Bob Richardson

History of IRS LIFO Resources & Audits

1990s – 2000s

The frequency & level of scrutiny being given to LIFO by the IRS has varied widely over the past 30 years that LIFOPro has been in business. When LIFOPro begun in 1992, the IRS Chief Counsel’s office employed multiple LIFO experts, and also employed many field agents that were LIFO specialists. During that time, LIFO audits seemed to be fairly commonplace, and there was a noticeable amount of scrutiny given by the IRS towards LIFO taxpayers during those audits. There was also an above-average amount of LIFO-related private letter rulings, technical advice memorandum & various other IRS publications issued during that time, which likely was a result of the IRS having more resources being devoted to LIFO during the 1990s – 2000s.

2010s

Somewhere between the late 2000s & early 2010s, most if not all of the LIFO experts & specialists employed by the IRS had transitioned to non-LIFO related positions within the IRS, took new jobs at different organizations, or retired. When this occurred, the IRS chose not to replace the majority of the open positions that had been devoted to LIFO. As a result, there was a noticeable decrease in the 2010s in the frequency of LIFO audits & scrutiny given during those audits during that time. Since LIFOPro offers up to 40 hours of IRS audit support to all software & turnkey solutions clients, we are often made aware of a client’s LIFO calculation being audited. Despite this, there were less than a handful of IRS audit support requests made by our clients between 2010 – 2020.

2021 – Present

Beginning in early 2021, a noticeable uptick in IRS LIFO audits & IRS audit support requests by clients has occurred. LIFOPro has had the same amount of IRS audit support requests over the last 18 months that were had over the prior decade. Although it has not been confirmed, many familiar with the subject believe the increased attention & scrutiny being given to taxpayers’ LIFO calculations likely coincided with the IRS releasing a LIFO Records Practice Unit.

About the 2021 IRS LIFO Records Practice Unit

In January of 2021, the IRS released a LIFO Records Concept or Practice Unit, which is part of a series of IRS examiner “job aides” and is meant to provide instructions to IRS examiners on specific tax issues during audits. The 21 page LIFO Records Practice Unit appears to be a road map of sorts to guide IRS examiners when auditing taxpayers that use LIFO. The General Overview section of the Practice Unit provides a high-level explanation of the IRS authoritative related to LIFO records, the required documents to be maintained by taxpayers to support their LIFO calculation & the potential consequences that could occur in the event that the taxpayer does not maintain adequate LIFO books and records. Click here to view the IRS LIFO Records Practice Unit The text of the General Overview contained within the IRS LIFO Records Practice Unit  is provided below:

A taxpayer’s current Last In-First Out (LIFO) inventory is a historic accumulation of quantity and price changes from the taxpayer’s initial year of the LIFO election. Therefore, the taxpayer must maintain supplemental and detailed LIFO inventory records that support the current value of the inventory and the clear reflection of income. The LIFO regulations underline the importance of these historic records by specifically requiring that taxpayers maintain them. See Treas. Reg. 1.472-2(h).

The taxpayer must maintain a current cost detail listing in its supplemental records for every year in which it employs the LIFO election. See Treas. Reg. 1.472-8(e). The detailed product listing includes the stock-keeping unit (SKU ) number, item description, quantity, and current cost of each item in inventory. These listings are necessary so that the examiner can verify the LIFO computation at any time during the duration of the LIFO election and verify when new items enter the inventory and the current cost of such items. The taxpayer must maintain detailed records of the current cost and the base cost of the items in inventory and the detail of all index determinations. Treas. Reg.1.472-2(e)(9)(h). The Service may terminate a taxpayer’s LIFO election if the taxpayer does not maintain adequate books and records for its LIFO inventory and all computations. See Rev. Proc. 79-23. However, termination in these situations is not automatic due to the Service’s discretionary authority in IRC 472(e)(2) and the underlying regulations.

Increase in IRS LIFO Audits Following Practice Unit Release

Following the IRS releasing the LIFO Records Practice Unit last year, LIFOPro has seen a noticeable increase in the number of clients who’ve had their LIFO calculations audited. Although it has not been confirmed by the IRS that the recent increase in audits of LIFO calculations is directly related or a result of the new IRS LIFO audit guide being published, there is strong evidence supporting this idea. Based on the most recent interactions that LIFOPro has had with IRS examiners while providing LIFO audit support services to their clients during audits, a strong connection appears to be present between the rise in IRS LIFO audits & the release of the IRS LIFO Records Practice Unit. Evidence of such a connection is supported by a pattern that LIFOPro has witnessed since the release of the LIFO Records Practice Unit. This pattern is outlined below.

  • LIFO Records Practice Unit Content
    • Emphasizes that IRS Regs. requires taxpayer to maintain comprehensive documentation of the LIFO calculation for all periods to, “support the current value of the inventory and the clear reflection of income”
    • Describes specific requirements that are essential to proving the adequacy of the taxpayer’s LIFO books & records, which includes the following:
      • Maintain a detailed product or “current cost” listing for every year it uses the LIFO method (aka item detail, stock status or inventory valuation report), which should include the following data:*
        • SKU or unique identifier (Item/Product/Part Code or Number)
        • Item description
        • Quantity on hand
        • Current & prior/base year unit costs
      • Maintain the annual detailed current cost listings for the duration of the LIFO election
    • Instructs examiners to obtain the above documentation to reproduce or verify the current & base year inventory costs
  • Recent Interactions with IRS Examiners During LIFO Audits
    • Taxpayers receive LIFO Information Document Request (IDR) containing a request listing that is identical to the listing contained within the IRS LIFO Records Practice Unit
    • IRS Examining agents performs the exact same steps & uses the exact same documentation described within LIFO Records Practice Unit to perform their LIFO audit procedures

*Detailed product or “current cost” listing described above is only required to be maintained for when an “internal index” or internally-calculated inflation measurement source is used & inflation is measured using year end quantities on hand, current & prior/base year item/unit costs. When an “external index” or externally calculated inflation measurement source is used (aka IPIC method using Bureau of Labor Statistics Consumer/Producer Price Indexes or BLS CPI/PPI), the required information for maintaining adequate LIFO books & records becomes the extended current year cost values summarized by the BLS categories that have been assigned to the goods on hand in ending inventory. Accordingly, for IPIC method calculations, taxpayers are precluded from maintaining the documentation required when using an internal inflation measurement source.

Based on the facts & information outlined above, one would be inclined to believe that the IRS LIFO Records Practice Unit has played a direct role in the recent rise of IRS LIFO audits.

Potential Consequences & Implications of Failing to Maintain Adequate LIFO Books & Records

The IRS LIFO Records Practice Unit states that, “The Service may terminate a taxpayer’s LIFO elections in certain situations set forth below… 4.The taxpayer does not maintain adequate books and records for its LIFO inventory and all computations. Rev. Proc. 79-23, Section 3.01(d), discusses the necessity for the taxpayer to maintain adequate books and records for its LIFO inventory and all computations.”

The purpose of Rev. Proc. 79-23 is to provide IRS examiners a list of situations that are distinguished between those warranting the termination of the taxpayers LIFO election & those that do not. Accordingly, although the content within any given IRS Practice Unit does not constitute authoritative guidance, Rev. Proc. 79-23 is considered authoritative guidance, and within it, the failure of the taxpayer to maintain adequate LIFO books & records is listed as one four situations that warrants the “disallowance or termination” of a taxpayer’s LIFO election. Excerpts of Rev. Proc. 79-23 are provided below:

Sec. 3 Application. .01 …. The situations set forth below will warrant the disallowance or termination of a LIFO election. However, termination in these situations is not automatic due to the discretionary authority in section 472 (e)(2) of the Code and the underlying regulations… (d) Failure by the taxpayer to maintain adequate books and records with respect to its LIFO inventory and all computations incident thereto.

Key Action Items for Companies on LIFO

  • Be aware of the fact that the IRS has increased their focus on LIFO following the release of their LIFO Records Practice Unit
  • Investigate whether there are standardized policies & procedures in place for completing the LIFO calculation, storing the supporting documentation & maintaining records or work files containing the calculation results
  • Upon reviewing whether standardized policies & procedures exist related to the LIFO calculation, take the following applicable steps:
    • If standardized LIFO policies & procedures DO NOT exist
      • Determine the appropriate documentation & steps required to maintain adequate LIFO books & records
      • Document/establish policies & procedures in order to maintain adequate LIFO books & records
      • Put controls or procedures in place to ensure the newly created policies and procedures are consistently performed on a recurring basis
    • If standardized LIFO policies & procedures DO exist
      • Determine whether the preexisting policies & procedures have created adequate LIFO books & records being kept historically by reviewing prior period LIFO calculation documentation
      • Determine the appropriate documentation & steps required to maintain adequate LIFO books & records
      • Document/establish policies & procedures in order to maintain adequate LIFO books & records
      • Put controls or procedures in place to ensure the newly created policies and procedures are consistently
  • Consider obtaining a free Best LIFO Practices & Review from LIFOPro which comes in the form of a PDF report & features the following items:
    • LIFO books & records adequacy review
    • LIFO calculation review
    • LIFO methods compliance review
    • Best LIFO practices review
      • Tax deferral maximization strategies, including:
        • Pro forma LIFO calculations of proposed vs. present LIFO submethods
        • Comparing results between using an internal vs. external inflation measurement source
      • LIFO policies & procedures development, improvement & simplification strategies, including:
        • Switching from internal to external inflation measurement source (aka IPIC method)
        • Automation and/or outsourcing opportunities
      • LIFO submethod optimization strategies
    • Findings & recommendations

Strategies for Maintaining Adequate LIFO Books & Records

  • Consider whether switching to the IPIC method would reduce the administrative burden of maintaining adequate LIFO books & records (pros/cons & implementation steps for changing to IPIC method included in Best LIFO Practices & Review Report)
  • Explore LIFOPro’s complete range of Offerings, including Turnkey Outsourcing Solutions or a LIFOPro software license. Features & benefits include:
    • Guarantee that adequate LIFO books & records are maintained going forward & reduce and/or eliminate IRS LIFO audit exposure with
    • Guaranteed inflation & LIFO reserve calculation accuracy
    • Preserve your LIFO reserve while avoiding all the administrative & compliance burden
      • Comprehensive documentation, including the following:
        • All clients
          • Current year inflation index & LIFO reserve calculation for all periods that the company has been a LIFOPro client
          • LIFO layer history or carry-forward schedule for all periods that the company has been on LIFO
        • Turnkey outsourcing solutions clients
            • Item detail report listings for all periods that the company has been a LIFOPro client
            • BLS CPI/PPI category assignment support for all periods that the company has been a LIFOPro client
    • Up to 40 hours of IRS audit support included with all software licenses & turnkey solutions engagements

Best LIFO Practices & ReviewIPIC LIFO Guide

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