Pub. 2 Issue 1

VIRGINIA AUTO DEALER www.vada.com 16 T he LIFO (last-in, first-out) accounting method for inventory valuation is one of the few business tax deferrals permitted by the IRS. Intended to benefit businesses through times of economic inflation, LIFO allows companies to include the effect of inflation in their cost of goods sold, thus lowering their taxable income. Many, but not all, auto dealerships use LIFO as a tax deferral strategy, not a permanent tax deduction. Dealers should invest their annual LIFO tax deferral each year to have the funds available when the tax comes due. A dealership could add to its LIFO reserve for many years, with amounts totaling well into the millions. When was the last time you considered the future tax lia - bility related to your LIFO reserve? Within the current tax climate, electing to change from LIFO means recapturing your tax deferral at a lower rate than when it was initially deducted. Although the top tax rate is 37%, most pass-through entities can take advantage of recapturing at a decreased tax rate of 29.6%, plus state tax, due to the Section 199a deduction. The opportunity to recapture at a lower rate is depen- dent on the tax law remaining in place as it is today. The Section 199a deduction is currently set to expire after Dec. 31, 2025. Changes in Washington could end it sooner. Dealerships that are thinking about recapturing their deferrals may not want to put it off any longer. Electing to Recapture LIFO When you choose to switch from LIFO to another inventory valuation method, you will need to file a Form 3115 with your current-year income tax return. Furthermore: • On your GAAP prepared financial statements, LIFO reserves will be recognized as a prior-period adjustment. • On your books, your LIFO reserve will be eliminated. • On your tax return, one-fourth of your LIFO reserve will be added to income for four years, starting with the year of change. Some dealerships elect to change from LIFO because the sale of their business would require the entire tax related to the LIFO reserve to be paid in the sale year. Others do not want to saddle the next generation with the future tax burden. Whatever the reason, failure to plan can negatively impact a dealer’s future goals. Decid- ing to change from LIFO is a big step, and it may not be right for everyone. If you are on the fence and would like to discuss your options further, our office professionals are ready for your call. Recapture LIFO at a Lower Tax Rate While You Can By John Comunale, CPA, Senior Vice President/Practice Chair — Automotive Committee