Question

Does LIFO permanently reduce income taxes or just reduce taxes in the current period?

Answer 1

There are mainly four types of inventory costing methods namely LIFO, FIFO, weighted average and specific identification method. There are both advantages and disadvantages of using any of the methods. There are also different tax implications applicable in all of the methods. In case of LIFO method, it results in reduction of taxable income when there is rise in prices causing lowest amount of taxes. This is helpful in case of financial reporting purposes. Hence many companies, in case of high inflation, has shifted from FIFO to LIFO to gain tax advantages. In case a company choses to use LIFO method, it has to use it in all the subsequent years and any change in method can be done only after approval from IRS. LIFO method can reduce income taxes in case of rise in prices. Hence LIFO method always reduce income taxes as it assumes everytime that newest inventory items are sold at first. This provides high cost to inventory which consequently reduce taxes.