We’ve heard all the arguments: “LIFO is just a one time benefit” or “LIFO is too complicated” or “I would have to change my entire technology infrastructure.”
Not true. For over 25 years we have taken something complex and made it simple. End result? You pay less tax and save more money.
We developed the industry’s first LIFO calculation software. What’s more, many businesses may be at risk of calculating the LIFO internal inflation index incorrectly. Your tax department may not have the adequate resources to accurately and efficiently account inventory for tax purposes. With inflation rates at a 27-year high and with increased IRS scrutiny regarding inventory, now is the time to consider an inventory review.
The Benefit:
In periods of rising costs the LIFO method decreases the value of ending inventory compared to the FIFO method. Lower ending inventory results in higher cost of goods sold which in turn lowers taxable income and the tax liability businesses must pay. This allows companies to use the tax savings to reinvest in their businesses. In summary, the LIFO inventory method, similar to other accounting expenses such as amortization and depreciation, increases a company’s cash flow by reducing income and tax liability.
In a period of rapid inflation as we are experiencing now, if you haven’t yet made the switch to LIFO accounting, now is the time to do so.
For more than 70 years, and especially in times of inflation as now, the LIFO inventory method has proven to be an extremely effective tax management tool to reduce taxable income and taxes.
LIFO Questions:
Q: Why should I be interested in LIFO? What’s the potential scale of the benefits?
A: The potential scale of the benefits can be enormous. A company that realizes an additional $200,000 in working capital from a change to the LIFO method the first year could realize additional working capital of over $1,000,000 in five years. As long as inflation continues, generally speaking, LIFO benefits increase.
Q: I have heard that LIFO is complicated, it provides a one-time benefit, and it will not benefit me if I turn my inventory too often. What’s the real story?
A: LIFO is not the black hole of complexity it is often labeled. New regulations issued in 2001 greatly simplified the mechanics of the LIFO calculation as well as encouraged taxpayers to switch to a uniform and IRS friendly methodology. Besides excessive complexity, many other misconceptions surround LIFO including the annual benefit and the relationship of inventory turns has on LIFO applicability. Unlike other change in methods, the LIFO benefit continues to grow in subsequent years with inflation. Inventory turns do not negatively the benefit of LIFO. Regardless of whether inventory turns once or 100 times throughout the year, taxpayers can still utilize the tax deduction generated from LIFO. After 25-years we have developed a solution in association with Big 4 CPA firm PricewaterhouseCoopers. Our LIFO process is simple and safe.
Q: Which industries are good candidates for LIFO?
A: While prices for commodities have greatly fluctuated during the year, underlying inflation is back in many industries. The following outlines inflation trends for manufacturers, wholesalers and retailers by Standard Industrial Code (SIC). Take advantage of this tool to help target LIFO opportunities in your existing and prospective client list. The following SIC types have current inflation percentages ranging from 6-50%. All very good candidates for LIFO: Agricultural chemicals, Paving and roofing materials, Gas Production & Distr., Petroleum refining, Grain Mill Products, Natural Gas Liquids, Coal mining, Meat Products, Poultry And Eggs, Soap, Cleaners, Paper mill products except building paper, Tires & Inner Tubes, Pulp mills, Electric Distributed Equipment, Groceries And Related Products, Public building and related furniture, Eating And Drinking Places, Beverages, Household Furniture, Paper & Paper Products, Oil and gas field services, Periodical publishing, Grocery stores, Plumbing, Heating And Air-conditioning.
Q: Is LIFO relevant for midsize manufacturers and distributors?
A: The LIFO inventory method is relevant for both midsize manufacturers and distributors. Two factors are important when determining the efficacy of LIFO – inflation and inventory. If a manufacturer or distributor maintains inventory and if that inventory is rising in cost, then the company should consider the LIFO inventory method.
Q: When must a company choose LIFO? When is it advisable to change back to FIFO? What are the restrictions on that?
A: A company may choose to elect the LIFO method by including a LIFO election form (Form 970) with the tax return for the year of election. There is no approval process to elect the method – it is automatically approved. Most companies elect LIFO for the long-term. Companies that expect a prolonged period of price deflation would want to elect off of the method. After 5 years on the method, a taxpayer may elect off of LIFO automatically (no IRS consent). Electing off of the method within the 5-year period is more problematic. It requires IRS consent and there is a filing fee to petition the Commissioner. However, the benefits of LIFO often times outweigh any conversion factor.
Q: What kind of circumstances could make LIFO particularly attractive to a company? What might rule out LIFO, or point away from it?
A: Circumstances that make LIFO particularly attractive include the following:
• Profitable company
• Owners are interested in deferring income
• No net operating losses
• Company maintains inventory
• Is experiencing price inflation and expects price inflation to continue for the foreseeable future or
• Is experiencing a spike in price inflation and, although continued inflation isn’t expected, price deflation is not expected
Conversely, situations that might rule out LIFO or point away from it include:
• Net operating losses, negating the benefits of lowering inventory values for tax
• Owners prefer to pay taxes as they go, seeing no value in deferring income
• Inventory value is consistently at or below $1M
• Company is experiencing price deflation or expects price deflation over the next few years
Q: What would a switchover to LIFO entail? When would measurable benefits be seen?
A: A switchover to LIFO is very easy for the taxpayer, especially when the implementation work is outsourced to a qualified CPA firm specializing in LIFO. We need an inventory download as of year-ending and year-beginning detailing the client’s inventory by description, quantity, and price. We’ll have a few questions about their inventory valuation, inventory turns, etc., and will prepare the LIFO election form and supporting documentation. Measurable benefits should be seen immediately in the implementation year. It’s not uncommon for us to see reductions in inventory the first year of $200,000 to $1,000,000 or more, depending on inventory value and the amount of inflation the inventory has experienced.
Q: Have there been recent changes in LIFO tax or accounting rules?
A: There have been no significant changes in LIFO rules for 6 years.
Free Initial LIFO Analysis – You Have Nothing To Lose & Everything To Gain
In periods of rising inflation and prices, the LIFO method is an effective method of increasing cash flow and reducing tax liability. Now is the time to investigate this cash flow savings opportunity.
Click here for your free LIFO Analysis
About SourceCorp Professional Services
Since 1983, SourceCorp has provided IRS-approved tax strategies and services to clients resulting in maximized tax deductions, increased cash flow, minimized tax payments and increased ROI. For more than 25 years, we have worked closely with CPAs, manufacturers, wholesalers, distributors, building owners, architects, engineers and auto dealerships to help them pay less tax and save more money. As a result, funds are available for reinvestment or to meet other current needs. Owned by Apollo Management, Inc., a New York-based private equity firm, SourceCorp is the nation’s leading provider of specialized tax services including LIFO Accounting, R&D Tax Credit Studies, Cost Segregation Studies, and Energy Efficient Commercial “Green” Building Tax Deductions.
