Interruption of LIFO inventories due to COVID-19 and Sec. 473 relief

A company with last-in-first-out (LIFO) inventory that experiences a decrease in LIFO inventory would typically have additional taxable income related to the LIFO decrement. A LIFO decrement is the excess of the prior-period ending inventory minus the current-period ending inventory. Decrements result in a reduction of increments or layers created in earlier years.

The various government restrictions implemented in response to the COVID-19 pandemic severely limited manufacturing capacity and caused major interruptions in foreign trade and the global supply chain. These restrictions made it extremely difficult for U.S. companies to replace their inventories in 2020, resulting in a significant reduction to inventory levels, and the difficulties continue into 2021. As a result of these circumstances, many companies will realize additional taxable income and unexpected tax liabilities, which may continue to hamper their recovery, as they may not have the cash readily available to pay taxes on the additional income.

Sec. 473 provides relief for eligible taxpayers that experience qualified liquidations of LIFO inventories. Sec. 473 applies if a business has had an interruption in the ability to obtain replacement inventory due to a trade embargo or other international event. Under Sec. 473, the company would have three additional years to replenish the liquidated inventory. Specifically, Sec. 473 authorizes Treasury to issue in the Federal Register a notice of determination that a qualified inventory interruption of LIFO inventories has occurred.

A “qualified inventory interruption” occurs under Sec. 473(c)(2) when the Treasury secretary, after consultation with the appropriate federal officers, determines that (1) any embargo, international boycott, or other major foreign trade interruption has made it difficult or impossible to replace any class of goods for any class of taxpayers during the liquidation year, and (2) the application of Sec. 473 to that class of goods and taxpayers is necessary to carry out the purpose of Sec. 473.

The AICPA recently submitted two letters, in April and August 2021, including detailed examples, that requested a safe-harbor method and expedited relief in this scenario. In particular, the AICPA recommended that the safe harbor provide that the taxpayer would disregard the liquidation for the liquidation year and would retain the LIFO layers related to the opening inventory of the liquidation year. In essence, this would alleviate the burden of paying additional taxes on the related income, and, in general, eliminate the need to file amended tax returns to obtain Sec. 473 relief.

Taxpayers should be aware of these potential consequences due to the disruption of the global supply chain and overall reduced inventory levels.

— Elizabeth Young, CPA, J.D., LL.M., is a senior manager–Tax Policy & Advocacy with the AICPA in Washington, D.C. To comment on this article or to suggest an idea for another article, contact Alistair M. Nevius, J.D., (Alistair.Nevius@aicpa-cima.org) the JofA’s editor in chief, tax.