Prop. Regs. Simplify LIFO IPIC Method

Under the dollar-value LIFO method, taxpayers compute LIFO inventory by comparing current-year costs with base-year costs to develop an index. Taxpayers use the index to convert current-year inventory costs to base-year dollars. Often, the index calculation becomes complicated and burdensome. In 1992, Regs. Sec. 1.472-8 simplified the calculation with the introduction of the inventory price index computation (IPIC) method. The IPIC method was intended to simplify the use of the dollar-value LIFO method, so that more taxpayers could use it. The IPIC method was also easier for taxpayers already using the dollar-value LIFO method.

Generally, the IPIC regulations allow taxpayers to compute an inventory price based on selected consumer or producer price indexes that the Bureau of Labor Statistics (BLS) prepares and publishes monthly in the Consumer Price Index Detailed Report (CPI) or Producer Prices and Price Indexes (PPI).

Prop. Regs. Sec. 1.472-8 was recently issued to “simplify and clarify certain aspects of the IPIC method,” as well as to modify the method, so that it “produces a more accurate and suitable inventory price index.”

Elimination of Certain Conversion Requirements

Currently, manufacturers that use the PPI must convert the selected indexes into cost indexes. Similarly, retailers (other than those using the retail inventory method) that use the CPI must convert their selected indexes to a cost index. This calculation should be made separately for each category of goods, which adds substantial complexity to the IPIC calculation. Further, because of the conversion to a cost index, a change in the taxpayers gross profit percentage has the same effect as inflation or deflation. As a result, the cost conversion can substantially affect a taxpayers LIFO index.

Prop. Regs. Sec. 1.472-8 eliminates the requirement to convert published price indexes into either retail price indexes or cost price indexes. According to the preamble, the IRS has concluded that the administrative burden of converting published indexes into retail price or cost price indexes outweighs any benefits of increased accuracy from the procedure.

Elimination of Requirement for 10% Categories and BLS Weights

For purposes of computing an inventory price index, Prop. Regs. Sec. 1.472-8 provides the following detailed rules for assigning inventory items to index categories published in the CPI or the PPI:

1. First assign the items to the most detailed index that contains those items. If the total cost of the items in a single detailed index category equals or exceeds 10% of the total inventory value, a taxpayer must use the published index for that category for all items in that category.

2. If the total cost of items in a single detailed index category is less than 10% of the total inventory value, investigate successively less detailed index categories until reaching an index category that meets the 10% threshold. Repeat this procedure either until all the inventory items in the pool have been included in a category, the remaining inventory items in the aggregate comprise less than 10% of total inventory value, or there is a determination that no appropriate index category exists for the aggregate of such remaining inventory items.

3. If there are inventory items in the pool that comprise less than 10% of total inventory value, select the most detailed index category that includes such inventory items. If no appropriate index category exists for such remaining inventory items, combine such remaining inventory items in a miscellaneous index category.

For items grouped under the second or third method, a taxpayer must weigh each item in the group, based on indexes that the BLS publishes annually. These calculations added substantial complexity and uncertainty to the IPIC calculation. Because the BLS weight of an item bears no relationship to an items relative weight in the pool, the index computed for these items does not necessarily reflect a taxpayers inflation experience.

Prop. Regs. Sec. 1.472-8 eliminates the requirement to use 10% categories and BLS weights. It would simply require taxpayers to classify inventory items into the most detailed index category listed in the CPI or PPI. In addition, the Service is requesting written comments on the rules for excluding index categories that contain items with a de minimis amount of relative cost from the pool index computation.

Selecting from the Two Major Indexes

Under the current regulations, a retailer may select indexes from the CPI or the PPI. However, if the retailer can select equally appropriate indexes from either, a retailer using the retail inventory method must select from the CPI. On the other hand, a retailer not using the retail inventory method must select from the PPI.

Under Prop. Regs. Sec. 1.472-8, a retailer no longer has to determine which index is most appropriate. Retailers using the retail inventory method must use the CPI; all other taxpayers must select indexes from the PPI.

Other IPIC Changes

In addition, Prop. Regs. Sec. 1.472-8 contains the following miscellaneous provisions:

• Clarification that taxpayers may use either the double-extension or link-chain method for an IPIC computation;
• Elimination of the restrictions that apply to certain taxpayers on their eligibility to use the IPIC method; and
• Rules for special elective pooling.

Transition Rules and Effective Date

Prop. Regs. Sec. 1.472-8 applies to tax years ending on or after the date that the IRS publishes it as final. The Service treats a change required to comply with the new rules as an accounting method change. For the first tax year beginning after the IRS finalizes the regulations, the change can be made pursuant to the procedures for automatic consent method changes. The change entails use of a cutoff basis and a new base year.

From Louis A. Panoutsos, CPA, Oak Brook, IL