Conmac Investments Inc.

United States Tax Court
T.C. Memo. 2023-40CONMAC INVESTMENTS INC.,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 2207-18. Filed March 27, 2023.
—————
Kevin M. Flynn, for petitioner.
Steven D. Tillem and Philip R. Cleary, for respondent.
MEMORANDUM OPINION
PARIS, Judge: This case is before the Court on respondent’s
Motion for Summary Judgment and petitioner’s Cross-Motion for
Summary Judgment under Rule 121. 1 The issues for decision are
(1) whether petitioner’s failure to secure consent under section 446(e)
precludes petitioner from implementing an accounting method change
with respect to base acres rented to tenant farmers for taxable years
2009 through 2014 and (2) whether petitioner must include in income
for 2013 a positive section 481 adjustment for section 197 amortization
deductions claimed for base acres for 2009 through 2012.
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C. (Code), in effect at all relevant times, all regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure.
Served 03/27/23
2
[*2] Background
The following facts are drawn from the record, which includes the
parties’ Stipulation of Facts with attached Exhibits. Petitioner is a
domestic corporation duly organized under the laws of Arkansas. It had
a principal place of business in a rural agricultural community in
northeast Arkansas when it filed the Petition. Petitioner owns and
leases farmland in Arkansas to tenant farmers, among several other
businesses it owns and operates.
I. Corporation Income Tax at Issue
Pursuant to extensions of time to file, petitioner timely filed
Forms 1120, U.S. Corporation Income Tax Return, for 2013 and 2014
(years at issue). In a timely issued notice of deficiency dated December
18, 2017, respondent determined deficiencies in petitioner’s 2013 and
2014 federal corporation income tax of $115,854 and $114,042,
respectively. The deficiencies reflected adjustments with respect to
petitioner’s unauthorized accounting method change for amortization of
base acres rented to tenant farmers and claimed deductions for rental
and vehicle expenses, depreciation expenses, and charitable
contributions. Petitioner timely petitioned this Court contesting the
deficiencies determined in the notice.
On October 25, 2018, the parties filed a Stipulation of Settled
Issues, which resolved all outstanding issues in the case except
(1) whether petitioner’s income should be increased by $185,555 and
$44,980 for 2013 and 2014, respectively, on the basis of a determination
that petitioner was precluded from changing its accounting method for
amortization of base acres rented to tenant farmers without the
Secretary’s consent, as required by section 446(e), 2 and, even if section
446(e) did not apply, whether petitioner’s new accounting method was
not permitted under the Code or the regulations; and (2) whether
petitioner is liable under section 6621(c) for interest on a large corporate
underpayment for those same years. Subsequently, but before filing the
pending Motion and Cross-Motion for Summary Judgment, the parties
agreed that the section 6621(c) issue is not appropriately before the
Court.
2 The regulation uses “consent of the Commissioner” instead of “consent of the
Secretary.” Treas. Reg. § 1.446-1(e)(2)(i); see also § 7701(a)(11)(B) and (12).
3
[*3] In regard to the first issue, the adjustment of $185,555 for 2013
consists of two parts: (1) a section 481 adjustment of $137,181 relating
to petitioner’s unauthorized amortization of base acres rented to tenant
farmers in 2009 through 2012 plus (2) an adjustment of $48,374 relating
to unauthorized amortization of base acres rented to tenant farmers in
2013. The adjustment of $44,980 for 2014 relates to petitioner’s
unauthorized amortization of base acres rented to tenant farmers in
that year.
With the Court’s permission, respondent filed a Second
Amendment to Answer seeking an increased deficiency under section
6214(a). The amendment increased the section 481 adjustment for 2009
through 2012 from $137,181 to $141,614.
II. Base Acres
Created by Congress, “base acres,” also known as acreage base or
crop contracts, are the right to receive farm program subsidies for the
production of certain commodities from the U.S. Department of
Agriculture (USDA). 3 These rights, which attach to the farm, not the
farm owner, are determined using the historical planted acreage of a
specific covered commodity, such as wheat, cotton, or rice. The farm
program payments at issue were made both under the 2008 Farm Bill, 4
as extended by the American Taxpayer Relief Act of 2012, 5 and under
the 2014 Farm Bill. 6
3 The current farm program subsidies originate from the Farm Security and
Rural Investment Act of 2002, Pub. L. No. 107-171, tit. I, 116 Stat. 134, 143–223
(codified as amended in 7 U.S.C. § 7901 and scattered sections).
4 Food, Conservation, and Energy Act of 2008 (2008 Act), Pub. L. No. 110-234,
122 Stat. 923. 2008 Act § 1001(2)(A) provides: “The term ‘base acres’, with respect to a
covered commodity on a farm, means the number of acres established under section
1101 of the Farm Security and Rural Investment Act of 2002 as in effect on September
30, 2007,” subject to any adjustment by the 2008 Act. 122 Stat. at 936 (citation omitted)
(codified as amended at 7 U.S.C. § 8702). Excluded are base acres for peanuts, which
are defined in a different but corresponding section of the Farm Security and Rural
Investment Act of 2002. 2008 Act § 1301, 122 Stat. at 966–67 (codified as amended at
7 U.S.C. § 8751).
5 Pub. L. No. 112-240, 126 Stat. 2313 (2013).
6 Agricultural Act of 2014, Pub. L. No. 113-79, 128 Stat. 649. Section 1111(4)
of that act carries forward the 2008 definitions of base acres, subject to certain
reallocations, adjustments, and reductions. 128 Stat. at 659 (codified as amended at
7 U.S.C. § 9011).
4
[*4] Petitioner acquired and placed in service farmland that included
base acres in 2004, 2006, 2007, 2008, 2010, 2011, 2012, and 2013. 7
Petitioner did not farm any of these base acres during the years at issue.
Instead, all of the base acres at issue, if farmed, were farmed by tenant
farmers. In addition, all base acre payments, if made, were paid to and
collected by tenant farmers.
None of the lease agreements between petitioner and the tenant
farmers were evidenced by writing. The annual rental rate for the oral
lease agreements was generally 25% of the gross income received by the
tenant farmers from their farming activities. Under these agreements,
the gross income of the tenant farmers included the farm subsidy
payments that they received on account of the base acres the farmers
rented from petitioner. 8
Petitioner reported the rental income on its Forms 1120 for 2013
and 2014. As a corporation, petitioner was not required to attach to the
returns Schedule F, Profit or Loss From Farming, to report farm income
or expenses.
III. Petitioner’s Change in Treatment of Amortization or Depreciation
of Base Acres Rented to Tenant Farmers
Before 2009 petitioner did not claim any deductions for
amortization or depreciation of base acres rented to tenant farmers.
Beginning in 2009, however, petitioner adopted a new treatment for
amortization or depreciation of certain base acres rented to tenant
farmers and began claiming an amortization or depreciation deduction
for base acres acquired and placed in service in 2004 continuing through
2013. 9 Petitioner did not attach Form 3115, Application for Change in
Accounting Method, to its Form 1120 for 2009 or otherwise seek or
obtain respondent’s consent to change its accounting method with
respect to the rented-out farmland in 2009 or thereafter. Neither did
petitioner file amended returns with an explanatory statement for all
7 Although petitioner acquired farmland with base acres before 2004, those
base acres are not at issue in this case.
8 Despite asserting an ownership interest in an intangible asset, petitioner
shares little risk in the production of crops on any given farm, effectively shifting the
risk to the tenant farmer. Petitioner claims deductions against guaranteed rental
income without assuming the risk of any other expenses.
9 Petitioner decided not to include in its amortization deductions any base acres
acquired before 2004.
5
[*5] open years reclassifying the base acres rented to tenant farmers as
amortizable section 197 intangibles. Nor did it adopt the same
accounting treatment for all base acres that it owned.
To determine the claimed deductions, petitioner developed a
methodology to calculate an average farm subsidy payment per base
acre rented to tenant farmers. Petitioner, selecting 2009 as the reference
year, determined its average farm subsidy payment per rented-out base
acre to be $39.62. 10 Petitioner then calculated the present value of its
average farm subsidy payment over a 15-year period, 11 which worked
out to be $431.81. 12 Using this present value, petitioner derived a
proposed amount for the amortization or depreciation of its base acres
each year, multiplying its total number of rented-out base acres by
$431.81 and then dividing that amount by 15 to recognize the
amortization or depreciation expense on a straight-line basis over 15
years. Using the methodology it devised, petitioner reported
amortization or depreciation expenses for base acres rented to tenant
farmers of $141,614.26 for 2009 through 2012, $48,373.82 for 2013, and
$44,980.21 for 2014. 13 By deducting its amortization expense, petitioner
was able to reduce its recognition of income paid by the tenant farmers.
In the notice of deficiency for 2013 and 2014, respondent
determined that petitioner’s new accounting treatment for amortization
or depreciation of base acres rented to tenant farmers was not a
permissible accounting method and increased petitioner’s income
accordingly. The remaining issue involves whether, as a matter of law,
petitioner was foreclosed from unilaterally changing its accounting
method with respect to such amortization or depreciation in 2009. On
January 19, 2023, pursuant to this Court’s Order, each party filed a
Supplemental Memorandum addressing this issue, giving particular
attention to (1) the relevance to the present case of the Court’s prior
opinions on the section 446(e) consent requirement, see, e.g., Sunoco, Inc.
& Subs. v. Commissioner, T.C. Memo. 2004-29, 2004 WL 205817, and
(2) whether petitioner’s failure to secure prior consent under section
10 This average was calculated from 6,624.45 base acres rented to tenant
farmers, which generated USDA farm subsidy payments to the farmers totaling
$262,484.50.
11 Petitioner’s stated rationale for using a 15-year period included the
longstanding existence of USDA farm subsidies and the generally applicable 15-year
amortization period of intangibles.
12 Petitioner’s present value analysis assumed an interest rate of 5%.
13 The parties have stipulated the amounts of deductions claimed.
6
[*6] 446(e) in and of itself would preclude petitioner from implementing
an accounting method change for 2009 through 2014.
Discussion
The purpose of summary judgment is to expedite litigation and
avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp.
v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant
summary judgment upon any or all legal issues in controversy when
there is no genuine dispute as to any material fact and a decision may
be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994).
In determining whether to grant summary judgment, the Court reviews
the facts in the record and draws inferences from them in the light most
favorable to the nonmoving party. Bond v. Commissioner, 100 T.C. 32,
36 (1993); Naftel v. Commissioner, 85 T.C. 527, 529 (1985). The
nonmoving party may not, however, rest upon the allegations or denials
in its pleadings but must set forth specific facts showing that there is a
genuine issue for trial. Rule 121(d); Sundstrand Corp., 98 T.C. at 520.
Because the parties agree upon the facts necessary to resolve the specific
questions of law before us, we conclude summary adjudication is
appropriate in this matter.
I. Unauthorized Change in Accounting Method for Amortization or
Depreciation of Base Acres Rented to Tenant Farmers
Section 446 requires a taxpayer to compute taxable income
“under the method of accounting on the basis of which the taxpayer
regularly computes his income in keeping his books.” § 446(a). A
taxpayer has considerable discretion in selecting an accounting method
and generally may adopt any permissible method. Treas. Reg. § 1.446-
1(e)(1).
An accounting method consists of both “the overall plan of
accounting for gross income or deductions” and “the treatment of any
material item used in such overall plan.” Id. subpara. (2)(ii)(a). An item
is “material” if it “involves the proper time for the inclusion of the item
in income or the taking of a deduction.” Id.In most instances, an accounting method is adopted for a material
item if there is “a pattern of consistent treatment” of that item. Id. This
is true “even if that treatment is erroneous or an incorrect application of
a chosen method.” Thrasys, Inc. v. Commissioner, T.C. Memo. 2018-199,
at *12 (quoting Cap. One Fin. Corp., & Subs. v. Commissioner, 659 F.3d
7
[*7] 316, 326 (4th Cir. 2011), aff’g 130 T.C. 147 (2008) and 133 T.C. 136(2009)).
What constitutes consistent treatment, however, differs for
permissible and impermissible methods of accounting. A permissible
method is generally adopted when a taxpayer files his first return using
the method, Treas. Reg. § 1.446-1(e)(1), whereas an impermissible
method is established only after a taxpayer files two or more consecutive
returns using the method, Thrasys, Inc., T.C. Memo. 2018-199, at *12–
13.
Once an accounting method has been adopted, it generally may
not be changed without the Commissioner’s permission. § 446(e). “[A]
change in the treatment of an asset from nondepreciable or
nonamortizable to depreciable or amortizable, or vice versa, is a change
in method of accounting.” Treas. Reg. § 1.446-1(e)(2)(ii)(d)(2). However,
“[a] change in the method of accounting . . . does not include a change in
treatment resulting from a change in underlying facts.” Id. subdiv.
(ii)(b).
Petitioner did not claim a deduction for amortization or
depreciation of base acres before 2009. That year, petitioner made a
“business decision” to begin claiming amortization deductions but only
with respect to rented-out farmland that it had acquired and placed in
service beginning in 2004.
Petitioner maintains that its change in tax reporting was based
on a change in underlying facts. However, petitioner never identifies
what facts changed despite having ample opportunity to do so. Instead,
petitioner contends that existing federal tax law allegedly allowed it to
allocate and deduct a portion of the purchase price of tillable farmland
using the present value of future farm program subsidy payments, and
therefore that the company did not change its accounting method.
To support this position, petitioner wants the Court to adopt a
selective reading of Treasury Regulation § 1.446-1(e)(2)(ii)(b). Although
petitioner is correct that a change in treatment due to a change in
underlying facts is not a change in accounting method, id., petitioner
has failed to demonstrate to the Court a change in underlying facts that
would permit petitioner’s change in treatment of amortization or
8
[*8] depreciation of base acres rented to tenant farmers. 14 To arrive at
its desired conclusion, petitioner would require this Court to ignore the
sentence immediately succeeding the proffered support: “For further
guidance on changes involving depreciable or amortizable assets, see
paragraph (e)(2)(ii)(d) of this section and § 1.1016-3(h).” Id.
Because we read the regulations to foreclose this outcome, see id.
subdiv. (ii)(d)(2), we are not persuaded by petitioner’s arguments. “A
change in tax reporting generally will be attributable to a ‘change in
underlying facts’ and not to a ‘change in method of accounting,’ where
the taxpayer continues to apply its existing method of accounting to a
change in business practices, a change in economic or legal
relationships, or an otherwise altered fact situation.” Stephen F.
Gertzman, Federal Tax Accounting ¶ 9.06 (2022), Westlaw FTA WGL.
Yet none of that occurred here. Petitioner did not change its existing
business practices; rather, it continued to serve as a landlord to tenant
farmers. Nor did petitioner change any of its economic or legal
relationships—for example, through modification of lease agreement
terms. See Hallmark Cards, Inc. & Subs. v. Commissioner, 90 T.C. 26(1988) (change in contractual terms resulting in change in timing of
recognition of sales). The only economic consequence we are left with
appears to be the tax benefit that petitioner received on account of the
change, which we have determined to be insufficient. See Gap Anthracite
Co. v. Commissioner, T.C. Memo. 1972-189, aff’d without published
opinion sub nom. Susquehanna Coal Co. v. Commissioner, 487 F.2d 1395(3d Cir. 1973). And, unlike this Court’s precedents in Southern Pacific
Transportation Co. v. Commissioner, 75 T.C. 497 (1980), and Federated
Department Stores, Inc. v. Commissioner, 51 T.C. 500 (1968), aff’d, 426
F.2d 417 (6th Cir. 1970), this case features no altered fact situation
(besides petitioner’s decision to start claiming a deduction). 15
Petitioner’s “subjective misunderstanding of fact or law” was not “a
change in underlying facts” within the meaning of the regulation. See
Pinkston v. Commissioner, T.C. Memo. 2020-44, at *22–23. Accordingly,
we determine petitioner’s change in the treatment of the rented-out
acreage base at issue from nonamortizable to amortizable beginning in
2009 was a change in accounting method.
14 Neither the express wording of the regulation nor the examples in paragraph
(e)(2)(iii) of the regulation lend support to petitioner’s specific factual scenario.
15 We also note that these two cases precede the effective date of Treasury
Regulation § 1.446-1(e)(2)(ii)(d)(2), which applies to depreciable or amortizable assets
placed in service in tax years ending on or after December 30, 2003.
9
[*9] Further, to make this method change, petitioner was required to
obtain respondent’s permission. See § 446(e). Typically, permission is
obtained by filing Form 3115. Prior consent is required regardless of
whether the existing method is proper or permitted. Treas. Reg. § 1.446-
1(e)(2)(i). A taxpayer’s failure to secure such consent gives the
Commissioner authority to return the taxpayer to his former method—
even if the former method was not a permissible method. See, e.g.,
Sunoco, Inc. & Subs. v. Commissioner, 2004 WL 205817, at *14–16.
Petitioner did not file Form 3115 for 2009 or otherwise seek or
obtain respondent’s permission to change its accounting method for
2009 or thereafter. Petitioner believes it was not required to do so and
that, even if it was, the lack of prior consent is irrelevant because it
relates to a closed tax year. We disagree.
Although the case is not cited by either party, the U.S. Court of
Appeals for the Fifth Circuit held in Commissioner v. Brookshire Bros.
Holding, Inc., 320 F.3d 507, 511–13 (2003), aff’g T.C. Memo. 2001-150,
that the Commissioner’s challenge to a method change for which consent
was never given must be for the year of the improper change and that
the failure to obtain prior consent pursuant to section 446(e) does not
serve as a basis to challenge such a change for a closed year. We find the
Fifth Circuit case to be distinguishable from the case at hand, however.
Unlike the taxpayer in Brookshire Bros., petitioner did not file amended
returns with an explanatory statement for all open years reclassifying
the property at issue (i.e., base acres rented to tenant farmers). Nor did
petitioner adopt the same accounting treatment for all property within
the same class of property (i.e., base acres). Instead, petitioner continued
to treat base acres acquired and placed in service in other years as
nonamortizable or nondepreciable. Upholding an unauthorized change
in accounting method in an instance like this would invite inconsistency
in a context where “[c]onsistency is the key and is required regardless of
the method or system of accounting used.” See Commissioner v.
O. Liquidating Corp., 292 F.2d 225, 231 (3d Cir. 1961) (quoting
Advertisers Exch., Inc. v. Commissioner, 25 T.C. 1086, 1092 (1956), aff’d,
240 F.2d 958 (2d Cir. 1957)), rev’g on other grounds T.C. Memo. 1960-29.
Moreover, sustaining respondent’s determination, which would
merely return petitioner to its old accounting method, one that it chose
to use for many years, does not offend basic fairness. It also promotes
sound tax administration. Therefore, by allowing respondent’s actions
to stand, we do not risk “approbat[ing] . . . [a] collateral, back-door attack
10
[*10] to get around the time bar for closed years.” Commissioner v.
Brookshire Bros. Holding, Inc. & Subs., 320 F.3d at 513.
Accordingly, we conclude petitioner was precluded from
implementing its method change for 2009 through 2014 because of its
failure to secure prior consent under section 446(e). 16 Therefore, we
sustain respondent’s determinations that petitioner’s 2013 and 2014
income should be increased by $48,374 and $44,980, respectively, and
will proceed to consider whether respondent’s section 481 adjustment
for 2009 through 2012 is proper.
II. Section 481 Adjustment Resulting from Amortization Deductions
Claimed for Base Acres for 2009 through 2012
Respondent’s method determination is afforded great latitude
and should be upheld unless clearly unlawful. See Thor Power Tool Co.
v. Commissioner, 439 U.S. 522, 532–33 (1979). Respondent determined
that petitioner’s amortization of base acres rented to tenant farmers was
an unauthorized change in accounting method. Therefore, respondent
was entitled to change petitioner’s accounting method with respect to
those rented-out base acres back to petitioner’s accounting method
before the unauthorized change.
When the Commissioner changes the treatment of an asset from
nondepreciable or nonamortizable to depreciable or amortizable (or vice
versa), the change results in a section 481 adjustment. See Treas. Reg.
§ 1.446-1(e)(2)(ii)(d)(5)(iii). Section 481 adjustments prevent the
duplication or omission of income or deductions when a change in
method occurs. Such adjustments reflect the cumulative difference
between the new and the old methods.
Petitioner contends that, even if a section 481 adjustment was
permissible, it needed to have been made for the “year of the change,”
which petitioner defines to be 2009. Because this year is closed by the
statute of limitations on assessment, petitioner maintains that no
section 481 adjustment would be allowed.
Petitioner’s conclusion is incorrect, however. The “year of the
change” in this case is the oldest open tax year. See Buyers Home
Warranty Co. v. Commissioner, T.C. Memo. 1998-98, 1998 WL 99336,
16 Consequently, this Opinion does not further address petitioner’s belated
arguments in regard to whether the new, unauthorized accounting method was
permitted under the Code or the regulations.
11
[*11] at *3; Handy Andy T.V. & Appliances, Inc. v. Commissioner, T.C.
Memo. 1983-713. In addition, and importantly for our purposes, a
section 481 adjustment may include amounts attributable to otherwise
time-barred tax years. See Huffman v. Commissioner, 126 T.C. 322(2006), aff’d, 518 F.3d 357 (6th Cir. 2008); Rev. Proc. 2015-13, § 2.06(1),
2015-5 I.R.B. 419, 425. In fact, “[t]he only limitation on § 481(a)
adjustments is that no pre-1954 adjustments shall be made.” Mingo v.
Commissioner, 773 F.3d 629, 636 (5th Cir. 2014) (alteration in original
omitted) (quoting Commissioner v. Welch, 345 F.2d 939, 950 (5th Cir.
1965), rev’g T.C. Memo. 1963-38), aff’g T.C. Memo. 2013-149. “[O]nce
there has been a change in the method of accounting, no statute of
limitations applies to the Commissioner’s ability to correct errors on old
tax returns.” Id.In discussing this “notable” feature of section 481, this Court
recognized in Huffman that “[w]hile section 481 may not necessarily
conflict with the statute of limitations found in section 6501 . . . , it does
place a premium on distinguishing between the correction of errors
(which is limited to open years) and a change in a method of accounting
(which implicates section 481).” Huffman, 126 T.C. at 341–42 (citing
Superior Coach of Fla., Inc. v. Commissioner, 80 T.C. 895, 912 (1983)).
The U.S. Court of Appeals for the Sixth Circuit confirmed the Court’s
approach in Huffman, holding that so long as a “‘change in method of
accounting’ has occurred,” the Commissioner may “adjust a taxpayer’s
taxable income in an open year to reflect amounts attributable to years
for which the applicable statute of limitations has expired.” Huffman v.
Commissioner, 518 F.3d at 358. And here, as in Handy Andy T.V. &
Appliances, Inc., T.C. Memo. 1983-713, a section 481 adjustment back
to the original method (to the closed year) is necessary to prevent the
omission of income.
Accordingly, we sustain respondent’s section 481 adjustment of
$141,614 relating to petitioner’s unauthorized amortization deductions
for 2009 through 2012.
III. Conclusion
The Court holds that petitioner’s new accounting method is
impermissible because petitioner violated the section 446(e) consent
requirement. The Court also holds that because respondent properly
returned petitioner to its old accounting method, respondent’s section
481 adjustment relating to petitioner’s unauthorized method change in
2009 is sustained to prevent the omission of income. Accordingly, the
12
[*12] Court will grant respondent’s Motion for Summary Judgment and
deny petitioner’s Cross-Motion for Summary Judgment. We will also
deny as moot respondent’s Motion to Strike. Because respondent’s
Second Amendment to Answer increased the deficiency for 2013 as
determined in the notice of deficiency, the parties will be ordered to
submit a Rule 155 computation. 17
To reflect the foregoing,
An appropriate order will be issued, and decision will be entered
under Rule 155.
17 The stipulations in the Stipulation of Settled Issues are concessions that do
not change the adjustments set forth in the notice of deficiency and, as a result, will
not affect the Rule 155 computation.