The IRS discovered that an S corporation had been “holding back” a large number of checks received in the fourth quarter of its tax year and not depositing them until January of the following year and, not surprisingly being on the cash basis of accounting, not reporting that income until it was deposited in the bank account. Given that the income was constructively received in the earlier year, the IRS issued notices of deficiency that required the taxpayers to pick up that income in the earlier year.
However while the IRS removed the January deposits that were from checks received in the prior year in two of the three years for which it issued notices, the IRS left the January deposits in gross receipts for the first year under exam. The taxpayers in Squeri, et al v. Commissioner, TC Memo 2016-116 protested that the IRS could not do that.
Of course the IRS didn’t remove the January deposits in the first year under exam (2009) because those checks, received in 2008, had not been reported in 2008 and the statute for assessing tax against 2008 was closed by this time. The taxpayers, of course, took the position that was just tough luck for the IRS.
However the IRS argued that even though the income was not properly included in 2009 generally, the taxpayers had to include it under the doctrine of the duty of consistency. The taxpayers had incorrectly asserted that the income was not taxable in 2008 but rather in 2009, thus they could not now take advantage of the statute to now gain an advantage by making use of the correct interpretation of the law.
The Tax Court noted that the Ninth Circuit Court of Appeals, to whom this case would be subject to appeal, had outlined the following standards that must be me for the doctrine of consistency to require a taxpayer to maintain a consistent position on a particular item despite that position being contrary to the law:
The Court of Appeals for the Ninth Circuit has held that for the duty of consistency to apply, the following requirements must be met: (i) a representation or report by the taxpayer, (ii) reliance by the Commissioner, and (iii) an attempt by the taxpayer after the statute of limitations has run to change the previous representation or to recharacterize the situation in such a way as to harm the Commissioner. Estate of Ashman v. Commissioner, 231 F.3d at 545. If all those elements are present, the Commissioner may act as if the previous representation, on which he relied, continues to be true, even if it is not. Id. The taxpayer is estopped to assert the contrary.
The taxpayers argued that although they had made a representation, they had done so consistently and argued that the case of Rivers v. Commissioner, 49 TC 663 (1968) held for the position they did not need to report the income.
The Tax Court did not agree:
In Rivers the taxpayer transferred assets to two corporations in exchange for shares of stock and promissory notes. The corporations made payments on the notes, but the taxpayer did not include any portion of the principal payments on the notes in his tax returns for 1951 through 1960. The Commissioner argued that the taxpayer should be required to report the income under the duty of consistency and the payments should be construed such that all of the early payments, made during years that were not at issue in the case, were payments for the recovery of basis in their entirety, rather than prorating the basis among all of the payments. Id. at 667.
We stated that the duty of consistency requires the taxpayer to take a consistent position with regard to a similar transaction for different tax years. We reasoned that the taxpayer had taken a consistent position with respect to the notes for all of the tax years. Id.
Rivers is distinguishable from the instant cases because we are not being asked to reach a conclusion that conjures a scenario. In Rivers the taxpayer failed consistently to report income from the notes and the Commissioner asked that we disregard the consistency of his reporting. In the instant cases petitioners consistently reported income on the basis of their bank deposits, and respondent is asking that we hold them to this consistent reporting.
Rather the Court the case more analogous to that found in the case of Estate of Ashman v. Commissioner, 231 F.3d 541 where a taxpayer attempted to argue that even though she took the position that a distribution had been rolled into an IRA in a closed year, that later when she took a distribution it should not be taxed in that year because, in fact, the transaction in the closed year had not met the requirements for a rollover. In that case the taxpayer was required to report the income in the year of the distribution to be consistent with her prior reporting.
The Court also found that the IRS had relied upon the taxpayers’ representation that the income was not taxable in 2008, but rather 2009, when it accepted the 2008 tax returns and, as well, that their position now that the income was properly reportable in 2008 was a change in position—thus all three prongs of the test being met, the income for the checks received in 2008 but deposited in 2009 had to be recognized in 2009, consistent with the taxpayers’ prior practice.