There continue to be rumblings that Congress may repeal the LIFO accounting method for inventory.

If that happens, companies using the last-in-first-out method may have to pay back LIFO savings accrued over many years. And while many think that LIFO is a “loophole” used mainly by the large oil companies, in fact it is a legitimate inventory accounting method in use in the U.S. since the 1930s.

Roughly 40 to 50 percent of businesses in nearly every industry that use inventories use LIFO, according to Christian Klein, vice president of public affairs for Associated Equipment Distributors. This includes auto dealers, distilled spirits distributors, big retail outlets, as well as pharmaceutical and medical supplies businesses.

AED, a trade association of heavy construction equipment distributors, is part of a coalition to preserve LIFO.

“The reason we got involved with the issue is that 30 to 40 percent of our members use LIFO,” said Klein. “Their collective reserves are $2.8 billion, and repeal would cost them $900 million in retroactive tax liability – that’s just on our own membership, not the entire construction industry.”

The origins of the current debate on LIFO stem from the confluence of high gas prices, animosity toward oil companies and windfall profits, and growing recognition on the part of Republicans that they were in trouble in the 2006 elections.
“The Republicans proposed LIFO repeal as a way to pay for a gas tax rebate,” said Klein. “It was an election year gimmick. The perception was that LIFO was used by oil companies to mitigate the impact of inflation on inventory, so they decided it was a good way to score political points against them. But they didn’t understand that LIFO is also used by small businesses, not just the big faceless oil companies.”

Eventually, the measure died. “But once a bad idea is out of the bottle, it’s hard to get it back in,” Klein observed. “The idea of targeting LIFO came back in 2007 in [Ways and Means Committee Chairman] Rangel’s comprehensive tax overhaul bill. And it popped up again in the Obama budget, but was not in either the House or Senate budget resolutions.”

Since it is currently not a “pay for” in the health care debate, Klein sees danger ahead in the context of comprehensive tax reform. “It will be a hot issue again next year,” he predicted.

“It’s not safe,” said Jade West, senior vice president of government relations for the National Association of Wholesale Dealers. “Once a revenue offset gets onto the radar screen, it never goes away. If it dodges the efforts to pay for extending current tax breaks, it will be back on the menu next year.”

Of course, strict convergence between GAAP and International Financial Reporting Standards would have the effect of repealing LIFO. That is because Section 472(c) of the Tax Code requires that a taxpayer who uses LIFO for tax purposes also use it for financial reporting.

“That was one of the initial catalysts,” said Klein. “The thought was ‘they’ll get rid of it anyway, so we might as well get all the money now.’”

And that is why those who support continued use of LIFO for tax purposes support legislative repeal of the code requirement that links financial accounting LIFO with tax reporting LIFO.