Bob Richardson

2024 Top LIFO Tax Savings Opportunities

Although inflation has slowed to a more normalized pace, there are many industries with inflation at or above the historical levels & will be good LIFO election candidates for the 2024 year end. The best opportunities will be in the following areas:

  • Food and beverage producers, wholesalers & retailers
  • Paper & paper product producers, wholesalers & retailers
  • Machinery & equipment producers, wholesalers & retailers
  • Nonmetallic equipment producers, wholesalers & retailers (Glass & glass products, rock/gravel/sand, concrete ingredients & products & stone)
  • Transportation equipment producers, wholesalers & retailers (including auto dealers)
  • Miscellaneous products producers, wholesalers & retailers (including toys, sporting goods, tobacco, photographic equipment, mobile homes, medical/surgical/personal aid devices & safety equipment)

See our comprehensive list of top LIFO election candidates below.
Top 2023 LIFO Election Candidates List and Identification Tool

Why Use LIFO?

The LIFO method (last-in, first-out) is the most beneficial inventory-based tax savings strategy because it uses inflation to create material long-term benefits (LIFO creates a tax benefit when there’s inflation), and tens of thousands of companies use LIFO because of this (most companies use LIFO in perpetuity  after an election is made since the tax benefits become bigger for every subsequent inflationary period). Since the LIFO tax benefit amount is primarily tied to the amount of inflation measured in a given period (for example, a 5x bigger LIFO tax benefit will occur in a period with 10% inflation compared to a period with 2% inflation), thousands of companies have elected LIFO because of the unprecedented inflation that’s occurred over the last few years. When there’s inflation, LIFO creates a tax benefit by lowering the inventory value and increasing cost of goods sold, which in turn reduces taxable income.

Quick LIFO Tax Benefit Formula

  • Current year taxable income reduction from LIFO (also known as LIFO expense): Prior year inventory balance * Current year inflation rate
  • Current year tax liability reduction from LIFO (aka tax deferral or after-tax savings from LIFO): Current year LIFO expense * Current year combined federal and state tax rate

LIFO Tax Benefit Example

  • Inputs
    • Prior year end inventory balance: $10M
    • Current year inflation rate: 5%
    • Current year tax rate: 30%
  • Outputs
    • Current year LIFO expense: $10M * 5% = $500K
    • Current year after-tax cash savings from LIFO: $500K * 30% = $150K

Does the Chosen Inventory Valuation Method Need to Match the Physical Flow of Goods?

The actual flow or physical movement of goods does not need to match the inventory costing method used to value inventory (aka cost flow assumption). The most two most predominant inventory valuation methods can be simplified as follows:

  • LIFO:
    • Matches current costs with current revenues, thereby reducing income & providing a better measure of current earnings
    • Commonly called the income statement approach as it provides the clearest reflection of income & costs of goods sold (removes inflation component from income that would otherwise be reported if FIFO or average cost was used)
  • FIFO (first-in, first out):
    • Amount reported for ending inventory most closely matches the current costs since it consists of most recent purchases
    • Commonly called the balance sheet approach because it most closely matches many companies’ physical flow of goods
    • Charges oldest costs against more current revenue, and creates artificial inventory profits

Are Unit Costs Required to be Tracked and Valued on a Last-in, First out Basis in Accounting Systems Incident & Subsequent to Electing LIFO?

The simple answer is NO! In fact, almost all companies using LIFO maintain a FIFO, average cost or standard cost system for internal reporting purposes for the following reasons:

  • Companies often base their pricing decisions on a FIFO, average cost or standard cost assumption
  • Recordkeeping on a non-LIFO basis is easier since LIFO does usually not approximate the physical flow of goods
  • Profit-sharing & other bonus arrangements often depend on a non-LIFO cost flow assumption
  • Tracking costs on a LIFO basis within a perpetual accounting system is burdensome since most accounting systems are designed to use FIFO, average cost or a standard cost flow assumption

One of the biggest misconceptions is item/unit costs must be tracked and valued on a last-in, first out basis once LIFO is adopted. Although this is not true, it’s a misnomer that causes many companies to choose not to use LIFO. In reality, there are two methods for valuing inventories on a LIFO basis, which are as follows:

  • Dollar-value method: Measures inflation in terms of the total dollar value of the inventories at a FIFO, average cost or standard cost basis, not by the physical quantity & unit cost on a LIFO basis. Under this method, inventories continued being maintained on a non-LIFO basis in perpetuity even incident & subsequent to adopting LIFO. When the dollar-value method is used, a top-side adjustment is recorded to account for the difference between the cost (FIFO, average cost etc.) & LIFO inventory value. When using the dollar-value LIFO method, item/unit costs are never “LIFO-ized”, but what instead occurs is that inflation is calculated outside of the accounting system, the total LIFO inventory value is determined, the change between the current & prior period’s LIFO reserve is computed, and a journal entry is made to adjust cost of goods sold and LIFO reserve (many companies outsource this work to LIFOPro or license our software to automate their in-house dollar-value LIFO calculation). Simply put, the dollar-value method delivers material tax benefits while avoiding LIFO’s most undesirable characteristics.
  • Specific goods method (aka unit LIFO): Item costs are tracked on a LIFO basis, and the accounting system must be set up in a manner to assume a last-in, first out basis cost flow assumption. Under this method, the accounting information system must calculate the cost of goods sold and inventory balance using the unit costs of the most recently purchased at the time of the sale, and the remaining older goods on hand and their respective unit costs are the ones that remain on hand. Under this method, companies often maintain two separate cost flow assumptions within their accounting information system: the costing method used in the existing accounting system since there’s still a need to maintain costs on a non-LIFO cost basis for internal reporting purposes, and on a LIFO method for tax benefit purposes.

Establishing LIFO as a Preferable Method

The costing method used to value inventory is considered an accounting method or principle. Since there are multiple inventory valuation methods available, preferability must be established when changing to the LIFO method from a non-LIFO method. Because of this, companies issuing GAAP financial statements must establish that LIFO is preferable to the existing method. Since there are multiple inventory valuation methods available (FIFO,

Furthermore, most companies use LIFO in perpetuity, and because of this, the LIFO reserve will often grow and become a materially large amount. For these reasons, companies and CPA firms should obtain or perform meticulous analysis prior to adopting LIFO for the following reasons:

  • Establish that LIFO truly is preferrable over the existing method (preferability)
  • Forecast/model LIFO’s short and long-term financial reporting and tax implications (quantify LIFO’s current & future estimated tax benefits)
  • Ensure the most favorable tax submethods are chosen (including assessing IRS audit risk amongst the available submethods)
  • Assess risks vs. rewards (cost-benefit analysis)

Such analysis should include historical calculations, current period estimates, exploring all available submethods and preparing comparisons amongst the available submethods (such as valuing all or only certain goods using LIFO, using an internal vs. external inflation measurement source, pooling methods and determining whether the same or different book & tax LIFO submethods will be used). Additional considerations should include a cost-benefit analysis which includes quantifying the administrative burden vs. outsourcing the LIFO calculation (or licensing software to automate the LIFO calculation if managing in-house).

LIFOPro’s Historical & Present Preferability Criteria

  • Historical Preferability Criteria: These criteria establish whether or not the past inflation trends are sufficient to consider LIFO to be a preferable method as now and in the future. LIFOPro also calls these our “good LIFO candidate” criteria, which are as follows:
    • Inflation level (how much inflation has there been historically?)
      • One of LIFOPro’s two primary preferability metrics used to measure preferability is the amount of inflation historically experienced since a minimum amount is required for LIFO to yield a meaningful long-term tax benefit. Auto dealers and supermarkets (predominant users of LIFO) have a 20 year average annual inflation rate of around 1% – 2%. In such industries, a 1% – 2% long-term average annual inflation rate is sufficient to establish preferability for two reasons: 1. Over a 20 year period, there will have been 20% – 40% cumulative inflation, which often represents a material amount of LIFO tax benefits 2. Industries such as auto dealers & supermarkets have high historic inflation frequency (inflation close to 100% of the time). More volatile industries such as oil/gas have much lower inflation frequencies of closer to 50%. Since there is more risk associated with industries with low inflation frequency, there is often higher historical average annual inflation rates of between 3% – 6%.
      • LIFOPro’s first preferability criteria is a 20 year average annual inflation rate of 1% or more. LIFOPro performs this measurement by assigning Bureau of Labor Statistics Consumer/Producer Price Indexes (BLS CPI/PPI) to a company’s current period product mix & performing a 20 year pro forma LIFO calculation (use of these indexes is commonly referred to as the IPIC method, which is widely used by many companies).
    • Inflation frequency (how often has inflation occurred historically?)
      • Inflation frequency is a key metric to establishing LIFO as a preferable method because the higher the rate of historical inflation frequency, the more often there has been inflation in the past, and the more likely it is that LIFO will create a tax benefit in the future. Conversely, LIFO will typically increase taxable income when there’s deflation, and because of this, LIFO will create a tax benefit less often when there is low inflation frequency. Because of this, good LIFO candidates are those with high inflation frequency since the intended purpose of being on LIFO (tax savings) will most often be achieved. Accordingly, the risk-averse business profiles should pay close attention to inflation frequency when considering a LIFO adoption (but can overcome the perceived risks if they have high historical inflation frequency since there’s mostly upside and negligible downside from LIFO when this is the case).
      • LIFOPro’s second preferability criteria is an inflation frequency rate of greater than or equal to 50% over the last 20 years (inflation measured in 10 or more of the last 20 years). LIFOPro also performs this measurement by assigning Bureau of Labor Statistics Consumer/Producer Price Indexes (BLS CPI/PPI) & performing a 20 year pro forma LIFO calculation.
    • Both of the two criteria listed above must be met for LIFO to be considered a preferable method. LIFOPro’s position is the use of the LIFO method is not preferable if both of the two criteria listed above are not met.
  • Present Preferability Criteria: These criteria establish the recommended timing of a potential LIFO election, which are as follows:
    • Both historical preferability criteria met (LIFOPro recommends not using LIFO if both historical preferability criteria aren’t met)
    • Election year vs. Historical inflation multiplier of greater than or equal to 1
      • Calculated by taking the quotient of the Current year inflation rate and the Historical average annual inflation rate. For example, if there’s a 5% election year or current period inflation rate for a company whose historical average annual inflation rate was 3%, the Election year vs. Historical inflation multiplier would be 1.67.
      • Current year inflation rate uses a company’s current period product mix & inflation measured at the time of the benefit analysis. Historical average annual inflation rate computed using 20 year pro forma LIFO calculation results.
    • If both criteria are met, LIFOPro’s opinion is that LIFO is a preferable method, and that a LIFO election should be made for the upcoming year end
    • If the Historic preferability criteria are met, but the Election year vs. Historical inflation multiplier criteria is not met, LIFOPro will recommend a future LIFO election in a period where the inflation multiplier is greater than or equal to one.

LIFOPro’s Complimentary Election Benefit Analysis

LIFOPro uses proprietary metrics and a comprehensive process to establish whether or not LIFO is a preferable method, to determine whether or not LIFO should be elected in the current period, and to provide recommendations regarding the most beneficial submethods to employ based on each company’s unique profile. The end product is our LIFO Election Benefit Analysis which comes in the form of a 15 – 20 page PDF report. This complimentary service includes an extensive evaluation of historical inflation trends, estimated election year tax savings and long-term LIFO tax benefit forecasting.

LIFOPro streamlines the LIFO implementation process by offering complimentary election benefit analysis. We minimize the time & effort required by companies and their CPA firms associated with first-time LIFO elections. LIFOPro works with companies and CPA firms to scope out a potential LIFO election to provide accurate, comprehensive, and user-friendly information and recommendations. Don’t leave a potential LIFO election up to chance and risk missing out on additional tax benefits or making an unforced error and creating audit risk! Our free benefit analysis report ensures maximum LIFO tax benefits, guarantees calculation accuracy/compliance and provides straightforward recommendations that includes everything companies and CPA firms need to make the right decisions. Furthermore, our turnkey outsourcing solutions makes managing the recurring annual LIFO process as simple as possible and delivers tax benefits that far outweigh the costs!

Does the Timing of the LIFO Election Matter?

Although LIFO can create meaningful short and long term tax benefits, there are many considerations that should be made prior to and during the implementation process. Most importantly, the timing of adopting LIFO is key for the following reasons:

  • The size of the first year tax benefit is primarily dependent on the amount of inflation measured in the year the LIFO election is made – The higher the inflation measured in the election year, the bigger the LIFO tax benefit will be. Conversely, LIFO will create a tax liability if deflation is measured in the year of adopting LIFO.
  • For tax purposes, LIFO must be elected prospectively – The reason this is important is because the tax benefits can not be obtained until the year that’s LIFO adopted, and can not be applied retrospectively. To further illustrate, lets assume a steel service center began considering a LIFO adoption for the 2022 year end because there was 200% inflation in the steel industry in the potential election year. Despite this, the steel service center deferred making a decision to elect LIFO for both the 2022 and 2023 year ends, but later revisited the idea of electing for the 2024 year end. While doing so, the steel service center estimated that there would be deflation for their first year on LIFO, and that a tax liability would be created if they adopted for the 2024 year end. Despite the fact that a material LIFO tax benefit could have been obtained if the election was made for the 2022 year end, the steel service center can not retrospectively apply their LIFO election as if it had occurred in the period where there was a material tax benefit that could have been obtained. The steel service center will now have to wait for a future inflationary period to obtain a tax benefit in the period of adoption.
  • It’s best to elect LIFO in a period where the inflation is greater than or equal to the historical levels –  This is recommended for the following reasons:
      • Ensures the election year tax benefits far outweigh the costs and first-time setup efforts
      • Maximizes probability of maintaining a net tax benefit from LIFO in the future

LIFOPro’s 2024 Top LIFO Election Candidates

Using price indexes published monthly by the Bureau of Labor Statistics (BLS), we continuously monitor inflation trends to identify the biggest tax savings opportunities, and in turn assist companies & CPA firms to determine the best LIFO election candidates for the upcoming year end. To date, price indexes through September have been published, sufficient information now exists to provide accurate inflation forecasts, and we have prepared our first release of the 2024 top LIFO election candidates. They are organized below at the least to most detailed groupings. Note: this blog will be updated monthly through the completion of the 2024 year end following the release of October, November & December ’24 BLS price indexes.

Top 2024 LIFO Election Candidates by Bureau of Labor Statistics Producer Price Index (BLS PPI) Major Commodity Group

Top 2024 LIFO Election Candidates by BLS PPI Subgroup

 

Top 2024 LIFO Election Candidates by BLS PPI Product Subclass