# UNITED STATES TAX COURT

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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

115 T.C. No. 38

UNITED STATES TAX COURT

FPL GROUP, INC. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 5271-96.

-

Filed December 13, 2000.

F, a regulated electric utility, is a wholly owned
subsidiary of P. F is required to follow prescribed
regulatory rules for regulatory accounting and
financial reporting purposes.
In preparing its
consolidated tax returns for the years in issue, P
characterized F' s expenditures by using the same
characterization that F used for regulatory accounting
and financial reporting purposes.
In.an amended
petition, P sought to recharacterize as repalr
expenses, expenditures which it had characterized as
capital expenditures for tax purposes.
Held: P's method of accounting for tax reporting
purposes was to characterize the expenditures in issue
consistently with the method that F used for regulatory
accounting and financial reporting purposes. By
seeking to alter the method which it used to
characterize expenditures, P is attempting to change
its method of accounting. P has failed to obtain the.
consent of the Secretary to change its method of

SERVED DEC 1 3 2000

- 2 acöounting under sec. 446(e), I.R.C.; therefore, P is
noh entitled to the claimed expense deductions.

Robert Thomas Carney, for petitioner.
Gary F. Walker, Sergio Garcia-Pages, and Robert W. Dillard,
for respondent .

OPINION

RÚWE, Judge:

This matter is before the Court on

respondent's motion for partial summary judgment filed pursuant

to Rule 121.1

The sole issue presented is whether petitioner's

attempf to recharacterize as repair expenses, expenditures which

it hadl characterized on its tax returns as capital expenditures
for the taxable years 1988 to 1992, is an impermissible change in
accounhing method under section 446 (e) .
Background
FPL Group, Inc.

(petitioner) is a corporation organized and

existihg under the laws of the State of Florida with its
principal office located in Juno Beach, Florida. . Florida Power &
Light Co.

(Florida Power) is a wholly owned subsidiary of

1Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all RÊle references are to the Tax Court Rules of Practice and
Procedure .

- 3 petitioner.

Petitioner filed consolidated returns with Florida

Power during the years in issue .
On December 28, 1995, respondent issued a notice of
deficiency for the taxable years 1988 through 1992.

In its First

Amended Petition, filed May 13, 1996, petitioner argued for the
first time that respondent erred in failing to allow a deduction

for certain repair expenses related to Florida Power when
determining the· deficiency amounts in the notice of deficiency.
Petitioner claimed that it had improperly characterized the
following expenditures relatedsto Florida Power as capital
expenditures and that it should have deducted them as repair

expenses:
Year
1988
1989
1990
1991 .
1992
Total

Amount
$35, 324 , 412
52,115,791
54,746,820
56,823,897
11, 914 , 614
210 , 925, 534

Petitioner did not file a Form 3115, Application for Change in

Accounting Method, with respondent to request a change in
accounting method for the expenditures at issue.

Respondent did

not raise the change in accounting method issue prior to the
filing of his motion for partial summary judgment.

Florida Power owns and operates fossil and nuclear electric
generating plants in Florida and also owns interests in coalfired electric generating plants in Georgia and Florida, which

I

are operated by other utilities. Florida Power provides.public
electric utility services in Florida.

Florida Power is subject

to the regulatory rules of the Federal Energy Regulatory

Commiss on (FERC) and the Florida Public Service Commission
(FPSC).

The FERC regulates the rates that Florida Power may

charge

o its wholesale customers.

The FPSC regulates the rates

that Florida Power may charge to its retail customers.
For regulatory purposes, property at Florida Power's
electrfc generating plants (electric plants) is considered as
consisning of "retirement units" and. "minor items of property".

A retirement unit is the overall unit of property while the minor
items of property are the associated parts or items which compose
a retirement unit.

Examples of retirement units include air-

conditioning systems, bridges, elevators, and cars.

The

regulatory rules determine which expenditures at Florida Power's
electric plants are capitalized and which expenditures are
expensed for regulatory accounting purposes.

Expenditures for

the addition or replacement of a retirement unit are required to
be caØitalized, while the replacement of a minor item of property
is generally deducted as a repair expense.2

Florida Power, as a

2Under regulatory accounting, expenses that are capitalized
are taken into the capital base for ratemaking purposes (i.e.,
they receive an allowed "rate of return" on capital investment).
On the other hand, expenditures deducted as current expenses are
passeÈ on to customers (and, therefore, reimbursed dollar-fordollar) in the allowed rates.

.

-

5

-

regulated electric utility, is required to follow regulatory
accounting for financial reporting purposes.
The FERC publishes a Uniform System of Accounts (USOA) which

contains a standard set of accounts3 rules, and regulations.
Florida Power, as a major electric utility, is required to follow
the USOA.
USOA.

The FPSC also requires Florida Power to follow the

For regulatory accounting purposes, the FERC also

publishes a list of Units of Property for Use in Accounting for

Additions and Retirements of Electric Plant (FERC.list), which is
separate from the USOA.

The units of property identified in the

list are referred to as retirement units.

The FERC list of

retirement units may be expanded by any utility without other
.

authorization by the FERC, but no retirement unit may be larger

in size than those identified in the FERC list.

The FERC list

may not be condensed, but a subdivision or addition of other
units is.permitted.
The FPSC authorizes an expanded list of retirement units

(FPSC list) beyond those prescribed by the FERC.

The FPSC has

the discretion to authorize a list of retirement units in which
the retirement units are larger in size than dhe corresponding
FERC retirement units.

Florida Power could add retirement units

to the FPSC list or expand the size of existing retirement units,
but it had to notify the FPSC semiannually of these changes.

Increasing the size of retirement units would increase the amount

of costs charged to expense, while decreasing the size of
retiremënt units would increase the amount of capitalized costs.
During the years in issue, petitioner utilized.the FPSC
requirements for regulatory ·accounting purposes.

Florida Power

made mo e than 450 changes between 1988 and 1992 to the FPSC list
of retirement units and semiannually notified the FPSC of the
changes.

However, the retirement units used by Florida Power for

FPSC'pu poses did not exceed the limits for retirement units as

prescribed by the FERC.

Thus, Florida Power's utilization of the

FPSC requirements in defining retirement units automatically
conforded with the FERC regulatory accounting requirements.3

32ba example of the aforementioned regulatory concepts
illust$ates the accounting principles of the FERC and FPSC.
Suppose that P owns five cars. Each car is defined as a
retirement unit in the FERC list. The wheels, seats, and other
components of the car would be considered minor items of
property. Under the FERC, P could add more cars or replace
existing cars, and the corresponding costs would be capitalized.
The costs of the replacement of the wheels, seats, etc., would
generally be considered as expenditures related to minor items of
property and generally would be expensed. Theoretically, P could
subdivide the car into smaller retirement units, so that the
wheels; seats, etc., would be considered separate retirement
units. This would increase the amount of capitalized costs
because additions or replacements of the wheels, seats, etc.,
would be required to be capitalized under regulatory rules.
However, under the FERC, P is prohibited from increasing the size
of the retirement units; i.e.,. defining a retirement unit to
include all five cars. The FPSC has the discretion to allow P to
increase the size of the retirement units. This action, if
available to P, might theoretically allow all five cars to be
identified as one retirement unit; thus, the individual cars
might be defined as minor items of property. This would result
in an increase in the size of the retirement unit (from one car
to five cars), and the amount of costs charged to repair expense
(continued...)

During the years in issue,'Florida PQwer incurred
substantial costs related to its electric plants.

The

expenditures for these costs were recorded as either capital
expenditures or repair expenses for regulatory.accounting and
financial reporting purposes.

In preparing its tax returns for

the years in issue, petitioner used the same characterization of
expenditures for tax reporting purposes that Florida Power did
for regulatory accounting and financial reporting purposes,
except for specific Schedule M-1, Reconciliatioh of Income (Loss)
Per Books With Income Per Return, adjustments.'

For the years in

.issue, petitioner characterized approximately $2.1 billion in

expenditures related to Florida Power's electric plants as repair
Texpenses for tax purposes.
During the years in issue,.petitioner made Schedule M-1
adjustments on its original tax returns with respect to Florida
Power.

The Schedules M-1 adjustments for the years 1988 to 1991

3(...continued)
might be increased. However-, if P did elect to increase the size
of the retirement units under the authority of the FPSC, P would
be in violation of the FERC rules prohibiting increases in the
size of retirement units. Thus, the retirement units actually
used by Florida Power for regulatory accounting purposes
conformed with FERC rules.
'A Schedule M-1 is a schedule attached to a Form 1120, U.S.
Corporation Income Tax Return. It identifies the different
treatment of income and expense items for book and tax purposes.
See Southwestern Energy Co. v. Commissioner, 100 T.C. 500, 503
n.4 (1993); Orange & Rockland Utils. v. Commissioner, 86 T.C.
199, 205

(1986).

- 8 reflected petitioner's election to apply the.percentage repair

allowance (PRA), a specific tax provision allowing petitioner to
deduct as repair expenses.a set percentage of expenditures for
the repåir, maintenance, rehabilitation, or improvement of

certain property.

See sec. 1.167(a)-11(d) (2), Income Tax Regs.®

The Schedule M-1 adjustment for 1992 was for a storm reserve and
related to damages caused by Hurricane Andrew.'

Other than the

variatiöns for the PRA and storm reserve, petitioner used the
same characterizations of expenditures for tax purposes that
Florida Power did for regulatory accounting and financial
reportihg purposes.

For the taxable year 1992, petitioner filed two amended
returns with claims related to the characterization of
expenditures associated with Florida Power.

In its first amended

return, filed in September of 1993, petitioner claimed additional
storm expenses of $412,042 and an additional repair expense
deduction of approximately $4.7 million for cable injection

Respondent has alleged -that the following amounts were
deductsd as repair expenses under the PRA for the years 1988 to
1991:

Year

Amount

1988
1989
1990
1991

$28,501,471
29,315,281
28,635,238
25,806,865

Petitioner has not disputed these amounts.
'The Schedule M-1 adjustment for the storm reserve was in
the amount of $6 million.

expenditures .

The storm expenses were accepted by respondent and

a portion of the claimed repair expense deduction was allowed by
respondent.

In its second amended return,. filed in December of

1993, petitioner claimed an additional repair expense deduction
of approximately $21 million related to the same type of
expenditures currently in issue .

Respondent allowed an

additional repair expense deduction for these expenditures .in the
amount of approximately $11 million.

During the audit of the .

years 1988 to 1992, respondent proposed to capitalize certain
expenditures related to Florida.·Power that. petitioner had
reported as deductible repair expenses on its original tax
returns.
Discussion

Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials.

See Northern Ind. Pub.

Serv. Co. v. Commissioner, 101 T. C. 294, 295
Commissioner, 61 T.C. 861, 862

(1974) .

(1993) ; Shiosaki v.

Rule 121(a) provides that

either party may move for a summary judgment :upon all or any part
of the legal issues. in controversy.

Full or partial summary

judgment is appropriate where there is no genuine issue as to any
material fact and a decision may be rendered as a matter of law.
See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518,
520 (1992), affd. 17 F.3d 965 .(7th Cir. 1994).

Respondent, as

the moving party, bears the burden of proving that no genuine

- 10 issue exists as to any material fact and that he is entitled to
judgment as a matter of law.

See Bond v. Commissioner, 100 T.C.

32, 36 .(1993); Naftel v. Commissioner, 85 T.C. 527, 529

(1985).

In deciding whether to'grant summary judgment, the factual
materials and the inferences drawn from them must be considered
in the light most favorable to the nonmoving party.

See Bond v.

Commissioner, supra at 36; Naftel v. Commissioner, supra at 529.

Once a motion for summary judgment is made and supported,
the nonmoving party must do more than merely allege or deny facts
in its pleadings, it must "set forth specific facts showing that
there is a genuine issue for trial.

If the adverse party does

not so respond, then a decision, if appropriate, may be entered
against such party."

Rule 121(d); Celotex Corp. v. Catrett, 477

U.S. 317, 324. (1986); Sundstrand Corp. v. Commissioner, supra at
520.

Moreover, summary judgment may be granted if the evidence

submitted by the nonmoving party is merely colorable or not
significantly probative.
477 U.S. 242, 249-250

See Anderson v. Liberty Lobby5 Inc.,

(1986).

Pëtitioner argues that some of the factual allegations made

by respondent are in dispute.

After reviewing the materials

filed by both parties, we find that there is no genuine issue as
to any of the material facts that we have set forth in the
background section of this opinion.

"Only disputes over facts

that sight affect the outcome of the suit under the governing law

- 11 -

will properly preclude entry of summary judgment.

Factual

disputes that are irrelevant or unnecessary will not be counted."
Anderson v. Liberty Lobby, Inc., supra at 248.
Respondent argues that petitioner's attempt to

recharacterize as repair expenses, expenditures which it had
characterized as capital expenditures, is prohibited under
section 446(e) as an impermissible change in accounting method
because petitìoner did not obtain respondent's consent to

recharacterize the expenditures.

Respondent claims that, for

regulatory, financial, and tax accounting purposes, petitioner
consistently followed the regulatory accounting rules and

4

pguidelines to determine which expenditures to capitalize and
which expenditures to expense at Florida Power's electric plants.
Respondent contends. that this consistent treatment constitutes
petitioner's method of accounting with respect to the
expenditures in issue.
Petitioner argues that its method of accounting was to

deduct expenditures to the extent allowed under section 1.162-4,
Income Tax Regs.,7 and that the regulatory accounting

7Sec. 1.162-4, Income Tax Regs., provides:

Sec. 1.162-4. Repairs.--The cost of incidental
repairs which neither materially add to the value of
the property nor appreciably prolong its life,.but keep
it in an ordinarily efficient operating condition, may
be deducted as an expense, provided the cost of
acquisition or production or the gain or loss basis of
(continued...)

- 12 requirements of the FERC and the FPSC were not its method of
accounting for purposes of determining the characterization of

expendiÜures at Florida Power's electric plants.

In classifying

expenditures as capital expenditures or repair expenses for tax
purposes, petitioner claims that it used the amount of repair

expensey determined for regulatory accounting and financial
reporting purposes as a "reasonable approximation" of the amount
of repair expenses allowable for tax purposes.

From there,

petitioner claims that it made certain adjustments to increase
the ded ctible repair amount for tax purposes when it became

aware that certain expenditures were erroneously classified as
capital expenditures.

Petitioner also claims that the

recharabterization is a mere "correction" which does not
constitute a change in accounting method.

Finally, petitioner

implies that respondent's failure to raise the change in
accountiing method argument when petitioner.claimed the additional

repair expense deduction for 1992 should prevent respondent from
now challenging petitioner's attempted recharacterization.

7(...continued)
the taxpayer's plant, equipment, or other property, as
the case may be, is not increased by the amount of such
espenditures. Repairs in the nature of replacements,
to the extent that they arrest deterioration, and
appreciably prolong the life of the property, shall
either be capitalized and depreciated in accordance
with section 167 or charged against the depreciation
reserve if such an account is kept.

L

- 13 -

I.

Method of Accounting
Section 446(a) provides that "Taxable income shall be

computed under the method of accounting on the basis of which the

taxpayer regularly computes his income in keeping his books."
The term "method of accounting" includes both the "over-all
method of accounting" and "the accounting treatment of any item."
Sec. 1.446-1(a) (1), Income Tax Regs.

A method of accounting

includes "the consistent treatment of.a recurring, material item,
whether that treatment be correct or incorrect."
Co. v. Commissioner, 53 T.C. 439, 447

(6th Cir. 1971).

H.F. Campbell

(1969),·affd. 443 F.2d 965

A taxpayer changes its method of accounting

when it changes either the "overall plan of accounting for gross

income or deductions" or "the treatment of any material item used
in such overall plan."

Sec. 1.446-1(e) (2) (ii) (a), Income Tax
I

Regs.

A "material item" is "any item which involves the proper

time for the inclusion of the item in income or the taking of a

deduction."
510

Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500,

(1989); sec. 1.446-1(e) (2) (ii) (a), Income Tax Regs.

A change

in accounting method may be ·effected only after consent is
obtained from the Secretary.

See sec. 446(e).

"The primary effect of characterizing a payment as either a

business expense or a capital expenditure concerns the timing of
the taxpayer's cost recovery: While business expenses are
currently deductible, a capital expenditure usually is amortized

.

-

14

-

and depreciated over the life of the relevant asset".
Inc. v. Commissioner

503 U.S. 79, 83-84

(1992).

INDOPCO,

This Court has

held that the determination of whether an expenditure constitutes

a capitål expenditure or a currently deductible expense involves
the question of the proper time for taking a deduction.

See

Pelaez à Sons, Inc. v. Commïssioner, 114 T.C. 473, 489 (2000);
Southern Pac. Transp. Co. v. Commissioner, 75 T.C. 497,. 683
(1980), supplemented by 82 T.C. 122

(1984); Hooker. Indus., Inc.

v. Commissioner, T.C. Memo. 1982-357; sec. 1.446-1(e) (2) (ii) (a),

Income Tax Regs.

An accounting practice involving the timing of

when ad item is deducted is considered a method of accounting.
See GMd & Subs. v. Commissioner, 112 T.C. 270, 296

(1999);

Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781,
797-798

(11th Cir. 1984).

In Southern Pac. Transp. Co. v. Commissioner,. supra, we

applieÊ section 1.446-1(e) (2) (ii) (b), Income Tax Regs., for
purposes of deciding whether the expenditures in issue were for a
"material item".

Section 1.446-1(e) (2) (ii) (b), Income Tax Regs.,

providès that "a correction to require depreciation in lieu of a
deduction for the cost of a class of depreciable assets which had
been cónsistently treated as an expense in the year of purchase

involvës the question of the proper timing of an item, and is to
be tre ted as a change :'u2 method of accounting."

Although the

taxpayer in Southern Pac. Transp. Co. v. Commissioner, supra, was

- 15 -

attempting to change from capitalizing the expenditures in issue
to expensing them, the reverse of the situation described in the
regulations, we were not convinced of the merit of this

distinction and we regarded both situations as examples of
changes involving the timing of a deduction.

See Southern Pac.

Transp. Co. v. Commissioner, supra at 683 n.211.

We held that

the expenditures that the taxpayer was attempting to
recharacterize from capital to expense fit the definition of

"material item".

Id. at 683.

Although section 446(a) requires a taxpayer to compute his
taxable income.in the same manner that he computes income in his

books, this requirement is not absolute.

Courts have permitted

variations between financial and tax reporting where other Code
requirements, such as sections 162 and 263, are met, and the
method of accounting clearly.reflects income.

See USFreightways

Corp. & Subs. v. Commissioner, 113 T.C. 329, 332

(1999).

Where

the taxpayer is governed by regulatory agencies, the taxpayer is
not automatically required to follow the regulatory accounting
rules when it reports its activities for tax purposes.
Commissioner v. Idaho Power Co., 418 U.S. 1,

14-15

Colony R..R. v. Commissioner, 284 U.S. 552, 562

See

(1974); Old

(1.932).

However,

while regulatory accounting rules are not binding on a taxpayer,
they are necessarily linked with tax accounting, and the
consistent practice of applying regulatory rules for tax

_ 16 -

reporti g purposes cannot be ignored.
Power Co., supra at 14-15.

See Commissioner v. Idaho

In that case, the Supreme Court

stated:
Some, although not controlling, weight must be
given to the fact :that the Federal Power Commission and
thé Idaho Public -Utilities Commission required the
taxpayer to use accounting procedures that capitalized
construction-related depreciation. Although agencyimposed compulsory accounting practices do not
necessarily dictate tax consequences, they are not
irrelevant and may be accorded some significance. * * *
where a taxpayer' s generally accepted method of
accounting is made compulsory by the regulatory agency
anÊl that method clearly reflects income, it is almost
presumptively controlling of federal income tax
consequences.
[Id. at 14-15; citations and fn. ref.
omitted.]
For regulatory accounting and financial reporting purposes,
Florida Power followed regulatory rules and guidelines to

determine the characterization of expenditures related to its
electric plants.

The fact that the regulatory accounting

requirements allowed Florida Power some flexibility in defining
retirempnt units does not change this.

The retirement units used

by Florida Power for FPSC purposes did not exceed the limits

prescribed by the FERC for the years in issue, and petitioner
. acknowledges that its characterization of expenditures for FPSC
purposes "automatically conformed with FERC regulatory .accounting
principles."

The FERC prohibited public utilities from

condensing the FERC list of retirement units or from adding any

retirement units that exceeded the size of the FERC retirement
units. 1 Once a retirement unit was established, the cost of

- 17.adding or replacing the retirement unit had to be capitalized.

Thus, while Florida Power's.limited ·flexibility in defining
retirement units could in some cases affect the amounts of
capital expenditures.or repair expenses, once the retirement unit
was identified the regulatory characterization rules requiring

capitalization were not flexible,. · The regulatory rules
ultimately determined which expenditures were capitalized and
which expenditures were expensed for regulatory accounting and
financial reporting purposes.
In Southern Pac. Transp. Co. v..Commissioner, supra, the
taxpayer was subject to Interstate Commerce Commission (ICC)

accounting rules which required the capitalization of certain
expenditures.

See id. at 676.

For the taxable years at issue,

the taxpayer followed the ICC accounting rules and capitalized

the expenditures in issue for regulatory and tax purposes.
id.

See

The Commissioner issued a notice of deficiency regarding

other issues, and the taxpayer filed a petition with this Court
for a redetermination of the deficiency.

See id. at 505.

In an

amended petition, the taxpayer raised,.for the first time, the
argument that the Commissioner erred in failing to allow the
capitalized expenditures as currently deductible expenses.

id. at 677.

See

The Commissioner argued that the taxpayer's attempt

to recharacterize the expenditures was an impermissible change in
the taxpayer's method of accounting under section 446(e) because

_ 18 -

the Comnissioner had not consented to the change.
680.

W

See id. at

held that, regardless of whether the expenditures were

more pr perly deductible as business expenses under section 162.,

allowin

the taxpayer to. deduct such expenditures would result in

an impe missible change in method of accounting.

We foun
alte

See id. at 687.

it readily apparent that the taxpayer was seeking to

the manner in which it had consistently accounteds for a

recurrihg, material item.

See id. - at 686.

We explained that a

change kn the treatment of the expenditures involved a. question
of prop r timing, .thus the àhange in treatment would af fect a

materia L item.

See id.' at 683.

The taxpayer consistently

followed the ICC accounting rules in capitalizing certain
expendi ures · for tax reporting purposes, and its later attempt to
recharapterize those. expenditures as repair expenses was
prohibited, absent consent by the Commissioner.
In Wayne Bol t & Nut Co . v . Commis s ioner , 93 T . C . 50 0 (1989) ,

the tax ayer, for a number of years, determined its ending
invento y by selecting a small portion of its inventory cards and
using them to approximate the ending. inventory.

See id. at 503.

Later, Èhe taxpayer completed a physical inventory in which it
identified and catalogued all inventory.

See id. at 504.

Based

on this thorough examination of inventory, the. taxpayer attempted
to adjust iÈs opening inventory to reflect the actual amount
identified.

See id. at 504-505.

This amount was considerably

- 19 larger than the amount determined under the approximation method
previously used by the taxpayer.

See id. at 512.

We held that

the taxpayer's "change from a seriously flawed and disorganized

method * * * to a method of determining both opening and ending
inventory * * * on the basis of a complete.physical inventory
[was] a change in the treatment of a material item and,
therefore,
510.

[constituted] a change in accounting method."

Id. at

We found that the approximation method of determining

inventory, while disorganized and inaccurate, was consistently

used by the taxpayer despite his actual knowledge that the
.

.inventory amounts were not completely accurate.

See id. at 512.

This consistent practice constituted a method of accounting for
determining inventory.

See id.

Petitioner argues that Wayne Bolt & Nut Co. v..Commissioner,
supra, does not apply because it involved inventories and they
are governed by separate ·and distinct rules.for purposes of
determining a method of accounting.

We disagree.

While there

are specific regulations which address the accounting treatment
of inventories, the basic principles apply for purposes of
determining a method of accounting; namely, that a consistent
method used to determine the tax treatment of a material item is

a method of accounting.

Our holding and reasoning in Wayne Bolt

& Nut Co. v. Commissioner, supra, is applicable to the instant
case.

- 20 -

The regulatory rules provided the guidelines for determining
Florida, Power's characterization of expenditures for regulatory
accounting and financial reporting purposes.

Petitioner

conscioûsly chose to use consistently the same characterization
for tax purposes that Florida Power did for regulatory and
f inancial purposes .

Petitioner argues that it used the amounts Florida Power
reported for regulatory purposes as a "reasonable approximation"

for tax purposes rather than reviewing its work orders to
determine which expenditures to capitalize and which to expense.
Petitioner has made no allegations that it alerted respondent to
the.fact that it was reporting only approximations and expected

to recharacterize expenditures years later.

Section 1.446-

1 (a) (4) , Income Tax Regs . , provides that the taxpayer' s
accounting records must be maintained in such a manner as to
enable him to file a correct return of his taxable income for

each taxable year.

One of the essential features that the

taxpayek must consider in maintaining such records is:
Exþenditures made during the year shall be properly
classified as between capital and expense. For
example, expenditures for such items as plant and
eqùipment, which have a useful life extending
substantially beyond the taxable year, shall be charged
to a capital account. and not to an expense account .
[Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324,
1332 (1971), affd. 496 F.2d 876 (5th Cir. 1974)
(quoting sec . 1. 446-1 (a) (4) (ii) , Income Tax Regs . ) . ]

- 21 The FERC and FPSC rules:provided a-regulatory accounting
system which afforded petitioner with a characterization method
based on basic accòunting principles thategenerally require the

capitalization of expenditures for larger items of property
having long-term lives and the expensing of .relatively smaller
expenditures for minor items needed for repairs.. . We,note "that
the 'decisive distinctions'.'between current expenses and capital

expenditures .'are those of degree .and not of kind, ' ,and * * *
each case 'turns on_its special facts'",

INDOPCO, Inc. v.

Commissioner,= 503 U.S. .at 86 (citation ómitted) .

Petitioner's

attempt to change retroactively from a consistent and logical
method of capitalizing the expenditures ;in issue to expensing
ethem involves the question'of proper timing and thus is a. .
material item.

See Southern Pac. Transp. Co. v. Commissioner, .75

T . C . at 683 ; sec . 1. 446-1 (e):(2 ) (ii) (a) and (b) ,

Income Tax Regs .

This attempt to recharacterize the expenditures in issue is to be
treated as 'a change,:in method of accounting.

See Southern Pac.

Transp. Co . ·v. Commissioner, supra; sec . - 1. 446-1 (e) (2) (ii) (a) and

(b) , Income Tax. Regs .:

.

.

Petitioner argues thats it made certain adjustments related
to Florida Power on its Schedules M-1 for the years in issue and
that such adjustments éstablish that petitione'r's method of*
accounting was not' simply to follow regulatory and f inancial
accounting for tax reporting purposes.

A' Schedule M-1 is a

- 22 -

schedule attached to a Form 1120, U.S. Corporation Income Tax
Return.

It identifies the different treatment of income and

expense items for book and tax purposes.

See Southwestern Energy

Co. & Subs. v. Commissioner, 100 T.C. 500, 503 n.4

(1993); Orange

& Rockland Utils. v. Commissioner, 86 T.C. 199, 205 (1986).
Respondent acknowledges that petitioner made Schedules M-1
adjustments on its tax returns for the years in issue.

However,

respondent argues that the adjustments do not change the fact
that petitioner's method of accounting with respect to the
expenditures in issue was to use the regulatory rules and
guidelines to determine the proper characterization of

expenditures for regulatory, financial, .and tax reporting
purposes.

Respondent claims that the Schedules M-1 adjustments

were only for the PRA and the storm reserve.

Petitioner does not

contend that there were any other Schedules M-1 adjustments.
A.

Percentage Repair Allowance (PRA)

Th

PRA concept originated in 1971 as part of- the Asset.

Depreciation Range system.e

The PRA was intended to end

controv rsies concerning whether certain expenditures for repair,
mainten nce, or improvement of property must be capitalized or

eI 1981, Congress repealed the entire PRA system effective
for property placed in service after Dec. 31, 1980, in taxable
years ebding after such date. See Economic Recovery Tax Act of
1981, Pub. L. 97-34, sec. 203, 95 Stat. 221.
The PRA continues
to be in effect for expenditures which, although incurred after
Dec. 31:, 1980, are for the repair, maintenance, rehabilitation,
or imprþvement of property placed in service before Jan. 1, 1981.

- 23 currently deducted.~ -See-Armco, Inc.· v. Commissioner, 88 T.
946,

949

(1987) J . sec . 1. 167 (a) -11'(a) (1) , Income $Tax ,Regs .

.
By

electing the PRA, the -taxpayer may:automatically deduct up to a
set percentage of all expenditures for repair, maintenance
rehabilitation, or .improvement- of "repair allowance property" for
the t'axablè year, as long asv such expenditures are not.;considered

"exclud'ed additions" .

Sec .ml . 042167
(a) ,11 (d) (2) , Income Tax Regs .

E penditures' in excess of the set percentage must be capitalized.
See id.

w

"Under * * * [the PRA],. system, certain, expenditures,

ch typicalsly would be capitalized can be treated as repair

allowances and, thus
A

deducted .as expenses."

United States v.

nW1sconsin Power & Light Co. , 38 F.3d 329, 331

(7th Cir. 1994) .

For the years 1988 to 1991

.

respondent -claims that

petitioner's repair deductions for tax_purposes consisted of the .
amounts deducted fór book purposes,. plus Schedules M-1
adjustments for the PRA as follows:
Y ar
1988
1989
1990
1991

.

Book Account

M-1 Adiustment

$372, 757, 769
385, 472, 395
408, 077, 080
' - 405, 017;292

$2 8, 501, 471
29, 315, 281
28, 635, 238
25, 806, 865

Tax Return
$401, 259, 240
414, 839, 472
. 436, 688, 025
430, 814, 717

P titiòñer does nott dispute respondent's figures, or allege that
there were Sdhedules M-1 adjustments for-any other. items for 1988

The PRA-is a specific taxsonly, provlslon.

Florida

not have the option 'of- using the PRA , to determine the

ower did

- 24 characterization of expenditures for regulatory accounting and
financial reporting purposes.

The PRA simply allowed petitioner

to characterize a set percentage of expenditures as repair

expenses for tax purposes.
Petitioner is now trying to recharacterize as repairs, items
that iti characterized as capital expenditures for tax purposes.

Petitidner cannot recharacterize amounts capitalized under the
PRA be ause to do so would violate. the percentage limitation.
Petitioner does not identify any adjustments in the PRA or claim
that i

made any error in the original computation under the PRA.

The ex enditures that petitioner is trying to recharacterize are
those

hat petitioner consistently capitalized for regulatory,

financial, and tax reporting purposes.

This attempted

recharacterization conflicts with petitioner's practice of having
tax accounting follow regulatory and financial accounting. .
B.

Storm Reserve

OS its original 1992 tax return, petitioner made a Schedule
M-1 adjustment of $6 million for a storm reserve related to
Florida Power.

The storm reserve related to an extraordinary

item; Namely, to offset damages caused by Hurricane Andrew.

This

was not a recurring item which petitioner accounted for every
year, as evidenced by the absence of any Schedule M-1 adjustment
for a Átorm reserve for any of the other years in issue.

Additionally, petitioner has not ~claimed that it is seeking to

- 25 -

recharacterize this item.

The Schedule M-1 adjustment for the

storm reserve does not affect petitioner's consistent treatment
of characterizing the expenditures in issue based on regulatory

rules and guidelines.

Petitioner has not alleged that there were

Schedule M-1 adjustments for anynother items for 1992.
C.

Audit Adiustments

Petitioner argues that respondent's allowance of additional
repair expense deductions on;audit supports its position that
later recharacterizations were part of its method- of. accounting.
Petitioner contends that the facts that it amended its 1992
return and that respondent:allowed additional repair expenses on

audit establish that petitioner's method of.accounting was not to
follow regulatory rules and guidelines when characterizing the
expenditures in issue for tax purposes.

Petitioner argues that

these adjustments support its position that its.accounting
practice was to use regulatory characterizations as a "reasonable
approximation" and then make adjustments when errors were

discovered.
Respondent disputes that the.failure to raise the change in
method of accounting issue in any way.prevents the current
disallowance- of petitioner's attempted recharacterization.
Respondent argues that the audit adjustments were simply part of

an overall settlement of the claim and that those actions do not
.establish the method'of accounting that petitioner is claiming.

- 26 -

Pe itioner consistently, applied the characterizations used
by Flor da 'Power for regulatory purposes when reporting for tax

purpose .

Petitioner made no references in its tax returns that

would nbtify respondent. that - the amount .of claimed repair
expenses was a "reasonable approximation" and represented the
method pf accounting that petitioner is claiming.
1992,

For the year

etitioner filed two amended returns. . - In its first amended

returnd filed in September of 1993,"petitioner claimed an
adjustment for storm expenses and an additional repair expense
for cade· injection costs.

In its second amended return, filed

in December of 1993, petitioner claimed additional repair
expens s for the same type sof expenditures as those currently in
issue and an adjustment for storm expenses.

After reviewing the

origin 1 and amended returns= and meeting with petitioner,- +
respondent allowed some of the. claimed expenditures to be
deducted as repair expenses "and accepted the adjustment for storm

expens s.

Petitioner has not alleged, nor is there any

indica ion, that respondent acquiesced in a method of accounting
which

ould 'allow petitioner to "approximate" the amount of

repair expenses and then file amended returns when, and if, it
realiz d it -might have deducted a larger amount.

The fact that

pétitii ner amended its 1992 tax return for additional expense

claims does not change the fact that, in preparing its original
tax re urn, petitiorier consistently used the same

- 27 -

characterizations that Florida Power used for regulatory and

financial reporting purposes.

Accordingly, we hold that the

audit adjustments by respondent do not establish,the method of

accounting that petitioner'is claiming.
Petitioner's treatment of= the.expenditures in issue for tax

purposes was consistent with the treatment.of those expenditures
by Florida Power for regulatory accounting and financial
reporting purposes.

The Schedules M-1 adjustments are, at best,

relatively minor deviations from petitioner'.s method of
accounting.
p

The Schedules M-1 adjustments.for the PRA and the

storm reserve, and the audit adjustments by respondent, do not

change the fact that petitionersissretroactively attempting to
erecharacterize expenditures that it regularly and consistently
capitalized for regulatory, financial, and tax reporting
purposes.

See Potter v. Commissioner, 44 T.C. 159, 167 (1965)

(methods of accounting must be regular and consistent).
II.

Correction

A change in method of accounting does not occur when a
taxpayer seeks to correct mathematical or posting errors, errors
in the computation of tax liability, a change in treatment
arising from a change in underlying facts, cn: any other

"adjustment of any item of income or deduction which does not
involve the proper time for the inclusion of the item of income
or the takïng of a deduction."

Northern States Power Co. v.

- 28 United States,

151 F.3d 876, 883

(8th Cir. 1998); sec. 1.446-

1(e) (2) (ii) (b), Income Tax Regs..
PÉtitiòner does not contend that it made errors in

mathematical computations or in the computation of its tax
liability.

Petitioner has failed to make specific allegations

establfshing there was a change in underlying facts.
Under section 1.446-1(e) (2) (ii) (b), Income Tax Regs., a

change 'from capitalizing and depreciating the costs of a class of
depreciable assets to expensing them involves a question of
proper$timing.

Petitioner's attempt to recharacterize

expenditures at Florida Power's electric plants, which were

consisÊently capitalized on its tax' returns, fits within the
princióles of this regulatory provision.

Although the.instant

case is the reverse of the situation set forth in the regulatory
provision, we regard both situations as examples of changes
involving the timing of a deduction.

See Southern Pac..Transp.

Co. v. Commissioner, 75 T.C. at 683 n.211.

Additionally, this

Court Ëas found- that the characterization of expenditures as
capital or expense involves-the proper time for taking a
deduction.

See Pelaez & Sons, Inc. v. Commissioner, 114 T.C. at

489; S uthern Pac. Transp. Co. v. Commissioner, supra at 683;
Hooker Indus., Inc. v.- Commissioner, T.C. Memo. 1982-357.

A posting error occurs when there is an error in "the act of
transfÅrring an original entry'to a ledger."

Wayne Bolt & Nut

- 29 -

Co. v. Commissioner, 93 T.C. at 510-511 (quoting Black's Law
Dictionary 1050 (5th ed. 1979)).

Petitioner does not contend

that it erred in transferring the amount or characterization of
expenditures reported by Florida Power for regulatory purposes to
petitioner's tax return.

Rather, petitioner relies on Northern

States Power Co. v. United States, supra, in arguing that it

erroneously capitalized the expenditures at issue and that the
attempted recharacterization should be treated as a posting
error:

Petitioner's reliance on Northern States Power Co. v.

United States, supra is misplaced.

In Northern States Power.Co.

v. United States, supra, the taxpayer's tax department was
a

unaware that certain amounts were improperly recorded in its
accounts.

Because the taxpayer lacked knowledge of the error, it

mistakenly capitalized the amounts instead of currently deducting
them.

See id; at 884.

When it discovered the mistake, the

taxpayer promptly filed refund claims in an effort to treat the

amounts in the same manner that it had consistently treated
similar items.'

See id.

The court held that the taxpayer's -

mistake was more "akin to a posting error" than a change in
method of'accounting.

IcL_

In the instant case, petitioner consciously chose to use the
same characterization of expenditures for tax reporting.purposes
that Florida Power used for regulatory accounting and financial
reporting purposes.

Petitioner gave no notice on its returns

- 30 -

that it was using an "approximation" method and expected to make
later 'corrections.

Petitioner's own'statements »establish that. it

Il

did not "mistakenly" capitalize the expenditures in issue based
on a labk of knowledge of an error.

Accordingly, -we hold that

petitidner' s attempted recharacterization of the expenditures in
issue

ak not a posting error.

Cf .. Wayne Bolt & Nut Co. v.

Commis ioner, supra at 512.
III. Consent

Petitioner implies. that respondent waived the right to
contest petitioner's recharacterization, of capital expenditures
as rep ir expenses.

Peddoner points to the fact that

respon ent allowed petitioner to reclassify approximately .$11
niillio

in capitalized expenditures related to Florida Power as

repair expenses for the 1992 taxable year.

Prior to this motion,

respondent did not raise the change in accounting method
argumer t .
Cênsent to change a method of accounting is required,
regardless of whether the "method is proper or is permitted under
the Intbernål Revenue Code or the regulations thereunder."
1.446-1(e) (2) (i), Income Tax Regs.

Sec.

In Southern Pac. Transp. Co.

v. Com issioner, :75 T.C. at 682, we stated:

9 etitioner Claims that it "is not trying to work an
'estop el'", but rather that'it is simply trying to show that
. respon lent never treated the similarities between regulatory,
financ al, and tax classifications of capital expenditures and
repair expenses as a method of accounting.

- 31 In addition, consent is required when a taxpayer,
in a court proceeding, retroactively attempts to alter
the manner in which he accounted for an item.on his tax
return.
If the alteration constitutes a change in the
taxpayer's method of accounting, the taxpayer cannot
prevail .if consent for the change has not been secured.
*

*

*

[101

-

The failure of the Commissioner previously to object to the
taxpayer's accounting method will not stop him from later

challenging it.

-

See Niles Bement Pond Co. v. United States, 281

U.S. 357, 362

(1930); Fort Howard Paper Co. v. Commissioner, 49

T.C. 275, 284

(1967); Hotel Kingkade v. Commissioner, 12 T.C.

561, 568-569 (1949), affd. 180 F.2d 310

(10th Cir. 1950).

While

the Commissioner's acquiescence in the taxpayer's use of an

accounting method is not binding on the Commissioner, it may be a
4factor in the taxpayer's favor.
Commissioner, 78 T.C. 445, 456

See Public Serv. Co. .v.
(1982); Geometric Stamping Co. v.

Commissioner, 26 T.C. 301, 304-305

(1956).

.

In the instant case, respondent allowed petitioner certain
additional repair expense deductions related to Florida Power.
Respondent did not question petitioner' s method of accounting or

assert that any impermissible change was being made.

Rather,

1°In Summit Sheet Metal Co. v. Commissioner, T.C. Memo.
1996-563, we relied on Southern Pac. Transp. Co. v. Commissioner,
75 T . C . 497

(1980 ) , supplemented by 82 T . C . 122

(1984) ,« in

drawing a negative inference against the taxpayer who did not
seek to change the treatment of an'item on its original tax
return or on an amended return, but rather waited until after the
Commissioner's audit and after the commencement of court
proceedings.

- 32 -

respondent simply reviewed petitioner's claim and allowed an
additidnal deduction based on the circumstances.

Petitioner has

not alleged any action on respondent's part which could be
construed as approving the method of accounting petitioner is
curren ly claiming for the expenditures in issue.

It is

undisputed that petitioner never filed a Form 3115 to request a
change in accounting method.
Tax Regs.

See sec. 1.446-1(e) (3) (i), Income

Accordingly, petitioner did not obtain respondent's

consent to recharacterize the expenditures in issue.
IV.

Purpose of Section 446(e)

..

The policy underlying section 446(e) was enunciated in
Pacific Natl. Co. v. Welch, 304 U.S. 191, 194 (1938):
Change from one method to the other, as petitioner
seeks, would require recomputation and readjustment of
tax liability for subsequent years and impose
burdensome uncertainties upon the administration of the
revenue laws. It would operate to enlarge the
statutory period for filing returns * * * to include
the period allowed for recovering overpayments * * * .
There is nothing to suggest that Congress intended to
pèrmit a taxpayer, after expiration of the time within
which return is to be made, to have his tax liability
computed and settled according to the other method.
*

*

*

(111

11Since the amendment of the consent requirement in 1954,
this passage has been endorsed as an appropriate statement of the
policy rationale of sec. 446(e). See Lord v. United States, 296
F.2d 333, 335 (9th Cir. 1961) ("If * * * [taxpayers) were allowed
to report income in one manner and then freely change to some

other manner, the resulting,confusion would be exactly that which
was to be alleviated by requiring permission to change accounting
methods"); see also Southern Pacific Transp. Co. v. Commissioner,
supra at 686-687 (endorsing and restating the policies
articulated by Pacific Natl. Co. v. Welch, 304 U.S. 191 (1938),
(continued...)

- 33 -

In Barber v. Commissioner, 64 T.C. 314 (1975), we identified the

following policy reasons served by section 446(e): "(1) To
protect against the loss of revenues;

(2) to prevent

administrative burdens and inconvenience in administering the.tax
laws; and (3) to promote consistent accounting practice thereby
securing uniformity in collection of the revenue."
320 (citations omitted).

Id. at 319-

A comprehensive discussion and analysis

of the policy rationale of section 446(e) is found in Diebold,
Inc. v. United States,

16 Cl. Ct. 193, 208-209. (1989):

a central policy underlying the consent requirement- is
that the Commissioner should have an opportunity to
review consent requests in advance. With advance
notice, the Commissioner has leverage to protect the
fisc, to avoid burdensome administrative uncertainties,
and to promote accounting uniformity. If taxpayers
generally were permitted to change accounting methods
unilaterally, the Commissioner would face the enormous
administrative burden of detecting changes and
reviewing the propriety of each switch without ready
leverage to protect the fisc or promote uniformity.

.

In the absence·of * * * [section 446(e)], a
taxpayer could adopt a method of accounting and after
several years unilaterally switch to an alternative
method which hindsight suggestsmwould have been more
.
financially beneficial. Thus, the Commissioner's
ability to protect the.fisc and prevent unnecessary
variations in accounting procedures would be
substantially reduced.
In order to avoid missing
taxable income, the IRS would be required to multiply
its detection and examination efforts to prevent abuse
of unconsented retroactive changes. The administrative
advantages of advance notice are thus integrally linked
to the purposes of protecting the fisc and promoting
accounting uniformity.

"(...continued)
and Lord v. United States, supra).

- 34 -

* * * * * * *
Moreover, the plaintiff in this case desires to
make precisely the kind of change that could undermine
the purposes of the prior consent rule. The plaintiff
seeks to apply a unilateral change retroactively to
cover many past tax years. If taxpayers were permitted
td select the accounting method which best reflects
their income over the past four years, only those
taxpayers gaining a financial advantage from switching
methods would seek refunds. Thus, uniformity in
adcounting would become a function of financial
advantage and the administrative difficulties of
detecting unwarranted unilateral changes would be
multipl.ied. Moreover, the potential impact on the fisc
would be likely to vary unpredictably from year to
yÁar. In sum, the purposes and policies underlying the
consent requirement are still served when a taxpayer
presumes.to change unilaterally from an incorrect to a
correct procedure.
Acceptance of petitioner's position would grant petitioner
the license to change freely from one characterization to another
when hindsight shows that it is financially advantageous.
Petitioner waited until 1996 to attempt to recharacterize as
repair lexpenses, expenditures that it had characterized for tax
purposes as capital expenditures for the years 1988 to 1992.

It

would place an enormous burden upon respondent to detect and
review the ramifications of such a change.

For example,

petitioner's attempt to recharacterize more than $200 million of
expenditures incurred from 1988 to 1992 as deductible repair
expenses would require adjustments to petitioner's capital asset

accounts for those years and subsequent years.

Adjustments to

depreciation deductions taken in the years in issue and
subsequent years would be necessary.

The administrative burden

- 35 -

of reviewing the effects of petitioner's recharacterization, such

as adjusting for claimed depreciation, would defeat the
accounting goal of promoting uniformity, to say nothing of the
complex computations and inconvenience in administering the tax

laws.

Petitioner's attempted recharacterization is precisely the

type of change which frustrates the purpose of section 446(e) and

renders the consent requirement necessary.
V.

Conclusion

Petitioner consistently used a method of accounting of
following regulatory rules and guidelines for regulatory,
financial, and tax reporting purposes for the expenditures in

issue.

Petitioner's attempt to alter its classification of the

expenditures changes the timing of deductions related to those
expenditures and thus is a change in the treatment of a material
item.

This change in treatment of a material item does not

result from a correction or a change in underlying facts.

Petitioner did not seek respondent's consent, nor did respondent
impliedly consent or waive the right to challenge petitioner's
recharacterization as an impermissible change of accounting
method.

Petitioner's claimed recharacterization frustrates the

purpose of section 446(e).

Accordingly, we hold that

petitioner's attempted recharacterization of the expenditures in

- 36 issue is an impermissible change in methocl. of accounting under

section 446 (e) .
An appropriate order will be
issued granting respondent's motion
for partial summary judgment .

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A03683bde5976042d. Public record. Not legal advice.