Demand & Inventory Planning

Understanding Inventory Tax: An eCommerce Merchant’s Guide

Demand & Inventory Planning
October 8, 2021
8 min read

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.

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, regardless of whether your business makes a profit that year or not. 

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.

Is There a Federal Inventory Tax?

Inventory tax is determined on a state-by-state basis. Currently, there are 11 states that collect some sort of inventory tax, some on a statewide level and some only collect it 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. The states that currently tax inventory are:

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 inventory tax 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 inventory tax are often more limited for SMB’s.

Looking for an inventory management solution? Talk to one of our supply chain experts.

How to Reduce Inventory Tax

Like with all expenses, inventory tax should be looked at within the full scope of your contribution margin and cost of goods sold. Making decisions primarily based on lowering inventory tax 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 have been shown to increase sales, with 69% of shoppers reporting that they are more likely to click on an advertisement that mentions free, 2-day shipping. Before moving inventory to another state, consider the top-line revenue implications it could have if delivery speed is negatively impacted.
  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 inventory taxes than you need to.
  4. Liquidate slow-moving or obsolete inventory. If inventory is turning at a rate of less than once per quarter, it’s probably going to start costing 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 that 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 is seen by many as disincentivizing retail and business growth in general. For that reason, some states have begun to 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 your inventory is stored.

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 SKU’s. 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.


What is considered inventory for tax?

The amount of inventory tax owed is determined by the value of inventory a merchant is carrying at the end of the year. The value can be determined 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: The fair market value of the inventory on a set valuation date is used to determine its taxable value.

How do I track inventory tax?

Inventory taxes are calculated differently on a state-by-state level. 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. Taxes are then calculated according to the policies of the state the inventory is being stored in.

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 means that it must be calculated by the taxpayer (business owner). Unsold inventory should be counted and valued 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 local governments in the states where it is collected. Each of the 11 states that require inventory tax has different policies and applies the funds in different ways.

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