Opinion ID: 259355
Heading Depth: 1
Heading Rank: 3

Heading: Circumstances of Adjustment

Text: 35 Sections 3801 and 1312 list seven classes of cases in which the circumstances permit opening of a barred year to correct an error. Section 3801 (b) (1) and Section 1312(1) allow an adjustment of tax when a determination requires the inclusion in gross income of an item which was erroneously included in the gross income of the taxpayer for another year. 36 The Commissioner argues that for an adjustment to be made here for 1948 and 1949, there should have been a determination that an item of income was included in the taxpayer's gross income for 1951, and the same item erroneously included in the gross income for 1948 and 1949. Here, the argument runs, at most there was a determination that the taxpayer had overvalued his closing inventories for 1949; but that determination did not require any items of income to be included in any years other than those for which he is seeking adjustment. And, contends the Commissioner, if the settlement of the taxpayer's liabilities for 1951 constituted a determination, it did not require any double inclusion of items for 1948 and 1949; the settlement involved a lump sum payment which included items other than inventory. 37 The Commissioner's arguments ignore the result flowing from a change in operating profits through adjustments in the value of inventories. If the first agent had used the unit price later used by the second agent, the Commissioner would not have contested the taxpayer's right to a refund from the adjustments. Thus: 38 While it is true that inventories are not of themselves items of income or deduction, they are vital in the determination of gross income, and when their cost or value, as disclosed in a return, is changed, gross income is    directly affected and the result and amount by which income is affected and the amount in which it is increased or decreased, through an increase or decrease in the operating profit or loss, is as specific and identifiable as an item or dividends, salaries, loss or the like. Gooch Milling & Elevator Co. v. United States, 1948, 78 F.Supp. 94, 100, 111 Ct.Cl. 576. Cf., Gill v. Commissioner, 5 Cir., 1962, 306 F.2d 902. 39 The statute looks to the fact of a double inclusion of an item of gross income resulting from an inconsistent position on the part of the Commissioner, and not to the ultimate tax liability caused by the duplication. Neither Section 3801 nor the case of MacDonald v. Commissioner, 17 T.C. 934 (1951),    requires that the amount erroneously claimed as a deduction in one year must be identical with the amount determined for another year — it is the item of deduction or credit which must be the same. First National Bank of Philadelphia v. Commissioner, 3 Cir., 1953, 205 F.2d 82, 85. As was said of the predecessor of Section 3801: 40 Subsection (b) (1) emphasizes the reliance placed by Section 820 upon the `item' concept of tax liability. The tax liability for a year is generally a unitary matter, and the concern is whether the correct dollars and cents total has been determined. Section 820, however, fastens upon the treatment accorded a particular item in different years regardless of the correct dollars and cents tax liability for those years. Maguire, Surrey, and Traynor, Section 820 of the Revenue Act of 1938, 48 Yale L.J. 509, 719, 751 (1939). 41 The district court found as a fact that the change in unit price changed the valuation of inventory and the cost of cattle and that this change had a direct effect on gross income; it shifted income from 1948 and 1949 to other years. The second agent's closing inventory in 1949 was $125,000 lower than the closing inventory of the first agent. The item of gross income on which the taxpayer paid twice was cattle inventory; the number of head of cattle was not changed. 42 Gooch Milling & Elevator Company v. United States, 1948, 78 F.Supp. 94, 111 Ct.Cl. 576, is a leading case holding that an item of inventory may constitute an item of income within the meaning of Section 3801. In that case the closing inventory for 1935 and the opening inventory for 1936 were overstated, resulting in an overassessment for 1935 and a deficiency for 1936. The court held that there the Commissioner's change in the inventory was an item of adjustment, that the second agent's report was inconsistent with the basis upon which the Commissioner had audited and closed the years 1935 and 1936 in the first examination, and that Section 3801 was applicable. The court said: 43 Where a closing inventory for any taxable year is reduced, the opening inventory for the following taxable year is automatically reduced in the same amount, and, if there is no further elimination from or decrease in the inventory during such ensuing year, the operating profit and gross income are increased in the amount by which the value of the opening inventory is decreased. 44 It is obvious, and is admitted, that the correction and adjustment of the closing inventory for 1935 had the direct effect of increasing taxable income for 1936, and produced a deficiency for that year. 45    The only change made by the Commissioner was the elimination in each year of the erroneously included value of an inventory item of the same character, yet the elimination of the amount or value erroneously included on account of that item affected the taxable income for the year in which eliminated and also the taxable income for the following year. As will hereinafter appear, the result in this case was to shift an amount of income from 1935 to 1936. 46 In H. T. Hackney Co. v. United States, 1948, 78 F.Supp. 101, 111 Ct.Cl. 664, the court, relying on Gooch, held that the term item includes the result flowing from an increase or decrease in operating profit or loss through adjustments in two or more years in the cost or value of inventories. The court found that there was a final determination when the Commissioner, on the taxpayer's claim for refund for 1938, gave authoritative sanction to the inconsistent treatment by the taxpayer in its amended returns for 1938 and 1939 with that which had occurred in previous years. See also Moultrie Cotton Mills v. United States, 1957, 151 F.Supp. 482, 138 Ct.Cl. 208. 47 We conclude therefore that the circumstance of adjustment here was the double inclusion of an item of gross income in more than one year.