When U.S. Senate leaders proposed a $100 gas-tax rebate for every American family in May, they intended to do so by repealing the last-in, first-out (LIFO) inventory-accounting method for oil companies, which would result in a bigger tax bill for those companies and more tax revenue for the government.
Although the plan was scrapped quickly, Congress hasn’t stopped thinking about the possibility of LIFO repeal for all companies that use the method. On June 13, in what may have been the first of a number of Senate Finance Committee hearings on corporate tax reform, George Plesko, an accounting professor at the University of Connecticut, testified on LIFO—and caused a stir among the many companies that use it.
The main benefit for companies using LIFO is the tax break it affords them during times of rising prices, Plesko contended. And that benefit is hefty, figures he presented showed: For 2004, the last year for which figures are available, the LIFO reserve—the difference between the cost of sales under LIFO and under an alternative inventory-accounting method—was $60 billion. “This $60 billion represents the cumulative amount of additional tax deductions that firms have claimed relative to what their deductions had been if they had not used LIFO,” the professor testified.
The last-in, first-out accounting method values the cost of goods sold as the cost of the most recent inventory purchases. In an inflationary environment, the use of LIFO results in increasing costs and lower reported profits than it would using the first-in, first-out method (FIFO). With prices going up, a company using FIFO would report higher profits and pay more in taxes than it would if it used LIFO.
Further, he said, only a relatively small number of companies use the method—just 8.7 percent of 5,000 publicly traded companies that report a LIFO reserve.
Plesko, however, isn’t proposing that the method should be jettisoned. “There is no attempt to repeal [LIFO], but a desire to think about broad-based tax reform going forward,” Plesko told CFO.com in an interview following the testimony. “If you want to talk about broadening the base to lower the [tax] rates, then you have to think about LIFO,” said Plesko, explaining why Congress is looking into LIFO. He added that the implications of a repeal cannot be considered until all the features of tax reform have been presented.
Although the Senate’s immediate plans for a repeal of LIFO were abandoned, the emergence of the possibility triggered fear among companies and industries that use the accounting method. Supporters of LIFO claim a repeal would be a significant issue for companies that use it and could cause some particularly small firms to go out of business.
As often happens in Washington, an ad hoc collection of over 50 industry associations, including the American Gas Association and the Post Card & Souvenir Distributors Association, formed The LIFO Coalition to lobby Congress on the importance of LIFO to businesses.