C O R P O R A T E B U S I N E S S T A X A T I O N M O N T H L Y TAX ACCOUNTING BY JAMES E. SALLES installment accounting 9 by granting affected taxpayers he courts were relatively quiet on tax accounting T consent to retroactively change from the accrual issues in the first few weeks of the new year. method to the installment method by filing appropriate However, there has been a spate of legislative amended returns. Taxpayers may make the change and administrative developments on various fronts. until the statute of limitations runs for any year in which INDOPCO REGS STILL IN PROCESS installment payments were received. 10 In an interview, Christine Turgeon of the Treasury’s THE “MERCHANDISE” Office of Tax Legislative Counsel confirmed that work CONTROVERSY was continuing on the promised proposed regulations addressing general capitalization questions. 1 Although Following a string of court losses described in ear- lier columns, 11 the IRS has now announced that, acknowledging that a “facts and circumstances” approach cannot be avoided in describing the general pending further guidance, it will no longer press the distinction between a capital outlay and a deductible issue of whether “construction contractors involved expense, Turgeon stated that various possible de min- in paving, painting, roofing, drywall, and landscap- imis thresholds and safe harbors, as well as other sim- ing” are required to use accrual accounting because plifying options such as a repair allowance, remain they sell “merchandise.” 12 The IRS continues to raise under active consideration. 2 Another high-profile open the “merchandise” issue when other types of taxpay- question is how to address the issue of capitalizing reg- ers are involved. For example, a recent Tax Court ular operating costs relating to intangible property in petition contests an IRS attempt to make a commer- light of the recent appellate court decisions in the Wells cial slaughterhouse inventory its carcasses and use Fargo 3 and PNC 4 cases. accrual accounting. The taxpayers contend that the slaughterhouse should not have to maintain invento- AIRLINE REPAIR COSTS ries because it did not take title to the livestock but Last month’s column discussed Revenue Ruling made its profits from “slaughtering fees.” 13 2001-4, 5 addressing airlines’ deductions for the cost of Meanwhile, Senator Christopher S. (“Kit”) Bond (R- periodic aircraft maintenance. The IRS has now for- Mo.), Chairman of the Senate Small Business mally amended the “automatic consent” revenue pro- Committee, has reintroduced his last year’s propos- cedure 6 to cover changes in accounting method to con- al 14 to permit taxpayers with up to $5 million in gross form to the new ruling. 7 In a related development, the revenues to continue to use cash accounting, even if head of the IRS’s Large and Midsize Business Division, they have inventories. 15 Congressman Wally Herger Larry Langdon, has been quoted as saying that negoti- (R-Ca.) has introduced companion legislation in the ations were proceeding toward a hoped-for industry- House. 16 wide settlement of the continuing controversy. 8 “SAFE HARBOR” REVENUE CHANGING BACK TO PROCEDURES INSTALLMENT REPORTING The IRS has issued two revenue procedures pre- The IRS has moved to implement Congress’s retroac- scribing specialized “safe harbor” accounting meth- tive repeal of the ban on accrual taxpayers’ use of ods. Revenue Procedure 2000-23 17 prescribes a simplified dollar-value LIFO method for used cars and trucks (the “Used Vehicle Alternative LIFO Jim Salles is a member of Caplin & Drysdale in Washington, D.C. A P R I L 2 0 0 1 27
C O R P O R A T E B U S I N E S S T A X A T I O N M O N T H L Y Method”) under which the relevant price indices are limitations has not run for the proposed year of change determined by reference to published price guides. or any later year. Note, however, that the new IRS posi- Revenue Procedure 2000-24 18 addresses the com- tion is confined to loans made in the ordinary course of mon situation in which an insurance company makes business by cash method taxpayers. The IRS may still advances to its agents to be repaid from future com- argue that other types of short-term loans have “acqui- missions. The issue in these cases is whether the com- sition discount,” and accrual taxpayers must accrue pany has made a loan that is unconditionally repayable interest income regardless of whether Code Section in cash or an advance payment for services that is 1281 applies. immediately reportable as income, 19 and the outcome INVENTORY “FLOOR STOCKS” turns on the nuances of the agreement between the parties and the particular facts and circumstances. 20 Finally, the IRS has issued Revenue Ruling 2001-8, The procedure provides that the IRS will respect an addressing payments made or received by dealers with insurance company’s cash advance to its agent as a respect to their “floor stocks” of inventory goods. Such loan if the parties’ agreement so characterizes it and payments can include taxes paid — and refunds of provides for adequate interest, the company consis- taxes previously paid — on such goods, as well as var- tently treats it as such, and the agent is personally liable ious types of subsidies. To the extent attributable to for repayment. goods on hand as of year-end, they are treated as adjustments to inventory basis. SMALL BANKS’ INTEREST INCOME Revenue Ruling 2001-8 provides that taxpayers must Code Section 1281 requires holders of certain short- treat floor stock payments as relating to the goods phys- term debt instruments to include both discount income ically on hand on the date as of which the payments are and stated interest on an accrual basis, regardless of computed, although LIFO taxpayers may simplify the their general method of accounting. The IRS has long necessary computations by assuming that the goods argued that this provision requires cash method banks physically on hand on that date are those most recent- to accrue interest income on routine short-term loans, ly acquired or produced. On the other hand, which either because that interest is “acquisition discount” goods remain in inventory as of year end is determined subject to Section 1281(a)(1) or because Section under the taxpayer’s normal inventory accounting 1281(a)(2) requires banks to accrue all interest income method (FIFO, LIFO, or specific identification). This regardless of whether there is discount or not. However, means that some floor stock payments may be attrib- the Tax Court, the Eighth Circuit, and the Tenth Circuit uted to goods that under the taxpayer’s inventory were have all held that Code Section 1281 does not apply to already included in computing the cost of goods sold in banks’ loans in the ordinary course of business, 21 a previous year. If that happens, the payments will be although these holdings are of limited application allowed as additional cost of goods sold, or treated as because virtually all banks of significant size report on “tax benefit” income, in the current taxable year. an accrual basis. 22 Several examples are provided applying these princi- The IRS has now announced that it will no longer liti- ples in various situations involving LIFO accounting. gate this issue 23 and modified the revenue procedure The IRS will not apply the new ruling adversely to tax- granting “automatic consent” to accounting method payers with respect to payments received on or before changes to allow cash-method taxpayers to stop accru- February 26, 2001, automatic consent being granted ing this interest income. 24 The change may be made on for any necessary accounting method change as to amended returns for past years as long as the statute of payments received after that date. 1. See discussion in J. Salles, “Tax Accounting,” 1(10) Corp. Bus. Tax’n in J. Salles, “Tax Accounting,” 2(2) Corp. Bus. Tax’n Monthly 35, 35-36 (Nov. 2000). Monthly 32, 33 (July, 2000). 4. PNC Bancorp v. Commissioner, 212 F.3d 822 (3d Cir. 2000), discussed in 2. L. Sheppard, “Participants Consider INDOPCO , Alternative Minimum J. Salles, “Tax Accounting,” 1(11) Corp. Bus. Tax’n Monthly 26, 26-28 (August, Tax,” 90 Tax Notes 992, 992-94 (Feb. 19, 2001). 2000). 3. Wells Fargo & Co. v. Commissioner, 224 F.3d 874 (8th Cir. 2000), discussed 5. 2001-3 IRB 1. 28 28 A P R I L 2 0 0 1
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