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The "simplified" IPIC method.

The IRS recently issued revised final regulations for published price indexes under the dollar-value LIFO inventory method, effective for tax years ending on or after Dec. 31, 2001.


Under dollar-value LIFO, taxpayers track inventories in dollar terms rather than units. They must either compute their own internally generated index or use an index approved by the IRS. The index reflects the inflation in inventory accounted for under LIFO. In computing an internal index, taxpayers compare the inventory's base-year at the end of the year with that at the beginning of the year, to determine if the investment in inventory has increased or decreased in constant (i.e., base-year) dollars.

The inventory price index computation (IPIC) is a sub-election of dollar-value LIFO. It is a method of determining an inflation index used in computing LIFO inventories with reference to the Bureau of Labor Statistics (BLS) Producer Price Index (PPI) or Consumer Price Index (CPI), rather than internally generated indexes. Congress intended the IPIC method to simplify the use of dollar-value LIFO, so that taxpayers could use an alternative method of computing their LIFO index.

Legislative History

On March 16, 1982, the IRS issued final regulations on published price indexes. One of the most significant provisions was that under IPIC, inflation was generally limited to 80%, of the change in the published indexes for taxpayers with gross receipts over $5 million. Taxpayers with gross receipts less than that amount were permitted to use 100% of the percent change in the selected indexes (prior to the Tax Reform Act of 1986, the 80% limit applied to taxpayers with gross receipts over $2 million). At the time, the IRS believed that the 80% change would approximate the inflation in inventory for many of the larger companies that would use LIFO.

On May 19, 2000, the IRS issued proposed regulations to simplify and clarify certain aspects of the IPIC method. On Jan. 8, 2002, it issued final regulations that contain several revisions and clarifications, most notably the elimination of the 80% limit. As noted, they are effective for tax years ending on or after Dec. 31, 2001.

Significant Changes

Inventory price index--20% reduction. The IRS eliminated the 80% limit (or "20% haircut"). Taxpayers electing the IPIC method can now use 100% of the pool index--now called the inventory price index (IPI)--to compute the LIFO value of a dollar-value pool.

10% categories and BLS weights. The new regulations retain the 10% BLS categories and BLS weights as an elective method (10% method) for determining a category's inflation index. They clarify that the 10% level is measured by comparing the current-year cost of the items in a category to the total current-year cost of the items in the dollar-value pool (not to the current-year cost of the items in the taxpayer's entire inventory). Taxpayers with only a few inventory items to classify will find that IPIC should be easier to implement if they do not elect the 10% method. On the other hand, taxpayers with numerous inventory items to classify (such as grocery stores) will find that the 10% method is probably easier.

Selecting an appropriate month. The final regulations clarify how to determine an appropriate month. The BLS publishes PPI and CPI indexes on a monthly basis. Thus, taxpayers must select an appropriate month from which to draw the indexes. For a retailer that uses the retail method, the appropriate month is the last month of its tax year. All other taxpayers must either select an appropriate month annually for each dollar-value pool or make a one-time binding election to use a representative month. The principles for determining whether a particular month is appropriate or representative under Rev. Rul. 89-29 were incorporated into the revised regulations. Accordingly, an appropriate month should be a month that has a relationship to the taxpayer's method of determining current-year costs and its historical experience of inventory purchases during the year.

Dual indexes. Several taxpayers have used dual indexes with IPIC (e.g., a cumulative index to deflate current-year FIFO cost to a base-year cost, to determine if an increment or decrement exists, and another to inflate any increment at base-year cost to current-year LIFO value). The revised regulations disallow the use of dual indexes in conjunction with the IPIC method. However, this does not mean that it will be prohibited in the context of other LIFO methods.

Calculation of a category inflation index. A category inflation index reflects the inflation that occurs in the BLS price indexes for a selected BLS category (or, if applicable, a BLS category group). Taxpayers should compute the category inflation index with reference to the BLS price indexes, for an appropriate month of the year preceding the year it made a LIFO election (in the case of the double-extension IPIC method) or of the preceding year (for the link-chain IPIC method). In addition, the revised regulations incorporate the guidance provided in Rev. Proc. 98-49 on computing a category inflation index when a selected BLS category is revised in a particular tax year. Accordingly, if a taxpayer cannot compute the category inflation index because of a revision, it must compute the category inflation index using a reasonable method, provided it uses that method consistently for all BLS categories affected within a particular year.

Use of cost price indexes. The BLS compiles the CPI indexes based on changes in retail selling prices, rather than on changes in wholesale or cost prices. Likewise, it compiles the PPI indexes based on changes in manufacturer selling prices. As a result, under prior law taxpayers had to convert published price indexes into either retail price indexes or cost price indexes. Under the revised regulations, no such conversion is allowed.

Selection of CPI Detailed Report or PPI Detailed Report. Retailers using the IPIC method may assign items to the BLS categories listed in either the CPI Detailed Report or the PPI Detailed Report. All other taxpayers must elect to compute LIFO price indexes from the PPI Detailed Report.

BLS category for work-in-process (WIP). Taxpayers do not have to compute a separate category inflation index for WIP, unless it regularly sells component parts of finished goods. For example, a gasoline engine manufacturer that also manufactures and regularly sells pistons must assign piston WIP items and finished pistons not attached to an engine to the most detailed PPI category that includes pistons. On the other hand, a gasoline engine manufacturer that does not regularly sell pistons would assign the same items to the most detailed PPI category that includes gasoline engines.

Selection of pools. Under the revised regulations, retailers can elect to establish dollar-value pools for items it accounts for under the IPIC method, based on either the general expenditure categories in Table 3 of the CPI Detailed Report, or the two-digit commodity codes in Table 6 of the PPI Detailed Report. Likewise, wholesalers, jobbers, distributors, manufacturers and processors can elect to establish dollar-value pools, based on the two-digit commodity codes in Table 6 of the PPI Detailed Report. For some retailers and wholesalers, this pooling method may be one of the primary advantages of adopting the IPIC method. For example, a company previously pooling by major lines, types or classes of goods may have, if it has several pools, frequent liquidations, even in years when there is no overall decline in its investment in inventory. By electing IPIC, the company may have fewer pools and, accordingly, fewer liquidations than in prior years. On the other hand, although manufacturers may take advantage of this election, the natural business-unit-pooling provisions permitted under the dollar-value LIFO regulations generally will tend to be more favorable.

Clarification of special pooling rules. The revised regulations clarify that both of the 5% rules are optional accounting methods within the broader IPIC pooling method. The 5% rules are:

1. If two or more pools each comprise less than 5% of the total value of the taxpayer's inventory, the taxpayer can combine them; and

2. If the combined pool is still less than 5% of the total value of the taxpayer's inventory, the taxpayer can add this pool to the pool with the largest inventory value.

The taxpayer must determine whether a specific IPIC pool or the miscellaneous IPIC pool satisfies the applicable 5% rule in either the year it adopts the pooling method or in the change year (whichever applies) and redetermine this every third tax year.

Scope of an IPIC method election. The regulations modified the requirement to use the IPIC method for all LIFO inventory. Taxpayers are now allowed to apply the IPIC rules on a trade-or-business basis, rather than a taxpayer-by-taxpayer basis.

Department stores. Under prior law, companies that could use the BLS Department Store Indexes were prohibited from using the IPIC method. This restriction has been eliminated. Accordingly, companies using the Department Store Indexes should determine if IPIC would produce a more favorable result. Inflation might be similar, as both indexes are published price indexes. However, a benefit may result from pooling changes. Instead of 20 or more historic pools, a department store may have four or five pools under IPIC.

Inventories received in certain nonrecognition transactions. Under prior law, companies had to take caution when contemplating the use of BLS indexes when they acquired inventory in a Sec. 351 or 721 transaction from a transferor that had used LIFO. The BLS indexes did not reflect inflation in the transferee's initial LIFO year (i.e., the transferor used LIFO). Put simply, the low basis carried over by the transferee from the transferor in the Sec. 351 or 721 transfer was the base-year cost of the transferee's beginning inventory. If at least one inventory turnover occurred before the end of the year, the current-year cost of the transferee's ending inventory would be considerably higher than the base-year cost of the beginning inventory, simply because of the transferred inventory's low basis. However, if the ending inventory's current-year cost were deflated by a normal one-year index under IPIC, it would not give effect to the low-basis beginning cost and would create an artificially large increment.

To prevent a recapture of a transferor's LIFO reserve in a non-Sec. 381 transfer, the revised regulations require the transferee to update its base-year cost to the transfer year and to use the current cost of such items as its new base-year cost, thereby preventing an artificial increment. This requirement applies whether the transferee is electing or continuing the use of LIFO. Under prior law, this potential recapture of LIFO was the reason why many companies that were constantly undergoing restructuring did not elect the IPIC method. Accordingly, companies with recent Sec. 351 or 721 transactions should reexamine whether they should elect this method.

Weighted harmonic mean for IPI. The revised regulations eliminated the weighted arithmetic mean as an acceptable method of computing the IPI for a dollar-value pool (even if the taxpayer elects the 10% method and uses a weighted arithmetic mean to compute the category inflation index). Using a weighted arithmetic mean is not a mathematically correct method of computing the inflation index for a pool when the corresponding weights are the relative current-year costs at the end of the tax year. Instead, the revised regulations require taxpayers to compute the IPI using a weighted harmonic mean.

Change in Accounting Method

The use of published price indexes is an accounting method. If a taxpayer is not presently using LIFO, it could adopt the new IPIC method by filing Form 970, Application to Use LIFO Inventory Method, with its return. If the taxpayer is presently using LIFO (including IPIC under the former regulations), it would generally be eligible to change to the new IPIC rules under Rev. Proc. 2002-9's automatic method change provisions, for the first or second tax year ending on or after Dec. 31, 2001. The scope limits described in Section 4.02 of Rev. Proc. 2002-9 and the five-year limit on the readoption of LIFO, as set forth in Section 10.01(2) of the appendix to Rev. Proc. 2002-9, are waived during this two-year period. The taxpayer makes the accounting-method change using the cut-off method (i.e., no Sec. 481(a) adjustment). In addition, if the taxpayer is changing from another LIFO method to IPIC or is conforming to the new regulations, it must update its base year.

Need to change entire calculation. Some companies have been under the false assumption that they can change their calculation for the 20% haircut and at the same time retain the remainder of the calculation. This would be a rare occurrence. Most companies will need to change other aspects of their calculation.


These revisions and clarifications are only a few of the new regulations' changes and alternatives. The regulations, in effect, provide taxpayers with an opportunity to review the IPIC alternatives and, if applicable, take a fresh look at their elections. The revised regulations may provide an opportunity for an additional tax benefit or for a more simplified LIFO computation.

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Title Annotation:inventory price index computation
Author:Leib, Irwin
Publication:The Tax Adviser
Geographic Code:1USA
Date:Jun 1, 2002
Previous Article:Significant new guidance for changing an accounting method.
Next Article:Rite Aid precipitates issuance of prop. and temp. regs.

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