Taxing Lessons From Court Decisions

Decisions — Counting the Cars

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Image source: Digital-Designs (I Think I Parked Next to the Jaguar...) [CC BY 2.0 (], via Wikimedia Commons
Image source: Digital-Designs (I Think I Parked Next to the Jaguar…) [CC BY 2.0 (], via Wikimedia Commons

When Mae West said that too much of a good thing can be wonderful, she wasn’t referring to making multiple changes to inventory methods.

In T.C. Memo. 2015-99 (Hawse), the taxpayer was a single-shareholder car dealership. Prior to 2001, the dealership accounted for new and used vehicle inventories with the Last-in-First-Out (LIFO) method.

Under the LIFO method, you put the last product cost you incur into the cost of sales and retain the earliest costs as inventory. This means your ending inventory is valued at the oldest costs and items in cost of goods sold are valued at the newest costs. For tax purposes, LIFO removes inflation from ending inventory and expenses it as part of cost of goods sold. Since the US economy is historically inflationary, use of LIFO defers income and the related taxes.

However, that deferral can cause a problem when you want to sell your business, because the deferred tax comes due and is generally owed in a single year.

The taxpayer in Hawse wanted to avoid this result. In 2001 the dealership filed the necessary forms to change its method of accounting for new and used vehicles from LIFO. The taxpayer changed to specific identification, with vehicles valued at the lower of cost or market rather than actual cost. The change allowed the taxpayer to spread the deferred income and tax over a period of four years—essentially a timing difference that affected the amount of taxable income for a number of years without altering lifetime income.

This change qualifies for “automatic consent.” That means IRS consent to the change is deemed received as soon as you file the application, provided you comply with the requirements in the relevant revenue procedure. In this case, Revenue Procedure 99-49 contained the requirements for making the change in accounting method. The revenue procedure states: “[A] taxpayer * * * [that] changes to a method of accounting without complying with all the applicable provisions of this revenue procedure” has not obtained the commissioner’s consent.

The taxpayer did not complete all the requirements of Revenue Procedure 99-49.

For the next seven years the taxpayer filed tax returns that accounted for inventory using the specific identification method. However, on those returns, the taxpayer did not value all its inventory at the lower of cost or market as it stated it would do on the forms for changing its method of accounting. Instead, the taxpayer used different valuation approaches for various inventories—actual cost for new vehicles, lower of cost or wholesale market for used vehicles, and lower of cost or market for parts.

The taxpayer’s accountant believed that using these different methods of valuation instead of one single method meant the taxpayer’s 2001 change of accounting method from LIFO to specific identification was defective. The accountant advised filing amended returns to correct the defective change—in other words, to return to the LIFO method of accounting for inventory used prior to the 2001 change.

In 2009 the taxpayer filed amended tax returns for 2002 and 2003, requesting a refund of the tax paid.

The taxpayer believed automatic consent to terminate LIFO was not received in 2001 because the taxpayer did not value the inventory the way it stated it would on the consent forms. That meant automatic consent could not be granted and the change in method could not occur. The amended returns were simply the correction of error for which no consent was needed.

The IRS refused to accept the amended returns. The IRS said the taxpayer only needed to comply with the applicable revenue procedure’s requirements in filing the form to obtain automatic consent. For the consent to be effective, the taxpayer need not, as a factual matter, implement the changes requested on the form.

Additionally, the IRS said that though the first request for change in accounting method was not properly completed, the taxpayer complied with all but procedural issues of filing. Therefore, consent was automatically granted.

The IRS says the amended returns are a second change of accounting method that also require consent. Since the taxpayer did not ask for consent, the taxpayer could not revert to the LIFO method simply by filing amended returns.

The court disagreed with the IRS’s contention that the taxpayer complied with all the relevant provisions of filing for a change in accounting method. Instead, the court found the taxpayer did not conform specifically to the requirements of the revenue procedure and so did not receive automatic consent to change its method of accounting.

The court then had to decide whether filing the 2001 through 2007 tax returns in accordance with a new method of accounting was itself a change in method of accounting. This decision hinged on whether use of the specific identification method rather than the LIFO method accelerated the taxpayer’s recognition of income.

If so, the amended returns reflected a second change in method of accounting for which consent was again required. Because the IRS had not consented to the change, the taxpayer could not revert to the LIFO method simply by filing amended returns.


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Sorry, wrong answer :(
Right answer!
For the IRS.

The taxpayer did not receive automatic consent to change its method of accounting for its LIFO inventory to specific identification.

However, by consistently accounting for that inventory on its 2001 through 2007 income tax returns using the specific identification method, the taxpayer changed its method of accounting.

The taxpayer’s proffered amended returns, on which it attempted to revert to the LIFO method, reflect a second change in method of accounting to which the IRS may refuse consent.

The taxpayer did not obtain that consent. Accordingly, the IRS was entitled to reject the amended returns. The taxpayer is not entitled to the claimed refunds.

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