Producer Price Index Usage by Supermarkets to Increase Tax Deferral

Producer Price Index Usage by Supermarkets to Increase Tax Deferral

The use of Producer Price Indexes instead of Consumer Price Indexes (PPI & CPI) as the tax LIFO inflation measurement source is a tax planning idea that can significantly increase the amount of tax deferral for supermarkets.

Most supermarkets use the LIFO method for inventory valuation and almost all use the IPIC method for their tax LIFO calculations. Taxpayers were first able to use the IPIC method after the IPIC LIFO IRS Regulations were written in 1982. Most of the supermarkets that switched to the IPIC method initially used CPI indexes for these reasons:

1. The IRS IPIC LIFO Regs. before 2002 required taxpayers using the retail LIFO method to use CPI indexes.
2. The PPI inflation for supermarkets was not consistently higher than CPI inflation until the 2000s.
3. There are fewer CPI commodity codes applicable to supermarkets than PPI codes and it requires less effort to obtain breakdowns by CPI codes.
4. The Food Marketing Institute (FMI) wrote a guide in 1983 entitled Handbook for LIFO Tax Valuations-Inventory Price Index Computation Method (IPIC) that was a practical how-to guide that was used extensively by supermarkets electing the IPIC LIFO method and this guide described how to change to the IPIC method using CPI indexes.

The IPIC LIFO Regs. that were written in 2002 specifically permitted retailers to use either CPI or PPI indexes (non-retailers can only use PPI indexes). The CPI and PPI inflation for supermarkets had been about the same for years before 2002 but since then PPI inflation for supermarkets has been consistently higher than CPI inflation by an average of about 1.5% annual inflation. This means that supermarkets using PPI indexes during that time enjoyed annual tax deferral about 70% greater than if CPI indexes were used. Supermarket CPI inflation has not exceeded PPI inflation for any year since 2002.

1.5% additional inflation each year will increase the tax LIFO expense by $150,000 per year for a taxpayer with $10 million in inventory investment, by $1.5 million per year for $100 million of inventory and by $15 million per year for $1 billion of inventory.

Some of the large supermarkets switched to use PPI indexes in about 2005 and some smaller supermarkets now use PPI indexes but the majority (by numbers) of supermarkets continue to use CPI indexes.

Most publicly traded supermarkets use internal indexes for financial reporting LIFO but many privately owned supermarkets use the IPIC method for financial reporting as well as for tax purposes. Some supermarkets that switched to use PPI indexes continue to use CPI indexes for financial reporting and the IRS Regs. LIFO conformity rule specifically permits this.

CPI v. PPI Supermarket Inflation Comparison

The historical CPI v. PPI supermarket inflation spread through August ’22 is shown in the table below:

A change from CPI to PPI indexes is an automatic approval method change which means that the required IRS Form 3115 Application for Change in Accounting Method can be filed with the tax return for the year of the change. Once this change has been made a taxpayer cannot switch back to use CPI indexes for 5 years. There is no guarantee that supermarket PPI inflation will continue to substantially exceed CPI inflation.

Some possible reasons for PPI inflation for supermarkets being consistently higher than CPI inflation include:

1. Drugs – PPI drug inflation has been 2% to 3% higher than CPI inflation (about double) for each of the 3, 5 and 10 year periods ending December 2013. It is likely that the CPI sampling methods used for drugs produces less CPI inflation. When drugs change from branded to generic or from prescription to nonprescription they typically decrease in price. After such change, if a drug is not considered a new item for CPI price samples but is for PPI samples this could contribute to lower CPI drug inflation compared to PPI drug inflation.
2. Nonfoods – PPI inflation for items other than food and drugs has been substantially higher than CPI inflation and this is why almost all department store and discount store retailers use PPI indexes for tax LIFO. PPI indexes are a measurement of the selling price of goods produced by domestic producers in the U.S. CPI indexes are a measurement of the marked selling prices for retail stores located in the U.S. A logical inference is that the many less-expensive imported goods now available in American stores results in lower CPI inflation.
3. Food and beverages – PPI food and beverages inflation has been at least 1% more than CPI inflation for each of the 3, 5 and 10 year periods ending December 2013. I do not know why this difference exists and the BLS offers no explanation either.

There are about 100 most-detailed CPI commodity codes applicable to the typical supermarket’s inventory but a substantially greater number of most-detailed PPI commodity codes apply. The IRS IPIC LIFO Regs. provide for a shortcut known as the 10% method which allows taxpayers to use less-detailed CPI and PPI commodity codes which reduces the minimum number of LIFO count codes to 33 for CPI and 55 for PPI.

Some larger supermarkets now use perpetual inventory systems that facilitate getting CPI and PPI LIFO count codes breakdowns. This is typically accomplished by mapping classes of inventory (which represent groups of similar items) to CPI or PPI codes. If these classes are not detailed enough for a single CPI or PPI count code to be assigned to a class, then CPI or PPI count code assignments may need to be made on an item-by-item basis.

Most smaller supermarket chains use the retail inventory method for non-perishable inventories which means that the required CPI or PPI code breakdowns must be obtained from physical inventory counts. There are procedures used by companies and their inventory services all across the U.S. that facilitate the required breakdowns whether the physical inventories are scanned or not.

The two guides LIFO-PRO, Inc. has written to describe the ways in which supermarkets can get the required breakdowns by PPI count codes are Inventory Accounting Requirements for Supermarkets using the Simplified LIFO (IPIC) Method and Guide for Planning & Implementation of the IPIC LIFO Method for Supermarket Chains.

Here are different ways supermarkets can get inventory balance breakdowns by CPI or PPI count codes:
Supermarket LIFO Count Procedures

Contact LIFO-PRO to obtain more information on the subject of PPI Index Usage by Supermarkets to Increase Tax Deferral.