Hoping for a LIFO lifeline
By Nathaniel J. Yost
Since 1938, companies have used “Last-In, First-Out” accounting to deduct the cost of replacing inventory, as long as it was restored by the end of the tax year.
But the manufacturing crunch and supply chain issues created by the COVID-19 pandemic have thrown a potentially massive monkey wrench into LIFO accounting since many businesses have been unable to replace sold inventory.
As recently as December 16, The National Automobile Dealers Association (NADA) and the American Institute of Certified Public Accountants (AICPA) met with the U.S. Department of the Treasury to discuss the significance of the issue and possible solutions. In addition, the AICPA as well as the NADA and other trade groups have written letters to Treasury on this issue.
If Treasury does not arrive at an administrative fix, unfortunately, the only available relief would need to come from federal lawmakers providing a legislative solution which may prove to be difficult. Without relief, companies using the LIFO accounting method may face hefty tax bills for failing to replace sold inventory.
What NADA and others are seeking
Under Sec. 473(c)(2), the Treasury Secretary can find that a situation has occurred that:
“Made it difficult or impossible to replace any class of goods for any class of taxpayers during the liquidation year, and (2) the application of Sec. 473 to that class of goods and taxpayers is necessary to carry out the purpose of Sec. 473.”
If this was deemed to have occurred, perhaps caused by a trade embargo or boycott, companies using the LIFO accounting method have three additional years to replenish the liquidated inventory.
AICPA's April letter argues that the situation caused by COVID justifies the Treasury allowing “safe harbor” relief similar to the application of Sec. 473. In its letter, AICPA says:
“The various government restrictions enacted in 2020 to prevent the spread of COVID-19 severely limited manufacturing capacity and caused major interruptions in foreign trade and the integrated global supply chain. These restrictions cascaded into the overall supply chains of U.S. taxpayers, making it difficult or impossible for many taxpayers to replace their inventories for taxable years ended March 31, 2020, and this problem is expected to continue at least through taxable years ending June 30, 2021.”
Significantly, NADA is also seeking a modified version of Sec. 473 relief that would allow companies to avoid paying higher taxes up front and then having the additional filing headache of submitting up to three years of amended returns for the liquidation year.
The April letter requests:
“A safe harbor method under which a taxpayer disregards the qualified liquidation for the liquidation year if the taxpayer completely replaces the inventory by the end of the replacement period alleviates the burden of paying additional taxes on the related income and obtaining Section 473 Relief by filing amended tax returns.”
Additionally, the letter warns of the consequences to companies if a LIFO safe harbor is not approved:
“The government restrictions described above are likely to result in significant tax costs to taxpayers with LIFO inventories due to artificial and permanent increases in income through an involuntary liquidation of LIFO layers.
“The decline in inventory and involuntary liquidation of LIFO layers result in an acceleration event of lower costs from prior years included in costs of goods sold in the liquidation year. This acceleration event, in turn, triggers an artificial increase in taxable income that would not have occurred but for the government actions that resulted in major foreign trade interruptions.
“Many taxpayers are struggling with the economic effects of government restrictions related to COVID-19 and may not have cash available to pay the taxes resulting from this unexpected involuntary liquidation of LIFO inventory.”
In its August letter, AICPA reiterated the need for the special relief and provided examples of how the safe harbor could work.
Bottom line
Unless Treasury or lawmakers provide safe harbor relief similar to what NADA seeks, companies using the LIFO accounting method may face higher-than-usual tax bills. Remember, even if the traditional Section 473 relief is provided, taxpayers would still face higher initial tax liabilities. The traditional Section 473 relief is only provided after filing amended tax returns. For this reason, NADA is pursuing a modified version of Section 473 relief.
We suggest you talk with your tax advisor to quantify what LIFO recapture may look like for your dealership and plan on setting aside the cash that may be needed due to the reduction of reserves. Even if relief is granted at a later date, it would take time to draft procedures and regulations and therefore may not be in time before the 2021 return needs to be filed.
The Boyer & Ritter team is ready to answer any questions about the tax implications surrounding LIFO and can help you figure out the best strategies to help you preserve your bottom line.