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Washington Tax Alert Sept. 4, 2007 (Definition of item for LIFO purposes)

Washington Tax Alert from Don Barnes, dbarnes@washingtontaxlaw.com

September 4, 2007

The Service recently issued a technical advice memorandum ( see TAM 200735020, published today) in which the National Office held that generally each stock keeping unit (SKU) in a taxpayer's inventory should be treated as a separate item for dollar value LIFO purposes. The TAM indicates that a taxpayer may treat two or more SKUs as a single item for dollar value LIFO purposes only if the SKUs are essentially the same product, and the differences between the SKUs do not affect the per unit cost of the item. The National Office followed similar principles in determining what constitutes a "product group" for the portion of the taxpayer's inventory accounted for under the specific-goods LIFO method.

As an example, the TAM states that a dollar value LIFO taxpayer may not treat two all-cotton shirts with different SKU numbers as a single item for LIFO purposes if one shirt costs $20 and the other shirt costs $25. As authority for this surprising conclusion, the National Office cited the Tax Court's decision in Amity Leather Products Co. v. Commissioner , 82 T.C. 726 (1984). The TAM's reliance on Amity appears questionable. The Court in Amity held that billfolds manufactured by a taxpayer in Puerto Rico and identical billfolds manufactured in the United States could be treated by the taxpayer as different items because the cost of the Puerto Rico billfolds were "substantially less." There is a considerable gap between the holding in Amity Leather and the position espoused in the TAM.

In light of this new TAM, it may be difficult for taxpayers to persuade examining agents that similar inventory items with different SKUs should be treated as a single item for dollar value LIFO purposes. However, I believe the Service is overstating its position in the TAM with regard to the definition of item for LIFO purposes. As a result, the issue of what constitutes an item for LIFO purposes will likely be the subject of future litigation.