Obama Tax Reform Proposals Would Repeal LIFO to Conform to IFRS; and Increase Taxes on Securities and Commodities Dealers

Anticipating SEC adoption of international financial reporting standards (IFRS), the Obama Administration proposed to repeal the last-in, first-out (LIFO) method of accounting for inventories. Since IFRS do not permit the use of the LIFO method, their adoption by the SEC would cause violations of the current LIFO book/tax conformity requirement. Repealing LIFO would remove this possible impediment to the implementation of IFRS in the United States.

The Internal Revenue Code permits a taxpayer with inventories to determine the value of its inventory and its cost of goods sold using a number of different methods. The most prevalent method is the first-in, first-out (FIFO) method, which matches current sales with the costs of the earliest acquired (or manufactured) inventory items. As an alternative, a taxpayer may elect to use the last-in, first-out (LIFO) method, which treats the most recently acquired (or manufactured) goods as having been sold during the year. To be eligible to elect LIFO for tax purposes, a taxpayer must use LIFO for financial accounting purposes.

The proposal would not allow the use of the LIFO inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its FIFO value in the first taxable year beginning after December 31, 2011. However, this one-time increase in gross income would be taken into account ratably over the first taxable year and the following seven taxable years.

The Administration also proposed requiring securities dealers and commodities dealers to treat the income from their day-to-day dealer activities as ordinary income and not as capital gains. Currently, securities and commodities dealers treat the income from day-to-day dealer activities as giving rise to capital gain. Under IRC section 1256, these dealers treat 60 percent of their income from their dealer activities as long-term capital gain and 40 percent of their income as short-term capital gain.

Noting that dealers in other types of property treat income from their day-to-day dealer activities as giving rise to ordinary income, the Administration said there is no reason to treat dealers in commodities and securities differently than dealers in other types of property.