T.C. Memo. 1995-496
UNITED STATES TAX COURT
OHIO PERIODICAL DISTRIBUTORS, INC., f.k.a. SCOTT KRAUSS
NEWS AGENCY, INC., RONALD E. SCHERER TRUST AND
LINDA S. HAYNER TRUST, PERSONS OTHER THAN THE
TAX MATTERS PERSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12982-94. Filed October 16, 1995.
Daniel M. Davidson, for petitioners.
James E. Kagy, for respondent.
MEMORANDUM OPINION
RAUM, Judge: The Commissioner determined adjustments in the
S corporation's income in the amounts of $3,869,422, ($101,725),
$165,516, and $464,205 for its taxable years 1985, 1986, 1987,
and 1988, respectively. At issue is whether an election made by
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the corporation under section 4581, resulting in the exclusion
from gross income of the amount of the corporation's income
attributable to returns from "qualified" sales of magazines and
paperbacks, requires the making of a corresponding adjustment to
cost of goods sold pursuant to section 1.458-1(g), Income Tax
Regs. More specifically at issue is the validity of section
1.458-1(g), Income Tax Regs., which, if valid, would without
dispute require a decision against petitioner.
Ohio Periodical Distributors, Inc. ("Ohio Periodical" or
"the corporation") has been operating as an S corporation in Ohio
since 1984. At all times relevant, the corporation prepared its
Federal income tax returns using the accrual method of
accounting. It was a wholesale distributor of magazines and
paperback books. Its customers were bookstores and other
businesses engaged in the retail sale of such merchandise to the
public.
At all times relevant, in accordance with industry practice,
Ohio Periodical sold more copies of paperbacks and magazines to
its customers than it expected the customers to resell. The
corporation nevertheless billed its customers for the full number
of copies thus sold to them. However, in accordance with
industry practice, the customers had the legal right to receive
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue.
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full credit from the corporation for the magazines and paperbacks
that they were unable to resell.
On its 1982 Federal income tax return, Ohio Periodical made
a proper election to use the provisions of section 458.2 The
election was effective for the 1982 tax year and every tax year
thereafter. For each of the years in issue, the corporation made
sales and had returns of those sales items during the merchandise
return period, defined in section 458(b)(7).3 Such sales were
2
Sec. 458. MAGAZINES, PAPERBACKS, AND RECORDS RETURNED
AFTER THE CLOSE OF THE TAXABLE YEAR.
(a) Exclusion From Gross Income.--A taxpayer who is on an
accrual method of accounting may elect not to include in the
gross income for the taxable year the income attributable to the
qualified sale of any magazine, paperback, or record which is
returned to the taxpayer before the close of the merchandise
return period.
3
Sec. 458(b)(7) reads:
(7) Merchandise return period.--
(A) Except as provided in subparagraph (B),
the term "merchandise return period" means, with
respect to any taxable year--
(i) in the case of magazines, the
period of 2 months and 15 days first
occurring after the close of taxable year, or
(ii) in the case of paperbacks and
records, the period of 4 months and 15 days
first occurring after the close of the
taxable year.
(B) The taxpayer may select a shorter period
than the applicable period set forth in
subparagraph (A).
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qualified sales under section 458(b)(5)4 because the corporation
had a legal obligation to adjust the price if the item was not
resold and the price was adjusted because of failure to resell.
On its Federal income tax returns for each of the years in issue,
Ohio Periodical, pursuant to section 458(b)(6),5 excluded from
gross income the amount of the qualified returns. The
corporation did not, however, make a corresponding adjustment to
cost of goods sold pursuant to section 1.458-1(g), Income Tax
Regs.
In 1994, the Commissioner issued a Notice of Final S
Corporation Administrative Adjustment for the corporation's 1985
4
Sec. 458(b)(5) reads:
(5) Qualified sale.--A sale of a magazine,
paperback, or record is a qualified sale if--
(A) at the time of sale, the taxpayer has a
legal obligation to adjust the sales price of such
magazine, paperback, or record if it is not
resold, and
(B) the sales price of such magazine,
paperback, or record is adjusted by the taxpayer
because of a failure to resell it.
5
Sec. 458(b)(6) reads:
(6) Amount excluded.--The amount excluded under
this section with respect to any qualified sale shall
be the lesser of--
(A) the amount covered by the legal
obligation described in paragraph (5)(A), or
(B) the amount of the adjustment agreed to
by the taxpayer before the close of the
merchandise return period.
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taxable year. At about the same time, the Commissioner also
issued Notices of Final S Corporation Administrative Adjustment
for the corporation's 1986, 1987, and 1988 taxable years.
The Ronald E. Scherer Trust (the "Scherer Trust") was the
Tax Matters Person of the corporation, for purposes of section
6231(a)(7), and a Notice Person of the corporation for purposes
of sections 6226(b)(1) and 6231(a)(8). The Linda S. Hayner Trust
(the "Hayner Trust") was also a Notice Person of the corporation.
The Scherer Trust, as Tax Matters Person, failed to file a
petition for readjustment of subchapter S items within the period
specified in section 6226(a). However, the Scherer Trust and the
Hayner Trust, as Notice Persons, timely filed a petition for
readjustment of subchapter S items under section 6226(b).
The parties have reached an agreement on all issues save the
treatment of adjustments to closing inventory and to cost of
goods sold pursuant to section 1.458-1(g), Income Tax Regs.
Petitioners contend that section 1.458-1(g), Income Tax Regs., is
invalid. However, the parties have stipulated that if this Court
determines that the regulation is valid, the adjustments made by
the Commissioner are proper and should be allowed in their
entirety.
Section 458(a) provides that an accrual basis taxpayer "may
elect not to include in * * * gross income for the taxable year
the income attributable to the qualified sale of any magazine,
paperback, or record which is returned to the taxpayer before the
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close of the merchandise return period." Section 458(b)(6)
defines the amount excluded from gross income as "the lesser of
* * * the amount covered by the legal obligation described in
paragraph (5)(A), or * * * the amount of the adjustment agreed to
by the taxpayer before the close of the merchandise return
period." The legal obligation of paragraph (5)(A) is the
obligation of the taxpayer to adjust the sales price of the
magazine, paperback, or record if it is not resold. Section
1.458-1(g), Income Tax Regs., contains the formula for
determining excludable gross income. It states:
If a taxpayer makes adjustments to gross receipts for a
taxable year under the method of accounting described
in section 458, the taxpayer, in determining excludable
gross income, is also required to make appropriate
correlative adjustments to purchases or closing
inventory and to cost of goods sold for the same
taxable year. Adjustments are appropriate, for
example, where the taxpayer holds the merchandise
returned for resale or where the taxpayer is entitled
to receive a price adjustment from the person or entity
that sold the merchandise to the taxpayer. Cost of
goods sold must be properly adjusted in accordance with
the provisions of section 1.61-3 which provides, in
pertinent part, that gross income derived from a
manufacturing or merchandising business equals total
sales less cost of goods sold.
Id.
The identical issue of the validity of section 1.458-1(g),
Income Tax Regs., was raised in Hachette USA, Inc. v.
Commissioner, 105 T.C. , (1995). Petitioners' counsel in
this case was also counsel in Hachette. Petitioners' briefs in
both cases presented identical arguments. In fact, the 30 pages
of brief in this case that address the validity of the regulation
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are the same verbatim as the corresponding argument in the brief
submitted in Hachette.
Petitioners contend that section 458(b)(6) provides an
explicit formula for determining the adjustment to income: the
amount of the credit against sales price which the taxpayer must
grant to the purchaser. They assert that the language of section
458(b)(6) is unambiguous, and that the formula contained in
section 1.458-1(g), Income Tax Regs., transforms the "amount
excluded" based on credit given for returned items into an amount
equal to the distributor's gross profit on those items.
In response to these arguments, this Court in Hachette held
the regulation valid. Id. at (slip op. at 27). After
examining the legislative history, the Court determined that the
regulation is consistent with generally accepted accounting
principles and with sections 446 and 471. Id. at (slip op.
at 20-21). The Court also held that there is no evidence that
Congress intended that a taxpayer who did not bear any costs
could forgo the correlative cost adjustments. Id. at (slip
op. at 22). Because distributors were reimbursed by publishers,
they should not get the benefit of the deduction without bearing
the risk. Id. In view of the identity of issues and the
detailed analysis by this Court in Hachette, it is unnecessary to
go over the same ground again. We follow Hachette.
Decision will be entered
for respondent.