Inventory can be a difficult financial consideration to wrap your head around as a small business owner. Inventory and the operations surrounding it are closely tied to your bottom line — mistakes that cause you to under- or overestimate your inventory needs can land you in financial hot water. Finding the best way to manage your inventory and supply chain operations is vital to running a successful small business.
Some people believe that inventory can be used as a line item deduction, but unfortunately you can’t deduct inventory expenses from your taxes. In fact, in some states, inventory carries additional taxes, though the exact amount varies by location. This means that inventory is one of those expenses that is very difficult to offset come tax time, and you need to be aware of how much you can afford to keep.
There is not a tax advantage to keeping either too much or too little inventory, but you should be aware of how timing and valuation affect your bottom line. There’s a balance between not enough and too much that small business owners on tight budgets need to consider.
What Is Inventory Tax and How Does It Affect Your Business?
Inventory tax is an additional property tax against the value of your business’s inventory. It’s often included with such taxes as furniture and equipment. Most states do not tax inventories, though some do. Of the states where an inventory tax exists, some are state-wide whereas others are taxed at the local level and often depend on the county or municipality.
Inventory taxes, when applied, are usually included in a state’s Business Tangible Personal Property Tax. They are sometimes defined as “intangible property.” This tax pertains to things like furniture, tools, and equipment owned by a business.
Inventory taxes are the subject of a great deal of debate, and many states are trying to do away with them, notes the Tax Foundation. Unfortunately, they can be persistent and difficult to get rid of because the revenue collected from inventory taxes often goes directly to local governments, which rely on the funding. Even in states where inventory isn’t taxed explicitly, it can’t be used as a tax deduction, according to Forbes.
The short of it is that no matter where you are, inventory is a complicated entry in your tax returns. In many states, unsold inventory can reduce the amount of taxable income for the year, but there are multiple ways of valuing inventory for tax purposes. In addition, it’s an income adjustment, not a line item, making accounting for it a lot more difficult. There are even different forms to file depending on the organization of your business, according to an Entrepreneur article.
That article goes over the three ways in which you can value inventory;
- Cost. Simply value the item at your purchase price plus any shipping fees.
- Lower of cost or market. Compare the cost of each item with the market value on a specific valuation date each year.
- Retail. Add the retail value (i.e., your selling price) and then subtract a set markup percentage to determine the cost.
If you file taxes in one of the states with an inventory tax, your decisions about inventory management will reflect that. Rather than helping you by reducing your taxable income, inventory can cost you additional business taxes.
What States Have Inventory Tax?
Seven states currently include inventories in their business personal property taxes. To be clear, the business personal property tax is the overarching tax that normally includes items such as furniture and tools. Some states also specify inventory, either state wide or in certain local jurisdictions.
- Arkansas applies a state-wide inventory tax.
- Kentucky applies a state-wide inventory tax.
- Louisiana applies a state-wide inventory tax.
- Mississippi applies a state-wide inventory tax.
- Oklahoma applies a state-wide inventory tax.
- West Virginia applies a state-wide tax that includes inventory, though property taxes may vary by local jurisdiction.
- Texas property taxes are handled locally, there are no state property taxes, but local taxes often include inventory taxes.
- Virginia defines inventory as intangible property, and is taxed at the state level, whereas tangible property such as furniture is taxed at the local level.
- Alaska handles all business property taxes at the local level, some of which may include inventory taxes.
- Maryland has no state business personal property tax, however, some local jurisdictions may require it, and they may include inventories.
- Vermont handles all business property taxes at the local level. Many jurisdictions provide an exemption for inventory, but some do not.
How an Inventory Management System can Reduce Inventory Taxes
Remember that excess or too little inventory doesn’t come with tax advantages. The best way to control the financial impact of your inventory is to practice good inventory management and make sure you are capable of filling orders without overspending on inventory stock.
Tracking inventory with precision is vital to running a financially secure and lean small business, as mistakes with inventory can affect your bottom line as well as your tax filing. The good news is that better inventory management doesn’t have to cost an arm and a leg: Boxstorm is a free cloud software solution that integrates with QuickBooks Online.
If you over-invest toward the end of the year hoping for a big tax advantage, you will likely be disappointed. In the same way, under-purchasing your inventory in order to avoid inventory taxes, if you’re in a state that uses them, can cause problems with order fulfillment and negatively affect your reputation. Whether you’re in an inventory tax state or not, planning your inventory purchasing around taxes may not be the best idea. How you value the inventory, as noted above, can affect your taxable income, and how you manage this will depend on the type of business you run.
The best way to handle inventory is to be aware of the tax implications, and continue to plan for your business needs while reducing errors. The best way to do this is to invest in an inventory management system that increases the accuracy of your reporting, helps you avoid over- or under-purchasing, and keeps track of values for accurate tax reporting. End of year taxes are just one of the complex issues that Boxstorm’s inventory management software streamlines. Using software to track your inventory assists your business in managing expenses, reducing bloat, and planning for the future. Instead of attempting to manipulate your inventory for a tax advantage, invest in the technology to have more streamlined inventory and supply chains.