In addition to the medical and sociological implications of the COVID-19 pandemic, the economy has been hard-hit by supply chain interruptions. The inability of manufacturers to get goods to market has also had a significant impact on retailers. That truth was felt by any parent looking for the latest tech gadget or hot toy between Thanksgiving and Christmas.
What do you need to know?
The inability to replenish inventory, in addition to hurting top line revenue, can have a significant impact on a business’s taxable income. Any business that has sales of inventory gets to reduce gross receipts from those sales by the cost of the goods sold. The Internal Revenue Code provides several ways to relieve inventory costs. The most common are the First In First Out (“FIFO”) and the Last In First Out (“LIFO”) methods.
- LIFO is attractive to vendors in an environment where prices continue to rise as it reduces taxable income, which in turn reduces taxes and increases cash flow.
- The true benefit of LIFO depends on the ability to replenish “LIFO layers” and purchase new, higher priced goods for sale or use in manufacture. Petroleum companies and auto dealers are two industries that have relied heavily on the LIFO method.
It has been difficult over the past 24 months to replenish inventory. This may be because of government actions or because of the pandemic itself but the net result is that these businesses will use lower cost inventory in their Cost of Goods Sold resulting in higher taxable income and a larger tax bill.
- The Treasury has the authority to grant relief. Introduced in 1980, Section 473 relief (for the Internal Revenue Code section spelling it out), allows the Secretary of the Treasury, after consultation with “appropriate Federal Officers”, to declare that there is a “qualified inventory interruption.”
- Affected taxpayers could then elect to replace the inventory over the following three years rather than by the end of the tax year of the potential LIFO recapture.
So, what’s next?
- Twenty Democratic Senators and a bipartisan group of members of the House of Representatives have written to Treasury Secretary Janet Yellen to ask her to invoke her authority, principally on behalf of the auto industry.
- The AICPA has sent two letters (April 27th letter and August 17th letter) requesting relief for all taxpayers and suggesting a safe harbor for how to apply it.
- At press (January 7, 2022), the response from Treasury has been to say that they are considering the matter.
Count on Friedman LLP
We will continue to monitor this issue. In the meantime, your Friedman LLP advisor can help you determine the impact of your inventory and other accounting methods and how to best take advantage of this relief when and if it is forthcoming. Contact us now with any questions.