WHAT IS LIFO?
LIFO (which stands for "last in, first out") is an inventory accounting method used by companies throughout the U.S. economy to determine both book income and tax liability. Primarily, LIFO is used to manage the costs of inflation. If inventory costs are rising, LIFO is a more accurate way of measuring financial performance and calculating tax. LIFO takes into account greater costs of replacing inventory, thereby giving a more conservative measure of the financial condition of the business and the economic income to which tax should apply.
LIFO is not a tax loophole. When inventory costs are rising, using the LIFO method will mean less tax liability in a given year than under the FIFO ("first in, first out") method. However, if prices fall, the taxpayer would repay the LIFO benefit through greater tax liability. Moreover, taxpayers may not change between LIFO and FIFO without Internal Revenue Service (IRS) approval, thus once a company elects to use the LIFO method, it assumes the risk of artificially increased tax liability if inventory costs should fall.
LIFO isn't something new; rather LIFO has been used and accepted as a legitimate accounting method by accountants, tax lawyers, the IRS, and Congress since the 1930's. In fact, when LIFO was officially recognized almost three quarters of a century ago, Congress imposed a financial reporting conformity requirement making the use of LIFO for financial reporting a condition of its use for tax purposes.
Unfortunately, proposals on Capitol Hill would abolish the use of LIFO. Repealing LIFO would force companies currently using this method to report their LIFO reserves as income, resulting in a massive tax increase for large and small businesses across the country. Additionally, repealing LIFO would mean potentially higher future tax bills and would make it harder for companies to manage inflation.