Lewes CPA
officeProgar & Company, P.A.
Certified Public Accounting services for businesses and individuals
S corporation LIFO recapture tax (MS Word)
S corporation LIFO recapture tax (.pdf)
S corporation LIFO recapture tax
Dear Reader:
You recently informed me that you are considering converting your C
corporation to as S corporation. Since you have been using the LIFO
inventory method, I want to make sure that you are aware of the LIFO
recapture income that will be triggered by converting to S
corporation status. We should get together soon to compute what the
tax on this recapture would be and to see what planning steps might
be taken to minimize it.
As you are aware, your corporation has been reporting a lower amount
of taxable income under LIFO than it would have under FIFO because
the inventory taken into account in calculating the cost of goods
sold under LIFO reflects current costs, which are usually higher.
This benefit of LIFO over FIFO is equal to the difference between
the LIFO value of inventory and the higher value it would have had
if the FIFO method had been used. In effect, the tax law treats this
difference as though it were profit earned while the corporation was
a C corporation. To make sure there's a corporate-level tax on this
amount, it must be “recaptured” into income when the corporation
converts from a C corporation to an S corporation. Also, the
recapture amount will increase the corporation's earnings and
profits, which can have adverse tax consequences down the road.
There are a couple of rules that soften the blow of this recapture
tax somewhat. The increase in tax imposed on the C corporation in
its final tax year because of the LIFO recapture may be paid over a
four-year period. And, the basis of the corporation's inventory will
be increased by the amount of income recognized. So, the net effect
may be one primarily of timing—because of the basis increase, the
corporation may realize less income in later years, though only if
there are decrements in the adjusted LIFO layer.
We can help you gauge your exposure to the LIFO recapture tax and
can suggest strategies for reducing it.