Thursday, December 02, 2010

Fiscal Reform Commission Calls for Elimination of LIFO Accounting as Part of Complete Overhaul of Federal Tax Code

Calling the US federal tax code hopelessly confusing and complicated and essentially broken, the final report of the President’s Commission on Fiscal Responsibility and Reform called for a complete overhaul of the Internal Revenue Code by 2012, including a new corporate tax system with an end to LIFO accounting and the adoption of a territorial tax system for foreign-sourced income. The Commission, co-chaired by former Clinton Chief of Staff Erskine Bowles and former Senator Alan Simpson, said that the current corporate income tax system hurts America’s ability to compete. On the one hand, statutory rates in the U.S. are significantly higher than the average for industrialized countries (even as revenue collection is low), and the US method of taxing foreign income is outside the norm.

The U.S. is one of the only industrialized countries with a hybrid system of taxing active foreign-source income, noted the Commission, and the current system puts U.S. corporations at a competitive disadvantage. The Commission recommended the adoption of a territorial tax system to put the U.S. system in line with other countries, leveling the playing field.

Thus, to bring the U.S. system more in line with US international trading partners’, the Commission asked Congress to create a new way to tax foreign-source income by moving to a territorial system. Under such a system, income earned by foreign subsidiaries and branch operations, such as a foreign-owned company with a subsidiary operating in the United States, is exempt from their country’s domestic corporate income tax. Under a territorial system, most or all of the foreign profits are not subject to domestic tax. The taxation of passive foreign-source income would not change. It would continue to be taxed currently.

Under the present Code, businesses may account for inventories under the Last In, First Out (LIFO) method of accounting. The Commission recommended eliminating LIFO with an appropriate transition period. President Obama’s 2011 budget also calls for the elimination of LIFO from corporate accounting.

In a letter to the tax-writing committees of Congress earlier this year, a coalition of LIFO users argued that LIFO is not an arcane provision of the federal tax code used by a select few businesses, but rather is a well-accepted method of accounting used by hundreds of thousands of businesses to track their costs and accurately measure their income for tax and SEC financial reporting purposes. LIFO has been part of the Code since the Internal Revenue Code of 1939. According to the coalition, LIFO repeal would result ina punitive tax on business that would force businesses to generate sufficient cash to pay tax on deemed income. Repeal would also be bad tax policy that would prevent companies from being properly taxed on their real income.

More broadly, the Commission found that the U.S. corporate tax system is a patchwork of overly complex and inefficient Code provisions that create perverse incentives for investment. Corporations engage in self-help to decrease their tax liability and improve their bottom line. Moreover, corporations are able to minimize tax through various tax expenditures inserted into the tax code as a result of successful lobbying.

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