T.C. Memo. 2003-75
UNITED STATES TAX COURT
GREEN FOREST MANUFACTURING INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1596-01. Filed March 14, 2003.
P is engaged in the business of assembling,
manufacturing, and selling furniture. P depreciated
certain items of equipment used predominantly outside
the United States. In accordance with the modified
accelerated cost recovery system (MACRS), alternative
depreciation system rules, R reclassified certain items
of P’s equipment. The reclassification required a
change in recovery period for all of the reclassified
items of equipment, and a change in depreciation method
for some of the reclassified items of equipment. P
concedes that R’s reclassification is correct.
R determined that reclassification of the items of
equipment is a change in P’s method of accounting that
requires an adjustment pursuant to sec. 481(a), I.R.C.
Held: The change in MACRS classification of the
items of equipment is excluded from the definition of a
change in method of accounting, and an adjustment
pursuant to sec. 481(a), I.R.C., is not required.
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Commissioner v. Brookshire Bros. Holding, Inc. & Subs.,
___ F.3d ___ (5th Cir., Jan. 29, 2003), affg. T.C.
Memo. 2001-150, followed.
Robert J. Gumser, for petitioner.
Yvonne M. Peters, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NIMS, Judge: Respondent determined Federal income tax
deficiencies for petitioner’s tax fiscal years ended in August
1996, August 1997, and August 1998, in the amounts of $147,277,
$31,983, and $46,729, respectively. At trial, petitioner
conceded that the modified accelerated cost recovery system
(MACRS), alternative depreciation system rules, in accordance
with section 168(g)(1), required petitioner to use a 10-year
recovery period and the straight-line method of depreciation for
items of petitioner’s equipment that were placed in service after
1986 and used predominantly outside of the United States. The
issue for decision is whether a change in MACRS classification
that results in a change in depreciation method and recovery
period is a change in method of accounting for purposes of an
adjustment pursuant to section 481(a).
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Unless otherwise indicated, all section references are to
sections of the Internal Revenue Code in effect for the years at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.1
The stipulations of the parties, with accompanying exhibits, are
incorporated herein by this reference. At the time the petition
was filed, petitioner’s principal office was located in San
Diego, California.
I. Petitioner’s Operations
Petitioner is engaged in the business of assembling,
manufacturing, and selling furniture. The dispute in this case
relates to the depreciation of several items of equipment
(Equipment) owned by petitioner. Each item of the Equipment was
placed in service after 1986. For each year petitioner owned the
Equipment, the number of days each item of the Equipment was
physically located outside the United States exceeded the number
1
The parties stipulated various facts relating to the
equipment at issue in this case. Paragraphs 4, 7, and 10 of the
“STIPULATION OF FACTS” describe the equipment at issue in this
case. In referring to the paragraphs describing the equipment at
issue in this case, the parties mistakenly refer to paragraphs 4,
7, and 9. Paragraph 9 does not describe any equipment at issue
in this case. The references to paragraph 9 appear to be a
repeated typographic error. As such, references in the
“STIPULATION OF FACTS” to paragraph 9 will be treated as if the
references were to paragraph 10.
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of days that each item was physically located within the United
States. During the time petitioner owned the Equipment, it was
used to assemble or manufacture furniture. The foreign business
using the Equipment was not subject to U.S. Federal income tax.
Petitioner sold the furniture that was manufactured using the
Equipment.
II. Petitioner’s Accounting
For all relevant years, petitioner used the accrual method
of accounting. On its Form 1120, U.S. Corporation Income Tax
Return, for each of the relevant years, petitioner depreciated
each item of the Equipment using either the double-declining
balance method or the straight line method. For each item
petitioner depreciated using the double-declining balance method,
petitioner used either a 3-year or a 5-year recovery period. For
each item petitioner depreciated using the straight line method,
petitioner used a 5-year recovery period.
Respondent examined petitioner’s returns for each of the
relevant years and issued a notice of deficiency with respect to
those years. Therein, respondent determined that petitioner’s
deductions for depreciation of items of the Equipment for the
relevant years must be decreased because petitioner failed to
compute depreciation using the alternative depreciation system
for tangible property used predominantly outside the United
States, as required under section 168(g)(1)(A). Respondent also
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determined that the change in deductions for depreciation was a
change in accounting method for which an adjustment pursuant to
section 481(a) was required for the tax year ended in 1996.
At trial, petitioner conceded that respondent’s
determination relating to the deductions for depreciation is
correct. Petitioner conceded that each item of the Equipment
should be reclassified under MACRS, alternative depreciation
system rules, in accordance with section 168(g)(1)(A), and
depreciated using the straight-line method and a 10-year recovery
period.
Petitioner continues to challenge respondent’s determination
relating to the adjustment pursuant to section 481(a) on
multiple, alternative grounds. First, petitioner claims that a
change in MACRS classification is not a change in method of
accounting for which section 481(a) requires an adjustment.
Second, petitioner claims that fairness should prevent an
adjustment under section 481(a) because respondent’s agent
reviewed and accepted petitioner’s method of depreciation and
accumulated depreciation during an examination of petitioner’s
tax years ended in 1992 and 1993. Finally, on brief, petitioner
argues that respondent should not be allowed to assert an
adjustment pursuant to section 481(a) without considering and
applying section 481(b).
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OPINION
I. General Rules
A. Depreciation Deductions
Depreciation deductions are primarily governed by sections
167 and 168. Section 168 describes a specific depreciation
system for tangible property. As part of the Tax Reform Act of
1986, Pub. L. 99-514, secs. 201, 203, 100 Stat. 2122, 2143,
Congress replaced the accelerated cost recovery system with
MACRS, effective generally for property placed in service after
December 31, 1986, and section 168 was amended accordingly. As
such, depreciation deductions for tangible property placed in
service after 1986 are generally determined under section 168.
Section 168 prescribes two systems for determining depreciation
deductions: (1) The general depreciation system in section
168(a), and (2) the alternative depreciation system in section
168(g). Taxpayers are required to use the alternative
depreciation system for “any tangible property which during the
taxable year is used predominantly outside the United States”.
Sec. 168(g)(1)(A).
B. Adjustments Pursuant to Section 481
Section 481(a) provides for adjustments required by changes
in a taxpayer’s method of accounting. If a taxpayer has changed
his method of accounting, the taxpayer must take “into account
those adjustments which are determined to be necessary solely by
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reason of the change in order to prevent amounts from being
duplicated or omitted”. Sec. 481(a)(2). If there has been a
change in method of accounting, then section 481(a) applies and
adjustments are made thereunder to prevent the omission or
duplication of taxable income caused solely by the change in
method of accounting. If there has not been a change in method
of accounting, then no adjustment pursuant to section 481(a) is
made.
A change in method of accounting to which section 481(a)
applies includes “a change in the overall method of accounting
for gross income or deductions, or a change in the treatment of a
material item.” Sec. 1.481-1(a)(1), Income Tax Regs.
Regulations promulgated under section 481(a) incorporate the
rules of section 446(e) and section 1.446-1(e), Income Tax Regs.,
for determining when a change in method of accounting has
occurred. Sec. 1.481-1(a)(1), Income Tax Regs. A change in
method of accounting “includes a change in the overall plan of
accounting for gross income or deductions or a change in the
treatment of any material item used in such overall plan.” Sec.
1.446-1(e)(2)(ii)(a), Income Tax Regs. A material item, in turn,
“is any item which involves the proper time for the inclusion of
the item in income or the taking of a deduction.” Id.
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Regulations also detail certain types of adjustments, with
examples thereof, that are specifically excluded from
characterization as changes in method of accounting:
A change in method of accounting does not include
correction of mathematical or posting errors, or errors
in the computation of tax liability * * *. Also, a
change in method of accounting does not include
adjustment of any item of income or deduction which
does not involve the proper time for the inclusion of
the item of income or the taking of a deduction. For
example, corrections of items that are deducted as
interest or salary, but which are in fact payments of
dividends, and of items that are deducted as business
expenses, but which are in fact personal expenses, are
not changes in method of accounting. In addition, a
change in the method of accounting does not include an
adjustment with respect to the addition to a reserve
for bad debts or an adjustment in the useful life of a
depreciable asset. Although such adjustments may
involve the question of the proper time for the taking
of a deduction, such items are traditionally corrected
by adjustments in the current and future years. * * *
[Sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs.]
Thus, even though an adjustment in the useful life of a
depreciable asset may involve the question of the proper time for
the taking of a deduction, such an item is includable among those
that are traditionally corrected by adjustments in the current
and future years, and a change in accounting method is not
involved. The regulation is totally consistent with the language
of section 481(a)(2) because the useful life adjustment is not a
change “necessary * * * to prevent amounts from being duplicated
or omitted”. Therefore, section 481(a) is not implicated so as
to require an adjustment thereunder.
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II. Contentions of the Parties
As detailed above, petitioner has conceded that each item of
the Equipment should be reclassified and depreciated in
accordance with MACRS, alternative depreciation system rules.
The parties agree that according to those rules, each item of the
Equipment should be depreciated using the straight-line method
and a 10-year recovery period.
Respondent argues that the reclassification is a change in
method of accounting because the term “useful life” is not
synonymous with the term “recovery period” for purposes of
section 1.446-1(e)(2)(ii), Income Tax Regs. Petitioner, however,
relies on our holding in Brookshire Bros. Holding, Inc. & Subs.
v. Commissioner, T.C. Memo. 2001-150, affd. ___ F.3d ___ (5th
Cir., Jan. 29, 2003), to argue that the reclassification is not a
change in method of accounting. In Brookshire Bros. Holding,
Inc. & Subs., we held that the taxpayer’s change in MACRS
classification of an asset, which resulted in a change in both
the depreciation method and the recovery period, was excluded
from the definition of a change in method of accounting by reason
of analogy to the useful life exception contained in section
1.446-1(e)(2)(ii)(b), Income Tax Regs.
III. Analysis
Petitioner did not alter its overall plan of accounting for
income and deductions. Rather, respondent required that
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petitioner reclassify each item of the Equipment in accordance
with MACRS, alternative depreciation system rules, as required
under section 168(g)(1)(A). Such reclassification resulted in a
change in depreciation method and recovery period. Even though
petitioner concedes that the reclassification is correct, it
argues that, under the rationale explicated in Brookshire Bros.
Holding, Inc. & Subs. v. Commissioner, supra, a reclassification
of property under MACRS is to be treated as synonymous with an
adjustment in useful life for purposes of a regulatory exception
contained in section 1.446-1(e)(2)(ii)(b), Income Tax Regs.
Respondent argues that for purposes of section 1.446-
1(e)(2)(ii), Income Tax Regs., as interpreted by the
Commissioner, the term “useful life” is not synonymous with the
term “recovery period.” Respondent cites Thomas Jefferson Univ.
v. Shalala, 512 U.S. 504 (1994), for the propositions that this
Court should “give substantial deference to an agency’s
interpretation of its own regulations”, and “must defer to an
agency’s interpretation unless an alternative reading is
compelled by the regulation’s plain language or by other
indications of the agency’s intent at the time the regulation is
promulgated.” The weight accorded to an agency’s interpretation
depends on the thoroughness of the agency’s consideration,
validity of its reasoning, consistency with earlier and later
pronouncements, and other factors that give an interpretation the
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power to persuade. United States v. Mead Corp., 533 U.S. 218,
228 (2001) (citing Skidmore v. Swift & Co., 323 U.S. 134, 140
(1944)).
Respondent urges that the Commissioner’s interpretation of
section 1.446-1(e)(2)(ii), Income Tax Regs., is that a change in
recovery period or depreciation method in contrast to a change in
useful life is a change in method of accounting.
As indicative of the Commissioner’s interpretation of
section 1.446-1(e)(2)(ii), Income Tax Regs., respondent cites
Internal Revenue Service Publication 538, which states:
“[C]hanges that are not changes in accounting methods and do not
require consent * * * [include an] adjustment in the useful life
of a depreciable asset. You cannot change the recovery period
for ACRS or MACRS property”. IRS Pub. 538, Accounting Periods
and Methods (1994). Respondent also cites Rev. Proc. 96-31, sec.
2.01, 1996-1 C.B. 714, which provides that a “change from not
claiming the depreciation or amortization allowable * * * to
claiming the depreciation allowable is a change in method of
accounting”.
The level of deference accorded to an agency’s
interpretation of its own regulation is based, in part, on the
thoroughness in the agency’s consideration and validity of its
reasoning. United States v. Mead Corp., supra at 228. Neither
Pub. 538 nor Rev. Proc. 96-31 provides any reason why a change in
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MACRS classification should not be treated as analogous to a
change in useful life and, therefore, excluded from the
definition of a change in method of accounting.
In Brookshire Bros. Holding, Inc. & Subs. v. Commissioner,
supra, we concluded:
The similarities between a change in MACRS
classification and a change in useful life are greater
than the differences. Section 1.446-1(e)(2)(ii)(b),
Income Tax Regs., was clearly intended to permit
taxpayers to alter their depreciation schedules. The
type of adjustment explicitly permitted--a change in
useful life--would have resulted both in depreciation
deductions over a longer or shorter period than
originally contemplated and in an increased or
decreased amount being deducted in any given period. A
change in MACRS classification will have precisely
these same two effects. Although a portion of the
change in amount may be attributable to calculation
method, as opposed to period length alone, such carries
insufficient weight when balanced against severely
limiting the intended relief. [Emphasis added.]
In affirming the opinion of this Court, the U.S. Court of
Appeals for the Fifth Circuit stated:
we fully agree with the Tax Court that the applicable
regulations were meant to allow taxpayers to make
temporal changes in their depreciation schedules * * *
Clearly, doing so would produce changes in the length
of time over which deductions are taken as well as
concomitant changes in the amount of the deduction for
any given tax year--and such a change under MACRS would
produce exactly the same results. [Commissioner v.
Brookshire Bros. Holding, Inc. & Subs., ___ F.3d ___
(5th Cir., Jan. 29, 2003), affg. T.C. Memo. 2001-150.]
Given our holding in Brookshire Bros. Holding, Inc. & Subs.
v. Commissioner, supra, and our statement therein as to agency
intent at the time the regulation was promulgated, we need not
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defer to the agency’s interpretation as reflected in Pub. 538 and
Rev. Proc. 96-31. Cf. Kurzet v. Commissioner, 222 F.3d 830 (10th
Cir. 2000)(giving deference to the Commissioner’s contrary
interpretation of section 1.446-1(e)(2)(ii)(b), Income Tax
Regs.), affg. in part, revg. in part, and remanding T.C. Memo.
1997-54 and an Oral Opinion of this Court. Moreover, there is
nothing in the record to indicate the adjustments that respondent
made to reflect the change in classification of each item of the
Equipment or that the rationale of Brookshire Bros. Holding, Inc.
& Subs. is not appropriate to this case.
For the foregoing reasons, we hold that the change in MACRS
classification of each item of the Equipment is not a change in
petitioner’s method of accounting. Since there is no change in
method of accounting, an adjustment pursuant to section 481(a) is
not required. Accordingly, we need not reach petitioner’s other
contentions regarding equitable relief or section 481(b).
To reflect the foregoing and petitioner’s concessions,
Decision will be entered
under Rule 155.