The People of America's Oil and Natural Gas Indusry

LIFO Repeal Could Have Devastating Effect on Jobs

Mark Green

Mark Green
Posted June 4, 2014

If you run a business that sells things produced from raw materials – manufacturers, retailers, wholesale distributors and car and equipment dealers and other industries – chances are good you’re familiar with “LIFO” accounting. The IRS first approved the “last-in, first-out” method for use by taxpayers with inventories in the 1930s. Repealing LIFO, as some in Congress are proposing, could impact the more than 30 percent of U.S. companies, large and small, that use it, as well as the larger economy.

That’s the message a bipartisan group of 113 U.S. House members conveyed in a recent letter to Ways & Means Committee Chairman Dave Camp, who has proposed LIFO repeal as part of his larger tax reform package.

Quick background: The tax code requires taxpayers with inventories to value their ending balances to determine which costs are included in the costs of goods sold during a given year. LIFO is a popular accounting method that many businesses with high inventory turnover use because sales revenues are generally in line with restocking costs. This occurs because LIFO accounting assumes the last goods brought into inventory are the first goods sold. More info here. The House members write:

This helps businesses … generate after-tax income that is reinvested in the purchase of replacement inventory, a cycle that is necessary for the company to remain in business.

And:

LIFO is a legitimate and longstanding accounting methodology. It is not a "loophole," "subsidy," or tax expenditure; rather, LIFO is a widely accepted and utilized inventory accounting method that has been part of the U.S. tax code for more than 70 years.

Repealing LIFO would stifle U.S. job creation and, as it impacts the energy industry, could impact U.S. energy production. That’s because repeal would create an assumed tax bill without any corresponding cash gain. Taxing inventory, versus taxing income, would require companies to redirect cash from capital reserves or ongoing operations or sell assets to cover the tax payment – negatively impacting production.

Like taxpayers in other industries, a number of oil and natural gas companies with refining operations properly elected to use LIFO to value and account for their inventory because the sector is based on purchases of a raw material (crude oil), the cost of which can fluctuate widely. LIFO accounting is the best way for current costs to offset income for the current year. API Tax and Accounting Policy Director Stephen Comstock:

“LIFO repeal is a tax on invested capital rather than any type of ‘gain.’ As such it requires businesses to take cash out of their operations, out of assets or budgets dedicated to already generating economic benefit to pay a deemed tax bill.”

The House letter reflects a broad range of businesses, not just the energy sector. Members also are concerned that the LIFO repeal proposal’s transition provisions wouldn’t sufficiently lessen impacts on businesses:

While the proposed transition rule and lower statutory rates attempt to lessen the economic and administrative burden of reserve recapture, they do not sufficiently mitigate the measureable harm that would be caused by repeal.  LIFO reserves are not cash accounts or liquid assets.  In fact, the savings generated from using LIFO are reinvested in replacement inventory.  Therefore, repealing LIFO and retroactively taxing the reserves will divert operating cash flows away from productive operations and investments and result in negative economic consequences on jobs and economic growth, especially for small and mid-size businesses.

Repealing a legitimate accounting method like LIFO could have a devastating effect on American jobs, the economy and revenue to the government. Any plan to change America's tax system should be comprehensive and recognize the benefits of America's energy and manufacturing renaissance.

ABOUT THE AUTHOR

Mark Green joined API after a career in newspaper journalism, including 16 years as national editorial writer for The Oklahoman in the paper’s Washington bureau. Mark also was a reporter, copy editor and sports editor. He earned his journalism degree from the University of Oklahoma and master’s in journalism and public affairs from American University. He and his wife Pamela live in Occoquan, Va., where they enjoy their four grandchildren.