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Prompted by Congressional thoughts of repeal, companies that use last-in, first-out inventory accounting start mobilizing their defense.
Helen Shaw, CFO.com | US
July 21, 2006
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.
The coalition, however, wasn't invited to the Senate Finance Committee hearing on corporate taxes, noted Jade West, a government relations representative at the National Association of Wholesaler-Distributors, a lobbying group that manages the coalition. "Our argument is with the Finance Committee because they had one person testifying" on LIFO, said West. The coalition asked the Finance Committee to be involved in hearings, but did not learn about the June hearing until after the witness list had been completed, she said.
Plesko, who characterized his testimony as a list of the pros and cons of LIFO and FIFO, nevertheless drew fire from the coalition. The coalition claimed, in a letter to the Finance Committee, that Plesko's testimony significantly understates the use of the accounting method by the business community and the adverse effect that would occur from a LIFO repeal.
Measuring the LIFO Effect
"If there were a repeal, the business community would pay a ton of tax," Stephen Elkins, tax director of the American Chemistry Council, a member of the LIFO lobbying coalition told CFO.com.
But information on the dollar amount of tax benefits companies would lose in case of a repeal is only anecdotal. There is no single database that compiles information on which companies use LIFO and how much they benefit from it.
Basing his estimate on public-company data amassed from 1975 to 2004 by the American Institute of Certified Public Accountants, Plesko also said at the hearing that LIFO repeal could yield a federal revenue gain of about $18 billion before tax credits. The coalition rejects that estimate because it says many privately-held companies employ the method, although it cannot estimate an amount.
PricewaterhouseCoopers, however, is attempting to measure the economic impact of the accounting method. The Big Four firm aims to produce a tax and economic analysis of the types of companies that use LIFO. PwC intends to "organize and represent a coalition of companies to support the retention of LIFO and refute the testimony of Dr. Plesko," according to its website. A partner in PwC's Washington National Tax Services Group did not return calls for comment.
Even without comprehensive statistics, it's possible to get some idea of the impact of a LIFO repeal on businesses, experts say. A broad ban would adversely affect all companies that use the accounting method, with a greater impact on small and mid-sized companies, according to David Auclair, a principal at Grant Thornton.
"If tax savings are not there, businesses would have to generate that from somewhere else," said Auclair. "It might impact prices to customers, which might lead to further inflation, and it could impact on their [firms'] ability to sell, which could impact their earnings."
For companies that have been using LIFO for decades, a repeal would be a surprise akin to people realizing that if they were to buy the houses they own today, they wouldn't be able to afford it, notes Stephen Gertzman, national director of federal tax accounting at Ernst & Young. "The principal burden from a tax standpoint is that now you have to report income on this LIFO reserve," he said, "which is like having additional tax liability but no additional income to help pay for it."
Further, companies would need to be prepared for the higher costs of inventory, if they include products that increase in price, he added. "You may have companies that would say [they] don't believe they could afford to pay all the tax they owe," comments Gertzman.