                            UNPUBLISHED

                   UNITED STATES COURT OF APPEALS
                       FOR THE FOURTH CIRCUIT


                            No. 05-1667



In re: HEILIG MEYERS COMPANY, d/b/a RoomStore
Furniture, ValueHouse, RentSmart, John M.
Smyth’s   Homemakers,   West    End  Furniture
Company, The HUB, The RoomStore Furniture,
Baton Rouge Furniture Outlet, Bedding Experts,
Incorporated,    Ganz    Furniture,   Guardian
Protection   Products   I,   Heath  Furniture,
McMahan Furniture, Renfrows Furniture, Rhodes
Furniture, Brown’s Furniture,

                                                           Debtor.
---------------------------------------------

HEILIG MEYERS COMPANY; HEILIG-MEYERS FURNITURE
COMPANY;    HEILIG-MEYERS   FURNITURE    WEST,
INCORPORATED; HMY STAR, INCORPORATED; HMY
ROOMSTORE, INCORPORATED; MACSAVER FINANCIAL
SERVICES, INCORPORATED,

                                          Plaintiffs - Appellants,

          versus


INTERNAL REVENUE SERVICE,

                                             Defendant - Appellee,

          and


OFFICIAL COMMITTEE OF UNSECURED CREDITORS,

                                                         Creditor,

          and

US TRUSTEE, Richmond,
                                                            Trustee.


Appeal from the United States District Court for the Eastern
District of Virginia, at Richmond.    Henry E. Hudson, District
Judge. (04-858-3-HEH; 00-34533-DOT; 03-3295-DOT)


Argued:   January 31, 2007                   Decided:    May 9, 2007


Before WILKINSON, NIEMEYER, and SHEDD, Circuit Judges.


Affirmed by unpublished opinion.    Judge Wilkinson wrote the
majority opinion, in which Judge Shedd joined.  Judge Niemeyer
wrote a dissenting opinion.


ARGUED: Michael Brown Quigley, WHITE & CASE, Washington, D.C., for
Appellants.   Joan Iris Oppenheimer, UNITED STATES DEPARTMENT OF
JUSTICE, Tax Division, Washington, D.C., for Appellee. ON BRIEF:
Brian S. Gleicher, Brian P. Arthur, WHITE & CASE, Washington, D.C.,
for Appellants. Chuck Rosenberg, United States Attorney, Eileen J.
O’Connor, Assistant Attorney General, Bruce R. Ellisen, UNITED
STATES DEPARTMENT OF JUSTICE, Tax Division, Washington, D.C., for
Appellee.



Unpublished opinions are not binding precedent in this circuit.




                                2
WILKINSON, Circuit Judge:

      Debtors   Heilig-Meyers    Company    et   al.   filed   an     adversary

proceeding in bankruptcy court challenging a proof of claim filed

by the Internal Revenue Service (“the Service”) for a deficiency

arising from Debtors’ undervaluation of their installment accounts

receivable under the mark-to-market accounting method set forth at

26 U.S.C. § 475(b) (2000).         Debtors contended that their loss

calculation and concomitant deduction were reasonable and should be

sustained. The bankruptcy court upheld the Service’s determination

on the ground that Debtors’ valuation method failed to reflect

income clearly, as required by 26 U.S.C. § 446(b) (2000).                   The

district court affirmed.        Debtors now appeal, claiming that the

§ 446(b) clear reflection of income requirement does not apply to

the   valuation   of   their     accounts    receivable,       and,    in   the

alternative, that if § 446(b) does apply, the bankruptcy court

erred in accepting the Service’s determination.                 Because the

assessment of fair market value is the core of the mark-to-market

method, § 446(b) was correctly applied to Debtors’ valuation.

Because the bankruptcy court properly found that Debtors failed to

meet their burden of proof, it did not err in upholding the

Service’s determination.       We thus affirm.




                                     3
                                      I.

     This appeal involves a tax issue arising in the course of

Chapter   11     bankruptcy   proceedings        for   Debtors   Heilig-Meyers

Company, Heilig-Meyers Furniture Company, Heilig-Meyers Furniture

West, Inc., HMY Star, Inc., HMY RoomStore, Inc., and MacSaver

Financial Services, Inc. (collectively “Debtors”).                Appellant is

Heilig-Meyers Liquidation Trust, successor in interest to Debtors.

Debtors   were    primarily   engaged      in    the   retail    sale    of   home

furnishings, with a large portion of their sales being made through

installment     credit   purchases.        The   dispute   concerns     Debtors’

valuation of their installment accounts receivable under the mark-

to-market method of accounting pursuant to Internal Revenue Code

§ 475, 26 U.S.C. § 475, for the tax year ended February 28, 1997.

      Section 475 imposes the mark-to-market method of accounting

on non-inventory securities held by securities dealers.                 26 U.S.C.

§ 475(a).      Under the mark-to-market method, any security that is

held by a securities dealer at the end of the year and is not

inventory must be “marked to market,” i.e., treated as though it

had been sold for its fair market value on the last business day of

the taxpayer’s taxable year.          Id. § 475(a)(2)(A).         The taxpayer

recognizes a gain or loss equal to the difference between the fair

market value so calculated and the security’s basis.               Id.    If the

taxpayer recognizes a loss on the security -- that is, if the

security’s fair market value on the last day of the taxable year is


                                      4
lower than its basis -- then the taxpayer receives a tax deduction

in the amount of the loss.

     It was unclear under § 475 as originally enacted whether the

statute’s definition of “securities” encompassed debt instruments

that constituted customer paper and thus obligated sellers of

nonfinancial goods and services to use the mark-to-market method

for those items.     See Omnibus Budget Reconciliation Act of 1993,

Pub. L. 103-66, 107 Stat. 312, 481; 26 U.S.C. § 475(c)(2)(C).         The

Department of Treasury promulgated regulations, in effect during

the tax period in dispute here, which provided that if sellers of

nonfinancial goods and services would not qualify as securities

dealers under § 475 but for their nonfinancial customer paper, they

did not constitute securities dealers and thus were not required

under § 475 to use the mark-to-market method.              See 26 C.F.R.

§ 1.475(c)-1(b)(1) (1997).      If, however, the taxpayer so chose, it

could elect § 475 treatment.        See id. § 1.475(c)-1(b)(3), (4).

Thus, for instance, retailers that made loans to customers, such as

Debtors in the present case, could elect to treat their accounts

receivable   in    accordance   with    §   475,   using   mark-to-market

accounting to calculate their gain or loss on such accounts.

Congress subsequently eliminated such election by amending § 475 to

provide that nonfinancial customer paper did not constitute a

“security” for purposes of the statute. See Pub. L. 105-206, Title

VII, § 7003(a), 112 Stat. 685, 832 (1998) (codified at 26 U.S.C.


                                    5
§ 475(c)(4)).       Thus retailers such as Heilig-Meyers may no longer

elect § 475 treatment for their accounts receivable.

     For Debtors’ taxable year ended February 28, 1997, Debtors

elected § 475 treatment for their accounts receivable.            Debtors

filed an Application for Change in Accounting Method, IRS Form

3115, which the Service approved.        Debtors retained Ernst & Young,

LLP, to determine the year-end fair market value of their accounts

receivable for purposes of § 475’s mark-to-market determination.

Ernst   &   Young    partner   Barbara   Rayner   (“Rayner”)   prepared   a

valuation study of the accounts receivable.

     Rayner determined the assets’ fair market value using a

discounted-cash-flow approach, which calculates an accurate present

value by discounting the future cash flow from the asset to present

value at an appropriate discount rate.            The method requires a

determination of the asset’s projected cash flow over its life and

the selection of an appropriate risk-adjusted discount rate for

reducing the future income to its net present value.

     In estimating the future cash flow of the accounts receivable,

Rayner reduced their face value by (1) the cost of servicing the

accounts, estimated at 3% of their face value; (2) anticipated

defaults by some customers; and (3) projected income taxes on the

receivables’ income stream.       In discounting the future income to

present value, Rayner selected a discount rate using a weighted

average cost of capital (“WACC”) methodology, which measures a


                                     6
company’s    cost   of   debt   and   equity    financing   weighted   by   the

percentage of debt and percentage of equity in a company’s capital

structure.    Rayner based her WACC analysis in part on an estimate

of the weighted average required investment return with respect to

the stock of seven consumer credit card companies.            On this basis,

Rayner arrived at a WACC of 11%.            From that rate she derived three

different discount rates for three different categories of Debtors’

accounts receivable: a rate of 8% for current receivables, 15% for

receivables that were 61 to 120 days delinquent, and 22% for

receivables that were 121 to 180 days delinquent.             Applying these

discount rates, she arrived at a fair market value for the accounts

receivable of $1,027,312,671.          As the undisputed book value of the

accounts receivable was $1,073,234,932, Debtors recognized a loss,

and thus a tax deduction, in the amount of $45,922,261.            The § 475

deduction contributed to a net operating loss for the tax year

ended February 27, 1998, the entirety of which Debtors carried back

to the tax year ended February 28, 1994.

     The Service later undertook an audit of Debtors’ federal

income tax returns for the tax years ended February 28, 1994

through February 28, 2001.            The Service concluded that, in the

return for the year ended February 28, 1997, Debtors inaccurately

determined the fair market value of their installment accounts

receivable pursuant to § 475.          The Service identified a number of

problems with Debtors’ methodology. In the determination of future


                                        7
cash flow, the Service questioned Debtors’ estimation of servicing

costs and rejected as improper the reduction of the assets’ value

by Debtors’ anticipated income tax liability on those assets.           In

the discounting of future income to present value, the Service

found Debtors’ discount rates excessive and unfounded.           It found

that the rates allowed too much for risks flowing from potential

customer defaults, both in that the rates themselves overestimated

the likelihood of such defaults and in that Debtors had already

reduced the face value of the receivables for anticipated defaults

when estimating future cash flow.       The Service found a risk-free

discount rate to be more appropriate and, applying a rate of 6.5%,

which was the rate of eighteen-month Treasury securities issued in

February 1997, computed the fair market value of the accounts

receivable   as   $1,048,940,674,   which   resulted    in   a   loss   and

deduction of $24,294,258 rather than $45,922,261. The Service thus

disallowed $21,628,003 of Debtors’ § 475 deduction.

     After Debtors filed for bankruptcy protection, the Service

filed an amended proof of claim seeking to recover, among other

amounts,1 $3,923,904 for underpayment of tax arising from Debtors’

inaccurate § 475 determination and $882,080 in statutory pre-

petition interest, for a total of $4,805,984.          Debtors commenced

this adversary proceeding in the bankruptcy court, objecting to the

Service’s proof of claim.

     1
      Other amounts sought by the Service involved claims not
related to this dispute.

                                    8
     The bankruptcy court heard argument and testimony on December

18, 2003 and January 16, 2004.              The Service called Theodore

Barnhill, Jr., a finance professor at George Washington University,

to testify to the problems with Debtors’ methodology.              Barnhill

conducted his own valuation of Debtors’ accounts receivable as of

February 28, 1997, using the discounted-cash-flow method. Barnhill

employed a range of discount rates from 6.2% to 7.3%, applying the

lower rate to accounts maturing earlier and the higher rates to

accounts maturing later. Based on this method, Barnhill calculated

Debtors’ § 475 deduction at $30,974,000, more than the IRS’s

calculation of $24,294,258 and less than Debtors’ calculation of

$45,922,261.        Barnhill offered several criticisms of Debtors’

method, including Rayner’s estimation of cash flows on a pre-tax

basis, her inappropriate use of a WACC methodology to arrive at

discount rates, and her lack of quantitative justification for her

choice   of   the    three   discount   rates   for   three   categories   of

receivables.

     Debtors attacked Barnhill’s method as inferior to Rayner’s.

They acknowledged that they no longer had accounting records for

the accounts receivable and thus could not provide any substantive

support for the assumptions upon which Rayner’s valuation was

based.    Rayner acknowledged that her valuation report did not

explain her choice of seven consumer credit card companies for the

WACC determination or her selection of discount rates of 8%, 15%,


                                        9
and 22%.     She offered as an explanation for these choices her

judgment as a valuation expert.

       In their initial post-trial brief, Debtors contended that

their valuation method need only be “reasonable” to satisfy I.R.C.

§ 475.    For support, Debtors cited Bank One Corp. v. Commissioner,

120 T.C. 174 (2003), which also involved the mark-to-market method

of   accounting.     In   its   post-trial   reply     brief,   the   Service

responded that the Tax Court in Bank One held that valuation of

property under § 475 is a method of accounting that must clearly

reflect income in accordance with § 446(b).          The Service contended

that     Debtors   therefore     had   to   prove    that   the   Service’s

determination was unlawful or arbitrary.

       In its opinion, the bankruptcy court held that Debtors’

valuation method was subject to § 446(b).           The court noted that in

Bank One, the Tax Court held that the taxpayer’s burden was to

prove that the Commissioner’s determination was clearly unlawful or

plainly arbitrary, by establishing that its own method clearly

reflected income.      In re Heilig-Meyers Co., 316 B.R. 866, 870

(Bankr. E.D. Va. 2004).         The court found that Debtors failed to

meet this burden due to three flaws in its valuation.                 First,

Rayner’s estimate of servicing costs at 3% of the face value of the

accounts receivable was contradicted by Debtors’ contemporaneous

assertion on an SEC Form 10-K that they could not accurately

calculate figures necessary to such an estimation.          Id. at 871-72.


                                       10
Second, Rayner’s WACC analysis was questionable because she was

unable to justify her selection of the seven particular credit card

companies on which she based her analysis.         Id. at 872.      Third,

Rayner    did   not   adequately    justify   or   provide     independent

verification for the three discount rates she chose.             Id.    The

court found that while Debtors had raised questions about the

valuation study of Service expert Barnhill, the fact remained that

Debtors bore the burden of showing their accounting method clearly

reflected income.     Id. at 873.   The court allowed the Government’s

claim    in   the   amount   of   $4,815,907.51,   which     included   the

recalculation of the § 475 deduction in the amount determined by

the Service.    Id.

     In the district court, Debtors argued that the bankruptcy

court erred in applying the § 446(b) clear reflection of income

requirement and should instead have considered Debtors’ valuations

under a reasonableness standard. Debtors also argued that, even if

§ 446(b) applied, the bankruptcy court had to make findings that

the Service’s valuation clearly reflected income before it could

uphold the Service’s determination.       The district court affirmed

the bankruptcy court.        It upheld the application of § 446(b)

because “[t]he income tax regulations clearly provide that ‘[t]he

term ‘method of accounting’ includes not only the overall method of

accounting of the taxpayer but also the accounting treatment of any

item.’” In re Heilig-Meyers Co., No. 00-34533, 2005 WL 1303351, at


                                    11
*3 (E.D. Va. 2005) (quoting 26 C.F.R. § 1.446-1(a)(1)).           The

district court further held that Debtors bore the burden of showing

that the Service’s determination of deficiency was clearly unlawful

and that they had failed to do so.      Id. at *4.   Debtors appeal.

        This Court reviews the judgment of a district court sitting in

review of a bankruptcy court de novo, using the same standards of

review used in the district court.      Thus we review the bankruptcy

court’s factual findings for clear error and questions of law de

novo.     In re Litton, 330 F.3d 636, 642 (4th Cir. 2003).



                                  II.

        Debtors’ principal contention is that § 446(b) does not apply

to the determination of the fair market value of their accounts

receivable because such a determination does not constitute a

method of accounting governed by § 446(b).           We hold that the

bankruptcy court properly applied § 446(b).

        Section 446 sets forth, and indeed bears the title of, a

“[g]eneral rule for methods of accounting.”          26 U.S.C. § 446.

Section 446(a) provides, “Taxable income shall be computed under

the method of accounting on the basis of which the taxpayer

regularly computes his income in keeping his books.” Id. § 446(a).

Section 446(b), meanwhile, sets forth an important exception: “[I]f

the method used does not clearly reflect income, the computation of

taxable income shall be made under such method as, in the opinion


                                   12
of the Secretary, does clearly reflect income.” Id. § 446(b).

Treasury Regulations further provide that “no method of accounting

is acceptable unless, in the opinion of the Commissioner, it

clearly reflects income.”          26 C.F.R. § 1.446-1(a)(2).

      Section       446   constitutes   a    recognition      that    the   aims    of

financial accounting and tax accounting, while sometimes congruent,

often diverge.       See Thor Power Tool Co. v Comm’r, 439 U.S. 522, 542

(1979) (noting the “vastly different objectives that financial and

tax accounting have”). While financial accounting aims “to provide

useful information to management, shareholders, creditors, and

others properly interested,” tax accounting serves to facilitate

the “equitable collection of revenue” and to “protect the public

fisc.”     Id.      For this reason, an accounting method that may be

entirely satisfactory for book purposes may be unsatisfactory for

reporting taxable income.          The design of § 446 is clear: whatever

accounting method is used by the taxpayer to calculate income, that

method must render a clear reflection of income consistent with the

goals    of   the    Internal   Revenue     Service,    as    determined     by    the

Service.

      As part of § 446’s general rule, § 446(b)’s clear reflection

of income requirement applies to all methods of tax accounting. As

the   Treasury       Regulations    make     clear,    “The    term    ‘method     of

accounting’ includes not only the overall method of accounting of

the taxpayer but also the accounting treatment of any item.”                        26


                                        13
C.F.R § 1.446-1(a)(1); see Thor, 439 U.S. at 531 n.10.                   Thus the

clear   reflection     of   income   requirement    applies       both    to    the

taxpayer’s overall accounting method, e.g., cash method or accrual

method, and also to the “accounting treatment of any item,” such as

inventory accounting for items of inventory, or mark-to-market

accounting under § 475.       26 C.F.R § 1.446-1(a)(1); see 26 U.S.C.

§§ 471-74 (inventory accounting); id. § 475.

      This case concerns what it means to say that the accounting

treatment of an item -- specifically, the marking to market of

Debtors’   accounts     receivable    under   §   475   --   is    subject      to

§   446(b)’s   clear   reflection     of   income   requirement.           It    is

undisputed that § 446 allows the Service to determine whether a

given accounting method -- either an overall method or the method

for a specific item -- is an appropriate method for accurately

representing taxable income. If the type of accounting method used

by the taxpayer does not result in a clear reflection of income,

the Service may compel the taxpayer to employ another method.                   See

id. § 446(b).

      Debtors recognize this power of the Service, but they contend

that it constitutes the entire scope of § 446(b).                        Once the

question of what accounting method to use is settled, Debtors

argue, the taxpayer’s particular employment of that method is not

governed by § 446(b).         Thus they argue that § 446(b) has no

relevance in this case, where it is undisputed that Debtors sought


                                      14
and received the Service’s approval to use § 475’s mark-to-market

method on their accounts receivable.    Rather, Debtors claim, this

conflict pertains merely to valuation, and thus the § 446(b) clear

reflection of income requirement has no bearing.      The Service, in

invoking § 446(b), is improperly framing a valuation dispute as a

clash over accounting methods.

       Debtors’ contention is not supportable.    The Supreme Court’s

elucidation of § 446(b) establishes that it is not limited to the

threshold question of which type of accounting method the taxpayer

should use.     See Thor, 439 U.S. at 532.       Where, as here, the

accounting method at issue essentially consists of a determination

of market value, § 446(b) applies to that determination.         The

conclusions of the Tax Court and one of our sister circuits in the

specific § 475 context further confirm that Debtors’ reading of

§ 446(b) is foreclosed in this instance.

       In Thor Power Tool Co. v Comm’r, 439 U.S. at 526-27, the

Service took issue with tool manufacturer Thor Power Tool Co.’s

determination of losses stemming from certain items of inventory --

namely, 44,000 pieces of excess merchandise, most of them spare

parts and accessories.    To value these items, Thor employed the

“lower of cost or market” (LCM) method of inventory accounting.

See id. at 533.   Under this method, the taxpayer values inventory

at either cost or market value, whichever is lower.       See id. at

535.   Thor put the market value of the items of excess merchandise


                                 15
at approximately their scrap value and thus recognized a loss on

those items, which contributed to a net operating loss for the

year.    See id. at 524.   Meanwhile, however, Thor continued to offer

the “excess” items for sale at their original prices.     See id.   The

Commissioner disallowed the offset on the ground that Thor’s

valuation of the inventory did not constitute a clear reflection of

income as required by §§ 446(b) and 471.2        Id. at 524, 530.   The

Court agreed, concluding that “the Commissioner acted within his

discretion in deciding that Thor’s write-down of ‘excess’ inventory

failed to reflect income clearly.”      Id. at 537-38.

        Thor is significant because there was no contention that Thor

should have been using a different type of accounting method.       The

government did not take issue with the fact that “[a]t all times

relevant, Thor has used . . . the ‘lower of cost or market’ method

of valuing inventories.”     Id. at 525.   Nevertheless, this did not

answer the question of whether Thor’s “particular method” was

clearly reflective of income.      Id. at 532.   The Court agreed with

the Commissioner that the taxpayer’s particular valuation method

had failed to “reduce[] its inventory to ‘market’ in accord with

     2
      Section 471 provides that “inventories shall be taken . . .
on such basis as the Secretary may prescribe as conforming as
nearly as may be to the best accounting practice in the trade or
business and as most clearly reflecting income.”      26 U.S.C. §
471(a). The Supreme Court in Thor made clear that the existence of
§ 471 is not an indication that § 446(b) does not apply to
inventory accounting. Rather, “[i]nventory accounting is governed
by §§ 446 and 471 of the Code.” 439 U.S. at 531. Thus the Court
reinforced what is clear from the face of § 446 -- that it governs
all methods of tax accounting.

                                   16
its ‘lower of cost or market’ method of accounting.”                      Id. at 530;

see id. at 532.          Thus, the clear reflection of income standard

applied not just to the selection of the LCM method over other

accounting methods, but to Thor’s determination of market value in

the course of employing the LCM method.

      The circumstances of Thor are strikingly similar to those of

the   present   case.       In     Thor,    the    Service     asserted       that   the

taxpayer’s determination of the market value of certain assets for

the purposes of a permitted tax accounting method failed to reflect

income clearly.      Id. at 537-38.         In this case, the Service asserts

that the taxpayer’s determination of the fair market value of

certain assets for the purposes of a permitted tax accounting

method    failed    to   reflect    income       clearly.       The    only     apparent

distinction is that in Thor the Treasury Regulations on proper LCM

methodology     were     more    specific       than   those    that    pertained     to

Debtors’ mark-to-market methodology.3                  The Court concluded that

Thor’s valuation procedures were “inconsistent with this regulatory

scheme.”     Id. at 535.         But this circumstance is immaterial to

Thor’s application to the present case.                  The Court noted Thor’s

lack of regulatory compliance simply as an indication that the

Commissioner       was    within    his     discretion         in     finding    Thor’s

      3
      Specifically, in Thor, Treasury Regulations defined “market
value” to mean the current bid price for the merchandise in the
volume usually purchased by the taxpayer and further identified two
limited circumstances in which the taxpayer could value inventory
at below market value so defined. See id. at 534-35 (citing 26
C.F.R. § 1.471-2(c), -4 (1964)).

                                           17
determinations not clearly reflective of income.         See id. at 533,

537. The fact remains that the Court subjected Thor’s market value

determination   to   the   clear   reflection   of   income   standard   of

§ 446(b).

     The Tax Court and the Seventh Circuit recently reached the

same conclusion about the precise issue in dispute here: the

determination of the fair market value of assets under the mark-to-

market method of § 475.    See Bank One Corp. v. Comm’r, 120 T.C. 174

(2003), aff’d in part, vacated in part sub nom. JPMorgan Chase &

Co. v. Comm’r, 458 F.3d 564 (7th Cir. 2006).              JPMorgan Chase

involved transactions known as interest swaps, which were subject

to § 475’s mark-to-market method.         See 458 F.3d at 568.           The

Commissioner rejected the taxpayer’s determination of the swaps’

fair market value as not clearly reflective of income as required

by § 446(b).    At the Tax Court level, the taxpayer asserted, as

Debtors do here, that the dispute was “a ‘valuation case,’ as

opposed to a method of accounting case, and that [taxpayer’s]

valuations must be sustained because its underlying methodology was

reasonable.”    120 T.C. at 281.         The Tax Court rejected this

contention and held that “the reporting of income under section

475, inclusive of the valuation requirement subsumed therein, is a

method of accounting.”     Id. at 282 (emphasis added).       The Seventh

Circuit agreed, stating in no uncertain terms that “[t]he method of

determining ‘fair market value’ under section 475 falls within the


                                    18
definition      of    ‘method’”        for   §    446(b)’s    requirement   that   the

taxpayer’s “method of accounting” must clearly reflect income. 458

F.3d at 570.         Thus the Tax Court and the Seventh Circuit rejected

Debtors’ contention that § 446(b) places no limitations on how the

taxpayer   implements        the       mark-to-market        method.   Instead,    the

determination of an asset’s fair market value for § 475 must

clearly reflect income.            Id.

     In light of this case law, it is difficult to read §§ 446(b)

and 475 otherwise than to subject determinations of fair market

value   under    §     475   to    §    446(b)’s     clear    reflection    of   income

requirement.         Debtors’ position to the contrary is inconsistent

with the Court’s approach in Thor and directly contradicts the

reasoned conclusion of the Tax Court and the Seventh Circuit in

JPMorgan Chase. Nor does our conclusion portend, as Debtors claim,

that the Service will attempt to bring every valuation dispute

within the compass of § 446(b).                  Here, as in Thor, the accounting

method at issue essentially consisted of the determination of the

market value of the asset.                   The LCM method involved in Thor

required the valuation of inventory at the lower of market or cost,

and thus necessarily entailed the determination of market value.

The mark-to-market method of § 475 requires nothing other than that

the taxpayer peg the asset’s value to its fair market value on the

last business day of the taxable year.                 In such instances, for the

taxpayer to fail to assess market value appropriately is in essence


                                             19
for it to have failed to execute the accounting method.                         In

contrast, a valuation that does not constitute the core of an

accounting method will not implicate § 446(b).               See, e.g., Estate

of Godley v. Comm’r, 286 F.3d 210 (4th Cir. 2002) (valuation of

asset for estate tax); Krapf v. United States, 977 F.2d 1454 (Fed.

Cir. 1992) (valuation of asset donated to charity). Our conclusion

today merely gives effect to the unexceptionable proposition that

a taxpayer may not, by invoking the name of an accounting method

that purports to reflect income, employ a methodology that does

not.       See Thor, 439 U.S. at 532.         To hold otherwise would be to

allow taxpayers to subvert the entire aim of § 446 merely by

confining the devil to the details.           See id. at 536 (“If a taxpayer

could write down its inventories on the basis of management’s

subjective estimates . . . the taxpayer would be able, as the Tax

Court observed, to ‘determine how much tax it wanted to pay for a

given year.’”)(citation omitted).

       Thus we affirm that Debtors’ determination of the fair market

value      of   its   accounts   receivable    under   §   475   is   subject   to

§ 446(b)’s clear reflection of income requirement.4

       4
      Debtors also argue that, as a procedural matter, the
bankruptcy court should not have considered the § 446(b) argument
because the Service did not refer to that provision until its
post-trial reply brief. While early notice of the Commissioner’s
legal theory is certainly preferable to late, “the Commissioner
does not necessarily forfeit his right to rely on a theory by
failing to raise it at the preferred times.” Ware v. Comm’r, 906
F.2d 62, 65 (2d Cir. 1990). The question is whether the timing of
the argument specifically prejudices the taxpayer. Id.
     In this case, Debtors do not identify any manner in which they

                                       20
                                     III.

      Debtors contend that, even if the bankruptcy court did not err

in   applying   §   446(b),   it   erred    in    upholding     the    Service’s

determination.      Having found that the application of § 446(b) was

proper, we also affirm the bankruptcy court’s factual findings

under that standard and its conclusion that the Commissioner’s

determination should be upheld.

      Section   446(b)   provides,    “[I]f      the   method   used    [by   the

taxpayer] does not clearly reflect income, the computation of

taxable income shall be made under such method as, in the opinion

of the Secretary, does clearly reflect income.”                 Id. § 446(b).

This provision gives the Commissioner “broad powers” to reject a

taxpayer’s accounting method and to substitute his own. See Comm’r

v. Hansen, 360 U.S. 446, 467 (1959).

      The Supreme Court made clear in Thor that the Commissioner’s

rejection of the taxpayer’s accounting method would be upheld

unless the taxpayer showed that it was “clearly unlawful” or

“plainly arbitrary.”     See Thor, 439 U.S. at 532; Bank One, 120 T.C.

at 288.   In accordance with Thor, Debtors’ first burden in this

case was to show that the Service’s rejection of their accounting

were prejudiced, nor do we conclude that they were. Characterizing
the Service as claiming that the valuation was not accurate, versus
that it did not clearly reflect income, does not change the nature
of the dispute or what evidence would be relevant at trial. See,
e.g., Nat’l Ass’n of Life Underwriters, Inc. v. Comm’r, 30 F.3d
1526, 1531 (D.C. Cir. 1994) (suggesting no prejudice where question
is “how to characterize the transactions involved, the raw facts
seeming to be established”).

                                     21
method was clearly unlawful or plainly arbitrary. In essence, this

burden required Debtors to show that their own method clearly

reflected income, for if it did, the Commissioner’s determination

would perforce be unlawful or arbitrary. See, e.g., Thor, 439 U.S.

at 536, 538 (Thor failed to prove Commissioner’s rejection of its

market valuation was unlawful or arbitrary where it “provided no

objective evidence” of its valuation).

     The bankruptcy court found that the taxpayer failed to bear

this burden due to three specific flaws in its determinations.

First, Debtors’ estimation of servicing costs at 3% of the face

value of the accounts receivable did not square with Debtors’

earlier assertion in a Securities and Exchange Commission Form 10-k

that they were unable to give an accurate estimate of numbers upon

which the 3% figure depended.       Second, the bankruptcy court found

Debtors’ WACC analysis unpersuasive because Debtors’ expert Rayner

was unable to provide any explanation for how she came to base the

WACC analysis on the stock of seven particular consumer credit card

companies out of the dozens of such companies that exist. Finally,

the bankruptcy court found insufficient support for the three

discount rates employed by Debtors, because Rayner offered no

explanation   for   the   choice   of   rates   other   than   her   personal

judgment as a valuation expert.5         Given the effect these actions


     5
     In addition to these issues noted by the bankruptcy court,
Rayner estimated the future cash flow of the receivables on a post-
tax rather than a pre-tax basis.

                                    22
had of inflating the losses recognized by Debtors under § 475, and

given Debtors’ inability to offer satisfactory explanations for

these actions at trial, the bankruptcy court had ample reason to

uphold the Commissioner’s rejection of Debtors’ determinations.

     Debtors contend that, even if Debtors’ calculations were

properly rejected, the bankruptcy court could not uphold the

Commissioner’s determination without make findings as to its clear

reflection of income.        In this, Debtors overlook factual findings

made by the court and misconstrue their own burden of proof.               Under

§ 446(b), the Service has broad powers not only to reject the

taxpayer’s accounting method but also to substitute one that, “in

the opinion of the Secretary, does clearly reflect income.”                    26

U.S.C.    §   446(b).      These    powers    are   not   unbounded:   like    the

rejection of the taxpayer’s method, the Commissioner’s substitution

of a new method may not be clearly unlawful or plainly arbitrary.

See Dayton Hudson Corp. & Subsidiaries v. Comm’r, 153 F.3d 660, 667

(8th Cir. 1998) (taxpayer succeeded in establishing that “the

Commissioner’s method does not reflect income and is plainly

arbitrary”); Russell v. Comm’r, 45 F.2d 100, 101 (1st Cir. 1930)

(“An arbitrary adoption of a substitute method of computing a tax,

which    does   not   in   fact    ‘clearly   reflect     the   income’   of   the

taxpayers, cannot be sustained.”).            This standard squares with the

general principle in federal tax disputes that the Commissioner’s

determination of deficiency will not be overturned unless the


                                        23
taxpayer proves it is “arbitrary and excessive.”                        Cebollero v.

Comm’r, 967 F.2d 986, 990 (4th Cir. 1992) (quoting Helvering v.

Taylor, 293 U.S. 507, 515 (1935)).

       Under this standard, after the bankruptcy court rejected

Debtors’ method as not clearly reflective of income, it was not

then    the   court’s        task   to   determine        de    novo    whether      the

Commissioner’s method clearly reflected income.                        It was rather

Debtors’ burden to prove that it did not.                      The Seventh Circuit

recently and persuasively addressed this issue in JPMorgan Chase.

In that case, as noted above, the Seventh Circuit affirmed the Tax

Court’s conclusion that fair market valuation of interest swaps

under § 475 was subject to the § 446(b) clear reflection of income

requirement.         458 F.3d at 570.         The Tax Court, however, after

rejecting     the     taxpayer’s     method,       went    on    to     analyze      the

Commissioner’s method to determine whether it accurately reflected

the fair market value of the swaps.               120 T.C. at 329-30.          The Tax

Court found that it did not and instructed the parties to prepare

a new computation following the court’s instructions.                    Id. at 331.

The Seventh Circuit rejected this approach.                Recognizing that “the

Supreme Court instructs that the Commissioner’s interpretation may

not be set aside unless clearly unlawful or plainly arbitrary,” it

concluded     that    “the    tax   court   was    required      to    defer    to   the

Commissioner’s method of calculating fair market value.”                       458 F.3d

at 570 (internal quotation marks omitted).


                                         24
     Similarly, in this case, the bankruptcy court properly upheld

the Service’s determination.        The bankruptcy court opinion offers

sufficient grounds for its conclusion that the Commissioner’s

determination should be upheld.              The only deficiency the court

notes in relation to the Service’s claim regards one aspect of its

expert Barnhill’s valuation study.              See In re Heilig-Meyers Co.,

316 B.R. at 872-73.      The bankruptcy court then went on explicitly

to uphold the Service’s determination of the § 475 loss and the

amount of tax owed.         Id. at 873.      Given these findings, it seems

clear   that   the    bankruptcy   court      did   not   find   the   Service’s

determination    to    be    unlawful     and     arbitrary,     nor   does   the

established record suggest it should have done so.               The court must

“afford the Commissioner the deference due under the statutory

scheme,” JPMorgan Chase, 458 F.3d at 570, as “[i]t is not the

province of the court to weigh and determine the relative merits of

systems of accounting,” Brown v. Helvering, 291 U.S. 193, 204-05

(1934).   Just as Debtors did not meet their burden of proving that

their own method clearly reflected income, they also failed to

prove that the Commissioner’s did not, and thus the bankruptcy

court did not err in upholding the Service’s claim in full.




                                        25
                                      IV.

     A word finally as to the dissent.               The dissent makes no

pretense of trying to reconcile its position with the most relevant

case from the Supreme Court.          It all but ignores the Thor Power

Tool decision.     The Court in Thor took exactly the approach that we

do here, finding that, regardless of the fact that the taxpayer’s

overall accounting method and specific accounting method were

agreed upon, the taxpayer’s particular way of determining market

value    was   subject   to   §   446(b)’s   clear   reflection   of   income

requirement.      See 439 U.S. at 532.         At issue in Thor was the

valuation of spare parts in inventory; the taxpayer’s method of

accounting was required in that case to reflect income clearly, and

we can see no reason, nor does appellant suggest any, why the

treatment should vary with respect to the accounts receivable in

this case.     We are bound to implement the law as interpreted by the

Supreme Court, and yet the dissent would overrule the Court on this

point summarily.6

     Nor does the dissent acknowledge that it would place this

court at loggerheads with both the Tax Court and the Seventh



     6
      The dissent’s purported distinction of Thor is, as we have
noted, “immaterial to Thor’s application to the present case. The
Court noted Thor’s lack of regulatory compliance simply as an
indication that the Commissioner was within his discretion in
finding Thor’s determinations not clearly reflective of income.
See id. at 533, 537. The fact remains that the Court subjected
Thor’s market value determination to the clear reflection of income
standard of § 446(b).” See supra, at 17-18.

                                      26
Circuit in JPMorgan Chase.7   The approaches of the Supreme Court,

the Tax Court, the Seventh Circuit, and this court today give

effect to a simple proposition -- that the taxpayer may not avail

itself of an accounting method, the entire substance of which

consists of accurately determining market value, only to implement

it in a way that does no such thing.       It is for this reason that

“the reporting of income under section 475, inclusive of the

valuation requirement subsumed therein, is a method of accounting.”

Bank One, 120 T.C. at 282. The dissent’s contrary approach accords

little respect to this body of law or to “the discretion rested by

Congress   in   the   Secretary     and   the   Commissioner   for   the

administration of the tax laws.”     United States v. Catto, 384 U.S.

102, 114 (1966).      Nor does it afford proper deference to the

factual findings of the bankruptcy court and its explicit adoption

of the Commissioner’s determination in light of the taxpayer’s

continuing burden of proof.       In all of these respects, we do not

write on a blank slate.

     Thus we conclude that § 446(b) was properly applied to the

valuation of Debtors’ accounts receivable under § 475, and we

     7
      The dissent suggests that the Seventh Circuit in JPMorgan
Chase placed the burden on the Service to establish that its method
was lawful and not arbitrary.     But the Court in JPMorgan Chase
clearly stated, “In applying the arbitrary or unlawful standard,
the tax court should bear in mind that the taxpayer retains the
burden of proof.”    458 F.3d at 571.    The dissent also entirely
ignores the fact that the Seventh Circuit only remanded on this
issue because the Tax Court made an error that the bankruptcy court
here did not: it showed too little deference to the Commissioner’s
method. Id. at 571-72.

                                    27
affirm the upholding of the Commissioner’s determination.   The

judgment of the district court is hereby

                                                     AFFIRMED.




                               28
NIEMEYER, Circuit Judge, dissenting:

      Relying on 26 U.S.C. § 446(b), the majority permits the IRS

simply to characterize the dispute in this case as one involving

the taxpayer’s method of accounting and thereby avoid a trial and

decision by a factfinder on the fair market value of the taxpayer’s

accounts receivable.

      During the course of this litigation, the IRS declared that

the   taxpayer’s      valuation   of    its    accounts     receivable    was    an

accounting method that did not clearly reflect income.                Therefore,

the   IRS   claimed    its   right     under   §   446(b)    to   recompute     the

taxpayer’s taxes under a method that does clearly reflect income.

The problem with this approach was that the IRS and the taxpayer

did not dispute a method of accounting, but only the valuation of

the taxpayer’s asset -- its accounts receivable.                     All of the

taxpayer’s practices properly regarded as methods of accounting

were never in dispute, and the methods the taxpayer used clearly

reflected income (or loss) to the very last detail.

      The IRS and the taxpayer agreed on the taxpayer’s overall

method of accounting -- the accrual method.                   The IRS and the

taxpayer agreed on how, under the accrual method, to value the

taxpayer’s accounts receivable -- the mark-to-market method.                    The

IRS and the taxpayer agreed on how to calculate income or loss

using the mark-to-market method -- by subtracting the market value

of the accounts receivable from their book value.                 The IRS and the


                                        29
taxpayer agreed on the method of determining the market value of

the receivables -- by reducing the book value to present value by

applying a discount rate.    The IRS and the taxpayer agreed on the

book value of the accounts receivable -- $1,073,234,932.         Finally,

the IRS and the taxpayer agreed on how to determine the discount

rate -- by adding a risk premium to the risk-free rate of return.

In short, there was no disagreement over the taxpayer’s method of

accounting.*   Moreover,    this   agreement   on   accounting   methods

resulted in very similar valuations.       The IRS and the taxpayer

agreed on a value of the taxpayer’s accounts receivable within 2%.

The narrow disagreement between the IRS and the taxpayer was over

the proper risk premium to add to the risk-free rate of return to

get a discount rate to apply to the book value, ultimately to reach

the market value.   That narrow issue is a factual question that

must be resolved by a factfinder.

     Under the majority’s view, the taxpayer never receives a trial

on the fact of the appropriate risk premium by which to discount


     *
      This agreement on the method of accounting makes this case
quite different from Thor Power Tool Co. v. Commissioner, 439 U.S.
522 (1979), on which the majority relies. In Thor Power Tool, the
taxpayer’s   “method   of  inventory   accounting”   was   “plainly
inconsistent with the governing Regulations” and the taxpayer
“‘made no effort to determine the purchase or reproduction cost’ of
its ‘excess’ inventory.”    Id. at 532-33, 535 (emphasis added).
This distinction also applies to JPMorgan Chase & Co. v.
Commissioner, 458 F.3d 564, 569 (7th Cir. 2006), where the
taxpayer’s method of accounting similarly violated IRS regulations.
Here, not only was the taxpayer’s method of accounting consistent
with all governing law and regulations, but the IRS explicitly
agreed with the taxpayer’s method in all material respects.

                                   30
the book value of its accounts receivable.     Rather, the majority

upholds the IRS’s post-trial declaration that the selection of a

particular risk premium is a method of accounting within the IRS’s

regulatory purview.    Under the majority’s view, at no point is the

taxpayer entitled to a finding of fact on the disputed issue by a

neutral adjudicator.     Thus, the IRS may always decree that the

taxpayer’s position on valuing accounts receivable fails to clearly

reflect income and therefore is subject to recomputation by the IRS

under 26 U.S.C. § 446(b) without a trial.    The IRS’s authority to

regulate the tax accounting system, however, does not reach down to

this level of detail, and it should not.        If the IRS and the

taxpayer disagree on the proper discount percentage to apply to the

book value of the taxpayer’s accounts receivable, the taxpayer is

entitled to have a factfinder resolve the disagreement.

     What is even more troubling in this case is that even if the

IRS had such a broad authority to deny the taxpayer a fact trial on

its accounts receivable valuation, its exercise of that power was

unreasonable and unfair.   The IRS undertook to exercise its “clear

reflection” authority for the first time in a litigation document

prepared after trial.     The IRS thus put the taxpayer through an

elaborate and costly trial, undertaken to determine the valuation

of the accounts receivable, only to then preempt the trial’s

results by declaring, during post-trial briefing, that the case was

resolvable by IRS fiat under § 446(b).      (As the IRS’s internal


                                 31
procedures now recognize, this practice was unreasonable. See Rev.

Proc. 2002-18 § 7, 2002-1 C.B. 678).              Deference to the IRS’s

regulatory authority under 26 U.S.C. § 446(b) should be based on

more than the post-trial briefing decision of a Department of

Justice   line    attorney.   See   Bowen    v.    Georgetown   University

Hospital, 488 U.S. 204, 213 (1988) (“Deference to what appears to

be nothing more than an agency’s convenient litigating position

would be entirely inappropriate”).

     Even under its own rationale, the majority has chosen the

wrong remedy.      In cases where the IRS declares unreasonable a

taxpayer’s method of accounting, the IRS must still demonstrate

that its own method is lawful and not arbitrary.           In this case,

the bankruptcy court, despite finding several serious flaws with

the IRS’s valuation, did not decide whether that valuation was

lawful and not arbitrary.       The Seventh Circuit, on which the

majority relies so heavily, has required just such a remand.          See

JPMorgan Chase, 458 F.3d at 572 (vacating in part and remanding for

evaluation   of   Commissioner’s    chosen   valuation    method).    The

majority improperly assumes that even though the bankruptcy court

has never addressed the issue, it would nonetheless uphold the

IRS’s method.     But that is not our decision to make.

     My position is not a far-reaching one -- only a demand for

simple procedural fairness.    My position does not deny the IRS any

of the authority that it was given under the Internal Revenue Code.


                                    32
I would simply remand this case so that the bankruptcy court can

determine the value of the taxpayer’s accounts receivable. The IRS

should not be able to avoid such factfinding simply by declaring

that    the   taxpayer’s   “method        of   accounting”   is   improper,

particularly after agreeing to every aspect of that accounting

method. This case centers solely on the proper percentage by which

to reduce book value to market value, and up until now, the

taxpayer has not had the opportunity to have this issue tried and

resolved.     Under the majority’s holding, it never will.

       In sum, I would reverse the judgment of the district court and

remand the case to the district court with instructions to remand

the case to the bankruptcy court to make a factual finding on the

proper valuation of the taxpayer’s accounts receivable.




                                     33
