Inventory and COGS Tax Planning for Product Businesses

Product businesses face unique tax challenges around inventory accounting, cost of goods sold (COGS), and sales tax compliance across multiple states. Getting these foundations right from day one prevents costly mistakes.

Inventory accounting is mandatory. Under Section 471, businesses that produce or resell merchandise must account for inventory using an acceptable method (FIFO, LIFO, or specific identification). You cannot simply deduct product costs when you buy them; you deduct the cost of goods sold (COGS) when items are sold. Getting this wrong misstates your taxable income.

COGS is your most important tax number. Cost of goods sold includes raw materials, direct labor, and manufacturing overhead allocated to products. It reduces gross income before any other deductions apply. A CPA will set up your chart of accounts to capture these costs correctly from the start.

Sales tax nexus creates compliance obligations. If you ship products to customers in other states, you may have physical or economic nexus triggering sales tax collection and filing requirements. Each state sets its own thresholds, typically $100,000 in sales or 200 transactions.

Shipping and fulfillment are deductible. Postage, packaging materials, warehouse rent, and third-party fulfillment fees are ordinary business expenses separate from COGS.

The pitfall: New product businesses often mix personal and business purchases, especially inventory bought with personal credit cards. Without clean records from day one, your COGS calculation becomes an audit target.