If you run a business in the United States that sells physical products, you may have come across Form 1125‑A while preparing your tax return. This IRS form is closely tied to how your company reports cost of goods sold (COGS) and, ultimately, how much tax it owes. In this article, we’ll explain what Form 1125‑A is and when your business must file it.
Understanding Form 1125‑A
Form 1125‑A, officially titled Cost of Goods Sold, is a tax schedule used by corporations, S corporations, and partnerships to calculate and report the direct costs associated with producing or purchasing goods that were sold during the tax year. These costs include inventory purchases, direct labor, and other production expenses. The form helps determine COGS, which is subtracted from gross receipts to calculate gross profit—a key figure for determining taxable income.
Unlike sole proprietors, who typically report COGS on Schedule C of Form 1040, businesses that file Form 1120, 1120‑S, 1065, or similar returns use Form 1125‑A to detail their inventory and COGS calculations. The form ensures compliance with IRS inventory and cost capitalization rules, such as Section 263A, which requires certain costs to be capitalized rather than immediately deducted.
Purpose of Form 1125‑A
The primary purpose of Form 1125‑A is to provide a clear computation for deducting COGS, which directly affects taxable income and gross profit reporting. By accurately reporting beginning and ending inventory, purchases, and direct production costs, businesses can ensure they are not overpaying taxes on their profits. The form also helps the IRS verify that businesses are following proper inventory valuation methods and capitalization rules.
For example, if a manufacturing company has a beginning inventory of $200,000, purchases of $300,000, direct labor costs of $50,000, and an ending inventory of $100,000, the COGS calculation would be:
COGS=Beginning Inventory+Purchases+Direct Costs−Ending Inventory
COGS=200,000+300,000+50,000−100,000=450,000
This $450,000 would then be reported on Form 1125‑A and carried over to the parent return (e.g., Form 1120 or 1120‑S).
Who Must File Form 1125‑A?
You must file Form 1125‑A if your corporation or partnership carries inventory and reports COGS on Form 1120, 1120‑S, 1120‑F, 1120‑C, 1065, or 1065‑B. Pure service businesses that do not maintain inventory generally do not need to attach this form. Sole proprietors usually report COGS on Schedule C instead.
Businesses that use the accrual method of accounting are more likely to need Form 1125‑A, as they must match expenses with the revenue they generate. However, even cash‑basis filers may need to use the form if they maintain inventory and report COGS.
When to File Form 1125‑A?
Form 1125‑A is filed along with your main tax return, such as Form 1120, 1120‑S, or 1065, by the applicable due date. Partnerships and S corporations generally file by March 15 (or the next business day if it falls on a weekend or legal holiday).
If you need more time to file, you can request an automatic extension by filing Form 7004 on or before the original due date. However, an extension to file does not extend the deadline to pay any taxes owed, so it’s important to estimate and pay any liabilities by the original due date.
How to Complete Form 1125‑A?
Completing Form 1125‑A involves several key steps:
- Beginning Inventory: Enter the value of inventory at the start of the tax year. This should match the ending inventory from the previous year unless a method change requires a refigured opening balance.
- Purchases: Report all purchases made for inventory during the year, reduced by any personal‑use withdrawals.
- Cost of Labor: Include total wages and production labor costs attributed directly to creating goods for sale. Administrative and selling payroll should not be included here.
- Additional Section 263A Costs: Enter costs required by Section 263A capitalization not included elsewhere. Attach a schedule if necessary.
- Other Costs: Document any other direct costs (e.g., freight, storage) not previously listed. Attach a schedule if needed.
- Total: Enter the total of all costs.
- Ending Inventory: Enter the value of inventory at the end of the year, validated by accurate, up‑to‑date records.
- Cost of Goods Sold: Subtract ending inventory from the total costs to determine COGS. This number carries to the COGS line on your parent return.
Supporting schedules for lines 4 and 5 must be attached to clarify additional cost entries.
Common Pitfalls and Penalties
Failing to file Form 1125‑A when required or submitting unsubstantiated entries may result in financial penalties, additional IRS scrutiny, or audits. Incorrect COGS calculations can lead to an inaccurate taxable income figure, potentially increasing your tax liability.
To avoid these issues, ensure your inventory records are accurate and reconciled with your general ledger. Document any changes in inventory valuation methods and maintain detailed records of purchases, labor costs, and other production expenses.