For several years there has been talk about eliminating the last-in, first out (LIFO) inventory accounting method for income tax purposes.
The topic is once again at the forefront for automotive dealers, as President Obama’s 2012 budget includes a tax proposal to eliminate the LIFO method.
The passing of this tax proposal could lead to a significant amount of income for the federal government, but would also lead to a significant amount of cash outflow for certain business owners and could be especially devastating to those automotive dealers who continue to have cash flow problems as a result of the industry’s recession.
The LIFO inventory accounting method has been allowed under Section 472 of the Internal Revenue Code (IRS) since the 1930’s and is a method used to determine a dealerships closing inventory cost.
Since the valuation of a dealership’s closing inventory helps determine the dealership’s cost of goods sold, the valuation method used by a dealership affects its calculation of taxable income.
Dealerships have successfully used the LIFO method for years as a tax deferral mechanism as the price for new light-vehicle units continues to increase year-after-year. In a period of rising prices for inventory, LIFO results in lower inventory balances and higher cost of goods sold, which ultimately decreases taxable income and increases tax savings.
Under the President’s tax proposal, the LIFO inventory accounting method will be prohibited and it will require taxpayers to write up their inventory to FIFO value in the first tax year beginning after 2012.
The resulting increase in income due to the write-up will be taken into account ratably over 10 years beginning with the first tax year after 2012.
Overall, it is important to note that as of today, the elimination of LIFO is only a proposal being considered in President Obama’s negotiations in Congress. RubinBrown will keep you informed as the budget progresses.
Example of Impact on a Dealership Utilizing the LIFO Inventory Method:
Assume Dealer ABC, a calendar Year-end Corporation, has a LIFO reserve of $5,000,000 as of December 31, 2012. If the tax proposal to eliminate LIFO is passed, Dealer ABC must write up their inventory by $5,000,000 on January 1, 2013. For tax purposes this will increase taxable income by $500,000 for tax years 2013 through 2022. Assuming a 35% federal tax rate and a 6% state tax rate, Dealer ABC will incur approximately $205,000 of additional tax liability for tax years 2013 through 2022.
Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.
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