The tax increase no one knows about

When browsing the federal budget this morning (I know, I know), I discovered a line-item I’ve heard nothing about: “Repeal LIFO method of accounting for inventories”. This is a tax increase on business (estimated to collect billions each year) brought about by a change in how business are required to account for the inventory. It’s technical, but not too difficult to understand.

LIFO stands for “last-in, first-out”. In computer science terms, it means that you may treat your inventory as a stack, rather than a queue. Consequently, the cost-basis for figuring the value of an item of inventory sold is the current replacement cost of that item. For example, let’s suppose you buy a widget for $10 and you turn around and sell it for $12. Under LIFO, you pay taxes on your $2 profit. It doesn’t matter if you happen to have a another widget in inventory that you bought when the price was $8.

In contrast, under FIFO (“first-in, first-out”), you are deemed to be selling the old $8 widget first. That means that you pay tax on $4, and you now have a $10 widget in inventory. When inflation is high (as it seems likely soon to be), the difference between LIFO and FIFO can be substantial.

The LIFO scheme makes sense. Let’s suppose you buy a widget for $10 and you turn around and sell it for $10. Your business has accomplished nothing; you’re back in exactly the same state as you were before. LIFO accounting respects that reality, you pay taxes on zero. Under FIFO, however, you need to look at what you have in inventory. If you had an $8 widget in inventory, you pay taxes on a $2 profit that doesn’t exist.

Unfair tax increases are no big surprise. Here’s the surprising thing: I’ve never heard anything about this. And it’s not just me. Having discovered this, I googled it and found a lot of stories in trade journals but not a single one from the general press. The closest thing I could find in the general press is a Fox News article from 2006 about a LIFO-repeal proposal that ultimately was defeated.

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