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How 2022 Equals LIFO Opportunities

With inflation on the rise, now is the time to look at Last-In-First-Out (LIFO) accounting if you have inventories of building supplies, lumber or hardware. Whether you are already on LIFO or not, analyzing the IPIC LIFO method for 2022 could be a great opportunity. IPIC LIFO uses indexes published by the Bureau of Labor Statics to measure inflation on your inventory. In 2022 these indexes show inflation is on the rise, which means businesses of all sizes could experience considerable tax savings using LIFO.

Whether you are a manufacturer, distributor, or retailer, you have the opportunity to mitigate the negative impact of price increases and annually save money by using the LIFO inventory method. Adopting LIFO removes the phantom profits caused by inflation, lowering your tax liability and creating cash for reinvestment in your business. 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, the cash savings can be quite substantial.

Tax Benefit Projections

Estimated Inflation

2.00%

5.00%

7.00%

10.00%

15.00%

Estimated After-Tax Cash Savings*

$2M inventory

$14,000

$35,000

$49,000

$70,000

$105,000

$5M inventory

$35,000

$87,500

$122,500

$175,000

$262,500

$10M inventory

$70,000

$175,000

$245,000

$350,000

$525,000

$20M inventory

$140,000

$350,000

$490,000

$700,000

$1,050,000

*Estimated After-Tax Cash Savings assumes a total Tax Rate of 35%. Estimated Inventory level is as of year beginning.

Case Studies

A lumber wholesaler with about $50m in inventory elected LIFO in 2017 while there was inflation of over 25% . After experiencing some deflation in 2018, inflation was back for them in 2019 and 2020. The business now has a LIFO reserve of almost $25m; that represents a cumulative $8.7m in tax savings they’ve been able to reinvest in their business. Year- to-date inflation continues to grow for their inventory so that savings may increase even more in 2022.

Inflation for lumber and hardware stores is currently ranging from 15%-20%. Assuming this holds out until year end, a lumber and hardware retailer with $8m in prior year inventory that elects LIFO in 2022 can expect a first year LIFO reserve of over $1,200,000, translating to more than $420,000 in tax savings.

An analysis of LIFO benefits is seamless and is provided at no cost to you. 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.

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

*Estimated After-Tax Cash Savings assumes a total Tax Rate of 35%. Estimated Inventory level is as of year beginning.

How Inflation Drives LIFO

Understanding LIFO as an effective mitigation strategy for inflation is an economic challenge that significantly impacts a wide range of businesses, from manufacturers and distributors to retailers. Amidst the challenge of rising costs for raw materials and finished goods, the Last-In-First-Out (LIFO) inventory method emerges as a potent strategy to navigate this tricky economic landscape.

How LIFO Contributes to Tax Savings

At its core, LIFO operates by matching the costs of goods sold with the most recent, and typically higher, costs, while the oldest costs remain tied to unsold inventory. This process results in a higher cost of goods sold, which in turn translates into lower taxable income, thereby reducing tax liability. This mechanism helps businesses effectively combat the adverse effects of inflation.

The Criteria for Adopting LIFO

Adoption of the LIFO method isn’t universal. It’s particularly beneficial for businesses experiencing inflation and maintaining an inventory valued at over $2M. The potential for significant tax savings, achieved annually, transforms LIFO into a sustainable method to manage the potential repercussions of inflation.

The Power of Reinvestment with LIFO

The use of the LIFO method not only provides tax relief but also frees up valuable cash flow for businesses. By lowering tax liabilities, these extra funds can be funneled back into the business, leading to reinvestment opportunities. These might include investing in technological upgrades, expanding the workforce, or scaling operations, thereby further enhancing business growth.

Adopting LIFO

The decision to adopt LIFO requires careful and strategic consideration of the client’s inventory flow and overall financial position. It’s not a one-size-fits-all solution. However, if a client qualifies, LIFO can emerge as a powerful tool to help combat the negative effects of inflation, strengthening their financial resilience.

LIFO represents an effective strategy that can help businesses counteract the impact of inflation, lower tax liabilities, and create opportunities for reinvestment. At Source Advisors, we stand ready to provide expert guidance on navigating this complex yet highly beneficial financial planning tool.