Auto Dealer LIFO Case Study

Auto Dealer LIFO Overview
- Auto dealer industry is likely the most predominant industry to use LIFO in terms of the percentage of total dealerships that use LIFO
- Is the only industry that has the option to use an inflation measurement source specially designed for its industry, which is commonly referred to as the alternative LIFO method (ALM)
- Majority of auto dealers on LIFO have use the alternative LIFO method as its inflation measurement source because it has historically provided much higher after-tax cash savings than other method alternatives such as the IPIC method (using external inflation indexes published by the Bureau of Labor Statistic’s Consumer/Producer Price Index divisions aka BLS CPI/PPI)
- Many dealerships have what is referred to as a limited or selective LIFO election, which infers that less than 100% of goods are valued under LIFO
- Reasons for having limited LIFO election are as follows:
  - Minimal or unfavorable tax impact of having used vehicles & parts on LIFO under alternative LIFO method
  - LIFO Taxpayers are required to value inventories on LIFO at cost & are therefore not allowed to maintain a lower of cost or market reserve (LCM) on used vehicles if valued under LIFO
  - Many dealerships also maintain lower of cost or market reserves for used vehicles, which provides a form of tax savings since it reduces ending inventory balances, increases costs of goods sold & reduces taxable income
- Some auto dealers leave used vehicles & parts off LIFO for the following reasons:
  - For used vehicles, they perceive the tax savings of maintaining LCM reserve on these goods to be greater than the tax savings of having these goods on LIFO
  - For parts, the alternative LIFO method inflation has been too minimal to warrant including those goods in the LIFO calculation
2022 Auto Dealer Inflation Environment
- Alternative LIFO method (ALM): inflation has remained around their historical averages of between 0.5% – 1.5%
CPI Historical Average Annual Inflation Rates Through June ’22
2022 Tax Savings Opportunities for Auto Dealers
- Dealers Already on LIFO
  - Switching inflation measurement sources from the alternative LIFO method to the IPIC method & CPI since CPI new vehicle inflation is 2x – 4x higher than alternative LIFO method inflation (ALM) in 2022 year end
  - Consider expanding LIFO election scope to include used vehicles and/or parts to maximize tax savings
  - See Auto Dealers on LIFO Case Studies below
- Dealers Not on LIFO
  - Elect LIFO for the 2022 year end using the IPIC method & CPI as the inflation measurement source
  - Consider including used vehicles and/or parts in the LIFO election scope to maximize after-tax cash savings
  - See New LIFO Election Case Study below
- All Dealers
  - 7% CPI used car inflation for 12M ended June ’22 & 3% year to date for 6M ended June ’22 CPI will create massive tax savings from LIFO by expanding or including used vehicles in election scope
  - For most auto dealers, preexisting used vehicle LCM reserve has been largely reduced as of 2021 year end due to inventory liquidations & appreciation in used vehicles
  - For most auto dealers, used vehicle LIFO tax savings will be greater than LCM reserve over long run since LCM reserve has to be paid back every time the vehicles with reserves are sold (unlike LIFO reserve that stays intact
Dealers on LIFO Case Studies: Inflation Measurement Source & Election Scope LIFO Reserve Comparisons

Case Study #1: AAA Motors

Case Study #2: BBB Motors

Case Study #3: CCC Motors
New LIFO Election Case Study: LIFO Election Benefit Analysis Comparisons
Auto Dealer LIFO Inflation Measurement Source Alternatives
- Alternative LIFO Method (ALM)
  - Pros
    - Historical average annual inflation through 2019 had been much higher than IPIC CPI/PPI inflation, which in turn provided much more favorable tax savings from LIFO
    - Most predominantly used LIFO inflation measurement source in the auto dealer industry
  - Cons
    - Much lower 2020 & 2021 inflation than IPIC CPI method, meaning benefits from LIFO during these periods will be lower
    - Much costlier than IPIC method to complete inflation calculation because it requires for detailed breakdowns of current & prior period’s invoices to be maintained for all vehicles
    - Much higher administrative effort & data requirements than the IPIC method
    - Most auto dealers either use software or outsource their LIFO calculation because of the complexity of the calculation
- IPIC Method using CPI
  - Pros
    - Much higher 2020 – 2022 inflation than ALM, which has & will result much higher tax savings from LIFO than ALM over last three years
    - Much lower costs compared to ALM because it only requires for inventories to be broken down by the following applicable categories:
      
      New cars
      
      New trucks, SUVs & vans
      
      Used vehicles (if included in LIFO election scope)
      
      Parts (if included in LIFO election scope)
    - Considered a safe harbor method by the IRS
    - Low administrative effort & data requirements than ALM
    - LIFOPro offers affordable turnkey outsourcing solutions & software licenses
  - Cons
    - Has historically had much lower inflation than ALM
    - Future inflation outlook is unknown, so auto dealers already on LIFO who switch to the IPIC method would be “stuck” with a less favorable method over the next four years after changing from the ALM in 2021 in the event that ALM inflation becomes better between 2022 – 2025
Other Considerations
- All Dealers
  - For tax purposes, lower of cost or market (LCM) reserve must be taken into income over a 3-year period beginning in the year of change if used vehicles are to be included in LIFO election scope
  - LCM reserve can continue for financial reporting, but Schedule M adjustment would need to be recorded beginning in year of change since LIFO taxpayers must determine current year cost of ending inventories valued using LIFO at cost
- Dealers already on LIFO:
  - IRS Form 3115 must be filed by return extended filing deadline to switch to IPIC method, but the switch is an automatic approval change
  - Change is made prospectively on a cutoff basis, meaning prior year end LIFO reserve remains intact
  - Must wait five years to switch back to alternative LIFO method. For example, a company switching to IPIC CPI for the 12/31/2021 year end must wait until the 12/31/2025 year end to switch back to the alternative LIFO method.
  - 2021 year end financial reports must reflect proposed method LIFO inventory balance (or an estimate of this amount; not present method LIFO inventory balance)
- Dealers electing LIFO:
  - 2022 year end financial reports must reflect inventory balances valued at LIFO
  - Can switch to alternative LIFO method in the next tax year end that occurs after the LIFO election. For example, a company electing to use IPIC CPI for the 06/30/2022 year end could switch to the alternative LIFO method for the 06/30/2023 year end.
  - Must wait five years to terminate LIFO election under automatic change procedures; advanced approval Form 3115 must be filed prior to year end & $12K IRS User’s fee must be paid if election is terminated prior to fifth year on LIFO.
Turnkey Outsourcing Solutions
- LIFOPro provides turnkey solutions for all your companies LIFO needs, including
  - Complimentary analysis
  - Year end LIFO calculation, including comprehensive documentation in the form of a LIFOPro PDF report package
  - IRS Forms preparation for accounting method changes & first-time LIFO elections
  - Interim estimates
- Analysis & year end calculation process requires minimal amount of data
- Flexible engagements structured to fit your specific wants/needs, not a one-size fits all solution
- Includes lightning-fast turnaround time on all analysis, calculation & IRS forms preparation services

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Auto Dealer LIFO Case Study