T.C. Memo. 2016-180
UNITED STATES TAX COURT
CAREY CLAYTON MILLS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26790-13. Filed September 27, 2016.
Carey Clayton Mills, pro se.
Brock E. Whalen, Sheila R. Pattison, and Bryan J. Dotson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Respondent determined deficiencies in petitioner’s income
tax of $9,068 and $9,861 for 2011 and 2012 (years in issue), respectively.
Respondent also determined penalties under section 6662(a)1 for the years in
1
Unless otherwise indicated, all section references are to the Internal
(continued...)
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[*2] issue; however, the parties have agreed petitioner is not liable for accuracy-
related penalties. After concessions, the issue for decision is whether the
allowable deduction for legal and professional services (legal fees) for 2011
should be $12,007 or $77,823. Petitioner’s amended 2011 return, which reflects
the $77,823 deduction for legal fees, requires us to consider whether a change in
accounting method from the cash receipts and disbursements method (cash
method) to the accrual method is a valid change. We hold the change in
accounting method is not valid, and thus petitioner is entitled to a deduction of
$12,007 for legal fees under the cash method.
FINDINGS OF FACT
At the time the petition was filed, petitioner resided in Alaska.
Petitioner began a for-profit activity to mine minerals (mineral mining
activity) in 2005. Petitioner formed Diversified Mining Ventures, L.L.C.
(Diversified), on January 31, 2005, pursuant to the laws of the State of Alaska,
through which he conducted his mineral mining activity. Between 2005 and 2010
petitioner accounted for gross income and expenses of his mineral mining activity
using the cash method. Petitioner reported income and expenses on Schedule C,
1
(...continued)
Revenue Code in effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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[*3] Profit or Loss From Business, attached to his income tax returns.2 Petitioner
has not filed with respondent an application to change his method of accounting.
On February 3, 2012, petitioner filed his 2011 income tax return (original
2011 return). He subsequently submitted an amended 2011 income tax return
(amended 2011 return), which was processed on or around May 28, 2012. On his
original 2011 return petitioner reported his business income and expenses on
Schedule C, using the cash method, and claimed a deduction for legal fees of
$12,007, reflecting the amount he paid in 2011. On his amended 2011 return he
reported that he was using the cash method although his return reflected the
accrual method of accounting for his legal fees. Petitioner cites a tax software
error for the reported use of the cash method. Petitioner claimed a deduction for
legal fees of $77,823 on his amended 2011 return, reflecting the total amount of
legal fees billed during the 2011 tax year.
During 2011 petitioner did not maintain any formal accounting books or
records. He reported $1,525 of gross receipts in 2011 from renting out equipment.
The only record reflecting the gross receipts was the check used to pay for the
2
Diversified is a disregarded entity for Federal tax purposes under secs.
301.7701-2(c)(2)(i) and 301.7701-3(b)(1)(ii), Proced. & Admin. Regs. Therefore
petitioner appropriately reported his business income and expenses on Schedule C.
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[*4] equipment rental, which did not include any information regarding the date
petitioner became entitled to receive the rental income.
On September 20, 2013, respondent mailed petitioner a notice of deficiency
for the years in issue. Respondent initially disallowed the deduction claimed for
legal fees for 2011. Respondent has since conceded that petitioner is entitled to a
deduction of $12,007 for legal fees. Respondent proposed adjustments to income
on Form 4549-A, Income Tax Discrepancy Adjustments, attached to the notice of
deficiency. The adjustment to petitioner’s deduction for legal fees was $12,007;
the adjustment for repairs and maintenance was $77,636. This, however, was an
error: the amounts that should have been listed are $77,823 for legal fees, and
$11,818 for repairs and maintenance, the amounts petitioner reported on the
amended 2011 return. The correction of these errors did not increase the amount
of the deficiency, and the amount left in dispute is significantly less than the
original determination.
Petitioner timely filed a petition with this Court disputing the notice of
deficiency.
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[*5] OPINION
I. Burden of Proof
Ordinarily, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and the taxpayers bear the burden of proving that the
Commissioner’s determinations are incorrect. Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace,
and the taxpayers bear the burden of proving that they have met all requirements
necessary to be entitled to the claimed deductions. Rule 142(a); INDOPCO, Inc.
v. Commissioner, 503 U.S. 79, 84 (1992).
Petitioner argues that respondent introduced a new matter outside the
original notice of deficiency in raising the change in accounting method issue.
Petitioner contends that he was instructed to change his accounting method by an
Internal Revenue Service (IRS) agent and that now the burden of proof is shifted
to respondent to prove that no such instructions were issued. Here the record fully
presents the facts, and the burden of proof plays no role in the outcome. See
Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
II. Change in Accounting Method
As a general rule, taxable income shall be computed under the accounting
method by which the taxpayer regularly computes his income in keeping his
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[*6] books. Sec. 446(a). Once the taxpayer has adopted an accounting method, he
must secure the Commissioner’s consent before he can compute his taxable
income under a different method. Sec. 446(e).
If the taxpayer changes the accounting method used in computing taxable
income without first obtaining consent, the Commissioner can assert section
446(e) and require the taxpayer to abandon the new method of accounting and to
report taxable income using the old method. Capital One Fin. Corp. v.
Commissioner, 130 T.C. 147, 155 (2008), aff’d, 659 F.3d 316 (4th Cir. 2011);
Sunoco, Inc. v. Commissioner, T.C. Memo. 2004-29, slip op. at 39. The question
in such a case is whether the change constitutes a change of accounting method
that is subject to section 446(e). Capital One Fin. Corp. v. Commissioner, 130
T.C. at 156; Sunoco, Inc. v. Commissioner, slip op. at 42. If the change
constitutes a change of accounting method that is subject to section 446(e), then
the taxpayer is foreclosed from making the change by section 446(e) and the
regulations promulgated thereunder without regard to whether the new method
would be proper. Capital One Fin. Corp. v. Commissioner, 130 T.C. at 156;
Sunoco, Inc. v. Commissioner, slip op. at 41-42.
A change in the accounting method includes a change in the overall plan of
accounting for gross income or deductions or a change in the treatment of any
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[*7] material item used in that overall plan. Sec. 1.446-1(e)(2)(ii)(a), Income Tax
Regs. A taxpayer’s change of his overall plan of accounting from the cash method
to the accrual method is a change in accounting method. Id.; see Sunoco, Inc. v.
Commissioner, slip op. at 45. Petitioner’s purported adoption of the accrual
method of accounting for Diversified in 2011 constitutes a change in accounting
method. Petitioner started his mineral mining activity in 2005. From 2005
through 2010, he accounted for the income and expenses for Diversified by using
the cash method. According to petitioner, he adopted the accrual method as his
overall accounting method in 2011. Petitioner’s purported change of his overall
accounting method from the cash method to the accrual method constitutes a
change of accounting method for which petitioner was required to obtain to
respondent’s consent.
Petitioner did not obtain respondent’s consent before his purported change
from the cash method to the accrual method of accounting. A taxpayer has two
means through which he can obtain the Commissioner’s consent to a change in
accounting method. Hawse v. Commissioner, T.C. Memo. 2015-99, at *14-*15;
see sec. 1.446-1(e)(3), Income Tax Regs. First, the taxpayer can file a properly
completed Form 3115, Application for Change in Accounting Method, with the
Commissioner during the taxable year for which the taxpayer desires to make the
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[*8] change and await an affirmative grant of consent. Capital One Fin. Corp. v.
Commissioner, 130 T.C. at 158; sec. 1.446-1(e)(3)(i), Income Tax Regs. The
Commissioner must notify the taxpayer that his request has been granted for the
Commissioner’s consent to be effective. Hawse v. Commissioner, at *23. Second,
the taxpayer can comply with the terms and conditions for obtaining consent under
any administrative procedure promulgated by the Commissioner for that purpose.
Sec. 1.446-1(e)(3)(ii), Income Tax Regs. Rev. Proc. 2011-14, 2011-4 I.R.B. 330,
and Rev. Proc. 97-27, 1997-1 C.B. 680, provide the procedures for obtaining the
Commissioner’s automatic (Rev. Proc. 2011-14) and nonautomatic (Rev. Proc. 97-
27) consent to a change in accounting method for the years at issue.
A taxpayer is required to file a Form 3115 or application in lieu of a Form
3115 to obtain the Commissioner’s automatic consent to a change in accounting
method. Rev. Proc. 2011-14, sec. 6.02(1)(a), 2011-4 I.R.B. 330, 346. Likewise, a
taxpayer is required to file a Form 3115 to obtain the Commissioner’s
nonautomatic consent to a change in accounting method. Rev. Proc. 97-27, secs.
5.01(1)(a), 6.01, 1997-1 C.B. at 684, 685. Neither Rev. Proc. 2011-14, supra, nor
Rev. Proc. 97-27, supra, provides that oral instructions from an agent are sufficient
to confer the Commissioner’s consent. Accordingly, petitioner did not obtain the
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[*9] Commissioner’s consent before his purported adoption of the accrual method
for 2011.
Under section 446(e), the Commissioner can require the taxpayer to
abandon the new accounting method and to report taxable income using the old
accounting method. Sunoco, Inc. v. Commissioner, T.C. Memo. 2004-29.
Petitioner never received permission from respondent to change his accounting
method and respondent has required petitioner to abandon his new accounting
method, the accrual method, under which petitioner’s amended 2011 return was
filed, and to report taxable income using his old accounting method, the cash
method. Under the cash method, the proper deduction for legal fees is $12,007,
not the $77,823 claimed on the amended 2011 return.
III. Conclusion
We hold that petitioner was required to compute Diversified’s income and
expenses for the years at issue under the cash method. Accordingly, petitioner is
entitled to a $12,007 deduction for legal fees for the 2011 tax year.
In reaching our holdings herein, we have considered all arguments the
parties made, and, to the extent not mentioned above, we conclude they are moot,
irrelevant, or without merit.
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[*10] To reflect the foregoing,
Decision will be entered under
Rule 155.