Lessen The Load of Rising Inflation

Chris Henderson
December 13, 2005 — 1,373 views  
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With the broad-based inflation we’ve experienced in 2005, now is the time to help your clients with inventory put rising costs to work for their businesses. While most view inflation by its clear downsides, Last In First Out (LIFO) accounting is a tool that CPAs can use to turn this negative into a positive. The LIFO inventory method enables businesses to defer federal income tax based on inventory inflation.

Who can benefit from LIFO?
Good candidates for LIFO include manufacturers, wholesalers and retailers that are experiencing inflation and carry a minimum year-end inventory of $2,000,000 or more. Those that fit the criteria may use potentially substantial 2005 inflation to significantly reduce federal income taxes.

LIFO – Why take another look?
LIFO enables a business to defer income based on inventory inflation. There are many different LIFO methods, but in January of 2002 the IRS issued updated regulations for a method that has been available for more than twenty years. Inventory Price Index Computation (IPIC) LIFO is a specific method using inflation data published by the Bureau of Labor Statistics to measure inflation. Prior to these new regulations, taxpayers could only use 80% of the inflation.

What kind of tax benefit is available?
The following examples represent the first-year LIFO reserve (reduction in inventory value) for several different business types:

Fence Wholesaler
YE Inventory: $23 million
1st Yr. LIFO Reserve: $4 million

Heavy Truck Retailer
YE Inventory: $15 million
1st Yr. LIFO Reserve: $360,000

Steel Wholesaler
YE Inventory: $10 million
1st Yr. LIFO Reserve: $1.6 million

Concrete Pipe Manufacturer
YE Inventory: $2.4 million
1st Yr. LIFO Reserve: 181,000

Garage Door Manufacturer
YE Inventory: $23 million
1st Yr. LIFO Reserve: $4.4 million

Manufacturer of Steel Buildings
YE Inventory: $37 million
1st Yr. LIFO Reserve: $8.7 million

What if my client is already on LIFO?
Many businesses on LIFO measure internal inflation on an item-by-item basis. In many cases, the government-published indexes utilized in the IPIC methodology results in more inflation which, under the LIFO method, yields lower inventory values and better tax benefits.

What other considerations are important when considering LIFO?
For clients with a December year-end, now is the time to explore potential LIFO benefits. Time is of the essence because a client electing LIFO for tax purposes must also have a LIFO provision on its financial statements. This “conformity requirement” is strictly enforced by IRS.

The LIFO impact on financial statements must be discussed with any company shareholders and/or debt holders. To the extent that LIFO reduces taxes, it also reduces book income. Creditors normally approve the LIFO election when they understand the cash flow benefits.

Conclusion: Be prepared for the 2005 year end and explore the potential tax benefits of implementing the IPIC LIFO method for your clients. This article used several benefit examples; however, the variety of inventory types potentially exposed to inflation in 2005 is vast. Experts like LIFO Systems’ inventory categorization specialists can assist a firm by quickly and accurately estimating the potential benefit available for any current or prospective clients.

Chris Henderson, CPA is Director of Accounting for LIFO Systems. LIFO Systems makes otherwise time consuming, complicated and highly specialized tax benefit opportunities readily available to businesses and CPAs across the nation. Its sophisticated, yet automated processes ensure accurate, consistent, cost-effective and timely results. http://www.lifosystems.com



Chris Henderson

LIFO Systems