114 T.C. No. 28
UNITED STATES TAX COURT
PELAEZ AND SONS, INC., CHRISTINA P. HOOKER, TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18049-97. Filed May 30, 2000.
Sec. 263A, I.R.C., enacted in 1986, requires the capitalization of developmental costs. For plants with preproduction periods that are 2 years or less, farmers may be excepted from the capitalization requirements. For certain plants, including citrus plants grown in commercial quantities in the United States, the statute requires that the standard for the 2-year test is to be based on a national weighted average preproductive period for that type of plant. If the preproductive period, so determined, is 2 years or less, citrus farmers could be excepted from the capitalization requirement of sec. 263A, I.R.C. No guidance had been issued as to the national weighted average preproductive period for citrus trees as of 1989, when P began growing citrus trees. Due to the lack of guidance, P did not deduct its developmental costs for the first 2 years and then determined, based on its growing experience, that some of its citrus trees were productive within 2 years. Based on that experience, - 2 -
P, in 1991, claimed to be excepted from the capitalization requirement of sec. 263A, I.R.C., and deducted the preproductive costs for 1989, 1991, and 1992. R determined that P was not entitled to deduct the costs. Held: P is not entitled to use its own growing experience to measure whether it meets the 2 years or less standard. Held, further, P must capitalize its preproductive development costs for its citrus trees.
Philip A. Diamond and Daniel C. Johnson, for petitioner.
Charles A. Baer and James F. Kearney, for respondent.
GERBER, Judge: Respondent issued a notice of final S
corporation administrative adjustment (FSAA) for Pelaez and Sons,
Inc.’s (corporation), taxable years ended September 30, 1992,
1993, and 1994, reflecting net adjustments in the amounts of
$1,514,209, $46,148, and ($155,814), respectively. The question
we consider is whether the corporation is required, under the
provisions of section 263A,1 to capitalize developmental expenses
in connection with citrus trees. Respondent did not issue
guidance as to the “nationwide weighted average preproductive
period” for citrus trees (the standard in section 263A), and we
must decide whether the corporation’s use of its own experience
will suffice to meet the statutory standard. If, under section
263A, the corporation is required to capitalize, it argues that
1 Unless otherwise indicated, section references are to the Internal Revenue Code, as amended and in effect for the taxable periods under consideration. - 3 -
respondent is precluded from making any adjustment concerning the
corporation’s 1991 taxable year due to the expiration of the
limitation period.
FINDINGS OF FACT2
Pelaez and Sons, Inc., a Florida corporation, was
incorporated during 1955 and has continuously had its principal
place of business and engaged in commercial farming, through the
time of trial, in the State of Florida. Since 1989, S
corporation status has been elected for Federal tax purposes, and
the corporation was a cash basis taxpayer for the years under
consideration.
Beginning in 1955, the corporation engaged in commercial
cattle ranching and during the early 1960’s began raising sugar
cane. In the late 1980’s the corporation entered into citrus
growing operations to increase profits and minimize risk by means
of diversification. After successfully accelerating the
reproduction time in its cattle-raising activity, the
corporation, in a favorable citrus market, attempted to
accelerate the production of citrus crops. The land to be used
for the citrus grove had been used for cattle grazing, which made
it most suitable for citrus production.
2 The parties’ stipulation of facts and the attached exhibits are incorporated by this reference. - 4 -
Innovations in citrus growing permitted accelerated growing
experiences. Some of the innovations include: Improved
irrigation, fertigation systems, higher density planting, virus-
free trees, disease control, pesticides, intensive fertilization,
and genetic development. Fertigation is a technology that
combines fertilization and irrigation to permit continuous
fertilizer application and thereby promote more rapid growth.
The corporation invested in and employed the above-described
technologies. The corporation invested extensively in land
preparation, water management, fertilization, and other measures
to maximize tree growth and fruit production. Generally, the
corporation exploited techniques that would accelerate the growth
of its citrus crop and maximize its crop output. The corporation
employed Henry Hooker, educated in mechanized agriculture and
experienced in fertigation, to assist in its citrus growing
activities.
Most citrus trees are grafted trees that consist of two
parts, the scion or variety which is grafted or “budded” onto the
rootstock, which comprises the tree’s root system. In the citrus
industry, it is customary to measure a tree’s life from the date
it is permanently planted, and prior development is disregarded.
During May through July 1989, 39,382 citrus fruit trees
(1989 trees) were planted. Eight varieties of citrus were
acquired from a commercial nursery and planted by a commercial - 5 -
planting service under Mr. Hooker’s supervision. The parties
agree that the costs incurred in establishing the citrus grove,
including purchase, bedding, installation of fertigation, and
irrigation of the trees are depreciable costs deductible over a
period of years.
After the 1989 trees were planted, the corporation incurred
certain developmental or cultivation expenses (including
herbicides, fertilizer, pesticides, interest, depreciation, and
care taking) that were not deducted for the years ended September
30, 1989 or 1990, but they were deducted in later years. The
corporation deferred the deduction of the developmental expenses
due to a lack of regulatory guidelines and because it was not
known whether the citrus grove would produce a marketable crop
within 2 years of planting the 1989 trees. At the end of a 2-
year productive period, the corporation reviewed the sales of
citrus in late 1990 and the potential for a 1991 crop based on
the spring blooms and decided to deduct, on its 1991 return, the
developmental expenses for the 1989 and 1990 taxable years. The
corporation did not deduct the cost of the trees but depreciated
them over a rateable period. For 1992 and subsequent taxable
years, the corporation deducted the developmental costs (i.e.,
herbicides, fertilizer, interest, depreciation, and care taking
expenses) for the 1989 trees for each year as incurred. - 6 -
Additional citrus trees were planted during late 1991 (1991
trees), and the planting costs were capitalized and depreciated.
Based on the performance of the 1989 trees, it was believed that
the 1991 trees would be productive within their first 2 years.
The corporation, for its 1992 year and successive years, deducted
the developmental expenses and depreciation for the 1991 trees.
Respondent, in the FSAA notice, under section 263A,
disallowed the following deductions claimed with respect to the
1989 and 1991 trees:
Taxable year ended 1989 trees 1991 trees 1 Sept. 30, 1991 $1,171,949 -0- Sept. 30, 1992 244,692 $90,513 Sept. 30, 1993 -0- 116,980 1 $649,126.11 of the amount claimed was paid in the 1991 tax year and the remainder in the 1989 and 1990 tax years.
Production History--1989 Trees--The 1989 trees bore blossoms
during early 1990, fruit was visible during the spring 1990, and
80 boxes of grapefruit were sold for $220, which was net of the
cost of harvest borne by the buyer. The $220 of income was
reported on the corporation’s 1991 return. The 1989 trees were
affected by a 1989 frost, causing a loss of about 50 percent of
the grove. The 1989 trees also bloomed in early 1991, and fruit
was visible during the spring of 1991. The harvest began in
October 1991, and the corporation sold the second crop for
approximately $14,600 net of the harvesting costs borne by the
buyer. - 7 -
Production History--1991 Trees--There were blooms on the
1991 trees during early 1993, fruit was visible during the spring
1993, and the corporation sold the fruit from the harvest
beginning in October 1993. Fruit from the 1991 trees won an
award, based on size and quality, in a 1993 county fair.
The corporation, for the taxable periods 1991 through 1994,
harvested and sold boxes of fruit as follows:
Tangerines/ Taxable year ended Oranges Grapefruit tangelos
Sept. 30, 1991 -0- 80 -0- Sept. 30, 1992 4,465 967 118 Sept. 30, 1993 28,906 30,439 3,469 Sept. 30, 1994 36,242 36,836 9,413
Production information for 1989 trees and 1991 trees was not
segregated.
During October 1993, a group described as the “Florida
Citrus Liaison Team” was formed, and it consisted of five citrus
industry representatives, two tax practitioners, and six
representatives from the Internal Revenue Service (IRS). The
IRS’ Specialization Program coordinator (for the citrus industry)
was a participant in the liaison group. The group sought
guidance from the Office of Chief Counsel of the IRS with respect
to issues concerning section 263A. There was a belief within the
liaison group that IRS examiners were not uniformly applying the
section 263A provisions. - 8 -
Albert W. Todd, a C.P.A. with 37 years of experience,
prepared the corporation’s Federal income tax returns, and he was
experienced in agricultural accounting issues. He had more than
one client with exposure to section 263A, and, prior to the time
of the filing of the corporation’s 1991 return, Mr. Todd
concluded that deferral of the decision to deduct the
developmental costs was prudent and that the 1989, 1990, and 1991
expenses would be deductible on the 1991 return. After
researching section 263A, Mr. Todd concluded that the U.S.
Department of the Treasury had not issued regulations and/or
guidance as to the nationwide weighted averages for citrus
plants, that no other guidelines existed, and that there was no
requirement that taxpayers determine nationwide guidelines. In
that setting, Mr. Todd advised the corporation to make a decision
based on its individual experience as to whether section 263A
applied.
Pelaez and Sons, Inc.’s, 1991 tax return was mailed on or
about January 10, 1992, and was received by the IRS on January
13, 1992. The notice upon which this case is based was mailed
June 2, 1997. The corporation’s 1991 taxable year was closed
when the June 2, 1997, notice was mailed. In calculating the
adjustments in the notice, respondent reversed and included in
1992 income the 1991 deduction of $1,171,949 for the 1989 tree
developmental expenses. - 9 -
OPINION
The parties have conflicting interpretations of section
263A. Petitioner argues that the statutory requirement that the
standard be based on a national weighted average is invalid and
should be disregarded in favor of an approach where each
taxpayer’s experience should be the measure of whether the
section 263A “within 2 years test” is met. Respondent argues
that the nationwide average is valid even though no guidance had
been issued. Respondent also notes that any guidance that could
have been issued would not have supported petitioner’s position.
The statute requires taxpayers to capitalize certain direct
and indirect expenses or costs. See sec. 263A(a)(1). Section
263A does not apply to “any plant which has a preproductive
period of 2 years or less” if produced by the taxpayer in a
farming business. Sec. 263A(d)(1)(A)(ii). A “preproductive
period” means “in the case of a plant which will have more than 1
crop or yield, the period before the 1st marketable crop or yield
from such plant”. Sec. 263A(e)(3)(A)(i). For plants grown in
commercial quantities in the United States, that crop will be
within or without the 2-year period based on “the nationwide
weighted average preproductive period for such plant.” Sec.
263A(e)(3)(B). Section 263A(i) provides that the “Secretary
shall prescribe such regulations as may be necessary or
appropriate to carry out the purposes of this section”. Section - 10 -
263A was enacted during 1986, and, through the years in
controversy, no regulations3 or other notification had been
issued to provide guidance regarding the nationwide weighted
average preproductive period for citrus trees.4
In these circumstances, respondent argues that petitioner
has failed to show the nationwide average preproductive period
for citrus trees and that the corporation should not be entitled
to meet the statutory requirement by using its own citrus tree
experience. Respondent also argues that congressional intent was
to include citrus trees within the capitalization requirements of
section 263A; i.e., that Congress knew that the preproductive
period for citrus trees was more than 2 years.
Petitioner argues that the corporation is not responsible
for determining the nationwide weighted average preproductive
period for citrus trees and that it should be allowed to meet the
requirements by showing that its actual experience resulted in a
3 Respondent makes the observation that the periodic publication of a list of the national weighted averages for preproductive periods for various plants would, as a matter of practice, have been issued in some form of notice and not be published in the more formal vehicle of a regulation. 4 No final regulation on this point has been issued. Subsequent to the taxable years under consideration, however, the U.S. Department of the Treasury issued temporary regulations, which included a statement that the U.S. Department of the Treasury intended to publish a list of 37 plants, including orange, grapefruit, and tangerine trees, that were expected to have a preproductive period in excess of 2 years. See T.D. 8729, 1997-2 C.B. 38. - 11 -
less than 2-year preproductive period. In essence, petitioner’s
argument is that the section 263A(e)(3)(B) nationwide weighted
average requirement has no effect unless respondent issues a
regulation or guidance providing the average. Petitioner, in the
alternative, argues that any adjustment that is sourced in the
corporation’s 1991 tax year is time barred. The first question
we consider is whether the absence of guidance and/or regulations
changes the statutory requirements.5
Petitioner’s argument assumes that the only possible source
for a nationwide weighted average is the Commissioner or the
Secretary. Although the statute requires that regulations be
prescribed as may be necessary or appropriate, the statute does
not specifically mandate that the Secretary calculate the
national averages for various plants. The statute does require
that the period in question be measured based on the nationwide
weighted average.6 Accordingly, if taxpayers were able to show
5 Generally, where regulations have been necessary to implement a statutory scheme providing favorable taxpayer rules, this Court has found that the statute’s effectiveness is not conditioned upon the issuance of regulations. See Estate of Maddox v. Commissioner, 93 T.C. 228, 233-234 (1989); First Chicago Corp. v. Commissioner, 88 T.C. 663, 676-677 (1987), affd. 842 F.2d 180 (7th Cir. 1988); Occidental Petroleum Corp. v. Commissioner, 82 T.C. 819, 829 (1984). We have held that the U.S. Department of the Treasury’s failure to provide the needed guidance should not deprive taxpayers of the benefit or relief Congress intended. See Hillman v. Commissioner, 114 T.C. 103, ___ (2000) (slip op. at 14). 6 Congress expected the Secretary periodically to publish (continued...) - 12 -
the nationwide weighted average was less than 2 years, they could
be excepted from the capitalization requirement of section 263A.
In other words, Congress has provided for a standard that is not
static and could change from year to year.
Next, we consider respondent’s argument that Congress
intended that the section 263A capitalization requirement apply
to citrus farmers. We first consider the statute to discern
congressional intent. See United States v. American Trucking
Associations, Inc., 310 U.S. 534, 542-543 (1940); Hospital Corp.
of Am. v. Commissioner, 107 T.C. 116, 128 (1996). If the
language of the statute is clear, we need look no further in
deciding its meaning. See Sullivan v. Stroop, 496 U.S. 478, 482
(1990). If the statute is silent or ambiguous, the legislative
history may reveal congressional intent. See Burlington No. R.R.
v. Oklahoma Tax Commn., 481 U.S. 454, 461 (1987); United States
v. American Trucking Associations, Inc., supra at 543-544;
Hospital Corp. of Am. v. Commissioner, supra at 129.
Respondent contends that Congress’ intent is demonstrated by
the language of section 263A(d)(3)(C). That section prohibits
farmers from electing out of the section 263A capitalization
6 (...continued) lists of preproductive periods for various plants. H. Rept. 99- 426, at 628 (1985), 1986-3 C.B. (Vol. 2) 1, 628 & n.45. The legislative history, however, is silent on the effect, if any, of the Secretary’s failure to so publish the preproductive periods as expected, the very question we consider. - 13 -
requirement with respect to the costs incurred to develop and
maintain a citrus or almond grove for the first 4 years after the
trees are planted. We note that growers of plants that produce
other than citrus and almonds may elect out of these
requirements. Respondent also points out that section
263A(d)(3)(C) is similar to former section 278 and reflects that
Congress considered the preproductive period for citrus trees to
be more than 2 years.7
Subsection (d) of section 263A provides for exceptions from
the capitalization requirements for certain farming businesses.
As explained above, section 263A(d)(1)(A)(ii) excepts farmers
growing plants with a preproductive period of 2 years or less
from the section 263A capitalization requirements. Paragraph (3)
of subsection (d) permits certain farming businesses to elect out
of the section 263A capitalization requirements (i.e., the
requirements otherwise applicable to growers of plants with a
preproductive period of more than 2 years). One exception from
the election out provisions is contained in section
263A(d)(3)(C), as follows:
SPECIAL RULE FOR CITRUS AND ALMOND GROWERS.--An election under this paragraph shall not apply with respect to any item which is attributable to the planting, cultivation, maintenance, or development of any citrus or almond grove (or part thereof) and which is incurred before the close of the 4th taxable year
7 Sec. 263A(d)(3)(C) and former sec. 278, in effect, contain a 4-year threshold period of mandatory capitalization. - 14 -
beginning with the taxable year in which the trees were planted. For purposes of the preceding sentence, the portion of a citrus or almond grove planted in 1 taxable year shall be treated separately from the portion of such grove planted in another taxable year.
Respondent contends that the 4-year limit on the ability of
citrus farmers to elect out of section 263A reflects a statutory
inference and congressional recognition that citrus farmers were
subject to section 263A.8
Petitioner argues that section 263A(d)(3)(C) simply provides
that the subsection (d)(3) election out of section 263A is not
generally available to citrus farmers. Petitioner contends that
section 263A(d)(1) defines which farmers are subject to section
263A, whereas section 263A(d)(3) allows certain farmers to elect
not to be subject to 263A. In other words, petitioner contends
that section 263A(d)(1) should be read separately from section
263A(d)(3). Finally, petitioner contends that respondent’s
comparison of section 263A(d)(3)(C) to repealed section 278,
creates, rather than solves, any ambiguity in section 263A.
We agree with respondent that the inclusion of section
263A(d)(3)(C), as part of section 263A(d), is an indication that
Congress intended or expected that the section 263A
capitalization rules would apply to citrus farmers (i.e., citrus
8 Respondent also surmises that by setting a 4-year threshold on election out of sec. 263A, Congress was aware that the nationwide weighted average preproductive period for citrus trees would exceed 2 years. - 15 -
farmers would not meet the “2 years or less” standard). In
general, it would be incongruous to include section
263A(d)(3)(C), if it was expected or intended that citrus farmers
would meet the “2 years or less” standard.
Former section 278 provided that expenses, incurred before
the close of the fourth year, for planting, cultivation,
maintenance, or development of citrus groves, were to be “charged
to [the] capital account.” Sec. 278(a).9 Section 278 was
repealed in connection with the enactment of section 263A in the
Tax Reform Act of 1986, Pub. L. 99-514, sec. 803(b)(6), 100 Stat.
2350. The 4-year limitation on electing out of section 263A
comports with a similar 4-year requirement that such expenses
were to be charged to the capital account under section 278.
Accordingly, for citrus farmers, the requirement that expenses be
capitalized, at least for the first 4 years, did not change by
repeal of section 278 and the enactment of section 263A. We are
not in a position to say, however, that the 4-year limit in
either statute indicates recognition by Congress that the
preproductive period for citrus trees was or is 4 years.10
9 Sec. 278 was added in 1969 as part of the Tax Reform Act of 1969, Pub. L. 91-172, sec. 216(a), 83 Stat. 615. 10 In the General Explanation of the Tax Reform Act of 1969, the staff of the Joint Committee on Taxation (J. Comm. Print 1970), explained the reason for enacting the now repealed sec. 278 was to address a situation where certain high-income taxpayers were taking advantage of the benefit of ordinary (continued...) - 16 -
The evidence in this case appears to reflect that during the
1989 through 1994 years, the preproductive period for citrus
trees was, generally, more than 2 years. It is evident that in
1989 when the corporation entered into the citrus growing
business it employed the latest technological advances.
Employing the most current technology, the corporation produced
only limited amounts of citrus from a limited number of its trees
within the first 2 years. We cannot assume that, nationally,
other citrus farmers had achieved the same technological state of
the art. It therefore appears possible, if not likely as argued
by respondent, that the nationwide average preproduction period
for citrus was more than 2 years.
The reports and testimony of the parties’ trial experts and
the reference sources provided by the parties also demonstrate
that the preproductive period for citrus plants was at least 2
years. A text on Florida citrus growing (received as Exhibit 23-
10 (...continued) deductions currently available against ordinary income and eventual capital gain upon sale of citrus groves. This benefit had resulted in “unfavorable economic consequences for the citrus industry”, in the form of overproduction and depression of prices. The capitalization requirement specifically addressed that problem by requiring that the expenses be “charged to [the] capital account” at least until the end of the third year after the year of planting (4-year rule). The legislative history, however, did not contain specific recognition of an established or recognized preproduction period with respect to citrus trees. Congress, however, may have set the 4-year period to coincide with the then (1969 or 1986) preproduction period for citrus trees. As evidenced in this case, however, the period may be becoming shorter due to advanced farming technology. - 17 -
R), in the opening two paragraphs of a chapter on “Bringing
Citrus Trees into Production”, contains the following:
During the first two or three years after planting a citrus tree, growers should not seek to obtain the earliest possible production of fruit but to develop a sturdy tree to good size so that it will bear productively over a long life. * * * Growers need to aid the growth of the trees only by supplying favorable conditions for their development. With no crop to consider, growers can devote all attention to promoting vegetative growth. Sometimes growers will give minimum attention to these young trees because they are not yet returning any income, but to neglect them is a mistake that will be regretted for a long time because of its adverse effect on the trees’ future bearing. By established custom in Florida, citrus trees are classed as nonbearing during the first four years after they are planted as yearling trees. Although they may bear a few fruits as early as the second or third year, all efforts are correctly directed toward tree growth, and any fruit production is incidental. * * * [Jackson, Bringing Citrus Trees into Production, Citrus Growing in Florida, 137 (3d ed. 1991).]
The last paragraph of the same chapter, contains the following
statement:
Beginning with the fourth or fifth year, when the trees are considered of bearing age, practices in grove management differ somewhat from those outlined above. The following chapters are devoted to the care of bearing trees. [Id. at 146.]
Other contemporaneous materials offered by respondent
generally reflect that no meaningful production occurs until the
third year, with full production commencing in the fourth to
sixth year of tree growth. Petitioner’s experts highlighted the
fact that the corporation’s particular experience demonstrates
that citrus trees are capable of producing some fruit by the end - 18 -
of the second year. Statistically, however, any such production
was incidental and not necessarily representative of an average
pattern for preproductive periods. Petitioner’s experts also
confirmed that the corporation took full advantage of the newest
technology. In that regard, one of petitioner’s experts opined
that technology was to a point where the fourth year standard or
convention for citrus development, as had been contained in
repealed section 278, was no longer the standard. Petitioner’s
experts concluded that the corporation’s use of advanced
technology likely caused the citrus trees to begin producing
earlier than would have been experienced under older technology.
During the years under consideration, it appears that technology
and methodology existed that permitted the possibility of some
production within 2 years of “planting”.11
Similarly, one of respondent’s experts opined that a citrus
tree needed about 18 months after planting to reach a minimum
size to flower and that “Young trees are typically about 24
months old and have reached their second flowering opportunity
when small amounts of fruit are produced.” Respondent’s expert
11 The parties differed in their views concerning when the 2-year preproductive period began. Essentially, petitioner argues for a later starting period, when the farmer plants as opposed to the time when the plant may have been prepared by a commercial nursery for use by farmers. There is no need to decide when the preproductive period begins because the result in this case would be the same no matter which party’s belief we follow. - 19 -
concluded that, industrywide, citrus plants begin their
productive life at about 30 to 36 months old. Respondent’s other
experts concluded that, generally, citrus is ready for harvest in
the third year. The experts did not preclude the possibility
that production could occur earlier. Accordingly, petitioner’s
and respondent’s experts are relatively close in their views.
Their opinions permit the conclusion that citrus trees can
produce a small amount of fruit within 2 years, but they vary
regarding whether that production is commercially viable within
the second year. None of the parties’ experts was able to
provide empirical or statistical evidence of a “nationwide
weighted average preproductive period” for citrus plants.
We can deduce from the election-out provisions applicable
exclusively to citrus farmers, that it was expected that citrus
tree farmers would not meet the section 263A(d)(1)(A)(ii) 2-year
test for being excepted from the section 263A capitalization
requirements. To conclude that citrus trees would meet the 2-
year test would render section 263A(d)(3)(C) superfluous. In
addition, the 4-year limitation on electing-out of section 263A
requirements comports with the similar 4-year capitalization
requirement in repealed section 278 that, to some extent, section
263A replaced. This supports our holding that Pelaez and Sons,
Inc., is subject to the capitalization requirements of section
263A. - 20 -
Petitioner’s argument that the corporation should be allowed
to use its individual experience because respondent failed to
issue regulations or guidance as to the national weighted average
preproduction period for citrus trees is without merit. The
plain language of section 263A requires that for a citrus farmer
such as petitioner, the preproductive period in the section
263A(d)(1)(A)(ii) exception from section 263A capitalization is
measured by means of the nationwide weighted average
preproductive period for citrus trees. As indicated above,
neither party was able to show that average.
Petitioner also argues that the use of a nationwide average
preproduction period for each type of plant is a vague standard
or concept and that the statutory standard is vague and should be
invalidated. Respondent counters that although no guidance was
published by the Secretary or respondent, the standard is not
vague. Respondent also explained that the reason that Congress
used a nationwide weighted average preproductive period for each
type of plant was to ensure that one region of the country did
not have an economic advantage over another region because of
more favorable growing conditions. So, e.g., if southern farmers
enjoy a longer growing season, they may be able to meet the 2-
year test and currently deduct their cost of production, whereas
northern farmers would not be able to take the current deductions
and would be required to capitalize the same expenses or costs. - 21 -
That is a reasonable explanation for the nationwide average
requirement for each type of plant.
Accordingly, the corporation must meet the statute’s 2-year
threshold based on the nationwide weighted average preproductive
period for citrus trees. Though neither the Secretary nor
respondent has published guidelines, we are not in a position to
hold that the statute is “invalid” as petitioner suggests. In
that regard, the terms of the standard are not vague, and there
is reasonable justification for the statutory requirement that
the exception from section 263A be on a uniform or nationwide
basis for each type of crop.
Finally, we consider petitioner’s argument that respondent
is time barred from making any adjustments to the corporation’s
income for the years before the Court to prevent duplication of
amounts that had been deducted in the corporation’s 1991 year, a
year that the parties agree is closed. Respondent, admitting
that the corporation’s 1991 tax year was otherwise closed at the
time the notice was mailed, contends that the corporation’s 1991
choice no longer to capitalize its production costs constitutes a
change of accounting method that triggers section 481(a) and
permits adjustments in the 1992 tax year with respect to items
deducted in the 1991 year. Accordingly, respondent’s ability to
make an adjustment in the 1992 year for deductions taken in the
1991 year is solely dependent on whether the corporation’s 1991 - 22 -
choice to deduct rather than capitalize the production costs was
a change in the accounting method.
Respondent explains that the corporation, under section
263A, had capitalized (not deducted)12 its citrus grove
production costs for its taxable years ended September 30, 1989
and 1990. Beginning in 199113 and in later years, the
corporation began deducting its production costs for the 1989 and
1991 trees. Respondent contends that the corporation changed its
method of accounting for costs of citrus production in its 1991
taxable year. Under respondent’s change in the accounting method
contention, respondent would be entitled to rely on section 481
to make an adjustment(s) to prevent a distortion of taxable
income. See sec. 481; Graff Chevrolet Co. v. Campbell, 343 F.2d
568, 572 (5th Cir. 1965); W.S. Badcock Corp. v. Commissioner, 59
T.C. 272 (1972), revd. on other grounds 491 F.2d 1226 (5th Cir.
1974). Under section 481 respondent increases the corporation’s
1992 tax year income to adjust for the 1991 tax year deductions
12 Petitioner argues that it did not capitalize the 1989 and 1990 costs for the 1989 trees, but that it deferred deducting them until it could be determined whether they met the 2-year test of sec. 263A(d)(1)(A)(ii). Petitioner’s characterization of the corporation’s actions as deferring the deductions as opposed to choosing to capitalize, however, is a distinction without a difference. In the context of this case and the subject statute, the failure to deduct is necessarily the equivalent of a choice to capitalize. 13 In 1991, the corporation deducted the costs for its 1989, 1990, and 1991 taxable years. - 23 -
that should have been capitalized under section 263A. Our
holding sustains respondent’s position that the corporation must
use capitalization principles, beginning in 1992, to account for
the expenditures of developing its trees. Unless a section 481
adjustment is made, the amounts already deducted for the 1991
year as development costs of the 1989 and 1991 trees would in
effect be deductible a second time, in 1992 and later years, if
not through depreciation, then as accumulated costs set off
against the proceeds realized from the sale of fruit grown on
these trees.
Petitioner does not question respondent’s authority to make
the adjustment under section 481 but argues that there has not
been a change in the accounting method that would make section
481 available to respondent. Without section 481, petitioner
contends that respondent is time barred from adjusting the 1992
taxable year. Accordingly, we must decide whether respondent, by
requiring the corporation to capitalize such costs under section
263A for 1992 and future years, has changed the corporation’s
method of accounting for such costs.
Respondent relies on the definition for change of accounting
method contained in Rev. Proc. 92-20, 1992-1 C.B. 688, as
follows:
Section 1.446-1(e)(2)(ii)(a) of the regulations provides that a change in method of accounting includes a change in the overall plan of accounting for gross income or deductions, or a change in the treatment of - 24 -
any material item. A material item is any item that involves the proper time for the inclusion of the item in income or the taking of a deduction. In determining whether a practice involves the proper time for the inclusion of an item in income or the taking of a deduction, the relevant question is generally whether the practice permanently changes the amount of taxable income over the taxpayer’s lifetime. If the practice does not permanently affect the taxpayer’s lifetime taxable income, but does or could change the taxable year in which taxable income is reported, it involves timing and is therefore considered a method of accounting. See Rev. Proc. 91-31, 1991-1 C.B. 566.
Petitioner argues that the corporation was on the cash
method of accounting and did not change from that for any year,
including 1991. In addition, petitioner contends that in 1989
and 1990 the corporation intended to defer deducting the costs
until such time as it was able to determine whether it met the “2
years or less” test. In that regard, petitioner argues that
exercising the election to deduct or capitalize in section 1.162-
12(a), Income Tax Regs., does not constitute a change in the
accounting method. Petitioner, relying on Wilbur v.
Commissioner, 43 T.C. 322 (1964), contends that the choice
available under the regulation is not a change in the accounting
method. Respondent contends that the holding in Wilbur is
contrary to petitioner’s interpretation.
Wilbur, which was decided prior to the 1969 enactment of
section 278, does not address the question of change of
accounting method, and, accordingly does not support either
party’s argument on that point. See Wilbur v. Commissioner, - 25 -
supra, involved an interpretation of section 162 and section
1.162-12(a), Income Tax Regs., concerning a farmer/taxpayer’s
ability to make or change an election to either deduct or
capitalize maintenance expenses in connection with preproductive
fruit and nut trees. The regulation was interpreted by this
Court to permit a farmer/taxpayer to choose to capitalize some
and deduct some expenditures in the same taxable period.
Further, it was held that a taxpayer may not be required to
capitalize certain expenditures that were inadvertently not
included with related expenditures that had been capitalized.
See Wilbur v. Commissioner, supra at 326. It was also held that
with respect to the expenditures that were capitalized, the
election was irrevocable.
In the setting of this case, section 263A governs whether or
not the corporation is required to capitalize the costs incurred
in connection with the citrus trees. In the context of section
263A, the corporation did not have the choice to capitalize or
deduct due to the prohibition contained in section 263A(d)(3)(C).
The choice not to deduct was based on the self-conceived
predicate that the question of whether the outlays were
deductible could not be determined until it was known whether the
trees had a preproductive period of 2 years or less under section
263A(d)(1)(A)(ii). As discussed above, the statute did not offer
that choice. By not deducting the costs for 1989 and 1990, the - 26 -
corporation actually complied with the section 263A
capitalization requirement. As we have held, Pelaez and Sons,
Inc., was not entitled to deduct the 1989, 1990, and 1991 costs
on its 1991 return.
There is no doubt that the question of whether to capitalize
or deduct the preproduction costs is, in the setting of this
case, a timing question and not a one-time inclusion or
deduction. Our holding that Pelaez and Sons, Inc., must
capitalize rather than deduct such costs beginning with 1992
involves a “material item” so as to constitute a change in the
accounting method that would trigger section 481. Accordingly,
within the established definition for change in the accounting
method, Pelaez and Sons, Inc., as a result of being required to
capitalize the preproduction costs beginning in 1992, has changed
its accounting method for the deduction of a material item. Such
a change warrants respondent’s use of section 481 to make the
adjustment necessary to prevent a distortion of income.
To reflect the foregoing,
Decision will be entered
for respondent.