                          T.C. Memo. 1995-496



                      UNITED STATES TAX COURT



     OHIO PERIODICAL DISTRIBUTORS, INC., f.k.a. SCOTT KRAUSS
          NEWS AGENCY, INC., RONALD E. SCHERER TRUST AND
           LINDA S. HAYNER TRUST, PERSONS OTHER THAN THE
                 TAX MATTERS PERSON, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12982-94.                  Filed October 16, 1995.



     Daniel M. Davidson, for petitioners.

     James E. Kagy, for respondent.



                          MEMORANDUM OPINION


     RAUM, Judge:   The Commissioner determined adjustments in the

S corporation's income in the amounts of $3,869,422, ($101,725),

$165,516, and $464,205 for its taxable years 1985, 1986, 1987,

and 1988, respectively.     At issue is whether an election made by
                                - 2 -

the corporation under section 4581, resulting in the exclusion

from gross income of the amount of the corporation's income

attributable to returns from "qualified" sales of magazines and

paperbacks, requires the making of a corresponding adjustment to

cost of goods sold pursuant to section 1.458-1(g), Income Tax

Regs.    More specifically at issue is the validity of section

1.458-1(g), Income Tax Regs., which, if valid, would without

dispute require a decision against petitioner.

     Ohio Periodical Distributors, Inc. ("Ohio Periodical" or

"the corporation") has been operating as an S corporation in Ohio

since 1984.    At all times relevant, the corporation prepared its

Federal income tax returns using the accrual method of

accounting.    It was a wholesale distributor of magazines and

paperback books.    Its customers were bookstores and other

businesses engaged in the retail sale of such merchandise to the

public.

     At all times relevant, in accordance with industry practice,

Ohio Periodical sold more copies of paperbacks and magazines to

its customers than it expected the customers to resell.    The

corporation nevertheless billed its customers for the full number

of copies thus sold to them.    However, in accordance with

industry practice, the customers had the legal right to receive




     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue.
                                 - 3 -

full credit from the corporation for the magazines and paperbacks

that they were unable to resell.

     On its 1982 Federal income tax return, Ohio Periodical made

a proper election to use the provisions of section 458.2    The

election was effective for the 1982 tax year and every tax year

thereafter.    For each of the years in issue, the corporation made

sales and had returns of those sales items during the merchandise

return period, defined in section 458(b)(7).3    Such sales were




     2
       Sec. 458. MAGAZINES, PAPERBACKS, AND RECORDS RETURNED
AFTER THE CLOSE OF THE TAXABLE YEAR.

     (a) Exclusion From Gross Income.--A taxpayer who is on an
accrual method of accounting may elect not to include in the
gross income for the taxable year the income attributable to the
qualified sale of any magazine, paperback, or record which is
returned to the taxpayer before the close of the merchandise
return period.
     3
         Sec. 458(b)(7) reads:

            (7)   Merchandise return period.--

                 (A) Except as provided in subparagraph (B),
            the term "merchandise return period" means, with
            respect to any taxable year--

                       (i) in the case of magazines, the
                  period of 2 months and 15 days first
                  occurring after the close of taxable year, or

                       (ii) in the case of paperbacks and
                  records, the period of 4 months and 15 days
                  first occurring after the close of the
                  taxable year.

                 (B) The taxpayer may select a shorter period
            than the applicable period set forth in
            subparagraph (A).
                                 - 4 -

qualified sales under section 458(b)(5)4 because the corporation

had a legal obligation to adjust the price if the item was not

resold and the price was adjusted because of failure to resell.

On its Federal income tax returns for each of the years in issue,

Ohio Periodical, pursuant to section 458(b)(6),5 excluded from

gross income the amount of the qualified returns.    The

corporation did not, however, make a corresponding adjustment to

cost of goods sold pursuant to section 1.458-1(g), Income Tax

Regs.

     In 1994, the Commissioner issued a Notice of Final S

Corporation Administrative Adjustment for the corporation's 1985



     4
         Sec. 458(b)(5) reads:

          (5) Qualified sale.--A sale of a magazine,
     paperback, or record is a qualified sale if--

                 (A) at the time of sale, the taxpayer has a
            legal obligation to adjust the sales price of such
            magazine, paperback, or record if it is not
            resold, and

                 (B) the sales price of such magazine,
            paperback, or record is adjusted by the taxpayer
            because of a failure to resell it.
     5
         Sec. 458(b)(6) reads:

          (6) Amount excluded.--The amount excluded under
     this section with respect to any qualified sale shall
     be the lesser of--

                 (A) the amount covered by the legal
            obligation described in paragraph (5)(A), or

                 (B) the amount of the adjustment agreed to
            by the taxpayer before the close of the
            merchandise return period.
                                - 5 -

taxable year.   At about the same time, the Commissioner also

issued Notices of Final S Corporation Administrative Adjustment

for the corporation's 1986, 1987, and 1988 taxable years.

     The Ronald E. Scherer Trust (the "Scherer Trust") was the

Tax Matters Person of the corporation, for purposes of section

6231(a)(7), and a Notice Person of the corporation for purposes

of sections 6226(b)(1) and 6231(a)(8).   The Linda S. Hayner Trust

(the "Hayner Trust") was also a Notice Person of the corporation.

The Scherer Trust, as Tax Matters Person, failed to file a

petition for readjustment of subchapter S items within the period

specified in section 6226(a).   However, the Scherer Trust and the

Hayner Trust, as Notice Persons, timely filed a petition for

readjustment of subchapter S items under section 6226(b).

     The parties have reached an agreement on all issues save the

treatment of adjustments to closing inventory and to cost of

goods sold pursuant to section 1.458-1(g), Income Tax Regs.

Petitioners contend that section 1.458-1(g), Income Tax Regs., is

invalid.    However, the parties have stipulated that if this Court

determines that the regulation is valid, the adjustments made by

the Commissioner are proper and should be allowed in their

entirety.

     Section 458(a) provides that an accrual basis taxpayer "may

elect not to include in * * * gross income for the taxable year

the income attributable to the qualified sale of any magazine,

paperback, or record which is returned to the taxpayer before the
                               - 6 -

close of the merchandise return period."    Section 458(b)(6)

defines the amount excluded from gross income as "the lesser of

* * * the amount covered by the legal obligation described in

paragraph (5)(A), or * * * the amount of the adjustment agreed to

by the taxpayer before the close of the merchandise return

period."   The legal obligation of paragraph (5)(A) is the

obligation of the taxpayer to adjust the sales price of the

magazine, paperback, or record if it is not resold.    Section

1.458-1(g), Income Tax Regs., contains the formula for

determining excludable gross income.   It states:

      If a taxpayer makes adjustments to gross receipts for a
      taxable year under the method of accounting described
      in section 458, the taxpayer, in determining excludable
      gross income, is also required to make appropriate
      correlative adjustments to purchases or closing
      inventory and to cost of goods sold for the same
      taxable year. Adjustments are appropriate, for
      example, where the taxpayer holds the merchandise
      returned for resale or where the taxpayer is entitled
      to receive a price adjustment from the person or entity
      that sold the merchandise to the taxpayer. Cost of
      goods sold must be properly adjusted in accordance with
      the provisions of section 1.61-3 which provides, in
      pertinent part, that gross income derived from a
      manufacturing or merchandising business equals total
      sales less cost of goods sold.

Id.

      The identical issue of the validity of section 1.458-1(g),

Income Tax Regs., was raised in Hachette USA, Inc. v.

Commissioner, 105 T.C.     ,     (1995).    Petitioners' counsel in

this case was also counsel in Hachette.     Petitioners' briefs in

both cases presented identical arguments.    In fact, the 30 pages

of brief in this case that address the validity of the regulation
                                   - 7 -

are the same verbatim as the corresponding argument in the brief

submitted in Hachette.

     Petitioners contend that section 458(b)(6) provides an

explicit formula for determining the adjustment to income:            the

amount of the credit against sales price which the taxpayer must

grant to the purchaser.    They assert that the language of section

458(b)(6) is unambiguous, and that the formula contained in

section 1.458-1(g), Income Tax Regs., transforms the "amount

excluded" based on credit given for returned items into an amount

equal to the distributor's gross profit on those items.

     In response to these arguments, this Court in Hachette held

the regulation valid.     Id. at       (slip op. at 27).     After

examining the legislative history, the Court determined that the

regulation is consistent with generally accepted accounting

principles and with sections 446 and 471.          Id. at       (slip op.

at 20-21).    The Court also held that there is no evidence that

Congress intended that a taxpayer who did not bear any costs

could forgo the correlative cost adjustments.          Id. at        (slip

op. at 22).    Because distributors were reimbursed by publishers,

they should not get the benefit of the deduction without bearing

the risk.    Id.   In view of the identity of issues and the

detailed analysis by this Court in Hachette, it is unnecessary to

go over the same ground again.      We follow Hachette.

                                                Decision will be entered

                                           for respondent.
