The last-in, first-out (LIFO) inventory method could generate significant tax benefits for dealerships. During times of inflation, this method places a lower value on inventory, allowing dealers to defer taxes and improve cash flow. The tax deferral may be viewed as an interest-free use of cash. The LIFO method has many technical requirements, including the so-called conformity requirement that mandates a taxpayer using the LIFO method for tax also must use the LIFO method for financial (book) accounting.
As year-end approaches, automobile dealers should be careful to verify that all year-end financial statements, including factory dealer statements, are in compliance with IRS LIFO conformity rules and regulations. Failure to comply with the conformity rules could result in the termination of the dealer’s use of the LIFO inventory accounting method for tax purposes and the recapture of the entire LIFO reserve.
A dealership may use the LIFO inventory method only if it has used no method other than the LIFO method for inventorying goods for the purpose of a report or statement covering a taxable year. Dealers who use LIFO should verify that all financial statements – to shareholders, to partners, to other proprietors or beneficiaries, or for credit purposes – report income on the LIFO basis. Normally, a LIFO adjustment should be included at least once a year on factory dealer statements. All statements covering a taxable year, or any other 12-month period, must have the LIFO adjustment. It also is necessary to verify that the income for any short taxable year is calculated on the LIFO basis. A reasonable estimate of the LIFO adjustment is acceptable. The LIFO adjustment should encompass all LIFO inventory (such as new and used vehicles and parts).
An automobile dealer’s financial statements provided to the manufacturer and its credit subsidiary, with which the dealer finances its purchase of new automobiles, are “for credit purposes” because they are issued to a creditor with whom the dealer maintains a continuing credit relationship. On the statements provided to the factory, an automobile dealer must reflect the LIFO adjustment on the income statement for both a current month and the year to date as well as on the balance sheet. Such statements may reflect the income statement adjustment either as an adjustment to cost of goods sold or on the line for other income and expense.