With Inflation, Your Inventory Can Be Source Of Tax Savings

The pandemic forced businesses to adapt in many ways. The economic recovery has highlighted supply chain issues exacerbated by strong demand and leading to overall inflation. Businesses are now continuing to adapt to higher prices. Those with inventory may be able to realize tax benefits to help with this inflationary effect through the Last-In, First-Out inventory method (LIFO). 

LIFO inventory methods are hardly a new tax concept but often may have been ignored due to complexity or periods of marginal inflation. This strategy deserves a second look during a year of high inflation. Read on to learn more about this tax savings strategy and the simplified calculation methods available.

Under the TCJA most businesses with less than $25 million in gross receipts are able to write off the inventory expenses at the time of purchase.  For our clients with inventories, they were all able to make the appropriate elections so LIFO or FIFO no longer matters.  But if your business has over $25 million in gross receipts or could not meet the safe harbor election rules, read on.


LIFO is a valuation method for inventory that is allowed instead of the common first-in, first-out (FIFO) method. FIFO assumes the oldest items of inventory purchased are the first items sold. In contrast, LIFO assumes the most recently purchased items of inventory are the first sold. Neither method will reflect the actual flow of inventory but instead will assume a consistent flow according to the method.

Practically speaking, the actual physical flow of inventory is never quite FIFO or LIFO. The grocery store will have a mix of workers rotating stock well or poorly. Workers may pay closer attention to the rotation of the short-lived yogurt than they do to the three-year-before-expiration canned goods. Even if complete rotation is achieved in stocking, perfect FIFO is ruined by customers who understand to dig deeper into the shelves to get those longer expiration dates. This is okay though. The grocery store can select an overall method of accounting for inventory even though it will never match the flow of goods. While the store ideally wants their inventory to flow FIFO, the store probably should consider LIFO methodology for tax purposes.


During a period of rising costs, LIFO will produce a tax savings in the form of higher cost of goods sold and lower ending inventory.

The LIFO method is not without risk. Additional taxable income may be realized if periods of deflation and lower costs occur which leaves older, higher cost inventory on the books under the LIFO method. Once the method election is made, you may revoke it but must wait five years before re-electing LIFO (unless they receive specific consent from the IRS commissioner under non-automatic procedures). So you cannot simply bounce back and forth between methods that suit the direction of your inventory’s value for tax purposes. As a result, those with highly volatile inventories are likely not good candidates for LIFO.  The best candidates for LIFO are profitable taxpayers with significant inventories and consistent inflation in their industry.


In a time of higher-than-average inflation, LIFO inventory methods deserve a second look as a tax reduction strategy. LIFO can be simpler than many realize through the use of BLS published inflation indexes and grouping many items into 10% categories. As the costs of inventory continue to inflate over time, the LIFO method will continue to produce higher costs of goods sold and lower tax bills.


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