Congress Must Ensure Any Changes in LIFO Do Not Negatively Impact Small Business

Issue
LIFO (last in, first out) is a longstanding inventory accounting method used by businesses to help mitigate rising inventory costs.  As costs rise, LIFO is a more accurate way of measuring financial performance and calculating tax.  Similarly, advertising has been considered an ordinary and necessary business expense for more than 100 years.  Recently released tax reform proposals would repeal LIFO, and significantly restrict the amount of advertising costs a dealership could deduct each year.  Eliminating LIFO and limiting advertising deductibility would take working capital away from dealerships that could otherwise be used to maintain or create jobs.

Background
LIFO accounting
allows companies to calculate their income by basing sales on the newest inventory for goods, such as vehicles and parts, which increase in price over time.  Dealerships use LIFO to better match the cost of goods sold to the cost of replacing inventory, and its preservation is critical for inventory management to manage price increases.
 
With the stated goal of tax reform, the Administration's budget for Fiscal Year 2015 proposes to repeal LIFO and require recapture of LIFO reserves in income evenly over 10 years.  Former Senate Finance Chairman Max Baucus’ proposal would require recapture of LIFO reserves in income evenly over 8 years.  Under the plan introduced by Ways and Means Chairman Dave Camp, LIFO reserves would be recaptured in income over 4 years beginning after 2018.  Also under the Camp plan, closely held entities—defined as those with 100 owners or less—would be subject to tax on only 20 percent of their LIFO reserves (28 percent for C corporations) resulting in LIFO reserves of closely held entities being subject to an effective reduced tax rate of 7 percent.

For advertising, the Baucus proposal would make 50 percent of the advertising expense deductible in the year the expense is incurred; the remainder would be amortized over five years. The Camp proposal would also make 50 percent of the expense deductible in the year it is incurred but would require the remainder to be amortized over 10 years.  Chairman Camp’s proposal also would permit taxpayers to expense the first $1,000,000 of advertising expenditures.  Taxpayers with advertising costs that exceed $2,000,000 would not be eligible for this deduction.
 
Key Points

• Repealing LIFO would have a significant effect on dealerships, as approximately 64 percent use LIFO.  Repeal proposals that force dealers to report their LIFO reserves as ordinary income would result in a retroactive tax increase for many family-owned dealerships.
• For many small business dealers, repealing LIFO would diminish their ability to maintain and create jobs.  In a recent survey, 39 percent of dealers stated that they “would have to lay off workers or eliminate positions” if LIFO were repealed.
• Advertising has been an ordinary and necessary business expense just like salaries, utilities, and rent for more than 100 years and should remain fully deductible.  Dealers utilize advertising extensively since it is an integral component of marketing cars.  There is no evidence to support reducing and delaying legitimate advertising deductions that are necessary to the operation of small business auto dealerships and their ability to create a competitive marketplace.

Status
No tax reform bill has been introduced. Congress is urged to ensure that any changes in LIFO and advertising deductibility do not negatively impact small business.


September 2014