Form 1125-A: cost of goods sold for corporations and partnerships

“Filers of Form 1120, 1120-C, 1120-F, 1120S, 1065, or 1065-B complete and attach this form if they report a deduction for cost of goods sold.” IRS, About Form 1125-A

Who has to file Form 1125-A?

Form 1125-A is required from any Form 1120, 1120-C, 1120-F, 1120-S or 1065 filer that reports a deduction for cost of goods sold, according to the Instructions for Form 1125-A (Rev. November 2024). Line 8 carries to page 1, line 2 of Form 1120, Form 1120-C, Form 1120-S or Form 1065. Form 1120-F filers use Section II, line 2.

Treas. Reg. 1.471-1(a) generally requires inventories at the beginning and end of each tax year when the production, purchase or sale of merchandise is an income-producing factor.

Small business taxpayers have an exception. For tax years beginning in 2025, the Instructions for Form 1120 define a small business taxpayer as one that is not a tax shelter and has average annual gross receipts of $31 million or less for the 3 prior tax years. Under IRC section 471(c), it can treat inventory as non-incidental materials and supplies or follow its financial statements or books, and IRC section 263A(i) exempts it from uniform capitalization.

How does the Form 1125-A calculation work, line by line?

Form 1125-A computes cost of goods sold as beginning inventory plus the year's inventoriable costs, minus ending inventory. Lines 1 through 5 build the cost pool, line 6 totals it, line 7 removes the goods still on hand at the end of the year, and line 8 is the deduction.

1. Line 1, beginning inventory. Last year's closing inventory. After an accounting method change, refigure it under the new method and attach an explanation of any difference.
2. Line 2, purchases. Reduced by items withdrawn for personal use. A partnership shows those items as distributions on Schedule K and K-1.
3. Line 3, cost of labor. Labor that belongs in inventory cost.
4. Line 4, additional section 263A costs. For simplified method users, the balance of section 263A costs not already on lines 2, 3 and 5. Attach a schedule.
5. Line 5, other costs. Any other costs not entered on lines 2 through 4, with an attached statement.
6. Line 7, ending inventory. Includes the additional section 263A costs allocable to goods on hand.

The Instructions for Form 1125-A treat the line 9 valuation methods as methods of accounting. A method, once established, cannot be changed in a later year without requesting an accounting method change on Form 3115. Any difference on line 1 from refiguring last year's closing inventory under a new method is taken into account when figuring the section 481(a) adjustment, so the line 1 explanation and the Form 3115 should agree.

Where does each source document go on Form 1125-A?

Form 1125-A pulls from a short list of source documents, and each one feeds a fixed line. The prior-year return supplies line 1, the purchase ledger supplies line 2, payroll supplies line 3, and the year-end count supplies line 7. Everything that doesn't fit lines 2 to 4 goes on line 5 with a statement.

Depreciation on production assets can sit inside cost of goods sold. The Form 1120 page 1, line 20 label covers depreciation "not claimed on Form 1125-A or elsewhere on return," so any depreciation included in line 4 or line 5 must come out of the page 1 depreciation deduction. The Form 4562 total and the split between the two lines should tie.

Schedule L, line 3 reports inventories per books. When book inventory differs from tax inventory, for example because of section 263A costs capitalized only for tax, line 7 will not equal Schedule L, line 3, and the difference should appear on Schedule M-1 or Schedule M-3.

Which inventory methods are reported on Form 1125-A line 9?

Form 1125-A line 9 records how closing inventory is valued, and the Instructions for Form 1125-A say to check every method used. Lines 9a(i) to 9a(iii) cover the general methods, and lines 9a(iv) to 9a(vi) cover the alternative methods available to certain small business taxpayers.

• 9a(i) Cost and 9a(ii) lower of cost or market. For normal goods, "market" means the current bid price on the valuation date for the volume usually purchased.
• 9a(iii) Other. Any other IRS-approved method, with an explanation attached.
• 9a(iv) to 9a(vi). Non-incidental materials and supplies, AFS method, or non-AFS method, checked instead of 9a(i) to 9a(iii).
• 9b. A writedown of subnormal goods, valued at bona fide selling price less direct cost of disposition, not below scrap value.
• 9c and 9d. LIFO. In the first LIFO year, attach Form 970 and check 9c. Line 9d(ii) is the closing LIFO reserve, FIFO value minus LIFO value.
• 9e. Whether section 263A applies to the entity.
• 9f. Any change in quantities, cost or valuation between opening and closing inventory, with an explanation.

The bona fide selling price for subnormal goods is the actual offering price during a period ending no later than 30 days after the inventory date. A writedown without evidence of that offering, such as price lists or listings dated within the window, is weak. A C corporation that elects S status, or transfers LIFO inventory to an S corporation in a nonrecognition transaction, may owe tax on the LIFO recapture amount, so the line 9d reserve matters beyond the current year.

What does a Form 1125-A calculation look like?

For example, a calendar-year C corporation manufacturer has average annual gross receipts above the $31 million small business threshold for 2025, so it values inventory at cost and applies section 263A using the simplified production method. Its 2024 Form 1125-A shows closing inventory of $4,120,000, and its 2025 records show the amounts below.

The corporation checks 9a(i) for cost and answers "Yes" on 9e. Cost of goods sold of $22,164,000 goes to page 1, line 2. The $265,000 of production depreciation is in line 5, so Form 1120 page 1, line 20 shows only the depreciation that is not in cost of goods sold.

The statement attached for line 5 lists the freight-in and the depreciation separately, as the Instructions for Form 1125-A require for other costs. The section 263A schedule supports line 4, and the same section 263A costs allocable to goods on hand are already inside the $4,553,000 on line 7.

What do reviewers check on Form 1125-A?

A reviewer checking Form 1125-A confirms six items, each tied to the form instructions or the Form 1120 instructions. The prior-year Form 1125-A and the year-end inventory count are the first two documents to pull, because lines 1 and 7 drive the whole computation.

The method boxes on line 9a should match the prior year. A new box with no Form 3115 on file is a method change made without consent, which the Instructions for Form 1125-A say requires a request for an accounting method change. Line 9f should be "Yes" with an explanation whenever quantities, cost or valuation changed between opening and closing inventory, and a "No" on 9e needs support, such as small business taxpayer status under section 263A(i).