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.  Recently released tax reform proposals would repeal LIFO and result in a retroactive tax liability on dealerships that would take cash away from businesses that would 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. 

Tax reform proposals released by the Obama Administration, (now former) Senate Finance Committee Chairman Max Baucus (D-MT), and House Ways and Means Committee Chairman Dave Camp (R-MI) would repeal LIFO. 

The Administration's budget for Fiscal Year 2015 proposes to repeal LIFO and require recapture of LIFO reserves in income evenly over 10 years.  The Senate proposal would require recapture of LIFO reserves in income evenly over 8 years. Under the House proposal, LIFO reserves would be recaptured in income over a four-year period beginning after 2018 in the following amounts: 10% in 2019, 15% in 2020, 25% in 2021 and 50% in 2022.  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 a reduced tax rate of 7 percent. 

Key Points

• Repealing LIFO would have a significant effect on dealerships, as approximately 64 percent use LIFO.  Repeal proposals would force dealers to report their LIFO reserves as ordinary income, resulting in a retroactive tax increase for many family-owned dealerships.

• LIFO repeal is the government changing the rules in the middle of the game to the detriment of America’s auto dealers and many other small businesses.  Its repeal is merely a revenue raiser to offset the cost of other tax priorities.

• 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.

Status
While tax reform proposals would repeal LIFO, no legislation has been formally introduced yet.  Congress is urged to ensure that any changes in LIFO do not negatively impact small business.

March 2014