_{Final Regs. Simplify LIFO IPIC Method}

Final regulations issued earlier this year make major modifications to the inventory price index computation (IPIC) method of determining inventory values under the LIFO inventory method (Regs. Sec. 1.472-8). Generally, the changes simplify the IPIC method.

Under LIFO, for each inventory pool, a company must compute an inventory price index (IPI), which factors in inflation that has occurred since the LIFO base year. The IPIC method is an optional LIFO method designed to simplify the LIFO computation. It measures inflation based on indexes contained in the Consumer Price Index Detailed Report (CPI Detailed Report) or the Producer Price Index Detailed Report (PPI Detailed Report) published by the Bureau of Labor Statistics (BLS).

Impact of the Final Regs.

Reduction eliminated. The most significant change was to eliminate the requirement for large companies to reduce the IPI by 20%; accordingly, all taxpayers electing to use the IPIC method will be permitted to employ 100% of the IPI to compute the LIFO value of a dollar-value pool. To change to 100% IPI, taxpayers must use a cut-off method. Therefore, taxpayers that used 80% of the IPI under the prior IPIC regulations may not adjust prior years' indexes; the benefit of using 100% only applies prospectively.

Eligibility. The final regulations liberalize the IPIC-eligibility restrictions. Generally, a taxpayer using the IPIC method must use that method for all dollar-value LIFO inventory (within a single trade or business). However, a retailer that uses Department Store Inventory Price Indexes may elect to use the IPIC method for items that do not fall within any of the index's 23 department store major groups. Alternatively, retailers (including department stores) may elect to use the IPIC method for all dollar-value LIFO inventory (within a specific trade or business).

Special pooling rules. The most significant change in the IPIC pooling rules is a new method that allows manufacturers and processors to establish pools based on the PPI Detailed Report's major commodity codes. Manufacturers could now include manufactured goods and goods purchased for resale in the same pool(s) if the goods fit into the same two-digit commodity code. This method is an alternative to natural-business-unit (NBU) pooling, which would require manufacturers to use separate pools for goods manufactured and goods purchased for resale, even if the goods are identical otherwise. However, this method could result in multiple pools for manufacturers with diverse types of raw materials or finished goods.

The final regulations retain both of the 5% rules for IPIC pools, but clarify that in determining eligibility for each of these, the pool's value is compared to only the total current-year cost of all dollar-value LIFO pools. The final regulations also clarify that each 5% rule is an accounting method, and therefore a taxpayer may not change to (or cease using) either of the 5% rules without the IRS's consent. In addition, whether an IPIC pool satisfies either or both of the 5% rules must be determined in the year of adoption or year of change (whichever applies) and redetermined every third tax year.

Selection of BLS tables. The final regulations eliminate the need for a retailer to determine whether the CPI or PPI Detailed Report contain equally appropriate indexes. Retailers may select indexes from either Table 3 of the CPI Detailed Report or Table 6 of the PPI Detailed Report, regardless of whether the retailer uses the retail method. This selection applies to each LIFO pool; therefore, retailers with more than one LIFO pool may use indexes from Table 3 of the CPI Detailed Report for one or more pools, as well as indexes from Table 6 of the PPI Detailed Report for one or more pools. All other taxpayers must select indexes from Table 6 of the PPI Detailed Report, unless they can demonstrate that selecting indexes from another table of the PPI Detailed Report is more appropriate.

Appropriate month. The final regulations retain the requirement that a retailer using the retail method must use indexes from the last month of its tax year. The final regulations clarify that all other taxpayers should either determine annually the month most appropriate to the method of determining the current-year cost (appropriate month) of each dollar-value pool or should make a one-time election of a representative appropriate month (representative month) for each pool. The final regulations incorporate the Rev. Rul. 89-29 principles for determining whether a particular month is either appropriate or representative. Most taxpayers will want to elect to determine an appropriate month on an annual basis, as inflation can vary significantly from month to month.

BLS categories. The final regulations provide that the 10% method under the prior regulations is optional. In determining whether a BLS category may be selected under the 10% method, the current-year cost of items in that category must be compared to the cost of items in the pool, rather than to the cost of all items in ending inventory. A taxpayer that elects not to use the 10% method must classify its inventory into the most-detailed index categories listed in the CPI Detailed Report or PPI Detailed Report.

The election to use the 10% method is made for each LIFO pool. Therefore, taxpayers with more than one LIFO pool may use that method for one or more LIFO pools, and the method of assigning items to the most-detailed BLS categories for other LIFO pools.

Depending on which method is used to assign items to BLS categories, the final regulations provide that manufacturers and processors must assign each raw material item to the 10% category or to the most-detailed PPI category that includes the raw material. Similarly, each finished-good item must be assigned to the 10% category or to the most-detailed PPI category that includes that finished good. Further, manufacturers and processors must assign each work-in-process (WIP) item to the 10% category or the most-detailed PPI category that includes the finished good into which the item will be manufactured or processed.

Category inflation index. The final regulations allow taxpayers to elect the link-chain IPIC method or the double-extension IPIC method. Under the link-chain method, the category inflation index is the quotient of the published BLS index for the current year's appropriate or representative month, divided by such index for such month used for the immediately preceding year. However, if the taxpayer did not have an opening inventory, it uses the month immediately preceding the month of its first inventory production or purchase.

Under the double-extension method, the category inflation index is the quotient of the published BLS index of the current year's appropriate or representative month, divided by such index for such month for the year preceding the base year. Most taxpayers will want to use the link-chain IPIC method because it is much simpler.

The final regulations incorporate Rev. Proc. 98-49's general provisions on computing the category-inflation index when the BLS changes the category. The regulations include an example of this computation. While the final regulations generally reduce the complexity associated with the IPIC method, this computation remains very complex.

IPI computation. The IPI should reflect a weighted average of the inflation rates of LIFO-pool items. Under the final regulations, the IPI must be computed using a weighted harmonic mean, based on the relative current-year costs in the LIFO pool. The regulations provide a formula for computing this mean and include examples of the IPI computation.

Effective Date

The IPIC-method final regulations apply for tax years ending on or after Dec. 31, 2001. For the first or second tax year ending on or after that date, a taxpayer is granted automatic consent to change to a method required or permitted by the final regulations. To receive automatic consent, the taxpayer must follow the automatic consent procedures in Rev. Proc. 2002-9, which involve filing Form 3115, Application for Change in Accounting Method. However, the scope limits in Section 4.02 of Rev. Proc. 2002-9 do not apply, and the five-year limit on the readoption of the LIFO method under Section 10.01(2) of Rev. Proc. 2002-9's appendix is waived. Under these transition rules, every taxpayer currently using the IPIC method must file Form 3115 for the first or second tax year ending on or after Dec. 31, 2001 to comply with the final regulations.

From Jim Martin, CPA, and Eric Lucas, J.D., LL.M., Washington, DC