Dealerships Using the CPI/IPIC LIFO Method … Beware: For 2024, CPI Produces Deflation & LIFO Reserve Reductions
By now most dealership CPAs are involved with finalizing year-end inventory LIFO calculations and complying with the restrictive financial statement reporting requirements imposed on dealerships using LIFO.
Recently, many of our LIFO clients have asked us for projections of the expected LIFO reserve changes because they were under time pressure to issue financial statements to manufacturers or other lenders and shareholders before the final LIFO calculations could be completed.
For the IPIC (Inventory Price Index Computation) LIFO pool, the estimated deflation rate for the year was determined by weighting of the dollars in the respective inventory categories using the price change information (i.e., inflation or deflation rates) published by the Bureau of Labor Statistics for the 12-month period Dec. 1, 2023 through November 30, 2024. To this, we factored in an estimate for the change for the month of December because the actual amount of inflation or deflation for the month of December was not published until mid-January, 2025.
The inflation or deflation rate computed for the pool was calculated by weighting the dollar amounts of the classes of the inventory included in the pool (i.e., new cars, new light-duty trucks, used vehicles, parts and tires) after applying appropriate BLS/CPI inflation/deflation information for the inventory categories.
After computing the weighted inflation/deflation rate for the pool, we rounded that result up or down to either the nearest ½ percent or 1 percent. Our software then prepared detailed schedules showing 2023 actual results with results expected if the deflation rate for the pool is either ½ or 1 percentage point greater or less than the estimated weighted index for the pool.
Detailed projections were prepared for our LIFO clients based on the dealership’s (1) LIFO layer valuation history which reflects the total dollars of inventory in the single LIFO pool, (2) the expression of that inventory in terms of base dollars, (3) the cumulative inflation experience over the life of the IPIC election and (4) the changes made to use the IPIC Method to value those inventories.
The results of our projected IPIC pool indexes ranged from ½% to 2% deflation. These were reflected in the dealership’s preliminary year-end financial statements for 2024. Given the multiple variation factors involved (i.e., inventory levels for each classification of goods in the IPIC pool and multiple individual inflation/deflation rates computed by the BLS for each component), most clients simply rounded the result produced by our calculations for the change in the LIFO reserve at year-end to the nearest $1,000.
On January 15, the Bureau of Labor Statistics released the Consumer Price Index Report containing multiple indexes reflecting deflation for the major inventory classifications involved in IPIC pools.
- Table A in the CPI News Release (USDL-25-0021) reflected 0.4% deflation for new vehicles and 3.3% deflation of used cars and trucks.
- Table 3 reflected a general category “new and used motor vehicles” with -1.3% deflation.
- Indexes for specific Series IDs (U.S. city average, all urban consumers, not seasonally adjusted):
- Deflation for New Cars: -0.7% … New Trucks: -0.3% … Used Cars & Trucks: -3.3%
- Inflation for Vehicle Parts & Equipment: 1.8% … Tires: 1.2%
This final information for 2024 from the BLS resulted in most dealerships having decreases in their final LIFO reserve calculations. Most dealerships had inventory levels higher at the end of 2024 than last year, and their LIFO calculations reflect “increments” …or slight decrements … in base dollar amounts with corresponding decreases in their LIFO reserves due to the deflationary pool indexes.
The year-end LIFO financial statement conformity rules require a dealership to reflect an estimate (or the actual amount, when computed) of the change in the year end LIFO reserve on the last income statement for the year issued to the manufacturer(s) and/or to the floorplan lender(s) and other lending institutions, creditors or shareholders.
All preliminary dealership year-end financial statements sent to the manufacturer(s) and/or to the floorplan lender(s) should reflect a best efforts estimate. The final (13th) year-end statement should reflect an adjustment of the estimated amount to the actual computed year-end LIFO reserve amount.
Dealerships previously reflecting an estimate of the LIFO reserve change on preliminary year-end financial statements should adjust the difference between the actual and the projected amounts as a net charge against 2024 income on all “final” income statements issued for 2024. Note: The adjustment should not be run through the 2025 financial statements.
The position of the IRS is that if all of these financial statement conformity requirements are not fully satisfied, the IRS Commissioner has the discretion to take action that could result in the termination or loss of the dealership’s entire LIFO election and reserves.
Final Thoughts
- Very few dealerships are likely to be reporting inflation indexes if they are using the IPIC method for 2024. Just because there is deflation in the ending inventory and therefore no increase in the LIFO reserve, that does not mean that an estimate of the change is unnecessary.
- In most cases, LIFO reserve decreases for 2024 will primarily be due to the deflation experienced. If there is a properly calculated decrement, the carryback of that decrement against an increment in 2023 will result in no payback of the LIFO reserve.
- As a result of adjusting the contributions to the LIFO reserve of pre-2024 LIFO layers, these layers should reflect negative contributions to the LIFO reserve. As a result, at year-end 2025, if there is a carryback against pre-2024 layers, that carryback will result in an increase in the LIFO reserve, rather than a decrease. Be careful in analyzing and explaining the effect of deflation and negative contributions to the LIFO reserve.
- Dealerships using the Alternative LIFO Method (instead of the IPIC Method) to value their new vehicle inventories are likely to reflect very small … probably not greater than 1% or 2% … inflation indexes for their 2024 ending inventories. Some Alt. LIFO inflation indexes for 2024 may be negative, depending on the make.
- Any dealership considering electing LIFO for 2024, should probably not elect LIFO this year.
Willard J. De Filipps, CPA (Jan. 21, 2025)
READ MOREYear-End 2024 LIFO / Dealer Tax Update Webinar
For many years, I’ve offered mid-year and/or year-end dealer tax planning and LIFO update seminars. This year, I will not be presenting a year-end update seminar for several reasons … The IRS has not issued anything significant in the way of technical developments, and – for those of you who have listened to prior years’ seminars – you are already familiar with the tried and true, traditional year-end planning activities for LIFO inventories and dealership tax clients.
That is not to say that there won’t be any mid-year or year-end LIFO / dealer tax seminars in 2025. It just makes sense to wait and see if significant developments warranting your time and attention occur.
In the meantime, we are very busy with LIFO projections and working out planning scenarios with our dealership clients … some who are using the IPIC Method and others who are using the Alternative LIFO Method.
The most recent CPI inflation index suggests that for 2024, deflation for new and used combined vehicles will be around 2% deflation. For Alternative LIFO Method purposes, we would expect inflation rates to vary depending on manufacturer and model mix to be within a -1% (deflation) to a +1% (inflation) range.
Until we resume our LIFO/Dealer Tax Update seminars, here are three things to consider…
First, there are many planning scenarios to be considered. A dealership may be expecting significant operating losses or accelerated depreciation deductions, which may or may not be passed through to shareholders or partners. In these situations, repaying some of the LIFO reserve already build up may be a strategy to consider since net operating losses cannot be carried back and/or lower tax rates may be wasted.
Second, in other situations, for dealers that previously elected to change to the IPIC Method from using the Alternative LIFO Method, the 5-year lookback period for purposes of changing accounting methods without getting advance permission from the IRS will be expiring. These dealerships may be looking to change back to the Alt. LIFO Method from the IPIC Method, without advance IRS permission, especially if they want to take their used vehicle inventory off of LIFO.
Third and finally, a more interesting potential LIFO issue for dealers could arise sometime soon if the IRS were to take the position that for LIFO purposes, some differentiation for pooling purposes should/must be made to reflect the fact that current inventories include all manner of hybrid and/or fully-electric vehicles.
For those who have long memories or familiarity with a 50-year-old Tax Court decision involving a Ford dealer, it’s interesting to consider – in the context of dealers having more electric vehicles in their inventories – the Tax Court’s comments in that case …
“ … It would not be uncommon for many of the manufacturers of these products (i.e., cars and trucks) to be continually altering their basic product in an attempt to improve its quality or modernize its style. These modifications could be relatively minor in scope, or, on the other hand, the alterations (either viewed individually or taken collectively) could be so significant and substantial as to change completely the basic product. When the latter transformation occurs it would not be inappropriate to require the retailer or wholesaler to account for the redesigned product as a new ‘item’ of inventory with a consequential adjustment to the base-year costs of its inventory pool.
“Where, however, the modifications in a product are relatively minor in nature, it would be unreasonable to have, and, in most instances, virtually impossible to comply with, a requirement that the retailer or wholesaler annually adjusts its base-year cost to reflect these modifications. Indeed, this attention to detail is precisely the type of accounting for inventories that the dollar-value method was designed to eliminate.”
“… The point at which a modification or modifications in a product are considered so substantial as to render it a new item for LIFO inventory purpose must, of necessity, be decided on a case-by-case basis from an examination of all the relevant facts.
“… The determination of when various changes and improvements in a product are sufficiently substantial to render it a new item for dollar-value inventory purposes can only be made by examining the facts of each case.”
“… Over a period of time, an automobile or truck may undergo a number of modifications which collectively make that vehicle a different item from the vehicle in existence in the base year.”
Notice that the reference is to the base year for the LIFO election. In many cases our dealership clients have been on LIFO for over 30 or 40 years, so the comparison would involve a 30 to 40 year look-back in some cases.
Former LIFO Lookout and Dealer Tax Update subscribers know that I used to open both publications with … If you had called me persionally to ask, “What’s happening lately with dealership LIFO / IRS audits of dealers and dealerships that I need to know about?”…
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Former LIFO Lookout and Dealer Tax Update subscribers know that I used to open both publications with … If you had called me persionally to ask, “What’s happening lately with dealership LIFO / IRS audits of dealers and dealerships that I need to know about?”…
Now I invite you to follow me on LinkedIn (join our LinkedIn Dealer Tax Advisors Discussion Group) as well as here on my Will’s World Blog as I will be more regularly writing about my various thoughts on LIFO matters and dealer tax issues in the new year.
And, if you have any questions or would like to discuss a situation you’re dealing with, please feel free to call me (847-577-3977, ext. 101) or email me at will@defilipps.com.
Regards,
Will
READ MOREAuto Dealer LIFO – Conformity Warning & IPIC Estimates
Like kids waiting for Santa Claus to come down the chimney on Christmas Eve, we’re waiting for the BLS to release the CPI inflation index for auto dealers for December.
Based on projections we’ve done for many, many IPIC LIFO dealerships reflecting estimates (of course), we’re finding inflation rates up to 5% and deflation rates as low as 2.5%, all depending on the mix of new, used and parts dollars in the projected inventory level.
Let us know if your estimates don’t fall within this range.
Incidentally, we’ve been informed that one 20 Group administrator has asked dealerships to not include a LIFO adjustment on their year-end December statement when it is sent in for composite analysis. We strongly disagree with their suggestion. We fear that any year-end statement – even for this purpose -¬ would violate the conformity requirement and be fatal to the LIFO election if a good-faith estimate is not reflected on that year-end statement.
Beware if you are tempted in this direction. If they have to take the LIFO adjustment out in order to prepare dealership composites, I think that’s out of your hands. But, if you make it easier for them by not reflecting the LIFO adjustment in the year-end statement, then my opinion is that you have violated the LIFO conformity requirement.
Happy New Year!
~ Will De Filipps
READ MORESection 473 Relief Request for DVM LIFO Taxpayers
Many dealers using the LIFO (Last-In, First-Out) Method for valuing their inventories are facing unexpected high tax bills this year. This is resulting from the combination of lower year-end inventories and the recapture of their LIFO reserves.
There is an obscure tax provision – Section 473 – which could provide relief for some of these dealers. Efforts are being pursued to convince the Treasury/Internal Revenue Service to provide alternative safe harbor calculation relief. Dealers and their CPAs should be aware of these requests. But there is nothing specific to report at this time on this development.
Since tax returns will be due soon, there is no harm in specifically including an election requesting relief under Section 473 as part of the 2020 income tax return when it is filed … even though the exact nature of the relief is not yet known.
You can see my proposal for relief in the form of a safe harbor alternative here.
Hopefully, clarifying assistance from the IRS or Treasury will be forthcoming soon.
~ Will De Filipps
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Update on Tax Deductions Related to PPP Loan Forgiveness
Today, the IRS issued Revenue Ruling 2020-27 and Revenue Procedure 2020-51. Particular problems will arise in handling situations where it is expected that the PPP loan will be forgiven, but that forgiveness has not yet occurred, by the end of the year (Dec. 31). Also, for taxpayers with fiscal years that have already ended, yikes!
I also found out that the AICPA and about 80 other organizations have sent a letter to four members of Congress offering comments and suggestions on SBA Form 3509. These letters were sent to House Representatives Nancy Pelosi and Kevin McCarthy, Senators Mitch McConnell and Charles Schumer and also to Treasury Secretary Steven Mnuchin and SBA Administrator Jovita Carranza.
Here are the links to IRS documents … Revenue Ruling 2020-27: https://www.irs.gov/pub/irs-drop/rr-20-27.pdf and Revenue Procedure 2020-51: https://www.irs.gov/pub/irs-drop/rp-20-51.pdf
READ MOREForm 970 Draft
The IRS has posted a revision to Form 970 – Application to Use LIFO Inventory Method – in Draft form. The Draft is dated November 2020, and it is not to be filed with the IRS.
Form 970 is to be used in making LIFO elections. For example, if you are going to elect LIFO for used vehicles, you would file Form 970, even though new vehicles are already on LIFO.
The current Form has a revision date 8 years earlier (November 2012). If you are going to elect LIFO in 2020, be sure to check the IRS website because the IRS may finalize the Draft Form 970 by the time you file tax returns for 2020.
View the Draft form at https://www.irs.gov/pub/irs-dft/f970–dft.pdf
READ MORESome Perspective (from an Unexpected Source) In Defense of the IRS’ Notice 2016-66
IRS Notice 2016-66 requiring dealers to file Forms 8886 to disclose Producer Owned Reinsurance Company (PORC-like activities) has created considerable uncertainty over what should be filed and by whom.
Over a decade ago, when the IRS specifically was looking at dealership PORCs, after a series of audit challenges and Technical Advice, the Service concluded that PORC arrangements were not, per se, tax shelters so long as they were operated as legitimate business activities.
It is my belief that most legitimate dealer PORCs should eventually obtain favorable interpretation/acceptance by the IRS on this point, and eventually, dealers and related parties will be excused from these onerous Form 8886 filing requirements.
In the meantime, I would suggest patience and understanding on the part of dealers and CPAs who have to put up with this uncertainty and the compliance work it engenders.
To appreciate the full magnitude of the outlandish arrangements which the IRS is faced with auditing, and to understand why Notice 2016-66 was issued, it is eye-opening to read two recently reported cases.
One case is “Owensboro Dermatology Associates PSC et al. v. Unites States; No. 4:16mc-00005” which involved the creation of multiple PORC entities.
The second case is “Crithfield, Duane et al. v. United States; No. 8:13-cr-00237.” This case did not involve the creation of a PORC entity, but it does fall within the ambit of being an arrangement substantially similar to what the IRS describes in Notice 2016-66. This case includes a list of 22 different potential risks against the happening of which individuals would purchase insurance and claim deductions in their tax returns. Here’s just a few to show you the imagination (and gullibility?): international communicable disease medical expense reimbursement … international kidnap/random investigation expense … key supplier loss expense reimbursement … market/CPGS fluctuation loss expense reimbursement … research and development expense overrun reimbursement, etc.
When one of the promoters was asked by a potential investor for a claim form, the promoter said, “There’s no claim form. No one has ever filed a claim. The whole idea is not to file a claim. But don’t worry, 85% of your premium will go into your trust account.”
(http://www.taxnotes.com/tax-notes-today/criminal-violations/court-finds-shelter-promoters-are-guilty-tax-fraud-conspiracy/2017/07/19/1vwpp?highlight=Crithfield)
In light of these and other situations where promoters and taxpayers try to take advantage, many advisors may feel that the Service is clearly not overreaching in casting a wide net initially to sort out the illegitimate from the legitimate insurance arrangements.
READ MOREAre PORCs on the IRS’ Endangered Species List?
Just wondering if anyone has heard anything within the last few weeks about the IRS Notices regarding the status of PORCs as “abusive” tax shelters and the related filing requirements with OTSA.
After digging into the changes made by the PATH Act affecting PORCs, it appears many will no longer be eligible for favorable tax treatment under Section 831(b) notwithstanding the impact – if any – of Notice 2016-66.
READ MOREHead’s-Up … A Significant Filing Date for Forms 8886 Is Approaching
Almost a decade has passed since IRS activities involving PORCs (that’s Producer-Owned Reinsurance Companies) rose to a level of general awareness of automobile dealers’ CPAs.
It appears the IRS is now in an intensive “information-gathering mode” driven by its suspicion that many auto dealers’ captive insurance arrangements under Sections 953(d) or 831(b) involve abusive tax shelter activities. It’s suspected to be so bad that “captive insurance” arrangements made it to the IRS’ Dirty Dozen List of Tax Scams for the 2017 filing season. (See IRS News Release IR-2017-31.)
CPAs for dealerships that have these micro-captive transaction structures should be alert to IRS Notices 2016-66 and 2017-08.
What stands out (where these structures and arrangements are in use) is the necessity that Form 8886 – Reportable Transaction Disclosure Statement requirements must be immediately addressed. May 1, 2017 is a key filing date we all should be aware of.
We are talking about filings with the IRS OTSA (Office of Tax Shelter Analysis), and possibly – depending on IRS interpretations – with some income tax returns filed for 2016.
Nowadays, the box to check for these arrangements is the Box (e) “Transaction of interest.” When I last wrote about these in the “Dealer Tax Watch” in Dec. 2003, the box to be checked on Form 8886 would have been for a “Listed Transaction.”
The real problems involve trying to interpret how many people who are involved (or related to others who are involved) need to file Form 8886. Further complications relate to whether or not information relating to all transactions dating as far back as November 2, 2006 needs to be reported on Form 8886.
Other complications arise depending on whether (1) C Corps or S Corps or other entity arrangements are involved, (2) an intermediary entity is involved between the dealership and the captive, and (3) rules of stock ownership attribution apply under Section 267(b), 267(c) and/or Section 707. This is heady stuff.
After discussion of interpretations with NADA, the IRS and some of the larger CPA firms whose practices include several hundred captive arrangements, I think it is possible that some general guidance for dealing with these requirements will be made available in the near future by NADA.
However, I will be surprised if the IRS publishes any clarification or guidance before the filing deadline.
READ MORETaxation of VW Settlement Payments: Don’t Expect Any Advance IRS Guidance
On February 14, I participated in a follow-up conference call / discussion hosted by Paul Metrey of NADA (Vice President, Regulatory Affairs) involving several CPA firms whose input NADA sought on whether it would be advisable at this time to seek guidance from the IRS on the interpretation of several key income tax issues arising from the payment of settlement awards by Volkswagen to Volkswagen dealers.
Prior to the “fairness hearing” on January 23, NADA had made the decision to wait to see if any changes were made to the settlement terms … and none were made.
As a result of the conference call and other input, NADA has made the decision to not seek guidance from the IRS on any of the tax issues involved. This was also the recommendation by a VW dealership group.
The almost unanimous conclusions from the CPAs involved in the conference call were that (1) guidance should not be sought from the IRS and (2) that payments received for reduction of the VW franchise goodwill would be, or could be, offset against any basis previously capitalized in connection with the VW franchise.
Accordingly, CPAs will have to reach conclusions on their own as to how much to accrue initially, whether payments are ordinary income, whether long-term capital gain or Section 1231 treatment may be involved, whether Section 1253 comes into play, whether Section 197 is operative, whether installment treatment under Section 453 is a possibility … not to mention the potential for the IRS to invoke the penalty provisions of Sections 6662–6664 if it does not agree with what it finds (if it finds it) in the tax returns when they are filed in just a few months from now.
The take-away from all of this is obvious … It seems that most CPAs are willing to wait in the weeds and see what happens to somebody else. Although many dealers will receive millions of dollars, the tax revenue arising from these amounts is a drop in the bucket compared to many of the other issues that the IRS might want to take on.
As a CPA, at this point, how comfortable are you with all of this?
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