T.C. Memo. 1998-223
UNITED STATES TAX COURT
JIM TURIN & SONS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17643-96. Filed June 24, 1998.
Norman Sepenuk and Gary P. Compa, for petitioner.
Kathey I. Shaw and Shirley M. Francis, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARR, Judge: Respondent determined deficiencies in
petitioner's Federal income tax for taxable years 1987, 1988,
1990, 1991, and 1993 in the amounts of $378, $302, $23,269,
$39,561, and $20,770, respectively.
All section references are to the Internal Revenue Code in
effect for the taxable years in issue, and all Rule references
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are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
After a concession,1 the issue for decision is: Whether
respondent's determination that petitioner must change from the
cash method of accounting to the accrual method of accounting was
an abuse of discretion. We hold it was.
Some of the facts have been stipulated and are so found.
The stipulated facts and the accompanying exhibits are
incorporated herein by this reference. At the time the petition
in this case was filed, petitioner's principal place of business
was located in Sandy, Oregon.
FINDINGS OF FACT
Petitioner is a corporation engaged in the business of
providing asphalt paving services. A sister corporation, Mt.
Hood Asphalt (Mt. Hood), manufactures asphalt. On an as-needed
basis, petitioner purchases asphalt from Mt. Hood at
approximately $19 per ton. Mt. Hood also sells asphalt to its
other customers at approximately $23 per ton.
When bidding on a contract or job, petitioner prices the
asphalt at cost. Since petitioner can generally purchase asphalt
at a lower cost, it has a competitive advantage over other paving
1
Respondent concedes a repairs expense adjustment for
1991 of $18,800 and related adjustments for depreciation expenses
for 1991, 1992, and 1993. In light of this concession, and
previously agreed adjustments set forth in the statutory notice
of deficiency, a Rule 155 computation is necessary.
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contractors in bidding on a contract. This competitive
advantage, the difference between petitioner's cost of asphalt
and the price other paving contractors have to pay for asphalt,
is passed along to the customer. If petitioner marked up the
asphalt, it would have no competitive advantage in bidding on
contracts. On some jobs, petitioner purchases asphalt from third
parties. In bidding on contracts where asphalt is purchased from
third parties, the asphalt is also bid at cost.
Over the years, petitioner has developed its own method for
determining the profit necessary for a normal job. This method
is to charge approximately $3,000 for a full paving crew for 1-
day's work. This $3,000 per day will cover petitioner's office
overhead and provide sufficient profit to keep petitioner in
business. The base $3,000 per day figure is then sometimes
modified depending on competitive conditions. If petitioner is
very busy or has some other competitive advantage such as
location and is requested to bid on a job, petitioner may bid
substantially higher than $3,000 per day. Conversely, if
business is slow, or for some other reason, petitioner may bid
substantially below $3,000 per day to get the job. Whatever the
job, asphalt is always priced at cost, and the income earned on a
particular job or contract bears no relation to the amount of
asphalt used.
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In performing its paving contracts, petitioner takes
delivery of the asphalt when its temperature is between 300 and
320 degrees Fahrenheit. If the asphalt is not on the ground and
rolled by the time it is 150 degrees, it can no longer be used.
Under normal circumstances, the window of opportunity is
approximately 3 hours.
Petitioner has approximately 100 to 150 jobs or contracts
per year of varying size and complexity. Generally, petitioner
does not get paid until it completes a job. When a job is
finished, petitioner bills the customer and requires payment
typically within 30 days.
OPINION
Respondent determined that for the taxable years 1990, 1991,
and 1993,2 petitioner's asphalt was merchandise that was an
income-producing factor, that petitioner therefore had
inventories, and thus it must use the accrual method of
accounting in order to clearly reflect taxable income.
The principal issue for decision is whether it was an abuse
of respondent's discretion to require petitioner to change from
the cash method of accounting to the accrual method of
accounting. Subsumed in this issue is the question of whether
2
Although the statutory notice of deficiency in the
instant case covered 1987, 1988, 1990, 1991, and 1993, respondent
did not change petitioner's method of accounting for 1987 and
1988.
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petitioner should be required to use inventories for tax
purposes.
By regulation, the Secretary has determined that inventories
are necessary if the production, purchase, or sale of merchandise
is an income-producing factor. Sec. 1.471-1, Income Tax Regs.
Although not specifically defined in the Internal Revenue Code or
the regulations, courts have held that "merchandise", as used in
section 1.471-1, Income Tax Regs., is an item acquired and held
for sale. See, e.g., Wilkinson-Beane, Inc. v. Commissioner, 420
F.2d 352, 354-355 (1st Cir. 1970), affg. T.C. Memo. 1969-79.
A taxpayer that has inventories is required to use the
accrual method of accounting, unless it can show that the use of
another method (here, the cash method) would produce a
substantial identity of results and that the Commissioner's
determination requiring a change is an abuse of discretion.
Ansley-Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 377
(1995); see also Knight-Ridder Newspapers, Inc. v. United States,
743 F.2d 781, 789, 791-793 (11th Cir. 1984); Wilkinson-Beane,
Inc. v. Commissioner, supra.
We find as fact that emulsified asphalt, which becomes
useless in approximately 3 hours, is not merchandise held for
sale by petitioner. See Galedrige Constr., Inc. v. Commissioner,
T.C. Memo. 1997-240. We further find as fact that petitioner has
no inventories; thus, section 1.471-1, Income Tax Regs., does not
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apply to petitioner for the taxable years at issue. In addition,
we find that petitioner's method of accounting clearly reflects
income, and that it was an abuse of respondent's discretion to
require petitioner to use the accrual method of accounting.3 See
Galedrige Constr., Inc. v. Commissioner, supra.
For the foregoing reasons,
Decision will be entered
under Rule 155.
3
Respondent acknowledges that the facts of the instant
case and Galedrige Constr., Inc. v. Commissioner, T.C. Memo.
1997-240, are similar. Notwithstanding this acknowledgment,
respondent attempts to distinguish Galedrige Constr., Inc. from
the instant case. We find these distinctions unconvincing.