In Conmac Investments, Inc. v. Commissioner, the United States Tax Court held that a corporate taxpayer (“Taxpayer”) that owns and leases farmland made an unauthorized change in its method of accounting related to base acres rented to tenant farmers, violating section 446(e)’s consent requirement and. Notwithstanding that the unauthorized change occurred in a closed year, the court sustained an IRS-imposed method change and resulting section 481 adjustment to put the Taxpayer back on its prior method of accounting.
In Conmac, the Taxpayer acquired and leased to tenant farmers farmland that included so-called “base acres” during years ranging from 2004 to 2013. Base acres are a congressionally created right to receive farm program subsidies for the production of certain commodities from the U.S. Department of Agriculture (“base acre payments”). The right to receive the base acre payments attach to the farm rather than the farm owner.
The Taxpayer’s base acres were all farmed by tenant farmers, who in turn collected all base acre payments. Under the leases between the Taxpayer and tenant farmers, tenants paid the Taxpayer annual rent equal to twenty-five percent of the tenant farmer’s gross income from farming activities (including base acre payments received by the tenants).
Historically, the Taxpayer refrained from claiming any amortization or depreciation deductions on its farmland; however, beginning in 2009 the Taxpayer began treating certain of its base acres assets subject to amortization under section 197 (governing the amortization of certain intangible assets), claiming an amortization deduction for base acres acquired and placed in service in 2004 through 2013. The Taxpayer failed to request the IRS’ consent before adopting such treatment (e.g., through filing a Form 3115) and did not otherwise file amended returns reclassifying the base acres rented to tenant farmers as amortizable section 197 intangibles.
During an examination of the Taxpayer’s 2013 and 2014 tax returns, the IRS determined that Taxpayer’s method of accounting for its base acres was not permissible and imposed an exam-related method change on the taxpayer for 2013, including calculating a section 481(a) adjustment for amounts taken into account in the prior, closed years.
In determining whether the Taxpayer made an unauthorized change in method when it began amortizing the base acres, the Tax Court observed that a change in tax reporting attributable to a change in underlying facts is generally not a change in method of accounting. However, a change in fact requires a change in business practices, a change in economic or legal relationships, or an otherwise altered factual situation.
In applying this principle, the Tax Court determined that the Taxpayer’s change was not precipitated by a change in fact because the Taxpayer did not change its economic or legal relationship with tenant farmers through the modification of any lease agreement terms and the only economic consequence resulting from the Taxpayer’s change in treatment was the tax benefit received by Taxpayer from changing its accounting method.
The Tax Court concluded that the change in the treatment of the base acres from nonamortizable to amortizable beginning in 2009 was a change in accounting method, and, as a result, the Taxpayer should have obtained the IRS’ consent by filing a Form 3115 regardless of whether the existing method was proper or permitted.
The Taxpayer’s failure to obtain the IRS’ consent triggered the IRS’ authority to return the Taxpayer to its former method, despite the method being impermissible. As a change in accounting method, the IRS was further permitted to impose a section 481(a) adjustment relating to amounts from closed years.
The Taxpayer argued that even if it was required to file a Form 3115, the lack of prior consent is irrelevant because it related to a closed tax year. Even though not cited by the IRS or the Taxpayer, the Tax Court noted that in Commissioner v. Brookshire Bros. Holding, Inc. the Fifth Circuit held that the IRS’ challenge to a method change for which consent was never given must be for the year of the improper change and that the failure to obtain prior consent does not serve as a basis to challenge a change made in a closed year.
The Tax Court distinguished Brookshire Bros. Holding, Inc. from the facts of this case, noting that unlike the taxpayer in Brookshire Bros., the Taxpayer neither filed amended returns to reflect its change in treatment, nor did the Taxpayer adopt consistent treatment for all of its base acres. The Tax Court concluded that the Taxpayer was precluded from implementing its method change because it failed to obtain the Commissioner’s consent under section 446(e), and as such, the IRS was entitled to change the Taxpayer’s accounting method back to its prior method, notwithstanding that the method change occurred in a closed year. The court further held that under the rules of section 481, the IRS was permitted to impose a section 481 adjustment that included amounts attributable to an otherwise time barred tax year.