§446 — General rule for methods of accounting

97-37, supra, had been superseded by Rev.

We find the Fifth Circuit case to be distinguishable from the case at hand, however.

Because our disposition "would be the same regardless ofwhich party had the burden of - 15 - [*15] proof," we need not decide where that burden lies.

Furthermore, we do not agree with the characterization ofJFLP's method as a hybrid method, a position petitioners assert for the first time in their briefs.

For the reasons discussed below, we hold that respondent’s calculation of the deficiency is supported by substantive evidence.

Section 446 Section 446 provides the general rule for accounting methods.

(1) Richmond is entitled to additional costs ofgoods sold (COGS) or deductions for business expenses other than those respondent allowed; (2) Richmond was a reseller or a producer ofmarijuana pursuant to section 471 during the years in issue; (3) Richmond is allowed to change its accounting method pursuant to section 446 for tax year 2015; and (4) Richmond is liable for accuracy-related penalties pursuant to section 6662(a).

- 263 they "have been prejudiced as they have been denied the opportunity to present any evidence regarding whether §446 applies to the treatment of tobacco tax refunds .

Section 446 provides in part : SEC .

We hold that neither FNBC’s method of accounting as to its swaps income nor respondent’s method of accounting as to that income clearly reflected FNBC’s swaps income.

We stated: Under all the circumstances herein, we hold that petitioner has satisfied its heavy burden and has convinced us that it employed a generally accepted method of accounting which ‘clearly reflects its income.’ In so doing, we neither hold nor imply that, under all circumstances, a taxpayer has a right to choose between alternative generally ac

Accordingly, we hold that petitioner's attempted recharacterization of the expenditures in - 36 - issue is an impermissible change in methocl.

446 provides in pertinent part: SEC.

Furthermore, section 446 controls the determination of the method of accounting.

Section 446 provides in pertinent part: (a) General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.

We distinguished the earlier and later versions of the contract. We held that Angelus did not recognize any income under the first version of its contract because it was a true trustee and had no rights to the money. Id. at 395. But we also held that Angelus did recognize income upon receipt under the second version because it didn’t impose any restraint or limitations on Angelus’s ability to use the funds. Id. at 398. This made it look like an advance-payment case. Id. at 399 (citing Schlude; A

The regulations promulgated under section 446 state: “The term ‘method of accounting’ includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item.” Sec.

Section 263 and Section 446 In general, amounts paid to acquire machinery and equipment, furniture and fixtures, and similar property having a useful life 2 Respondent allowed depreciation for the disputed assets of $72,802 for 1995 and $178,819 for 1996.

1997-240, is in error, and, accordingly, the majority’s reliance upon it is unfounded; and (5) this case is factually distinguishable from Osteopathic Med. Oncology & Hematology, P.C. v. Commissioner, 113 T.C. 376 (1999). The majority sets forth the correct standards for determining whether respondent has abused his discretion. Those standards are summarized here to emphasize that petitioner has failed to meet the standard expressed by the majority: The Commissioner has broad authority to decide

1.446-1(e)(2)(ii)(a), Income Tax Regs. A material item is defined as "any item which involves the proper time for the inclusion of the item in income or the taking of a deduction." Sec. 1.446-1(e)(2)(ii)(a), Income Tax Regs. When an accounting practice does nothing more than postpone the reporting of income, rather than permanently avoiding the reporting of income over the taxpayer's lifetime, it involves the proper time for reporting income. See Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500

We decide this issue in the context of whether it was an abuse of respondent’s discretion to exercise his authority under section 446 to require petitioner to change from the cash method to the accrual method.

1992-236, this Court held that, for purposes of section 446, a question of whether collections should be reported in income is different from a question as to the proper time when collections should be reported in income.

1038, 1046-1047 (11th Cir. 1992), affg. 95 T.C. 525 (1990) (taxpayer who lacked control of the management and operations and had limited liability for cattle-feeding losses, and did not work on feedlot, hire or fire employees was not a farmer under sec. 446); compare Hi-Plains Enters., Inc. v. Commissioner, 496 F.2d 520, 523 (10th Cir. 1974), affg. 60 T.C. 158 (1973), in which the - 16 - Court of Appeals indicated that a grain elevator or feed store that sells grain or feed to farmers, and that

Petitioner next argues that, even if the units used in the computation are "items" for section 446 purposes, the change from body size to model line was not a change in item for section 446(e) purposes, as such change was a permissible refinement or delineation of Investments’ existing item definition.

(Diehl), petitioned the Court to redetermine respondent's determination of a $142,986 deficiency in its Federal income tax BERVED OCT 2 9 2001 - 2 - for its taxable year ended May 31, 1995 (1995 taxable year).¹ We must decide whether respondent abused his discretion under section 446 when he determined that Diehl must change its overall method of accounting from a hybrid method to an accrual method.

r without regard to actual receipt. The method sought by respondent, petitioners The parties do not dispute that the timing of petitioners' deductions for the amounts paid to Western General constitutes a "method of accounting" within the meaning of sec. 446. See sec. 1.446-1(a)(1), Income Tax Regs. ("The term 'method of accounting' includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item."). - 17 - contend, distorts income because it limi

without regard to actual receipt. The method sought by respondent, petitioners ' The parties do not dispute that the timing of petitioners' deductions for the amounts paid to Western General constitutes a "method of accounting" within the meaning of sec. 446. See sec. 1.446-1(a)(1), Income Tax Regs. ("The term 'method of accounting' includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item."). - 17 - contend, distorts income because it limi

without regard to actual receipt. The method sought by respondent, petitioners S The parties do not dispute that the timing of petitioners' deductions for the amounts paid to Western General constitutes a "method of accounting" within the meaning of sec. 446. See sec. 1.446-1(a)(1), Income Tax Regs. ("The term 'method of accounting' includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item."). - 17 - contend, distorts income because it limi

r without regard to actual receipt. The method sought by respondent, petitioners The parties do not dispute that the timing of petitioners' deductions for the amounts paid to Western General constitutes a "method of accounting" within the meaning of sec. 446. See sec. 1.446-1(a)(1), Income Tax Regs. ("The term 'method of accounting' includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item."). - 17 - contend, distorts income because it limi

446; Meneguzzo v. - 7 - Commissioner, 43 T.C. 824, 831 (1965).2 Petitioner argues that the notices of deficiency in this case were arbitrary and erroneous, in which case they would not be entitled to the presumption of correctness ordinarily accorded to deficiency notices. Pittman v. Commissioner, 100 F.3d 1308, 1317 (7th Cir. 1996), affg. T.

Section 446 expressly authorizes the Commissioner to reconstruct a taxpayer’s income if the method the taxpayer employs doesn’t clearly reflect income. § 446(b). He has great latitude in doing so—especially when a taxpayer fails to keep adequate books and records—and his reconstruction need only to be reasonable in light of all surrounding facts an

ax Regs., convinces us that respondent was correct to adjust the method the Project Man used.3 The more difficult question is whether respondent's change requires the application of section 481. 3Any combination ofthe methods ofaccounting set out in sec. 446 is permitted in connection with a trade or business ifthe combination clearly reflects income and is consistently used. Sec. 1.446-1(c)(1)(iv)(a), Income Tax Regs. Here, use ofthe cash method in computing gross income from a trade or busines

ax Regs., convinces us that respondent was correct to adjust the method the Project Man used.3 The more difficult question is whether respondent's change requires the application of section 481. 3Any combination ofthe methods ofaccounting set out in sec. 446 is permitted in connection with a trade or business ifthe combination clearly reflects income and is consistently used. Sec. 1.446-1(c)(1)(iv)(a), Income Tax Regs. Here, use ofthe cash method in computing gross income from a trade or busines

When a taxpayer fails to keep adequate books and records, the Commissioner is authorized by section 446 to reconstructthe taxpayer's income using any reasonable method.

Section 446 provides in part: SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule. — Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions. — If no method of accounting has been regularly used by the taxpayer, or if the met

The regulations promulgated under section 446 state : "The term `method of accounting' includes not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item ." Sec .

If taxpayers fail to maintain or do not produce adequate books and records, respondent is authorized by section 446 to reconstruct the taxpayers’ income.

ly 31, 1994 (1994), July 31, 1995 (1995), and July 31, 1996 (1996) (collectively, years in issue); and (2) whether respondent abused his discretion in determining that Qwest’s incremental cost allocation method failed to clearly reflect income under section 446.2 1 Petitioners agree to: (1) Decrease the cost of sales for costs allocated to conduits sold to Metropolitan Fiber Systems (MFS) in the MFS Dallas and MFS Los Angeles projects by $915,870 and $635,317, respectively, and increase the basi

Under section 446,7 the 7 Sec. 446 provides in pertinent part: SEC. 446(a). General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions.--If no method of accounting has been regularly used by the taxpayer, or if the method used does no

Section 446 provides generally that taxpayers are to compute taxable income using the method of accounting that they use in computing income for book purposes, unless such method does not clearly reflect income. Under section 446(c), the accrual method is a permissible method of accounting. Sec. 446(c)(2). Specifically, under the accrual method of

Section 446 provides: SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule.–-Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions.–-If no method of accounting has been regularly used by the taxpayer, or if the method used d

Section 446 provides: SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule.–-Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions.–-If no method of accounting has been regularly used by the taxpayer, or if the method used d

The sole issue for decision is whether - 2 - it was an abuse of respondent’s discretion, under section 446, to require petitioner to change from the cash method of accounting to the accrual method of accounting in order to reflect clearly the income of petitioner’s oil and gas business.

ess nor required for the effective discharge of respondent’s revenue-collecting responsibilities. Accordingly, we turn to a determination as to whether petitioner’s method of accounting ‘clearly reflects - 94 - income’ pursuant to the provisions of section 446. * * * Id. at 283–284. In Fort Howard Paper Co., we found the taxpayer’s method of accounting clearly to reflect income notwithstanding that the taxpayer allocated no overhead to self-constructed property under the “incremental cost” metho

ess nor required for the effective discharge of respondent’s revenue-collecting responsibilities. Accordingly, we turn to a determination as to whether petitioner’s method of accounting ‘clearly reflects - 94 - income’ pursuant to the provisions of section 446. * * * Id. at 283–284. In Fort Howard Paper Co., we found the taxpayer’s method of accounting clearly to reflect income notwithstanding that the taxpayer allocated no overhead to self-constructed property under the “incremental cost” metho

In addition, regulations promulgated under section 446 further clarify the operation of these statutory mandates: Requirement respecting the adoption or change of accounting method.

As used in section 446, the term “method of accounting” encompasses “not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item”.

446; Don Casey Co. v. Commissioner, 87 T.C. 847, 862 (1986). Before our decision in Osteopathic Med. Oncology & Hematology, P.C., Wilkinson-Beane, Inc. v. Commissioner, supra, and its progeny provided at least a colorable factual and legal basis for the Commissioner’s conclusion that drugs used in treating patients constituted merchandise, the

446; Don Casey Co. v. Commissioner, 87 T.C. 847, 862 (1986). Before our decision in Osteopathic Med. Oncology & Hematology, P.C., Wilkinson-Beane, Inc. v. Commissioner, supra, and its progeny provided at least a colorable factual and legal basis for the Commissioner’s conclusion that drugs used in treating patients constituted merchandise, the

- 7 - Under section 446,6 the Commissioner has broad powers to determine whether an accounting method used by a taxpayer clearly reflects income.

Section 446 imposes a heavy burden on a taxpayer disputing the Commissioner’s determination on accounting matters. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532-533 (1979). We review the Commissioner’s exercise of authority under section 446(b) for abuse of discretion. See Ford Motor Co. v. Commissioner, 102 T.C. 87, 91 (1994), affd. 7

er asserts that, although the costs are expensed ratably over 2 years for purposes of financial records and deducted currently, in 1 year, for tax purposes, the method of tax accounting used clearly reflects petitioner’s income within the meaning of section 446. - 5 - Thus, any attempt by respondent to require a change in this tax accounting method constitutes, in petitioner’s view, an abuse of discretion. Conversely, respondent contends that, since a greater percentage of the costs at issue is

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

We decide this issue in the context of whether it was an abuse of respondent’s discretion to exercise his authority under section 446 and require petitioner to change from the cash method to a hybrid method.

* * * Section 1.1502-17, Income Tax Regs., entitled “Methods of accounting”, stated that “The method of accounting to be used by each member of the group shall be determined in accordance with the provisions of section 446 as if such member filed a separate return.” Section 446(a) stated that “Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.” Section 1.446-l(a)(l), Income Tax Regs., further prov

Petitioners contend that section 446 requires the Commissioner to make an express finding that the method of accounting used by the taxpayer does not clearly reflect income.

Given respondent's broad authority pursuant to section 446, the paucity of information that petitioners maintained with respect to cost of goods sold, and the fact that petitioners did not have a valid method of accounting for reporting inventories, we reject petitioners' contention.

Section 446 provides in pertinent part: (a) General Rule. — Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions. — If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income

Pursuant to section 446,4 the Commissioner has broad powers to determine whether an accounting method used by a taxpayer clearly reflects income.

Section 446 imposes a heavy burden on the taxpayer disputing the Commissioner's determination on accounting matters. Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532-533 (1979). To prevail, a taxpayer must establish that respondent's determination is "clearly unlawful" or "plainly arbitrary". Id. However, if the taxpayer's method of accountin

respondent's discretion to require petitioner to change from the cash method of accounting to the accrual method of accounting.3 Subsumed in this issue is the question of whether petitioner should be required to use inventories for tax purposes.4 3 Sec. 446 provides in pertinent part: SEC. 446(a). General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Exceptions.--If no method of ac

That court has said: § 446 gives the Commissioner discretion with respect to two determinations.

ion or use of medical supplies. For psychiatric - 39 - hospitals, ancillary services include group and individual therapy. OPINION Section 446(a)16 requires a taxpayer to compute taxable income under the method of accounting it regularly uses in 16 Sec. 446 provides in pertinent part as follows: SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in ke

We consider section 446 in deciding this issue.

ion or use of medical supplies. For psychiatric - 39 - hospitals, ancillary services include group and individual therapy. OPINION Section 446(a)16 requires a taxpayer to compute taxable income under the method of accounting it regularly uses in 16 Sec. 446 provides in pertinent part as follows: SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING. (a) General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in ke

"An action taken by the Commissioner under section 446 will be set aside by the courts only if there is a clear abuse of discretion." Cole v.

Accrual method taxpayers like Norwich recognize taxable income when all events fixing the right to receive income have occurred and the amount can be determined with reasonable accuracy. See I.R.C. § 451(b). The claim of right doctrine provides an interesting twist to determining when the receipt of funds constitutes taxable income a

● If respondent’s position on one or both of the foregoing questions is sustained, whether the Commissioner’s action constitutes a change to GWA’s method of accounting to clearly reflect income under section 446, requiring one or more section 481 adjustments to prevent amounts from being duplicated or omitted.

§ 1.446-1(c)(1)(i). 27 [ *27] B. Qualified Research To constitute qualified research, the research must satisfy a four- part statutory test: Sec. 41(d). Qualified research defined. . . . (1) In general.—The term “qualified research” means research— (A) with respect to which expenditures may be treated as expenses under section 1

ner’s reliance on the economic performance requirement of section 461(h) is misplaced. Section 461 provides general rules with respect to the proper year for taking deductions, which in turn rest in part on the taxpayer’s method of accounting under section 446. An accrual method taxpayer is generally entitled to deduct expenses for the years in which the taxpayer 9 The sale provision provides: If, in connection with the sale or exchange of a trade or business by a taxpayer, the purchaser express

accounting method “clearly reflect[s] income,” a concept the Code does not define, and therefore whether a taxpayer may use that method to compute taxable income.14 See Commissioner v. Hansen, 360 U.S. 446, 467 (1959) (discussing the predecessor of section 446). The IRS abused this discretion by denying a taxpayer the use of an accounting method permitted by Rev. Proc. 71-21, 1971-2 C.B. 549, even though the taxpayer qualified to use the method by the terms of the revenue procedure itself. Barn

522, 532 (1979) (“[I]t is obvious that on their face, §§446 and 471, with their accompanying Regulations, vest the Commissioner with wide discretion in determining whether a particular method of inventory accounting should be disallowed as not clearly reflective of income.”); Commissioner v.

422, 440 (1926); see also Trinity Indus., Inc.

422, 440 (1926); see also Trinity Indus., Inc.

422, 440 (1926); see also Trinity Indus., Inc.

522, 532 (1979) (“[I]t is obvious that on their face, §§446 and 471, with their accompanying Regulations, vest the Commissioner with wide discretion in determining whether a particular method of inventory accounting should be disallowed as not clearly reflective of income.”); Commissioner v.

- 16 - Section 1.446-1(a)(4)(i), Income Tax Regs., provides that a taxpayerwho is involved in the production, purchase, or sale ofmerchandise must account for merchandise on hand at the beginning and end ofeach year, so as to compute properly taxable income for each year.

- 16 - Section 1.446-1(a)(4)(i), Income Tax Regs., provides that a taxpayerwho is involved in the production, purchase, or sale ofmerchandise must account for merchandise on hand at the beginning and end ofeach year, so as to compute properly taxable income for each year.

Section 481 was designed "to complement section 446." German, 65 T.C.M.

446; Petzoldt v. Commissioner, 92 T.C. at 686-687. The reconstruction need only be reasonable. Petzoldt v. Commissioner, 92 T.C. at 687. One established method of reconstructing a taxpayer's income when the taxpayer has inadequate records and large bank deposits is the bank deposits method. M DiLeo v. Commissioner, 96 T.C. at 867; Estate ofMas

446; Petzoldt v. Commissioner, 92 T.C. 661, 686-687 (1989). The reconstruction need only be reasonable. Petzoldt v. Commissioner, 92 T.C. at 687. One established method ofreconstructing a taxpayer's income when the taxpayer has inadequate records and large bank deposits is the bank deposits method. See DiLeo v. Commissioner, 96 T.C. at 867. Ba

The Commissioner has broad powers under section 446 to compute the taxable income ofa taxpayer.

e full income was not recognized in those prior years. Respond- ent's adjustments to the entities' returns are shown below in the following tables: S. I. Securities Ordinary income adjustments Adjustment 2007 2008 Sec. 481(a) adjustment $532,746 --- Sec. 446 currentyear adjustment 188,786 $28,694 Gross receipts (reclassified capital gains) 150,151 54,377 Contract for deed default expenses ¹ (48,998) (40,870) Total 822,685 42,201 ¹Petitioners have not challenged respondent's determination with re

e full income was not recognized in those prior years. Respond- ent's adjustments to the entities' returns are shown below in the following tables: S. I. Securities Ordinary income adjustments Adjustment 2007 2008 Sec. 481(a) adjustment $532,746 --- Sec. 446 currentyear adjustment 188,786 $28,694 Gross receipts (reclassified capital gains) 150,151 54,377 Contract for deed default expenses ¹ (48,998) (40,870) Total 822,685 42,201 ¹Petitioners have not challenged respondent's determination with re

e full income was not recognized in those prior years. Respond- ent's adjustments to the entities' returns are shown below in the following tables: S. I. Securities Ordinary income adjustments Adjustment 2007 2008 Sec. 481(a) adjustment $532,746 --- Sec. 446 currentyear adjustment 188,786 $28,694 Gross receipts (reclassified capital gains) 150,151 54,377 Contract for deed default expenses ¹ (48,998) (40,870) Total 822,685 42,201 ¹Petitioners have not challenged respondent's determination with re

446; Meneguzzo v. Commissioner, 43 T.C. at 831. The Commissioner has great latitude in adopting a suitable method for reconstructingthe taxpayer's income. Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970). The amount ofincome determined by the Commissioner need not be exact so long as it is based on a reasonable methodology in the light ofall

446; Meneguzzo v. Commissioner, 43 T.C. 824, 831 (1965); see also Miller v. Commissioner, 237 F.2d 830, 838 (5th Cir. 1956), aff'g in part, rev'g in part T.C. Memo. 1955-112. The reconstruction need only be reasonable in the light ofall surrounding facts -7- [*7] and circumstances. Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970); Schroeder

- 9 - [*9] Notice ofDeficiency The notice ofdeficiency stated that the IRS had made a section 446 adjustment of$902,851 and a section 481 adjustment of$2,740,161 to HFM's 2005 tax return.

Mingo's partnership proceeds attributable to unrealized receivables as an installment sale, petitioners' reporting ofthat sale constituted the election ofan accounting method under section 446 such that section 481(a) applies; (3) additionally, ifsection 481(a) applies, whether petitioners must recognize ordinary income of$126,240 under section 481(a) for tax year 2003 as a result ofrespondent's change oftheir accounting method with respect to the sale; 1Unless otherwise indicated, section refer

Frontier used the same accounting method for tax that it used for financial (book) accounting. In 2005 Frontier capitalized direct material and labor costs and post-production-period carrying costs, but it claimed deductions for salaries, yearend bonuses, and other miscellaneous expenses. Frontier requests this Court to sustain its origin

ferences are to the Internal Revenue Code (Code) in effect for the year in issue, and all Rule references are to the Tax Court Rules ofPractice and Procedure. 2Respondent concedes that alternative argument set forth in the notice of deficiency under sec. 446. windows. Petitioner handles sales and research and development for Zeluck, Inc. Petitioner and Kevin Zeluck often invest in similar ventures together. PW & F-W-01 Drilling Co. (PW Partnership) was formed August 1, 2001, purportedly for the

Where a taxpayer's method of accounting does not clearly reflect lncome, section 446 (b) authorizes the Commissioner to compute taxable income under a method which, in his opinion, clearly reflects income.

Where a taxpayer fails to keep the required books and records, or if the records the taxpayer maintains do not clearly reflect income, the Commissioner is authorized by section 446 to reconstruct the taxpayer's income in accordance with a method that clearly reflects the full amount of income äreceived.

446(h); Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989). The Commissioner may use indirect methods, and he is given latitude in determining which method of reconstruction to apply. Petzoldt v. Commissioner, supra at 693. The Commissioner's reconstruction of a taxpay r's income need only be reasonable in the light of all surrou ding facts and

Was the IRS' s determination that section 446 required Penco to use the accrual method of accou ting an abuse of discretion?

actment of section 448, taxpayers whose businesses did not involve inventories generally could elect to use any method of accounting that clearly reflected income and that was regularly used in keeping the taxpayer's(cid:127)books and records under section 446 . Congress enacted section 448(a) because it believed "that the cash method 15 - of accounting frequently fails to reflect accurately the economic results of a taxpayers's trade or business over a taxable year ." H . Rept . 99-426, at 605

The Commissioner may use any of several methods to reconstruct a taxpayer' s taxable income ; and when a taxpayer fails to keep adequate books and records, the Commissioner is authorized by section 446 to determine the existence and amount of the taxpayer's income by any method that clearly reflects income .

re the enactment of section 448, taxpayers whose businesses did not involve inventories generally could elect to use any method of accounting that clearly reflected income and that was regularly used in keeping the taxpayer’s books and records under section 446. Congress enacted section 448(a) because it believed “that the cash method of accounting frequently fails to reflect accurately the economic results of a taxpayers’s trade or business over a taxable year.” H. Rept. 99-426, at 605 (1985),

In general section 446 and the regulations thereunder govern the timing and computation of income, deduction, and loss with respect to a notional principal contract that is a section 988 transaction .

In general section 446 and the regulations thereunder govern the timing and computation of income, deduction, and loss with respect to a notional principal contract that is a section 988 transaction.

Examples of actions in which we conduct a trial de novo include those where we must decide whether it was an abuse of discretion for the Commissioner to (1) determine that a taxpayer's method of accounting did not clearly reflect income under section 446, e .g ., Thor Power Tool Co .

Marlin When a taxpayer fails to maintain or produce adequate book s and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method that clearly reflects .income .

are treated as materials and supplies that are not incidental are considered consumed and used in the year in which the taxpayer sells the merchandise or finished goods. See Rev. 15The IRS will not challenge a taxpayer’s use of the cash method under sec. 446, or a taxpayer’s failure to account for inventories under sec. 471, in a tax year ending before Dec. 17, 1999, if the taxpayer would satisfy the 3-tax-year-period gross receipts test of Rev. Proc. 2001-10, sec. 5.01, 2001-1 C.B. 272, 273. Id

Examples of actions in which we conduct a trial de novo include those where we must decide whether it was an abuse of discretion for the Commissioner to (1) determine that a taxpayer’s method of accounting did not clearly reflect income under section 446, e.g., Thor Power Tool Co.

The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer’s taxable income by any method which, in the Commissioner’s opinion, clearly reflects income.

When a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which clearly reflects income .

The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer’s taxable income by any method which, in the Commissioner’s opinion, clearly reflects income.

The Commissioner has broad powers under section 446~to compute the taxable income of a taxpayer .

The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer’s taxable income by any method which, in the Commissioner’s opinion, clearly reflects income.

The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer’s taxable income by any method which, in the Commissioner’s opinion, clearly reflects income.

The Commissioner’s Use of the Bank Deposits Method of Income Reconstruction Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer’s taxable income by any method which, in the Commissioner’s opinion, clearly reflects income.

Section 446 Section 446 prescribes certain rules with respect to methods of accounting: A taxpayer computes its taxable income in accordance with its method of accounting, see sec. 446(a), and has some discretion in choosing a permissible method of accounting, see sec. 446(c). Nevertheless, no method of accounting is acceptable unless, in the opini

Bank Deposits Method for Computing Taxable Income The IRS has broad powers under section 446 to compute the taxable income of a taxpayer.

Section 446 Section 446 prescribes certain rules with respect to methods of accounting: A taxpayer computes its taxable income in accordance with its method of accounting, see sec. 446(a), and has some discretion in choosing a permissible method of accounting, see sec. 446(c). Nevertheless, no method of accounting is acceptable unless, in the opini

When a taxpayer fails to keep the required books and records, section 446 authorizes the Commissioner to “reconstruct income in accordance with a method which clearly reflects the full amount of income received.” Petzoldt v.

Section 446 Section 446 prescribes certain rules with respect to methods of accounting: A taxpayer computes its taxable income in accordance with its method of accounting, see sec. 446(a), and has some discretion in choosing a permissible method of accounting, see sec. 446(c). Nevertheless, no method of accounting is acceptable unless, in the opini

er, without further explanation or support, what would seem to be a novel legal theory. Section 461 provides general rules with respect to the proper year for taking deductions, which in turn rest in part on the taxpayer’s method of accounting under section 446. An accrual method taxpayer, such as KareMor and Mayor in these cases, is typically entitled to a deduction “in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability c

If the taxpayer does not, the Commissioner is authorized by section 446 to reconstruct the taxpayer’s income.

Examples of actions in which we conduct a trial de novo are whether it was an abuse of discretion for the Commissioner to (1) determine that a taxpayer’s method of accounting did not clearly reflect income under section 446, e.g., Thor Power Tool Co.

tandard may be the subject of a trial de novo does not necessarily mean that we are free to substitute our judgment for that of the Commissioner in such cases. See, e.g., Capitol Fed. Sav. & Loan Association v. Commissioner, 96 T.C. 204, 209 (1991) (sec. 446); Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525 (1989), affd. 933 F.2d 1084 (2d Cir. 1991) (sec. 482). Separately, the majority cites two Memorandum Opinions of this Court in support of the proposition that "[t]he Court has (continued...)

Commissioner, 94 T.C. 654, 658 (1990); Petzoldt v. Commissioner, 92 T.C. 661, 687 (1989). The reconstruction need only be reasonable in light of - 6 - all surrounding facts and circumstances. See Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970); Schroeder v. Commissioner, 40 T.C. 30, 33 (1963). Respondent determined that petiti

Examples of actions in which we conduct a trial de novo are whether it was an abuse of discretion for the Commissioner to (1) determine that a taxpayer’s method of accounting did not clearly reflect income under section 446, e.g., Thor Power Tool Co.

rly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.” In general, the accrual method is designated a permissible method of accounting for purposes of section 446. Sec. 446(c)(2). Under the accrual method, income is to be included for the taxable year when all events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy. Secs.

ses the cash method of accounting, entitlement to a section 162(a) deduction presupposes that the taxpayer can substantiate by sufficient records that the underlying expense has been paid. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.; see also sec. 446; sec. 5 E.g., according to the notice of deficiency, the gain realized from the sale of the condominium is includable in petitioner’s 1993 income because he has “not established the requirements of section 121 or section 1034 * * * have been

As used in section 446, the térm “method of accounting” encompasses “not only the over-all method of accounting of the taxpayer but also the accounting treatment of any item”.

The issues presented implicate not only section 472, enti- tled "Last-In, First-Out Inventories", but also section 446, entitled "General Rule for Methods of Accounting", and section 471, entitled "General Rule for Inventories".

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

Section 703(a) provides that with exceptions "The taxable income of a partnership shall be computed in the same manner as in the case of an individual".

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

When a taxpayer fails to keep adequate books and records, respondent is authorized by section 446 to reconstruct the taxpayer’s income using any reasonable method.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

axpayer] should be required to use the inventory method for tax purposes." J.P. Sheahan Associates, Inc. v. Commissioner, T.C. Memo. 1992-239. Accordingly, we turn to the applicable Code provision and case law dealing with this matter. We begin with section 446. That section provides in pertinent part as follows: SEC. 446(a). General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Ex

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

axpayer] should be required to use the inventory method for tax purposes." J.P. Sheahan Associates, Inc. v. Commissioner, T.C. Memo. 1992-239. Accordingly, we turn to the applicable Code provision and case law dealing with this matter. We begin with section 446. That section provides in pertinent part as follows: SEC. 446(a). General Rule.--Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books. (b) Ex

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

OPINION Where a taxpayer fails to maintain or produce adequate books and records, the Commissioner is authorized under section 446 to compute the taxpayer's taxable income by any method which, in the Commissioner's opinion, clearly reflects income.

learly reflects income.5 Sec. 446(b); United States v. Johnson, 319 U.S. 503 (1943); Burka v. Commissioner, 179 F.2d 483 (4th Cir. 1950). Petitioners bear the burden to prove that respondent's method does not clearly reflect income. Rule 142(a); see sec. 446. The indirect method used to calculate income must be reasonable. See, e.g., Holland v. United States, 348 U.S. 121 (1954). The percentage markup method is well recognized as a reasonable means of reconstructing income, see Bollella v. Commi

er asserts that, although the costs are expensed ratably over 2 years for purposes of financial records and deducted currently, in 1 year, for tax purposes, the method of tax accounting used clearly reflects petitioner’s income within the meaning of section 446. Thus, any attempt by respondent to require a change in this tax accounting method constitutes, in petitioner’s view, an abuse of discretion. Conversely, respondent contends that, since a greater percentage of the costs at issue is alloca

OPINION The issues presented implicate not only section 472, entitled “Last-In, First-Out Inventories”, but also section 446, entitled “General Rule for Methods of Accounting”, and section 471, entitled “General Rule for Inventories”.

(Emphasis added.) For purposes of section 446, however, the “taxpayer” is the partnership.

o doing, have been acting in 37 accordance with established industry practice that has been in effect for decades, respondent's characterization of these costs as capital expenditures would amount to a change in its accounting "methods" contrary to section 446. Section 446(a) permits a taxpayer to compute taxable income "under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books." A taxpayer's "method of accounting" includes not only the

893 (1954). Under the percentage markup method, gross receipts are determined by adding a percentage to the cost of goods sold. The burden of proof is on petitioners to show that respondent's method does not clearly reflect income. Rule 142(a); see sec. 446. Since petitioners did not keep books to show gross receipts from sales, it was permissible for respondent to apply a markup percentage to determine their gross receipts for 1992 and 1993. In 1992, on their Schedule C, petitioners claimed su

* * * (3) Exceptions.--Where property is substantially vested upon transfer, the deduction shall be allowed to such person in accordance with his method of accounting (in conformity with section 446 and 461).

446; Petzoldt v. Commissioner, 92 T.C. 661, 686-687 (1989). The cash method is designed to reconstruct the income of a taxpayer who consumes his income during the year and does not invest it. Id. at 694. It 4 This method has been referred to by both names. See DeVenney v. Commissioner, 85 T.C. 927, 930 (1985). - 14 - is based on the assumptio

If a taxpayer fails to maintain or does not produce adequate books and records, the Commissioner is authorized by section 446 to reconstruct the taxpayer's income.

o doing, have been acting in 37 accordance with established industry practice that has been in effect for decades, respondent's characterization of these costs as capital expenditures would amount to a change in its accounting "methods" contrary to section 446. Section 446(a) permits a taxpayer to compute taxable income "under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books." A taxpayer's "method of accounting" includes not only the

Where property is substantially vested upon transfer, the deduction shall be allowed to such person in accordance with his method of accounting (in conformity with section 446 and 461).

Commissioner, 92 T.C. 661, 686-687 (1989); Harbin v. Commissioner, 40 T.C. 373, 376 (1963). This Court has approved the Commissioner's use of the source and application of funds method to reconstruct income. Vassallo v. Commissioner, 23 T.C. 656, 661-662 (1955). This method is based on the assumption that the amount by which th

The Court of Appeals for the Sixth Circuit has stated: - 23 - § 446 gives the Commissioner discretion with respect to two determinations.

501, to implement an administrative decision, made by the Commissioner of Internal Revenue in the exercise of his discretion under section 446 of the Internal Revenue Code of 1954, to allow accrual method taxpayers in certain specified and limited circumstances to defer - 18 - the inclusion in gross income for Federal income tax purposes of payments received (or amounts due and payable) in one taxable year for services to be performed by the end of the next succeeding taxable

446; Holland v. United States, 348 U.S. 121, 130-132 (1954). The bank deposits method has long been approved by the courts as a method for computing income. Estate of Mason v. Commissioner, supra at 656. Bank deposits are prima facie evidence of income. 7 Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Estate of Mason v. Commissioner, supra

Purpose The purpose of this Revenue Procedure is to implement an administrative decision, made by the Commissioner in the exercise of his discretion under - 14 - section 446 of the Internal Revenue Code of 1954, to allow accrual method taxpayers in certain specified and limited circumstances to defer the inclusion in gross income for Federal income tax purposes of payments received (or amounts due and payable) in one taxable year for services to be performed by the end of the next succeeding tax

If a taxpayer fails to keep the required books and records, or if the books and records maintained do not clearly reflect income, respondent is authorized by section 446 to reconstruct income in accordance with a method that clearly reflects the full amount of income received, Petzoldt v.

Under this method, an expense is deductible when all events have occurred to establish the fact of liability, the amount can be determined with reasonable accuracy, and economic performance has occurred. Sec. 461(h)(1), (4); United States v. General Dynamics Corp., 481 U.S. 239, 243 (1987) - 26 - (accrual method taxpayer may not deduct a

501, to implement an administrative decision, made by the Commissioner of Internal Revenue in the exercise of his discretion under section 446 of the Internal Revenue Code of 1954, to allow accrual method taxpayers in certain specified and limited circumstances to defer the inclusion in gross income for Federal income tax purposes of payments received (or amounts due and payable) in one taxable year for services to be performed by the end of the next succeeding taxable year.

Purpose The purpose of this Revenue Procedure is to implement an administrative decision, made by the Commissioner in the exercise of his discretion under section 446 of the Internal Revenue Code of 1954, to allow accrual method taxpayers in certain specified and limited circumstances to defer the inclusion in gross income for Federal income tax purposes of payments received (or amounts due and payable) in one taxable year for services to he performed by the end of the next succeeding taxable ye

Commissioner, 40 T.C. 373, 377 (1963); sec. 1.446-1(b)(1), Income Tax Regs. The Commissioner may use any reasonable method to compute the income, and no particular method is required. Campbell v. Guetersloh, 287 F.2d 878, 880 (5th Cir. 1961). The Commissioner's method need not be exact but must be reasonable. Holland v. United S

United States, 348 U.S. 121, 130-132 (1954). The bank deposits method has long been approved by the courts as a method for computing income. Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir. 1977). Bank deposits are prima facie evidence of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986