Why LIFO relief for car dealers from Treasury may be preferable to alternatives

The impact of reduced new-vehicle inventories and the resulting LIFO recapture continues to be a major concern for dealers. The National Automobile Dealers Association has been very active for more than a year advocating for and educating dealers about this issue. This is certainly a complex issue and dealers should be working closely with their tax advisers to consider various options even as NADA continues to pursue regulatory and possible legislative solutions.

NADA focused first on Section 473, a decades-old, never-utilized provision that allows the U.S. Treasury secretary to grant relief to taxpayers using the "last in, first out" method when inventory reductions are the result of a major foreign trade interruption. While bipartisan groups from the House and the Senate have sent letters to Treasury stating that the new-vehicle inventory reductions resulting from the pandemic are within the scope of this law, Treasury has yet to act as of press time.

The primary advantage of Section 473 relief is that it would allow dealers to remain on current LIFO methods for their current LIFO inventories while allowing up to three years for levels to recover. While application of such relief might be complex, every alternative available to dealers is as well. Treasury and the IRS have the authority to provide procedures to grant this relief in a practical and expedient manner while remaining within the framework of Section 473. We have seen many similar applications of this authority during the pandemic. If Treasury fails to act, NADA will urge Congress to enact new legislation that would provide similar relief to dealer taxpayers without the need for regulatory approval. In that instance, NADA is expected to launch a major dealer grassroots initiative in support of the legislation.

As dealers approach filing and tax payment due dates in March and April, time is running short. Dealers should consult with their tax advisers to examine their specific facts and circumstances because the impact of LIFO recapture is highly fact-specific and tax filings can create adverse unintended consequences.

Under existing LIFO rules, dealers have several options, including changing their LIFO method to another specific method and expanding the LIFO election to additional inventories. One approach that may include both a change of the LIFO method and an expansion of the LIFO election is the inventory price index computation, or IPIC, method.

The IPIC method determines inflation using Bureau of Labor Statistics data from either the Consumer Price Index or Producer Price Index. Historically, the inflation for dealer inventories has been much lower and more volatile under IPIC methods, producing an unfavorable result when compared with other methods. For example, new- and used-vehicle CPI inflation for the 10 years prior to 2021 averages about half a percent per year and fluctuates significantly from year to year. In contrast, 2021 new- and used-vehicle CPI inflation was almost 27 percent, significantly outpacing inflation computed under other LIFO methods.

Most dealers use the new-vehicle alternative LIFO method. This is a simplified automobile dealer-specific calculation framework provided by the IRS with a history of consistent and favorable inflation. Some dealers also use a similar method for used vehicles and/or a separate calculation for parts inventories. The new- and used-vehicle alternative methods require separate pooling or calculations for these groups of inventories while IPIC may allow all inventories to be pooled together. Many dealers might benefit by switching from the alternative to IPIC method along with a combination of their new vehicle, used vehicle and parts LIFO or an expansion of the LIFO election to used cars and parts.

The combination of high inflation under IPIC along with the ability to combine pooling for new vehicles, used vehicles and parts inventories can have a dramatic and favorable result for dealers.

However, before switching to the IPIC method, dealers should carefully consider the future as well as the impact of this change. If taxpayers have made any change to their LIFO method in the past five years, they may be prohibited from electing the IPIC method. When expanding a LIFO election to used vehicles, any prior-year used-vehicle lower of cost or market (LCM) adjustments must be taken into income for tax purposes over three years and dealers may not benefit from LCM adjustments for LIFO inventories. Once a dealer makes the switch to IPIC, the dealer generally will be required to remain on that method for five years. Inflation could vary dramatically over that time frame and could potentially reverse the benefits gained in 2021.

Unwinding the combined new-vehicle, used-vehicle and parts LIFO can also be very difficult or result in recapture of LIFO benefits. Dealers with generally accepted accounting principles financial statements may also need to consider the financial reporting consequences of using the IPIC method for tax purposes. Even without those statements, dealers would need to consider whether an expansion of their LIFO method would satisfy the book and tax conformity requirement relative to other financial reporting such as monthly factory statements. Any LIFO method change by a dealer is a highly complex exercise requiring the assistance of a professional well versed in dealer LIFO matters.

Considering only one option might miss the big picture and fail to fully consider the ongoing impacts and risks inherent in such an approach.

Moreover, any dealer analysis of LIFO alternatives should also include potential income tax rate volatility. For example, today's top 37 percent personal rate and 20 percent qualified business income deduction are scheduled to expire after 2025.

Finally, individual dealers may have specific circumstances that could lead to varying results, especially over several years. These LIFO issues are highly complex and technical. NADA and tax professionals are working to provide dealers visibility to every option that should be available to assist them in managing this situation, and NADA will provide updates on material developments related to potential Section 473 regulatory relief or legislative action.