The opinion
114 T.C. No. 1
UNITED STATES TAX COURT
SUZY’S ZOO®, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9423-98. Filed January 6, 2000.
P, a corporation the stock of which is owned 84
percent by S and 16 percent by two individuals
unrelated to S, sells greeting cards and other paper
products bearing an image of one or more of P’s
licensed cartoon characters. P’s employees develop and
draw the originals of all of the characters, and P
transfers the original drawings to independent printing
companies to reproduce images of the drawings onto P’s
paper products, which are made by the printers on P’s
behalf. The printers must reproduce the drawings and
make the products in accordance with P’s
specifications, and they may not sell to a third party
either P’s original drawings, or reproductions thereof,
or P’s paper products.
Held: P produces, rather than resells, its paper
products; thus, P does not qualify for the “small
reseller” exception to the uniform capitalization
(UNICAP) rules of sec. 263A, I.R.C.
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Held, further, P is not excepted from the UNICAP
rules by virtue of the artist exemption of sec.
263A(h), I.R.C.; none of P’s shareholders owns
“substantially all” of P’s stock within the meaning of
sec. 263A(h)(3)(D)(i)(I), I.R.C.
Held, further, the “year of change” for purposes
of sec. 481, I.R.C., is the subject year (i.e., the
year in which P’s method of accounting is changed to
conform to the UNICAP rules), rather than the first
year to which the UNICAP rules apply.
Richard A. Shaw and Bruce M. O’Brien (specially recognized),
for petitioner.
Christine V. Olsen, for respondent.
OPINION
LARO, Judge: This case is before the Court fully
stipulated. See Rule 122. Respondent determined a $131,077
deficiency in petitioner’s Federal income tax for its taxable
year ended June 30, 1994. We decide primarily whether petitioner
is subject to the uniform capitalization (UNICAP) rules of
section 263A. We hold it is. We also decide whether the subject
year is the “year of change” for purposes of section 481. We
hold it is. Unless otherwise indicated, section references are
to the Internal Revenue Code applicable to the subject year, and
Rule references are to the Tax Court Rules of Practice and
Procedure.
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Background
All facts were stipulated. The stipulation of facts and the
exhibits submitted therewith are incorporated herein by this
reference. Petitioner is a corporation with a taxable year
ending on June 30. Its business is “social expression” through
the original drawing of licensed cartoon characters and the
dissemination of images of those drawings on certain paper
products. Its principal place of business was in California when
the petition was filed.
Eighty-four percent of petitioner’s stock is owned by Suzy
Spafford; the balance is owned by two individuals unrelated to
her. Ms. Spafford is an artist who graduated from San Diego
State University in 1967 with a bachelor’s degree in fine arts.
She obtained a teaching certificate in 1968 and taught high
school art from 1968 through 1969. She began to develop cartoon
characters in the 1960's, and she gradually developed
petitioner’s business from those characters. She incorporated
petitioner’s business in 1976, and she registered petitioner’s
name as a trademark with the Federal Government.
Petitioner sells paper products (primarily Christmas and
greeting cards, but also secondary items such as stationery,
calendars, recipe books, and invitations), each bearing a copy of
one or more of its cartoon drawings. Petitioner’s artistic work
is all done at its headquarters in San Diego by Ms. Stafford and
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two nonshareholder employees. Ms. Spafford is petitioner’s
principal artist; she has personally drawn and painted most of
petitioner’s original cartoon characters and most of the scenes
in which the characters appear. The other two employees also
draw original cartoon characters and scenes; their drawings are
reviewed, modified (as necessary), and approved by Ms. Spafford.
Ms. Spafford and the two employees together draw between 300 and
400 cartoon character/scenes a year, and each character/scene is
numbered and licensed.
Petitioner offers for sale at its headquarters all currently
available merchandise that bears an image of at least one of its
cartoon characters. Petitioner does not sell items that do not
bear an image of at least one of its cartoon characters, and it
does not sell its original cartoon drawings. Petitioner’s
primary customers are card and gift shops and licensing partners,
and most of its nonlicensing partner sales are by or through
independent sales representatives, each of whom has a specified
sales territory and each of whom earns a straight sales
commission. Sales representatives order petitioner’s products
directly from it, and they place the products in card and gift
shops and the like. Petitioner ships most of its inventory from
its headquarters, where petitioner’s employees generally package
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the paper products for sale to the retailers on the basis of the
sales representative’s orders.
Petitioner uses several independent printing companies to
print its products. Generally, petitioner sends an original
cartoon drawing to a printer, and the printer photographs the
drawing, performs the necessary color separations, and creates
“proofs” of a particular paper product in accordance with
specifications dictated by petitioner (e.g., the size of the card
to be printed, the color of ink, and the grade of the card stock
to be used in printing the card). The printer uses its own paper
and its own ink, and it holds title to and bears the risk of loss
of the supplies and printed goods until it ships the goods back
to petitioner for petitioner to accept or reject. If petitioner
rejects the goods, it informs the printer of changes which must
be made to meet petitioner’s specifications.
Printers do not print petitioner’s paper products absent an
order from it, and they are not allowed to sell petitioner’s
paper products or any of petitioner’s original cartoon characters
or reproductions thereof. Petitioner sends a purchase order to a
printer indicating the number of a particular paper product that
it wants printed, and the printer prints the approximate number
of products ordered. In the case of cards, the printer prepares
an invoice with artist’s adjustments noted and ships the printed
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items, per petitioner’s instructions, to San Diego Bindery.
Petitioner contracts with San Diego Bindery to cut the sheets of
cards into individual cards and to fold each individual card, and
San Diego Bindery bears the risk of loss if it damages any card
during that process. San Diego Bindery ships the finished goods
(with an invoice) to petitioner’s headquarters, where petitioner
stores all of its inventory.
In addition to selling products which bear at least one of
its cartoon characters, petitioner enters into licensing
agreements under which certain manufacturers are given the right
to use one or more of petitioner’s characters. Under a licensing
agreement, petitioner generally charges the licensee a fee to use
an original cartoon drawing and a royalty equal to a percentage
of the licensed products sold. The licensees sell and distribute
the products they create bearing images of petitioner’s cartoon
characters. Petitioner does not sell its licensees’ products
through either its independent sales representatives or through
its catalogue; most of the licensees sell and distribute their
products themselves. Petitioner does sell all of its licensees’
products at its retail store.
Petitioner has never adjusted the value of its inventory to
reflect section 263A. Petitioner’s reported ending inventory on
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June 30, 1994, was $1,556,404, and its absorption ratio for the
year then ended would have been 42.87 percent.
Petitioner’s gross receipts and other revenue for the
subject year totaled $5,874,039. Of that amount, $5,241,830 was
from sales,1 $623,469 was from royalties from the licensing
agreements, and $8,740 was from interest, discounts, and service
charges. The gross receipts from sales were attributable to the
following items:
ITEMS Receipts
Greeting cards $2,034,561
Boutique; e.g., party goods and balloons 849,656
Stationery, box notes & memo pads 675,639
Christmas products; e.g., cards 621,082
Books, calendars, & recipe cards 315,034
Wrap and tote 193,101
Invitations 191,280
Gift enclosures 86,425
Other items 275,052
Total 5,241,830
For the 3 taxable years preceding the subject year, petitioner’s
gross receipts were $6,711,723, $6,772,772, and $5,898,638,
respectively.
Respondent determined that petitioner is subject to the
UNICAP rules. Respondent determined that petitioner’s cost of
goods sold for the subject year was overstated by $667,267 by
1
The cost of goods attributable to those sales was
$2,108,921. The only item reportedly included in that cost was
“Purchases”.
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virtue of the fact that petitioner had failed to change its
method of accounting to account for the UNICAP rules.
Discussion
We decide primarily whether petitioner is subject to the
UNICAP rules of section 263A. The UNICAP rules, which generally
require capitalization of expenses related to tangible property,
were added to the Internal Revenue Code as part of section 803 of
the Tax Reform Act of 1986 (TRA), Pub. L. 99-514, 100 Stat. 2085,
2350. As applicable herein, the UNICAP rules are effective with
respect to taxable years beginning after December 31, 1986. See
TRA sec. 803(d)(2)(A).
Section 263A provides in relevant part:
SEC. 263A. CAPITALIZATION AND INCLUSION IN INVENTORY
COSTS OF CERTAIN EXPENSES.
(a) Nondeductibility of Certain Direct and
Indirect Costs.--
(1) In general.--In the case of any
property to which this section applies, any
costs described in paragraph (2)--
(A) in the case of property
which is inventory in the hands of
the taxpayer, shall be included in
inventory costs, and
(B) in the case of any other
property, shall be capitalized.
(2) Allocable costs.--The costs
described in this paragraph with respect to
any property are –
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(A) the direct costs of such
property, and
(B) such property's proper
share of those indirect costs
(including taxes) part or all of
which are allocable to such
property.
Any cost which (but for this subsection) could not be
taken into account in computing taxable income for any
taxable year shall not be treated as a cost described
in this paragraph.
(b) Property to Which Section Applies.-–Except as
otherwise provided in this section, this section shall
apply to–-
(1) Property produced by the taxpayer.-
–Real or tangible personal property produced
by the taxpayer.
(2) Property acquired for resale.--
(A) In general.–-Real or
personal property described in
section 1221(1) which is acquired
by the taxpayer for resale.
(B) Exception for taxpayer
with gross receipts of $10,000,000
or less.-–Subparagraph (A) shall
not apply to any personal property
acquired during any taxable year by
the taxpayer for resale if the
average annual gross receipts of
the taxpayer * * * for the 3-
taxable year period ending with the
taxable year preceding such taxable
year do not exceed $10,000,000.
* * * * * * *
(g) Production.-–For purposes of this section–-
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(1) In general.-–The term “produce”
includes construct, build, install,
manufacture, develop, or improve.
(2) Treatment of property produced under
contract for the taxpayer.–-The taxpayer
shall be treated as producing any property
produced for the taxpayer under a contract
with the taxpayer * * *.
(h) Exemption for Free Lance Authors,
Photographers, and Artists.--
(1) In general.–-Nothing in this section
shall require the capitalization of any
qualified creative expense.
(2) Qualified creative expense.--For
purposes of this subsection, the term
“qualified creative expense” means any
expense--
(A) which is paid or incurred
by an individual in the trade or
business of such individual (other
than as an employee) of being a
writer, photographer, or artist,
and
(B) which, without regard to
this section, would be allowable as
a deduction for the taxable year.
* * * * * * *
(3) Definitions.--For purposes of this
subsection--
* * * * * * *
(C) Artist.--
(i) In general.--The term
“artist” means any individual if
the personal efforts of such
individual create (or may
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reasonably be expected to create) a
picture, painting, sculpture,
statue, etching, drawing, cartoon,
graphic design, or original print
edition.
(ii) Criteria.--In
determining whether any expense is
paid or incurred in the trade or
business of being an artist, the
following criteria shall be taken
into account:
(I) The originality
and uniqueness of the item created
(or to be created).
(II) The
predominance of aesthetic value
over utilitarian value of the item
created (or to be created).
(D) Treatment of certain
corporations.--
(i) In general.--If--
(I) substantially
all of the stock of a corporation
is owned by a qualified employee-
owner and members of his family (as
defined in section 267(c)(4)), and
(II) the principal
activity of such corporation is
performance of personal services
directly related to the activities
of the qualified employee-owner and
such services are substantially
performed by the qualified
employee-owner,
this subsection shall apply to any
expense of such corporation which
directly relates to the activities
of such employee-owner in the same
manner as if such expense were
incurred by such employee-owner.
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(ii) Qualified employee-
owner.--For purposes of this
subparagraph, the term “qualified
employee-owner” means any
individual who is an employee-owner
of the corporation (as defined in
section 269A(b)(2)) and who is a
writer, photographer, or artist.
Petitioner makes two arguments as to why it is not subject
to the UNICAP rules. First, petitioner argues, it is excepted
from those rules because it is a small reseller under section
263A(b)(2)(B).2 Petitioner asserts that it engages in no
manufacturing or production activity with respect to its paper
products and that it resells those products after buying them
from the producers thereof; namely, petitioner asserts, the
printers. Second, petitioner argues, it is an artistic business
that is exempt from the UNICAP rules by virtue of section
263A(h). Petitioner asserts that Ms. Spafford is a qualified
employee-owner and that she owns substantially all of
petitioner’s stock. Petitioner asserts that Ms. Spafford’s
cartoon characters are original and unique and that her artwork
is reproduced and disseminated through the paper products
primarily for the character’s aesthetic value.
Respondent argues that petitioner does not meet the reseller
exception because it produces rather than resells its paper
2
For purposes of sec. 263A, “resellers” are “retailers,
wholesalers and other taxpayers that acquire property described
in section 1221(1) for resale”. Sec. 1.263A-1(a)(3)(iii), Income
Tax Regs.
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products.3 Respondent argues that petitioner does not qualify
under section 263A(h). Respondent asserts that Ms. Spafford does
not own substantially all of petitioner’s stock within the
meaning of section 263A(h)(3)(D)(i)(I) and that petitioner’s
paper products are utilitarian rather than unique.
We agree with respondent that petitioner is subject to the
UNICAP rules of section 263A. As to petitioner’s primary
argument, namely, that it is a reseller and not the producer of
its paper products, we disagree. The facts of this case lead us
to conclude that petitioner is and has been the only “owner” of
its paper products up until the time that they are sold to its
customers, and, thus, that petitioner is the only producer of
those products for purposes of section 263A. See sec. 1.263A-
2(a)(1)(ii), Income Tax Regs. (“a taxpayer is not considered to
be producing property unless the taxpayer is considered an owner
of the property produced under federal income tax principles”).
Petitioner’s ownership interest in the paper products attaches at
the first stage of their production; i.e., when the cartoon
characters are developed and drawn. Petitioner performs this
step solely by itself, and this step, which requires the most
skill, expertise, and creativity of any step in the production
3
For purposes of sec. 263A, the term “produce” “includes *
* * construct, build, install, manufacture, develop, improve,
create, raise, or grow.” Sec. 1.263A-2(a)(1)(i), Income Tax
Regs.
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process, is critical and indispensable to the paper products’
production. But for these characters, petitioner would not be
able to sell its paper products in the form that it does.
Petitioner also does not let anyone (e.g., a printer) sell, copy,
or use any of its cartoon characters without its permission, and
anyone who does so is in breach of the license that petitioner
holds as to its characters.
Petitioner focuses on the fact that the producers actually
develop the paper products and argues therefrom that the printers
are the producers of its products. We disagree with this
argument. The printer’s reproduction of petitioner’s characters
onto ordinary paper is merely one small step in petitioner’s
process of exploiting its characters as sellable images, and the
reproduction process is mechanical in nature in that it involves
little independence on the printers’ part and is subject to
petitioner’s control, close scrutiny, and approval. Petitioner
personally selects the printers merely to reproduce the
character’s images in a specified manner onto standard sheets of
plain paper. The printers cannot print the paper products
without the cartoon images, and the finished products must
conform to petitioner’s specifications. Given the added fact
that a printer does not acquire a proprietary interest in a
cartoon drawing so that it may sell the drawing (or copy thereof)
either separately or as part of a paper product, we conclude that
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the printers are not producers because they never meet the
necessary requirement of owning the paper products for Federal
income tax purposes. See Charles Peckat Manufacturing Co. v.
Jarecki, 196 F.2d 849 (7th Cir. 1952).4
Nor do we believe that a product such as petitioner’s paper
products may be considered within the meaning of section 263A
(g)(2) when the product, in its finished form, requires such an
extensive involvement on the part of the taxpayer vis-a-vis the
purported producer, and the taxpayer has the exclusive right to
sell the finished product. See id.; see also Polaroid Corp. v.
United States, 235 F.2d 276 (1st Cir. 1956). Petitioner’s
transfer of the cartoon characters to the printers gave the
printers only the bare right to possess the characters or
reproductions thereof. It did not give the printers any right to
sell the characters (or reproductions thereof) either alone or as
4
The case of Charles Peckat Manufacturing Co. v. Jarecki,
196 F.2d 849 (7th Cir. 1952), is instructive to our analysis.
There, the taxpayer owned a patent on a certain bracket for
automobile visors and contracted with an independent machine shop
to fabricate the bracket for it. The machine shop’s entire output
had to be sold to the taxpayer at a per-piece price, and the
machine shop never had a proprietary interest in the bracket.
The court held that the taxpayer manufactured the bracket for
purposes of the Federal excise tax. The court focused on the
control maintained by the taxpayer over the manufacturing process
and observed that the fabricator "never had a proprietary
interest in the completed product" because the bracket was
subject to the patent that the taxpayer controlled. Id. at 852.
The court stated: “it is not unusual in taxing statutes for the
term 'manufacturer' to include one who has contracted with others
to actually fabricate the product". Id. at 851.
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part of a product such as petitioner’s paper products. The ink
and characterless paperstock which the printers sell to
petitioner is sufficiently different from the character-filled
paper products which petitioner sells to its customers so as to
characterize the latter products as sold initially by petitioner,
rather than as sold first by the printers to petitioner and then
resold by petitioner to its customers. We also note that the
approximately 60-percent gross profit percentage reported by
petitioner for the subject year on the sale of its paper products
leads directly to the conclusion that the printers charge
petitioner solely for the paper, ink, and labor devoted to the
paper products, rather than for the value of the paper products
as items that are sold to petitioner for purposes of resale.
Petitioner focuses on the fact that the printers bear the
risk of loss during the printing process. We do not find this
fact dispositive as to who owns (and thus produces) the paper
products. The identification of the owner of property for
purposes of the UNICAP rules does not necessarily rest on who
bears the risk of loss when the product is fabricated or
assembled, or, for that matter, on who actually turns the screws
or hammers the nails into the product. The owner of property
must be identified from the facts and circumstances of the case,
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see sec. 1.263A-2(a)(1)(ii), Income Tax Regs.,5 and who bears the
risk of loss is merely one factor to consider. That a good
damaged during the printing process may cause a printer to suffer
a loss for the ink and paper used on that good (and possibly the
labor spent or value of the machinery used in applying the ink to
the paper) does not necessarily mean that the printer was the
damaged good’s owner. As a matter of fact, a reasonable printer
would most likely have factored into its price of the print job
the projected expense for damaged or nonconforming goods.6
As to petitioner’s second argument that it qualifies for
section 263A(h)’s exemption for artists and other stated
professionals, we also disagree. This exemption was not included
in section 263A as originally enacted, but was added to that
5
Sec. 1.263A-2(a)(1)(ii), Income Tax Regs., also provides
that a taxpayer may be considered the owner of property produced
even though it does not have legal title thereto.
6
Petitioner also discusses at length sec. 1.263A-3(a)(3),
Income Tax Regs. That section is inapplicable to the facts at
hand. Sec. 1.263A-3(a)(3), Income Tax Regs., provides:
(3) Resellers with property produced under
contract. Generally, property produced for a taxpayer
under a contract * * * is treated as property produced
by the taxpayer. * * * However, a small reseller is
not required to capitalize additional section 263A
costs to personal property produced for it under
contract with an unrelated person if the contract is
entered into incident to the resale activities of the
small reseller and the property is sold to its
customers. * * *
That section is inapplicable because petitioner has no resale
activities in that it is not a reseller of its paper products.
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section by way of an amendment that was retroactive to the
effective date of the TRA. See sec. 6026(a) of the Technical and
Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. 100-647, 102
Stat. 3342, 3691. As amended by TAMRA, section 263A(h)(3)(D)(i)
and (ii) allowed a “personal service corporation” (as defined in
section 269A(b)) to qualify for section 263A(h)’s exemption if,
among other requirements, “substantially all of * * * [its] stock
* * * is owned by * * * [a qualified employee-owner] and members
of his family”. The House Ways and Means Committee stated in its
report that “For this purpose, the term “substantially all” means
95 percent or more of the value of the corporation’s stock”. H.
Rept. 100-795, at 531, 532 (1988). In the following year,
Congress amended section 263A(h) a second time, again retroactive
to the effective date of section 263A, to provide that any
corporation (and not simply a personal service corporation) could
qualify for section 263A(h)’s exemption if, among other
requirements, “substantially all of * * * [its] stock * * * is
owned by a qualified employee-owner and members of his family”.
See secs. 7816(d)(1) and 7817 of the Omnibus Budget
Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106,
2420.
We must apply the term “substantially all” to determine
whether petitioner qualifies for the exemption set forth in
section 263A(h). We generally apply statutory text in accordance
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with its ordinary, everyday usage. When the meaning of statutory
text is “unescapably ambiguous”, however, we may resort to the
relevant legislative history to resolve that ambiguity. Garcia
v. United States, 469 U.S. 70, 76 n.3 (1984) (quoting Schweumann
Bros. v. Calvert Distillers Corp., 341 U.S. 384, 395 (1951)
(Jackson, J., concurring)); see Venture Funding, Ltd. v.
Commissioner, 110 T.C. 236, 241-242 (1998), affd. F.3d
(6th Cir. 1999); see also Albertson's, Inc. v. Commissioner, 42
F.3d 537, 545 (9th Cir. 1994), affg. 95 T.C. 415 (1990). Here,
we believe that the term “substantially all” is “unescapably
ambiguous”, and, accordingly, we consult the term’s legislative
history for guidance as to its meaning. As mentioned above, we
find in the report of the House Ways and Means Committee that it
clearly intended for that term to require that a qualified
employee-owner and members of his family own “95 percent or more
of the value of the corporation’s stock”.7 H. Rept. 100-795,
supra at 531, 532 (1988). We also find in the House conference
report that the conference agreement followed the House bill as
7
The legislative history to the TRA reveals that Congress
also equated a 95-percent test with the term “substantially all”
for purposes of sec. 448(d)(2), a provision included in the TRA
as sec. 801(a). See H. Conf. Rept. 99-841 (Vol. II) at II-287
(1986), 1986-3 C.B. (Vol. 4) 1, 287. The legislative history to
TAMRA reveals that the joint conferees to that Act knew that the
term “substantially all” had been equated with a 95-percent
requirement. See H. Conf. Rept. 100-1104 (Vol. 2) at II-152
(1988), 1988-3 C.B. 473, 642.
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amended by the Senate.8 See H. Conf. Rept. 100-1104 (Vol. II),
at 145, 146 (1988), 1988-3 C.B. 473, 635-636. Given the fact
that none of petitioner’s shareholders owns the requisite
percentage of stock as set forth in the report of the House Ways
and Means Committee, we hold that petitioner does not qualify for
the exemption set forth in section 263A(h).9 We need not and do
not address whether petitioner was otherwise disqualified for
that exemption because, as asserted by respondent, its paper
products are utilitarian in nature.
Having concluded that petitioner is subject to the UNICAP
rules, we now turn to the remaining issue; i.e., the year in
which section 481 requires that petitioner account for its change
to the UNICAP rules. Petitioner argues that TRA section
803(d)(2) requires that it account for this change in its taxable
year ended June 30, 1988. In relevant part, that section
provides:
8
None of the Senate’s amendments are relevant for purposes
of our discussion.
9
Petitioner argues that the Court should apply a “facts and
circumstances test” to determine whether Ms. Spafford owns
“substantially all” of petitioner’s stock for purposes of sec.
263A(h). Petitioner notes that neither the text of sec. 263A nor
the regulations thereunder have ever mentioned the 95 percent
test referenced in the committee report and states that the
“House Committee Report to Public Law 100-246 * * * suggested
that a 95% interest would clearly satisfy the substantially all
test.” Suffice it to say that the 95-percent test referenced in
the committee report is more than a mere suggestion and that
petitioner fails the 95-percent test because none of its
shareholders owns the requisite percentage of stock.
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(d) Effective date.--
(1) In General.--Except as provided in
this subsection, the amendments made by this
section shall apply to costs incurred after
December 31, 1986, in taxable years ending
after such date.
(2) Special Rule For Inventory
Property.--In the case of any property which
is inventory in the hands of the taxpayer–-
(A) IN GENERAL--The amendments
made by this section shall apply to
taxable years beginning after
December 31, 1986.
* * * * * * *
Petitioner focuses on the fact that section 803(d)(2)(A) of
the TRA provides explicitly that the amendments contained therein
“shall” apply to taxable years beginning in or after 1987 and
asserts that this language means that the “year of change” for
purposes of section 481 is the year for which it was required to
change its method of accounting to conform to the UNICAP rules
rather than the first year for which it actually made the change.
Respondent argues that the “year of change” for purposes of
section 481 is the year in which the change actually occurred;
i.e., the subject year.
We agree with respondent. Section 481(a)(1) provides that
where in computing a taxpayer's taxable income the computation is
under a method of accounting different from the method under
which the taxpayer's income for the preceding taxable year was
computed, there shall be taken into account those adjustments
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which are determined to be necessary solely by reason of the
change in order to prevent an amount from being duplicated or
omitted. Section 481 was designed by Congress to prevent the
duplication or omission of income or expense that may otherwise
occur solely through a change in a method of accounting that is
used by a taxpayer to compute his or her taxable income. See
Graff Chevrolet Co. v. Campbell, 343 F.2d 568, 572 (5th Cir.
1965); Pursell v. Commissioner, 38 T.C. 263, 271 (1962), affd.
315 F.2d 629 (3d Cir. 1963). Congress designed section 481
broadly to allow the Commissioner to adjust income for a "year of
the change" by increasing that year's income by any income that
was earned in a "closed year" but went unreported due to the
mechanics of the taxpayer's old accounting method. See Graff
Chevrolet Co. v. Campbell, supra at 572. The year of change is
the first taxable year in which taxable income is computed under
a method of accounting that is different from the method of
accounting that was used in the prior year. See sec. 1.481-
1(a)(1), Income Tax Regs.
In accordance with this firmly established law, the year of
change in this case is the subject year; i.e., the first year in
which petitioner’s method of accounting was changed to reflect
the UNICAP rules. Petitioner attempts to distinguish this law by
arguing that, as of its first taxable year beginning in 1987, TRA
section 803(d)(2) changed its method of accounting to conform to
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the UNICAP rules as an operation of law.10 We find that argument
unpersuasive. The fact of the matter is that, up until and
including the subject year, petitioner used a method of
accounting that did not reflect the UNICAP rules, and our
holdings herein mean that petitioner must recompute its income
for the subject year under a method of accounting that does take
into account those rules. See also sec. 1.263A-1T(e)(11),
Temporary Income Tax Regs., 52 Fed. Reg. 10052, 10083-10084 (Mar.
30, 1987) (“Taxpayers who are required to change their method of
accounting under this section and who fail to comply with the
requirements of this paragraph (e)(11) [regarding an automatic
10
Petitioner also notes that the Commissioner had previously
examined some of its earlier taxable years that postdated the
effective date of the UNICAP rules and that the Commissioner had
never changed its method of accounting for those years to conform
to those rules. Petitioner suggests that the Commissioner now is
estopped from making the sec. 481 adjustment for the subject
year. We find this suggestion unavailing. The fact that the
Commissioner had the opportunity to, but did not, change an
improper method of accounting in an earlier year does not mean
that he is estopped from making the change in the later year.
See Knight-Ridder Newspapers Inc. v. United States, 743 F.2d 781
(11th Cir. 1984). The doctrine of equitable estoppel does not
bar the Commissioner from correcting a mistake of law, see
Automobile Club v. Commissioner, 353 U.S. 180, 183 (1957); see
also Norfolk S. Corp. v. Commissioner, 104 T.C. 13, 61 (1995),
and the cases cited therein, affd. 140 F.3d 240 (4th Cir. 1998),
"even where a taxpayer may have relied to his detriment on the
Commissioner's mistake", Dixon v. United States, 381 U.S. 68,
72-73 (1965). The Commissioner may correct mistakes of law
because "'Whoever deals with the government does so with notice
that no agent can, by neglect or acquiescence, commit it to an
erroneous interpretation of the law."' Graff v. Commissioner, 74
T.C. 743, 762 (1980) (quoting Schafer v. Helvering, 83 F.2d 317,
320 (D.C. Cir. 1936)), affd. 673 F.2d 784 (5th Cir. 1982).
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change in method of accounting to comply with the UNICAP rules]
shall be considered as using an improper method of accounting
under the Code”). Because the subject year is the first taxable
year in which taxable income is computed under a method of
accounting that is different from the method of accounting used
in the prior year, we agree with respondent that the subject year
is the “year of change” for purposes of section 481. See also
sec. 1.481-1(a)(1), Income Tax Regs.
All arguments not discussed herein are either irrelevant or
without merit. To reflect concessions,
Decision will be entered
under Rule 155.