Tax Laws and Regulations - Manufacturing
The following is a partial list of issues solicited from Internal Revenue Agents on accounting method changes identified during examinations. This is posted for informational purposes only and does not represent any official position of the Internal Revenue Service.
Improper adjustment period:
Taxpayer has changed its method of accounting for depreciation, which resulted in a negative adjustment (in the taxpayer's favor). Taxpayer has taken this negative adjustment into account in the year 19x1. No form 3115 was filed requesting an accounting method change.
Updated Analysis: Revenue Procedure 2002-09 modified by RP 2002-19 and 2004-11 for years 2001 and subsequent: When Form 3115 is filed an automatic consent is granted. This is available if not enough or too much depreciation was claimed by using an improper method of depreciation; compliance with section 2 of the appendix necessary; one-year reporting of taxpayer favorable section 481(a) and four-year reporting of Service favorable section 481(a) adjustment.
Erroneous method becomes an accounting method:
For unknown reason, taxpayer's internal system writes up the cost of used cars (inventory) by $100. The taxpayer has done this for more than two years. Now in year 199X the taxpayer wishes to restate its inventory balance to the correct amounts and makes a large adjusting entry reducing taxable income for the amount. No form 3115 requesting an accounting method change.
According to the analysis in Revenue Ruling 90-38, 1990-1, CB 57 the "treatment of a material item in the same way in determining the gross income or deductions in two or more consecutively filed tax returns represents consistent treatment of that item for purposes of section 1.446-1(e)(2)(ii)(a) of the regulations." A scenario similar to this represents the use of an erroneous accounting method. Any change would require the filing of Form 3115 and an adjustment period of 4 years, rather than 1 year.
The filing of an amended return to change an accounting method:
Taxpayer elected to use the accrual method on its initial return filing in year 19X1. In 19X3, the taxpayer decided that the use of the cash method might be more favorable.
The use of a proper method of accounting on its first return established the method of accounting. The taxpayer, therefore, is bound by its initial election. See generally in section 1.446-1(e)(1) of the regulations and Revenue Ruling 90-38, 1990-1, CB 57
Revenue Ruling 94-38 - Environmental Cleanup Cost of Land
Costs incurred to clean up land and to treat groundwater that a taxpayer contaminated with hazardous waste from its business are deductible by the taxpayer as ordinary and necessary business expenses under section 162 of the Code. Costs properly allocable to constructing groundwater treatment facilities are capital expenditures under section 263. Revenue Ruling 88-57 modified.
Environmental Cleanup Rev Ruling 2000-7
Mountain State Ford Truck Sales, Inc., 112 T.C. No. 7, March 2, 1999
LIFO - Replacement Costs
- For LIFO inventory purposes, taxpayers must use actual cost and not replacement cost
- The use of replacement cost does not clearly reflect income
- The IRS did not abuse its discretion by adding the taxpayer's LIFO reserve back to income since the taxpayer failed to keep adequate records to compute LIFO using any other method
Update: Automotive Alert (from Automotive section) on Revenue Procedure 2002-17
On March 11, 2002, the IRS released the long anticipated resolution to the replacement cost LIFO issue. Revenue Procedure 2002-17 describes a safe harbor method of accounting for vehicle parts inventory that allows automobile dealers to approximate the cost of their parts. The revenue procedure includes procedures for dealers to receive automatic consent to change to the replacement cost method.
Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979), 1979-1 C.B. 167
Lower of Cost or Market Method Ruling:
The taxpayer, who used the "lower of cost or market" method of valuing inventories, wrote down what it regarded as "excess" inventory to its net realizable value, which in most cases was determined to be scrap value. The taxpayer determined that this inventory, mostly spare parts, was "excess" inventory because it was held in excess of any reasonably foreseeable future demand, although this inventory was not scrapped or sold at reduced prices. The taxpayer physically retained the excess items in inventory and continued to sell them at original prices. The Supreme Court, in disallowing the taxpayer's write-down, held that because the taxpayer provided no objective evidence of the reduced market of its excess inventory, its write-down was plainly inconsistent with the regulations and was properly disallowed by the Commissioner. The taxpayer could not have properly taken advantage of any permitted write-down because it did not scrap its "excess" inventory nor sell or offer it for sale at prices below market (replacement cost).
IRC Section 471 - General Rule for Inventories
IRC Section 472 - Last In, First Out Inventories
IRC Section 263A - Capitalization and Inclusion in Inventory Costs of Certain Expenses
Standard Oil Company (Indiana) v. Commissioner, 77 T.C. 349 (1981)
Gimbel Brothers, Inc., 1976-1 U.S.T.C. 9404 (1976) not followed per Rev. Rul. 90-38.
Korn Industries, Inc., 532 F.2d. 1352 (CT.CL. 1976) not followed per Rev. Rul. 77-134.
Schuster's Express, Inc. v. Commissioner, 66 T.C. 588(1976). Court ruled in favor of taxpayer who claimed it was a correction of error.
Knight-Ridder Newspaper, Inc., 743 F.2d. 781 (11th Cir. 1984). Court ruled in favor of IRS and ruled it was a method change.
Pacific Enterprises, Inc., 101 T.C. 1 (1993).
Miller (Addressed 471, what is inventoriable cost. Full absorption)
Goldengate Litho (Determined that printers are manufacturers and let them go on accrual basis)
Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.