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Construction Company Disputes Change in Method of Accounting

SEP. 7, 2000

Manor Concrete Construction Co. Inc. v. Commissioner

DATED SEP. 7, 2000
DOCUMENT ATTRIBUTES
  • Case Name
    MANOR CONCRETE CONSTRUCTION CO., INC., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE Respondent.
  • Court
    United States Tax Court
  • Docket
    No. 9625-00
  • Authors
    Kaplan, Steven Z.
  • Institutional Authors
    Fredrikson & Byron, P.A.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    S corporations, capital gains
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-27270 (12 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 221-15

Manor Concrete Construction Co. Inc. v. Commissioner

 

=============== SUMMARY ===============

 

Manor Concrete Construction Co. has challenged the determination that it had to change from the cash method of accounting to the accrual method and the consequent change in its liability for the built-in gains tax.

Manor Concrete uses the cash method of accounting and, in 1993, elected to be taxed as an S corporation. This change required Manor Concrete to compute its actual and potential liability for the built- in gains tax under section 1374. Manor Concrete contends that in computing its liability for the built in gains tax for 1995-1996, the IRS erred in determining that Manor Concrete sold bricks and concrete and that these masonry materials were "merchandise" which was a "material income producing factor" in its business. Manor Concrete further insists that the Service erred in determining that it was required to report inventories of the masonry materials that it used in its work and that the need for inventories required that Manor Concrete change its method of accounting to the accrual method.

Manor Concrete also argues that even if it were to report its income under an accrual method of accounting, the IRS erroneously overstated the amount of built-in gains tax resulting from the change. Manor Concrete insists the IRS overstated the company's tax liability because it: failed to correctly apply the provisions of section 481(b), failed to allow deductions for bad debts and additional state income tax liabilities, failed to use the completed contract method of accounting, and failed to consider alternative minimum tax credits.

Period and Amount at Issue: 1995 -- $358,000

Code Sections: 1374; 481, 165, 53

 

=============== FULL TEXT ===============

 

UNITED STATES TAX COURT

PETITION

The Petitioner hereby petitions for a redetermination of the deficiency set forth by the Commissioner of Internal Revenue in the Commissioner's notice of deficiency dated June 20, 2000, and for a determination of any overpayment, and as the basis for Petitioner's case, alleges as follows:

1. The Petitioner is Manor Concrete Construction Co, Inc. ("Manor Concrete"), a Minnesota corporation with its principal place of business at 4370 Naber Avenue NE, St. Michael, Minnesota 55376. Manor Concrete has engaged in the masonry subcontracting business since 1982. It contracts with general contractors to construct masonry improvements to real property. Manor Concrete does not sell brick, concrete, or other masonry materials and does not maintain any inventories of those items. It does not sell "merchandise."

At all times, Manor Concrete has correctly reported its taxable income using a cash method of accounting. Prior to 1993, Manor Concrete had elected to be taxed as a C Corporation. In 1993, it elected to be taxed as an S Corporation. This change in reporting status required that Manor Concrete compute its actual and potential liability for the built in gains tax for 1993 and subsequent taxable years pursuant to Section 1374 of the Internal Revenue Code of 1986, as amended (the "Code"). For taxable year 1995, Manor Concrete correctly reported a built in gains tax liability in the amount of $19,975.

2. The notice of deficiency (a copy of which is attached hereto as Exhibit A) was mailed to the Petitioner on June 20, 2000 and was issued by the District Director of the Internal Revenue Service, St. Paul, Minnesota.

3. The deficiency as determined by the Commissioner is in built in gains tax under Section 1374 of the Code for taxable year 1995 in the amount of $357,751. The entire amount of the deficiency, including any other amounts legally due and any and all interest thereon, is in dispute.

4. The determination of tax set forth in the said notice of deficiency is based upon the following errors:

a. In computing Manor Concrete's liability for the built in gains tax for taxable year 1995 and 1996, the Commissioner erred in determining that (i) Manor Concrete sold bricks and concrete; (ii) these masonry materials were "merchandise" which was a "material income-producing factor" in its business; (iii) Manor Concrete was required to report inventories of the masonry materials that it used in constructing its masonry work; (iv) the need for inventories required that Manor Concrete change its method of accounting to an accrual method; and (v) Manor Concrete's use of its established cash method of tax accounting did not clearly reflect its income.

b. The Commissioner erroneously determined that Manor Concrete could not report its income for taxable years 1995 and 1996 using its established cash method of tax accounting. The Commissioner therefore erroneously changed Manor Concrete's overall method of tax reporting from its established cash method to an accrual method of accounting of the Commissioner's choosing.

c. The Commissioner erroneously recomputed and adjusted Manor Concrete's taxable income for 1995 and 1996 based upon this mandated change of accounting. As a result of this erroneous change in Manor Concrete's overall method of accounting, the Commissioner has determined that for built in gains tax purposes, Manor Concrete had additional income for taxable year 1995 in the amount of $1,138,359, but a reduction of income for taxable year 1996 in the amount of $22,506.72.

d. Even if Manor Concrete were to report its income under an accrual method of accounting, the Commissioner has erroneously overstated the amount of any additional built in gains tax resulting from the change to an accrual method. The Commissioner erroneously overstated Manor Concrete's tax liability because he failed to (i) correctly apply the provisions of Section 481(b) of the Code that apply when a taxpayer's method of accounting is changed; (ii) allow Manor Concrete deductions for specifically identifiable bad debts; (iii) allow Manor Concrete deductions for its additional state income tax liabilities resulting from the forced change to its method of accounting; (iv) correctly compute Manor Concrete's gain using the completed contract method of accounting; and (v) compute Manor Concrete's built in gains tax liability by taking account of a 1995 alternative minimum tax credit of $2,832 and a 1996 alternative minimum tax credit of $4,687.

5. The facts on which the Petitioner relies, as the basis of the Petitioner's case, are as follows:

a. Manor Concrete did not sell or hold for sale any masonry materials to any customer or contractor. Because it did not sell or hold for sale any such products, it was not required to report inventories and/or report its taxable income under an accrual method of tax accounting.

b. Manor Concrete did not sell "merchandise." It constructed improvements to real property that were not "merchandise" for inventory reporting purposes.

c. Even if such masonry materials were "merchandise" that had to be reported for inventory purposes, such materials would constitute the "merchandise" of the general contractors with whom Manor Concrete contracts and not of Manor Concrete itself.

d. Manor Concrete not only did not maintain any masonry material inventories but, even if it did, any fluctuations in any purported inventories of masonry materials would have been either be zero, insignificant, or de minimis.

e. Even if Manor Concrete had to report inventories, its established cash method of accounting clearly reflected its income and the Commissioner lacks discretion and authority to require a change in Manor Concrete's overall method of accounting from the cash method to an accrual method.

f. All of the masonry materials that Manor Concrete purchased were ordered for and delivered to a designated job site and were physically dedicated to that particular project at the time of order and delivery. The cost of those materials was properly recovered for income tax purposes when Manor Concrete paid for them because they were immediately dedicated to the project for which they were purchased. Any requirement that Manor Concrete inventory its masonry materials would impermissibly distort its income.

g. There was no material distortion to Manor Concrete's income that resulted from reporting its income under its cash method. The Commissioner lacks any discretion to require that Manor Concrete change its overall method of accounting to an accrual method or to the particular accrual method that the Commissioner seeks to impose upon Manor Concrete.

h. Even if the Commissioner has correctly determined that Manor Concrete must report its income on the basis of an accrual method, the Commissioner has erroneously overstated Manor Concrete's resulting increased income. In this regard, the Commissioner must allow Manor Concrete deductions for its specific bad debt losses and for the increased state income tax and interest liabilities that automatically and simultaneously result from the increase in Manor Concrete's income under an accrual method of accounting.

i. In addition, even if the Commissioner has correctly determined that Manor Concrete must report its income on the basis of an accrual method, the Commissioner has erroneously overstated Manor Concrete's resulting increased income because he has failed to correctly compute Manor Concrete's increased income for 1995 in accordance with the limitation provisions of Section 481(b) of the Code.

j. Furthermore, even if the Commissioner has correctly determined that Manor Concrete must report its income on the basis of the accrual method, the Commissioner has erroneously overstated Manor Concrete's resulting additional income because he has failed to compute Manor Concrete's income for 1995 using the completed contract method of reporting income from Manor Concrete's construction contracting business, as Manor Concrete has requested in the event a change of method is required.

k. In addition, the Commissioner has failed to compute any additional built in gains liability with reference to Manor Concrete's 1995 and 1996 alternative minimum tax credits.

WHEREFORE, the Petitioner prays that the Court determine that:

1. There is no deficiency in built in gains tax due from the Petitioner pursuant to Section 1374 of the Code;

2. The Petitioner has overpaid built in gains tax in the amount as may be determined; and

3. The Petitioner is entitled to a refund of any such overpayment and to such other relief as may be just and equitable.

Dated: September 7, 2000.

 

 

Steven Z. Kaplan

 

 

Steven Z. Kaplan (#KS 0241)

 

FREDRIKSON & BYRON, P.A.

 

1100 International Centre

 

900 Second Avenue South

 

Minneapolis, MN 55402

 

(612) 347-7169

 

 

ATTORNEYS FOR PETITIONER
DOCUMENT ATTRIBUTES
  • Case Name
    MANOR CONCRETE CONSTRUCTION CO., INC., Petitioner, v. COMMISSIONER OF INTERNAL REVENUE Respondent.
  • Court
    United States Tax Court
  • Docket
    No. 9625-00
  • Authors
    Kaplan, Steven Z.
  • Institutional Authors
    Fredrikson & Byron, P.A.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    S corporations, capital gains
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-27270 (12 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 221-15
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