The Tax Court required an auto parts remanufacturer to include in income charges it normally waived in exchange for used parts from its customers. In so ruling, the court underscored that where a taxpayer’s accounting method does not clearly reflect income, the government can require it to use a different method.
Jeffrey, Bruce and Donald Bigler owned BBB Industries, an accrual-method S corporation that rebuilt alternators and starters. When the company sold a part, the bill consisted of a unit price and a core price. The customer paid the unit price, plus (rarely) the core amount or (usually) traded for equivalent credit a used part, which BBB would then remanufacture. BBB reported as taxable income the unit price but not the core price, which it accounted for on its balance sheet as a liability or deferred income, depending on when it was credited and the used part received.
Under the accrual method, income is reported when all events have occurred that fix the right to receive the income, and its amount can be determined with reasonable accuracy (the “all-events” test). Generally, it is met on the earliest of the date payment is received, the date payment becomes due, or the date economic performance takes place. The government used its authority under IRC § 446(b) to declare that BBB’s method of accounting under the all-events test did not clearly reflect income and that the core amount must be reported when and in the amount billed. It assessed deficiencies for 2002 on Jeffrey, Bruce and Donald Bigler’s returns of $236,286, $237,523 and $506,443, respectively.
According to the court, the income accrued when the bills were sent, because the company had the right to collect the full amount. The fact that a future credit could be issued or that historically the company rarely collected cash for the core was immaterial. Nor was the court persuaded by BBB’s arguments it should be allowed to deduct cores credited but not yet received, or that the core amount exceeded the cores’ fair market value. The court compared the case to others where allowances for merchandise returns or deposits for returnable containers have been held to be taxable income when billed.
The government attempted to impose an accuracy-related penalty under section 6662(a). The court found, however, that the taxpayers were not liable for it because they acted with reasonable cause and in good faith. It noted the Biglers had kept detailed records and followed GAAP and industry standards.
Jeffrey M. Bigler v. Commissioner, TC Memo 2008-133
By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accountancy and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.