It’s the end of another fiscal year, and your business is taking stock of its inventory. As you look at the pile of unsold products sitting in your warehouse, you may be wondering what impact that inventory has on your tax situation.
After all, any business that sells products maintains an inventory – raw materials, works-in-progress, and finished goods. But what happens when some of that inventory goes unsold by the end of the tax year? Can unsold inventory lead to higher taxes for your business?
In this post, we’ll explore what unsold inventory is, how it impacts your business’s taxable income, inventory accounting methods, and strategies you can use to minimize the tax hit from unsold stock.
Understanding Taxes and Retail Inventory
To understand how unsold inventory impacts taxes, you need to understand the cost of goods sold (COGS) deduction. This deduction allows businesses to reduce their taxable income based on the costs of producing or acquiring inventory. COGS represents the direct costs associated with the production or purchase of goods that a company intends to sell during a specific period. These costs typically include the following:
- Product wholesale costs
- Freight charges
- Vendor fees
- Storage fees and warehousing costs
- Beginning inventory is the value of the inventory at the beginning of the accounting period.
- Purchases are the costs incurred to acquire goods during the accounting period.
- Ending inventory is the value of the inventory at the end of the accounting period.
Read also: Average Cost Inventory Method
Inventory Accounting for Retailers
Inventory accounting methods determine the COGS and the value of ending inventory on a company’s financial statements. There are several common inventory accounting methods, each for valuing inventory and calculating COGS:
- First In, First Out (FIFO) – With FIFO, the inventory items purchased first are assumed to be the first sold. For example, if 100 units were purchased for $1 each on January 1st, and another 100 units were purchased for $2 each on February 1st, and 150 units were then sold, the COGS under FIFO would be the first 100 units at $1 cost ($100) plus 50 units at $2 cost ($100), for a total COGS of $200.
- Last In, First Out (LIFO) – With LIFO, the inventory items purchased last are assumed to be the first sold. Using the same example, the COGS under LIFO would be the last 100 units at $2 cost ($200) plus 50 units at $1 cost ($50), for a total COGS of $250.
- Weighted Average Cost – The weighted average cost method takes the average cost of all inventory units available for sale. Continuing the example, with 200 units at a total cost of $300, the weighted average cost is $1.50 per unit. With 150 units sold, the COGS under the weighted average is 150 x $1.50 = $225.
You should also read: What Is Inventory Valuation In a Retail Business?
Strategies to Minimize Inventory Tax Bites
No retailer wants to get stuck holding the bag with piles of unsold inventory eating into their tax bill. Here are some strategies to consider:
Sell excess inventory
If you can, sell excess merchandise at the end of the tax year. Offer sales, promotions, discounts – whatever you need to do to sell it down before year-end. Even selling at break-even or a small loss is likely better than keeping unsold inventory in COGS.
- One of the most common methods is to offer discounts or promotions on excess inventory. This can incentivize customers to purchase these items, especially if they believe they are getting a good deal. You can run sales events, bundle products, or offer “buy one, get one free” deals.
- Create bundles that include both excess inventory and popular items to encourage customers to purchase more. Cross-selling involves offering related products alongside the excess inventory, increasing the chances of selling both.
- Return to supplier. Check supplier agreements – some allow for returns of unsold goods within a certain period. This gets inventory off your hands.
- Sell excess inventory in bulk to discount retailers or liquidators, even at lower profit margins. This generates some revenue from goods you can’t sell.
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Write-down obsolete inventory
Retailers can reduce their taxable income by writing down the value of inventory that is obsolete or unsalable. When a retailer determines that certain inventory can no longer be sold at its original value, they can write down the inventory value on their books to reflect its reduced or salvage value.
This write-down from original cost to lower market value allows the retailer to claim a loss on their tax return, reducing their taxable income. The key is properly identifying and documenting obsolete merchandise according to accounting rules. With proper write-downs, retailers can avoid paying taxes on inflated inventory values that can’t be recovered, minimizing their tax obligations. This removes most of the unsold costs from COGS so you get the deduction.
Donating excess unsold inventory to a charitable organization accomplishes two things:
- Inventory gets removed from the COGS account on your taxes.
- You get a charitable donation deduction, which further reduces taxable income.
Be sure to follow the rules on documenting donations and valuing inventory appropriately. An appraisal may be required. The more excess unsold inventory you can remove from COGS at year-end, the better for lowering taxes. But even better is not having excess inventory in the first place.
Proactive inventory management
The best way to avoid issues with unsold inventory and taxes is not overbuying in the first place. Improving inventory management can prevent getting stuck with huge piles of unsold goods at tax time. Here are some best practices for retailers:
- Use historical sales data and forecasting to predict optimal inventory needs.
- Place smaller, more frequent inventory orders to match demand.
- Turn over inventory quickly – don’t let items sit unsold for months.
- Evaluate sales trends for seasonal items to prevent overstocking.
- Use promotions and sales to clear slow-moving items.
It takes work, but proactively managing your retail inventory flows will benefit your financials and taxes enormously.
Inventory taxes can bite retailers if not careful. Use LIFO accounting, limit excess purchases, and sell down inventory by year-end. Your accountant will thank you when tax time comes!
Reducing Unsold Inventory With KORONA POS
First, KORONA POS provides real-time inventory tracking, so retailers can always see what products they have in stock and which are selling well. This helps retailers to avoid overstocking products that are not selling, which can lead to unsold inventory.
Second, KORONA POS allows retailers to set par levels for each product. Par levels are the minimum amount of inventory that a retailer needs to have on hand to meet customer demand. When a product’s inventory level falls below its par level, KORONA POS can automatically generate a purchase order to replenish the inventory. This helps retailers to avoid stockouts, which can lead to lost sales.
Third, KORONA POS provides retailers with various reports to help them identify and manage unsold inventory. For example, the inventory turnover report shows retailers how quickly their products sell. Products with a low turnover rate may be candidates for discounts or promotions to help reduce unsold inventory.
Finally, KORONA POS can help retailers to track their inventory shrinkage. Inventory shrinkage is the difference between the amount of inventory that a retailer should have on hand and the amount of stock that is present. Inventory shrinkage can be caused by theft, damage, or human error.
Click on the button below to learn more about how KORONA POS can streamline your retail inventory and help reduce inventory unsold inventory.