While tax reform has been a presidential agenda item for decades, the current administration appears to be close to releasing a blueprint for broad reform. There are, however, more unknowns than knowns at this point given the closed-door nature of discussions in Washington. To date, it is not clear if the proposal to cut the corporate tax rate would provide a permanent fix or whether Congress will pass a temporary solution to allow reconciliation. If revenue neutrality, or “pay fors,” are required, the impact to incentives such as LIFO could be dramatic.
LIFO, or last-in-first-out accounting, is a GAAP-approved inventory accounting method that was adopted in 1939. It is not, nor has it ever been, considered a tax expenditure. Instead, LIFO is a method to track products and costs and appropriately align the cost of goods sold with the cost of replacement inventory. The need for LIFO has not changed since its inception, which is why it has existed for nearly 80 years and is used by hundreds of thousands of US companies across many industries.
LIFO was designed to respond to price fluctuations, mitigate the negative impact of inflation and trigger income during times of deflation. During the recession, for example, many small businesses used LIFO reserves to fund payroll. This prevented them from being forced to lay off workers or close their doors altogether. Repealing LIFO would reduce GDP, federal revenue and cost jobs, and it would disproportionately harm small businesses, which operate on tighter margins and use LIFO to maintain necessary inventory levels. Repeal would mean a retroactive recapture of deductions that many businesses have taken for decades. While recapture would theoretically happen over eight years, if the tax rate cut is ultimately temporary, small businesses would end up losing the benefits of LIFO and paying higher corporate tax rates.
Given the multitude of ideas being floated in Washington and the lack of specifics surrounding all of them, trading an 80-year-old, well-proven accounting method for the promise of a “better” outcome with tax reform is a frightening prospect for any small business that currently uses LIFO. While the threat of repeal has been around for years, it has never been more urgent to communicate the need to keep LIFO. For more information on how to share your thoughts with Congress, click here.