The Inventory Blind Spot: How LIFO Can Unlock Massive Tax Savings, Ep #36

[0:00] Cindy: Inventory is likely the biggest asset most companies have on their balance sheet, right? Even if you move the needle a tiny bit for such a massive asset, you’re going to have a significant impact.

[0:15] Narrator: Welcome to Buy the Numbers. Each week, we’ll explore the numbers that drive your business, from accounting and finance to operations and the exciting realm of mergers and acquisitions. Whether you’re a seasoned veteran or just starting out, our discussions will equip you with the insights and strategies you need to rein in the power of data to elevate your manufacturing company.

Let’s crunch some numbers.

[0:43] Mike Payne: Erica, Cindy, welcome to Buy the Numbers.

[0:45] Erica Parra: Thank you. Thanks.

[0:47] Mike Payne: So listeners, you’ve heard throughout the year, of course, we talk a lot about accounting and finance issues. We’ve talked a lot about inventory throughout Buy the Numbers and making chips. And there’s a lot of options with how you handle inventory.

I mean, in my experience, a lot of us in this space, it’s just a thing we have, and we don’t pay near enough attention to it. But you’ve heard me talk about inventory accounting methods. And I’ve got Erica and Cindy to like really drill in on that because they are the gurus at Cliffs & Larsen Allen.

And I’m going to let them introduce themselves. Erica, you’re just first on my screen. So I’ll let you introduce yourself first.

[1:27] Erica Parra: Oh, thank you. So my name is Erica Parra. I am a manager at Cliffs & Larsen Allen, and I spend my days breathing, living and talking about inventory accounting, which is great.

[1:40] Mike Payne: Yeah. So and then Cindy?

[1:42] Cindy: Yeah. Oh, I actually refer to Erica as the queen of inventory.

[1:46] Mike Payne: There you go.

[1:46] Cindy: At CLA. I actually am a principal at Cliffs & Larsen Allen CLA, and I pretty much oversee our entire federal tax strategies accounting methods team.

[1:57] Mike Payne: That’s across the firm, right?

[2:00] Cindy: Yes. We’re a national team, and Erica is a part of that as well. And our team focuses on tax strategies involving timing and character of income and expense items, whether it be any income revenue recognition, expense recognition provisions, or capitalization provisions such as inventory, which is Erica’s area of specialty.

[2:23] Mike Payne: Yeah. So Cindy, I think people are going to be surprised how important inventory accounting methods are by the end of this episode. But Cindy, based on what you just said, I bet we could record 10 more podcasts on all the other things.

I mean, when you talk about revenue recognition, and I mean, golly, there’s so many things that affect this industry that I just know for a fact we’re not dealing with. I mean, there are good strategies that as an industry, we don’t address.

[2:53] Cindy: Oh, absolutely. Yeah.

[2:55] Mike Payne: So we’ll have to follow up on some of that as well, because that could be some really good, valuable information. So here’s my experience in this industry and throughout my career, really. A lot of companies just, I mean, inventory is the stuff sitting on the shelf.

If we’re doing a good job, we count it once a year and we put it on our balance sheet and we leave it there. There’s a lot more to inventory than that, right, Erica?

[3:18] Speaker 6: Oh, yeah.

[3:19] Mike Payne: There’s different ways you handle that. So when we talk about accounting methods, can you give us kind of that overview of the best handful? I mean, I know of three ways really to do it.

You probably know of 10, but what do people need to be thinking about when they’re thinking about how they’re doing their inventory accounting?

[3:37] Erica Parra: Well, when they’re thinking about their inventory, they really need to be thinking about two things. One is how you’re going to value your inventory, and the other one is how you’re going to identify your inventory. So a lot of the times we think of valuation of inventory, it’s very easy for us.

We’re like, oh, we paid for it. That’s the cost that we’re actually paying someone to give us something. We might be including some freight overhead into that, and that’s what we put on our balance sheet.

There are different ways that we could do that. We could use historical costs and average costs, which is just taking the average of all the inventory that we have over all the purchases for the year and kind of coming up with a single thing that we’re looking at. Then you have the identification of your inventory.

So we’re looking at the cost flow assumption, and everyone doesn’t really think about this one very much because they don’t want to. It makes it a little bit more complicated. So the one thing that we normally see is the first in, first out method, which basically means all the costs of the inventory that you first purchase in the year or that you had on hand when the year started is the items that are going out the door first.

That’s how you create your cost of goods sold, is using the value of those types of inventory first. Then there’s the last in, first out method, which is something that we’re going to be talking about today, which is the assumption that the most recently purchased items are the ones that we are going to get rid of first. So the benefit of that might actually be that you get to get rid of items that cost more because inflation usually happens over the year, and then your cost of goods sold goes up.

That’s something that we really would like to see prevalently in a lot of our clients. It’s something that nobody really thinks about, but it could help them in a very large way.

[5:21] Mike Payne: Yeah, so if I put that in layman terms for those of us that don’t live this every day like you guys do. So in an inflationary period, like we’ve been for a few years, I think everybody in our industry is going to definitely recognize that really ever since COVID, we’ve had incredible raw material price increases. And then even more recently now where we’re still in an inflationary period, you’ve got tariffs and so forth.

So what I bought today generally is going to cost me quite a bit more than what I bought a year ago, two years ago, four years ago, whatever. So where you described there, like the last in, first out, so LIFO. When people have heard us talk about LIFO, FIFO, and weighted average is the three things you just said.

So the first one was weighted average, then FIFO, then LIFO. So when I look at that LIFO, if I capture… Now, Cindy, some of this is going to come back to that broader strategy.

So if by using today’s prices versus last year’s prices for that inventory, my cost of goods sold goes down, which then ultimately means my net profit’s gone down and my overall tax liability has gone down. Is that fair?

[6:38] Speaker 6: Absolutely.

[6:39] Mike Payne: And then so from there, and I would venture to say… I mean, what do you see as most common, the weighted average or first in, first out?

[6:48] Erica Parra: First in, first out usually is how… I mean, most ERP systems are already set up for that sort of analysis. So it makes it a little bit easier for them to deal with.

When it comes to LIFO, usually it’s not an ERP system change. Usually we do like an outside calculation to calculate it. And then it’s like a top side adjustment that you put where you’re just removing costs from COGS or putting costs to COGS and then putting a reserve on your balance sheet.

So it’s something that’s easily done. You don’t have to worry about your ERP system. You can kind of keep it the same as it was previously.

[7:23] Mike Payne: And before we dig into kind of the details behind what we’re going to talk about here, which is really the LIFO methodology, to set a baseline for the listeners, I mean, I think it’s very common for my listeners to have kind of three buckets of inventory, if you will, right? We’re going to have our raw materials. Most of my listeners are buying raw materials, making something and sending it, and some of that may go to inventory, right?

Or maybe a lot of it goes to inventory, but some portion of that maybe ships immediately and the other goes to inventory. So for me, like I track three buckets of inventory as it relates to that, you know, outside of my tooling and all that type of stuff, I look at my raw material, my WIP, and my finished goods, right? And then I do have probably one of the areas that maybe affects people the most really is our tooling because most of us have lots of money tied up in cutting tools, and some of that we’ve had for a while, and some of that we’ve bought very recently, and I think there’s an element there too.

So FIFO you see the most, weighted average is, where would you recommend weighted average? Just let’s cover weighted average and FIFO real quick. Where do those two fit good?

[8:44] Erica Parra: You know, I would say if it’s one of those things for the weighted average, if it’s more so kind of inventory that doesn’t change very often, I would say in terms of price, if you’re dealing with weighted average, that would be something that I would personally say is okay. A lot of times what I see for FIFO is just like a default. We’ll call that the default.

[9:06] Mike Payne: Yeah, that’s how our systems are set up to do it.

[9:09] Erica Parra: That’s how our systems are set up. And so a lot of the times people are like, well, I don’t want to have to keep track of this, or they’re like, oh, maybe it’d be better if we went to an average of all the inventory, which is just rolling. Every time we get a purchase invoice, we take that amount, add it to the cost of the inventory, and then divide all that by the amounts of units that we have to figure out how many we have.

And then we don’t have to even worry about FIFO, LIFO, is that name of the thing. We can just go from there. So maybe an administrative ease type activity.

[9:42] Cindy: And I guess what FIFO, I mean, in reality at year-end, companies do their inventory count, their physical inventory count. They know exactly how many units they see in front of them. They know that value, and that’s really the value that’s hanging up at year-end on their balance sheet.

And so it’s much easier mechanically to tick and tie to a FIFO method because you can actually tie it to your inventory count.

[10:06] Mike Payne: Yeah, you can see it, right? You can touch it, feel it.

[10:08] Erica Parra: Yeah, exactly. And if you have a lot of inventory that’s changing prices pretty drastically, I almost would want to know, well, how much were we getting this for at the beginning of the year? How much are we getting it for at the end of the year?

So maybe then if you have volatile inventory prices, maybe you don’t want to have a weighted average type method because you’re worried, I want to know, do I need to change vendors? Is this something where it’s just becoming astronomical and it might not be too visible if you’re just using a weighted average assumption?

[10:41] Mike Payne: Manufacturers, what is your biggest headache? Is it measuring improving profitability, gaining efficiencies with AI and automation, maybe tightening up your cybersecurity, maybe getting your business ready to sell? At CLA, their goal is to know you and help you with challenges like these and more.

Every day, CLA helps manufacturers tap into millions in revenue and cost savings, like one manufacturer that boosted capacity and revenues by 15% to 20%. Visit claconnect.com to hear real success stories and learn how you can grow your top and bottom line. I know I can speak for myself, but I think I can speak for a lot of our listeners.

What we’ve really seen post-COVID, it is not uncommon for us to, let’s say we haven’t made something in a couple of years and someone orders it. It is not out of the question that the material cost today is more than we used to sell the finished product for. The volatility has been there.

There is massive volatility, especially in the raw materials market and has been, I would say, ever since post-COVID with all the things that affected supply chains and so forth. It has definitely stabilized, I would say, over the last 24 months, but it is substantially higher. I think that’s something we’ve all experienced.

Again, in my listener base, a lot of that was bought then and sold then, so that’s not necessarily still sitting in inventory. But it certainly is out there. I mean, I’ve got inventory on the shelf that is drastically different now than it was before.

Okay, so let’s dig into LIFO again, last in, first out. Let’s talk about what are some of the signs that you would look at? Cindy, this might be a good question for you.

When you’re taking that broader federal tax strategy approach, what are you looking for to indicate to you that, hey, we might want to look at LIFO on this? We might want to do an analysis if this even makes sense.

[12:53] Cindy: Yeah, LIFO in general is a tax-favorable strategy. Anytime we deal with a client and we’re going in and they have inventory period, some of the things we look at are from a compliance perspective. There are other provisions where it’s not good news.

You actually have to capitalize more costs and disallow more period costs. But LIFO in general allows a taxpayer to deduct the most recent higher costs. And in times of rising costs, instead of valuing your ending inventory at the higher costs that you’re paying recently, you get to value your ending inventory at these lower costs that you’ve locked in the year you elected LIFO, essentially.

And so if there’s any client with inventory, we’re going to look at everything. We’re going to look at the compliance-related things. We’re going to look at the tax-favorable-related provisions such as LIFO.

And so anytime we see inventory, we’re going to assess and do really a free assessment on the back end on whether we would recommend that they be on LIFO in general. And then further, as we’ll get into it, whether we recommend that they urgently adopt LIFO in 2025.

[14:11] Mike Payne: Right. I can imagine, again, I’m trying to put myself in the position of listeners. I think when I just in the companies I see and the listeners I talk to and their companies and their financials, I think lots of times we think, again, we just kind of discount inventory in general.

But when you go back to those three buckets of raw material, WIP, and finished goods, and not to mention then like all our tooling and all those types of things. I mean, I think everybody would be surprised how big of a topic this really is.

[14:45] Cindy: Yeah. I mean, inventory is likely the biggest asset most companies have on their balance sheet, right? And even if you move the needle a tiny bit for such a massive asset, you’re going to have a significant impact.

[14:59] Mike Payne: Yeah. So, okay. So let’s assume and I’ll go ahead and frame up.

I mean, you guys, we’ve been preparing for this for a few weeks and we kind of built a case study, right? And you guys sent me kind of the request you would need for an analysis and then you took that and you flipped that into the analysis of what the impact would be. Let’s talk a little bit about what the process would look like for somebody to say, you know what, I should pay attention to this.

I mean, let’s go back to your example and I’m going to have to like kind of flip between screens here. So if I’m not looking at the screen, I apologize. I am paying attention, but let’s talk about what that process looks like in determining if this matters to you.

[15:51] Erica Parra: Well, I think I would probably say that there are two things if I was a client that I want to know. One is, does it matter right now? Like what kind of instant benefit am I going to get from this?

And then the second thing that I’d be thinking about is what are the long-term consequences of doing this? Because obviously my inventory is not going away. This is going to be a consistent issue that we’re looking at all the time.

And those are actually the two factors that we analyze when we’re looking at it. We look at what is the 2025 effect going to be if you want to change from say FIFO to LIFO in 2025. And one of the reasons for that is because of that large tariff swing and all the inflation that we’re seeing, 2025 is going to be a great year to adopt LIFO because you might be going from normal inflation to like somewhere between two and five times the normal inflation just for this year.

And you don’t want to miss that big pickup. The second thing that we’re going to be looking at is historically, have I been in an industry or has my inventory specifically been of an inflationary product? Because if 2025 is giving you 15% inflation, great.

But what if next year you get negative numbers or if it just is deflating continuously after that and this was just an anomaly due to tariffs? We don’t want to see that. So I’ll throw it over to Cindy to kind of go through the mocked up file just to kind of explain the analysis of what we do just because I think it’s a really great one.

And she’s the archetype of putting together a lot of our scoping stuff. So. Right.

[17:27] Cindy: Yeah. I guess from an experience perspective, right. If we have a client and we know we have some of their inventory files, what we’ll do is we’ll get their perpetual inventory listing detail.

That’s the detail of all the thousands of units of inventory and the description of the types of inventory that they have on hand at year end. And we’ll pretty much code each inventory item to a PPI index code. Right.

Which really that code stands for the nature of that inventory and the published inflation rates that are published by the Bureau of Labor Statistics. Once we figure out what their inflation based on the nature of their inventory is, we’ll compute what we think that incremental benefit would be had they adopted LIFO in 2025. And so with inventory, you can go down rabbit holes of information and information, but really the information that our clients need to determine whether they should pull that trigger or not in 2025 is what is the benefit?

What is the extra debit to cost of goods sold expense credit to LIFO reserve liability that we’re going to be able to generate for them if they adopt LIFO? And then secondly, if they had stayed on LIFO for 20 years, what would that accumulated deferral of taxable income look like? Because the longer you stay on LIFO, the more your benefits accumulate.

And I, I equated to kind of jumping into the stock market investing where in a year where the market dips, savvy investors will buy the dip and they will buy low and they will hold. Right. And as, as the market increases over time, the gains increase over time.

And I think that’s very similar to how I think about LIFO where in a year where you have peak unprecedented inflation rates, your benefit will peak. And you want to get in at that time and hold that lower inventory base costs because as inventory prices rise over the years, 10 years from now, when you go in and you value your ending inventory, you get to use prices of 2025 to value those units of inventory. And so the longer you stay on LIFO and the higher prices rise over time, the more you’re deferring taxable income into the future until one day, maybe you get off, whether you have a transaction of some sort or you close shop or you sell your business.

Those are the periods where you’re going to have a lower inventory tax basis and pretty much recapture all of that benefit that you’ve been deferring.

[20:18] Mike Payne: You just said something there. I always try to let the listeners know when we’re talking tax strategies is, you know, you’re, you’re not avoiding tax with any of these strategies. You’re deferring tax with these strategies, right?

It’s still always due in the end. You’re just putting strategies in place that, you know, minimize and defer your taxes. So I mean, everybody keep that in mind.

Like there’s no, this isn’t a magic wand and not pay taxes. It’s just deferring them to the most tax advantageous period that you can find.

[20:53] Erica Parra: And I think Cindy brought up a good point, which maybe is something that we should tackle just in general, that there are multiple different types of calculations that you can do to calculate your LIFO. Cindy had mentioned a PPI or a producer price index, external index that’s done with the Bureau of Labor and Statistics. So when we are doing our analysis, not only are we looking at our internal inflation index, which is essentially based on your internal pricing from like the beginning of the year to the end of the year to determine like how much inflation you as a company are seeing.

We are also analyzing other types of calculations. One of which is called the dollar value LIFO method, which allows us to use external indexes, which is based off of and collected by the, the BLS over the entire year across the entire nation. So even if you as a company are not seeing any sort of inflation in your costs, you still get the benefits from using the external indexes if you want.

[21:57] Mike Payne: Sure. So for the listeners out there, I mean, as, as you know, I’m involved intimately or closely with, with several companies. I’ve gone through this myself a few times.

I have not done it in my current operations, although it’s probably something needs to be looked at. The, the savings that I’ve seen in a, in a LIFO conversion are real numbers. I mean, it’s, it’s not just a, Oh, that’s, that was nice.

I saved $2,000 on my taxes this year. I mean, it was, it’s significant. Let’s, let’s dig into that a little bit on, on again, kind of our mock scenario.

So, so you guys send an information request again, this was all mock and we just kind of made up stuff. It’s not indicative of my numbers or anything like that, but, but, but they’re generalized. So you send an information request, which was relatively simple, really.

I mean, it wasn’t like, I mean, when I looked through it, it might take a couple hours of mine or my accounting staff’s time or something like that, but it wasn’t burdensome, right? You get that information back and, and what do you now go through as a process to, to identify that?

[23:11] Erica Parra: So I think that’s kind of where Cindy had led off with. We get the perpetual inventory reports, right? We identify the types of inventory you have.

And as she was saying, if we’re using a, an external index, which is the, you know, could be the producer price index on the BLS website, we then apply the most detailed code that is related to that product. And each of those codes has an inflation that’s related to it. So you just assign it to that code.

We go through the process of gathering that into different pools, depending on what types of product you have. So the nice thing about the pools is the same thing as like, when you’re doing a, like a, some sort of stock market index fund or the S&P 500 that has like all of them, you’re, you’re getting to adjust or net together the inflation on certain items against the deflation in certain items. So you have a better, a better answer, or at least a more concrete answer across the board over years.

And then we end up doing a calculation to determine what the overall effect is from a year over year perspective to, to see how much of that inventory based on the FIFO method or based on costs we can then make a reserve out of, and then move to our, into our cost of goods sold.

[24:33] Mike Payne: Hey, Paul, next year’s 2026. Guess what happens?

[24:37] Speaker 4: That means it’s an even year, which means IMTS is happening.

[24:41] Mike Payne: I’m so excited. And I assume ProShop will be there exhibiting again as always.

[24:45] Speaker 4: Yeah, it’ll be our fifth time, I think. Wow. Would have been six if COVID hadn’t happened.

But yeah, even after being there that many years, there’s a lot to understand about that show. It is a massive event, massive execution to, to exhibit. On a big investment, right?

It’s got your time, your money. It is a big investment. Yeah.

It’s one of our biggest marketing investments for sure.

[25:05] Mike Payne: Well, I’m looking forward to in January, you and Nick and I are going to be at the IMTS Exhibitor Workshop where exhibitors can come and learn like how to get their most out of IMTS.

[25:15] Speaker 4: Yeah, the workshop is fantastic. There’s a bunch of different benefits from it. One, you can connect with all the vendors for your furniture, for your logistics, getting all your stuff in and out of the show, electrical, everything.

But this year they’re also doing an executive session or series. So really focused on getting the most out of the conference. How are you going to go in with a marketing plan, really execute it and get your maximum ROI if you’re, if you’re exhibiting at the show?

[25:42] Mike Payne: Well, it’s a major commitment to go to the show. I mean, I, you know, I go as a, as an attendee, but seeing all the work that goes into it, if I was exhibiting, I would definitely want to maximize my experience there and get the most out of it. And the workshop I know is going to be interactive where they really work through things.

Like you said, you can place the orders, all that type of stuff. And you know, that’s going to bring a bunch of value to exhibitors.

[26:03] Speaker 4: Yeah, absolutely. The difference between coming with a plan and executing on that, it’s a big difference as opposed to just showing up, throwing up your booth and hoping for the best. So yeah, it’s, it’s definitely advisable.

So exhibitors that want to make more of it, whether they’re first time exhibitor, or even if they’ve done it many times, but they really want to maximize their ROI this time, you should definitely show up at this thing.

[26:23] Mike Payne: And what are the dates again? Yeah. So it’s January 27th to 29th at the McCormick place.

So you kind of get familiar with where your booth is going to be and all that type of stuff. To find out more, people should just go to amtonline.org slash events and get signed up and we’ll see you there in January. Sounds good, Mike.

So using that as the baseline for, for again, this, this kind of mock scenario, let’s, let’s, let’s kind of lay out the details then. Okay. So you got back this information from me.

What was the analysis? Let’s kind of talk through what the results of the analysis were and the savings that, that this mock company could, could realize.

[27:04] Cindy: Yeah, absolutely. Oh, okay. Yeah.

I was just going to talk about the fact pattern. Really. We’ve had mock client with about a little bit over 50 million in inventory.

Right. And we said that they manufactured parts, engine parts, motor parts, things like that.

[27:23] Speaker 6: Right.

[27:24] Cindy: And we generated our assessment, noticed that with this client, 50 million ending inventory, if they adopted LIFO in 2025, that they would be able to run through an extra cost of goods sold expense of nearly $6 million and applying their tax rates, federal and state, that’s almost $2 million of cash tax savings.

[27:52] Speaker 6: Right.

[27:52] Cindy: Compare that to an average year where it’s not a year of peak inflation. It’s due to all these tariffs that we’re encountering. They would have only saved about $850,000 pre-tax deductions, which is really only close to $300,000 of cash tax savings.

So this is a very strike when the iron’s hot situation. And further, it, it’s also a use it or lose it situation because unlike all the other accounting method changes that we do, we don’t have a mechanism for LIFO to go back and retrospectively apply LIFO. So LIFO in the year of adoption is applied in inventory that you acquire in that year and then going forward.

So let’s say we don’t catch this huge wave of peak inflations in 2025 and we wait for 2026. We may go back down to those average savings that I talked about.

[28:50] Mike Payne: And, and, and you talked about some big numbers there. And of course it’s all scalable from there. Right.

I mean, it’s, it’s, it’s up and down, up and down that chain, but, but from a percentage standpoint, then that’s, that’s what, I mean, doing the math off top of my head, it’s 7% or something like that. Is that about right? You probably have it in this report.

[29:11] Cindy: You’re talking about the, the inflation percentage or.

[29:14] Mike Payne: The difference in the tax savings.

[29:16] Cindy: Oh, I think it’s like more than six times. Yeah.

[29:19] Mike Payne: Yeah. Yeah. Okay.

Yeah. Yeah. Yeah.

Yeah. Yeah. Yeah.

I said 7%. I mean, I was thinking seven times, but yeah. So six times.

Yeah. I mean, that’s, that, that’s significant. I mean, that’s.

[29:29] Cindy: It is, but it makes sense too, because you know, the effective tariff rates right now in 2025 are about, I think 18% compared to 2024, it was less than 3%. I think so. That does make sense why you’re seeing the impact.

[29:46] Mike Payne: Sure. Now let’s, let’s tackle something I thought we’d maybe tackle a little bit later, but I think we’re kind of right there at it. There, there’s lots of accounting.

I mean, Cindy, again, you know, per your specialty of, of, you know, just kind of that whole federal tax market, there’s a lot of accounting method changes you can make to experience savings. And a lot of them have different, like when you make that change, how long do you have to stay there? Right?

So there, there is the reality that there could be a, a deflationary position in the market in the future and which would justify maybe going to a different inventory accounting method. Is that a fair statement? So, but what is the period on this?

You can do LIFO and then how long do you have to stay there?

[30:28] Erica Parra: Generally five years.

[30:30] Mike Payne: Five years. Okay. I knew there had to be some time period.

I didn’t know what it was.

[30:35] Erica Parra: But I will say like, you know, in terms of timing is everything of when you want to do these things. So like we have companies that have 20 million plus of a reserve and if they start to see deflation and they’re like, oh, well when maybe we should just like get off of this, like, well, do you want to just, you could always take the position that you’re just going to let the LIFO slowly kind of eat away at your prior layers. And you’re just going to slowly recover that income over time as the deflation occurs.

Or you can choose to do it, you know, a method change, which might allow you to take that all in the current year, you know, or to take it in over four years, excuse me, especially if you have to take that all back into income. So you would take it over four years if you do a method change. But in that sort of instance, like you make that choice, like, is it better to stay on it for a while, let it get to a really small number, then change your method, or you could potentially just change your method depending on your income position.

[31:35] Mike Payne: Okay. Yeah, like I said, I just, I know with a lot of the different ways of doing accounting, you can’t just change year to year based on what’s best for you. I mean, there is a, there’s usually some sort of horizon you have to hit to do that.

And again, that’s, that goes back, you know, for the listeners, I mean, that goes back to this is a, this isn’t a cheat code. It’s a deferral method, right? So you make these decisions, you are locked into decisions like this for some period of time, generally.

But yeah, so if I’m, again, I’m a typical manufacturer in the United States, where do I start with this process? I mean, like how, I mean, maybe I’ve got a CPA down the street in the strip mall, maybe I’ve got someone like CLA, maybe I do it myself. I mean, where are those first steps, you know, of like, maybe working with you guys to really dig into this?

[32:32] Cindy: Go ahead, Eric.

[32:34] Erica Parra: So in terms of wanting to get started, I first have to say that LIFO can be very complicated. It’s not something that I would suggest you tackle yourself. Right.

The right, just reading the regulations are the most confusing thing that you ever have to go through in general. So it’s not something that I would say, hey, do some back of the napkin calculations for yourself to see where you’re at. So I really do suggest reaching out to someone who’s qualified in the area to make sure, you know, whether it’s CLA or, or your own advisors to see if they have a way for you to test or assess the benefits that could be had.

Because otherwise it’s really, you’re kind of shooting in the dark and we don’t really want that.

[33:21] Mike Payne: Yeah. And, and I’ll, I’ll, let me tack on to that. So, so anytime I, we talk to tax strategies on by the numbers, I generally do hear from listeners.

They’re like, man, do you have a recommendation on a good accountant? Because, you know, I’ve been using this person, my parents knew or, you know, like whatever, right. Like just the random person in town and, and, and I mean, taxes largely compliance, right.

I mean, I guess completely compliance, you know, but, but some CPAs and we all know them and they’re great. You know, they, they fill out the form, right. It’s purely like this number goes in this box and, and then, you know, and then there’s folks like you guys that specialize down in the different industries and so forth.

You know, CLA has a, an amazing manufacturing presence. And as I told my listeners, you’ve got to go follow their, like, especially all their manufacturing content. It’s great.

On all the, all the platforms, but I mean, Cindy, this is, this, this falls right back into your lap, right. This is, this is where like, so often I hear from people, do you have any recommendations on someone that though will give me ideas, right. So, and this is all this is, right.

It’s an idea. It’s a discussion of, does this make sense for me? And this is one of 20 discussions that should probably be had, which is, which all falls in your lap, right.

I mean, those, those overarching strategies of, of, of how do I bring, how do I stay compliant? I mean, everybody needs to stay compliant. Let’s preface that.

But how do I use compliance to my advantage rather than my detriment in a lot of cases, right. I had a great year. How do I, how do I handle that?

[35:01] Cindy: Yeah.

[35:01] Mike Payne: And Cindy, that falls right in your lap, correct?

[35:04] Cindy: Yeah. I mean, just the other day we were going in and we had a client that was subject, they crossed that small business taxpayer threshold, which is 31 million this year. And when that happens, you enter into just a lot of compliance.

Yeah.

[35:20] Mike Payne: It’s a whole new world, isn’t it?

[35:22] Cindy: A whole new world. It’s very expensive to implement and adopt and keep them compliant. And so we went in and we said, Hey, got inventory.

You need to be computing. Well, you need to be on an overall accrual method. You need to also apply 263 cap, a uniform capitalization, which is just capitalizing more costs into inventory.

Once you’re not a small business taxpayer. And then we said, Hey, wait a minute. If they adopt LIFO, they will save enough money to pay for all that compliance costs and more.

And so it’s a package deal. You know, it’s a perfect storm of, Hey, let’s stay compliant. But why don’t we just find other lovers that rely on inventory to help you pay for all this compliance as well?

[36:07] Mike Payne: Yeah. No, I mean, I can tell you in my experience, I mean, you know, when you, you start talking about tax strategies and compliance and, I mean, obviously you engage in a lot of these strategies. Yeah.

I mean, preparation of your, your tax return goes up significantly in some cases. Right. But I, but I’ve never seen a case that I wasn’t.

I mean, I mean, I would even say arguably personally, I haven’t seen a case where that fee of doing it wasn’t 10 to one, right. Over the savings I was hitting. And I don’t know that’s a real number or not, but I’m literally shooting from the hip with that.

But, but I’ve never, the benefits I’ve had from, from, you know, utilizing good tax strategy has always by far outweighed the cost of utilizing that strategy.

[36:55] Cindy: Yeah, absolutely. And that 10 to one ratio, we typically don’t like to approach clients until we know that we can get them that kind of return on investment to begin with, right. Otherwise the juice might not be worth the squeeze, or maybe it’s not the year to do something.

But for LIFO specifically, I think just piggybacking off of what Erica was saying on not doing it yourself further, you know, some of your listeners may find that their service providers shy away from LIFO. Oftentimes it is cumbersome complex. If they don’t have a software based solution to help provide these services, it can really be taxing on a service provider themselves.

So, you know, maybe find a service provider with a software solution that we do have one, and it does allow us to be pretty agile in performing these complementary assessments as well. And so we can go out there and assess, assess, assess without making it very taxing exercise on our team as well.

[37:59] Mike Payne: Well, and that’s such a great point because that’s one of the things I appreciate about the mock exercise we went through was, you know, it was very non-invasive from my perspective, right. And you’re able to take that data and say, okay, here’s the expected results. Here’s the expected fees, all that type of thing.

And you can see, you can make a decision real quick that, okay, I’m going to spend X thousands of dollars, but I’m going to save X hundreds of thousands of dollars this year. That’s pretty easy decision to make it at some point, right?

[38:34] Cindy: Yeah, absolutely. I’ve had many clients say, well, you made it so easy for me. And I think that’s our goal, right?

To shield them from all of the complexities and all of the headaches behind the scenes and really just provide a very pleasant and easy experience. Absolutely.

[38:50] Mike Payne: So, Cindy, I want to ask you one more question because you have such a broad, you know, federal tax strategy standpoint, and I do want to dig in deeper with you over the next year. Like, let’s touch on your favorite two to five, you know, whatever the number is of, like, let’s preview the five things we need to talk about next year or the two things or whatever it is that probably people are missing the boat on. We’ll use inventory as number one.

Give me a couple more.

[39:16] Cindy: Okay. LIFO for sure in 2025 is number one, right? It’s that use it or lose it.

So even if I personally may or may not like LIFO, I’m going to say you have to do it. It’s the right thing to do. It’s the right thing to look at.

Number two, there are a lot of rule changes starting in 2025 around the section 163J business interest expense limitation. It’s already in 2025 for calendar year taxpayers. That’s the year where we have a return to EBITDA.

And what that means is that basis of how much interest expense you can deduct, it’s computed based on earnings before interest, taxes, depreciation, and amortization. And so now we open up a whole slew of planning ideas where we say, if I can just figure out a way to not tamper with my total taxable income, but convert expenses into depreciation expense, I can, without even increasing taxable income, increase the amount of interest expense I can deduct. And that’s really applicable for larger taxpayers that cross that small business taxpayer threshold, or even take it a step further.

How can I generate amortization? I’m used to deducting my prepaid expenses. Maybe I want to capitalize them and amortize them.

And so I trade off maybe a slightly slower recovery of some of these prepaids, but I’m generating amortization so that I can unlock some business interest expense that I would have really not tapped into for a very, very long time.

[40:56] Mike Payne: Sure, sure. Yeah. And the capital intensity of the manufacturing industry, I can imagine that you could get into some pretty big numbers there real quick.

[41:05] Cindy: Oh, yeah. Top five, you said?

[41:07] Mike Payne: Well, or two.

[41:09] Cindy: Those, I think, are my two favorites right now.

[41:11] Mike Payne: If that’s the two, that’s fine. I just know, I mean, again, just from my personal experience and kind of spending 25 years of my career in and around this space, I mean, again, you need people like you in your circle of advisors that are thinking beyond just fill the box and get the return done, right? Like, you know, I’ve been fortunate in my career to be surrounded by advisors such as yourselves.

I mean, it makes a real difference. It’s, I mean, it’s incredibly impactful in how things work out. I mean, it’s, and certainly, again, we talk a lot about transition periods and ownership and things like that.

I mean, you know, if you’re in those periods, it’s, I’d say it’s even more important that you really dig in and look at these opportunities as maybe you’re preparing to sell or, you know, anything like that. It’s even if you’re in the market to buy. I mean, these are also important discussions because there’s a lot of things you can do in that first year that you’ve now acquired all this, these new assets and expenses.

I mean, in my own personal experience, you know, can net cash flow you an acquisition for not a lot of money. So having people like you in your, on your team, in your corner can, you know, really be impactful on these decisions you’re making as you’re just continuing operations, you’re maybe transitioning operations, anything like that. And so with that said, if people are listening to this and going, man, I’m missing out, how do we get a hold of Cindy and Erica?

[42:53] Erica Parra: I think you can probably just email one of us.

[42:56] Mike Payne: Your guys’ emails are pretty simple, right?

[42:59] Erica Parra: It’s pretty long.

[43:00] Mike Payne: Yeah. Well, they’re long, but they’re pretty straightforward, right? Isn’t it just a, it’s just your name.

[43:06] Erica Parra: Yeah. First name dot last name at CLA connect. So Erica dot para at CLA connect.com.

[43:14] Mike Payne: And Cindy, same for you.

[43:15] Cindy: Yeah. Cindy dot Hauser at CLA connect.com.

[43:20] Mike Payne: And, and listeners, if, if you can’t find them via email or LinkedIn or something like that, reach out to me, I’ll make a direct connection as well. As I’ve said, every time I talk to anybody on the CLA team, they’re all just absolutely outstanding. Before we hit record, I was, I was telling Cindy, my daughter is in accounting.

She’s with another national firm. And like, I just want her to go work for you guys. Cause everybody I’ve met from your firm is great.

We just got to find you a firm in Oklahoma. So that my future grandkids are close to me and not somewhere else in the country.

[43:55] Cindy: I’m happy to talk to her. We’re very happy over here. There’s a lot of energy at our firm.

We just, we get energized serving clients.

[44:03] Mike Payne: Well, you guys kill it. I mean, I’ve, I don’t know. I’ve, I’ve, I’ve met at least a couple of dozen of your team members now, and they’re in the single one of them that I haven’t been thoroughly impressed with.

So we’ll always love working with you guys. I love it when you can, you can contribute to the podcast. I think our listeners learn a lot from it.

And, and, you know, with that said, thank you both for today. And yeah, listeners, if you have any questions on this, reach out to me, I can connect you with them directly. I’m happy to give you my opinions on stuff, but, but really you need to talk to Cindy and Erica and, and just drill in and let them do that assessment.

And, and you’ll see if it’s worth your time and effort to, to chase down this LIFO or, or maybe some of the other strategies and so forth. Ladies, thank you very much. I appreciate you joining me.

[44:51] Erica Parra: Thanks for having us.

[44:53] Mike Payne: With that listeners, we will talk to you next time.

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