department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division number release date date date uil dear contact person identification_number contact number employer_identification_number form required to be filed tax years this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file - we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions you should follow the instructions in notice our deletions you do not need to take any further action if you agree with if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter about your federal_income_tax status and responsibilities please contact irs customer service at if you have any questions letter cg catalog number or the irs customer service number for businesses the irs customer service number for people with hearing impairments is sincerely holly o paz director exempt_organizations rulings and agreements enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter letter cg catalog number department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date date legend x organization b state c date d individual e f dollar amount dollar amount dear contact person identification_number contact number fax number employer_identification_number uil we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code sec_501 based on the information provided we have concluded that you do not qualify for exemption under code sec_501 the basis for our conclusion is set forth below issue do you qualify for exemption under sec_501 of the code no for the reasons stated below facts you were incorporated under the mutual benefit law of the state of bon c previously granted exemption from federal_income_tax under sec_501 as a domestic fraternal society not providing life sick accident or other_benefits to members your exemption was then revoked you reapplied for recognition of exemption under sec_501 as a domestic fraternal society providing life sick accident or other_benefits to members you were letter cg catalog number 47628k sec_2 article of your amended articles of incorporation state your purposes are to be operated under the lodge_system the net_earnings of the corporation shall be devoted exclusively to fraternal charitable and educational_purposes the corporation shall provide for the distribution of a one-time cash payment of e dollars upon the death of any members this is not a life_insurance_policy but is simply a benefit of membership said payment shall be made to the beneficiary designated by the member in the most recent beneficiary designation form completed by the member and returned to the corporation during that member's period of membership in the corporation if during the member's period of membership in the corporation the member fails to complete and return a beneficiary designation form no payment shall be made by the corporation your bylaws authorize the creation of lodges in states where membership can reach at least five members these lodges must agree to abide by your bylaws be a member in good standing with you and pay a per capita tax each december of your time is devoted to providing funds to various child abuse you indicate agencies nationwide however you later indicated fundraising to support breast cancer amber alerts and troopers in need you accomplish this through a contract with x you will also provide financial assistance to your members of f dollars per year for medical_care and to the member's family in the event of the member's death by payment of e dollars you offer a scholarship for e dollars to a child or grandchild of a member as well as a semi-annual informational newsletter to all members and other interested individuals and groups your members must be retired from active police duty eligible to retire from active_duty on disability or a surviving_spouse of a former member member dues are g dollars however fund solicitation materials indicate you provide free membership and healthy benefits programs you have a comprehensive contract with x for professional fundraising services essentially all your income is from fundraising campaigns x conducts on your behalf x of has raised between this was for fundraising expenses paid to x approximately one percent of your total income was expended on charitable activities consisting of donations to various charitable organizations the remaining benefits to members payroll and professional expenses was used for your expenses including dollars on your behalf about dollars and per your agreement x conducts telephone and direct mail public relations and fundraising campaigns on your behalf some of the provisions in the contract are letter cg catalog number 47628k x will use its call center for you located in the state of b x will distribute brochures tax receipts or any other printed materials provide entertainment and other promotional materials on your behalf you will either create written or solicitation materials or x may create these for you and you must approve ail materials x uses x will establish mailboxes for receiving mail for you you acknowledge these mailboxes will not be exclusively dedicated to you and the mailboxes are x’s property x will receive your mail during the term of the agreement and during any wind down period of any fund raising campaign you also acknowledge mail addressed to you may continue to be forwarded to x after the wind down period of any fund raising campaign you must establish a bank account within miles of x’s account receivables department so x can deposit the funds raised on your behalf moreover you must agree to maintain on record with each applicable bank an irrevocable written direction to the bank authorizing electronic transfer of the percentage of the gross deposits authorized in the contract to x the same day funds are deposited or the day the funds become available you will not close any bank accounts without giving x ten days notice prior to closing said account you agree not to close any such account during the term of agreement unless you have opened another bank account that meets the above requirements you agree to enter into merchant accounts with certain credit cards so x can receive credit card donations for you x has the right to conduct the campaign on your behalf and the fundraising is limited to the states described in the agreement in addition x’s rights in the particular states shall be exclusive and you will not authorize any other person to solicit donors and or funds on your behaif within the particular state you will promptly review and complete any forms registrations certificates or other documents required by the governing body of any charitable organizations federal state or local governments or professional solicitors within five days of receipt and return such forms registrations and certifications to the appropriate governing body and or x within such time period you will promptly review and return to x any forms registrations certifications or other documents that x requires to fundraise within the particular state you agree to conduct some of your programs in each of the states the funds are raised the contract is long term in nature and calls for an automatic renewal of terms unless notification by one party days in advance of the intent to terminate the contract guarantees income to x based on prior year amounts you provided addendums to the contract to address compensation each addendum letter cg catalog number 47628k was tailored to each particular state in which x was conducting fundraising and the percentage of compensation is based on the minimum amount of gross_receipts required by state law the amount of gross_receipts you are entitled to is generally between expenses the contract states depending on state law however concerning the allocation of and the parties acknowledge and agree that in accordance with generally_accepted_accounting_principles expenses_incurred as joint activities may be allocated among various expense categories therefore x agrees to make available to an accountant who represents you such information that may be necessary to accomplish such allocations on your behalf you use d as your accountant who is contracted to represent you for all tax forms and matters including the form_1024 application_for recognition from federal_income_tax form_990 information_return form_1120 income_tax return form_941 employment_tax in addition d prepares financial reporting for x you stated and form_w-2 income_tax using the same cpa as x is not a conflict since you are not opposing groups and you stood nothing to lose by sharing a cpa finally you provided the following inconsistent information e e e e you stated you are providing education campaigns to prevent child abuse but the most recent contract between you and x states you are providing educational programs on breast cancer awareness before your exemption was revoked you had operations in several states but then you said you only have operations in states your website still says you is still fundraising on your behalf in are operating in more than two states and x these states you then stated you intend on operating in ten states you provided no evidence that you have active lodges you stated that you and individual lodges will be responsible for fundraising activities however you have contracted with x to fundraise in certain states and agreed to have programs in these states on form_1024 you indicate you intend on both operating page and not operating part under a lodge_system around support’ with around around three largest around of your funding over the past five years has come from ‘direct public of your income from member fees fundraising comprises of your expenses with benefits payroll and funeral_expenses the next of your annual expenses are contributions law sec_501 describes fraternal beneficiary societies orders or associations operating_under_the_lodge_system or for the exclusive benefit of the members of a fraternity itself letter cg catalog number 47628k operating_under_the_lodge_system and providing for the payment of life sick accident or other_benefits to the members of such society order or association or their dependents sec_501 of the code provides for the exemption from federal_income_tax of fraternal beneficiary societies orders or associations- a b operating_under_the_lodge_system or for the exclusive benefit of the members of a fraternity itself operating_under_the_lodge_system and providing for the payment of life sick accident or other_benefits to the members of such society order or association or their dependents sec_1 c - a of the regulations states that a fraternal beneficiary society is exempt from tax only if operated under the lodge_system or for the exclusive benefit of the members so operating operating_under_the_lodge_system means carrying on its activities under a form of organization that comprises local branches chartered by a in parent organization and largely self-governing called lodges chapters or the like order to be exempt it is also necessary that the society have an established system for the payment to its members or their dependents of life sick accident or other_benefits revproc_2012_9 superseding revproc_90_27 1990_1_cb_514 sec_4 provides the internal_revenue_service will recognize the tax-exempt status of an organization only if its application and supporting documents establish that it meets the particular requirements of the section under which exemption from federal_income_tax is claimed section dollar_figure states that a determination_letter or ruling on exempt status is issued based solely upon the facts and representations contained in the administrative record it further states the applicant is responsible for the accuracy of any factual representations contained in the application any oral representation of additional facts or modification of facts as represented or alleged in the application must be reduced to writing over the signature of an officer or director of the taxpayer under penalties of perjury statement the failure to disclose a material fact or misrepresentation of a material fact on the application may adversely affect the reliance that would otherwise be obtained through issuance by the service of a favorable determination_letter or ruling section dollar_figure states that the organization must fully describe all of the activities in which it expects to engage including the standards criteria procedures or other means letter cg catalog number 47628k adopted or planned for carrying out the activities the anticipated sources of receipts and the nature of contemplated expenditures revrul_78_87 1978_1_cb_160 describes a situation in which possible benefit to non- exempt entities was determined to be incidental to the accomplishment of a c 's purposes the c participated in a state sponsored reinsurance pool along with non-exempt insurers there was concern that the non-exempt insurers would derive a benefit from the participation of the c and its payments into the pool however any such benefit derived was determined to be incidental to the accomplishment of the c 's exempt purposes the court in 74_f_775 cir stated that even if the member of an organization enjoys a common tie or goal the organization does not serve a fraternal purpose unless its members engage in fraternal activities the court in 2_f2d_367 e d mo stated that by the ‘lodge system’ is generally understood as an organization which holds regular meetings at a designated place adopts a representative form of government and performs its work according to ritual in philadelphia and reading relief association v commissioner 4_bta_7 the court held that an organization of railroad company employees that made payments to members who became disabled because of accident or sickness was not entitled to exemption because it was not fraternal the court cited rituals ceremonies and regalia as evidence of a fraternal purpose and was are unable to discover a single fraternal feature in its organization being entirely without social features or fraternal object the petitioner has neither lodges rituals ceremonial or regalia and it owes no allegiance to any other authority or jurisdiction in 19_tc_240 it was held that the mere recitation of common ties and objectives in an organization is governing instrument is insufficient to be classified as fraternal there must be specific activities in implementation of the appropriate purposes application of law you do not meet the provisions of sec_501 or sec_1 c - a of the regulations you are providing death and health benefits to members however you do not have any activities that accomplish a fraternal purpose in addition you set up lodges in certain states so x could fund raise on your behalf in that state you did not provide any information that these lodges are active or are conducting any fraternal activities your activity in these states is merely the donation of funds to charitable organizations like you these lodges have been set up to enable x to operate letter cg catalog number 47628k you are not like the organization revrul_78_87 because you are benefiting x in a substantial manner without the use of your tax exemption x would not be permitted exclusive rights to fundraise on your behalf in certain states x receives about of the proceeds from the fundraising campaign you do not have control and supervision of how funds are being raised most of the funds raised end up as compensation to x the benefit x derives from the contract is not incidental and therefore this precludes exemption finally d is the accountant for both you and x transactions between you and x are not arms-length you do not meet the definition of fraternal as provided in the national_union v marlow you have not provided any evidence that you have rituals ceremonies or regalia as described in the court case philadelphia and reading relief association v commissioner you indicate various non-profit organizations the remainder is spent on member health death scholarship benefits as well as a semi-annual newsletter you have demonstrated no fraternal activities of your activities are providing financial support to you do not operate under a lodge_system as defined according to western funeral you did not substantiate the existence of any lodges only the plans on how lodges may be formed and fees they would pay you did not describe any meetings or established locations or rituals you are similar to the organization in 19_tc_240 even though your governing instrument indicates you have common ties and objectives this is insufficient to be classified as fraternal you do not have specific activities to accomplish fraternal purposes as required by revproc_2012_9 you have not established that you are organized and operated exclusively for purposes described in sec_501 you provided inconsistent and very general information concerning your lodges and your activities the information you have provided indicates that you have no fraternal activities as required by section dollar_figure of this rev_proc you must fully describe all of the activities in which you expect to engage including the standards criteria procedures or other means adopted or planned for carrying out the activities the anticipated sources of receipts and the nature of contemplated expenditures you have failed to provide adequate details to allow us to determine that you are operating primarily for fraternal purposes within the meaning of sec_501 applicant’s position concerning the relationship with x you simply could not reach the vast numbers of people that a professional company can and x raises money from new donors as well as donors that have contributed in the past through a detailed callback program x approached you and offered to fund raise on your behalf and you selected them based letter cg catalog number 47628k on their terms and reputation you are also in the discussion stages of additional fund- raising plans you are reviewing your community partnerships to see how you might better capture donations at the local level concerning the conflict of interest d has he is a licensed professional in the accounting field and provides professional services according to professional standards service response to applicant's position you failed to provide any additional information from which it can be concluded that you qualify under sec_501 you have not shown you are actively engaged in fraternal activities your contract with x indicates x is deriving a substantial benefit and has substantial control_over your fundraising activities because d works for you and x your agreements are not arms-length conclusion you do not qualify for exemption under sec_501 of the code because you have not shown that you are substantially engaging in fraternal activities in addition your activities benefit x in a substantial manner you have also not met the requirements to provide consistent and detailed information establishing you are qualified for exemption you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if that information affects our determination if your statement does not provide a basis to reconsider our determination we will forward your case to our appeals_office you can find more information about the role of the appeals_office in publication exempt_organization appeal procedures for unagreed issues types of information that should be included in your appeal can be found on page of the statement of facts publication under the heading regional_office appeal item must be declared true under penalties of perjury to the appeal the following signed declaration this may be done by adding under penalties of perjury declare that have examined the statement of facts presented in this appeal and in any accompanying schedules and statements and to the best of my knowledge and belief they are true correct and complete your appeal will be considered incomplete without this statement if an organization’s representative submits the appeal a substitute declaration must be included stating that the representative prepared the appeal and accompanying letter cg catalog number 47628k documents and whether the representative knows personally that the statements of facts contained in the appeal and accompanying documents are true and correct an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you during the appeal process to be represented during the appeal process you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not already for more information about representation see publication practice done so before the irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications if you do not intend to protest this determination you do not need to take any further action determination_letter to you that letter will provide information about filing tax returns and other matters if we do not hear from you within days we will issue a final adverse please send your protest statement form_2848 and any supporting documents to the applicable address mail to deliver to internal_revenue_service eo determinations quality assurance internal_revenue_service eo determinations quality assurance you may also fax your statement using the fax number shown in the heading of this letter letter to confirm that he or she received your fax if you fax your statement please call the person identified in the heading of this if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely enclosure publication holly o paz director exempt_organizations rulings and agreements letter cg catalog number 47628k


t c no united_states tax_court capital one financial_corporation and subsidiaries commissioner of internal revenue respondent petitioners v docket nos filed date ps’ subsidiaries capital one bank cob and capital one f s b fsb issuers of visa and mastercard credit cards earn income from late fees charged to cardholders who do not timely pay at least their minimum monthly payment due from to cob and fsb included the late fees in income when the fees were charged to cardholders ie when they accrued under the all_events_test on date congress enacted the taxpayer_relief_act_of_1997 publaw_105_34 sec 111_stat_911 which codified sec_1272 i r c this provision allows taxpayers who maintain a pool of debt instruments such as credit card loans to treat certain receivables related to that pool of debt instruments as creating or increasing original_issue_discount oid in r provided that a taxpayer could receive automatic consent to change its method_of_accounting in accordance with sec_1272 i r c by filing form_3115 application_for change in accounting_method with the taxpayer’s return cob submitted form_3115 with ps’ return ps treated certain credit card receivables as creating or increasing oid on their and returns but they continued to recognize cob’s and fsb’s late-fee income at the time the fee was charged to the cardholder through this proceeding ps seek to retroactively treat cob’s and fsb’s and late-fee income under sec_1272 i r c thereby reducing their taxable_income substantially held cob and fsb were required to obtain consent to change their treatment of credit card receivables to comply with sec_1272 i r c held further neither cob nor fsb received consent to change its treatment of late-fee income on ps’ or return held further ps may not retroactively change their treatment of cob’s and fsb’s and late- fee income because the requested change is a change in the treatment of a material_item and is therefore an impermissible change in method_of_accounting under sec_446 i r c and sec_1_446-1 income_tax regs held further ps’ motion for partial summary_judgment on the late fees issue will be denied and r’s motion for partial summary_judgment will be granted jean ann pawlow elizabeth a erickson holly k hemphill kevin spencer and robin l greenhouse for petitioners gary d kallevang james hill and alan r peregoy for respondent opinion haines judge this case is before the court on the parties’ cross-motions for partial summary_judgment filed pursuant to rule the issue for decision is whether sec_446 prohibits capital one bank cob and capital one f s b fsb from changing their treatment of late-fee income from the current-inclusion method when it accrued under the all_events_test to a method which allows late-fee income to create or increase original_issue_discount oid background the parties have stipulated the facts applicable to the issue considered in this opinion capital one financial corp is a publicly held financial and bank_holding_company based in mclean virginia its principal subsidiaries cob and fsb are among the world’s largest issuers of visa and mastercard credit cards during the years at issue cob and fsb earned various types of income from their credit card business including finance 1unless otherwise indicated section references are to the internal_revenue_code code as amended rule references are to the tax_court rules_of_practice and procedure amounts are rounded to the nearest dollar 2petitioners’ motion applies only to cob because fsb unlike cob did not file a form_3115 application_for change in accounting_method with petitioners’ consolidated return respondent’s motion applies to cob and fsb charges when cardholders carried a balance on their cards annual fees overlimit fees when cardholders exceeded their credit limit cash advance fees when cardholders accessed cash with their cards and interchange pertinent to these motions for partial summary_judgment cob and fsb also earned_income from late fees charged when the cardholder was delinquent in making at least the minimum payment due for the years through cob and fsb recognized late-fee income at the time the fee was charged to the cardholder for financial_accounting purposes as well as tax purposes late-fee income was recognized in the following amounts cob fsb year late-fee income year late-fee income dollar_figure big_number big_number big_number big_number total big_number -0- dollar_figure big_number big_number big_number total big_number 3in addition to the motions for partial summary_judgment addressed in this opinion petitioners filed a motion for partial summary_judgment as to the proper tax treatment of interchange interchange is a fee usually a percentage of the amount charged that is paid on every credit card transaction to the bank which has issued the card petitioners contend that interchange increases oid under sec_1272 because the cardholder bears the economic burden of paying interchange respondent disagrees and contends that the merchant’s bank not the cardholder is contractually responsible for paying interchange to the bank which issued the card on date cob submitted form_3115 application_for change in accounting_method to respondent by attaching it to petitioners’ consolidated federal_income_tax return for cob stated on the form capital one bank cob a domestic_corporation requests permission under section dollar_figure of revproc_98_60 to change its method_of_accounting for interest and original_issue_discount that are subject_to the provisions of section of the tax relief act of petitioners did not treat late-fee income as oid under the taxpayer_relief_act_of_1997 tra publaw_105_34 sec 111_stat_911 sec_1272 in or they continued to use the current-inclusion method for late-fee income petitioners did not attempt to amend their or return to treat late-fee income as increasing oid petitioners began to treat cob’s and fsb’s late-fee income as increasing oid on their return respondent has not conceded that petitioners had consent under sec_446 to make that change in response to respondent’s notice_of_deficiency with respect to and petitioners timely filed a petition with this court petitioners subsequently filed their amended petition claiming they are required to treat late-fee income as increasing oid on their pool of credit card loans thus reducing their taxable_income for and by dollar_figure and dollar_figure respectively on date the parties filed cross-motions for summary adjudication on the late fees issue on date the parties filed objections to each other’s motions a hearing was held on the motions in washington d c on date discussion i change in the law on date congress enacted tra sec which added sec_1272 to the code sec_1272 has the effect as explained below of requiring taxpayers to treat credit card receivables as creating or increasing oid on the pool of credit card loans to which the receivables relate petitioners seek to change their treatment of cob’s and fsb’s and late-fee income from the current-inclusion method to a method based on sec_1272 the parties have stipulated that if the court finds that a change in the treatment of late-fee income is permissible then such income may be treated as creating or increasing oid under sec_1272 an understanding of that section and 4treating late-fee income as oid decreases petitioners’ taxable_income because under the current-inclusion method petitioners recognized late-fee income when a cardholder’s liability for the fee accrued whereas treating late-fee income as oid allows recognition to be deferred ie included in increments over time on the basis of reasonable assumptions regarding how long it will take a cardholder to pay off the debt its application to credit card receivables is helpful to an understanding of the issues in this case the holder of a debt_instrument with oid generally accrues and includes in gross_income as interest the oid over the life of the obligation even though the interest may not be received until the maturity of the instrument sec_1272 the amount of oid with respect to a debt_instrument is the excess of the stated_redemption_price_at_maturity srpm over the issue_price of the debt_instrument sec_1273 the srpm includes all amounts payable at maturity sec_1273 in order to compute the amount of oid and the portion of oid allocable to a period the srpm and the time of maturity must be known this presents a problem for debts such as credit card loans and real_estate mortgages that may be satisfied over a very short or a very long period thus making the time of maturity an unknown at the inception of the debt for this reason special rules were created for determining the amount of oid allocated to a period for certain instruments that may be subject_to prepayment in the case of any regular_interest in a real_estate_mortgage_investment_conduit remic qualified mortgages held by a remic or any other debt_instrument if payments under the instrument may be accelerated by reason of prepayments of other obligations securing the instrument the daily portions of the oid on such debt instruments are determined by taking into account an assumption regarding the prepayment of principal for such instruments sec_1272 and ii sec_1272 applies this special oid rule to any pool of debt instruments the payments on which may be accelerated by reason of prepayments it is clear that sec_1272 was intended to apply to credit card loans and the related receivables see h conf rept pincite 1997_4_cb_1457 what was unclear at the time of enactment and is still not fully resolved is which credit card receivables increase oid under sec_1272 and which do not revproc_98_60 app sec_12 1998_2_cb_759 provides procedures by which taxpayers may receive automatic consent to change their method_of_accounting for pools of credit card receivables in accordance with sec_1272 under the revenue_procedure automatic consent is achieved by filing form_3115 with a taxpayer’s return id sec app sec_12 c b pincite when sec_1272 was added to the code credit card companies could be certain that grace period interest 5although the commissioner has clarified the scope of sec_1272 by revenue procedures and other published guidance issues still remain such as whether interchange income is properly treated as oid fell under the new rule see revproc_98_60 app sec_12 staff of joint comm on taxation description and analysis of certain revenue-raising provisions contained in the president’s fiscal_year budget proposal jcs-10-97 j comm print grace period interest is the interest that accrues from the date of a credit card charge if the balance of a cardholder’s account is not paid_by the end of the grace period usually days after the close of a monthly billing cycle if the cardholder pays the balance within those days no interest is charged the operation of sec_1272 with respect to grace period interest is best explained by the following example assume the cardholders of a credit card company a calendar_year taxpayer incur dollar_figure million of charges in december of year grace period interest will be charged to the cardholders who do not pay their balances in full by january of year the end of their grace period before enactment of sec_1272 the taxpayer was not required to include any 6grace period interest is the equivalent of a finance charge and is distinct from a late fee assume a cardholder with a zero balance at the beginning of a billing cycle charges dollar_figure during that cycle and the credit card company calculates a minimum payment due of dollar_figure if the cardholder timely pays dollar_figure he will be liable for grace period interest because the entire balance was not paid in full if the cardholder timely pays dollar_figure no grace period interest will be charged if the cardholder does not make a timely payment of at least the minimum due he will be liable for grace period interest and a late fee interest_income in year with respect to the december charges because it was possible that all the cardholders would pay off their balances by january year of course not all cardholders paid their balances within the grace period thus the taxpayer was permitted to defer grace period interest allocable to december year until year under sec_1272 the taxpayer is required to make a reasonable assumption as to what portion of the december balances will not be paid off within the grace period and is required to accrue interest_income through the end of year with respect to that portion the taxpayer then adjusts the accrual in the following year to reflect the extent to which the prepayment assumption reflected the actual payments received before expiration of the grace period the application of sec_1272 to grace period interest causes a taxpayer to recognize income in a taxable_year which it previously had deferred to the following year thus increasing the tax due the application of sec_1272 to other credit card receivables such as late-fee income generally has the effect of deferring income to later years which otherwise would be recognized in the year the fee was charged to the cardholder see supra note which 7petitioners treated cob’s and fsb’s and grace period interest under sec_1272 receivables are eligible for this treatment has been the subject of contention respondent has conceded that cash advance fees generally increase oid under sec_1272 see revproc_2005_47 2005_2_cb_269 when a cardholder repays the loan the amount of cash advanced the cardholder will also pay the cash advance fee thus the srpm is the amount of the loan plus the fee as the srpm is greater than the issue_price the amount of the loan there is oid on the transaction before petitioners treated cob’s and fsb’s cash advance fee income as increasing oid for and petitioners continued to treat cash advance fee income as increasing oid under sec_1272 respondent concedes this treatment is proper respondent has taken the position that overlimit fees paid_by a cardholder to a credit card company increase oid tech adv mem date before petitioners treated overlimit fees under the current-inclusion method petitioners treated cob’s and fsb’s and overlimit fee 8to treat cash advance fees as increasing oid the taxpayer must be able to demonstrate that the amount of the fee is separately_stated on the cardholder’s account and that the fee is not charged for property or specific services performed by the taxpayer for the benefit of the cardholder revproc_2005_47 sec_5 2005_2_cb_269 income as increasing oid under sec_1272 respondent concedes this treatment is proper in contrast to overlimit fees and cash advance fees the parties agree that annual fees may not be treated as increasing oid under sec_1272 annual fees are charged to the cardholder for all of the benefits and services available under the credit card agreement and not for any specific service revrul_2004_52 2004_1_cb_973 therefore annual fees are compensation_for services and not for the use or forbearance of money thus they are not interest and do not increase oid whether interchange increases oid under sec_1272 is the subject of petitioners’ separate motion for partial summary_judgment which is still before the court petitioners treated cob’s and fsb’s and interchange income as increasing oid under sec_1272 respondent has taken the position that interchange income does not increase oid see tech adv mem date respondent has conceded that as a general proposition credit card late-fee income may be treated as increasing oid on the pool 9although respondent has conceded petitioners’ treatment of cash advance fees and overlimit fees is proper respondent has not conceded that petitioners correctly calculated the amount includable of credit card loans to which the income relatesdollar_figure revproc_2004_33 2004_1_cb_989 from through petitioners treated cob’s and fsb’s late-fee income under the current- inclusion method the issue in these motions is whether sec_446 prohibits a retroactive change in the treatment of the and late-fee income from the current-inclusion method to a method based on sec_1272 ii sec_446 sec_446 at issue in this case provides sec_446 requirement respecting change_of_accounting_method --except as otherwise expressly provided in this chapter a taxpayer who changes the method_of_accounting on the basis of which he regularly computes his income in keeping his books shall before computing his taxable_income under the new method secure the consent of the secretary the purpose of the sec_446 consent requirement is to assure consistency in the method_of_accounting used for tax purposes and thus prevent distortions of income which usually accompany a change_of_accounting_method and which could have an adverse effect upon the revenue see 292_f2d_225 3d cir revg t c 10to treat late fees as increasing oid the taxpayer must be able to demonstrate that the amount of the late fee is separately_stated on the cardholder’s account and that the late fee is not charged for property or specific services performed by the taxpayer for the benefit of the cardholder revproc_2004_33 sec_5 2004_1_cb_989 memo 38_tc_357 36_tc_620 affd 316_f2d_249 5th cir 25_tc_1086 affd per curiam 240_f2d_958 2d cir in part the consent requirement is also intended to lessen the commissioner’s burden of administering the code see 296_f2d_333 9th cir casey v commissioner supra pincite this court identified the following as the policy reasons served by sec_446 ‘ to protect against the loss of revenues to prevent administrative burdens and inconvenience in administering the tax laws and to promote consistent accounting practice thereby securing uniformity in collection of the revenue ’ 115_tc_554 quoting 64_tc_314 by requiring the taxpayer to obtain the commissioner’s consent before changing its method_of_accounting sec_446 gives the commissioner authority to approve or disapprove such changes prospectively this court has stated that the commissioner also has discretion to accept or reject a request for a retroactive change in a taxpayer’s choice between two permissible methods of computing taxable_income see barber v commissioner supra pincite if the commissioner acting within his discretion does not consent to the taxpayer’s request to make a change in the taxpayer’s method of computing taxable_income the taxpayer is required to continue computing taxable_income under the taxpayer’s old method_of_accounting see eg 291_f2d_913 8th cir 118_f2d_541 6th cir 34_tc_1070 and the cases cited thereat advertisers exch inc v commissioner supra pincite- if the taxpayer changes the method_of_accounting used in computing taxable_income without first obtaining consent the commissioner can assert sec_446 and require the taxpayer to abandon the new method_of_accounting and to report taxable_income using the old method_of_accounting see eg commissioner v o liquidating corp supra drazen v commissioner supra pincite advertisers exch inc v commissioner supra pincite in deciding whether to consent to a change_of_accounting_method the commissioner is invested with wide discretion see eg commissioner v o liquidating corp supra pincite 96_tc_204 drazen v commissioner supra pincite in a case in which the taxpayer has requested the commissioner’s consent to change methods_of_accounting the commissioner’s action in refusing to give consent is reviewed under an abuse_of_discretion standard see schram v united_states supra pincite capitol fed sav loan association sub v commissioner supra pincite s pac transp co v commissioner 75_tc_497 in a case in which the taxpayer does not first obtain the commissioner’s consent such as where the taxpayer attempts in a court_proceeding to retroactively alter the manner in which the taxpayer accounted for an item on its tax_return the question is whether the change constitutes a change_of_accounting_method that is subject_to sec_446 see s pac transp co v commissioner supra pincite wright contracting co v commissioner supra pincite cf 423_f2d_157 3d cir 352_f2d_807 fpl group inc subs v commissioner supra pincite if the change constitutes a change_of_accounting_method that is subject_to sec_446 then the taxpayer is foreclosed from making the change by sec_446 and the regulations promulgated thereunder without regard to whether the new method would be proper see s pac transp co v commissioner supra pincite wright contracting co v commissioner supra pincite iii whether consent is required under sec_1272 as a preliminary matter the court must address whether taxpayers are required to obtain consent in order to change their method_of_accounting to comply with sec_1272 petitioners argue that congress provided that a taxpayer did not need consent to change its method_of_accounting to comply with sec_1272 tra sec b provides change in method_of_accounting --in the case of any taxpayer required by this section to change its method_of_accounting for its first taxable_year beginning after the date of the enactment of this act-- a such change shall be treated as initiated by the taxpayer b such change shall be treated as made with the consent of the secretary_of_the_treasury the court must read this provision which was not codified with sec_446 and the regulations promulgated thereunder which require a taxpayer to secure consent before adopting a new method_of_accounting by filing form_3115 and setting forth the classes of items that will be treated differentlydollar_figure sec_1 e i income_tax regs sec_446 begins with the qualification except as otherwise expressly provided in this chapter nothing in sec_1272 expressly provides that a taxpayer is not required to receive consent to change its method of 11petitioners have not challenged the validity of the sec_446 regulations accounting tra sec b was not codified and therefore does not qualify as an exception to sec_446 nevertheless if that provision had been codified taxpayers would still be required to follow the applicable procedures in order to effect a change in accounting_method language similar to that of tra sec b has been used in other provisions of the code the manner in which taxpayers change their method_of_accounting under those provisions informs the court’s interpretation of tra sec_448 bars c corporations and partnerships if one or more partners is a c_corporation from using the cash_method_of_accounting exceptions apply to this prohibition see sec_448 for example entities with annual gross_receipts of dollar_figure million or less may use the cash_method sec_448 c if sec_448 forces a taxpayer off the cash_method such as a c_corporation that no longer meets the gross_receipts_test the mandatory adoption of another method presumably the accrual_method is a change in method_of_accounting generally requiring consent sec_448 provides coordination with sec_481 -- in the case of any taxpayer required by this section to change its method_of_accounting for any taxable year-- a such change shall be treated as initiated by the taxpayer b such change shall be treated as made with the consent of the secretary nevertheless a taxpayer forced to change its method_of_accounting under sec_448 must still file a form_3115 with its return for the year_of_change sec_1_448-1 income_tax regs if the form_3115 is not filed timely a taxpayer forced off the cash_method must comply with the requirements of sec_1_446-1 income_tax regs in order to secure the consent of the commissioner sec_1_448-1 income_tax regs pursuant to sec_1_446-1 income_tax regs a taxpayer requesting to change its method_of_accounting is required to file a form_3115 during the year in which it intends to make the change in effect the filing of a form_3115 is a request for a ruling from the commissioner sunoco inc subs v commissioner tcmemo_2004_29 see capitol fed sav loan association sub v commissioner t c pincite sec_601_204 statement of procedural rules the issuance of such a ruling is a matter within the commissioner’s discretion capitol fed sav loan association sub v commissioner supra pincite timely notification of an accounting_method change prevents the loss of tax revenue because the commissioner may then ensure that appropriate adjustments are made to the taxpayer’s taxable_income in accordance with sec_481 without notification the commissioner would be unaware that such adjustments are necessary furthermore timely notification prevents administrative burdens and inconvenience in administering the tax laws and promotes consistent accounting practice thereby securing uniformity in collection of the revenue see fpl group inc subs v commissioner t c pincite sec_448 and the regulations promulgated thereunder illustrate that when the law provides that a change is treated as made with consent the taxpayer must still comply with the applicable procedures in order to effect the change if the taxpayer does not file a timely form_3115 automatic consent will not be granted sec_1_448-1 income_tax regs it follows that if the taxpayer files an incomplete or otherwise deficient form_3115 automatic consent will not be granted this would be especially true when the change in accounting_method is more complex than the change envisioned by sec_448 a change from the overall cash_method to the overall accrual_method in the light of the purposes for requiring notification to the commissioner of a taxpayer’s change in method_of_accounting the court holds that petitioners were required to follow all applicable procedures put in place by respondent in order to receive consent to change their method_of_accounting to comply with sec_1272 see revproc_98_60 1998_2_cb_759 failure to follow those procedures would negate automatic consent to the proposed change iv the meaning of item the parties dispute the meaning of item as it is used in sec_1_446-1 income_tax regs sec_1 e ii a income_tax regs provides a change in the method_of_accounting includes a change in the overall plan of accounting for gross_income or deductions or a change in the treatment of any material_item used in such overall plan although a method_of_accounting may exist under this definition without the necessity of a pattern of consistent treatment of an item in most instances a method_of_accounting is not established for an item without such consistent treatment 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 the dispute arises because cob requested permission to change its method_of_accounting for interest and oid that are subject_to the provisions of section of the taxpayer_relief_act_of_1997 petitioners contend that the relevant item is interest including oid and by using that description cob obtained consent to change its treatment of late-fee income a component of interest including oid respondent contends that the relevant item is late-fee income respondent further argues that the description used by cob is ambiguous at best and that because cob did not apply the oid rules to late-fee income on its return for or cob did not obtain consent to change the treatment of late-fee income see infra v the meaning of item is also important to our discussion infra vi regarding whether a change in the treatment of late-fee income is a change in the treatment of a material_item see sec_1_446-1 income_tax regs whether an item is material is a question of timing but before determining materiality we must know which item to address interest or late- fee income petitioners contend that the references to item throughout sec_1_446-1 income_tax regs mean an item_of_income or deduction items of income are listed in sec_61 under petitioners’ theory because item means item_of_income under 531_us_206 the court must look to sec_61 to determine what an item is petitioners give the supreme court’s holding in gitlitz far too much weight gitlitz involved the effect of discharge_of_indebtedness income on the basis of s_corporation stock not the ability of an entity to change its method_of_accounting the court addressed the commissioner’s argument that the discharge_of_indebtedness of an insolvent s_corporation was not an item_of_income id pincite to resolve the issue the court looked to sec_61 which provides that discharge_of_indebtedness is generally included in gross_income id pincite the court did not address how narrow an item_of_income may be or whether a specific type of discharge_of_indebtedness is also an item under sec_1_446-1 income_tax regs the regulations promulgated under sec_446 make frequent reference to the broad term item and the narrower term material_item material items are necessarily a subset of the broader group items courts have identified a variety of material items all of which are narrower than the broad items of income listed in sec_61 for example courts have found the following to be material items commissions from a particular insurance_company leonhart v commissioner tcmemo_1968_98 affd 414_f2d_749 4th cir the treatment of automated teller machine replacement modules 891_f2d_1579 fed cir gain from sales of automotive inventory 126_tc_322 affd 578_f3d_357 6th cir the treatment of natural_gas as working gas inventory or cushion gas capital_asset 101_tc_1 the treatment of costs as a repair expense or as depreciable 115_tc_554 a change in depreciation method resulting from a change from sec_1250 property to sec_1245 property 77_tc_349 and overburden removal costs under sec_616 sunoco inc subs v commissioner tcmemo_2004_29 see also sec_1_446-1 example income_tax regs real_estate_taxes are a material_item sec_1_446-1 example income_tax regs allocation of overhead to value of inventory is a material_item the preceding examples fall within the narrow group material items and therefore must also be items an item under sec_1_446-1 income_tax regs may be narrower than the broad items of income listed in sec_61 whether particular income is an item under sec_1_446-1 income_tax regs depends on all the facts and circumstances surrounding that income cob and fsb earned most of their income from interest and items deemed to be interest for federal tax purposes a taxpayer is required to obtain the commissioner’s consent before making changes to the treatment of a material_item used in its overall plan of accounting sec_1_446-1 income_tax regs under petitioners’ theory because late-fee income and presumably other credit card receivables are not items themselves but are merely components of the item of interest they would also not be material items consequently petitioners could make changes to these components of interest without first receiving respondent’s consent defining item in this way would severely undermine the reasons for sec_446 in and cob and fsb earned late-fee income of dollar_figure and dollar_figure they earned more in late-fee income than any other type of fee in cob’s and fsb’s late-fee income accounted for approximately percent of the gross_receipts and percent of the total income reported on petitioners’ consolidated_return late fees are earned for reasons independent of the reasons other types of income are earned such as finance_charges overlimit fees interchange and cash advance fees late fees are a separate and distinct item_of_income in this context the court holds that the relevant item for purposes of sec_1_446-1 income_tax regs is late-fee income v whether cob received consent to change its treatment of late-fee income having found that the relevant item is late-fee income we must determine whether cob received consent to change its treatment of late-fee income by requesting permission to change its treatment of interest and oid that are subject_to the provisions of section of the taxpayer_relief_act_of_1997 petitioners argue the description is sufficient to obtain consent to change cob’s treatment of late-fee income petitioners further argue that since cob received consent they may now fix their error in failing to implement the change respondent argues cob’s description of the item to be changed was ambiguous at best and that because cob did not apply the oid rules to late- fee income on its or return it did not obtain consent to change its treatment of late-fee income in response to the enactment of sec_1272 the commissioner set forth the procedures by which consent would be given to a taxpayer to change its method_of_accounting revproc_98_60 1998_2_cb_759 specifically a taxpayer was required to file form_3115 with its return id cob filed a form_3115 which stated capital one bank cob a domestic_corporation requests permission under section dollar_figure of revproc_98_60 to change its method_of_accounting for interest and original_issue_discount that are subject_to the provisions of section of the tax relief act of question on form_3115 states if the applicant is not changing its overall_method_of_accounting attach a description of each of the following a the item being changed b the applicant’s present method for the item being changed in response cob stated question 9a the taxpayer proposes to change its method_of_accounting for interest and original_issue_discount that are subject_to the provisions of section of the taxpayer_relief_act_of_1997 pub l question 9b credit card obligations are not currently accounted for as required by sec_1272 of the internal_revenue_code the taxpayer’s present method of account ing for credit card obligations is to take into account the differences between issue_price and stated principal_amount upon origination in certain cases cash advance fees are taken into account as original_issue_discount in accordance with revproc_98_60 app sec_12 a cob also stated additional requirements pursuant to section dollar_figure of revproc_98_60 the taxpayer makes the following representations the pool of debt instruments consists of all credit card receivables held by the taxpayer the proposed method is to account for interest and oid as required by sec_1272 the prepayment assumption on the pool is the actual rate at which payments occur on the whole pool in the succeeding months the amount of grace period interest included is determined using the same assumption used for book purposes cash advance fees continue to be accounted for as original_issue_discount the form_3115 did not mention late fees on petitioners’ consolidated return filed with the form_3115 they treated cob’s income from overlimit fees cash advance fees and interchange as increasing oid on its pool of credit card loans under sec_1272 on their returns for and petitioners did not treat cob’s late-fee income as increasing oid but instead continued to recognize late-fee income at the time it was charged to the cardholder as discussed previously the relevant item in this context is late-fee income neither revproc_98_60 supra nor cob’s form_3115 nor petitioners’ or return gave any indication that late-fee income would be treated as oid the language used in cob’s application to change its method_of_accounting was ambiguous and vague the ambiguities in cob’s description of the item to be changed were clarified by the treatment of the respective fees on petitioners’ consolidated_returns the court therefore finds that cob did not receive consent to change its treatment of late-fee income for or in fact by failing to mention late fees or to account for late fees as oid on the returns for those years cob did not seek consent for the changedollar_figure even though petitioners began to treat late-fee income as increasing oid with their return they made no effort to change their treatment of late-fee income for and until they filed a motion to amend their petition in may dollar_figure 12petitioners contend that if respondent did not consent to cob’s request to change its method_of_accounting for late- fee income then that refusal constituted an abuse_of_discretion because cob did not make clear to respondent that it was requesting permission to change its method_of_accounting for late-fee income petitioners’ contention is unpersuasive 13even if cob had been given consent to change its accounting_method for late-fee income with its return the court doubts that cob would be entitled to correct its error in implementation by failing to implement the change and continuing to treat late-fee income under the current-inclusion method for and cob did not adopt the oid method for late-fee income the error petitioners would be attempting to correct would be a total failure to implement the accounting_method not a mere correction of an adopted method it is doubtful that such a correction would be permissible under sec_446 see 77_tc_349 although sec_446 is inapplicable where certain intangible drilling costs are treated improperly sec_446 may be applicable where all intangible drilling costs are treated improperly a correction of that nature would likely be continued vi whether recharacterization of late-fee income as oid is a prohibited change in petitioners’ method_of_accounting petitioners argue that if cob did not receive consent it is still entitled to change its treatment of late-fee income because it is not changing its treatment of a material_item and is therefore not changing its method of accountingdollar_figure see sec_1_446-1 income_tax regs we have determined that the relevant item is late-fee income now we must determine whether a change in the treatment of late-fee income would be material as that term is used in sec_1_446-1 income_tax regs if the recharacterization of late-fee income is material petitioners will be foreclosed from making the change by sec_446 and the regulations promulgated thereunder without regard to whether the new method would be proper see s pac transp co v commissioner t c pincite wright contracting co v commissioner t c pincite a the regulations before a taxpayer changes its method_of_accounting it must secure the consent of the commissioner sec_446 sec_1 e i income_tax regs the code does not define the phrase continued a prohibited change in method_of_accounting under sec_1 e income_tax regs 14petitioners’ motion applies only to cob but their argument on this subissue is equally applicable to fsb respondent’s motion applies to both cob and fsb method_of_accounting the court has held that the phrase includes the consistent treatment of any recurring material_item whether that treatment be correct or incorrect see 120_tc_174 affd in part and vacated in part sub nom j p morgan chase co v commissioner 458_f3d_564 7th cir 53_tc_439 affd 443_f2d_965 6th cir the regulations promulgated under sec_446 state the term ‘method of accounting’ includes not only the over-all method_of_accounting of the taxpayer but also the accounting treatment of any item sec_1_446-1 income_tax regs sec_1_446-1 income_tax regs provides the following discussion of changes of accounting_method a change in the method_of_accounting includes a change in the overall plan of accounting for gross_income or deductions or a change in the treatment of any material_item used in such overall plan although a method_of_accounting may exist under this definition without the necessity of a pattern of consistent treatment of an item in most instances a method_of_accounting is not established for an item without such consistent treatment 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 to determine whether late-fee income is an item which involves the proper time for the inclusion of the item in income and hence is material under the regulation we must determine whether a change in the treatment of late-fee income will change the taxpayer’s lifetime income or will merely postpone or accelerate the reporting of income see 93_tc_500 when an accounting practice merely postpones the reporting of income rather than permanently avoiding the reporting of income over the taxpayer’s lifetime it involves the proper time for reporting income petitioners seek to change cob’s and fsb’s treatment of late-fee income from the current-inclusion method to a method where late-fee income creates or increases oid on the pool of credit card loans to which it relates treatment as oid would reduce petitioners’ and late-fee income considerablydollar_figure the reductions would result in corresponding increases in later years petitioners would include all of the late-fee income under either method the only difference being whether the income is recognized entirely in the year the fee is charged to the cardholder or whether the recognition of income is spread to subsequent years the difference is a matter of timing therefore the proposed method constitutes a change in a material_item in petitioners’ overall plan of accounting and is a change in method_of_accounting the regulations detail certain situations that are not considered changes in method_of_accounting sec_1 e ii b income_tax regs provides 15petitioners claim the reduction would be dollar_figure and dollar_figure in and respectively a change in method_of_accounting does not include correction of mathematical or posting errors or errors in the computation of tax_liability such as errors in computation of the foreign_tax_credit net_operating_loss percentage_depletion or investment_credit also a change in method_of_accounting does not include 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 taking of a deduction for example corrections of items that are deducted as interest or salary but which are in fact payments of dividends and of items that are deducted as business_expenses but which are in fact personal expenses are not changes in method_of_accounting a change in the method_of_accounting also does not include a change in treatment resulting from a change in underlying facts on the other hand for example a correction to require depreciation in lieu of a deduction for the cost of a class of depreciable assets which had been consistently treated as an expense in the year of purchase involves the question of the proper timing of an item and is to be treated as a change in method_of_accounting the term mathematical error includes errors in arithmetic ie ‘an error in addition subtraction multiplication or division’ huffman v commissioner t c pincite quoting sec_6213 see also 131_fsupp_626 n d cal whatever error petitioners made in treating late-fee income under the current-inclusion method in and it was not a mathematical errordollar_figure 16petitioners argue that they made a mistake of law by failing to treat late-fee income under sec_1272 and that a mistake of law which affects the computation of a deduction under an established method_of_accounting is ‘tantamount to a mathematical error ’ standard oil co indiana v commissioner t c pincite quoting 43_tc_149 cob did not establish the oid method_of_accounting for late-fee income continued the term posting error means an error in ‘the act of transferring an original entry to a ledger ’ wayne bolt nut co v commissioner supra pincite quoting black’s law dictionary 5th ed in support of their position that sec_1_446-1 income_tax regs should be broadly construed petitioners cite n states power co v united_states 151_f3d_876 8th cir in that case the court held that the taxpayer’s failure to account for losses on nuclear fuel contracts in the same way it accounted for coal and oil losses was nothing more than a type of posting error id pincite the taxpayer an energy company was required by the federal energy regulatory commission ferc to use a prescribed method_of_accounting for book purposes id the taxpayer’s tax department was unaware that nuclear fuel losses were accounted for as a portion of work order capital accounts under the method prescribed by ferc id had the taxpayer’s tax department known of the error it would have been corrected and nuclear fuel losses would have been treated in the same way as losses from other types of fuel id continued therefore there were no mistakes made under that method furthermore the court in standard oil did not hold that the taxpayer’s mistake was tantamount to a mathematical error the court did so in north carolina granite corp a case which analyzed the regulations prior to the revisions which gave consistency and timing considerations an important role see 126_tc_322 affd 518_f3d_357 6th cir petitioners’ error was not made in transferring late-fee income from their financial_accounting books to their tax books petitioners were fully aware of the nature of late-fee income and how it was accounted for under financial_accounting principles petitioners may not have been aware that late-fee income could be treated as increasing oid under the new statutory provision but that is not akin to a posting error because petitioners made neither a mathematical nor a posting error and because a change in the treatment of late-fee income is a change in the treatment of a material_item this issue appears to be resolved in respondent’s favor however our discussion cannot end here b the caselaw this court has previously noted that there appears to be an incongruity between sec_1_446-1 income_tax regs and the proposition evidenced by a body of caselaw including cases of this court that a taxpayer does not change its method_of_accounting when it does no more than conform to a prior accounting election or some specific requirement of law huffman v commissioner supra pincite petitioners use that body of caselaw to argue that a change in the treatment of late-fee income is not a prohibited change in method_of_accounting petitioners cite numerous cases that were decided before the revisions to sec_1_446-1 income_tax regs e g 218_f2d_697 10th cir revg 21_tc_610 44_tc_159 73_fsupp_765 w d okla these cases do not address the consistency and timing considerations emphasized in sec_1_446-1 income_tax regs therefore their weight is uncertain see huffman v commissioner supra pincite the cases decided after on which petitioners rely are 77_tc_349 and 535_f2d_14 dollar_figure petitioners equate the requirement of sec_1272 with the elections made in those two cases so that deviation from the chosen method and subsequent adherence to that method do not amount to changes in accounting_method petitioners’ argument fails for a number of reasons first unlike the taxpayers in those cases neither cob nor fsb adopted the oid method with respect to late-fee income therefore there was no deviation from or subsequent adherence to the oid method second these cases raise the issue of what item is being corrected in standard oil and gimbel bros the correction was 17the court notes that 535_f2d_14 was decided by the court of claims and is therefore not binding on this court further the case analyzes and applies prior regulations in effect before the case is included because it was decided after issuance of the regulations in effect in the instant case made to a component of the material_item not to the item itself in standard oil the relevant item was intangible drilling costs idc the taxpayer in error failed to deduct certain components of idc and this court held that the retroactive correction of that error was permissible id the court stated the taxpayer’s position constitutes an attempt to remedy its failure to report similar items consistently under a fixed method_of_accounting id pincite in gimbel bros the taxpayer was a department store which validly elected the installment_method of accounting to report its installment_sales income the taxpayer applied the election to all installment_sales except revolving or rotating charge accounts id the taxpayer subsequently attempted to change its treatment of revolving_charge_accounts id the court held that revolving_charge_accounts were a component of installment_sales and that therefore the taxpayer was correcting its error rather than changing an accounting_method id petitioners analogize the components of idc and the components of installment_sales income with the components of oid late fees cash advance fees overlimit fees and grace period interest dollar_figure petitioners’ analogy falls short of the mark as discussed above late-fee income not interest including oid is 18petitioners would also include interchange income as a component of oid whether interchange income is properly treated under sec_1272 is still an issue before the court the relevant item late fees are earned for a purpose independent of the other components of cob’s and fsb’s oid the same cannot be said about the other costs the taxpayer in standard oil failed to deduct those costs were expenses_incurred during the first_phase of the construction of offshore drilling platforms id pincite costs for the other three phases of construction and installation of the platforms were deducted as idc id the four phases of construction and installation were interdependent in a way that late-fee income and the other types of credit card receivables are not the same can be said about the installment_sales income the taxpayer in gimbel bros failed to treat consistently with the rest of its installment_sales income all of the installment_sales income was earned in the same way from the sale_of_goods on an installment_plan finally more recent cases of this court hold that a taxpayer does change its method_of_accounting when it changes its treatment of an item in order to adhere to a method adopted pursuant to a prior accounting election these cases cast doubt on standard oil co indiana v commissioner supra and gimbel bros inc v commissioner supra see huffman v commissioner t c pincite we question whether there is vitality to the notion that a taxpayer conforming to a required but theretofore ignored method_of_accounting does not change its method_of_accounting by so conforming in sunoco inc subs v commissioner tcmemo_2004_29 this court held that a retroactive attempt to change treatment of certain mining expenses would be a change in method_of_accounting and not a correction_of_an_error where the taxpayer had knowingly and consistently albeit improperly capitalized and amortized expenses that should have been included in the taxpayer’s cost_of_goods_sold in 88_tc_1069 a transferee_liability case the transferee argued that the transferor’s alteration of a lifo inventory_valuation procedure constituted the correction of an accounting error and not a change in method_of_accounting the court held that although the alteration in question may have constituted the correction_of_an_error it also constituted a change in method_of_accounting pursuant to sec_472 id pincite the court added where the correction_of_an_error results in a change in accounting_method the requirements of sec_446 are applicable id vii conclusion neither cob nor fsb received consent to change its method_of_accounting for late-fee income under sec_446 in they continued to treat late-fee income under the current- inclusion method and did not deviate from that treatment until the submission of their return a retroactive change in the treatment of and late-fee income is a change in the treatment of a material_item and is therefore a prohibited change in method_of_accounting the error petitioners attempt to correct is neither a posting error nor a mathematical error and petitioners are not entitled to correct that error with retroactive effect for and because to do so would be a prohibited change in method_of_accounting accordingly the court holds that petitioners’ requested recharacterization of late-fee income is an impermissible change in method_of_accounting under sec_446 to reflect the foregoing an order will be issued denying petitioners’ motion for partial summary_judgment on the late fees issue and granting respondent’s motion for partial summary_judgment


t c memo united_states tax_court david w goldston petitioner v commissioner of internal revenue respondent docket nos filed date david w goldston pro_se lauren b epstein for respondent memorandum findings_of_fact and opinion cohen judge in separate notices of deficiency respondent determined deficiencies and additions to tax as follows additions to tax_year deficiency sec_6651 sec_6651 sec_6654 dollar_figure dollar_figure --- big_number dollar_figure --- dollar_figure big_number big_number dollar_figure dollar_figure big_number dollar_figure big_number dollar_figure big_number big_number dollar_figure dollar_figure big_number dollar_figure big_number dollar_figure big_number big_number dollar_figure dollar_figure big_number big_number dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure 1the addition_to_tax will continue to accrue from the due_date of the return at a rate of percent for each month or fraction thereof of nonpayment not exceeding percent the cases were consolidated for trial briefing and opinion after concessions the issue for decision is whether petitioner is liable for the additions to tax under sec_6651 for fraudulent_failure_to_file returns all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference petitioner resided in florida at the time the petitions were filed at all material times he was married to nancy sharp goldston petitioner received a degree in dentistry in and was a practicing dentist during the years in issue before he operated his dental practice in corporate form in he sold his practice thereafter he worked for various persons and entities his gross_receipts from dentistry for the years in issue were as follows year gross_receipts dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number petitioner also received taxable_income from various sources during the years in issue including taxable retirement distributions of dollar_figure in sales of property rentals interest and beginning in social_security_benefits petitioner’s total taxable_income for the years in issue was as follows year taxable_income dollar_figure big_number big_number big_number big_number total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number beginning in or about petitioner began a course of conduct intended to conceal the sources and amount of income that he received that conduct and concealment continued through the years in issue although the sources of income and the names of the entities used varied from year to year petitioner placed funds and property in the names of nominees and trusts and used cashier’s checks money orders and currency to conduct transactions all with the intent and for the purpose of concealing his income and assets from the internal_revenue_service irs petitioner opened bank accounts operated a dentistry practice engaged in various real_estate transactions and purchased residential_real_property and personal vehicles in the names of various trusts the trust names so employed included sharp management_trust sharpstone irrevocable_trust cool stream holding trust old times holding trust high mountain holding trust old oak holding trust comfort holding trust rainy day management_trust work holding trust carriage holding trust blue lake holding trust patio holding trust and sun stroke management_trust petitioner was the grantor of the trusts managed the assets purportedly held by the trusts deposited income from his dental practice in trust accounts and paid personal expenses from those accounts and otherwise treated as his own the assets held in the names of the trusts petitioner failed to file federal_income_tax returns for through he espoused frivolous tax arguments and advised others including patients and an employee that he was not required to pay taxes he did not make any estimated_tax payments on date petitioner was convicted of violation of sec_7201 on an indictment charging that from on or about the 15th day of april and continuing through in or about september petitioner did willfully attempt to evade and defeat the payment of a substantial amount of federal_income_tax due and owing by him to the united_states of america for the calendar years and by concealing and attempting to conceal from the internal_revenue_service the nature and extent of his assets and the location thereof by placing funds and property in the names of nominees and trusts and by utilizing cashier’s checks money orders and currency to conduct transactions on date petitioner was sentenced to a prison term of months and ordered to be on supervised release for months upon release from prison as a condition of his supervised release petitioner was required to cooperate with the internal_revenue_service regarding all outstanding taxes interest and penalties and provide the probation officer with verification that the income_tax obligations are being met to the fullest extent possible since his release petitioner has not cooperated with the irs and has not met his income_tax obligations opinion notwithstanding his recent incarceration petitioner’s denials and defiance of his tax obligations continued through the time of trial of these cases he admitted that he did not file returns for any of the years in issue he did not dispute any of the facts establishing his receipt of substantial taxable_income during the years in issue and his receipt of specific items of income was deemed admitted pursuant to rule by his failure to respond to requests for admissions no adjustments to the deficiencies determined by respondent are required on this record the deemed admissions also establish petitioner’s liability for additions to tax under sec_6651 and sec_6654 petitioner failed to file the answering brief ordered by the court and thus he has not raised any objections to the extensive and detailed findings_of_fact proposed in respondent’s opening brief in view of the absence of dispute as to the underlying facts our findings summarize the material facts without describing the evidentiary detail the addition_to_tax in cases of fraud is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the government for the heavy expense of investigation and the loss resulting from the taxpayer’s fraud 303_us_391 to sustain the 75-percent addition_to_tax provided by sec_6651 respondent has the burden of proving that petitioner’s failure_to_file returns was fraudulent see sec_7454 rule b respondent has pleaded and argued in the alternative applicability of the addition_to_tax under sec_6651 in view of our conclusion that petitioner’s failure_to_file was fraudulent we do not consider that alternative in applying the addition_to_tax under sec_6651 we consider the same elements or long-recognized badges_of_fraud discussed in cases applying sec_6663 or former sec_6653 102_tc_632 see 99_tc_202 fraud may be proved by circumstantial evidence and the taxpayer’s entire course of conduct may establish the requisite fraudulent intent 80_tc_1111 circumstantial evidence of fraud present here includes the pattern of failure_to_file returns failure to report substantial amounts of income concealing assets dealing in cash failing to maintain records giving implausible or inconsistent explanations of behavior and failure to cooperate with taxing authorities in determining petitioner’s correct liability see eg 796_f2d_303 9th cir affg tcmemo_1984_601 252_f2d_56 9th cir clayton v commissioner supra pincite 75_tc_1 67_tc_181 affd without published opinion 578_f2d_1383 8th cir petitioner argues that he had no intention of breaking the law and that his admitted failure_to_file returns was not fraudulent his filings and his testimony are replete with implausible and inconsistent explanations of his behavior he claims that he acted in accordance with the directions of the trustees but there is no evidence that anyone other than petitioner and his wife controlled any of the transactions or earned any of the income attributed to him he admits that the trusts were funded by gifts from him that his personal expenses were paid from trust bank accounts and that properties purchased in the names of various trusts were used by him for professional and personal purposes according to his testimony the beneficiaries of the trusts were his children and grandchildren he claims that his accountant made mistakes reporting pension_plan distributions and he asserts that his criminal conviction resulted from false testimony he asserts that my decision to quit paying the tax was made in not before and was the result of a letter sent asking for the basis for their taxing me which received a reply after about months which was no answer to my question but simply stated to ignore any correspondence received from them until i received an answer in a statement at the conclusion of the trial he alleged that he was a victim of tax_shelter promoters at some unidentified time that thereafter he was repeatedly audited that he was convicted because of misconduct by his accountant and that his object was civil disobedience petitioner engaged in a complex scheme to conceal his income and assets during the years in issue his taxable_income for those years exceeded dollar_figure million and his unreported tax_liabilities before additions to tax exceeded dollar_figure million he was convicted of engaging in that conduct in order to defeat the payment of taxes due for and and the obvious purpose of continuing the scheme was to evade taxes for the subsequent years as well the objective facts are clear_and_convincing evidence of fraud sufficient to satisfy respondent’s burden_of_proof the additions to tax for fraud have frequently been imposed on taxpayers like petitioner who were knowledgeable about their taxpaying responsibilities and consciously decided to unilaterally opt_out of our system of taxation 94_tc_316 citing numerous relevant cases see niedringhaus v commissioner supra pincite- petitioner’s excuses are unpersuasive and we do not believe that he acted as he did for nonfraudulent reasons he has not presented evidence of any consultations with competent tax professionals or reliance on any legal authority for his positions he incorporated boilerplate frivolous arguments about the paperwork reduction act in his petition and alleged in his pretrial memorandum that the irs lacks delegated authority to collect tax perhaps he believes that feigning lack of understanding or sincere beliefs will help him avoid the consequences of his deliberate choices in view of his education sophistication and success in conducting his profession and business transactions persistence after his criminal conviction and acknowledged civil disobedience we reject any suggestion of good_faith see chase v commissioner tcmemo_2004_142 we have considered the other arguments of the parties they are irrelevant moot or otherwise lack merit for the reasons explained above for respondent decisions will be entered


internal_revenue_service number release date index number --------------------------- ------------------------------- --------------------------------------------------- ----------------------------------------- -------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------- id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-130658-08 date january legend x ----------------------------------------- --------------------------------- country --------------------------- date ------------------------- dear ------------- this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting that the service grant x an extension of time under sec_301_9100-3 of the procedure and administration regulations to elect to be treated as a partnership the information submitted states that x was formed under the laws of country x represents that x is a foreign_entity eligible to elect to be treated as a partnership however x inadvertently failed to timely file a form_8832 entity classification election electing to treat x as a partnership effective date sec_301_7701-3 of the income_tax regulations provides that an eligible_entity with at least two members may elect to be classified as either an association and thus a corporation under sec_301_7701-2 or as a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner plr-130658-08 sec_301_7701-3 further provides that so long as a business_entity is not classified as a corporation under sec_301_7701-2 or an eligible_entity it may elect its classification for federal tax purposes sec_301_7701-3 provides that except as provided in sec_301 b unless the entity elects otherwise a foreign eligible_entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to seventy-five days prior to the date the form is filed or up to twelve months after the date on which the form is filed sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and granting relief will not prejudice the interests of the government based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file a form_8832 with the appropriate service_center and elect to be treated as a partnership effective date a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose plr-130658-08 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representatives sincerely curt g wilson associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes cc