In Uncategorized on 12/04/2018 at 16:09

It may not be a change in method of accounting if you change an item to reflect changed external facts. In any case, it’s not a subject for summary J in Thrasys, Inc., et al., 2018 T. C. Memo. 199, filed 12/4/18.

Thrasys was developing hospital operating software for Siemens, the multinational electric outfit, and got a $15 million payment in Year One. Ordinarily, Thrasys reported similar payments as “advance payments,” and deferred these one year forward per Rev. Proc. 2004-34, which lets software developers defer such payments.

IRS claims the $15 million should have been reported in Year One, not Year Two, because Thrasys once before blew the one year deferral and took two. Thrays claims that was a one-off error, not an abandonment of the advance payment deferral method.

If you book items the same way for two years running, you’ve established your method of accounting, and cannot change without the blessing of the Com’r. As a certain ethnic group remarks, “We make the same mistakes three times running and call it a tradition.”

IRS is ready to pounce, nailing Thrasys for recognizing in the wrong year, and also claiming that when Thrasys went from C Corp to S Corp in that same year, the $15 million was “net recognized built-in gain.”

As to the latter, Judge Lauber isn’t going there. But there’s a preliminary problem for IRS’ summary J.

“For at least two reasons we believe that there exist genuine disputes of material fact concerning the correctness of respondent’s submission.

“First, as far as the record reveals, Thrasys treated only one customer payment–the $15 million payment it received from Siemens in [Year One]–as a ‘deposit’ for book or Federal income tax purposes.  That treatment appeared on only one tax return, namely, petitioner’s Form 1120 for [Year One].  (On its Form 1120S for [Year Two} Thrasys shifted the $15 million from the ‘deposit’ category into the ‘deferred revenue category.)  A question of material fact exists as to whether petitioner’s ‘deposit’ treatment displayed the consistency required to constitute a method of accounting on the basis of which Thrasys ‘regularly compute[d]’ its income.  See sec. 446(a), (e).

“Second, a change in method of accounting does not include ‘a change in treatment resulting from a change in underlying facts.”  Sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs.  Thrasys treated the $15 million payment differently from the customer payments it had received during {Three Previous Years], and it did so in accordance with adjustments that an independent auditor had made to its {Year One] financial statement.  Because Thrasys at yearend [Year One] was in technical breach of its software development contract(s) with Siemens, the auditor believed that the $15 million payment might have to be refunded and thus should be reflected on Thrasys’ financial statement as a customer ‘deposit’ offset with a ‘deposit obligation.’ 2018 T. C. Memo. 199, at pp. 16-17.

A “deposit” or “advance payment” characterization goes off on whether the lucky recipient has a good chance of keeping the boodle, or having to disgorge.  But that doesn’t matter for Rev. Proc. 2004-34 purposes, because that states that deferral does not depend upon the chances of having to give the money back based on a condition subsequent.

Nevertheless, the independent auditor’s conclusion may have justified use of the deposit method based upon changed facts.

So no summary J.

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