IPIC as an alternative to regular LIFO.

• Author: Staley, Dan
• Position: Inventory price index computation, last-in-first-out

Many taxpayers using LIFO to determine the cost of inventory are examining whether they should modify their LIFO calculations, either to simplify them or to reverse a trend in which recent calculations show little inflation (or even deflation). These taxpayers are considering a switch to the inventory price index computation (IPIC) method for their LIFO calculations. The IPIC method replaces a taxpayer's internal inflation/deflation calculations with external inflation/deflation factors, taken from the Bureau of Labor Statistics (BLS) Consumer Price Index (CPI) and Producer Price Index (PPI) reports.

Simplifying LIFO

Taxpayers and practitioners agree that IPIC usually mitigates the complexity of item definition, one of the most difficult aspects of a regular LIFO calculation. "Items" are the detailed categories by which a taxpayer must classify its inventory to compute inflation properly. Item definition (the process of determining whether specific inventory goods are similar enough to be grouped together as an item) is subjective in nature and often a source of controversy between the IRS and taxpayers.

Neither the Code nor the regulations has defined the term "item," but the Service has intensified its examinations of item definition in industries in which it believes the number of LIFO items have been inadequate, Rulings such as Letter Ruling (TAM) 9632001 reflect the IRS position that LIFO items should be maintained at a more detailed level, taking the view that differences (such as disparate cost characteristics for identical inventory goods) are significant enough to warrant separate-item treatment.

Businesses that do not keep their inventory item books and records at acceptable Service levels can use IPIC, as that method removes much of the item definition uncertainty and leads to fewer items than an internal calculation. For instance, a tire manufacturer may produce many tire types in terms of size, performance, construction materials and cost. If a taxpayer aggregates all of these tire types into just a few LIFO items, its prior-year LIFO calculations could be subject to adjustment. If the IRS raises the issue, the taxpayer may have difficulty reconstructing base-year costs for additional items the Service identifies, and still retain its full LIFO reserve. However, if the taxpayer voluntarily adopts the IPIC method, it may be able to do so on a cut-off basis (i.e., without a Sec. 481(a) adjustment). Moreover, a voluntary filing...