Key Takeaways
- Potential Tax Benefits: LIFO may help dealerships defer income taxes when vehicle costs rise. Results depend on the dealership’s inventory and tax situation.
- Calculation Support: LBMC’s LIFO software helps dealerships and CPA firms prepare calculations and reports. Compliance also requires appropriate accounting practices and documentation.
- Ongoing Review: Dealerships should review inventory changes, maintain complete LIFO records, and evaluate the method with their tax advisor.
FAQs: Understanding LIFO for Auto Dealerships
What does LIFO stand for?
Under IRS permission, U.S. businesses apply LIFO (Last In, First Out) as an inventory valuation technique. For more than 80 years, this approach has been included into U.S. tax legislation and is extensively applied by auto dealerships for tax planning and inventory control needs.
How does LIFO operate?
The LIFO method treats the last items put into inventory as the first items sold. Value the inventory at the conclusion of an accounting period using the most current vehicle cost. This produces a LIFO reserve, which lowers the value of ending inventory relative to the first-in, first-out (FIFO) approach therefore lowering taxable income.
Is your dealership a good candidate for LIFO?
Your dealership’s profitability, inventory levels, and vehicle costs all help determine whether LIFO is appropriate. Read more about why auto dealers choose the LIFO inventory valuation method and discuss the decision with your tax advisor.
Should dealers value vehicle inventory using LIFO?
LIFO is used most successfully in profitable dealerships to value their new-vehicle inventory. For sellers of new vehicles, the IRS has offered thorough instructions on the “Alternative Method” for computing LIFO. This approach compares the base model expenses at both ends of the year after building two pools—one for new automobiles and one for new trucks.
How are LIFO adjustments calculated?
Under the “Alternative Method,” the base model costs of items in inventory at the end of the year to those at the beginning of the year creates an index. If a dealer ends the year with $5,000,000 of inventory and the cumulative base model cost price rise is 2%, for instance, the LIFO adjustment will be roughly $100,000, saving roughly $40,000 in federal and state taxes.
How do dealerships stay compliant with LIFO rules?
Following IRS rules requires a dealer to choose to apply LIFO in the first year on Form 970 and adjust for LIFO on the twelfth-month statement. Income could be recorded should lower inventory or base model pricing cause the LIFO reserve to drop.
Why Your Dealership Needs Excellent LIFO Records
LIFO Recordkeeping Requirements
For dealerships applying the LIFO approach to guarantee compliance with IRS criteria and to prevent possible tax difficulties, maintaining thorough and accurate records is absolutely vital.
Dealerships have to follow particular IRS rules, including Revenue Procedure 97-36, and save all pertinent records including purchase invoices and LIFO computations, going back to the first year of LIFO election.
LIFO data should be kept in a safe place, ideally with a CPA company focused on auto dealerships, to guard them from natural catastrophes, theft, or other possible damage.
Though it requires careful recordkeeping, the Last-In, First-Out (LIFO) approach of inventory accounting can provide major tax advantages. The following is a list of the basic criteria and how your tax advisor may assist you stay free from future issues.
LIFO Foundation
Under the Last-In, First-Out (LIFO) approach, your dealership’s acquired or manufactured last items of inventory are sold or eliminated from inventory first. Closing inventory items are taken from the opening inventory in the order of purchase and obtained in that tax year.
The LIFO approach has complicated guidelines for use. The IRS claims that two often utilized techniques to price LIFO inventories are:
- Dollar-Value Method: Based on the types of things in the inventory, goods and products have to be arranged into one or more pools—classes of objects.
- Simplified Dollar-Value Method: From suitable government price indexes, create several inventory pools generally falling into appropriate categories. Project the annual change in price for inventory items in the pools using variations in the price index. This approach is electable by qualified small businesses (average annual gross receipts of $5 million or less for the three prior tax years).
Maintain Complete LIFO Records
Many auto dealerships apply the LIFO approach of inventory accounting. Although it can offer major tax advantages, it’s important to satisfy several tax law criteria including keeping thorough documentation.
Dealerships choosing to employ the alternative LIFO approach for new vehicle inventories have to follow IRS Revenue Procedure 97-36, which replaced IRS Revenue Procedure 92-79. Under this direction, a vehicle dealer has to keep “complete records” of the computations applying the alternative LIFO approach. Every new car also has actual purchase invoices that the dealership needs to keep.
Generally speaking, this means that the dealership should keep all invoices and related LIFO calculations going back to the first year the alternative LIFO method was used for. Should your dealership have chosen to employ alternative LIFO years ago, the records should be permanently kept in a safe place. Steer clear of maintaining records on the company grounds to avoid having a natural disaster or other damage or theft destroy them.
Possible Drawbacks of Inadequate Documentation
Poor records might cause costly tax difficulties. Good records will help you avoid tax penalties and resist IRS challenges. Should you also be selling your dealership, the buyer could ask you to lower the price by the LIFO taxes avoided.
LBMC Technology Solutions LIFO Tools
LBMC Technology Solutions provides LIFO calculation software for auto dealers and CPA firms serving dealership clients. For a closer look at the software’s role in the calculation process, read about LIFO automation for dealerships and CPA firms.
Confirm Which Records Your CPA Maintains
A company applying the alternative LIFO approach should also make sure it keeps copies of any IRS Form 3115 requests to switch accounting systems as well as copies of the IRS Form 970 originally used for the LIFO election.
Ask your CPA firm whether they have the necessary LIFO data, particularly if they focus on auto dealerships. If you used another practitioner years ago, do not assume the company has the records.
Complete records and regular conversations with your CPA can help your dealership manage LIFO calculations and address compliance requirements.
Are manual processes slowing down your accounting team?
LIFO calculations may be one part of a broader technology need. If your team also works across disconnected applications or repeatedly enters the same data, learn how integration and custom software development can help address those challenges.
LIFO Calculation Software
LBMC LIFO Solutions, LLC, offers LIFO calculation software for auto dealers and CPA firms with auto dealer clients. The software includes databases for new and used vehicles and uses Microsoft Excel® to report results. Review the LIFO software features to learn more.
Could LIFO software simplify your year-end calculations?
See how LBMC’s software could fit your dealership’s or CPA firm’s calculation process. Download the free demo, or call 615-709-5060 to discuss your needs and request an estimate.
