Obama administration going after LIFO rule?

The Obama administration has scoured the tax code looking for “loopholes” to close to generate more revenue, and apparently has found one it really likes.  The New York Times says that Barack Obama describes the “last-in, first-out” rule of inventory accounting “arcane,” but it’s going to be a critical problem for businesses if the decade-long tax rule gets changed.  Instead of using the last sale price of inventory as a cost basis to determine taxable profit, the elimination of the LIFO rule will create accounting headaches that will impact smaller businesses most:

One of the biggest revenue-raisers proposed byPresident Obama in negotiations with Congress is what he describes as an arcane change in the tax treatment of business inventories — things like steel, groceries and oil.

But however complex the details, the effect of the change would be substantial, and in pushing for it Mr. Obama has kicked a hornet’s nest. Lobbyists from companies of all sizes are swarming around Congress to kill the proposal, which would prohibit the use of an accounting technique known as last in, first out, or LIFO. The technique is used to determine the cost of goods sold, and therefore the income earned, by a company.

Mr. Obama’s proposal, projected to raise $65 billion to $95 billion over 10 years, would increase the taxable income and tax liability of companies that have been using this method of accounting for decades. Small businesses, manufacturers, wholesalers, retailers and oil companies would be especially hard hit.

Here’s how LIFO works, using a simple example.  A business that buys oil for resale will accumulate inventory over a fairly long period of time at a variety of prices, depending on the spot market and the source of the oil.  When they sell the oil — an asset like any other asset — the business has to declare the cost of the item to determine for the IRS what the reported profit should be.  The LIFO rule, which has been in place since the days of FDR, allows businesses to assume that the last barrel of oil purchased (in this example) was the first one sold, and uses the last purchase price by the business as the cost basis of the transaction.  Not only does that simplify accounting, it avoids having to identify what got bought when for items that don’t lend themselves to unique identification, as well as stripping inflation calculations out of the process.

Instead, businesses would have to identify which specific items in their inventory got purchased at specific prices, and then calculate each cost basis individually.  For businesses that resell in bulk, this would create a huge new burden in accounting.  Larger firms could absorb more of that cost burden, thanks to economies of scale, but smaller players would get squeezed harder.  For everyone, however, it means having to do a recalculation of risk based on inventory costs, a process that will hardly encourage businesses to expand inventories.  Since inventories are already at record levels, this would drop a bomb on manufacturing in the near term, an outcome that will not look pleasant for the White House.

In fact, the New York Times reports that the rule change might mean having to recalculate past tax declarations, too — although the White House insists that filers will get ten years to repay their newly-acquired tax liabilities:

The president’s proposal would also undo the tax benefits that companies have obtained by using the LIFO method of accounting over the years.

“It’s a huge retroactive tax,” said Jade C. West, senior vice president of the National Association of Wholesaler-Distributors, who is leading the business coalition opposed to the change. “The government would tell companies that they must go back and recalculate the tax savings they have claimed for decades.”

The Treasury Department said, in response to a question, that the president’s proposal “requires that tax be paid on long-deferred gains.” However, it said, the tax could be paid over 10 years.

In other words, we’ll have the economic impact of this change pressuring capital investment for the next ten years on top of the impact that the tax hike itself will take on future sales and future orders.  It might not ever have been more obvious that no one in this administration has ever run a business before assuming to know how to reorder industry.

Update: There’s a good and interesting debate on the merits of LIFO in the comments section; some Hot Air readers think this might be more of a wash.  Be sure to read through them.