Does My Inventory Affect My Taxes? | Workful (2024)

Yes. At the end of the year, your business will betaxed on your profits, which your inventory indirectly affects because it willlower your earnings. This will then reduce your taxable income.

Your profits are your total revenue minus the cost of goodssold (COGS). Your COGS are your inventory at the beginning of the year plusanything purchased during the year, minus your ending stock. Becauseyou’re taxed on your profits, and not your total revenue, you’re essentiallydeducting the cost of your inventory.

How should you value your inventory?

The IRS generally accepts three ways:

  1. Cost– purchase price of the item plus any additional costs, like shipping fees
  2. Costvs. market value – compare the cost of each item with the market value andchoose the lower of the two
  3. Retail– subtract a set markup percentage from your selling price.

Read also: Cost of Goods Sold

The cost method is the easiest one to keep track of, but onceyou choose a particular way, you must use it year after year. You can’t switch eachyear, depending on which method gives you the biggest deduction.

If you can’t determine the cost of individual items, or if theychange throughout the year, you can use the first-in, first-out (FIFO) method.

The FIFO method assumes the first products you purchasedwere the first products you sold.


You bought products for resale in three batches during theyear and sold 400.

  • 100 products at $10 each = $1,000
  • 250 products at $10.50 each = $2,625
  • 150 products at $11 each = $1,650

Assuming the first items purchased were the first sold, you’d assume you sold 100 products at $10 each, 250 products at $10.50 each, and 50 products at $11 each. So, your total COGS would be $4,175.

What about items you can’t sell?

If you can no longer sell a product, it’s considered“worthless” and taken out of inventory. The loss will result in slightly higherCOGS, which means a larger deduction and a lower profit.

Read also: Back to Basics: Gross Profit & Gross Profit Margin

There’s no tax advantage for keeping more inventory than youneed, however. You can’t deduct your stock until it’s removed from inventory –either it’s sold or deemed “worthless.”

As an expert in accounting and taxation, I bring a wealth of knowledge and experience to the table, with a focus on how inventory management directly impacts a business's financials. Let's delve into the concepts mentioned in the article you provided:

  1. Taxation and Profit Calculation: At the end of the year, businesses are taxed on their profits, which are calculated as total revenue minus the Cost of Goods Sold (COGS). This COGS is influenced by inventory management because it represents the cost of the inventory items sold during the year.

  2. Inventory Valuation Methods: The IRS accepts three main methods for valuing inventory:

    • Cost Method: This involves using the purchase price of items along with any additional costs like shipping fees.
    • Cost vs. Market Value: This method compares the cost of each item with its market value and chooses the lower of the two.
    • Retail Method: It involves subtracting a set markup percentage from the selling price.
  3. Consistency in Valuation Method: Once a valuation method is chosen, it must be consistently applied year after year. Switching between methods for tax advantage is not allowed.

  4. FIFO Method: When individual item costs are not determinable or when costs change throughout the year, the First-In, First-Out (FIFO) method is used. It assumes that the first items purchased are the first items sold.

  5. Example Illustration: An example in the article demonstrates how to calculate COGS using the FIFO method based on the quantities and selling prices of products purchased in batches throughout the year.

  6. Treatment of Unsellable Items: Items that can no longer be sold are considered "worthless" and are removed from inventory. This results in a higher COGS, which leads to a larger deduction and ultimately lowers the taxable profit.

  7. Inventory Management Impact: It's emphasized that there's no tax advantage in keeping excess inventory. Inventory can only be deducted once it's sold or deemed worthless, so maintaining excessive stock levels does not offer any tax benefits.

Understanding these concepts is crucial for businesses to effectively manage their inventory and optimize their financial performance while staying compliant with tax regulations.

Does My Inventory Affect My Taxes? | Workful (2024)
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