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KSM Blog | Katz, Sapper & Miller CPA

LIFO: Will It Stay or Go?

Posted 7:58 PM by

Among the top revenue raising topics included in the current budget proposal is the repeal of the LIFO method. Though this is not the first time the LIFO repeal has been included in a proposed budget, some are worrying that it may just pass this time. This could be a nightmare for some manufacturing companies. If repealed, taxpayers would have to write-up their beginning inventory as of Dec. 31, 2013 to its FIFO (first-in, first-out) value. In an attempt to alleviate some of the pain that would stem from having to recognize all of the income associated with eliminating the taxpayer’s LIFO reserve, the proposal states that the taxpayer would have the ability to recognize the Section 481(a) adjustment ratably over a period of 10 years. 

The LIFO (last-in, first-out) method enables companies to expense their priciest inventory (last purchased) in a time of rising prices, in order to drive-up their cost of goods sold. This in turn offsets the gross sales, thus resulting in a lower tax liability in the current year. On the other hand, when prices are falling, just the opposite is true in that cost of goods sold would be lower and the tax liability would be increased. The LIFO method has been considered a permissible method by the IRS for years. The only stipulation to electing this method for tax purposes is that the taxpayer must also use LIFO for financial accounting purposes in conformity with generally accepted accounting principles (GAAP).

The government has a few reasons for its push to repeal LIFO. Among the most obvious is the mere fact that this would raise revenue and eliminate the ability of taxpayers to defer their tax liabilities. Another important reason the government wants to repeal LIFO is that it is not permissible under International Financial Reporting Standards (IFRS).  As long as the U.S. allows LIFO to be used, it stands as one more obstacle in the way of implementing IFRS into the U.S. Many large companies that are under a foreign parent company have already had to adopt and adhere to IFRS. Repealing LIFO would also simplify the Internal Revenue Code. The accounting method associated with LIFO is complex and has often been scrutinized by the IRS. The General Explanations of the Administration’s Fiscal Year 2014 Revenue Proposal outlines these reasons for the proposed repeal.

The Indiana Manufacturers Association (IMA) is opposed to repealing the LIFO method. The LIFO method has become such a commonly used method and outside of the reasons stated above, the government has not provided any true tax policy justification for the change. IMA Policy Guide states, “Rather it is an attempt at a tax reporting uniformity that will increase the taxes of many smaller Indiana manufacturers. These companies are the central driver in job creation as economic recovery takes hold. The proposed tax increase is not only unwarranted but could be economically counter-productive if implemented at this time.”

If you are a company that utilizes the LIFO method, there is no need to panic, but you do need to be aware of the issues. If in fact LIFO gets repealed, keep in mind that there are ways to mitigate the tax consequences; it just requires some thought and planning. Two of the key tax planning factors to consider are (1) the favorable Section 481(a) adjustment spread period, and (2) choosing an advantageous inventory valuation method. Then again, LIFO could stick around for a while.

Read more on the current news surrounding the LIFO Method.

About the Author
Sarah Hammond is a manager in Katz, Sapper & Miller’s Business Advisory Group. Sarah provides financial, tax and consulting services to a variety of industries. She has experience in tax planning, forecasts and projections, and financial analysis. Connect with her on LinkedIn.

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