A Hidden Business Tax Increase

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As to Muser saying that LIFO will go away eventually because it is only a matter of time before U.S. GAAP does not allow LIFO, Congress could do away with the current IRS tax regulations “LIFO conformity rule“. Doing so would allow the use of LIFO for tax purposes regardless of whether it is used for GAAP just as companies can take Sec. 179 write-offs for tax purposes but not for GAAP.
Whether LIFO is a tax dodge is in the eye of the beholder. Congress first allowed the use of LIFO in 1938, so this method has been around for 70 years of the 90 years since we have had a permanent income tax. The amount of taxable income deferral provided by using LIFO correlates directly to the amount by which a company’s cost of sales has been affected by inflation; the amount is not arbitrary as are Sec. 179 write-off limits.
One could argue that LIFO is less of a tax dodge than are the home mortgage interest deduction, the deductibility of health insurance premiums or the fact that some people purposely earn less than $106,800 per year so they don’t have to pay the maximum social security tax. Many tax provisions have resulted in negative unintended consequences such as those associated with the home mortgage interest and health insurance items described above. Use of the LIFO method helps companies with inventories finance a portion of their increased inventory investment requirement that results from inflation. This helps companies create jobs and compete with foreign competitors. I don’t know of negative unintended consequences of companies using LIFO.
As to only a “few sophisticated companies” being able to use LIFO, the U.S. Treasury wrote regulations in 1982 to allow companies to use what is called the “simplified LIFO” method to reduce the time required to calculate LIFO. This method is now widely used & of the 20,000 companies now using LIFO, only 600 of these are publicly traded. Our company provides LIFO software and LIFO calculation services & the time and fees involved for many companies is nominal.
Erik is correct that reductions in inventory levels reduce the amount of LIFO reserves. LIFO reserves can increase in the future but only if there is inflation in the future.
It is not a good assumption that LIFO reserves for all companies have decreased a lot because of the severe recession because: 1) Large decreases in inventory levels will decrease LIFO reserves but not wipe them out, 2) inventory purchases and/or production often decrease as a result of reduced sales but purchases/production must be reduced at a faster rate than sales for inventory to decrease & 3) not all companies have been hit as hard by the recession.
The business owners we talk to think now would be an especially bad time to repeal LIFO because they know substantial inflation in the near future is inevitable because of the massive government deficit spending and using LIFO will help them reduce the negative effects this inflation has on their business.

lifopro (Lee Richardson) of NE 1:26PM July 18, 2009

I suspect that many companies who've carefully maintained their inventories over the years in order to gain the most from LIFO accounting may have already eaten into those older cost (ei: cheaper) layers of goods with this unprecedented draw-down on inventories... layers that they'll never, ever get back. From that standpoint, why not ban LIFO now while its apparent advantage to companies is all but gone anyways. A higher tax burden results either way; mandate OR LIFO liquidation.

erik of RI 10:13PM July 07, 2009

but America is on the fast track to having to scrap our own "Generally Accepted Accounting Principles" (GAAP) in favor of "International Financial Reporting Standards" (IFRS). This is a side effect of globalization AND a sign of America's declining influence in the financial world as a whole.
As for the FIFO/LIFO debate, it's time to go to FIFO only. The main reason is that LIFO is and always has been nothing but a tax dodge---and one that only a few sophisticated companies are able to use.
I maintained a LIFO inventory valuation for a manufacturing company for nearly 20 years. Because the inventory you have today is not the same physical stuff you had 20 years ago, there is a great deal of pure estimating that goes on to "guess" what your exact stuff today "would have" or "might have" cost 20 years ago. LIFO deliberately understates the value of your inventories on the balance sheet you present to the world, AND FOR ONLY ONE PURPOSE, TO EVADE TAXES THAT MOST OTHER SMALLER AND LESS SOPHISTICATED COMPANIES ARE PAYING.
Obama is right to end the LIFO charade in the tax code. And, our capitulation to IFRS is probably going to end it for other financial reporting purposes. Investors might see the value of some stocks go up, as the effect would be stronger-looking balance sheets with inventories at real current prices.

Muser of NM 11:07AM July 01, 2009