How Inflation Drives LIFO Planning

Source Advisors | Source Advisors

August 31, 2021. 4 min read
How Inflation Drives LIFO Planning

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 Inflation 2.00% 5.00% 7.00% 10.00%
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%

With inflation on the rise, now is the time to look at LIFO accounting for clients. Whether already on LIFO or not, analyzing the
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.
Case Studies
  • 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.

Industry Estimated
2021 Inflation
Prior Year Inventory Value Estimated Year 1 LIFO Reserve After-tax
Cash Savings*
Furniture Retailer 10% $2,000,000 $200,000 $70,000
Non-current carrying wiring devices Manufacturer 38% $12,000,000 $4,560,000 $1,596,000
Boat Retailer 7% $17,000,000 $1,122,000 $392,700
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
Fertilizer Manufacturer 15% $6,000,000 $922,638 $322,923

*After tax-cash savings is measured using 35% tax rate.

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