Articles
Demand & Inventory Planning
Demand & Inventory Planning
January 22, 2024
Everything you need to know about inventory tax. Learn which states collect it, its impact on your business, how to reduce it, and how to leverage fulfillment technology to accurately track and control inventory.
Table of Contents
Understanding Inventory Tax
How Is Inventory Taxed?
Is There a Federal Inventory Tax?
How Does Inventory Tax Affect My Business?
Three Tips to Reduce Inventory Tax
Implementing Inventory Controls
FAQ’s
Understanding Inventory Tax
Inventory tax is a property tax that is determined by the value of inventory and usually falls under a Business Tangible Personal Property tax. Other types of property that often fall under this same classification are machinery, office equipment, and furniture.
Inventory management, therefore, directly affects a business’s bottom line, not only when it comes to inventory carry costs and storage costs, but also when tax season rolls around. Each year you will be taxed not only on your profits (total revenue minus cost of goods soldEc), but in 11 states you will also be required to pay a tax on inventory stored there. The states that currently tax inventory and their rates are:
- Arkansas(0.34 – 0.91%)
- Alaska (0.35-1.47%)
- Kentucky(0.49-1.36%)
- Louisiana(0.23-0.89%)
- Maryland (varies by taxing districts)
- Mississippi(0.48-1.45%)
- Oklahoma (0.42-1.22%)
- Texas (0.37-2.58%)
- Vermont(1.86-2.13%)
- Virginia (0.40-1.33%)
- West Virginia(0.31-0.77%)
Similar to sales tax and economic nexus, inventory tax requirements vary by state and can vary based on how long the inventory is stored there, whether it is being shipped out of state or being stored in a 3PL or other third party warehouse, and in some cases may even include work in process (WIP) inventory.
How Is Inventory Taxed?
Inventory tax is calculated by multiplying the assessed value of the inventory by the tax rate of the county where the inventory is located. The assessed value may be based on the cost of goods sold (COGS), retail value, or the lower of cost or market. Here’s an example of how inventory tax can be calculated:
- Determine the Cost of Goods Sold (COGS):
- Calculate the total value of products sold during the year.
- Calculate Ending Inventory:
- Ending Inventory = Beginning Inventory + Net Purchases – COGS
- Calculate Inventory Tax:
- Multiply the Ending Inventory by the county’s tax rate.
Is There a Federal Inventory Tax?
Inventory tax is determined on a state-by-state basis. Currently, there are 11 states that collect it, some on a statewide level and some only within particular municipalities. It’s important to look at each state’s property tax policies before deciding to house inventory there on a short-term or long-term basis to understand the full impact it will have on your business.
How Does Inventory Tax Affect My Business?
Inventory tax affects your business if you store inventory in one of the 11 states that collect it. As with other property taxes, you will be required to pay regardless of whether your business is profitable that year or not. You will also be responsible for tracking your inventory, determining its value, and calculating the taxes due. This can be time consuming for small to mid-sized businesses (SMB’s), and although they carry less inventory and therefore pay less inventory tax than major retailers, the resources required for tracking inventory and calculating taxes are often more limited for SMB’s.
Looking for an inventory management solution? Talk to one of our supply chain experts.
Three Tips to Reduce Inventory Tax
Like with all expenses, you should look at inventory tax within the full scope of your contribution margin and cost of goods sold. Making decisions primarily based on lowering tax liability can negatively impact your business in other ways. Below are a few considerations for merchants looking to reduce their inventory tax.
1. Store inventory in a state that doesn’t collect inventory tax.
This may seem like an obvious solution. However, the location of inventory directly impacts service levels. Merchants should store their inventory closest to their end customers to meet consumer expectations for 1- to 2-day shipping without increasing their fulfillment costs.
Fast and free delivery promises increase sales, with 69% of shoppers reporting that they are more likely to click on an advertisem*nt that mentions free, 2-day shipping. Before moving inventory to another state, consider the top-line revenue implications it could have if the move negatively impacts delivery speed.
2. Sell through inventory before calculating taxes.
Many merchants may have the impulse to carry as little inventory as possible come tax season to reduce their inventory taxes. However, carrying too little inventory can lead to costly stockouts and backorders that can disappoint first-time shoppers and decrease customer loyalty.
3. Don’t over-spend on inventory.
Carrying too much inventory negatively impacts your business’s bottom line in the way of increased storage costs, limited capital to invest in other areas of the business, and higher inventory tax rates. Determining your risk tolerance will help you find the perfect balance between carrying enough inventory to keep up with demand and keeping stock low enough that you’re not paying more taxes than you need to.
4. Liquidate slow-moving or obsolete inventory.
If inventory turns at a rate of less than once per quarter, it will cost your business more in long-term storage costs than you can make back on a sale. It may be in the best interest of your business to liquidate excess inventory or donate it for a tax write-off rather than having to pay inventory tax on it at the end of the year.
Inventory Tax & Freeport Exemptions
Inventory tax is highly unpopular among merchants, and many believe it disincentivizes retail and business growth in general. For that reason, some states allow exemptions on county levels. These Freeport Exemptions may make broad exemptions based on inventory type or the amount of time that the products are housed in the state. To take full advantage of these exemptions, contact the local assessor in the area(s) where you store your inventory.
Implementing Inventory Controls
Ultimately, inventory is a merchant’s greatest asset and capital investment. Tracking inventory will improve several aspects of your business including inventory forecasting, reducing stockouts, reducing inventory shrinkage, and calculating inventory tax. Ware2Go’s state-of-the-art warehouse management system (WMS), FulfillmentVu, ensures 99.5% inventory cycle count accuracy and includes automatic notifications that alert merchants of inventory status changes on their SKUs. To learn more about how FulfillmentVu can help you control your inventory to improve the profitability and efficiency of your business, talk to one of our fulfillment specialists.
Looking for information on ecommerce sales tax? You can find that piece here.
FAQ’s:
What is considered inventory for tax?
The value of inventory a merchant is carrying at the end of the year determines how much inventory tax you owe. You can determine its value using any one of the following methods:
Cost: The simplest and most straightforward cost valuation is the price paid for the goods plus the cost of any shipping or transportation.
Retail: This valuation method takes into account the retail value of the inventory by using the selling price and then deducting the markup percentage.
Lower of cost or market: Use the fair market value of the inventory on a set valuation date to determine its taxable value.
How do I track inventory tax?
Each state calculates inventory tax differently. Track your inventory tax by finding the amount of unsold inventory on-hand and determine its value according to one of the valuation methods listed above. You will then calculate taxes according to the policies of the state where you’re storing that inventory.
Can I expense my inventory?
Inventory is not expensable. In fact, it is considered an asset and cannot be deducted from your taxes. In 11 states inventory is actually subject to inventory taxes, but even in states that do not tax inventory, it cannot be claimed as a deduction.
Do I need to report inventory?
Yes. Inventory tax is a “taxpayer active” tax. That the taxpayer (business owner) must calculate it. Business owners can count and value unsold inventory based on one of the three accepted valuation methods: cost, retail, or lower of cost or retail.
What is the purpose of inventory tax?
Inventory tax is decided on the state level, and it funds the local governments in the states that collect it. Each of the 11 states that require inventory tax has different policies and applies the funds in different ways.
