With new vehicle inventory levels significantly lower as a result of the current economic circumstances and as a result of the government’s CARS program, many dealers will likely recognize LIFO income for 2009 instead of LIFO expense. The resulting tax impact may be significant.

One option some dealers may take to mitigate this additional tax is to order more inventory in an attempt to have a year-end inventory level that exceeds their December 2008 level. If this is your plan, please remember that title to this inventory must have transferred to you before December 31st in order to prevent the LIFO recapture. There are a few other pitfalls you must consider if you are taking this approach with your new vehicle inventory:

• You have probably been managing your inventory levels based upon market demands, and ordering excess inventory will likely send a mixed and confusing message to your managers.
• We know from experience that carrying excess inventory results in higher operating costs such as:
  - Spiffs
  - Interest
  - Insurance
  - Advertising
• We also know from past experience that vehicle grosses significantly erode when excess inventory is carried.

We have seen, time and time again, a dealer take on extra inventory to avoid paying income tax relative to LIFO recapture only to give it back in the form of additional costs and reduced grosses.

Another option for dealers to take is to look at LIFO from a long-term perspective and to not manage LIFO during any one year. In practice a dealer will just let the LIFO impact happen and manage inventory based solely upon his stocking guidelines. In essence, a dealer taking this approach will not let the “tax tail wag the business dog.”

A better answer in today’s business environment is probably a blend of the two approaches. Somerset’s recommendation is to:

1. Perform LIFO and tax projections based upon different anticipated inventory levels.
2. Calculate the costs associated with carrying extra inventory at each of these levels (see bullets above).
3. Compute the reduced gross profit resulting from carrying too much inventory (see bullets above).
4. Finally, compare the LIFO savings projected in step #1 with the extra costs and reduced grosses calculated in steps #2 and #3.  Then make a decision and move forward with running your dealership in these difficult times.

Please let us know if we can help.