SECTION 4. RETAIL SAFE HARBOR

METHOD

.01 The retail safe harbor method of estimating inventory shrinkage, as described in sections 4.02 through 4.07 of this revenue procedure, may be used in computing ending store inventory by taxpayers that are primarily engaged in retail trade (the resale of personal property to the general public), where physical inventories are normally taken at each location at least annually.

.02 The retail safe harbor method uses a historical ratio of shrinkage to sales to estimate the inventory shrinkage that occurred between the date of the last physical inventory and the end of the taxable year. This historical ratio is based on the actual shrinkage established by all physical inventories taken during the most recent three taxable years and the sales for related periods. The most recent three taxable years include the taxable year for which the shrinkage estimate is to be made and the two prior taxable years. The historical ratio, or estimated shrinkage determined using the historical ratio, cannot be adjusted by judgmental or other factors (for example, floors or caps).

.03 For stores with departments, a taxpayer must determine the historical ratio separately for each store or each department in a store. This determination must be done in the same manner for all stores with departments that are in the same trade or business of the taxpayer. For stores without departments, a taxpayer must determine the historical ratio separately for each store. If a taxpayer has a new store (or a new department in a store) for which the taxpayer has not verified shrinkage by a physical inventory in each of the most recent three taxable years, the historical ratio is the average of the historical ratios of the taxpayer’s other stores (or other departments in the store where the taxpayer computes the historical ratio on a department basis) during the most recent three taxable years.

.04 The estimated inventory shrinkage permitted by the retail safe harbor method is determined by multiplying the histori

cal ratio for each store or each department in a store by its sales for the period between the date of the last physical inventory and the end of the taxable year.

.05 Taxpayers using the last-in first-out (LIFO) inventory method must allocate shrinkage among their various LIFO inventory pools in a reasonable and consistent manner.

.06 Estimated shrinkage determined in accordance with consistent application of the retail safe harbor method may not be recalculated, through a look-back adjustment or otherwise, to reflect the results of physical inventories taken after year-end.

.07 A taxpayer that changes to the retail safe harbor method must use the retail safe harbor method consistently to determine the ending inventory for all stores that comprise a separate trade or business of the taxpayer. Use of the retail safe harbor method for estimating inventory shrinkage results in the clear reflection of income, provided this method is used consistently and the taxpayer’s inventory methods otherwise satisfy the clear reflection of income standard.