A proposal to eliminate the Last In, First Out (LIFO) accounting system has generated alarm and protests from several major industry associations, including the National Federation of Independent Business. The proposal to ban this inventory accounting system was introduced by President Obama during the recent debate about reducing the nation’s debt. The administration believes a ban would generate new revenue – to the tune of $60 billion more in taxes over 10 years. Opponents of the repeal proposal see it as a tax hike that will primarily fall on small businesses and manufacturing companies.

Here’s what is being discussed. First, the LIFO system is one of two popular ways that businesses – large and small – may choose to value their inventory holdings. The other option is FIFO (or First In, First Out). Both systems have their proponents, and tax professionals consider the nature of their clients’ businesses and the current economic climate before recommending an option. The LIFO system could allow a company to reduce its tax bill by using an inventory valuation based on the last inventory purchased – predicated on the strategy that they sell their new stock first (Last In, First Out). Businesses that employ the LIFO reporting system to reduce their taxes sell their newer (presumably more costly) inventory first, allowing them to value older inventory at the old (lower prices). Obviously, LIFO is not the system of choice for all business owners, including those whose inventory could decrease in value fairly rapidly (like high tech products and toys that might quickly lose their appeal).

The National Federation of Independent Business is a vocal opponent to any move to eliminate LIFO. The lobbying group represents some 700,000 small business owners. Top Republicans also slammed the proposed ban, calling it a threat to economic recovery and a misguided shot at small businesses and manufacturers who generate new jobs. The White House has responded to this criticism by arguing that scrapping LIFO would create a more level playing field in the manufacturing sector, and that it would be a component in a balanced budget package designed to reduce the nation’s debt. The White House press secretary said the administration believes repealing LIFO is the right thing to do at a time when tough choices must be made in the effort to achieve significant deficit reduction.

Detractors suggest that proposals, like the current one to repeal LIFO, should be made as part
of a broad-based tax-reform program, and that the proposed ban should not be part of the current effort by both Republicans and Democrats to address the deficit issue.

This is not the first time the administration has proposed repealing LIFO – the first effort started as an attempt to remove LIFO from the tax code in 2009. Business groups that have aired their disapproval of repeal efforts include the U.S. Chamber of Commerce and the National Association of Manufacturers. The sparring over LIFO comes at a time when the two political parties continue to bicker over other issues and debate the merits of various proposals on how best to arrive at an agreement to significantly reduce the nation’s debt.  

For more about how this issue and other proposals in the debt-ceiling debate might affect your business, contact your professional tax consultant.