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There are few things in life of which one can be certain, but taxes are one such thing. Depending on where your business is headquartered, you may have to pay an inventory tax based on the amount of goods or products you have stored in a warehouse.
Key Takeaways
Whether you conduct your business online or through brick-and-mortar stores, learn more about how inventory tax can affect you.
Inventory taxes are classified in the same column as a business tangible personal property tax. It is imposed on a company’s unsold stock at the end of the year. Inventory is taxed within the same bracket as furniture, tools, and/or equipment belonging to a business. This tax is separate from income tax, although there can be some interplay between the two.
Inventory can also include more than just your finished sale product. If you import raw materials or parts for assembly, they may be subject to this tax.
The value of your inventory determines the tax levied against you. The following three methods are commonly used by businesses in the U.S.
The most common formula businesses use to calculate inventory tax is:
This is the method we’ll be referring to for the remainder of the article. You can see how this calculation works in the table below.
Once you have the ending inventory value, you would multiply it by the applicable tax rate to get your inventory tax figure. For instance, in a state with a rate of 0.48%, you’d owe $864.00.
The best method of calculation is determined by your business practices. If you have a smaller, limited-variety inventory, calculating based on cost is easier. The second and third options provide more flexibility in the case of rising or falling price changes.
If you base your inventory tax calculation on COGS, you have options as to how you determine the cost of goods sold. These options are based on which warehousing practice you use: FIFO and LIFO.
Related: FIFO Procedures for Warehousing
First off, let’s break down these acronyms:
Since the cost of goods can fluctuate through the year due to factors like seasonal demand, these procedures, when applied to accounting practices, can directly affect your COGS calculation. Let’s take a look at how LIFO and FIFO produce different values for cost of goods sold.
As stated above, companies that use a LIFO system will sell newer items first. This may seem odd, since most companies simply can’t afford to hold on to stock that could expire or become obsolete. However, there are some potential benefits from an accounting perspective.
In a LIFO system, the most recent goods will determine COGS, making it higher. This results in your ending inventory being valued lower because it’s based on the cost of older items. Your net income will also be lower as a result.
This may not sound helpful until you take into account that a lower net income and ending inventory valuation will place your company into a lower inventory tax liability.
Let’s say you run a clothing store called ABC Articles. This basic data set shows one month’s calculation of inventory value.
Assume that ten articles were sold in the specified period. If you use LIFO to manage your inventory, the 10 articles sold were the ones valued at $6.00 and $4.00. The remaining four items would be valued at their original, lower purchase price.
Three articles @ $3 per article + 1 article @ $4 per article = $7 of ending inventory valuation.
The tax you would be required to pay would be lower, but you risk getting stuck with inventory you can’t unload in the long term.
Using FIFO, a company is less likely to get stuck with older items in the inventory. Business owners will also have a more accurate representation of value because inventory is more likely to reflect the current market.
The net income will generally be higher, with COGS being correspondingly lower. Greater profits will also mean higher inventory taxes for that year.
Using the same data from above, we can calculate ending inventory if ABC Articles used FIFO for inventory management.
The 10 articles sold would be valued at the lower rate. The remaining four articles would be calculated using the value of the last items added.
4 articles @ $6 per article = $24 of ending inventory
With a higher valuation of ending inventory, your tax payment also gets increases. However, your company is also less likely to waste goods that expire or get superseded by new models.
Both management systems have pros and cons. However, it’s worth noting that LIFO is not a permitted accounting practice in many countries, including major economic powers like Japan and the European Union. For this reason, U.S. businesses who engage in international trade use FIFO to conform to international financial reporting standards (IFRS).
Of course, all of this is contingent upon whether you do business in a state that levies an inventory tax and where you store your goods.
If you have inventory stored in any of the following states, you’ll likely be responsible for remitting inventory tax.
Keep in mind that tax rates vary not just from state to state, but from county to county in many cases. Additionally, some states only consider fully finished products to be taxable inventory, while others tax every stored good down to raw materials.
While there are websites that aggregate that average range of these rates, you should always ensure that you get the most up-to-date inventory tax rate information from state and/or county-level sources for the sake of accuracy.
You might also find that your inventory qualifies for a freeport exemption in several states that impose inventory tax. These states include GA, TX, KY, and MS. This exemption can reduce or eliminate inventory taxes entirely in some cases.
For ecommerce businesses that operate in multiple states, the correct calculation of inventory taxes can be further complicated.
The simple answer is that if you own an ecommerce business and store goods in a state that levies inventory tax, it will apply to you even if you don’t have a physical storefront.
Inventory tax is based on the state in which you store your inventory, not in the state where your business is registered. Therefore, even if your business is registered in a state that does not have an inventory tax, you may not avoid it entirely.
Consider the following scenarios.
Other factors that may affect inventory tax for retailers of any type are:
With profits on the line, many businesses do everything they can to reduce or circumvent inventory tax. Fortunately, there are some perfectly legal ways to do so.
The most obvious answer to this question is simple: don’t store goods in states that assess this tax. Unfortunately, this isn’t always feasible.
If you have to store goods in a state with an inventory tax, you can reduce this expense by ensuring you have as little inventory in stock as possible when it’s time to calculate the tax. You can accomplish this by using inventory control methods, such as calculating your stockout levels. Doing so will result in a lean but efficient inventory with no extra units taking up space and driving your tax bill higher.
This and other inventory control strategies can be most ably executed by logistics professionals at a third-party logistics provider (3PL). Experienced 3PLs can tailor storage and distribution solutions to your needs, including mitigating inventory taxes.
Related: Inventory Tracking Technology: Cut Costs With Real-Time Data
Since the best ways to reduce or eliminate inventory taxes involve storing goods in untaxed states and practicing advanced inventory controls, it makes sense for businesses to partner with a 3PL to expand their warehousing options. That’s where we come in.
Fulfillment and Distribution specializes in helping businesses like yours manage their inventory and complete their fulfillment needs. Our leaders have decades of experience and can provide the tools you need to keep growing your business.
Our list of logistics services includes:
Don’t let inventory taxes cut into your business’s bottom line. Call us at (866) 989-3082 or submit a contact form online today!.
