Last-In-First-Out (“LIFO”) is something that all auto dealers have talked about at some point over the last 20 months. With new vehicle inventory levels down, the assumption is that some, if not most, of a dealer’s LIFO reserve is going to be recaptured on your 2021 financial statements and tax returns. That means more tax due come April 15.
The concept of LIFO has been great for the automotive industry. We look at it as an interest-free loan from the government. For example, your truck inventory might be recorded on your books at 1980 prices, which means you have accelerated your expenses. That is a good thing for you since less tax paid to date has helped the cash flow of your business. LIFO ultimately has allowed dealers to expand, stay in business through downturns or meet other financial goals. But now with the new vehicle inventory level being very low, a LIFO recapture is more likely to happen, and much of that cash tax savings is going to be paid back… OR IS IT?
We have found a lot of success working with our dealership relationships regarding use of the Inventory Price Index Computation (“IPIC”) method of calculating your LIFO reserve instead of the historical industry standard of the Alternative LIFO method we are accustomed to. Here are some things to think about if considering the IPIC LIFO accounting method change:
The IPIC method uses the consumer price index (“CPI”) which, as you know, is extremely inflated currently. The December CPI inflationary rates year over year are above 35% for used vehicles, 10% for new vehicles and 10% for parts.
Why did we mention used vehicles and parts, you ask? The IPIC method can bring other inventory items into your LIFO calculation. If you bring more inventory items into your LIFO pool, it should help the LIFO calculation as you build layers over the years. Not to mention that potentially there will be no more used vehicle write-down analysis needed… Yay!!
The Alternative LIFO method calculation only compares the same new models year over year and won’t get you inflationary rates as high as the CPI for 2021.
Let’s stop and consider the possibility of deflation in the used vehicle market in 2022. What impact might that have on your 2022 calculation? Let’s discuss.
Will tax rates go up with the Build Back Better Plan? Good question. After we discuss some 2022 assumptions, let’s see if it still makes sense after we project the 2022 LIFO calculation.
If you have not yet considered using IPIC for 2021, it is not too late! This LIFO accounting method change can be made up to the due date of filing your 2021 tax return, including extension.
Let’s talk about real results. Due to low year-end new vehicle inventory levels, we saw 75% of a dealer’s LIFO reserve being recaptured in 2021 using the Alternative LIFO method. This same dealership increased its 2021 LIFO reserve by 30% by using the IPIC method. Once again, to think this through, let’s look at the 2022 LIFO calculation too.
We know many dealers have liquidity right now. So, you might ask: why not just pay the LIFO recapture tax due and get part of the monkey off your back? Our response is why?! Don’t you like interest-free money? With the liquidity that dealers have now, it is a good time to expand and/or diversify portfolios. Liquidity within a dealership is not normal, since it takes much capital to run the business. For the first time as a dealer owner, there is excess cash. Let’s do something other than pay tax (at least for today).
You’ve heard our thoughts… We’d like to hear yours
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.