- Reid Hanson
It's Tax Time! How Does Your Inventory Impact Your Taxes?
Effective Inventory Tax Management is Crucial to Your Bottom Line
With tax season upon us, we are often asked about a business’s inventory’s impact on its tax bill. Is inventory a tax deduction? No. It’s important to understand that inventory is not a tax deduction but it is a reduction of gross receipts, which simply means that your inventory’s value can decrease taxable income.
Here are a few things to keep in mind with regard to your business’s inventory’s impact on your taxes:
A business’s inventory value may significantly impact your tax liability since the Internal Revenue Service (IRS) calculates a business’s tax liability based on profits, not gross revenue. The taxable profit on the inventory sold is calculated from the value of the starting and ending inventory.
When is inventory taxed? Traditionally, inventory value is only taxed if inventory items are sold, no longer have value, or are completely removed from stock.
When can you deduct inventory to reduce taxable income? There is a new rule for the 2018 tax year (for items costing less than $2,500): a retail owner may deduct inventory when it’s bought versus after it’s sold. This could be a significant amount to many businesses.
You may account for inventory loss to reduce your tax liability, including damage, theft, fire, natural disaster, etc. To record loss, you can either include the amount as part of the “Cost of Goods Sold.” A higher COGS will lead to a lower “taxable” profit.
All inventory-related purchases have no impact on your tax bill, so having a modest amount of inventory is generally good for your business as you would incur low depreciation costs.
A few other inventory considerations that may qualify for deductions, include: using your residence for inventory storage space, donating slow-moving inventory to a charity, or selling inventory at a loss.
We wrote about LIFO versus FIFO in a previous blog post. The inventory management technique that you use can also have a significant impact on your tax liability.
Given all of this, there is no benefit in keeping a large inventory, nor with holding no inventory. Experts suggest using solid year-end inventory planning to best manage tax liability. This can be accomplished through effectively forecasting needs in order to pre-purchase inventory. This will help you decrease your gross income and taxable income.
These are some general guidelines to help with your inventory management. Tax laws do vary by state and change frequently. We recommend hiring an experienced bookkeeping or accounting professional to provide specific inventory tax advice.
Properly tracking your inventory is crucial since it can reduce your tax liability and increase your profitability. TRXio can help effectively manage your inventory by generating real-time reports and providing item-level traceability.