Does Cost of Goods Sold Include Labor Taxes?

Cost of goods sold refers to the entire of cost of raw materials plus the direct and indirect costs incurred to make finished products. It also applies to products bought for resale. The Internal Revenue Service allows businesses to deduct their cost of goods sold from revenue when determining taxable income. You can factor in labor cost, which includes taxes, when calculating cost of goods sold if it’s part of your manufacturing expense.

Costs of goods sold pertain to businesses that sell products, such as manufacturers, wholesalers and retailers. It doesn’t apply to service-only businesses. If you provide services and also sell products, then your cost of goods represents the items you sell, not the service you provide. Labor cost is generally part of cost of goods sold only in the manufacturing and mining industries, according to the IRS. It includes the wages paid to and taxes paid for employees who manufacture the product .

When reporting labor cost on IRS Schedule C form, include only the amounts paid to employees who are involved in the manufacturing process. Exclude amounts paid to you. If you only resell merchandise, then you don’t have any labor costs that can be associated with actually making the finished product. State tax laws vary, so apply your state revenue service’s guidelines when taking labor cost deductions on your state tax return.

To determine your labor cost, include both direct and indirect costs. Direct labor relates to the cost you pay employees who actually make the finished product. This includes, for example, assembly line workers and employees who transport raw materials to the production site. Indirect labor represents the staff that supports the manufacturing process, such as factory managers and supervisors. They are necessary to the manufacturing process but are not directly tied to making the final product. If you simply resell items and have employees that you pay wages to, do not include those wages in your cost of goods sold, but you can take a separate deduction for those administrative costs on your tax return.

Labor cost also includes your hidden expenses, beyond what you pay your workers directly. To arrive at your total cost, calculate all forms of compensation. This includes regular and overtime wages, salaries, company benefits such as health insurance and 401(k) match, Social Security tax, Medicare tax, federal and state unemployment taxes, and workers’ compensation. Count any other payroll taxes or insurance that the state or local government might require, such as job training or transit taxes.

When you buy products, the items remain assets until you sell them, at which point they become inventory. To calculate cost of goods, first add up the value of your inventory -- including purchases, freight in and cost of labor -- at the start of your fiscal period. This gives you the value of inventory that’s available to sell. Then subtract the value of your inventory at the end of the fiscal period from the starting value to get your cost of goods sold.