A significant number of dealerships has utilized the last in, first out inventory (LIFO) method for many years. This article deals primarily with the use of the LIFO method for valuing new vehicle inventories. Approximately 30% of the dealerships we represent use this method of inventory valuation.
In its most basic form, the LIFO method of inventory eliminates the effects of inflation from the value of the inventory, thereby increasing the cost of goods sold and decreasing taxable income. The tax savings resulting from the decrease in taxable income increases the amount of working capital available to the dealership that would have been otherwise paid out for income taxes.
In addition, the resulting LIFO reserves (the difference between actual cost and the LIFO value) have continued to grow over the years and typically amount to a few hundred thousand for dealerships with smaller new vehicle inventories to several million for dealerships that have historically maintained larger inventories.
In 2020, several dealerships experienced a recapture of a portion of their LIFO reserves due to reduced inventory levels. In most instances, the amounts recaptured were not significant. The disruption in the supply of new vehicles in 2021 has put many dealers in the position of recapturing a considerable amount of this reserve if inventory levels are not restored to the amounts held at the end of 2020.
The National Automobile Dealers Association and the American Institute of Certified Public Accountants are working with Treasury officials to obtain some relief from this impending recapture of LIFO reserves.
The National Automobile Dealers Association and the American Institute of Certified Public Accountants are working with Treasury officials to obtain some relief from this impending recapture of LIFO reserves. Currently, it is impossible to determine the outcome of their continuing efforts.
Absent relief from the Treasury, we see two options in dealing with the recapture of the LIFO reserves and corresponding increase in taxable income and income tax. The first option is to elect off the LIFO inventory method in 2021. If a dealer elects to do so, 25% of the reserve would be brought into income each year and taxed in 2021-2024. This election would spread the effects over a more extended period and reduce the income tax due currently.
The second option is to do nothing and pay the tax that is due on the 2021 recapture. I believe this option deserves some consideration. The current tax rates are not going down in the near-term and, more likely than not, will increase. In addition, with inflation increasing, remaining on LIFO in the future may provide significant tax benefits.
You should consult with your CPA on the potential tax effects of reducing inventory levels if you utilize the LIFO inventory method.
Leon M. (Lonnie) Rogers, CPA/ABV/CFF is the managing member of Tetrick & Bartlett, PLLC, and has provided accounting, tax, valuation, and consulting services to automobile dealers since 1977. Tetrick & Bartlett, PLLC currently serves over 50 dealers in West Virginia, Virginia, Ohio, and Pennsylvania and is a member of the AutoCPA Group, a nationwide organization made up of 25 CPA firms specializing in services to automobile dealers. Lonnie can be reached at lrogers@tb.cpa or 304-624-5564.
