What expense category is Packaging?

Packaging is essential for protecting products, presenting them to customers, and enabling shipment. Businesses incur costs for various packaging materials, from product boxes and bottles to shipping cartons and bubble wrap. For accurate financial accounting and tax reporting, it's important for accountants and SMB owners to understand how to categorize these different packaging expenses correctly.

The classification often depends on whether the packaging is considered an integral part of the product itself or is used primarily for shipping and handling. This guide clarifies the appropriate categories and tax treatment.

Packaging Expense Category

The correct accounting category for packaging costs depends on the packaging's function:

1. Packaging is Integral to the Product Sold

• This includes containers or packaging that are considered part of the finished product delivered to the customer (e.g., the bottle containing a beverage, the box holding cereal, the label on a jar).
• Accounting/Tax Treatment: Costs for these materials are typically included as part of the Cost of Goods Sold (COGS). They become part of the inventory cost and are expensed through COGS when the product is sold. IRS Publications 535 and 334 confirm that containers forming part of the product sold are included in COGS.

2. Packaging for Shipping or Selling (Not Integral)

• This includes materials used primarily to protect goods during transit or handling, which are not part of the primary product container (e.g., outer cardboard shipping boxes, packing peanuts, bubble wrap, pallets).
• Accounting/Tax Treatment: These costs are generally treated as operating expenses (often Selling Expenses).
• Category: Common expense accounts include Shipping Supplies, Packaging Expense, or sometimes grouped under Freight Expense or Delivery Expense. According to IRS guidance, if these materials have a useful life of one year or less (which is typically the case for disposable shipping packaging), they are currently deducted as supplies. If they have a life expectancy of more than one year (such as durable, reusable crates), they should be depreciated.

3. General Use Packaging

Materials used for internal storage, organization, or general administrative tasks might be categorized under Office Supplies or General & Administrative Expenses.

Some Important Considerations While Classifying Packaging Expenses

When handling packaging costs, consider these factors:

• Integral vs. Shipping/Selling: This is the primary factor determining classification (COGS vs. Operating Expense/Supplies). Analyze whether the packaging is sold with the product or used primarily for transit/protection.
• Uniform Capitalization Rules (UCR): Businesses subject to UCR (certain producers and resellers, often excluding small businesses) generally must capitalize the costs of integral packaging into their inventory value. Costs of packaging used for shipping/selling (not integral) are typically treated as period costs (operating expenses) and are not subject to UCR capitalization in the same way. Check if the small business taxpayer exemption from UCR applies (generally <= $30M average annual gross receipts per Pub 334/535).
• Useful Life (for Non-Integral Packaging): As per IRS guidance, shipping or handling containers/packaging not sold with the product should be depreciated if their useful life exceeds one year. Most disposable shipping materials (boxes, wrap, tape) have a life of one year or less and are expensed currently.
• Ordinary and Necessary: Packaging costs must be both ordinary (common and accepted) and necessary (helpful and appropriate) for the production, protection, or shipping of your products.
• Recordkeeping: Maintain detailed invoices from packaging suppliers listing the materials purchased, quantities, costs, and proof of payment. Records should support the allocation between COGS-related packaging and operating expense packaging.

Examples of Packaging Expenses

Packaging costs can include a variety of materials:

Included in COGS (Integral Packaging)

• Bottles, cans, jars, and bags holding the product.
• Retail boxes containing the product, such as software boxes or toy boxes.
• Product wrappers, labels, and tags affixed to the item.

Expensed as Operating/Selling Costs (Shipping/Handling Packaging, life <= 1 year)

• Outer cardboard shipping boxes.
• Mailers (bubble mailers, poly mailers).
• Packing tape.
• Bubble wrap, packing peanuts, air pillows, foam inserts.
• Shipping labels.
• Disposable pallets.

Potentially Depreciated (Non-Integral Packaging, life > 1 year)

• Durable, reusable shipping crates or containers.
• Specialized, long-lasting protective cases used for transport.

Tax Implications of Packaging Expenses

Deductibility / Cost Recovery

• Integral Packaging: Costs are recovered through Cost of Goods Sold (COGS) when the product is sold.
• Shipping/Selling Packaging (life <= 1 year): Deductible as an ordinary and necessary business expense (e.g., supplies) in the year paid or incurred (subject to timing rules).
• Durable Packaging (life > 1 year): Costs are recovered through Depreciation over the asset's useful life.

Timing 

COGS recovery occurs upon sale. Operating expenses follow cash/accrual and prepayment rules. Depreciation follows specific IRS schedules.

Capitalization (UCR)

Integral packaging costs may require capitalization into inventory under UCR if the business is subject to those rules (and not exempt as a small business).

Where to Report (Schedule C)

For sole proprietors:

• Integral packaging costs are included in the COGS calculation in Part III.
• Shipping/selling packaging costs (expensed) typically go on Line 22 ("Supplies") or Line 27a ("Other expenses") specifying "Packaging" or "Shipping Supplies."
• Depreciation for durable packaging is calculated on Form 4562 and reported on Line 13 ("Depreciation...").

How Fyle Can Automate Expense Tracking

Managing the purchase of diverse packaging materials requires effective record-keeping. Here’s how Fyle can help:

• Capture Purchases: Track payments for packaging materials made via company credit card using Fyle's real-time feeds. Manage supplier invoices paid via other methods by attaching proof of payment.
• Centralize Invoices: Store digital copies of invoices from packaging suppliers directly within Fyle, linked to the purchase transaction.
• Consistent Categorization: Use Fyle to consistently categorize packaging costs based on their type (e.g., "Shipping Supplies," potentially flagging items for COGS allocation in the accounting system).
• Integration with Accounting: Fyle syncs categorized expense data seamlessly to your accounting system (QuickBooks, Xero, NetSuite, Sage Intacct). This ensures accurate reporting of operating expenses related to packaging and provides documented purchase information to support COGS calculations made within the accounting software.

The correct expense category for packaging depends on its function: is it part of the product sold (Cost of Goods Sold, or COGS) or used for shipping and handling (Operating Expense/Supplies or Depreciation)? 

Understanding this distinction, along with potential UCR implications for integral packaging, is crucial for accurate financial records and tax compliance. Maintaining clear supplier invoices and leveraging tools like Fyle for tracking purchases simplifies the management of these essential business costs.