internal_revenue_service national_office technical_advice_memorandum date ------------------------------------ ------------------------------ -------------------------- --------------------------- ---------------- ------- ---------------------- 263a 263a tam-137496-03 cc ita b06 number release date index uil no case-mis no district_director director of field operations taxpayer's name taxpayer's address taxpayer's identification no year involved date of conference legend p sec_1 sec_2 d1 d2 d3 d4 product product product ------------------------------------ ------------------------------------- ------------------------ ----------- --------------- --------- -------- --------------------- ------------------------ --------------------------------- -------------------------------- ------------------- ---------------- ------------------ ------------------------------------ tam-137496-03 product product product product product issues whether for purposes of the uniform_capitalization_rules under sec_263a of the internal_revenue_code unicap direct labor is an appropriate base to develop standard costs to allocate storage and handling costs to the taxpayer’s inventory if direct labor is not an appropriate base to develop standard costs to allocate storage and handling costs to the taxpayer’s inventory what method may the commissioner use to allocate the taxpayer’s storage and handling costs conclusions for purposes of sec_263a direct labor is not an appropriate base to use in developing standard costs to allocate storage and handling costs to the taxpayer’s inventory since direct labor is not an appropriate base to develop standard costs to allocate storage and handling costs to the taxpayer’s inventory the commissioner may allocate the taxpayer’s storage and handling costs using any method that in his opinion clearly reflects income facts p is a corporation engaged in the business of manufacturing product product product product product product product and product collectively products p consists of four divisions d1 d2 d3 and d4 p does not maintain separate storage facilities devoted to the storage of raw materials instead each division of p purchases raw materials and stores them at the plant where they will be manufactured into the final product thus a portion of the cost of the manufacturing_facility including rent and depreciation is allocable to the raw materials requirements of sec_263a because it manufacturers products p determines its sec_471 p sec_1 and sec_2 file a consolidated federal_income_tax return p is subject_to the tam-137496-03 costs as defined in sec_1_263a-1 remaining in ending inventory on a division-by- division basis p determines its additional sec_263a costs as defined in sec_1_263a-1 remaining in ending inventory on an entity-level basis in other words p first determines its sec_471 costs remaining in ending inventory for each of its divisions and then allocates additional sec_263a costs to its total ending inventory all of p’s divisions use a standard_cost_method to allocate sec_471 costs to items in their ending inventories in developing its standard costs p uses direct labor as a base to allocate its sec_471 overhead costs to ending inventory at the end of the taxable_year p’s ending inventory consists of unassigned raw materials work-in-process wip and finished goods for the taxable_year at issue p allocated storage and handling costs related to raw materials wip and finished goods as a sec_471 cost thus in accordance with its standard_cost_method p allocated storage and handling costs to its inventory using direct labor as a base p’s direct_labor_costs are allocable to its wip and finished goods ending inventories but are not allocable to its raw materials ending inventory since storage and handling costs are treated as sec_471 overhead costs storage and handling costs along with other overhead costs are only allocated to p’s wip and finished goods ending inventories and not its raw materials ending inventory p has asserted that it has allocated storage and handling costs in this manner for all the years of its existence including years prior to the effective date of sec_263a for purposes of this request for technical_advice the commissioner has assumed that p’s assertion is correct that is the commissioner will assume that p treated its storage and handling costs as indirect production_costs for years prior to the effective date of sec_263a p allocates any resulting variances from its use of its standard_cost_method using an inventory-turn method sec_1 and sec_2 allocate sec_471 overhead costs using an inventory- turn method p sec_1 and sec_2 use the simplified_production_method provided in sec_1 263a- b to allocate their additional sec_263a costs the cost of storing and handling raw materials that are held for future production the examination_division further contends that unicap requires costs associated with storing and handling raw materials that are held for future production to be allocated to unassigned raw materials that is raw materials that have not yet entered the production process thus the examination_division argues that p’s method of allocating storage and handling costs which uses a standard_cost_method with direct labor as a base does not clearly reflect income because it does not allocate costs to unassigned raw materials in response p concedes that unicap requires it to capitalize the cost of storing and handling raw materials that are held for future production however p argues that unicap does not require such costs to be allocated to unassigned raw materials the examination_division contends that unicap requires taxpayers to capitalize tam-137496-03 law analysis sec_263a generally requires a taxpayer to capitalize the direct costs and an allocable share of the indirect_costs of the real or tangible_personal_property that it produces sec_263a provides that the term produce includes construct build install manufacture develop or improve sec_1_263a-1 provides that producers must capitalize direct_material_costs and direct_labor_costs sec_1_263a-1 provides that indirect_costs are properly allocable to property produced or property acquired for resale when the costs directly benefit or are incurred by reason of the performance of production or resale activities sec_1_263a-1 provides that storage and handling costs are examples of costs that must be capitalized to the extent they are properly allocable to property produced or property acquired for resale sec_1_263a-1 sets forth various detailed or specific facts-and- circumstances cost allocation_methods that taxpayers may use to allocate direct and indirect_costs to property produced and property acquired for resale sec_1_263a-1 provides that a specific_identification_method traces costs to a cost objective such as a function department activity or product on the basis of a cause and effect or other reasonable relationship between the costs and the cost objective sec_1_263a-1 provides that a burden rate method allocates an appropriate amount of indirect_costs to property produced or property acquired for resale during a taxable_year using predetermined rates that approximate the actual amount of indirect_costs incurred by the taxpayer during the taxable_year sec_1_263a-1 provides that a standard_cost_method allocates an appropriate amount of direct and indirect_costs to property produced_by_the_taxpayer through the use of preestablished standard allowances without reference to costs actually incurred during the taxable_year sec_1_263a-1 provides that a taxpayer may use the methods described in paragraph f or of this section if they are reasonable allocation_methods within the meaning of this paragraph f in addition a taxpayer may use any other tam-137496-03 reasonable method to properly allocate direct and indirect_costs among units of property produced or property acquired for resale during the taxable_year an allocation method is reasonable if with respect to the taxpayer's production or resale activities taken as a whole- i the total costs actually capitalized during the taxable_year do not differ significantly from the aggregate costs that would be properly capitalized using another permissible method described in this section or in sec_1_263a-2 and sec_1_263a-3 with appropriate consideration given to the volume and value of the taxpayer's production or resale activities the availability of costing information the time and cost of using various allocation_methods and the accuracy of the allocation method chosen as compared with other allocation_methods ii the allocation method is applied consistently by the taxpayer and iii the allocation method is not used to circumvent the requirements of the simplified methods in this section or in sec_1_263a-2 sec_1_263a-3 or the principles of sec_263a sec_1_263a-2 provides that if property is held for future production taxpayers must capitalize direct and indirect_costs allocable to such property eg purchasing storage handling and other costs even though production has not begun if property is not held for production indirect_costs incurred prior to the beginning of the production_period must be allocated to the property and capitalized if at the time the costs are incurred it is reasonably likely that production will occur at some future date thus for example a manufacturer must capitalize the costs of storing and handling raw materials before the raw materials are committed to production in addition a real_estate developer must capitalize property taxes incurred with respect to property if at the time the taxes are incurred it is reasonably likely that the property will be subsequently developed sec_1_471-11 provides that in order to conform as nearly as may be possible to the best accounting practices and to clearly reflect income as required by sec_471 of the code both direct and indirect production_costs must be taken into account in the computation of inventoriable costs in accordance with the full absorption method of inventory costing sec_1_471-11 provides a taxpayer may use the so-called standard_cost_method of allocating inventoriable costs to the goods in ending inventory provided he treats variances in accordance with the procedures prescribed in subdivision ii of this subparagraph the method used by the taxpayer in allocating such costs in his financial reports shall be given great weight in determining whether the taxpayer's method tam-137496-03 employed for tax purposes fairly allocates indirect production_costs to the ending inventory issue whether for purposes of sec_263a direct labor is an appropriate base to develop standard costs to allocate storage and handling costs to the taxpayer’s inventory for the following reasons direct labor is not an appropriate base to develop standard costs to allocate storage and handling costs to the taxpayer’s inventory p’s use of direct labor as a base to allocate storage and handling does not allocate any storage and handling costs to unassigned raw materials this is contrary to the specific requirements of sec_1_263a-2 the capitalization of pre-production costs is supported by both the legislative_history of unicap and case law the legislative_history of unicap provides that the costs of acquiring producing or carrying property should be capitalized and recovered when the property is sold in order to prevent a mismatching of expenses and related_income and an unwarranted deferral of income the unicap regulations permit taxpayers to continue to use methods of allocation similar to those provided by the full absorption_rules under sec_1_471-11 a standard_cost_method is permitted under the full absorption_rules and the unicap regulations however the unicap regulations clearly contemplate that a taxpayer may be required to change its standard_cost_method in order to comply with the requirements imposed by unicap p’s standard_cost_method is not reasonable for purposes of sec_1_263a-1 because it does not allocate storage and handling costs to its inventory of unassigned raw materials that are stored and handled p’s reliance on the fact that direct labor hours is a commonly used basis for allocating overhead costs under generally_accepted_accounting_principles gaap is misplaced each of these reasons is discussed in more detail below sec_1_263a-2 specifically provides that a taxpayer must allocate storage and handling costs to unassigned raw materials unicap generally requires a taxpayer to capitalize the direct costs and an allocable share of the indirect_costs of the real or tangible_personal_property that it produces see ' 263a a a taxpayer aproduces property when it constructs builds sec_1_263a-1 provides various detailed or specific facts-and- tam-137496-03 installs manufactures develops or improves property see ' 263a g the direct costs of property produced by a taxpayer include direct materials and direct_labor_costs see ' 263a-1 e i the indirect_costs of produced property are all costs other than direct_material_costs and direct_labor_costs indirect_costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities see ' 263a-1 e storage and handling costs are examples of indirect_costs that must be capitalized to the extent they are properly allocable to property produced or property acquired for resale see sec_1_263a-1 g and h circumstances methods cost allocation_methods that taxpayers may use to allocate direct and indirect_costs to produced property a standard_cost_method is one of the facts-and-circumstances methods permitted by the regulations see sec_1_263a-1 a standard_cost_method allocates an appropriate amount of direct and indirect_costs to property produced through the use of pre-established standard allowances without reference to costs actually incurred during the taxable_year see sec_1 263a- f ii a generally standard allowances for overhead costs are developed using a ratio percentage or unit dollar amount obtained by dividing the costs being allocated by a base such as a measure of activity or volume level the regulations do not elaborate on the precise mechanics of the standard_cost_method however as discussed below the preamble to the treasury_decision that promulgated the unicap regulations reveals that the standard_cost_method was meant to follow the conceptual framework of standard costing employed by traditional cost accounting the preamble to treasury_decision 1987_1_cb_98 which promulgated the temporary unicap regulations indicates that the regulations permit the use of the standard_cost_method in accordance with the legislative_history of the tax_reform_act_of_1986 the act publaw_99_514 vol c b the legislative_history of the act indicates that congress expected that the unicap regulations would permit allocations of costs among numerous items produced or held for resale by a taxpayer to be made on the basis of a burden rate method or other appropriate methods similar to those already provided under the law at the time see s rep no vol c b in this regard the committee report specifically cites sec_1 d which authorizes the use of the manufacturing_burden_rate_method the standard_cost_method or any other method that fairly apportions such costs among items of inventory see footnote of s rep supra when taxpayers use any of these under sec_1_471-11 manufacturers are required to use the full absorption tam-137496-03 methods they are required to allocate additional sec_263a costs to specific items in their inventory method under the full absorption method production_costs are allocated to goods produced during the taxable_year pursuant to sec_1_471-11 indirect production_costs required to be included in inventoriable costs must be allocated to goods in ending inventory using a method of allocation that fairly apportions such costs among the various items produced these regulations provide that the standard_cost_method is an acceptable method for this purpose see sec_1_471-11 moreover the regulations further provide that the standard_cost_method used by the taxpayer in allocating costs in financial reports shall be given great weight in determining whether the taxpayer’s method employed for tax purposes fairly allocates indirect production_costs to the ending inventory see id in comparison to the full absorption method which only required manufacturers to allocate manufacturing costs to items that are manufactured during the taxable_year unicap specifically requires producers to capitalize direct and indirect_costs except interest costs properly allocable to produced property without regard to whether those costs are incurred before during or after the production_period see sec_1 263a- a i see also 112_tc_14 104_tc_207 therefore under unicap a taxpayer that is holding property for future production must capitalize the direct and indirect_costs allocable to such property eg purchasing storage handling and other costs even though the taxpayer has not yet begun production see sec_1_263a-2 the regulations further provide that if property is not held for production indirect_costs incurred prior to the beginning of the production_period must be allocated to the property and capitalized if at the time the costs are incurred it is reasonably likely that production will occur at some future date see id thus the regulations specifically require manufacturers to capitalize the costs of storing and handling raw materials before the raw materials are committed to production see id unassigned raw materials as is stated above the unicap regulations provide that i f property is held for future production taxpayers must capitalize direct and indirect_costs allocable to such property eg purchasing storing handling and other costs even though production has not begun sec_1_263a-2 emphasis added moreover the regulation section further provides that i f property is not held for production indirect_costs incurred prior to the beginning of the production_period must be allocated p argues that the unicap regulations do not require the allocation of costs to the simplified resale and the simplified production methods described in sec_1_263a-2 and sec_1_263a-3 are exceptions to the general_rule that costs required to be capitalized under sec_263a must be allocated to specific items of inventory tam-137496-03 to the property and capitalized if at the time the costs are incurred it is reasonably likely that production will occur at some future date id emphasis added p’s unassigned raw materials are held for future production accordingly p’s argument ignores the requirements of sec_1_263a-2 which clearly provides that p is required to capitalize and allocate the storage and handling costs of unassigned raw materials to such property the capitalization of pre-production costs is supported by both the legislative_history of unicap and case law the tax_court has consistently held that sec_1_263a-2 is consistent with the legislative_history of unicap see reichel v commissioner supra von-lusk v commissioner supra in fact in reichel the court specifically states that a close analysis of the language and structure of sec_263a supports the conclusion that congress intended that the capitalization_rules cover costs incurred before as well as during the production_period the tax_court supported its statement by citing h_r rep no 1986_3_cb_1 and s rep no supra these reports indicate that congress was concerned that the full absorption_rules were deficient because they allowed costs that are in reality costs of producing acquiring or carrying property to be deducted currently rather than capitalized into the basis_of_property and recovered when the property is sold or as it is used by taxpayers these reports further reveal that congress believed that the capitalization_rules prior to unicap produced a mismatching of expenses and the related_income and an unwarranted deferral of income see id congress enacted unicap to provide a single comprehensive set of rules to govern the capitalization of costs of producing acquiring and holding property see s rept supra pincite the storage and handling costs that p incurs for its raw materials are the carrying costs of such property the legislative_history also indicates that congress generally patterned unicap after the extended period long-term_contract rules see s rep no supra pincite under the extended period long-term_contract rules certain pre-production expenses such as contract bidding costs are required to be deferred until the contract is awarded subsequently if the contract is awarded to the taxpayer the costs are capitalized and if the contract is not awarded to the taxpayer the costs are deducted see sec_1 d ii s in reichel the tax_court also noted that the interest capitalization provisions of sec_263a provide that capitalization does not begin until the production_period begins the tax_court observed that this provision would be superfluous if costs were not to be capitalized until the beginning of the production_period tam-137496-03 the unicap regulations contemplate that a taxpayer may be required to change its standard_cost_method in order to comply with the new requirements imposed by unicap the legislative_history of unicap and the unicap regulations provide that taxpayers are permitted to use allocation_methods similar to those already provided under the full absorption_rules provided by sec_1_471-11 including the standard_cost_method see s rep no supra sec_1_263a-1 however neither the regulations nor the legislative_history of unicap indicate that a specific taxpayer’s method is insulated from modification instead sec_1_263a-1t b iii a i of the temporary income_tax regulations provides that taxpayers may be required to change their existing allocation_methods if they do not result in the allocation of sufficient amounts of indirect_costs to production or resale activities moreover articles by tax practitioners indicate that practitioners were aware that the changes made by unicap might require taxpayers to change their traditional cost accounting methods see eg richard garrett james e connor annette b smith tax management portfolio uniform_capitalization_rules inventory self-constructed assets real_estate no modifying existing burden rate to comply with sec_263a b n a worksheet in fact one such article indicates that unicap requires a taxpayer to modify its existing burden rates even if a taxpayer’s method previously treated costs related to raw materials as sec_471 costs see id p’s standard_cost_method is not reasonable for purposes of sec_1_263a-1 because it does not allocate storage and handling costs to its inventory of unassigned raw materials that are stored and handled similar to sec_1_471-11 the unicap regulations permit taxpayers to allocate sec_263a costs using one of the facts-and-circumstances methods a specific_identification_method a burden rate method or a standard_cost_method see sec_1_263a-1 the unicap regulations also permit taxpayers to allocate additional sec_263a costs using certain simplified methods the simplified_production_method and the simplified_resale_method see sec_1_263a-2 and sec_1_263a-3 by their very nature the simplified methods do not produce the same inventory value as the facts-and- circumstances methods the simplified methods may capitalize more costs or less costs than a facts-and-circumstances method depending upon the taxpayer’s particular facts and circumstances in written comments to the proposed_regulations concerning the generally a taxpayer’s sec_471 costs are the costs other than interest capitalized under the taxpayer’s method_of_accounting immediately prior to the effective date of sec_263a see sec_1_263a-1 whereas a taxpayer’s additional sec_263a costs are generally defined as the costs other than interest that were not capitalized under the taxpayer’s method_of_accounting immediately prior to the effective date of sec_263a but that are required to be capitalized under sec_263a see sec_1_263a-1 tam-137496-03 simplified methods some commentators expressed dissatisfaction with the simplified methods in cases where the methods capitalized more costs than a facts-and- circumstances method specifically a number of commentators requested that the simplified_production_method in the temporary regulations be revised to reduce the amount of sec_263a costs allocable to raw materials inventories these commentators suggested that allocations based on this method may result in an excessive_amount of the sec_263a costs being allocated to raw materials inventories they argue that this result occurs because the simplified_production_method does not take into account the fact that fewer indirect_costs are incurred with respect to raw materials normally held only a short_period of time than are incurred with respect to other items of inventory held longer for example a taxpayer that buys additional raw materials on the last day of the year would be required to allocate significantly more additional sec_263a costs such as storage handling and carrying costs to those materials under the simplified_production_method than it would under a facts and circumstances allocation method see preamble to t d 1987_1_cb_98 the final regulations did not adopt the commentators’ recommendations instead the preamble to the final regulations states t he service and the treasury believe that the simplified_production_method formula properly reflects the costs of raw materials that are purchased on the last day of the year the taxpayer will have likely incurred purchasing costs and handling costs in obtaining these materials which should be included in the inventoriable costs of these materials see id accordingly it clearly was contemplated that taxpayers using a facts-and-circumstances method would be required to capitalize storage and handling costs to unassigned raw materials furthermore under a specific_identification_method costs are traced to a cost objective such as a function department activity or product on the basis of a cause and effect or other reasonable relationship between the costs and the cost objective see sec_1_263a-1 in other words the regulations require that the cost objective have some relationship to the allocated cost likewise sec_1_263a-1 requires a taxpayer’s burden rate or standard_cost_method to be a reasonable allocation method within the meaning of the regulations for this purpose sec_1_263a-1 provides that an allocation method is reasonable if with respect to the taxpayer’s production or resale activities taken as a whole - i the total costs actually capitalized during the taxable_year do not differ significantly from the aggregate costs that would be properly capitalized using another permissible method described in the regulations with tam-137496-03 appropriate considerations given to the volume and value of the taxpayer’s production or resale activities the availability of costing information the time and cost of using various allocation_methods and the accuracy of the allocation method chosen as compared with other allocation_methods ii iii the allocation method is applied consistently by the taxpayer and the allocation method is not used to circumvent the requirements of the simplified_production_method contained in sec_1_263a-2 or the simplified_resale_method contained in sec_1_263a-3 or the principles of sec_263a for an allocation method to be accurate the base chosen to allocate costs must have some causal relationship to the costs being allocated in this case p’s method does not capitalize any storage and handling costs to its ending inventory of raw materials p’s ending inventory of raw materials necessarily has caused and is continuing to cause p to incur storage and handling costs an accurate and reasonable allocation method must allocate costs to the items that give rise to the costs therefore a method that allocates no costs to the items that gave rise to the costs is inaccurate which in itself indicates that the base that p has chosen does not have any causal relationship to the costs being allocated in this case p could have allocated its storage and handling costs using a standard_cost_method developed with an appropriate base eg square footage or direct_material_costs the use of a standard_cost_method developed with an appropriate base would have resulted in the allocation of storage and handling costs to wip finished goods and also raw materials therefore p’s method is inaccurate as compared to another allocation method accordingly p’s standard_cost_method as related to its storage and handling costs is not reasonable for purposes of sec_1 263a- f p’s reliance on the fact that direct labor is a commonly used base to allocate overhead costs for gaap is misplaced p argues that its use of direct labor as a base to allocate all of its overhead costs including storage and handling is reasonable for purposes of gaap and the full absorption provisions contained in sec_1_471-11 and is therefore appropriate for purposes of unicap p further argues that this result is required and contemplated by the legislative_history of unicap p also contends that its method already capitalizes the cost of storing and handling raw materials because such costs are considered by its present standard_cost_method that is p contends that its method capitalizes and allocates the cost of storing and handling raw materials to its work-in-process and finished goods inventories to support its argument p cites the preamble to the unicap regulations and the legislative_history for the proposition that unicap only p’s argument oversimplifies the state of cost accounting prior to the adoption of under traditional cost accounting principles there are two primary methods used tam-137496-03 changed the type of costs required to be capitalized but it did not require taxpayers to change their existing allocation_methods unicap traditional cost accounting principles are far from simple and require detailed analysis of a company’s product lines and manufacturing steps and processes to assign overhead costs to production under the first method actual manufacturing_overhead_costs are charged to actual goods produced the other basic approach is a standard_cost_method see sidney davidson roman l weil handbook of cost accounting10-13 to prentice hall under a standard_cost_method standard or predetermined rates are temporarily substituted for actual overhead costs a standard or overhead rate is a ratio percentage or unit dollar amount obtained by dividing the manufacturing_overhead_costs for a segment of the firm’s business by a measure of activity or volume level such as direct labor hours see id other commonly used activity bases include direct labor dollars machines hours product units direct material units or dollars see id a firm’s predetermined or standard costs are based on overhead expense budgets and predetermined activity levels and are typically established by the cost accounting department in conjunction with budget and production planning departments see id generally firms develop overhead rates on either a plant-wide or departmental basis see id other acceptable alternatives are to develop product_class rates or to apply separate rates for materials and labor see id the method chosen by any particular firm is contingent upon that firm’s particular facts and circumstances for example a plant-wide rate is generally only applicable in a one-product one-process plant see id on the other hand a firm that manufactures some of its products and purchases others for which little direct labor is incurred may find it desirable to use two overhead rates one based on labor and another based on materials in this situation if overhead costs were only applied to direct labor the purchased items would be charged with little or no overhead costs even though they had to be purchased received inspected handled warehoused and shipped see id thus traditional cost accounting requires a detailed analysis to determine the appropriate base to use to allocate costs and a one size fits all approach does not suffice instead the determination of an appropriate base must be made in the context of a firm’s particular facts and circumstances and the particular costs that are being allocated costs is reasonable because it considers all storage and handling costs when allocating overhead costs to work-in-process and finished goods inventories is misleading and does not lead to the conclusion that its method properly determines the cost of its unassigned raw materials instead p’s method merely determines the amount of cost p’s argument that its present method_of_accounting for storage and handling sec_1_263a-2 specifically provides that if property is held for future lastly p implies that conformance with gaap is all that is required with regard to tam-137496-03 allocable to the products it was designed to allocate costs to ie work-in-process and finished goods production a taxpayer must capitalize the indirect_costs allocable to such property the regulation further elaborates that manufacturers must capitalize the costs of storing and handling raw materials before the raw materials are committed to production for purposes of unicap capitalize means to include in inventory costs if the costs are allocable to property included in inventory see sec_1_263a-1 inventories include raw materials that physically become part of merchandise intended for sale see sec_1_471-1 moreover as previously stated the regulations require taxpayers using a facts-and-circumstances method including a standard_cost_method to allocate costs to specific items in inventory in this case p’s method does not determine the indirect_costs allocable to unassigned raw materials in its inventory accordingly p’s use of direct labor as a base to allocate storage and handling costs is improper a taxpayer’s allocation method at first glance this argument seems to find support in sec_1_471-11 which provides that the standard_cost_method used by a taxpayer in allocating costs in financial reports will be given great weight in determining whether the taxpayer’s method employed for tax purposes fairly allocates indirect production_costs to ending inventory however the general presumption provided by this section must yield to any inconsistency provided by the unicap regulations see 439_us_522 as explained above the results obtained by p’s allocation method is inconsistent with the unicap regulations moreover in thor power the supreme court specifically recognized the vastly different objectives of financial and tax_accounting in that case the supreme court noted that generally_accepted_accounting_principles tolerate a range of reasonable treatments leaving the choice among alternatives to management and if management’s choice were dispositive for tax purposes a firm could decide unilaterally - within limits dictated only by its accountants - the tax it wished to pay see thor power tool co v commissioner supra pincite likewise p’s decision to use direct labor as a base to allocate storage and handling costs is not dispositive instead the allocation method used must be judged in light of the capitalization requirements provided by unicap since p’s present method of allocating overhead cost fails to allocate any amount of overhead costs to its unassigned raw materials inventory we conclude that p’s use of direct labor as a base to allocate storage and handling costs is improper issue if direct labor is not an appropriate base to develop a standard cost to allocate storage and handling costs to the taxpayer’s inventory what method may the commissioner use to allocate the taxpayer’s storage and handling costs tam-137496-03 sec_446 provides that if no method_of_accounting has been regularly used by the taxpayer or if the method used does not clearly reflect income the computation of taxable_income shall be made under such method as in the opinion of the secretary does clearly reflects income the commissioner’s authority under sec_446 permits him to select the method_of_accounting a taxpayer must use once he has determined that a taxpayer’s method does not clearly reflect income see thor power tool co v commissioner supra since we have determined that p’s method for allocating storage and handling cost is inappropriate the commissioner may compute p’s taxable_income using any method for allocating storage and handling costs that in his opinion clearly reflects income caveat a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service appeals_office silverside rd wilmington de date feb uil redacted letter g0 _ - ---- - department of the treasury employer_identification_number person to contact employee id number tel fax refer reply to ap fe ap4 bal ral in re application_for recognition of exemption - sec_501 form required to be filed tax years and subsequent years last day to file a petition with the united_states tax_court _ may certified mail dear this is a final adverse determination as to your exempt status under sec_50i c of the internal_revenue_code it is determined that you do not qualify as exempt from federal_income_tax under sec_501 of the internal_revenue_code effective date our adverse determination was made for the following reason s a substantial part of your proposed activities consists of providing down payment assistance to home buyers to finance the assistance you plan to rely on home sellers that stand to benefit from these down payment assistance transactions the manner in which you plan to operate demonstrates that you will be operated primarily to further your insiders’ business interests therefore you propose operating for a substantial nonexempt purpose in addition your proposed operations will further the private interests of the persons who finance your activities accordingly it is determined that you do not plan to be operated exclusively for exempt purposes described in sec_501 contributions to your organization are not deductible under code sec_170 you are required to file federal_income_tax returns on the form indicated above processing of income_tax returns and assessment of any taxes due will not be delayed in the event that you file a petition for declaratory_judgment under code sec_7428 if you decide to contest this determination under the declaratory_judgment provisions of code sec_7428 a petition to the united_states tax_court the united_states court of claims or the district_court of the united_states for the district of columbia must be filed before the 91st ninety-first day after the date this determination was mailed to you contact the clerk of the appropriate court for rules for filing petitions for declaratory_judgment to secure a petition from the united_states tax_court write to united_states tax_court second street nw washington d c we will notify the appropriate state officials of this action as required by code sec_6104 if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter you also have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate is not able to reverse legally correct_tax determinations nor extend the time fixed by law that you have to file a petition in the u s tax_court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling if you want taxpayer_advocate assistance please contact the taxpayer_advocate for the irs office that issued this notice_of_deficiency see the enclosed notice helpful contacts for your notice_of_deficiency for taxpayer_advocate telephone numbers and addresses thank you for your cooperation sincerely fr c es fisher appeals team manager enclosures notice - helpful contacts for your deficiency_notice


internal_revenue_service department of the treasury number release date index number 468a washington dc person to contact telephone number refer reply to cc psi 6-plr-155809-01 date date legend taxpayer parent plant plant commission state company company company company company law a b c d e f g h dear this letter responds to your request dated date that we rule on certain tax consequences under sec_468a of the internal_revenue_code of the transfer of plant and plant to genco a limited_partnership and a soon to be created plr-155809-01 wholly owned subsidiary of taxpayer as set forth below you have requested rulings regarding the tax consequences to the taxpayer and its qualified nuclear decommissioning funds the taxpayer represents the facts and information relating to the ruling_request as follows the taxpayer is an electric utility engaged in the generation purchase transmission distribution and sale of electric energy wholly within the state the taxpayer is under the regulatory jurisdiction of commission and the nuclear regulatory commission nrc the taxpayer is a wholly-owned subsidiary of the parent and files its federal_income_tax return as part of the parent’s consolidated_return under the audit jurisdiction of the industry director lmsb natural_resources the taxpayer owns two nuclear-fueled generating units plant and plant the nrc license for plant expires on a the nrc license for plant expires on b the taxpayer maintains qualified nuclear decommissioning funds for each plant and has pursuant to approved schedules of ruling amounts made contributions to the qualified nuclear decommissioning funds in c the state enacted law effective on d pursuant to law a traditionally vertically integrated state electric utility is required to separate its generation transmission and distribution and retail activities into three segments under either common or separate ownership law allows all retail electric customers of state investor-owned utilities such as taxpayer to take action to select a new retail electric provider under law the new electric retail provider may begin providing services starting in e in f commission approved taxpayer’s business separation plan to separate taxpayer’s generation business and its transmission and distribution business with respect to its transmission and distribution business taxpayer will form company as its wholly-owned subsidiary taxpayer will contribute all of the assets of its transmission and distribution business to company in exchange for all of the outstanding_stock of company and the assumption of certain taxpayer liabilities by company with respect to its generation business taxpayer will transfer its generation assets to genco a limited_partnership in exchange for all of the interests in genco and the assumption by genco of a portion of the debt of taxpayer the asset transfer to genco will consist of the following steps taxpayer will form the following subsidiaries genco a limited_partnership company a single member limited_liability_company and disregarded_entity for federal_income_tax purposes company a single member limited_liability_company and disregarded_entity for federal_income_tax purposes company a single member limited_liability_company and disregarded_entity for federal_income_tax purposes and plr-155809-01 company a single member limited_liability_company as part of the formation of genco company will contribute cash to genco in exchange for a g percent general_partnership interest in genco in compliance with the timing mandated by state law taxpayer will contribute its generation assets to genco in exchange for all of the limited_partnership interests in genco totalling h percent taxpayer will then contribute its limited_partnership_interest in genco to company in exchange for all of the membership interests in company as a consequence company and company will collectively hold all of the partnership interests general and limited respectively in genco taxpayer will contribute its membership interests in company and company to company in exchange for all of the membership interests in company taxpayer will contribute its membership interests in company to company in exchange for all of the membership interests in company after all of the contributions have been completed genco will hold all generation assets as a fourth tier subsidiary of taxpayer since the entities between taxpayer and genco company company and company will be disregarded entities for tax purposes taxpayer will be treated as directly owning the generation assets held by genco thus ultimately taxpayer will have transferred its interests in genco to company in exchange for all of the membership interests of company specifically with regard to plant and plant taxpayer will transfer and deliver to genco its ownership interests in plant and plant and associated qualified and nonqualified decommissioning funds to genco the nrc license will be transferred to genco and genco will assume the decommissioning liability genco will have access to funds from ratepayers to recover through a non-bypassable charge collected by the distribution utility the cost of decommissioning plant and plant thus pursuant to an order issued by commission company will collect from its customers the decommissioning costs on behalf of genco and transfer all collected amounts to genco genco will deposit all nuclear decommissioning collections to its nuclear decommissioning trust funds requested ruling neither the taxpayer genco nor their respective qualified nuclear decommissioning funds will recognize any gain_or_loss or otherwise take into account any income_or_deduction into account by reason of the transfer of the taxpayer’s qualified nuclear decommissioning trust funds to genco’s qualified nuclear decommissioning trust funds genco’s qualified nuclear decommissioning funds will have a basis in the assets held equal to the basis of such assets in the taxpayer’s qualified nuclear decommissioning funds immediately prior to the transfer plr-155809-01 sec_468a provides that a taxpayer may elect to deduct payments made to a nuclear decommissioning reserve fund the qualified nuclear decommissioning fund sec_468a limits the annual deduction of the electing taxpayer to the lesser_of the ruling_amount or the amount of decommissioning costs included in the electing taxpayer’s cost of service for ratemaking purposes for the taxable_year sec_468a provides that the ruling_amount means the amount determined by the service to be necessary to a fund that portion of the nuclear decommissioning cost with respect to the nuclear power plant that bears the same ratio to the total nuclear decommissioning costs with respect to such nuclear power plant as the period for which the fund is in effect bears to the estimated_useful_life of the nuclear power plant and b prevent any excessive funding of such costs or the funding of such costs at a rate more rapid than level_funding under sec_1_468a-2 of the income_tax regulations decommissioning costs are included in a taxpayer's cost of service for a taxable_year to the extent such costs are directly or indirectly charged to customers of the taxpayer by reason of electric energy consumed during the taxable_year or otherwise required to be included in the taxpayer's income under sec_88 and the corresponding regulations sec_1_88-1 provides that decommissioning costs directly or indirectly charged to customers of the taxpayer include all decommissioning costs that consumers are liable to pay by reason of electric energy furnished by the taxpayer during the taxable_year whether payable to the taxpayer a_trust state government or other entity sec_468a provides that the rate_of_tax on the income of a qualified nuclear decommissioning fund is percent sec_468a provides in pertinent part that the assets in a qualified nuclear decommissioning fund shall be used exclusively for satisfying the liability of any taxpayer contributing to the qualified nuclear decommissioning fund sec_1_468a-1 of the federal_income_tax regulations provides that an eligible_taxpayer is a taxpayer that possesses a qualifying interest in a nuclear power plant sec_1_468a-1 provides that a qualifying interest is a direct ownership_interest or a leasehold interest meeting certain additional requirements sec_1_468a-1 provides in part that a nuclear power plant is any nuclear power reactor that is used predominantly in the trade_or_business of the furnishing or sale of electric energy if the rates for such furnishing or sale have been established or approved by a public_utility commission sec_1_468a-5 sets out the qualification requirements for nuclear decommissioning funds it provides in part that a qualified nuclear decommissioning fund must be established and maintained pursuant to an arrangement that qualifies as a_trust under state law an electing taxpayer can establish and maintain only one qualified nuclear decommissioning fund for each nuclear power plant sec_1 468a- plr-155809-01 c i provides that if at any time during the taxable_year a nuclear decommissioning fund does not satisfy the requirements of sec_1_468a-5 the service may disqualify all or a portion of the fund as of the date that the fund does not satisfy the requirements sec_1_468a-5 provides that if a qualified nuclear decommissioning fund is disqualified the fair_market_value with certain adjustments of the assets in the fund is deemed to be distributed to the electing taxpayer and included in that taxpayer’s gross_income for the taxable_year sec_1_468a-6 generally provides rules for the transfer of an interest in a nuclear power plant and transfer of the qualified nuclear decommissioning fund where after the transfer the transferee is an eligible_taxpayer under sec_1_468a-6 the service may treat any disposition of an interest in a nuclear power plant occurring after date as satisfying the requirements of the regulations if the service determines that such treatment is necessary or appropriate to carry out the purposes of sec_468a since commission’s order specifically requires company to collect from its customers the decommissioning costs on behalf of genco and transfer all collected amounts to genco the service will treat these transfers as dispositions qualifying under the general provisions of sec_1_468a-6 commission’s order enables the service to treat these transfers as decommissioning costs that are directly or indirectly charged to customers of genco by reason of electric energy furnished by genco within the meaning of sec_88 and sec_468a and the corresponding regulations thus under sec_1_468a-6 the taxpayer’s funds will not be disqualified upon the transfer of plant and plant and the funds to genco sec_1_468a-6 provides that neither a transferor of an interest in a nuclear power plant nor the transferor’s fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of a sale_or_other_disposition accordingly neither the taxpayer nor its qualified funds will recognize gain_or_loss or otherwise take into account any income_or_deduction upon the transfer of the qualified nuclear decommissioning funds to genco sec_1_468a-6 provides that transfers to which sec_1_468a-6 apply do not affect basis thus the qualified funds in the hands of genco will have a basis in their assets equal to the basis in their assets prior to the transfer from the taxpayer requested ruling following the transfer of plant and plant and the nuclear decommissioning funds to genco genco will be treated as the eligible_taxpayer and the electing taxpayer with respect to the genco’s qualified nuclear decommissioning funds and therefore genco may make deductible contributions to its qualified nuclear decommissioning funds in an amount equal to the lesser_of the amount of nuclear decommissioning costs allocable to such funds which are included in genco’s cost of service for ratemaking purposes for such taxable_year or the ruling_amount applicable to such taxable_year plr-155809-01 sec_1_468a-1 defines an eligible_taxpayer as any taxpayer that possesses a qualifying interest in a nuclear power plant sec_1_468a-1 defines a qualifying interest to include a direct ownership_interest pursuant to sec_1_468a-2 an eligible_taxpayer that elects the application of sec_468a is an electing taxpayer sec_1_468a-6 provides rules for the determination of a schedule of ruling amounts for a transferee of a nuclear power plant sec_468a limits the deductible contribution to the lesser_of the ruling_amount or the nuclear decommissioning costs allocable to the fund which is included in a taxpayer’s cost of service for ratemaking purposes for the taxable_year fundamental to making a deductible contribution to a qualified nuclear decommissioning fund pursuant to a schedule of ruling amounts under sec_468a are four requirements first a taxpayer must be an eligible_taxpayer second a taxpayer must be liable for the decommissioning of the nuclear power plant third a taxpayer must have decommissioning costs included in its cost of service for ratemaking purposes for the year for which the deductible contribution is made fourth a taxpayer must request and receive a schedule of ruling amounts from the service based on the information submitted by the taxpayer genco clearly satisfies the requirements for being an eligible_taxpayer under sec_1_468a-1 and an electing taxpayer under sec_1_468a-2 in addition as part of the business separation plan approved by commission the liability to decommission plant and plant has been transferred to genco since commission’s order requires genco to contribute all nuclear decommissioning collections to its nuclear decommissioning trust funds genco has satisfied the requirement of having decommissioning costs included in its cost of service for ratemaking purposes for the year for which the deductible contribution is made genco may rely on the provisions of sec_1_468a-6 for a determination of the ruling_amount in the year of transfer pursuant to sec_1_468a-6 genco must request a revised schedule of ruling amounts for any_tax year subsequent to the tax_year in which plant and plant are transferred finally sec_468a limits the deductible contribution to the lesser_of the ruling_amount or the nuclear decommissioning costs allocable to the fund which is included in a taxpayer’s cost of service for ratemaking purposes for the taxable_year the rulings expressed herein are expressly conditioned on commission’s order regarding the collection and contribution of decommissioning costs eg company collects costs from ratepayers transfers the amounts collected to genco and genco contributes the authorized amounts to its funds in addition these rulings are expressly conditioned on the continued direct or indirect ownership and control of genco by the taxpayer except as specifically determined above no opinion is expressed or implied concerning the federal_income_tax consequences of the transaction described above this letter_ruling is directed only to the taxpayer that requested it sec_6110 provides that this ruling may not be used or cited as precedent plr-155809-01 pursuant to sec_1_468a-7 of the regulations a copy of this letter must be attached with the required election statement to the taxpayer’s federal_income_tax return for each taxable_year in which the taxpayer claims a deduction for payments made to the fund in accordance with the power_of_attorney we are sending a copy of this ruling to your authorized representative we are also sending a copy of this letter_ruling to the industry director lmsb natural_resources sincerely peter c friedman senior technician reviewer branch office of associate chief_counsel passthroughs and special industries enclosure copy


internal_revenue_service department of the treasury index number washington dc person to contact telephone number refer reply to cc dom p si 1-plr-103062-98 date may legend date pursuant to a power_of_attorney on file in this office this responds to a letter that requests relief under sec_1362 of the internal_revenue_code facts x was incorporated on date the shareholder desired s_corporation treatment for x effective date but an election to be treated as an s_corporation was not timely filed law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective sec_1362 provides in relevant part that if an s election is made within the first two and one-half months of a corporation's taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made under sec_1362 however if an s election is made after the first two and one-half months of a corporation's taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is filed plr-103062-98 sec_1362 provides that if no sec_1362 election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply x did not file a timely election to be treated as an s_corporation under sec_1362 effective on date x has however established reasonable_cause for not making a timely s election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and the representations made and provided that x otherwise qualifies as an s_corporation we conclude that x will be treated as an dollar_figure corporation effective date within days from the date of this letter please submit a copy of this letter and a copy of a properly executed form_2553 to the relevant service_center except as specifically set forth above no opinion is expressed or implied as to the federal_income_tax consequences of the transaction described above under any other provision of the code this ruling is directed only to the taxpayer on whose behalf it was requested sec_6110 provides that it may not be cited or used as precedent pursuant to a power_of_attorney on file in this office a copy of this letter is being sent to your representative sincerely yours cp ye daniel j coburn assistant to the branch chief branch office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for purposes form_2553


t c memo united_states tax_court michele petty petitioner v commissioner of internal revenue respondent docket no filed date michele petty pro_se brooke s laurie for respondent memorandum opinion cohen judge respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax as well as additions to tax under sec_6651 and and a after concessions the issue for decision is whether petitioner is entitled to an overpayment credit or refund all section references are to the internal_revenue_code for the year in issue and all rule references are to the tax_court rules_of_practice and procedure background this case was submitted fully stipulated under rule and the stipulated facts are incorporated as our findings by this reference petitioner resided in texas at the time the petition was filed on april and date petitioner made estimated_tax payments of dollar_figure and dollar_figure respectively towards her federal_income_tax liability on date petitioner made an estimated_tax payment of dollar_figure towards her federal_income_tax liability petitioner is also entitled to a dollar_figure withholding credit for on date petitioner timely filed an application_for an extension of time to file a return for extending the due_date for her federal_income_tax return to date petitioner failed to file timely her form_1040 u s individual_income_tax_return for and did not file her form_1040 for before the internal_revenue_service irs sent her a notice_of_deficiency on date the irs first received petitioner’s form_1040 for on date on date petitioner filed a petition with this court respondent now concedes that petitioner’s proper federal_income_tax liability for was dollar_figure and that petitioner’s payments and withholding credits towards her tax_liability total dollar_figure respondent also concedes that no additions to tax are due discussion petitioner seeks a refund for the dollar_figure she overpaid for her federal_income_tax respondent argues that petitioner is not entitled to a refund because none of the overpayment was paid within the 3-year period required under sec_6512 and sec_6511 under sec_6512 this court has jurisdiction to determine the existence and amount of any overpayment_of_tax to be refunded for a year before us subject only to the look-back period in sec_6512 and sec_6511 see 516_us_235 t he restrictions governing the tax court’s authority to award a refund of overpaid taxes incorporate only the look-back period and not the filing deadline from sec_6511 krape v commissioner tcmemo_2007_125 sec_6512 provides sec_6512 overpayment determined by tax_court -- limit on amount of credit or refund --no such credit or refund shall be allowed or made of any portion of the tax unless the tax_court determines as part of its decision that such portion was paid- a after the mailing of the notice_of_deficiency b within the period which would be applicable under sec_6511 c or d if on the date of the mailing of the notice_of_deficiency a claim had been filed whether or not filed stating the grounds upon which the tax_court finds that there is an overpayment or c within the period which would be applicable under sec_6511 c or d in respect of any claim_for_refund filed within the applicable_period specified in sec_6511 and before the date of the mailing of the notice of deficiency- in a case described in subparagraph b where the date of the mailing of the notice_of_deficiency is during the third year after the due_date with extensions for filing the return of tax and no return was filed before such date the applicable_period under subsections a and b of sec_6511 shall be years sec_6512 is not relevant because petitioner did not make any payments for her federal_income_tax after the notice_of_deficiency was mailed sec_6512 is not relevant because petitioner did not file a claim for a refund before the date of the mailing of the notice_of_deficiency thus to determine the amount to be refunded we must decide the amount that qualifies under sec_6512 to calculate the period during which an overpayment may be refunded under sec_6512 and sec_6511 we utilize the date the notice_of_deficiency was mailed date as the date petitioner filed her claim for a refund see 123_tc_132 the due_date for filing petitioner’s tax_return was date because the notice_of_deficiency was mailed in the third year after the due_date with extensions for filing the tax_return the applicable_period during which an overpayment may be refunded under sec_6512 and sec_6511 i sec_3 years from the date of the claim for a refund see sec_6512 flush language zarky v commissioner supra thus petitioner is entitled to a refund of any payments made within years of date petitioner bears the burden of proving that her overpayments are refundable see rule krape v commissioner supra jackson v commissioner tcmemo_2002_44 petitioner made a number of estimated_tax payments towards her federal_income_tax liability before date under sec_6513 any amount_paid as estimated income_tax for any taxable_year shall be deemed to have been paid on the last day prescribed for filing the return under sec_6012 for such taxable_year determined without regard to any extension of time for filing such return the last day prescribed for filing a federal_income_tax return under sec_6012 for was friday date see sec_6072 thus the estimated payments were deemed paid on date which is not within years of date the dollar_figure withholding credit was also deemed paid on date see sec_6513 528_us_431 as a matter of law petitioner is not entitled to credit for an amount_paid or deemed paid more than years before a claim for a credit of that amount was filed it is unfortunate that petitioner loses the benefit of payments she made but that is one of the consequences of failing to file timely a federal_income_tax return we have considered petitioner’s other arguments and they are irrelevant to our decision for the reasons explained above decision will be entered that there is no deficiency or addition_to_tax due from petitioner and no overpayment due to petitioner


tcmemo_2005_288 united_states tax_court raleigh cox and brenda j cox petitioners v commissioner of internal revenue respondent docket no filed date charles a crocker for petitioners susan greene for respondent memorandum opinion holmes judge tax records are the ancient egyptians of the modern age--plagued not by boils frogs flies and lice but by fire flood mold and theft the cursed tax records in this case belonged to raleigh cox who owned a business that fixed used cars and then resold them when audited cox failed to produce the records that would have supported many of his claimed business deductions and blamed their absence on a thieving former employee the parties have since settled most of these issues but the commissioner hardened his heart against cox’s deductions for cash purchases of used cars we must decide whether to let them go background raleigh cox grew up in houston he is a talented mechanic and started a small_business washington car care in he made the better part of his living by buying used cars--often cars that were nowhere near working order--from local wholesalers he then fixed them up and cleaned them up and resold them to other dealers the business was not in the most desirable section of houston as cox pointedly testified the irs did not contest his deduction for the cost of a guard dog washington car care’s biggest problem however wasn’t crime it was thin_capitalization there were years when cox was just scraping by and he often had customers who wrote bad checks this caused enough of washington car’s checks to bounce that banks became unwilling to finance the business cox worked his way around this problem with an old solution--a trade- financed floor_plan he set up the plan with concord motors a used-car wholesaler that was his main source of supply he and concord would negotiate each car’s price and he would then sign a draft for that amount and leave it with concord along with the car’s title which in texas is a car’s proof of ownership under the plan concord gave washington car possession of up to dollar_figure- worth of cars thus giving cox an inventory of vehicles that he could work on in return cox promised to pay concord dollar_figure a week these payments would accumulate from week to week and cox would draw on their accumulated value by periodically taking back drafts and titles for cars so that he could resell them to third parties at a profit cox and his wife reported washington car’s income and deductions on a schedule c to their income_tax return which was prepared by roman spiller their long-time accountant spiller was a former irs auditor and had prepared both the coxes’ personal and business returns since before this case they had never had any reason to doubt the quality of his work the schedule c for washington car’s tax_year reported sales of dollar_figure and aggregate expenses of dollar_figure but spiller got his signs confused and reported the difference as a net_loss the commissioner’s service_center noticed the math error made the appropriate correction and notified the coxes that the resulting adjustments required them to pay tax due on the increase in taxable_income plus a penalty and interest spiller prepared and submitted an amended tax_return on which the coxes flipped the numbers from their original return reducing their reported sales to dollar_figure and increasing their aggregate expenses to dollar_figure although spiller entered dollar_figure as the total expenses on line of the amended schedule c the actual sum of expenses listed equals dollar_figure remarkably--since washington car’s business was buying cars to repair and resell-- neither the original nor the amended schedule c reported any cost_of_goods_sold more remarkably spiller submitted a second amended return that reduced schedule c sales to dollar_figure and expenses to dollar_figure this time spiller inexplicably kept the prior net_loss figure and claim of refund and continued to report no cost_of_goods_sold this was not a good tax preparation strategy the irs audited the returns and rejected both the original and amended form sec_1040 the resulting notice_of_deficiency included a penalty under section for negligence before trial cox and the commissioner stipulated that his gross_receipts were actually about dollar_figure and stipulated as well that he was entitled to deductions and allowances of about dollar_figure left for trial were two issues the deduction of what cox claimed were cash payments to concord and the penalty for negligence the trial was in houston where the coxes lived when they filed their petition unless otherwise stated section references are to the internal_revenue_code and regulations as amended and in effect for discussion a allowability of cash payments it’s easy to see why the commissioner questioned cox’s claim that he routinely made cash purchases from concord not only was the amount_involved quite large but the most common way cox got cash was by writing checks to himself or his wife drawn on the washington car care account cox’s general ledger from lists dozens of such checks recorded as a debit to purchases which was washington car’s cost-of-goods-sold account he cashed many of these checks at local grocery or convenience stores this pattern raised the commissioner’s suspicion that business accounts were being used for personal expenses the commissioner’s counsel vigorously grilled cox on these points at trial and hammered away especially hard at his failure to produce business records to support his claims but cox's story held up--with an honest demeanor no hesitation and perfect reasonableness he explained both the absence of records and his own check-cashing habits he credibly explained that he kept most of his business receipts and records stuffed in duffel bags which he stored in a loft above his repair shop he also credibly testified that he was in the habit of employing recently released prisoners encouraged in part to do so by his father a retired sergeant in the county sheriff's office washington car’s records went missing in and cox convinced us that one of his evidently not-quite-rehabilitated employees stole one of the duffels no doubt thinking it contained cash instead of canceled checks receipts and bank statements that employee disappeared shortly thereafter it was also about this time that spiller died after heart surgery preceded by what cox thought to be a serious and probably illegal substance-related illness leaving him without his long-time accountant when the irs began its audit cox quickly did the right thing and hired a new accountant katie beal to help recreate his business records beal had few of the original receipts and none of the checks or bank records to review as they had been in the stolen duffel bag but her careful piecing together of the available information corroborates cox’s story we conclude that the records really were stolen cox credibly explained the circumstances regarding their disappearance it is quite believable that an ex-convict who had access to the area where most of the records were kept might take the duffel bags thinking there was more in them than just records and what written evidence exists supports cox’s story he had kept the general ledger for washington car upstairs at his shop and beal and he got copies from the bank of the statements that had been stolen our close side-by-side scrutiny of those statements and the general ledger shows that the ledger reasonably matches the statements for those purchases cox made from concord by check and the commissioner has conceded those expenses we infer from that that the ledger is accurate when it shows that cash--even cash obtained by cashing checks at grocery stores and gas stations--was going to concord on a regular basis to pay for cars cox also insisted the owners of concord give him receipts and he kept them too--fortunately not stuffing them into the missing duffel bag those receipts also match--not perfectly but in more than enough instances for us to believe that the ledger and remaining records are legitimate cox also credibly explained why he didn’t just write checks to concord as he told it his relationship with concord had begun with his making payments by check but there were times that his business account had insufficient funds or at least insufficient collected funds to make the checks good this made concord’s owners leery of accepting his checks and for most of they demanded that he pay cash accepting checks only occasionally when he warned them that he was short and they agreed to hold off presenting them for payment and the existing documents also show combinations of checks to concord and cash payments totaling about dollar_figure week which corroborates cox’s testimony cox also credibly explained his practice of cashing checks made out to himself or his wife--he did so because spiller advised him to create a paper trail of the cash withdrawals that he was using to pay concord we note that cashing checks at other merchants with whom he did not have an ongoing business relationship would both delay their presentment for payment and not immediately result in the repossession of any of his inventory if they bounced so we find that cox is entitled to a deduction for his cash expenses the parties did not stipulate the precise amount at stake but they did stipulate that washington car or the company’s sometime alter ego washington car rental had receipts for payments totaling dollar_figure from washington car care two additional receipts show payments from concord to washington car of dollar_figure however cox testified at trial that he mistakenly switched the names of the companies on the to and from lines and that concord never made any refund payments to the company we believe cox’s testimony that these receipts were actually for payments made to concord therefore the total amount of the purchases from concord is dollar_figure of which dollar_figure was paid_by check because the commissioner has already conceded the dollar_figure paid_by check we hold that cox should be allowed an additional dollar_figure deduction for cash purchases as a cost_of_goods_sold b sec_6662 penalty the only other issue for us to decide is whether the coxes are liable for an accuracy-related_penalty in his notice_of_deficiency the commissioner does not specify why he imposed the penalty but there are only two possibilities negligence or a substantial_understatement part of this penalty will disappear with the portion of the underpayment traceable to the cash purchases that we have allowed sec_6664 may provide a defense to the remainder-- under either the negligence or substantial_understatement theory-- if it is shown that there was a reasonable_cause and that the taxpayer acted in good_faith sec_6664 the regulations issued under this section require that our analysis be conducted on a case-by-case basis taking into account all pertinent facts and circumstances sec_1 b income_tax regs the crucial fact here is that the coxes relied in good_faith on spiller to correctly prepare their tax_return based on the financial records and receipts they gave him this was reasonable--he was a former irs auditor and had competently done their taxes in the past before his evidently rapid decline and death while a taxpayer cannot hide behind a tax preparer or adviser we have often held that a taxpayer who supplies his preparer with accurate information relating to the return is not negligent in relying upon the preparer’s advice kurzet v commissioner tcmemo_1997_54 affd revd and remanded on other issues 222_f3d_830 10th cir we do not fault the coxes for the errors on their return when the mistakes stemmed from their accountant’s lack of professional care reinhardt v commissioner tcmemo_1993_397 no negligence when an incorrect return is the result of the preparer’s mistakes we also take into account the coxes’ educational and business experience see pratt v commissioner tcmemo_2002_279 the trial showed that cox though gifted in his field knew little of accounting such men should especially be able to rely on a preparer if they give him their business records holding no information back as we specifically find that he did given cox’s genuine lack of knowledge of accounting we do not construe his actions as constituting negligence or disregard of tax law see 85_tc_934 to reflect the settlement of the other issues in this case decision will be entered under rule