Inventory accounting for small sellers: §471(c), the cash method, and COGS

For product businesses, inventory accounting decides when you deduct your biggest expense. Smaller sellers have more options than many realize.

The small business gross receipts test

A business qualifies if its average annual gross receipts for the prior three years, counting related businesses under common control, don't exceed the inflation-adjusted threshold of $32 million for 2026. It also must not be a tax shelter, a term that can catch a loss-year LLC with passive investors. Qualifying businesses can:

• Use the cash method of accounting even with inventory.
• Choose a simplified inventory method under §471(c).
• Skip the uniform capitalization (§263A) rules.

Two simplified methods under §471(c)

1. Non-incidental materials and supplies. Inventory is deducted when the products are sold or, if later, when they are paid for. Unsold items stay on the balance sheet.
2. Method used in your books. Follow the inventory treatment in your applicable financial statement or, if you have none, your books and records. This method can allow simpler practices if it is applied consistently.

Under the first option, bulk-buying in December only helps if the goods sell. The books option can allow deducting purchases when paid, but only if your records genuinely expense them. If your financial statements, inventory counts, or reports to lenders or owners track inventory, you must follow those.

Key numbers: gross receipts test $32M for 2026 · uniform capitalization doesn't apply below the threshold · Form 3115 for method changes.

What belongs in COGS

• Product cost from the manufacturer.
• Inbound freight, customs duties, and tariffs to get goods to your warehouse.
• Packaging that ships with the product.
• Certain FBA fees tied to getting inventory ready for sale, depending on method.

Outbound shipping, advertising, and marketplace referral fees are operating expenses, not COGS.

Tariffs and landed cost

Higher tariffs on many imported goods have increased landed cost. Tariffs paid are part of inventory cost and are deducted as the goods sell, not when paid, unless you use the books option and your books expense them. Track landed cost per SKU so that margins and taxes are calculated correctly.

A worked example

A seller with $4M of receipts buys $1.6M of inventory in 2026, sells goods that cost $1.3M, and ends with $300,000 in stock. Under the materials-and-supplies option, or a books method that tracks inventory, 2026 COGS is about $1.3M, and the $300,000 is not deducted until those goods sell. Expensing all $1.6M works only under a books method whose records genuinely expense purchases. Otherwise, it overstates deductions by $300,000 and invites an adjustment.

Changing methods

Switching inventory methods is an accounting method change, filed with Form 3115. Many changes are automatic, and any catch-up is taken as a §481(a) adjustment. Positive adjustments are generally spread over four years.

Common mistakes

1. Expensing inventory when purchased even though your books, counts, or lender reports treat it as inventory.
2. Leaving freight-in and duties as expenses rather than in inventory cost, unless your books method consistently expenses them.
3. Never counting FBA inventory or writing off damaged and lost units.

How Summer Associates helps

Summer Associates' e-commerce team sets up landed-cost tracking, picks the inventory method that fits, and files Form 3115 when a change helps.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.