Inventory: LIFO and UNICAP Planning

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1 Inventory: LIFO and UNICAP Planning Upstream and Downstream Tax Planning Houston TEI Tax School May 4, 2017

3 Contents Proposed LIFO Regulations 4 Changes from MFG to PFR 10 Negative (Debit) LIFO Reserve 16 LIFO Planning for Inventory Liquidations 21 IRS Update 24 Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 3

5 Current Regulation Status LIFO Taxpayers using an internal index method and using Natural Business Pooling ( NBU ) Required to put purchased and manufactured items in separate LIFO Pools Treas. Reg (b)(1) and (2) LIFO Taxpayers using the Internal Producer Price Index ( IPIC ) method and the IPIC Pooling method Regulations are silent on the treatment of purchased versus manufactured goods Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 5

6 Proposed Regulations Taxpayers using the IPIC Pooling method would be required to maintain separate pools for items that are purchased for resale and items that are manufactured Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 6

7 Resolution without a Problem Internal Index Method Separate Pools Avoids Distortion of inflation Year 1 Year 2 Purchase Price : $3.00 Manufactured Price: $0.75 Combined: $3.75 Purchase Price : $3.5 Inflation % = 116% Manufactured Price: $1.25 Inflation % = 166% Combined: $4.75 Inflation %: 127% *Items within the same pool creates distortion of inflation for all items due to mix shift of inventory items Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 7

8 Resolution without a Problem IPIC Method Combined Pooling Creates No Distortion of Inflation Year 1 Year 2 IPIC Index: 100 Purchase Price : $3.00 Manufactured Price: $0.75 Combined Price: $3.75 IPIC Index: 110 Purchase Price : $3.5 Inflation % = 110% Manufactured Price: $1.25 Inflation % = 110% Combined Price: $4.75 Inflation %: 110% *Items within the same pool creates no distortion of inflation for any items because one external index is used for both PFR and MFG goods Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 8

9 Impact of New Regulations Separate Pools Creates More Increments and Decrements Decreases or increases in purchase for resale or manufactured goods could net together when the items are in a single pool Separate pools will result in decrements not being offset by increments in items now is separate pools resulting in larger LIFO income in years of inflation. Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 9

11 Definition of Manufacture for LIFO Minimal Production is Required for an item to be Considered a Manufactured Good : The blending process is considered manufacturing for tax inventory purposes Effect Under NBU pooling, and soon to be IPIC pooling, most goods are considered manufactured as they are either the result of blending process or they are raw materials that will be blended before being sold Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 11

12 Removal of Blending Process If Blending is removed from the business : If the goods are purchased and sold without being blended, they are no longer manufactured goods Effect The existing pool of manufactured goods would be liquidated and the LIFO reserve picked up in income Under NBU pooling, and soon to be IPIC pooling, most goods are A new pool of considered manufactured as they purchase for resale are either the result of blending goods would need to process or they are raw materials be created that will be blended before being sold This pool would have a LIFO reserve of zero in its first year Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 12

13 Removal of Blending Process - Example Assumptions: Inventory is 90% manufactured, 10% purchase for resale in Year 1 Manufactured Goods Pool Current Year FIFO 1,800,000 Base Costs Inflation (Cost) LIFO (Historic) Year of Layer Of Layer Value of Layer LIFO Reserve , , , , , ,000 Under NBU pooling, and soon to , ,500 be IPIC pooling, most goods are Total 1,516,500 considered manufactured 283,500 as they are either the result of blending process or they are raw materials that will be blended before being Purchase for Resale Goods Pool sold Current Year FIFO 200,000 Base Costs Inflation (Cost) LIFO (Historic) Year of Layer Of Layer Value of Layer LIFO Reserve , , , ,667 Total 166,667 33,333 Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 13

14 Removal of Blending Process - Example Assumptions: Inventory is 10% manufactured, 90% purchase for resale in Year 2 Manufactured Goods Pool Current Year FIFO 200,000 Base Costs Inflation (Cost) LIFO (Historic) Year of Layer Of Layer Value of Layer LIFO Reserve , , Under NBU pooling, and soon to be IPIC pooling, most goods are Total 160,000 considered manufactured 40,000 as they are either the result of blending process or they are raw materials Purchase for Resale Goods Pool that will be blended before being sold Current Year FIFO 1,800,000 Base Costs Inflation (Cost) LIFO (Historic) Year of Layer Of Layer Value of Layer LIFO Reserve , , , , ,050, ,575,000 Total 1,741,667 58,333 Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 14

Effects of Change Taxpayers will not be able to avoid this impact under the proposed IPIC regulations Blender s Credit changed to a Producers Credit If

15 Effects of Change Taxpayers will not be able to avoid this impact under the proposed IPIC regulations Blender s Credit changed to a Producers Credit If operations are driven by the credit change could result in removal of blending from operations Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 15

17 LIFO in a Time of Deflation Many industries, specifically oil and gas, have experienced significant drops in prices over the last few years Those companies that use the Last-In, First- Out ( LIFO ) inventory method are now experiencing income rather than deductions from LIFO due to deflation There are options to consider when a company is faced with LIFO income; however, consideration should be given to future impact of any changes Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 17

18 Impact of Deflation LIFO income comes from historic inventory layer(s) having higher cost than the current-year cost of inventory This is either the actual cost of inventory (specific goods) or the relative current-year cost of the pool (dollar value) Continued cost deflation will increase the income in each layer and overall Base Year Price Index 1.00 CY Cumulative Price Index 1.10 a Base Costs Inflation (Cost) LIFO (Historic) FIFO (Current) LIFO Reserve Year of Layer Of Layer Value of Layer Value of Layer Of Layer ,500,000 b c 4,500,000 e = b * c 4,950,000 d = c * a (450,000) = d - e , , ,000 96, ,000, ,000,000 2,200, , , , ,000 53,000 Total 8,760,000 8,261, ,000 Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 18

19 Effect of Price Increases As prices increase, then LIFO deductions in each layer and overall will increase Current year prices or inflation need to be higher then the price or inflation in each individual layer to cause a deduction in that layer Base Year Price Index 1.00 CY Cumulative Price Index 1.40 a Base Costs Inflation (Cost) LIFO (Historic) FIFO (Current) LIFO Reserve Year of Layer Of Layer Value of Layer Value of Layer Of Layer ,500,000 b c 4,500,000 e = b * c 6,300,000 d = c * a (1,800,000) = d - e , , ,000 (48,000) ,000, ,000,000 2,800, , , , ,000 (106,000) Total 8,760,000 10,514,000 (1,754,000) Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 19

20 Short Term Gain? Consider Long Term Pain Some changes to current LIFO methods or other planning strategies will create deductions in the current year, but careful consideration of the future implications is important before committing to a strategy o Sub-methods: Changing to different LIFO sub-methods for the current year may be a good strategy, but they may cause additional future deflation or false decrements with limited ability to change methods again for five years o Decrements: decrements into higher cost historic layers will create deductions equal to the LIFO reserve in each layer. If inventory levels go back up then new layers will be created at high costs and lower LIFO reserve than the layers that were used in the decrease of inventory o LIFO Termination: Termination will allow for recapture of a negative LIFO reserve o o Any benefit in historical LIFO layers will be lost The ability to take advantage of a rebound may be limited by the inability to re-elect LIFO for 5 years Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 20

22 Business Reduction of Inventory Carrying Amounts Inventory Volumes have increased through the decrease in prices As prices rise, operations may begin to sell of excess inventory This will create decrements in the LIFO pools Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 22

23 Business Reduction of Inventory Carrying Amounts - continued Considerations : Temporary Reductions in Inventory : If operations believe that they will return to the higher inventory then the LIFO layers will be liquidated and then replaced at higher costs when inventory returns Permeate Reductions : Layers that are liquidated that are at a lower cost then the current year will result in income Consider any planning that could be done for the year of the income pickup Layers that are liquidated that are at a higher cost then the current year will result in deductions Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 23

25 IRS Update Audit rules for partnerships start for taxable years beginning after 12/31/17 Areas of Considerations UNICAP Methods LIFO Methods and Sub methods Pooling Lower of Cost or Market Reserves in Inventory Inventory Costing Joint sales realization methods Tank bottoms Costing of items under joist sales realization methods ACE Adjustment Inventory stated at Lower of Cost or Market for purposes of LIFO recapture Copyright 2017 Deloitte Development LLC. All rights reserved. Houston TEI 25

26 This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. About Deloitte Deloitte refers to Deloitte Tax LLP, a subsidiary of Deloitte LLP. Please see to learn more about our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2017 Deloitte Development LLC. All rights reserved.

The LIFO Inventory Training Basics & Audit Guide

The LIFO Inventory Training Basics & Audit Guide Prepared by LIFO-PRO, INC. LIFO Software LIFO Services 920 South 107 th Ave., Suite 301 Omaha, NE 68114 (402) 330-8573 (877) 848-6583 Fax www.lifopro.com