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Legislative changes, loss of franchises may affect tax benefits sooner

November 15, 2010
Dealership LIFO benefits may be lost

During times of inflation, the last-in first-out (LIFO) method of valuing inventory generally results in a lower value of inventory than other methods. Dealers using the LIFO method are able to lower their income tax for a period of time, which is like having use of the money interest-free.

It is not a permanent benefit, however, as LIFO benefits are lost when the business is sold or the entire inventory is otherwise liquidated. Eventually, but maybe not for many years, the benefit will be lost and the taxes saved must be paid back.

The future of LIFO

The availability of the LIFO benefit may end sooner than expected. As the federal government looks for ways to reduce the budget deficit, discontinuing the LIFO method might be a potential source of tax revenue.

It has even been proposed that taxpayers currently using the LIFO method be required to recapture their LIFO inventory benefits in the first taxable year beginning after Dec. 31, 2011. The increase in gross income attributable to recapturing the LIFO reserve would be spread over eight years.

While the future of LIFO is uncertain, dealers should remain informed about potential legislative and regulatory changes and the impact on their businesses.

Various trade and professional organizations are lobbying to preserve the LIFO method. The LIFO Coalition is concerned that representatives in Washington are not well-informed about the LIFO method of accounting and the effect discontinuing the method would have on taxpayers, including dealers.

Dealers nationwide should consider sending a letter to their U.S. senator to share the impact a loss of the LIFO method would have on their business.

Closing franchises and the LIFO effect

Dealers across the country are facing the reality of losing their LIFO benefits as franchises are terminated and inventories are eliminated. If a dealer has other franchises, he or she might be able to combine the inventories to limit the tax effect.

Another option may be to terminate using the LIFO method and spread the tax effect over four years if a dealer can manage to continue the business — for instance, as a used-car operation.

The entire amount of a dealer’s LIFO reserve must be reported as income for the current tax year if the dealer loses all of his or her franchises and does not remain in business.

Unfortunately, franchise terminations happen quickly, leaving little time to plan for the many technical aspects of tax law that must be considered. Dealers also should consider accumulating cash now to fund any future tax liability.

Dealers should consult their tax professionals to determine the potential impact LIFO termination would have on their particular circumstances. Dealers required to begin recapturing their LIFO inventory benefits in the coming years should consider the various options available to help soften the blow.