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Another look at simplified LIFO for retailers.

The tax benefits available under the LIFO inventory method are well established. Yet in recent years, expectations have sometimes surpassed results. Some retailers have been disappointed by less than anticipated benefits, while others have seen LIFO actually create tax liabilities. Still others have chosen not to elect LIFO because they were concerned about administrative difficulties or adverse financial reporting effects.

Many taxpayers are not maximizing the tax benefits of this inventory method and are paying more taxes than necessary. There have been several changes in the LIFO area in the last 10 years that have proved beneficial to retailers. Perhaps it is time to reexamine the various tax alternatives under the LIFO method.

In 1981, the IRS adopted Regs. Sec. 1.472-2(e)(3), which substantially reduced the potential adverse financial reporting impact of LIFO. While the LIFO method is still required for financial reporting if it is used for tax purposes, supplemental disclosure of non-LIFO information is permitted. In addition, identical LIFO methods are not required. Thus, a company could adopt the most beneficial LIFO methodology for tax purposes while using a more conservative method for financial reporting purposes. For example, a government index could be used for tax purposes and an internally generated index for financials. Therefore, if the financial reporting requirement was the only reason for not electing LIFO, it may be wise to reconsider.

In 1982, the Service published Regs. Sec. 1.472-8(e)(3) allowing any taxpayer (other than department stores eligible to use the Bureau of Labor Statistics' (BLS) Department Store Indexes) to use government indexes for dollar value LIFO calculations. Computing a LIFO index is generally considered the most difficult requirement of LIFO. Under these regulations, a taxpayer may now use the Consumer Price Index (CPI) or the Producer Price Index (PPI) published monthly by the government. Although the IRS exacts a toll by limiting the index to 80% of the indicated inflation, the use of this method could provide improved results.

Effective in 1987, a statutory simplified dollar value LIFO method using the CPI and PPI indexes and categories was provided in new Sec. 474 for taxpayers with annual receipts under $5 million.

* The indicated inflation may be more than a taxpayer currently experiences. * New items need not be priced at beginning-of-the-year cost. The published index may be used to deflate the cost of the new items. * Fewer inventory groupings, or pools, are generally required. * The exposure to a successful IRS challenge of LIFO calculations is greatly reduced.

To get a quick idea of whether a government index might be beneficial, review the CPI or PPI indexes for the last two or three years and compare them to the inflation determined under the company's current method. For those considering the adoption of LIFO, multiply these indexes by the beginning inventory for the last several years to estimate the potential yearly income deferral. This amount should then be multiplied by the company's effective tax rate to estimate the annual tax benefits.

Any retailer that is not a department store or qualified specialty store is eligible to adopt or change to the Inventory Price Index Computation method. Department stores and qualified specialty stores remain eligible to adopt or change to the use of the BLS Department Store Index, which offers benefits similar to those previously described. Note: A taxpayer can adopt a LIFO method after year-end by attaching an election form to its return.
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Author:Holt, Jeremy K.
Publication:The Tax Adviser
Date:Jan 1, 1992
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