Don't be Caught with a Year-End LIFO Surprise
By Jeffrey Brogley
Auto Dealer Alert , August 2005

A big surprise may be on the horizon for dealers using the LIFO inventory method, thanks to changes in manufacturer's pricing strategies. For years, many dealers have taken advantage of the LIFO inventory method to defer income taxes. Dealers using LIFO are assumed to have sold the inventory with the highest cost first. This allows them to build up a LIFO reserve, or tax deferral, over time. Assuming the dealer keeps its inventory at a constant or rising level from year to year and prices continue to rise, taxes can be deferred, sometimes indefinitely. However, if you use the LIFO method, you need to be aware that recent changes in manufacturer pricing may “throw a wrench” into your plans for 2005. GM has announced that they will be reducing base prices for many 2006 models, and other manufacturers have hinted that they may adopt similar pricing strategies. These pricing changes, coupled with reduced dealer inventories, could mean that dealers using LIFO will see significant recapture of their LIFO reserves in 2005. In many cases, dealers who have grown accustomed to deferring several hundred thousand dollars a year may instead see significant LIFO related income in 2005. Since many dealers are not as profitable as in previous years, this could create a significant cash flow problem at tax time.

What can a dealer do to combat this?

Some might suggest that dealers should micromanage inventory levels to achieve the best LIFO results for tax purposes. However, it is rarely advisable to let tax decisions dictate how you purchase inventory or run your business on a daily basis. The good news is that the effects of this problem can be mitigated substantially if a dealer's advisors do appropriate tax planning before year end. It may also be possible to change LIFO methods to avoid undesired results. Keep in mind that there are advantages and disadvantages to various LIFO methods, and appropriate consideration needs to be given to the long-term impact on your business.

Should you be on LIFO?

If you take a longterm approach to your business and are interested in deferring income taxes, the answer is generally yes. However, given the current state of the manufacturers' pricing programs, dealers need to be sure their advisors are providing them with accurate tax projections that take into account the impact of LIFO. Without appropriate planning, dealers could be writing larger checks to the IRS in early 2006. We can help with any questions you may have. Call Jeff Brogley at 248.223.3349 or contact your Plante & Moran advisor.