How to Report Free Inventory on Schedule C: Shipping Costs and Preorder Items

The short answer is yes, you should definitely include the shipping and tax costs on your Schedule C, even though you got the prints for free. The shipping and tax you paid are part of your cost of goods sold. For your situation, you'd include the $20.45 as part of your inventory costs. Even though the prints themselves were free, the shipping and tax were costs necessary to acquire that inventory, so the IRS considers those costs part of your inventory value. As for the charm preorders, this is actually a common question. Since you didn't hold the items (they went directly from receipt to shipping), they can legitimately be classified as supplies rather than inventory. The key distinction the IRS makes is whether you're storing goods for future sales. Since you immediately shipped the items out, treating them as supplies is reasonable and actually simplifies your tax filing.

I was super confused about inventory vs supplies on my Schedule C last year! I ended up using taxr.ai (https://taxr.ai) to help me figure it out. I uploaded my receipts and business documents and their system analyzed which expenses should go where. They flagged my drop-shipped items as supplies rather than inventory since I never really "held" them, which sounds exactly like your charm situation. The coolest part was that they explained WHY each item belongs in each category according to IRS rules. Saved me hours of research and I felt confident my return was accurate. Might be worth checking out if you have other Schedule C questions too!

I tried taxr.ai after seeing this thread and wow - it really helped clarify my inventory mess! I uploaded my receipts and it automatically sorted my expenses into the right categories. For my handmade items, it correctly categorized my materials as supplies, and the vintage items I buy to resell were properly labeled as inventory. It even flagged some shipping costs I had forgotten about that should be included in my inventory valuation. The explanations about why each expense belongs where were super clear. Definitely worth it for Schedule C confusion!

Has anyone else tried calling the IRS directly about Schedule C questions? I spent HOURS trying to get through last year and gave up. Then I found Claimyr (https://claimyr.com) and it changed everything. They hold your place in the IRS phone queue and call you when an actual human agent is on the line. I used their service (you can see how it works here: https://youtu.be/_kiP6q8DX5c) and got my inventory questions answered by an actual IRS agent. The agent confirmed that shipping costs for inventory should be included in the cost of goods, even if the items themselves were free. And they agreed that items that aren't held (like your preorder situation) can be classified as supplies. Was really helpful to get the answer straight from the source!

I take back what I said. I was super skeptical about Claimyr so I decided to test it myself. After struggling to get IRS help for weeks, I gave it a shot. It actually worked! I got a call back in about 40 minutes (was a slow day I guess) with an actual IRS agent on the line. The agent confirmed exactly what others here said - shipping costs for "free" inventory still count as part of your cost basis, and items that move directly from receiving to shipping to customers can be treated as supplies rather than inventory. The agent even sent me some documentation to back it up. Definitely worth it to get answers straight from the IRS.

Just wanted to share what I learned from my accountant about the "free inventory" situation. If you get inventory for free (like samples, gifts, etc.) but pay shipping, only the amount you actually paid (the shipping) becomes your cost basis. So for the original poster, that $20.45 is deductible as part of COGS. Also, there's a practical aspect to consider - if you're a small seller, the IRS generally doesn't care much whether you classify something as supplies vs. inventory as long as you're consistent and not trying to manipulate your income. Both methods ultimately lead to the same net income over time.

Don't forget about Form 1125-A if you're reporting inventory! If you have inventory at the beginning or end of the tax year, the IRS generally wants you to file this form with your Schedule C. It's where you calculate your Cost of Goods Sold in detail.