U.S. Senate Finance Committee Chairman Max Baucus recently released “discussion drafts” of several tax reform proposals. In the current political climate, tax reform may be a long way off, and a discussion draft is a long way from a formal proposal. However, it is never too early to pay attention to ideas that have actually been put on the table.
The basic concept of business tax reform is to lower the corporate tax rate (currently 35%) to somewhere below 30%. To do this in a revenue-neutral fashion so as not to increase the deficit would require numerous specific tax benefits to be cut back. Overall, these benefits tend to be utilized more by manufacturers than retailers. As a result, retailers currently have among the highest effective tax rates. However, a few such benefits affected by the Baucus proposals are particularly important to retailers. Each retailer will need to determine for itself how it is affected by tax reform, something that cannot be known until the reduced tax benefits and the amount of rate reduction are determined.
While some of Senator Baucus’s proposals for reductions in benefits may be extremely important to certain retailers (e.g., the international proposals that would affect large multinational retailers), the focus here is on a few proposals likely to be of interest to many retailers.
- Advertising costs. At present, the costs of advertising are generally deductible right away. Under the Baucus proposals, 50% of such costs would be deductible immediately; the remainder would have to be amortized over 5 years. “Advertising” for this purpose does not include promotional pricing.
- LIFO inventory. Under the “last-in, first-out” method of inventory accounting, a retailer may assume that its goods sold during the year are those most recently purchased. In an inflationary economy, this increases the cost of goods sold, reducing taxable income. LIFO becomes less important when inflation is slight and “just in time” procurement strategies keep inventories to an absolute minimum, but it still provides a tax benefit. (Note: the “lower of cost or market” method would also be repealed.)
- Cost recovery. To the extent that a retailer has its own equipment and real property, the Baucus proposals would generally slow down depreciation deductions.
The Baucus draft would ameliorate these changes somewhat for small retailers by expanding the amount of depreciable property that may be expensed immediately from $500,000 to $1,000,000. Also, advertising costs could be included in that total. However, as under present law, this relief phases out where the amount of qualifying property placed in service during the year exceeds $2,000,000.
Economists may say that increased profitability in the retail sector that would result from favorable tax reform should attract additional investment, which could lead to increased competition. By the same token, an increased tax burden on manufacturing could result in capital flight, lessened competition, and increased prices for manufactured goods. So, it is possible that a retailer could find a new competing store across the street (or on the Web) and higher inventory costs, further complicating any analysis of the potential benefits of tax reform.
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