June 17, 2022
Supply chain disruptions are nothing new to auto dealerships at this point. Chip shortages and the difficulty obtaining new semiconductors are just two factors that have strained the automotive industry. More than two years after COVID-19 was declared a global pandemic, dealerships using the last-in-first-out (LIFO) inventory method are still hurting, but for a less obvious reason. Under the LIFO method, auto dealers have been losing money. It has resulted in increased tax liabilities despite shrinking inventory – not a favorable outcome. An undesirable tax result combined with the inability to restock vehicles has put many in a lose-lose situation.
The House of Representatives recently introduced legislation to help. The Supply Chain Disruptions Relief Act (Act), if passed, would grant relief to qualified auto dealers of new vehicles for the 2020 and 2021 tax years. But is it enough – and more importantly, will it pass? To help clients, prospects, and others, Wilson Lewis has provided a summary of the key details below.
Even before COVID-19, the automotive industry was seeing signs of struggle. Weak demand, international trade disputes, and labor strikes in 2018 and 2019 were already impacting auto sales. Further, consumers were looking at higher price tags and longer loan terms, two additional factors that complicated demand.
It’s been an entire series of events blocking auto dealers from replenishing inventories. Government shutdowns still persist in some parts of the world. Worker shortages and labor strikes have hampered manufacturing output. Chip shortages now mean that new cars are delivered without extra features. The war in Ukraine and its impact on global auto production. To add to this, the semiconductor shortage has been predicted to have a worse impact on the U.S. auto industry than the chip shortage.
Even the fast-growing electric vehicle market will face an uphill battle if difficulties sourcing raw materials like lithium, nickel, and cobalt persist.
With all these disruptions considered, the auto industry saw a 12.6 percent decline in new light-vehicle sales in May 2022 for a total of 12.7 million units. That’s almost 25 percent less than the year before. The primary reason for deflated sales? Limited new-vehicle inventory, according to the National Automobile Dealers Association (NADA).
When an auto dealer that elects the LIFO accounting method struggles to replace inventory, its taxable income is artificially inflated. This happens when the dealer ends a reporting period with a quantity of inventory lower than when the period started. This liquidation event causes an artificial spike in taxable income, and a higher tax bill follows.
So, does Section 473 provide relief when this happens?
It depends. Section 473 provides narrow relief for some supply chain interruptions, and the Treasury Department must approve a designated event or a “qualified inventory interruption.” In that scenario, the Treasury would need to say that businesses operating with the LIFO method cannot acquire replacement goods due to either a disruption in energy supplies (or Department of Energy regulation) or an “embargo, international boycott, or other major foreign trade interruption.”
If the Treasury deems that one of these two situations has occurred in a given tax year, then LIFO businesses and other qualified taxpayers would essentially have three years to restore their inventory to pre-liquidation levels, thus avoiding artificial increases in taxable income.
Last year, the AICPA petitioned Congress for relief under Section 473. In the proposed notice, AICPA recommended that taxable years ended March 31, 2020, through June 30, 2021, be included. The Treasury has since indicated it does not have the authority to grant relief under current circumstances.
But that’s where potential new legislation could come in.
There are two similar bipartisan bills up for consideration in both the House of Representatives and the Senate. The House’s version, the Supply Chain Disruptions Relief Act, was introduced first on April 4, 2022. Under the Act, LIFO auto dealers of new vehicles would have until 2025 to replace inventory attributed to liquidation events in 2020 or 2021. This would treat LIFO auto dealers as having satisfied the requirements of Sec. 473 relief and grant a longer recovery period for struggling auto dealerships.
The Senate’s version, also of the same name, was introduced on April 28, 2022. Both the AICPA and NADA have publicly stated support for Congressional help. These are promising first steps but at this point, there is no timeline or when or if the legislation could move forward or if it would become law.
A related piece of legislation, the Bipartisan Innovation Act, addresses overall supply chain disruptions and proposes to bolster the domestic production of semiconductors, among other provisions.
If the Act becomes law, auto dealers would be permitted to claim the tax benefits retroactively without the need to file an amended return. To do that, dealerships would elect the benefits on their next tax return and adjust income as needed the next year.
One possible option would be for auto dealers to wait until it is closer to the October 15 extension deadline, assuming they previously requested an extension. In the meantime, dealerships will want to continue making tax payments as needed to avoid unnecessary fees or penalties.
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The recently introduced legislation in both the House and Senate is good news for many Atlanta auto dealerships already facing significant struggles. Unfortunately, it is not clear how long it will take for the legislation to make its way through Congress. If you have questions about the information outlined above or need assistance with a tax or accounting issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.