Choosing the Best Inventory Method
In a period of rising prices, the use of the LIFO (last-in, first-out) inventory identification method can produce income tax savings. This method increases your cost of goods sold (thereby reducing your taxable income) by assuming that the higher priced inventory units that you most recently purchased were the ones actually sold. If you use the LIFO method for tax purposes, you must also use it in preparing financial statements for credit purposes and reports to stockholders.
In times of falling prices, the FIFO (first-in, first-out) inventory identification method will provide larger tax savings. It assumes that higher priced inventory units you purchased first are the ones that have been sold.
You can generally change from one inventory method to another, but you may need to get IRS approval for some changes. Depending on your situation, you may be able to realize substantial income tax savings by choosing one method over the other. Some small businesses with gross receipts of $10 million or less may be able to ignore inventories all together. Call us to see if you qualify.