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Accounting Method Change Results in a $5.4 Million Tax Consequence


August 2015

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Synopsis

In Hawse v. IRS, T.C. Memo 2015-99, the Tax Court upheld a $5.4 million tax deficiency judgment against a California automotive dealership, JHH Motor Cars, Inc., and denied their claim for a refund. The Tax Court determined that the taxpayer had not received automatic consent from the IRS to change its accounting method. Nevertheless, because the dealership had consistently used the specific identification method for seven years in a row, a change in accounting method did occur.

Issue

The petitioner was the sole shareholder and president of JHH Motors Cars, Inc., an S corporation. In 1985, the company elected to use the last-in, first-out (LIFO) method of accounting for its vehicle inventory. The election was made by filing Form 970, Application to Use LIFO Inventory Method, with the IRS. In 2001, the petitioner was looking to sell the car dealership and filed Form 3115 as it wanted to change from the LIFO method of accounting for inventory to the specific identification method under a procedure that grants automatic consent if certain strict requirements are met. The petitioner believed that the LIFO method could deter prospective buyers because of the accumulated LIFO reserve that may need to be recaptured if the dealership was sold.

JHH neglected to comply with certain procedural requirements associated with that specific type of accounting method change. JHH applied the specific identification accounting method for tax years 2001 to 2007. After using the specific identification method of accounting for its inventory, JHH later filed amended tax returns using the LIFO inventory method (instead of the specific identification method) and requested a refund. After filing the amended returns, and after JHH received its refund, the IRS sent the taxpayer a notice of deficiency for the years covered by the amended returns. JHH filed a petition with the Tax Court.

The Tax Court held that JHH had not received automatic consent in 2001 to use the specific identification method because it did not fully comply with all of the provisions of Revenue Procedure 99-49. The Tax Court noted that, if a taxpayer changes the method of accounting without obtaining the Commissioner’s consent, the Commissioner has two options. The Commissioner can require the taxpayer to abandon the new method of accounting and to report taxable income using the old method of accounting; or, it can accept the accounting method change and require the taxpayer to make any necessary adjustments. The IRS chose the second option.

The Tax Court emphasized that a short-lived deviation from a previously established method of accounting does not constitute the establishment of a new method of accounting. However, consistent treatment of a material item in two or more consecutively filed tax returns does create a change in accounting method. Notwithstanding JHH’s failure to obtain automatic consent, due to its use of the specific identification method for seven consecutive tax years, the Tax Court deemed this to be a change of accounting method. The Tax Court held that the IRS was entitled to deny JHH’s amended returns and reject its refund claims as well as its attempt to revert back to the LIFO method of accounting.

Contact

For more information, please contact Richard Shevak, Director, at richard.shevak@cohnreznick.com or at 862-245-5029.

To learn more about CohnReznick’s Tax Practice, please visit our webpage.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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