For US federal income tax purposes, businesses are permitted to use Last-in, First-out (LIFO) inventory.....yeah, another way of saying this is the oldest bought is still here (FISH....First-in, Still Here). By using LIFO, businesses get to increase their Cost of Goods Sold Expense Tax Deduction, and thus get to decrease their Taxable Income, and thus also get to reduce their US federal income tax bill.
Under US generally accepted accounting principles, LIFO is one of the many ways that businesses can value their inventory on their balance sheets. The precision of accountants is clearly overrated.
The IRS has the LIFO conformity rule, which lets businesses use LIFO for federal income tax purposes only if they also value their inventory on their financial statements at LIFO.
Companies that economically benefit from using LIFO the most are ones whose inventories have increased in price the most.
Many companies using LIFO are pricing a good chunk of their inventory at prices of decades ago. Does that make any sense? I don't think so.
Just focusing on four US Big Oil Companies, here are their related Dec 31, 2010 Inventories for their Crude Oil and Petroleum Products on their books, and how much it would change if these inventories were instead valued at the much more relevant current cost to replace this inventory.
………………………………………..........Step Up To
…………………………...Inventory…Replacement...Inventory at
…………………………....at LIFO………....Cost…….....Current Cost
………………………..…….........(in millions of US dollars)………
Exxon Mobil……………9,852……….21,300…………...31,152
Chevron………………….3,589………...6,975…………...10,564
ConocoPhillips………..4,254…………6,794…………...11,048
Marathon Oil…………..3,049…………4,166………….....7,215
Total…………………...20,744………..39,235…………..59,979
My proposal here is to eliminate LIFO for all US Multinational Corps in all industries, which have a significant amount of their US inventory priced at LIFO. The cutoff amount is subject to debate, but I would consider something like total LIFO inventory of $100 mil or more….or perhaps, a bit more than $100 mil. And all US Multinational Corps with LIFO inventory less than $100 mil, could elect to switch out of LIFO, and get the same tax benefits under this proposal.
I wouldn’t require pure domestic businesses to switch out of LIFO.
The economic damage to Big Corps from this proposal is substantially softened here.
For the US Multinational Corps that would be required to switch out of LIFO for US federal income tax purposes under my proposal here, the logical action will be for them to also switch out of LIFO in their financial statements. Thus, there will be no income tax expense charge in their income statement from this switch out of LIFO. Further, by switching out of LIFO, this should increase their Gross Margins and their Pretax earnings on their income statements, as well as significantly increase their total inventory and their total stockholders’ equity, both on their balance sheets.
I wouldn’t require the initial switch out of LIFO to be paid for in US federal income taxes immediately. Instead, I would let them pay for it equally in 7 years starting in say Year 4 and continuing to Year 10.
I would also let US Multinational Corps switching out of LIFO here to be permitted to repatriate some of their foreign earnings in either 2011 or 2012, and also receive a significant tax benefit. Let me explain with an illustration.
Say US Multinational Corp A switched out of LIFO starting in 2012. From this switch out of LIFO, the resultant additional US federal income tax owed for this switch is say $140 million.
Under my proposal, Corp A would be permitted to repatriate an amount of its foreign earnings, which results in additional US federal income tax of $140 mil. This $140 mil is then used to liquidate the $20 mil of LIFO tax owed in each of the 7 years from 2015 to 2021.
The end result is that Corp A gets immediate access to a significant amount of its foreign earnings parked overseas. And Corp A, in essence, doesn’t have any US federal income tax owed from this foreign earnings repatriation, to boot.
There will be substantially positive CBO scoring to the US Government from this proposal, for the next 10 years and for many years thereafter.
