Weekly Legislative Update May 17, 2021
Fact Sheet on Last-in, First-out Inventory Accounting Method
Purpose of LIFO and FIFO inventory accounting system:
1) To track product. A business always wants to have adequate inventory on hand to meet demand, whether manufacturing, distribution, or retail.
2) To track costs. A business must manage cash flow to maximize efficiencies. Since inventory items tend to be fungible, inventory conventions are a key part of tracking costs.
3) To determine income. The tax code requires taxpayers to use the best inventory accounting practice in the trade or business that most clearly reflects income. FIFO (First-in, First-out) is best suited to a business with falling prices. LIFO is best suited to a business with rising prices.
4) LIFO and FIFO achieve the same purpose: they most closely match the cost of goods sold with the cost of the replacement inventory the company must purchase in order to remain in business.
5) Myth-buster: It’s a myth that either FIFO or LIFO tracks the physical flow of inventory. Tracking the flow of physical inventory and tracking the costs of inventory are two different things. Both FIFO and LIFO track costs, not the flow of physical inventory.
LIFO is used by a wide cross-section of industries:
LIFO is used by more than a third of all U.S. companies, including hundreds of thousands of pass-through small and mid-sized businesses, including manufacturers, distributors and retailers of a wide variety of products. Click here for a list of LIFO Coalition members: http://savelifo.org/about-lifo-coalition/ and here for a Georgia Tech study on LIFO usage: http://savelifo.org/pdf-2011/GA%20Tech%20Study%20Consequences%20of%20the%20Elimination%20of%20LIFO.pdf
LIFO works the way it was intended to work:
LIFO is designed to react to price fluctuations. LIFO has a built in “toggle switch” that triggers tax when prices go down. For example: Crude oil prices dropped in recent years, significantly reducing LIFO reserves of oil and gas companies, bringing millions of dollars into current taxable income. Under current statute, the benefit from LIFO is recaptured when the taxpayer’s inventory levels decline, prices fall, or the taxpayer goes out of business.
Small businesses are disproportionately dependent on LIFO:
Small businesses that operate on tighter margins particularly rely on LIFO to ensure their ability to maintain inventory levels. Repeal of LIFO could force many of them into debt not only to pay the recapture tax, but to replenish inventory – a backward spiral that will put them in a position of always trying to play catch up. Some may be forced out of business. Click here for a Small Business Administration Office of Advocacy letter: http://savelifo.org/pdf-2011/SmallBusAdministrationLetter.pdf
LIFO repeal would slow the economy, cost jobs, and reduce revenue prospectively
The economic dislocation that repeal of LIFO would cause would more than offset any new Federal revenue. A Tax Foundation study released in February 2016, found that repeal of LIFO would reduce GDP by $116 billion per year, reduce federal revenue by $518 million annually, and cause the loss of as many as 50,300 jobs. Click here for a Tax Foundation study on the impact of LIFO repeal: http://savelifo.org/wp-content/uploads/2016/02/TaxFoundation-FF501.pdf
LIFO repeal would be uniquely and punitively retroactive:’
LIFO repeal would require the retroactive recapture all LIFO-related deductions that have been taken by LIFO taxpayers, sometimes over many decades. Under current law this recapture tax is paid only when the company reduces its inventory levels, experiences deflation, or goes out of business. To impose that tax in the absence of any of those triggering events would retroactively change the rules for LIFO taxpayers. For more on this click here: http://savelifo.org/wp-content/uploads/2021/02/LIFO_Repeal_Unprecedented_Retroactivity_2021.pdf
LIFO should not be repealed on a prospective-only basis:
LIFO was added to the U.S. tax code as an approved inventory accounting method in 1939 to address the corrosive impact of inflation on the ability of U.S. companies to maintain adequate levels of replacement inventory. The need for LIFO has not changed. If a company which sells a product that rises in price does not have sufficient after-tax profit to buy replacement inventory that company cannot remain in business.
Repeal of LIFO will not raise revenue post-COVID, and would be particularly damaging if inflation increases
Despite the static revenue score attributed to LIFO repeal, most recently by the CBO, the revenue and job losses that would be caused by repeal would more than offset any revenue increases. Moreover, many economists are predicting rising inflation in reaction to the massive pandemic-relief Federal spending. LIFO is designed to help companies which sell products that rise in price remain profitable, and repealing LIFO as inflation increases will result in many of those companies having insufficient after-tax profit to buy replacement inventory; smaller companies would likely be put out of business.
No factually accurate substantive arguments have been made to justify LIFO repeal:
While LIFO repeal has been discussed for nearly a decade, no factually accurate substantive argument for repeal has been made; rather, LIFO repeal has been proposed to generate revenue to fund other programs or tax cuts. Click here for a letter on LIFO legislative history and purposes: http://savelifo.org/wp-content/uploads/2017/01/Camp-Letter-re-Comments-Draft-Tax-Reform-Act-03-31-14.pdf
LIFO is not a tax expenditure:
LIFO is an 80+-year-old GAAP-approved inventory accounting system which does not meet the statutory definition of a tax expenditure. From its adoption in 1939 through 2008, LIFO was not included in the Joint Tax Committee list of tax expenditures, and is still not included on the Department of Treasury list of expenditures today. http://savelifo.org/wp-content/uploads/2017/06/LIFO-is-not-a-tax-expenditure.pdf
LIFO Letter to Speaker Pelosi
Dear Madam Speaker:
Like all Americans, we share your desire for improved infrastructure, greater investments in science, technology and manufacturing and commend the ambitions of the American Jobs Plan. While we appreciate the goal to offset the cost of the legislation, we are concerned that the “last-in, first-out” (LIFO) accounting method may be considered to help pay for the infrastructure package. We believe it is important to avoid using an offset that would harm businesses that rely on the LIFO method of inventory to maintain adequate cash flow in order to replenish inventory and also retroactively penalize those businesses for using LIFO in the past. Keeping LIFO in the tax code is consistent with the goals of the Biden administration and Congressional Democrats to incentivize businesses to operate and thrive in the United States, provide well-paying jobs, and contribute to our nation’s long-term economic growth and global competitiveness.
Hundreds of thousands of American businesses representing a wide array of enterprises, both small and large, use LIFO because they produce products from raw materials or feedstock that generally rise in price over time or sell products that generally increase in cost. LIFO best matches the replacement cost of goods with the revenue from inventory that is sold. This helps businesses such as manufacturers, retailers, wholesaler-distributors, and car and equipment dealers generate after-tax income that is reinvested in the purchase of replacement inventory, a cycle that is necessary for the company to remain in business. Note that a common misperception of LIFO is that it matches the flow of physical inventory when in actuality it matches the flow of cash available to replenish inventory.
LIFO is not an “accounting gimmick,” "loophole," "subsidy," or tax expenditure; rather, LIFO is a widely accepted and utilized inventory accounting method that has been part of the U.S. tax code for more than 75 years. Repeal of LIFO to offset the cost of an infrastructure bill would be antithetical to the policy goals of generating economic growth and job creation and would unduly harm businesses still clawing out of the economic impacts of the pandemic.
The LIFO inventory method is an integral part of the accounting processes for many industries. Many LIFO users are involved in construction/farm equipment manufacturing and distribution and consequently manage an integral role in creating, building and strengthening our nation’s infrastructure. In addition, other LIFO taxpayers are essential to wholesale distribution support for many of the sectors deemed essential to navigating the COVID-19 response, including the pharmaceutical and medical device industries. The LIFO accounting method is fundamental to these businesses and helps to prevent the drain of capital necessary for growth and job creation in sectors vital to the rebuilding process.
We applaud the Administration’s efforts to think big on infrastructure but also want to emphasize that not all pay-fors are created equal and repeal of LIFO could devastate thousands of American businesses at a particularly sensitive time when many of those businesses are on the cusp of survival. In order to ‘Build Back Better’ we should instead look to empower and encourage American businesses to spur job creation and economic growth. We therefore urge you not to consider the repeal of LIFO as a pay-for for the American Jobs Act.
As non-members of the Ways & Means Committee, we will of course be communicating with our Ways & Means colleagues on this matter. We wanted to express the depth of our concerns to you, however, as early in the process as possible.
We thank you for considering our request and look forward to working with you and the Committee to advance a proposal that is fair, simple, and promotes economic growth and competitiveness.
TIA and other trade associations