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Schedule C Lines 2 to 5: Returns, COGS, Gross Profit (2025)

Updated October 18, 2026. Quick answer: Lines 2 to 5 turn gross receipts into gross profit. Line 2 is your sales returns and allowances, entered as a positive number. Line 3 subtracts line 2 from line 1, line 4 brings in the cost of goods sold from line 42, and line 5 subtracts line 4 from line 3. Only line 2 has its own instruction paragraph; the others are arithmetic on the form.

Picking the Schedule C business code for your work (2025 chart): Schedule C code for online sellers and Schedule C code for Etsy sellers.

Picking the Schedule C business code for your work (2025 chart): Schedule C code for hair, nail, and beauty.

S corporation return (Form 1120-S) for 2025, read line by line: Form 1120-S lines 1a to 6.

Partnership return (Form 1065) for 2025, read line by line: Form 1065 lines 1a to 3.

What lines 2 to 5 ask for

The form prints the four lines as “Returns and allowances”, “Subtract line 2 from line 1”, “Cost of goods sold (from line 42)” and “Gross profit. Subtract line 4 from line 3”. Only line 2 is something you look up and enter from your records: line 3 and line 5 are subtractions, and line 4 is copied from Part III. The instructions have no separate paragraph headed for line 3, line 4 or line 5, so the form captions are the whole rule for those three. The income that comes before these lines is on the Schedule C line 1 page, and the Schedule C (Form 1040) page shows how the parts of the schedule fit together.

Line 2: returns and allowances

The instructions say to “Report your sales returns and allowances as a positive number on line 2.” They define both terms. “A sales return is a cash or credit refund you gave to customers who returned defective, damaged, or unwanted products.” “A sales allowance is a reduction in the selling price of products, instead of a cash or credit refund.”

In plain terms, line 2 is money you gave back or price you reduced after a sale you already counted on line 1. Because the form subtracts it on line 3, you enter it as a plain positive amount rather than with a minus sign.

Line 4: cost of goods sold from line 42

Line 4 is not typed in from scratch. It comes from the Part III worksheet at the bottom of page 2 of the schedule, where line 42 reads “Cost of goods sold. Subtract line 41 from line 40. Enter the result here and on line 4”. The Part III instructions open with a general rule: “In most cases, if you engaged in a trade or business in which the production, purchase, or sale of merchandise was an” income-producing factor, “you must take inventories into account at the beginning and end of your tax year.” The line by line walk through of Part III is on the Schedule C Part III page.

There is also an exception for small businesses: “If you are a small business taxpayer, you can choose not to keep an inventory, but you must still use a method of accounting for inventory that clearly reflects income.” The instructions define who qualifies: “qualify as a small business taxpayer if you (a) have average annual gross receipts of $31 million or less for the 3 prior tax years (indexed for inflation), and (b) are not a tax shelter (as defined in section 448(d)(3)).” Pub. 538 is the publication the instructions point to for more detail on inventories.

Where the number comes from, step by step

Here is a labelled illustration, computed from the form’s own arithmetic, not an IRS example. Suppose line 1 were $80,000 and line 2 were $5,000. Line 3 is computed by subtracting line 2 from line 1, so it would be $75,000. Suppose Part III produced a cost of goods sold of $30,000 on line 42, copied to line 4. Line 5 is computed by subtracting line 4 from line 3, so gross profit would be computed as $45,000. A business with no cost of goods sold would simply carry line 3 to line 5.

Where it goes next

Gross profit on line 5 is added to other income on line 7, whose caption is “Gross income. Add lines 5 and 6”. That step is explained on the Schedule C lines 6 and 7 page. Expenses are subtracted later, starting with line 8 on the Schedule C lines 8 and 9 page.

This line is one step in a chain that ends at line 31. For a profit, the schedule says “If a profit, enter on both Schedule 1 (Form 1040), line 3, and on Schedule SE, line 2.” Schedule SE is the form that figures self-employment tax; it is introduced on the Schedule SE (Form 1040) page. The last step is covered on the Schedule C lines 31 and 32 page, and the return the schedule attaches to is explained on the Form 1040 page.

Edition and line numbers

This page reads the 2025 Schedule C (Form 1040) and its 2025 instructions, the current files irs.gov served on 2026-10-18 (byte-identical to the archived copies). They are the files for the tax year 2025 return, filed in 2026. The schedule says “Attach to Form 1040, 1040-SR, 1040-SS, 1040-NR, or 1041”. Check the tax year printed on the schedule you are filling in and use the line numbers on that year’s schedule, because a different year’s schedule can number or word its lines differently.

Common mistakes

  • Entering a sales return as a negative number on line 2. The instructions say to “Report your sales returns and allowances as a positive number on line 2.”
  • Treating a price reduction as a deduction somewhere else. The instructions define it: “A sales allowance is a reduction in the selling price of products, instead of a cash or credit refund.”
  • Typing a cost of goods sold figure on line 4 that does not match Part III. Line 42 says “Enter the result here and on line 4”.

Related: Schedule C (Form 1040), Form 1040, and self-employment tax.

Sources

Read from the IRS documents linked above on October 18, 2026. General information, not tax advice. Your own facts decide the outcome, and a preparer, the account provider or the IRS is the right place to confirm anything consequential.

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