Out With the Bad, In With the Good
Forget about LIFO's poor reputation--find out how the IRS is making it better for you.
Here's some good news about inventory methods and their
potential tax impact. The IRS issued new regulations that make the
LIFO (last-in, first-out) method of accounting for inventory far
more attractive than it used to be. In fact, says Brian Lucas,
federal tax partner in the Chicago office of accounting firm Grant
Thornton, "the IRS has cleared up a lot of the ambiguity with
these new regulations."
As you know, LIFO and FIFO (first-in, first-out) are two
inventory identification methods. FIFO assumes that sales are made
from items that have been sitting in inventory the longest. LIFO
assumes that the most recently purchased items are the first ones
sold.
With the FIFO method, if prices are increasing, your gross
income will be matched against the lowest-priced items in your
inventory, which means higher net profits. LIFO, on the other hand,
matches your gross income against the most expensive items in your
inventory, resulting in lower net profits and lower taxes.
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The LIFO calculation has always been considered more complex
than FIFO. As a result, many business owners have shied away from
LIFO, even though it could prove to be beneficial, says Lucas. The
new regulations, which are now effective for taxable years ending
on or after December 31, 2001, simplify what is known as the
inventory price index computation (IPIC) method used in calculating
LIFO.
The simplified IPIC method uses a Bureau of Labor Statistics
index so you don't have to spend extra time calculating and
maintaining your own internally developed indices. The new rules
also eliminate the 20 percent reduction in the price index that
affects some business owners. "Now every business can get 100
percent of the calculated inflation based on the published
indices," says Lucas.
The change is expected to have an impact on many businesses,
including manufacturers, distributors and retailers. In addition,
it could create potential tax savings opportunities. Such an
outcome, however, depends on your own particular business
situation, so talk to your tax advisor first.
Great Falls, Virginia, writer Joan Szabo has reported on tax
issues for more than 15 years.
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