LIFO in a Deflationary Market
IPIC Method May Minimize Impact for 2009
Since 1939, thousands of companies across multiple industries have used LIFO as their method of inventory accounting. Where LIFO is concerned inflation is good—but deflation is bad.
Inventory values bottomed out in 2009 as a result of inventory management and price deflation. While this presents great opportunities for companies not currently using LIFO to elect to do so in 2010, companies already on LIFO may be looking at a tremendous recapture of LIFO reserve as a result of deflation. This “phantom income” will be costly and potentially crippling for many companies.
For the past 27 years, SourceCorp has worked with taxpayers to maximize LIFO benefits and to minimize the downside of LIFO in deflationary business environments. We have a potential solution for companies currently on LIFO who experienced significant deflation in 2009.
There is a preferred IRS method that yields better tax results for the majority of taxpayers. The IPIC (Inventory Price Index Computation) LIFO method bases inflation measurements on data published by the Bureau of Labor Statistics (BLS).
These BLS indexes are the result of regular surveys performed by the BLS and are a domestic measure of inflation. As a business, you do everything possible to minimize inventory costs, but the BLS indexes do not necessarily reflect the same efficiencies. This is good news for LIFO taxpayers.
The case study below is a LIFO taxpayer with a diverse chemical inventory. This example compares a conventional measurement of inflation for 2009 with a sample IPIC LIFO inflation measurement and shows the resulting income adjustment. Because the IPIC method allows us to use published inflation factors, we are able to save many companies significant tax dollars.
IPIC LIFO Case Study
A chemical distributor elected LIFO in 1993 and had grown their LIFO Reserve to $11.9 million as of 2008 year end. As the 2009 year end approached, the company grew concerned with the looming tax liability that would be generated from the LIFO reserve decrease, attributable to significant deflation throughout the year. By moving to the IPIC method, the taxpayer was able to reduce their LIFO recapture by over $3.5 million, saving over $1.2 million in taxes that would have otherwise been due (assumes 35% tax rate).
| Inventory Value |
$18,796,794 |
| IPIC Inflation | -15.10% |
| IPIC LIFO Reserve | $8,223,515 |
| Current Methodology Inflation | -24.68% |
| Current Methodology LIFO Reserve | $4,661,185 |
| Additional LIFO Reserve Under IPIC | $3,562,330 |
Each inventory is unique and results will vary, but we find that the majority of taxpayers realize better tax results with the IPIC method. Many choose it because the computation is more straightforward than conventional methods and less administratively burdensome. Taxpayers also choose the IPIC LIFO method because the IRS affords audit protection, or LIFO amnesty, for the previous LIFO method. In addition, the IRS provides automatic consent for LIFO taxpayers to change to the IPIC method with no income adjustment.
The only way to understand the income effects of a possible LIFO method change is to run parallel computations. Our commitment to our clients includes performing free custom IPIC estimates to help each company understand the possible benefits of making a LIFO accounting method change.
Contact us today for a no-cost estimate.
