IRS Releases Roadmap for Auditors to use on LIFO Taxpayers

The recent release of a new LIFO practice unit by the Large Business & International (LB&I) division of the IRS suggests that IRS agents will be increasing their focus on LIFO during exams. The “concept unit” titled LIFO records includes a 21 page slide deck PDF file outlining a road map of sorts to guide IRS agents when examining taxpayers that use LIFO. The LIFO records concept unit slide deck was released on January 28th, 2021. It’s listed on LB&I’s IRS practice unit webpage & can be read here: IRS LIFO Records Concept Unit Slide Deck.

Key areas of focus within the concept unit are as follows:

• Taxpayers must maintain historic LIFO inventory records to verify current value of LIFO inventory
• The IRS may terminate a taxpayer’s LIFO election under the following circumstances:
  • The taxpayer fails to maintain adequate books and records for its LIFO calculation
  • LIFO conformity requirements not met
  • LIFO method was not properly elected in the adoption year (base year; IRS Form 970 Application to Use LIFO Inventory Method is required to be filed in the adoption year)
  • Inventories are valued using a method other than cost. A taxpayer on LIFO whom also maintains an LCM reserve or excess & obsolete reserve for tax purposes for the same inventories that are also valued on LIFO would be considered to be valuing their inventory using a method or than cost. Said another way, LIFO taxpayers are required to value their inventory using a cost method such as FIFO or average cost, and must also value these inventories gross of any reserves (GAAP allows for the inclusion of valuation reserves in the current year cost, but this is not allowed for tax).
• Key records that are suggested for examining agents to request from taxpayers to verify adequate LIFO books & records include:
  • Documentation of the current year cost of inventory (aka inventory at cost which is the equivalent of FIFO or average cost for most taxpayers, but could include earliest acquisitions cost or specific identification)
  • Documentation of the base year cost computation
  • Item detail listing showing the calculation of the current year or cumulative inflation index on an item by item basis for all periods that the taxpayer has used LIFO (current year index for link-chain method; cumulative index for double-extension)
• The audit techniques listed at the end of the guide include the following steps:
  • Request copies of all Forms 3115, Application for Change in Accounting Method, and the Form 970, Application to use the LIFO Inventory Method
  • Ask how many years of detailed product listing the taxpayer retained
  • Request the detailed LIFO workpapers from the date of election until the end of the audit year
  • Request the formulas for the computations shown on the LIFO workpapers
  • Request the detail product listings from the date of election until the end of the year under examination
  • Request a sample of invoices from the detailed product listing for the year under exam and the previous year to verify cost. Concentrate on items that have unusually high indexes. Make sure that the products are identical in both years and the SKU number of the products is the same for both years.
  • When examining the detailed product listing, ensure that the method used is the same method set forth in the Form 970

Key takeaways from the IRS LIFO records concept unit are as follows:

• The IRS appears to be placing an increased focus on the adequateness of LIFO books & records during an exam
• The following criteria must be met for the IRS to consider for a taxpayer’s LIFO books & records to be “adequate”:
  • The taxpayer has retained comprehensive LIFO calculation documentation. LIFOPro considers comprehensive documentation to be the following:
    • Documentation of any given period’s LIFO calculation documentation from start to finish, which includes the following:
      • Front-end: The current year or cumulative index calculation, which is aka the inflation calculation
      • Back-end: The calculation of the inventory at base year costs, increments/decrements (layers) & LIFO inventory balance (which will also include the LIFO reserve & LIFO expense (income) calculation)
    • The aforementioned LIFO calculation documentation is retained for all periods that the taxpayer has been on LIFO
  • The taxpayer’s LIFO calculation is accurate or computationally sound for all periods that the taxpayer has been on LIFO
• LIFO taxpayers that don’t meet both of the above criteria now face increased IRS audit risk, and potentially could have their LIFO election terminated upon exam, which would force such a taxpayer to take 100% their LIFO reserve into income in the year of the change.
• Companies should take appropriate steps to ensure the adequacy of their LIFO books & records, such as:
  • Obtain a complimentary LIFO Calculation, Methods & Best Practices Review from LIFOPro, which provides the following benefits:
    • Verify LIFO calculation accuracy, identify potential errors & be provided with steps for correcting any errors
    • Verify LIFO methods compliance or identify potential unauthorized methods usage & be provided with steps for changing from impermissible to permissible methods
    • Identify strategies for optimizing LIFO calculation & methods used
    • Identify opportunities to increase tax savings from LIFO
  • Obtaining a LIFOPro software license, which provides the following benefits:
    • Guarantee LIFO calculation accuracy & eliminate errors
    • Create comprehensive documentation for both the current period & all prior periods
    • Minimize the time required to maintain adequate LIFO books & records in-house
  • Turnkey outsourcing solutions, which would provide all the benefits of a LIFOPro software license listed above, plus the following:
    • Eliminate the hassle of LIFO calculations altogether while continuing to build tax savings
    • LIFOPro PDF/Excel report package delivered electronically containing all amounts required to book journal entries & record tax return entries
    • Up to three interim estimates at no additional cost
    • Services to correct LIFO calculation errors and/or make accounting method changes
    • LIFO-related IRS forms preparation, including Form 970 & 3115
    • Best LIFO practices feedback & recommendations from the LIFO experts

Contact LIFOPro today via phone at 402-330-8573, email at lifopro@lifopro.com or by using our Online Request Form to eliminate IRS audit risk & ensure the adequacy of your company’s LIFO books & records!