The Property Tax on Business Inventories

 

Contents

Introduction
Inventory as Part of Assessed Value
How Inventory is Assessed
The Debate Over the Inventory Tax
If the Inventory Tax Is Eliminated, Who Pays?
Economic Impact of Inventory Taxes

A Constitutional Challenge?

 

 

Introduction

Every February Indiana sees an advertising blitz for "inventory tax sales."  This so-called inventory tax is actually the property tax on the assessed value of inventories.  Applying the property tax to inventories is controversial.  Fewer than ten states still do it.  And soon, Indiana won't do it either.  The tax restructuring passed by the General Assembly in June 2002 will effectively eliminate the inventory tax in 2007.  After that, property owners will not owe taxes on their inventories, and presumably, there will be no more inventory tax sales.

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Inventory as Part of Assessed Value

Property taxes on inventories raised $452 million for Indiana local governments in 2002. Indiana assessed inventories at $14.5 billion, 7.9% of the state's total assessed value.  Assessed value is the "base" of the property tax, the dollar measure of property to which property tax rates are applied.  The property tax is almost exclusively a local tax, collected by counties, cities and towns, school corporations and other local units. The assessment date is March 1 each year.  On that day businesses or local assessors fix the assessed value of the inventories the business has on hand.  This is why the end of February always sees the tax sales.  Businesses try to sell their inventories so their assessment on March 1 is as small as possible.

Inventories are part of "personal property," which also includes depreciable equipment (like machines in factories or the generating equipment of electric utilities), some mobile homes and some large vehicles, like R.V.'s.  Most personal property is inventories and depreciable equipment owned by commercial, industrial, farm and utility businesses. 

Links to More Information

To Find: Go To:
Table of County assessed values by property type, including inventories, for pay 2000 This website:  Indiana Assessed Value by County (excel spreadsheet)
Pie Chart showing shares of real and personal property in total A.V., pay 2000 This website:  Assessed Value by Category, pay 2000
Data by County for many categories of assessed value, pay 2000 Department of Local Government Finance website
Data for Indiana as a whole, showing detailed categories of assessed value, pay 2001 General Assembly publications website:  see pp. 95-97 of Handbook, Fiscal 2001 edition

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How Inventory is Assessed

Real property (land and buildings) is reassessed only during mass, statewide reassessments, which happen every four to ten years.  Personal property is reassessed every year.  Business taxpayers or local assessors value inventories and equipment as of March 1, by filling out a personal property form.  Taxes on the value of this property are due in the following year.

Page 4 of the personal property "long form" (Indiana Form 103) deals with inventories.  The form has 28 lines, all of which are important to a business accountant.  The citizen trying to understand how inventory assessment works can focus on a few of these lines, however.

Line 10 is "Total inventory on hand March 1."  The business must enter a dollar figure on this line.  The figure represents the value of the businesses' inventories on March 1, the assessment date.  Included are the values of raw materials, work in progress, finished goods, stock in trade, and supplies.  "Value" can be either the cost of the inventory to the business, or its expected selling price, whichever is less.

Lines 11 through 24 are where the tax accountant earns his or her keep.  Businesses can value their inventories based on the average over a year, rather than on March 1.  They must make some additions, and can make some deductions from the inventory value on line 10.  (Many of these entries must be justified on form 106, which is a separate personal property form a business must file.)  Line 24 is the result of all this averaging, adding and deducting:  "Total inventory before special adjustments."

Line 25 is labeled "Valuation adjustment @ 35% of Line 24 above."  Businesses calculate 35% of the value of their inventories (after all those averages, additions and deductions).  They subtract this valuation adjustment from the inventory value.  

Line 28 is the true tax value of inventories.  This figure is transferred to the first page of the form, and added to depreciable equipment value to get the true tax value of personal property.

Until March 1, 2001, true tax value was divided by three to get assessed value.  As of 2001 (taxes payable in 2002), Indiana no longer divides by three.  When taxes are paid on this property in 2002, taxpayers found that tax rates were about one-third what they were the year before.  Eliminating division by three had no effect on tax payments.

Here's a simple example.  Suppose an automobile dealer has a car on his/her lot on March 1.  Suppose the cost to the dealer was $20,000.  If there were no further additions or deductions, this figure would be entered on Line 24.  The 35% inventory adjustment would be $7,000, so the true tax value of the car would be $13,000. 

The local tax rate would by applied to this figure to determine the tax payment owed.  The statewide average is about $3.00 per $100 assessed value (that is, 3%).  The tax payment would be $390.  (Before 2002, the tax rate would have been triple, $9.00 per $100 assessed value, but the automobile's assessment would have been one-third, $4,333.33.  That works out to $390, too.) 

Links to More Information

To Find: Go To:
Personal Property Assessment Long Form 103 (see p. 4 for inventory assessment) This website:  Personal Property form 103 (PDF, 178 k)
Personal Property Assessment Form 106, explanations of inventory adjustments This website:  Personal Property form 106 (PDF, 40 k)
Entire collection of Personal Property forms Department of Local Government Finance forms catalogue website
Discussion of the issues surrounding the 2002-03 property tax reassessment This website:  Property Tax Assessment topic

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Tax Restructuring Changes to the Inventory Tax

The property tax on inventories is an especially controversial part of the property tax.  Retailers and wholesalers in particular want to see it abolished.  The General Assembly has long considered bills to exempt some business inventories from taxation, or to phase out the tax over several years.  The last two long sessions of the General Assembly (1999 and 2001) have passed bills providing (and rescinding) tax breaks for inventory taxpayers.  Finally, during the special session of May and June, 2002, the General Assembly voted to phase out the property tax on inventories.  The tax is scheduled to be eliminated for taxes payable in 2007.

Inventory taxes were debated throughout the 1999 session of the General Assembly.  At the very end of the session the legislature passed a personal property tax credit, which allowed taxpayers to a credit on the taxes paid on the first $12,500 of personal property (including inventories).  This cost the state $180 million in credit payments in 2000, which was more than expected.  The credit was rescinded by the 2001 General Assembly as of the end of 2001. 

The tax restructuring bill passed by the special session of the General Assembly in June 2002 affected property taxes on inventories in three ways.  First, inventories of goods or materials that manufacturers will ship out-of-state, or use in products to be shipped out-of-state, were immediately exempted.  Second, for taxes payable in 2007 (on assessments from March 1, 2006), owners of inventories can take a 100% deduction against the value of their inventories.  That effectively eliminates property taxes on inventories.  Third, counties can adopt a 100% inventory deduction prior to 2006-07.  They also can adopt a higher local income tax (up to 0.25% on EDIT), and use it to fund added homestead credits for homeowners, to offset the shift in taxes to homeowners that would occur with the elimination of inventory taxes.  This can be done with the local option inventory deduction before 2006-07, or with the statewide inventory deduction in 2006-07.

 

Links to More Information

To Find: Go To:
Sections of the June 2002 Tax Restructuring Bill dealing with inventory tax exemptions and deductions This website:  Inventories in the Tax Restructuring Bill
Discussion of the new local option inventory deduction This website: Local Option Inventory Deduction topic
An explanation of the homestead credit This website:  Read Your Property Tax Bill

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If the Inventory Tax is Eliminated, Who Pays?

If businesses do not pay property taxes on their inventories, someone must pay.  There are essentially three possibilities.

1.  Local governments can reduce their spending.  Businesses paid $452 million in inventory taxes in 2002, which was about eight percent of the property tax revenue local governments received.  About half of this revenue went to school corporations, another 40% to counties, cities and towns, and the rest to townships, library districts and other special districts.  If inventory taxes are eliminated, one option is for these governments to reduce their spending and provide fewer services. 

2.  All other property taxpayers can pay more.  Inventories will be effectively removed from the property tax base for taxes in 2007.  If no other changes are made, the existing property tax levy (the revenue collected) would be paid by the remaining taxpayers.  Tax rates would increase.  This would increase property taxes for homeowners by about 10%. 

3.  Other taxpayers can pick up tab.  Counties have the option to adopt a higher homestead credit, to offset the shift of inventory taxes to homeowners.  The credit would be funded by an increase in a local income tax.  This means that income taxpayers would foot part of the bill for the elimination of inventory taxes.  

Some proponents of inventory tax elimination claim that without the tax, Indiana will become a magnet for warehousing businesses.  This added development, it is said, will so increase incomes that income and sales tax revenues will rise enough to fund the tab in option 3 above.  Evidence shows, however, that while inventory tax elimination probably will enhance economic development, it would not generate enough added state revenue to fully fund elimination.  The next section discusses this evidence.

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Economic Impact of Inventory Taxes

One of the attractions of inventory tax reduction or elimination is the economic development benefits that it might bring.  Proponents of elimination point to Indiana's location at the crossroads of many interstate highways.  Indiana could be a major warehouse distribution center, it is said, but for the property tax on inventories.  The result would be increases in jobs, incomes and sales.  Added income and sales could generate added state revenue through income and sales taxes.  Some claim that this additional revenue would be enough to completely offset the cost of the inventory tax cut.

Would the reduction or elimination of property taxes on inventories increase the amount of inventories held in Indiana?  Indiana data can be used to provide evidence on this question.  In 2001 average property tax rates on inventories among Indiana counties varied from a low of $1.77 per $100 assessed valuation to a high of $6.63 per $100 assessed valuation.  If inventory taxes inhibit inventory location, one would expect high tax rates to inhibit location more than low tax rates.  All else equal, if inventory taxes affect inventory location, there would be more inventories in low tax counties and less in high tax counties.

An analysis of this data shows that 

Links to More Information

To Find: Go To:
Text of the research article which reports these results:  L. DeBoer, "Taxing Inventory:  An Analysis of its Effects in Indiana," Indiana Business Review, Fall 1999, pp. 1-6. Indiana Business Review website, click on Fall 1999 issue

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A Constitutional Challenge?

Article 10, Section 1 of the Indiana Constitution says

(a) The General Assembly shall provide, by law, for a uniform and equal rate of property assessment and taxation and shall prescribe regulations to secure a just valuation for taxation of all property, both real and personal. The General Assembly may exempt from property taxation any property in any of the following classes:
    (1) Property being used for municipal, educational, literary, scientific, religious or charitable purposes;
    (2) Tangible personal property other than property being held for sale in the ordinary course of a trade or business, property being held, used or consumed in connection with the production of income, or property being held as an investment;
    (3) Intangible personal property.
    (b) The General Assembly may exempt any motor vehicles, mobile homes, airplanes, boats, trailers or similar property, provided that an excise tax in lieu of the property tax is substituted therefor.

It says personal property--which includes inventories--must be assessed and taxed.  Inventories do not appear on the list of possible exemptions.  Under tax restructuring, in 2006 and after inventories would still be assessed.  With the 100% inventory deduction, however, in 2007 and after property owners would pay no taxes on inventories.  The valuation may be just, and assessment may be uniform and equal.  But is this a uniform and equal rate of taxation

It is possible that the inventory deduction will be challenged in court.  If so, the courts will have to decide whether the Indiana General Assembly has the power to eliminate the inventory tax.

Anticipating this possibility, during the 2003 session both houses of the General Assembly passed a resolution to amend the Constitution to allow inventories to be exempted.  Senate Joint Resolution 5 would change the Constitution's Article 10, section 1 to read

(a) The General Assembly shall provide, by law, for a uniform and equal rate of property assessment and taxation and shall prescribe regulations to secure a just valuation for taxation of all property, both real and personal. The General Assembly may exempt from property taxation any property in any of the following classes:
        (1) Property being used for municipal, educational, literary, scientific, religious, or charitable purposes.
        (2) Tangible personal property other than property being held for sale in the ordinary course of a trade or business, property being held used or consumed in connection with the production of income or property being held as an investment.
        (3) Intangible personal property.
         (4) Tangible real property, including curtilage, used as a principal place of residence by an:
            (A) owner of the property;
            (B) individual who is buying the tangible real property under a contract; or
            (C) individual who has a beneficial interest in the owner of the tangible real property.

    (b) The General Assembly may exempt any motor vehicles, mobile homes, airplanes, boats, trailers, or similar property, provided that an excise tax in lieu of the property tax is substituted therefor.

To become part of the Constitution, a resolution must be passed by two sessions of the General Assembly, with an election in between.  This amendment passed the last session, so this is the second time it has passed.  It will now go to a referendum, probably in 2004.  If the voters approve, the General Assembly would probably rescind the inventory deduction, and simply exempt inventories, so they do not have to be assessed in the first place.

Looks like the resolution gives the General Assembly the authority to exempt business depreciable equipment and homes, too.  The phrase "property being held used or consumed in connection with the production of income" was crossed out, so this property can be exempted.  And section 4 was added to allow exemption of homes ("curtilage" is the lot that the house is on). Homes and depreciable equipment are about two-thirds of the property tax base.  That would amount to a tax restructuring beyond anything Indiana has ever seen.
 

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