T.C. Memo. 2021-59
UNITED STATES TAX COURT
BRC OPERATING COMPANY LLC, BLUESCAPE RESOURCE COMPANY LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
BLUESCAPE RESOURCES COMPANY LLC, BLUESCAPE RESOURCES INVESTORS LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 12922-16, 12923-16.1 Filed May 12, 2021.
Charles W. Hall, Robert C. Morris, Andrew P. Price, and Richard L. Hunn,
for petitioners.
Jeffrey B. Fienberg, Travis Vance, Julie M. Holmes Chapel, and Ashley
Vaughan Targac, for respondent.
1 On April 12, 2017, we consolidated these cases for trial, briefing, and opinion.
Served 05/12/21 -2-
[*2] MEMORANDUM OPINION
PUGH, Judge: These consolidated cases are before the Court on
respondent’s motion for partial summary judgment, and petitioners’ motion for
partial summary judgment. In two notices of final partnership administrative
adjustment (FPAA) dated March 7, 2016, respondent disallowed reported costs of
goods sold for the tax years ending December 31, 2008 (tax year 2008), and
December 31, 2009 (tax year 2009). The crux of the dispute remaining between
the parties is whether the economic performance requirement in section 461(h)(1)2
applies to, and precludes recognition of, the estimated drilling costs reported as
costs of goods sold for the tax years in issue. As we explain below a resolution of
the parties’ dispute with respect to the reported estimated drilling costs turns on a
more basic question about when a cost of goods sold offset may be recognized for
tax purposes.
Background
The following facts are from the parties’ pleadings and other materials in
the record and are not in dispute, except as noted.
2 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. -3-
[*3] BRC Operating Co., LLC (BRC), and Bluescape Resources Co., LLC
(Bluescape), were organized as Delaware limited liability companies in 2008.
During the tax years in issue BRC was wholly owned by Bluescape and was
classified as a disregarded entity for Federal tax purposes. Bluescape was a
partnership for Federal tax purposes and used an accrual method of accounting.
During tax years 2008 and 2009 Bluescape paid approximately $180 million
to acquire hundreds of thousands of acres of minerals and lease interests in West
Virginia, Pennsylvania, Ohio, and Kentucky (leases). Bluescape planned to
explore for, mine, and produce natural gas for sale. On its Forms 1065, U.S.
Return of Partnership Income, Bluescape reported, as costs of goods sold,
estimated drilling costs for natural gas exploration and mining. The amounts in
issue claimed as costs of goods sold are $100 million for tax year 2008 and $60
million for tax year 2009.3
3 These amounts reflect stipulations by the parties in the stipulation of settled issues filed September 14, 2018, at docket No. 12923-16. -4-
[*4] Bluescape did not drill, receive drilling services from third parties, or
receive drilling property during the tax years in issue.4 Bluescape reported no
gross receipts or sales during these years attributable to the sale of natural gas.5
On March 7, 2016, respondent issued two FPAAs to Bluescape Resources
Investors, LLC, as Tax Matters Partner for Bluescape, one for each of tax years
2008 and 2009. Respondent disallowed the claimed costs of goods sold in their
entirety, determining that Bluescape had not established that it satisfied the all-
events test and the economic performance requirement in section 461(h)(1).6
4 Petitioners allege Bluescape drilled two test wells in 2009; respondent does not explicitly stipulate that fact but does not challenge it either, and petitioners stated at the hearing that the test wells were not relevant to the motions. 5 Bluescape reported no gross receipts of any kind for 2008 and reported $139,876 of delay rental payments for 2009. 6 Respondent also issued an FPAA to BRC for tax year 2008, proposing an identical adjustment to 2008 cost of goods sold for estimated drilling costs. BRC argues that, as a single-member disregarded entity, it cannot be classified as a partnership for Federal tax purposes and therefore the FPAA is invalid. BRC did, however, file a partnership return for tax year 2008. Under sec. 6233 and sec. 301.6233-1, Proced. & Admin. Regs., respondent may treat BRC as a partnership for the tax year for purposes of subchapter C of chapter 63 of the Code. See Marcy v. Commissioner, T.C. Memo. 2018-42, at *10 (“The filing of a partnership return, even when an entity is not in fact a partnership, triggers the application of the TEFRA procedures unless the entity (or purported entity) is (or would have been) a ‘small partnership’.”); see also Bedrosian v. Commissioner, 143 T.C. 83, 104 (2014) (noting that under TEFRA an entity will not be considered a small partnership if any partner during the taxable year is a “pass-thru partner”, such as (continued...) -5-
[*5] Discussion
Respondent’s motion for partial summary judgment asks us to sustain his
determinations disallowing Bluescape’s reported costs of goods sold, advancing
two alternative theories. First, respondent argues that the undisputed facts show
that economic performance under section 461(h)(1) did not occur with respect to
the reported costs of goods sold during the years in issue. In the alternative
respondent argues that the reported costs of goods sold should be disallowed
because they were derived from Bluescape’s use of a method of accounting that
failed to clearly reflect income. Petitioners object.
Petitioners’ motion for partial summary judgment asks us to rule that the
economic performance requirement in section 461(h)(1) does not apply to the
amounts claimed as costs of goods sold for the tax years in issue. Respondent
objects.
6 (...continued) partnership), aff’d, 940 F.3d 467 (9th Cir. 2019). The identical adjustment is before us in the FPAA to Bluescape, and therefore our decision on the validity of the FPAA to BRC has no practical consequences. Nor was this a point of contention between the parties. Nonetheless we must decide whether we have jurisdiction over the FPAA to BRC at issue in docket No. 12922-16. We conclude that we do; we conclude that the FPAA to BRC is valid. -6-
[*6] I. Summary Judgment Standard
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). A motion for partial summary judgment may be granted
where there is no genuine dispute as to any material fact and a decision may be
rendered as a matter of law. Rule 121(a) and (b); see Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994).
Partial summary adjudication is proper where some but not all of the issues in the
case may be disposed of summarily. Rule 121(b).
Where a motion for summary judgment has been properly made and
supported, the nonmoving party “may not rest upon the mere allegations or denials
of such party’s pleadings” but must “set forth specific facts showing that there is a
genuine dispute for trial” by affidavits or otherwise. Rule 121(d); see Dahlstrom
v. Commissioner, 85 T.C. 812, 820-821 (1985). The moving party bears the
burden of showing that there is no genuine dispute as to any material fact, and any
factual inferences are drawn in a manner most favorable to the party opposing
summary judgment. See Dahlstrom v. Commissioner, 85 T.C. at 821. “If there
exists any reasonable doubt as to the [material] facts at issue, the motion must be
denied.” Sundstrand Corp. v. Commissioner, 98 T.C. at 520. -7-
[*7] II. Bluescape’s Drilling Costs as Costs of Goods Sold
The dispute raised by the motions is whether the economic performance
requirement in section 461(h)(1) applies to Bluescape’s estimated drilling costs
reported as costs of goods sold. Respondent argues yes, citing the regulations.
E.g., sec. 1.61-3(a), Income Tax Regs. (“[A]n amount cannot be taken into account
in the computation of cost of goods sold any earlier than the taxable year in which
economic performance occurs with respect to the amount[.]”). Petitioners argue
that the economic performance requirement does not apply because the regulations
“extending” it to amounts included in cost of goods sold went too far. Petitioners
argue that, as an offset against gross receipts to arrive at gross income, cost of
goods sold is an “item of gross income” the timing of which is governed by
section 451 and the corresponding regulations, and therefore the economic
performance requirement in section 461 does not apply.
After ample briefing on this dispute, the Court scheduled a hearing on the
motions to pose a basic question to the parties: Can Bluescape recognize costs of
goods sold before it has any gross receipts from the sale of goods? In other words
do we even reach the question of whether costs of goods sold are subject to the
economic performance requirement when there are no gross receipts to offset yet?
At the conclusion of the hearing we invited the parties to file a motion for leave to -8-
[*8] file supplemental memoranda on this issue. The parties accepted the
invitation, we granted their joint motion, and each party filed a supplemental
memorandum.
The question before the Court is not whether the estimated drilling costs can
ever give rise to costs of goods sold but whether they can give rise to costs of
goods sold for the years in issue. Respondent argues that Bluescape is not entitled
to recognize costs of goods sold for the years before the Court because it did not
sell any goods or have any gross receipts related to the sale of natural gas.
Petitioners, framing respondent’s position as a “clear reflection of income”
argument, argue that “matching” of cost of goods sold and gross receipts is not
required. Thus, petitioners argue, they can recognize cost of goods sold as soon as
they assume the obligations to drill the wells, giving rise to a loss that flows
through to their partners.
We start our analysis of this question with an overview of the cost of goods
sold offset. Under the Sixteenth Amendment to the Constitution, Congress may
tax the gross income of a producer or reseller, not its gross receipts. See Doyle v.
Mitchell Bros. Co., 247 U.S. 179, 185 (1918). Gross income is calculated by
subtracting the cost of goods sold from gross receipts. Sec. 1.61-3(a), Income Tax
Regs. -9-
[*9] Cost of goods sold includes the “costs of acquiring inventory, through either
purchase or production.” Patients Mut. Assistance Collective Corp. v.
Commissioner, 151 T.C. 176, 205 (2018), aff’d, __ F.3d __, 2021 WL 1570288
(9th Cir. Apr. 22, 2021); see also Reading v. Commissioner, 70 T.C. 730, 733
(1978), aff’d, 614 F.2d 159 (8th Cir. 1980); secs. 1.61-3(a), 1.162-1(a), Income
Tax Regs. The cost of goods sold offset against gross receipts ensures that there is
not a tax on the return of capital. See Commissioner v. Weisman, 197 F.2d 221,
224 (1st Cir. 1952) (“The return of capital is guaranteed by the ‘cost of goods’
offset against gross receipts and thus is avoided the charge that it is a tax on
capital and not on income.”). Thus, the “‘cost of goods sold’ concept embraces
expenditures necessary to acquire, construct or extract a physical product which is
to be sold; the seller can have no gain until he recovers the economic investment
that he has made directly in the actual item sold.” Reading v. Commissioner, 70
T.C. at 733. The regulations reflect this principle. Section 1.61-3, Income Tax
Regs., provides in part:
(a) In general. In a manufacturing, merchandising, or mining business, “gross income” means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. * * * The cost of goods sold should be determined in accordance with the method of accounting consistently used by the taxpayer. * * * - 10 -
[*10] The parties do not dispute--and therefore we assume for purposes of the
motions before us--whether the estimated drilling costs should be included in costs
of goods sold; they dispute only when.
Cost of goods sold is calculated as the sum of the cost of beginning
inventory and purchases (and other acquisition or production costs) during the tax
year less the cost of ending inventory. Huffman v. Commissioner, 126 T.C. 322,
324 (2006), aff’d, 518 F.3d 357 (6th Cir. 2008); see also Alterman v.
Commissioner, T.C. Memo. 2018-83 (holding taxpayer’s method of computing
cost of goods sold improper when taxpayer considered only purchase and
production costs and not beginning and ending inventory); see also secs.
1.162-1(a), 1.446-1(a)(4)(i), 1.471-1, Income Tax Regs.7 The taxpayer must retain
records sufficient to substantiate the reported cost of goods sold. See sec. 6001;
Newman v. Commissioner, T.C. Memo. 2000-345. For instance, the Court has
disallowed cost of goods sold when a taxpayer fails to present evidence of net
sales, or beginning or ending inventory. See Petzoldt v. Commissioner, 92 T.C.
661, 698 (1989) (sustaining disallowance of cost of goods sold offset when
7 And under certain circumstances not relevant here the taxpayer may value closing inventory at the lower of cost or market. See W.C. & A.N. Miller Dev. Co. v. Commissioner, 81 T.C. 619, 632-633 (1983); secs. 1.471-2(c), 1.471-4, Income Tax Regs. - 11 -
[*11] taxpayer did not provide records to determine net sales or inventory); Chico
v. Commissioner, T.C. Memo. 2019-123, at *25 (sustaining disallowance of cost
of goods sold offset because taxpayers presented invoices for materials but no
information regarding beginning and ending inventory).
Cost of goods sold generally is determined under section 471 and the
accompanying regulations. See secs. 1.471-3, 1.471-11, Income Tax Regs.
Producers must include in cost of goods sold both the direct and indirect costs of
creating their inventory. See secs. 1.471-3(c), 1.471-11, Income Tax Regs.
Section 471 and its regulations also direct taxpayers to section 263A for additional
rules. Under section 263A, a taxpayer is not allowed to deduct currently the direct
or indirect costs of personal property produced by the taxpayer. See sec.
263A(a)(1), (b)(1). Instead, these costs must be capitalized or included in
inventory costs. See id. subsec. (a)(1).
Generally, cost of goods sold is not allowable unless, and until, the taxpayer
actually sells or disposes of goods. See Patients Mut. Assistance Collective Corp.
v. Commissioner, 151 T.C. at 205 (“But when accounting for COGS * * * [as
opposed to deductions, taxpayers] have to capitalize an item’s cost in the year of
acquisition or production and either amortize it or wait until the year the item’s
sold to make the corresponding adjustment to gross income.”); see also Jones v. - 12 -
[*12] Commissioner, 25 T.C. 1100, 1102-1104 (1956) (holding that the taxpayer
could not recover cost of goods sold until the goods were sold or otherwise
disposed of), rev’d on other grounds, 259 F.2d 300 (5th Cir. 1958). This principle
is illustrated by Bernard v. Commissioner, T.C. Memo. 1998-20, 1998 WL 17621,
and Weaver v. Commissioner, T.C. Memo. 2004-108, 2004 WL 938293.
In Bernard v. Commissioner, 1998 WL 17621, the Court held that a
taxpayer starting a model train store was not entitled to cost of goods sold reported
on Schedule C, Profit or Loss From Business, because the model train store had
not yet begun selling goods to customers during the tax year in issue. In 1994 the
taxpayer quit his job to start a model train store and acquired $56,218 in inventory
with the hope of beginning sales during the upcoming holiday season. Id. at *1.
Because of delays in acquiring retail space, he did not open the store during 1994
and instead stored the inventory in his home, selling only a few items to family
and friends until he could find retail space during the following year, 1995. Id.
Because the taxpayer did not sell any goods in 1994, the Court held that he could
not recover cost of goods sold for 1994. Id. at * 2. The Court also rejected his
alternative argument for recovering cost of goods sold--that the inventory became
worthless during 1994--because the taxpayer did not offer the inventory for sale or - 13 -
[*13] otherwise provide any evidence that the market price for the yearend
inventory was less than cost. Id.
Similarly, in Weaver v. Commissioner, 2004 WL 938293, the Court rejected
the notion that a taxpayer could claim cost of goods sold in the absence of gross
receipts or sales of goods. There, a married couple reported on a Schedule C for
an “automobile construction” business zero gross receipts or sales, $374,885 of
cost of goods sold, and $73,235 of expenses, for a total loss of $448,120. Id.
at *2. Because the business did not sell any goods in the relevant year, the Court
treated the taxpayers’ claim of cost of goods sold as a claim for additional section
162 business expense deductions, explaining:
[E]ven where otherwise appropriate, cost of goods sold generally is not allowable with respect to goods that have not been sold or otherwise disposed of during the taxable year. Jones v. Commissioner, 25 T.C. 1100, 1103-1104, 1956 WL 805 (1956), revd. on other grounds 259 F.2d 300 (5th Cir. 1958); Bernard v. Commissioner, T.C. Memo. 1998-20. Because petitioners in any event reported no gross receipts for Shrike Cars and offered no evidence indicating that any goods were disposed of by the venture, and because the parties did not distinguish at trial or on brief between the various components of the Shrike Cars loss, we shall treat the $374,885 amount as a claim for additional business expenses under sec. 162. See Keegan v. Commissioner, T.C. Memo. 1997-511 (considering reported cost of goods sold to be a claim for sec. 162 expenses).
Id. n. 2. - 14 -
[*14] Bernard and Weaver illustrate what is obvious from the phrase “cost of
goods sold” itself: “goods sold” are generally a prerequisite to recognizing cost of
goods sold. And these cases illustrate the basic flaw in petitioners’ position:
Bluescape had no gross receipts from the sale of goods to offset. Cost of goods
sold does not exist in a vacuum, as a stand alone deduction in the Code, but serves
as an offset against gross receipts. See Sullenger v. Commissioner, 11 T.C. 1076,
1077 (1948) (“Section 23 [now section 162] makes no provision for the cost of
goods sold, but the Commissioner has always recognized, as indeed he must to
stay within the Constitution, that the cost of goods sold must be deducted from
gross receipts in order to arrive at gross income. No more than gross income can
be subjected to income tax upon any theory.”); sec. 1.61-3, Income Tax Regs.
Petitioners do not cite, nor could we find, any cases that allowed an offset
for cost of goods sold as a stand alone deduction in advance of any gross receipts;
rather cost of goods sold was allowed only as an offset against gross receipts from
the sale of goods.8 Indeed, that is the foundation on which petitioner’s argument
against application of the economic performance requirement rests. That is,
petitioners argue that cost of goods sold is not subject to the economic
performance requirement under section 461(h) because cost of goods sold offsets
8 The exceptions--which we discuss below--illustrate this broader premise. - 15 -
[*15] gross receipts for purposes of computing gross income under section
1.61-3(a), Income Tax Regs., and hence is an “item” of gross income, the timing
of which is governed by section 451. Petitioners’ own formulation thus confirms
that cost of goods sold is not a stand alone deduction but rather serves as an offset
against gross receipts.
Petitioners’ argument that cost of goods sold need not “match” gross
receipts cannot bridge the gap in their logic. First, petitioners cite Hezel v.
Commissioner, T.C. Memo. 1985-10, as an example where “the [C]ourt allowed a
taxpayer to adjust * * * [cost of goods sold] for labor costs associated with the
taxpayer’s business despite the fact that the taxpayer did not have any sales of
inventory during the tax year in issue”. That is not so. In Hezel the taxpayer, an
individual, paid $20,000 in 1977 to acquire an obsolete mail conveyer system in
order to salvage the equipment and resell it. In 1978 the taxpayer claimed
approximately $15,000 of cost of goods sold without reporting any sales, and
initially, the Commissioner disallowed the entire amount. But after discovery, the
Commissioner conceded a deduction of approximately $1,300 for labor costs that
had been claimed by the taxpayer as a part of cost of goods sold. Thus, the labor
costs were not even before the Court. And the Court ruled in the Commissioner’s
favor with respect to the claimed cost of goods sold remaining after concessions - 16 -
[*16] (approximately $13,700 for equipment purchases, supplies, and inventory
shrinkage).
Petitioners also cite Van Pickerill & Sons, Inc. v. United States, 445 F.2d
918 (7th Cir. 1971), as part of this argument that they need not “match” accrued
drilling costs to gross receipts from the sale of goods. But in that case the
taxpayer avoided “matching” of certain costs to sales by claiming those costs as
expense deductions, not as cost of goods sold. Specifically, the court rejected the
Commissioner’s position that a whisky distributor must add costs for storage, State
taxes, and insurance premiums to cost of goods sold and offset cost of goods sold
against gross receipts at the time of sale of the whisky. The taxpayer successfully
argued that its practice of current expensing of such costs was a permissible
method of accounting. Crucially, the “taxpayer hinge[d] his argument on the
impropriety of characterizing the charges as costs of acquisition [of the whisky].”
Id. at 920. Here, by contrast, petitioners take the position that Bluescape’s
estimated drilling costs are not deductible expenses but costs included in cost of
good sold--that is, that the expenses are part of the cost of acquiring the natural
gas. This position is how they claim to avoid the economic performance
requirement. But it is also what requires them to wait until there are gross receipts - 17 -
[*17] against which to offset cost of goods sold. Van Pickerill & Sons therefore
highlights the inconsistency of petitioner’s position.
Cases petitioners cite involving stolen or worthless inventory likewise miss
the mark. For instance, petitioners cite Nat’l Home Prods., Inc. v. Commissioner,
71 T.C. 501, 530-532 (1979) (holding that the taxpayer could reduce its ending
inventory in the cost of goods sold computation by the amount of stolen inventory
and thus claim the amount of the inventory loss as a part of its cost of goods sold),
C-O-Two Fire Equip. Co. v. Commissioner, 219 F.2d 57 (3d Cir. 1955) (holding
that the taxpayer could offset a loss in 1946 for obsolete inventory on a totally
failed business venture by writing down ending inventory for the year of the loss),
rev’g 22 T.C. 124 (1954), and United States v. Kollman, 105 A.F.T.R. 2d
2010-1331 (D. Ore. 2010) (holding that the taxpayer was entitled to a deduction
for worthless inventory after Government regulation made certain inventory
unmarketable). Petitioners also point out that a taxpayer may write down the cost
of ending inventory to “market” in certain situations if the taxpayer is using the
lower of cost or market method. See secs. 1.471-2(c), 1.471-4, Income Tax Regs.;
see also Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 533-537 (1979)
(describing the lower of cost or market method). But petitioners did not allege - 18 -
[*18] that Bluescape had inventory that was stolen or lost value, or that it was
using the lower of cost or market method. Therefore, these authorities are no
help.9
Third, petitioners’ reliance on Garth v. Commissioner, 56 T.C. 610 (1971),
is misplaced. Petitioners cite Garth as an example where “the taxpayer was
allowed to claim the costs of raising chickens in years prior to the years in which
the taxpayer’s inventory of chicken eggs or chickens were sold”. But the taxpayer
in Garth was in business for approximately five years before the tax year in issue,
and during the year in issue the taxpayer was actively engaged in the production
and sale of eggs and hens. There is no indication that the taxpayer in Garth
attempted to recognize cost of goods sold for a tax year in which the taxpayer had
no gross receipts from the sale of inventory.
Finally, petitioners’ attempt to block partial summary judgment by arguing
that this is a fact-intensive “clear reflection of income issue” not appropriate for
9 We do not express an opinion on whether a taxpayer who writes down ending inventory for stolen, worthless, or obsolete goods could recognize cost of goods sold in the absence of gross receipts from the sale of goods. Neither do we express an opinion on whether a taxpayer using the lower of cost or market method could recognize cost of goods sold in the absence of gross receipts from the sale of goods. The facts before us do not raise these issues. - 19 -
[*19] summary judgment is unavailing.10 The only facts material to our analysis
of whether the costs in issue should be recognized for the years in issue as part of
costs of goods sold are that Bluescape did not receive or report any gross receipts
from the sale of natural gas or other goods or inventory during the years in issue.
And that is not disputed.
In arguing that partial summary judgment is not available after casting
respondent’s position as a clear reflection challenge, petitioners assert that they
will present evidence at trial bearing on whether their method of accounting
10 Under sec. 446(b), the Commissioner has broad authority to challenge a taxpayer’s method of accounting as failing to clearly reflect income. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979) (“[I]t is obvious that on their face, §§446 and 471, with their accompanying Regulations, vest the Commissioner with wide discretion in determining whether a particular method of inventory accounting should be disallowed as not clearly reflective of income.”); Commissioner v. Hansen, 360 U.S. 446, 467 (1959) (“The Commissioner has broad powers in determining whether accounting methods used by a taxpayer clearly reflect income[.]”); Rockwell Int’l Corp. v. Commissioner, 77 T.C. 780, 808 (1981) (“Since the Commissioner has ‘[m]uch latitude for discretion,’ his interpretation of the statute’s clear-reflection standard ‘should not be interfered with unless clearly unlawful.’” (alteration in original) (quoting Lucas v. Am. Code Co., 280 U.S. 445, 449 (1930))), aff’d, 694 F.2d 60 (3d Cir. 1982). Whether a method of accounting clearly reflects income is a question of fact to be determined on a case-by-case basis. Howard Hughes Co., LLC v. Commissioner, 142 T.C. 355, 376 (2014), aff’d, 805 F.3d 175 (5th Cir. 2015); Ford Motor Co. v. Commissioner, 102 T.C. 87, 91-92 (1994), aff’d, 71 F.3d 209 (6th Cir. 1995). Consequently, we have held that cases deciding whether a taxpayer’s method of accounting fails to clearly reflect income generally are not suitable for summary judgment. Dayton Hudson Corp. & Subs. v. Commissioner, 101 T.C. 462, 466 (1993). - 20 -
[*20] clearly reflected income, including: the precise terms of the leases; several
actions taken in 2008 and 2009 to “preserve and enhance” the values of the leases,
including drilling two test wells in 2009 and infrastructure development; work
done by third party engineering companies to evaluate the test wells in 2009;
generally accepted principles for the particular trade or business; and how
Bluescape’s method of accounting was consistently applied over the years. But
none of these facts is material to the issue of whether Bluescape had any gross
receipts from the sale of goods during the years in issue. In Bernard and Weaver,
discussed above, we rejected--without reference to clear reflection of income--the
argument that a taxpayer may recover cost of goods sold when the taxpayer had no
gross receipts from the sale of goods. Petitioners cannot fend off partial summary
judgment on this fundamental legal question by invoking clear reflection of
income; without disputed material facts this becomes a red herring.11
In sum, we conclude that to recover cost of goods sold a taxpayer generally
must have some gross receipts from the sale of goods to offset. Because
11 To be clear, respondent did argue in his motion, as an alternative to his sec. 461(h)(1) argument, that Bluescape’s reported costs of goods sold should be disallowed because it used a method of inventory accounting that failed to clearly reflect income. We need not reach that argument here because we hold that, without gross receipts from the sale of goods, Bluescape may not recover its estimated drilling costs as costs of goods sold. - 21 -
[*21] Bluescape had no gross receipts from the sale of natural gas for the years in
issue, the estimated drilling costs reported as “cost of goods sold” are not
allowable as a cost of goods sold offset to gross receipts.
Accordingly, we sustain respondent’s disallowance of Bluescape’s
estimated drilling costs reported as costs of goods sold for tax years 2008 and
2009. We do not reach the parties’ dispute over whether the economic
performance requirement in section 461(h)(1) applies to Bluescape’s estimated
drilling costs.12 Therefore, we will deny petitioners’ motion as moot.
III. Conclusion
In sum, we will deny petitioners’ motion for partial summary judgment
because Bluescape’s reported estimated drilling costs are not costs of goods sold
12 We note that petitioners’ position is that Bluescape should be able to take into account its estimated drilling costs as costs of goods sold for tax years 2008 and 2009 and we have confined our analysis to this question. Petitioners do not argue that those costs should give rise to sec. 162 deductions. And on brief petitioners belabor the distinctions between costs of goods sold “offsets” to gross receipts and deductions against gross income in arguing that sec. 461(h)(1) should not apply to costs of goods sold. We do not read their alternative argument that they satisfy the economic performance requirement to change their characterization of the expenses as costs of goods sold. We therefore will not consider recharacterizing Bluescape’s reported costs of goods sold as claims for sec. 162 deductions in the same amounts, as the Court did in Weaver v. Commissioner, T.C. Memo. 2004-108. - 22 -
[*22] for Federal tax law purposes. Therefore, we need not consider petitioners’
arguments concerning the application of section 461(h)(1) to cost of goods sold.
We will grant respondent’s motion for partial summary judgment based on
the reasoning in this opinion. On the basis of the undisputed facts before us,
petitioners were not entitled to recognize cost of goods sold for tax year 2008 or
2009.
To reflect the foregoing,
An appropriate order will be issued.