What Are These Methods?
Think of a stack of boxes in your garage.
FIFO — First In, First Out. The oldest box leaves first. You sell what you bought first. This is how most sellers naturally think about inventory — you don't want older stock sitting around longer than necessary.
LIFO — Last In, First Out. The newest box leaves first. The older boxes stay at the bottom. It sounds counterintuitive, but in certain conditions it can lower your taxable income.
A Simple Example
Let's say you sell t-shirts online.
In March, you make two purchases:
March 5: 100 shirts at $50 each — $5,000
March 15: 150 shirts at $54 each — $8,100
March 25: You sell 120 shirts
What did those 120 shirts cost you?
With FIFO: You sold the oldest shirts first — all 100 at $50 ($5,000), then 20 more at $54 ($1,080). Total cost: $6,080.
With LIFO: You sold the newest shirts first — all 120 at $54. Total cost: $6,480.
The difference is $400. With LIFO, your costs appear higher, your profit appears lower, and your taxes follow. That was just 250 shirts. Scale that across thousands of products and the numbers grow quickly.
Why Prices Going Up Makes This Matter More
When prices are rising, LIFO creates a bigger gap. Here's another example with an Amazon seller buying phone cases:
First order: 100 cases at $5 each
Second order: 200 cases at $7 each
Sold: 150 cases
With FIFO: Cost = (100 × $5) + (50 × $7) = $850
With LIFO: Cost = (150 × $7) = $1,050
LIFO shows costs that are 24% higher — which means 24% less profit on paper, and lower taxes to match. For a business with $1,000,000 in inventory, the potential tax savings could reach $42,000.
That said, LIFO comes with real complexity, which we'll get to.
IRS Rules Worth Knowing
Pick one method and stay with it. You can't switch between FIFO and LIFO from year to year. The IRS requires consistency.
LIFO requires matching. If you use LIFO for taxes, you must use it for all financial reporting — including what you show banks and investors. You can't report one thing to the IRS and another to your lender. This is called the conformity rule.
Small businesses have simpler options. If your annual sales are under $31 million (as of 2025), you may qualify for simplified inventory tracking.
LIFO needs a special form the first year. You must file Form 970 with your first tax return using LIFO. If this form is missed, the LIFO election is invalid.
Changing methods later is a significant process. Switching inventory methods requires Form 3115, and the cost depends on the type of change.
Before assuming your switch qualifies for automatic consent, check the latest IRS Form 3115 guidance directly at irs.gov/forms-pubs/about-form-3115. This is another reason to choose the right method from the start.
Why Most eCommerce Sellers Choose FIFO
FIFO is the most widely used inventory method — and for good reason.
It reflects how most businesses actually operate. Selling older stock first keeps products fresh and prevents items from sitting too long.
Most software uses it by default. QuickBooks runs on FIFO automatically. When you connect your platforms through Link My Books, your sales data flows directly into QuickBooks and your cost tracking stays accurate without manual work.
It's accepted everywhere. LIFO is banned under international accounting standards — Europe, Asia, and Australia all require FIFO or average cost. If you sell internationally or plan to, FIFO keeps things straightforward.
Lenders prefer it. FIFO shows inventory at more current market values, which works in your favor when applying for business financing.
It's what most companies use. Among S&P 500 companies, approximately 55% use FIFO as their primary inventory method, while only about 15% use LIFO. Overall, roughly two-thirds of U.S. corporations use FIFO — a reflection of both its practical simplicity and the fact that LIFO isn't an option for businesses operating under international standards.
Method | S&P 500 Usage |
|---|---|
FIFO | ~55% |
LIFO | ~15% |
Average Cost / Other | ~30% |
A Note for Amazon FBA Sellers
Amazon stores your inventory in fulfillment centers across the country. When a customer orders, Amazon ships from the nearest warehouse — not necessarily the oldest stock.
Does that affect your accounting method? Not directly. Your chosen method tracks costs on paper, independently of how products physically move.
Many Amazon seller accountants recommend average cost — which is even simpler than FIFO.
With average cost, you total all inventory costs and divide by the number of units. Every item carries the same per-unit cost.
Example:
100 items at $10 each = $1,000
200 more at $12 each = $2,400
Total: 300 items, $3,400
Average cost = $11.33 per item
Every sale uses $11.33 as the cost — no batch tracking needed.
A couple of things to keep in mind for FBA:
Amazon fees (storage, shipping, handling) should factor into your inventory costs. QuickBooks, connected via Link My Books, tracks this automatically as your Amazon data syncs in.
Returns need to be reflected in your records — the sale is reversed and the inventory comes back.
How to Set Up FIFO in QuickBooks
Getting started is simpler than it sounds.
Step 1: In QuickBooks, go to Settings → Products and Services → turn on "Track inventory." FIFO is the default.
Step 2: Record every purchase with the date, quantity, and cost per unit. Keep all invoices and receipts.
Step 3: Label your batches. Date your boxes or storage bins so you can identify which stock arrived when.
Step 4: Count your inventory at least every three months and compare it to what QuickBooks shows. Reconcile any differences right away.
Step 5: Keep records for a minimum of six years. For LIFO users, records should be retained indefinitely.
Common Inventory Accounting Gaps to Watch For
These are the situations we see come up most often — and all of them are avoidable with the right setup.
Not tracking cost layers. FIFO requires knowing "I bought 50 units at $10, then 30 at $12." If you only track totals, the calculation doesn't work correctly.
Using LIFO without following the conformity rule. Reporting LIFO costs to the IRS while showing FIFO figures to a bank violates IRS rules. If identified, you can lose your LIFO status and face back taxes.
Switching methods without IRS approval. Changing from FIFO to LIFO (or back) requires going through a formal process — it's not something you can do unilaterally at filing time.
Missing Form 970 in year one of LIFO. Without this form filed with the first LIFO return, the election doesn't count.
LIFO inventory depletion. With LIFO, older lower-cost inventory stays at the bottom. In a high-volume year, if you sell into that older stock, costs drop sharply, profits appear to spike, and so does your tax bill. This can catch sellers off guard.
Year-end timing. Whether a shipment arrived December 31 or January 1 changes which tax year it belongs to. This is worth confirming carefully at year-end.
Mixing methods without clear documentation. You can use FIFO for one product line and average cost for another — but it requires meticulous recordkeeping. Most sellers are better served by keeping it consistent.
Not planning for business structure changes. Converting from a C-corp to an S-corp while using LIFO triggers a tax event. This is worth planning for well in advance.
How to Choose Your Method
FIFO is a strong fit if you:
Sell food, fashion, or anything time-sensitive
Sell or plan to sell outside the U.S.
Want the simplest setup
May seek loans or investors
Use QuickBooks or similar software
Average cost works well if you:
Sell on Amazon FBA
Carry a large volume of similar, low-cost items
Don't have dedicated accounting staff
Want the lowest-maintenance option
LIFO may be worth exploring if you:
Sell only in the U.S.
Carry products that don't expire or go out of style
See consistent price increases year over year
Have an accountant experienced with LIFO management
Maintain high inventory levels consistently
For most eCommerce sellers, FIFO or average cost is the right answer. The tax savings from LIFO rarely outweigh the complexity it introduces.
Record Retention at a Glance
3 years — the IRS standard after filing. 6 years — recommended if there's any chance of underreporting (and a good general practice). Indefinitely — required for LIFO records, which the IRS can review at any time.
Keep purchase orders, invoices, receipts, inventory counts, and sales records. Digital copies with secure backups are ideal.
State Tax Considerations
Most states follow federal inventory rules. If you use FIFO federally, the same applies to your state return.
A few states have their own wrinkles — Texas, for example, has specific inventory rules tied to its franchise tax, and some states assess inventory as taxable property. A tax professional familiar with your state can help you navigate what applies to your situation.
When to Bring in Professional Support
Some situations genuinely benefit from expert guidance:
Starting out? Work with an accountant before your first tax year closes to set up the right method from day one.
Considering LIFO? Get professional advice before making the election — the paperwork and compliance requirements are significant.
Selling internationally? Confirm your method works across every market you operate in.
Inventory value over $100,000? Professional guidance at that level pays for itself.
Planning to sell your business? Your inventory method affects how buyers assess and value your books.
Want to make sure your inventory accounting is set up correctly? At Tall Oak Advisors, we work exclusively with eCommerce entrepreneurs — Amazon FBA sellers, Shopify store owners, and multichannel businesses navigating the unique layers of online selling. From inventory method selection to FBA fee allocation and multi-state sales tax, we speak your language.
Schedule a free consultation and let's make sure your books are working for you from the start.
This article is for educational purposes only and does not constitute tax, legal, or financial advice. Tax laws change frequently and individual circumstances vary. Always consult with a qualified tax professional before making decisions about your specific situation.
