Author | Source Advisors
With both monetary policy and COVID-related supply chain disruptions driving current and future price increases, safeguarding inventory, often your clients’ largest asset, from the detrimental effects of inflation is now on the minds of many tax advisors.
Whether your clients are manufacturers, distributors or retailers, they have the opportunity to mitigate the current negative impact of price increases and annually save money by using the Last-In-First-Out (LIFO) inventory method. Adopting LIFO removes the negative consequences of inflation, lowering tax liability and creating cash for reinvestment. Any business with over $2M in inventory that is experiencing inflation is a qualified candidate for electing LIFO. Depending on the inflation rate and the inventory level, a taxpayer’s cash savings can be quite substantial.
Tax Benefit Projections
|Estimated After-Tax Cash Savings*|
|$2M P/Y inventory||$14,000||$35,000||$49,000||$70,000|
|$5M P/Y inventory||$35,000||$87,500||$122,500||$175,000|
|$10M P/Y inventory||$70,000||$175,000||$245,000||$350,000|
|$20M P/Y inventory||$140,000||$350,000||$490,000||$700,000|
*Estimated after-tax cash savings assumes a total tax rate of 35%
IPIC method for 2021 could be a great opportunity. The IPIC method of LIFO uses indexes published by the Bureau of Labor
Statics to measure inflation on your inventory. Currently in 2021, inflation is on the rise and businesses of all sizes may
experience substantial tax savings.
- An agricultural machinery retailer with $5m in inventory elected LIFO in 2019. After experiencing modest inflation in 2019 and 2020, their current inflation is 7% year-to-date. This will result in $350,000 in additional LIFO expense in 2021 and a LIFO reserve of $500,000. Since electing LIFO that represents a cumulative $175,000 in tax savings to reinvest in their business.
- Travel trailer and RV dealers’ inflation is currently 10%. Assuming this holds out until year end, an RV dealership with $8m
in prior year inventory that elects LIFO in 2021 can expect a first year LIFO reserve of up to $800,000, translating to
$280,000 in tax savings.
Many industries are currently experiencing inflation. An analysis of LIFO benefits is seamless and is provided at no cost to you
and your client. Just send a copy of the year beginning and year ending inventory files, including unit costs, and we’ll provide a
free estimate of benefit and a price quote for the project. Business of all types are taking advantage of LIFO.
|Prior Year Inventory Value||Estimated Year 1 LIFO Reserve||After-tax
|Non-current carrying wiring devices Manufacturer||38%||$12,000,000||$4,560,000||$1,596,000|
|Custom Metal Fabricator||50%||$20,000,000||$10,000,000||$3,500,000|
|Retailer of Agricultural machinery and equipment||7%||$12,000,000||$790,644||$276,725|
*After tax-cash savings is measured using 35% tax rate.