Many auto dealerships rely on the LIFO (last in, first out) accounting method for inventory valuation to defer taxes. Since this method allows businesses to include inflation in the cost of goods sold, it’s a great way to temporarily lower tax liability and is most effective in times of high economic inflation.
However, the COVID-19 pandemic has interrupted supply chains and created myriad challenges in most industries, including car manufacturing. Most notably are the shortage in computer chips required for modern vehicles to operate causing bottlenecks at manufacturing facilities, and staff shortages at docks because of COVID precautions forcing slower unload times for ships and cargo. This has resulted in unprecedentedly low inventory levels for car dealerships and a spike in auto sales prices.
Since any dealership using LIFO accounting methods would have additional taxable income with a significant decrease in inventory, these supply chain issues could force a LIFO recapture for auto dealers and raise their tax liability for 2021.
The National Association of Auto Dealers (NADA) is lobbying the IRS for relief under Section 473 of the Internal Revenue Code (IRC). This section allows LIFO participants up to three years to increase inventory and avoid recapture, but only in instances of a “qualified inventory interruption.”
With the unprecedented inventory decrease, the 2021 tax liability could cause further challenges for auto dealers recovering from the pandemic by decreasing their cash and further impacting dealerships that do not have the cash on hand to pay the additional taxes.
While NADA believes these pandemic-related supply chain issues are cause for the IRS to issue a “qualified interruption,” the IRS has not yet approved these emergency measures. In the meantime, dealership leaders should consider their alternate options, so they’re informed and ready to take action at the end of their fiscal year.
The following options are available for dealerships who have elected LIFO inventory valuation methods to offset the coming LIFO recapture this year. Keep in mind, any options that require a change in accounting method (Form 3115) will also restrict a dealership from re-electing LIFO accounting methods for a period of five years.
Determining which method would be best for your dealership can be complex, as is calculating any qualifications for an extended inventory recapture period if NADA is successful. A knowledgeable tax and accounting professional can help guide your team in the right direction. Reach out to our team to set up a consultation today!
Contact Daniel Keefer via our online contact form for more information.