line for each and don't use both.
Don't count it twice
- Materials in Part III aren't also on Line 22. Each receipt goes on one line.
- Etsy's charges stay in Part II. Fees and fee credits are on Line 10, Etsy Ads and Offsite Ads on Line 8, and shipping labels on Line 18 or Other expenses (Line 27b). Don't add them to Line 39 "Other costs". Every statement row, line by line.
- Your own time isn't Line 37. The form excludes amounts paid to yourself.
- Pieces you kept or gave away come out of Line 36 purchases, which the form labels "less cost of items withdrawn for personal use".
Sources
- IRS, Instructions for Schedule C (Form 1040) (2025): Part III and the small business taxpayer exception, Line 22, Lines 33 and 35, and capitalizing costs in Part II.
- IRS, Schedule C (Form 1040), 2025 form: labels for Lines 3, 4, 5, 22 and 33 to 42.
Line numbers are from the 2025 Schedule C, the latest published when this was written; the IRS can renumber lines. If something here no longer matches, tell us. This guide is not tax advice; check your return with your tax software or a tax professional.