                      T.C. Memo. 2004-29



                  UNITED STATES TAX COURT



       SUNOCO, INC. AND SUBSIDIARIES, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19631-97.          Filed February 4, 2004.



     Robert L. Moore II, Thomas D. Johnston, and

Marjorie A. Burnett, for petitioner.

     John A. Guarnieri and Michael A. Yost, Jr., for

respondent.



                      MEMORANDUM OPINION


     WHALEN, Judge:   Respondent determined the following

deficiencies in petitioner’s Federal income tax:

               Year             Deficiency

               1979            $10,563,157
               1981              5,163,449
               1983             35,916,359
                            - 2 -


Petitioner disputes the above deficiencies and further

claims to have overpaid income taxes for 1979, 1981, and

1983 by at least $25,082,591, $6,881,055, and $14,137,211,

respectively.

     After concessions, there are three issues for decision

in this case.   Each issue is the subject of a separate

opinion.   The issue that is the subject of this opinion

involves the deductions claimed on petitioner’s returns

for 1983, 1984, and 1986 for certain expenses incurred in

removing the overburden at a strip mine.     Specifically,

the issue is whether petitioner is entitled to change the

income tax treatment of the subject overburden removal

expenses from the treatment applicable to development

expenditures, as reported on petitioner’s returns, to the

treatment applicable to production costs.     This issue

turns on whether that change is foreclosed because it is

based upon a change of method of accounting as to which

petitioner had not first secured the consent of the

Secretary under section 446(e).     Unless stated otherwise,

all section references are to the Internal Revenue Code

as in effect during the years in issue, and all Rule

references are to the Tax Court Rules of Practice and

Procedure.   For purposes of this opinion, the tax years

in issue are 1983, 1984, and 1986.
                            - 3 -

                         Background

     The parties have stipulated the facts applicable to

the issue considered in this opinion.     During the period

1971 through 1993, petitioner was the common parent of an

affiliated group of corporations that included Cordero

Mining Co. or one of its predecessors, Sunedco Coal Co.

and Sunoco Energy Development Co.     When we use the term

“Cordero” in this opinion, we mean Cordero Mining Co.

and its predecessors.   For each of the years in issue,

Cordero was a member of petitioner’s affiliated group of

corporations and was included in the consolidated return

filed by petitioner on behalf of the group.     At the time

the instant petition was filed on its behalf, petitioner’s

principal place of business was in Philadelphia,

Pennsylvania.

     Before 1971, Cordero engaged in coal mining in the

Powder River Basin in Wyoming.   In 1971, Cordero acquired a

working interest in a Federal lease of 6,560 acres of land

near Gillette, Wyoming, that contained approximately 500

million tons of coal reserves.   We sometimes refer to this

property as the Gillette mine or the Gillette property.
                              - 4 -

In 1976, Cordero began mining the property for coal, and

it continued mining the property until June 1993 when

petitioner sold Cordero to Kennecott Coal Co. (Kennecott),

as described below.

     Cordero began mining the Gillette property by making a

“box cut” in the ground to expose the coal seam.      The term

“box cut” describes the vertical and lateral removal of

“overburden” to gain initial access to the coal.      The term

“overburden” refers to the soil and rock that overlay a

coal seam.

     After making the box cut on the Gillette property,

Cordero began strip mining coal.      This type of mining

involves the systematic advance removal of overburden to

expose the coal seam and to permit continuous extraction

of the exposed mineral.   The parties agree that the

removal of overburden in this case benefited only the

limited increment of the coal seam that was exposed after

the overburden was removed.    Following its removal, the

stripped overburden was either deposited as part of

reclaiming the disturbed or mined areas, or it was stored

for later use in reclaiming those areas.
                            - 5 -

     Cordero employed trucks and shovels at the Gillette

mine to remove the overburden and to strip mine the exposed

coal.   The expenses that Cordero incurred in removing

overburden and extracting coal at the Gillette mine

included the salaries and wages paid to employees who

operated the equipment, depreciation on and repairs to the

equipment, fuel for the equipment, utilities, and employee

benefits.

     Cordero quantified its overburden removal costs at

the Gillette mine using a volumetric ratio method.    Cordero

first determined the volume of overburden that was removed

during the year, and it computed the ratio of that amount

to the sum of the volumes of overburden removed and coal

extracted.   Cordero then multiplied the ratio by the total

of each category of expense incurred in the process of

removing overburden and extracting coal (viz, wages and

benefits, fuel, utilities, depreciation, and repairs).    The

product of each of these multiplications was deemed to be

the portion of each expense category that was attributable

to the overburden removed during the year.   Using this

method, Cordero computed its aggregate overburden removal

costs at the Gillette mine for the years in issue.    These

aggregate amounts are as follows:
                              - 6 -

                 Year          Amount
                          1
                 1983      $13,743,557
                            1
                 1983         3,456,699
                 1984       19,071,400
                 1985       17,756,308
                 1986       10,452,801
     1
       During 1983, Cordero’s coal mining operations were
transferred from one member of petitioner’s affiliated
group to another. This amount is the aggregate overburden
removal cost incurred by one member of petitioner’s
affiliated group of corporations during 1983.


     For financial accounting purposes, beginning in 1976

and continuing through the last year in issue, petitioner

treated the costs incurred for overburden removal at the

Gillette mine as associated with the coal extracted during

the year, and petitioner included those costs in its cost

of goods sold.   Before December 1983, Cordero added all of

its overburden removal costs to its costs of goods sold as

the overburden removal costs were incurred.

     In December 1983, Cordero changed its financial

accounting treatment of overburden removal costs in order

to defer the portion of those costs that is attributable

to exposed but unmined coal.    Beginning in that month,

the costs of removing overburden, determined using the

volumetric ratio method described above, were booked

as additions to a general ledger account entitled:

“Preproduction Overburden Removal-–Year to Date Change.”

As coal was produced, the overburden removal costs
                            - 7 -

attributable to the volume of coal produced were booked as

reductions to the account and were “expensed” as production

costs through the cost of goods sold.   The net change to

the account for the month, the difference between the total

additions and reductions to the account, represented the

net change in the overburden removal costs associated with

exposed but unmined coal.

     Thus, in keeping its books, petitioner treated the

overburden removal costs incurred at the Gillette mine as

costs that were incurred to maintain current production of

the coal, and petitioner included those costs in its cost

of goods sold.   Petitioner did not treat them as costs

related to future coal production, such as development

costs, which are capitalized.   See generally Fixed,

Financial Reporting in the Extractive Industries,

Accounting Research Study No. 11 at 49-57 (1969); FASB

Discussion Memorandum, Financial Accounting and Reporting

in the Extractive Industries 45-58 (Dec. 23, 1976).

Furthermore, in December 1983, petitioner created a general

ledger account, Preproduction Overburden Removal--Year to

Date Change, that quantified the amount of the overburden

removal costs attributable to exposed but unmined coal for

purposes of deferring those expenses until the related coal

was extracted and sold.
                            - 8 -

     The record of this case contains the separate Federal

income tax returns of Cordero that were included with, and

incorporated in, petitioner’s consolidated Federal income

tax returns for taxable years 1982 through 1986.    On each

of those returns, Cordero stated that it used the accrual

method of accounting.   On its separate returns for 1982,

1983, 1984, and 1985, Cordero reported the costs incurred

in removing overburden at the Gillette mine as part of

the deductions claimed for salaries and wages, repairs,

depreciation, employee benefit programs, and “other

deductions”, without identifying the portion of the

deduction that was incurred for the removal of overburden.

Similarly, on its separate return for 1986, Cordero

included its overburden removal costs in cost of goods

sold without identifying the portion thereof that was

incurred for the removal of overburden.

     Thus, for tax reporting purposes, Cordero treated

overburden removal costs as deductions on its returns for

1982 through and including 1985, and it treated them as

an offset of gross income on its return for 1986.

Furthermore, Cordero reported the overburden removal costs

at the Gillette mine as the costs were incurred, except for

the portion of those costs allocated to ending inventory.

Cordero did not defer for tax reporting purposes the
                            - 9 -

portion of those costs attributable to exposed but unmined

coal, as it did for financial accounting purposes.    The

aggregate of the deductions claimed on each of Cordero’s

separate returns for the removal of overburden at the

Gillette mine was equal to the amount added for the year to

the general ledger account described above, Preproduction

Overburden Removal-–Year to Date Change, except for the

amount allocated to ending inventory.

     Each of Cordero’s separate returns for 1983 through

1986 includes an adjustment that has the effect of

capitalizing a portion of the subject overburden removal

costs as would be required under section 291(b)(1),

assuming that the total overburden removal costs incurred

during the year at the Gillette mine were mine development

expenditures that are otherwise deductible under section

616(a).   The adjustment reported on Cordero’s separate

return for the first part of 1983 consists of a

“miscellaneous” reduction of the “other deductions” claimed

on line 26 of the return.   The adjustments reported on

Cordero’s returns for the second part of 1983 and for 1984,

1985, and 1986 consist of reductions to Cordero’s cost of

goods sold and are labeled “mine development costs”.
                                - 10 -

       The following schedule shows the aggregate income

offsets or deductions claimed on each of Cordero’s separate

returns that Cordero treated as mine development

expenditures (column 2), and the portion thereof that was

capitalized (column 3), pursuant to section 291(b)(1):

       Total develop-   Total amount       Overburden      Amount
Year     ment costs     capitalized      removal costs   capitalized

1983    $16,871,299     $2,530,695       $13,743,557     $2,061,534
1983       3,456,699        518,505        3,456,699         518,505
                        1                                1
1984      21,521,593      4,304,319       19,071,400       3,814,280
        2               3
1985      18,033,139      3,606,278       17,756,308       3,551,262
1986      10,714,828      2,142,966       10,452,801       2,090,560

   1
     Cordero capitalized 20 rather than 15 percent, the statutory rate,
and as a result overstated the total amount capitalized by $1,076,080.
   2
      The parties agree that this amount is overstated by $16,760.
   3
      The parties agree that this amount is overstated by $3,002.


Column 4 of the above schedule, entitled “Overburden

removal costs”, shows the amounts of overburden removal

costs that were incurred at the Gillette mine and were

treated by Cordero as mine development expenditures.             These

amounts form the bulk of Cordero’s total development costs

set out in column 2.      Column 5 of the above schedule,

entitled “Amount capitalized”, shows the portion of each

amount in column 4 that was capitalized, pursuant to

section 291(b)(1).      These amounts form the bulk of the

total amount capitalized set out in column 3.

       Generally, Cordero amortized the total amount

capitalized (column 3) for each of the years in issue
                            - 11 -

over 5 years beginning with the year the costs were paid

or incurred, as permitted by section 291(b)(2)(B)(i),

and through 1985 it included that amount in “qualified

investment” (within the meaning of section 46(c)) for

purposes of computing investment credit, as permitted by

section 291(b)(2)(B)(ii).   Cordero also took the total

amount capitalized for each year into account in computing

the adjustment set forth on Schedule M-1, Reconciliation

of Income Per Books with Income Per Return, for “expenses

recorded on books this year not deducted on this return”.

     As noted above, Cordero mistakenly capitalized 20

percent of the mine development expenses reported for 1984,

rather than 15 percent, the statutory rate then in effect

under section 291(b)(1).    The parties agree that petitioner

is entitled to increase the aggregate deduction claimed in

1984 by the excess amount capitalized, $1,076,080, as long

as petitioner also makes appropriate correlative

adjustments to petitioner’s reported investment tax credit

for 1984 and to its reported amortization for 1984 through

1988.

     For each of the taxable years 1987 through 1990,

Cordero treated all of its overburden removal costs at the

Gillette mine as mine development costs, subject to section

291(b).   For each of those years, Cordero capitalized 30
                           - 12 -

percent of the amount allowable as a deduction under

section 616(a), as required by section 291(b)(1), and it

amortized that amount over 60 months beginning with the

month in which the costs were paid or incurred, as

permitted by section 291(b)(2) as in effect during 1987

through 1990.   For alternative minimum tax purposes,

Cordero also treated overburden removal costs as mine

development costs, and Cordero took advantage of the

adjustments permitted under section 56(a)(2) under which a

taxpayer’s taxable income for the taxable year is adjusted

for purposes of computing alternative minimum taxable

income by capitalizing the amount allowable as a deduction

under section 616(a) (determined without regard to section

291(b)) and amortizing that amount ratably over the 10-year

period beginning with the taxable year in which the

expenditures were made.

     For each of the taxable years 1991 through 1993,

Cordero elected under section 59(e) to amortize all of its

mine development costs.   In accordance with this election,

Cordero capitalized all of its mine development expenses

and amortized those costs over 10 years.   Cordero’s

election under section 59(e) covered overburden removal

costs of $17,129,007 that were paid or incurred in 1991,

overburden removal costs of $19,799,530 that were paid
                            - 13 -

or incurred in 1992, and overburden removal costs of

$7,901,682 that were paid or incurred in 1993.

     On June 4, 1993, petitioner sold Cordero to Kennecott.

A joint election was made under section 338(h)(10) to treat

the stock sale as a sale of assets.    Cordero claimed

unamortized mine development costs of $41,254,283 as part

of the basis in the assets sold to Kennecott, including

$41,185,210 of unamortized overburden removal costs.


                          Discussion

Factual and Legal Background

     Generally, for Federal income tax purposes, there are

at least two ways for a mining business to treat the costs

of removing overburden during the producing stage of a mine

or other natural deposit located in the United States.

One way is to treat them as costs of producing the ore or

mineral and to include them in the taxpayer’s cost of goods

sold.   See sec. 1.61-3(a), Income Tax Regs.   Under this

approach, the overburden removal costs, in effect, are

taken into account in computing gross income, as offsets

of sales.   See id.   Another way is to treat them as

development expenditures that are currently deductible

under section 616(a), or at the election of the taxpayer,

ratably deductible as deferred expenses under section

616(b).   Under this second way, the overburden removal
                          - 14 -

costs would be deducted from gross income in computing

the taxpayer's taxable income.   See sec. 616(a).

     Section 616(a) and (b) provides as follows:


          SEC. 616(a). In General.-–Except as
     provided in subsection (b), there shall be
     allowed as a deduction in computing taxable
     income all expenditures paid or incurred during
     the taxable year for the development of a mine
     or other natural deposit (other than an oil or
     gas well) if paid or incurred after the
     existence of ores or minerals in commercially
     marketable quantities has been disclosed. This
     section shall not apply to expenditures for the
     acquisition or improvement of property of a
     character which is subject to the allowance for
     depreciation provided in section 167, but
     allowances for depreciation shall be considered,
     for purposes of this section, as expenditures.

          (b) Election of Taxpayer.-–At the election
     of the taxpayer, made in accordance with regula-
     tions prescribed by the Secretary, expenditures
     described in subsection (a) paid or incurred
     during the taxable year shall be treated as
     deferred expenses and shall be deductible on a
     ratable basis as the units of produced ores or
     minerals benefited by such expenditures are sold.
     In the case of such expenditures paid or incurred
     during the development stage of the mine or
     deposit, the election shall apply only with
     respect to the excess of such expenditures during
     the taxable year over the net receipts during the
     taxable year from the ores or minerals produced
     from such mine or deposit. The election under
     this subsection, if made, must be for the total
     amount of such expenditures, or the total amount
     of such excess, as the case may be, with respect
     to the mine or deposit, and shall be binding for
     such taxable year.


     The applicable treatment of overburden removal costs,

either as development costs or as production costs,
                            - 15 -

depends upon the circumstances of each case.      The term

“development”, as used in section 616(a), is not defined

by the Code or the regulations.      Nevertheless, in

distinguishing development expenditures, which are

deductible under section 616, from production costs,

which offset gross sales, it is generally understood that

development expenditures are expenditures benefiting an

entire mineral deposit or a large area of a mineral

deposit, such that they provide benefits that extend over

relatively long periods of extraction of the valuable ore

or mineral.   See Rev. Rul. 86-83, 1986-1 C.B. 251; Rev.

Rul. 77-308, 1977-2 C.B. 208; Rev. Rul. 67-169, 1967-1

C.B. 159.   For Federal income tax purposes, development

expenditures would be treated as capital expenditures but

for the provisions of section 616.      See Rev. Rul. 67-169,

supra.    Production costs, on the other hand, are costs that

are directly related to the mining of a particular

increment of the mineral or ore deposit and to no other.

See id.

     Typically, the costs incurred in removing overburden

in connection with an open pit mine, as opposed to a strip

mine, are treated as development expenditures because

removal of the overburden in that case not only facilitates
                             - 16 -

mining the first layer of ore, but it also allows eventual

access to lower layers of ore.    See Rev. Rul. 86-83,

supra.    On the other hand, the costs incurred in removing

overburden in connection with a strip mine typically are

integrally related to extraction of a limited area of the

ore or mineral to be mined and, for that reason, are

included among the costs of producing a particular

increment of the ore or mineral.      See Rev. Rul. 77-308,

supra; Rev. Rul. 67-169, supra.

     Before 1983, development expenditures could be

deducted under section 616(a) without limitation.

Beginning in 1983, the current deduction of development

expenditures under section 616(a) in the case of a

corporation became subject to the special rules of section

291(b).    As first enacted, section 291(b) provided in

pertinent part as follows:


          SEC. 291(b). Special Rules for Treatment
     of Intangible Drilling Costs and Mineral
     Exploration and Development Costs.–-For purposes
     of this subtitle, in the case of a corporation--

                 (1) In general.-–The amount allowable
            as a deduction for any taxable year
            (determined without regard to this section)
            --
                      *   *   *   *   *   *   *

                      (B) under section 616(a) or 617,
                 shall be reduced by 15 percent.
                  - 17 -

     (2) Special rule for amounts not
allowable as deductions under paragraph
(1).--

          *   *    *   *   *   *   *

           (B) Mineral exploration and
     development costs.-–In the case of any
     amount not allowable as a deduction
     under section 616(a) or 617 for any
     taxable year by reason of paragraph
     (1)--

               (i) the applicable percent-
          age of the amount not so allow-
          able as a deduction shall be
          allowable as a deduction for the
          taxable year in which the costs
          are paid or incurred and in each
          of the 4 succeeding taxable
          years, and

               (ii) in the case of a
          deposit located in the United
          States, such costs shall be
          treated, for purposes of
          determining the amount of the
          credit allowable under section
          38 for the taxable year in which
          paid or incurred, as qualified
          investment (within the meaning
          of subsections (c) and (d) of
          section 46) with respect to
          property placed in service
          during such year.

     (3) Applicable percentage.-–For
purposes of paragraph (2)(B), the term
“applicable percentage” means the
percentage determined in accordance with
the following table:
                                   Applicable
Taxable Year:                      Percentage:
     1.................................15
     2.................................22
     3.................................21
     4.................................21
     5.................................21
                           - 18 -

Under this provision, the amount that otherwise would be

deductible for the current year under section 616(a) is

reduced by a certain percentage.    Sec. 291(b)(1)(B).   The

percentage changed over the years.    It was 15 percent for

taxable years 1983 and 1984, 20 percent for taxable years

1985 and 1986, and 30 percent for taxable years 1987

through 1990.

     Under section 291(b), as quoted above, the amount of

the reduction is, in effect, capitalized and amortized over

5 years beginning with the year in which the expenditures

were paid or incurred.   See sec. 291(b)(2)(B)(i).   In the

case of a mineral deposit located in the United States,

the amount of the reduction is also treated as qualified

investment for purposes of the investment tax credit.     See

sec. 291(b)(2)(B)(ii).   Section 291(b) became effective

for tax years beginning after 1982.    Tax Equity and Fiscal

Responsibility Act of 1982, Pub. L. 97-248, sec. 204(a),

96 Stat. 423.

     On each of Cordero’s returns for 1983, 1984, 1985, and

1986, petitioner, in effect, treated the overburden removal

costs incurred at the Gillette mine as “development

expenditures” within the meaning of section 616(a), in that

petitioner capitalized and amortized over 5 years a portion

of those costs, as required by section 291(b)(1)(B) and
                            - 19 -

(2)(B)(i), and, through 1985, it included that amount in

“qualified investment” (within the meaning of section

46(c)) for purposes of computing investment credit, as

permitted by section 291(b)(2)(B)(ii).    The portion of the

overburden removal costs that was capitalized was also

taken into account in computing a Schedule M adjustment on

Cordero’s separate returns for book expenses that were not

deductible.    This Schedule M adjustment was necessary

because, as mentioned above, the overburden removal

expenses were treated as production costs for book purposes

and, as such, were treated as an offset to sales without

reduction.

     The parties have stipulated that, for tax purposes,

“Cordero incorrectly classified its costs of overburden

removal at its Gillette mine as a mine development

expense.”    They agree that the subject overburden removal

costs should not have been treated as development

expenditures during any of the years in issue, and that

the treatment of the subject costs on Cordero’s separate

returns included with petitioner’s consolidated returns is

wrong.   The parties have also stipulated that “the removal

of overburden in the continuous mining operation benefited

only that limited increment of the coal seam exposed after

removal of the overburden.”    Accordingly, they agree that
                          - 20 -

the subject overburden removal costs should have been

treated as production costs.   As such, these costs should

have been included in petitioner’s cost of goods sold

and should have offset gross income from sales, see

sec. 1.61-3(a), Income Tax Regs., and no part of those

costs should have been capitalized and amortized.

     Significantly, this is the manner in which petitioner

treated the subject overburden removal costs for financial

accounting purposes, as described above.   From 1976, when

mining on the Gillette property started, until 1993 when

petitioner sold Cordero, Cordero consistently treated the

overburden removal costs incurred at the Gillette mine on

its books as a cost of producing the coal, and it included

those costs in Cordero’s cost of goods sold.

     In these proceedings, petitioner seeks to treat the

subject overburden removal costs incurred at the Gillette

mine during 1983, 1984, and 1986 as production costs on its

tax returns for those years.   If petitioner were permitted

to do so, the subject overburden removal costs would be

treated as increases of petitioner’s cost of goods sold

for the year in which the costs were incurred, and no part

of such costs would be subject to capitalization under

sections 291(b)(1)(B) and (2)(B)(i), or included in

qualified investment for purposes of computing investment
                          - 21 -

credit pursuant to section 291(b)(2)(B)(ii).    In effect,

petitioner now wants to change the manner in which the

overburden removal costs incurred at the Gillette mine are

treated for tax purposes; and beginning with its return for

1983, petitioner wants to bring its tax accounting for

overburden removal costs at the Gillette mine into

conformity with its book accounting for those costs.


The Issue for Decision

     The parties disagree about whether petitioner is

entitled to change the treatment of Cordero’s overburden

removal costs on its returns for 1983, 1984, and 1986 from

development expenditures to production costs.    Respondent

asserts that the change is a change of accounting method

and that petitioner is foreclosed from making the change by

reason of the fact that petitioner failed to secure the

consent of the Secretary under section 446(e).    Therefore,

the issue is whether changing the treatment of Cordero’s

overburden removal costs on petitioner’s returns for 1983,

1984, and 1986 from development expenditures to production

costs is subject to the consent requirement of section

446(e).
                            - 22 -

Petitioner’s Position

     Petitioner’s position is that it is not required to

obtain the consent of the Secretary under section 446(e)

as a prerequisite to making this change.    In support of

that position, petitioner makes two arguments.    First,

petitioner argues the change that it seeks to make is

not a change of method of accounting for purposes of

section 446(e).   Rather, according to petitioner, it is

a recharacterization of the expenses from development

expenditures to production costs.    Second, petitioner

argues, even if the change in its tax reporting of

overburden removal costs is a change of accounting

method, petitioner can still make the change without the

Secretary’s consent.    According to petitioner, there is no

need for the application of section 446(e) or section 481

in this case because correcting the treatment of overburden

removal costs would not distort petitioner’s income.

     In support of its first argument, petitioner explains

that the mistake in its reporting of the overburden removal

costs at the Gillette mine resulted from its mischaracter-

ization of the mining method that Cordero employed at the

mine.   According to petitioner, it had incorrectly viewed

Cordero’s mining method as open pit mining, rather than

strip mining and, as a consequence, it had incorrectly
                             - 23 -

reported the subject overburden removal costs on its

returns for 1983 through 1986 as mine development costs,

rather than as production costs.      Petitioner states that

mischaracterizing Cordero’s mining method “resulted in

Petitioner’s misposting of Cordero’s overburden removal

costs as mine development.”

     Petitioner argues that it is now required to correct

that mistake on each of those returns and it must

recharacterize the subject expenses from mine development

costs to production costs.    Petitioner notes that the tax

treatment of the subject expenses follows from their

characterization and petitioner has no choice about the

tax treatment of those expenses once they are properly

recharacterized.

     Petitioner asserts that, for tax purposes, the effect

of having treated the subject overburden removal costs as

mine development expenditures is that a portion of the

aggregate expense for the year was capitalized, as required

by section 291(b), and the remainder was deducted under

section 616(a).    Petitioner argues that it is only the

treatment of the amount capitalized that it is seeking to

change.   Petitioner reasons that most of the overburden

removal costs for the year were reported in the same manner

as production costs.    As petitioner states:    “petitioner
                            - 24 -

treated all of Cordero’s overburden removal costs as

production costs on its federal income tax returns, except

for the amount capitalized due to the mischaracterization.”

(Emphasis supplied.)

       Petitioner argues that it is not attempting to change

its method of accounting for production costs or its method

of accounting for mine development costs, nor is it

attempting to change the treatment of a material item.

According to petitioner, adjusting a deduction, as it

proposes to do in this case, does not involve a change in

method of accounting, such that the taxpayer is required

by section 446(e) to obtain the consent of the Secretary,

because the change does not “[involve] the proper time

for the * * * taking of a deduction.”    See sec. 1.446-

1(e)(2)(ii), Income Tax Regs.    Petitioner argues that

correcting its mischaracterization of overburden removal

expenses in this case, where petitioner has no choice in

how to report the item for tax purposes, “involves a matter

of characterization not a matter of timing as defined in

the regulations.”    Thus, petitioner argues, the change in

this case does not involve a change in method of account-

ing.    Petitioner asserts that there is a difference between

characterizing an item for tax purposes and accounting for

it.    Petitioner argues that it “should be permitted to
                            - 25 -

recharacterize its overburden removal as production costs

consistent with its treatment of other production costs.”

     As support for its first argument, that the proposed

change is not a change of accounting method, petitioner

principally relies upon Standard Oil Co. (Indiana) v.

Commissioner, 77 T.C. 349 (1981), which it argues “governs”

the case.   Petitioner also cites Underhill v. Commissioner,

45 T.C. 489 (1966), Tex. Instruments, Inc., & Consol. Subs.

v. Commissioner, T.C. Memo. 1992-306, and Coulter Elecs.,

Inc. v. Commissioner, T.C. Memo. 1990-186, affd. without

published opinion 943 F.2d 1318 (11th Cir. 1991).    Accord-

ing to petitioner, the central lesson of Standard Oil Co.

(Indiana) is that “correcting improperly characterized

costs is not a change in method of accounting if the

taxpayer already accounts for similar items on its tax

return”.    Petitioner argues that, in this case, because

it accounts for its other production costs and the

noncapitalized portion of overburden removal as production

costs, there is no change in method of accounting when it

correctly characterizes overburden removal to eliminate the

erroneous capitalization.

     In support of petitioner’s second argument, that there

is no need for the application of section 446(e) or 481,

petitioner argues that there is no potential for distortion
                            - 26 -

in this case because the first year at issue, 1983, is the

first year that the tax treatment of overburden removal

costs differed from that of production costs.     Petitioner

asserts that the periods of limitations for all affected

years are still open.    Petitioner argues:   “if the

correction can be made in the first year of the change,

there will be no distortion of income, which is the policy

reason for the consent requirement of sec. 446(e).”

Furthermore, petitioner notes that respondent has not

identified a distortion of income that would be brought

about by the change.    In fact, according to petitioner,

the change would actually achieve the clear reflection

of petitioner’s income “by reversing the erroneous

capitalization of overburden removal costs” and relating

those costs to the income realized from the coal produced,

as contemplated by Rev. Rul. 77-308, supra, and Rev. Rul.

67-169, supra.   Furthermore, petitioner argues:    “treating

Cordero’s overburden removal expenses as production costs

on its Federal income tax returns would be consistent with

Cordero’s treatment of overburden removal expenses on its

books and records.”


Respondent’s Position

     Respondent’s position is that petitioner cannot change

the treatment of the subject overburden removal costs on
                           - 27 -

its returns for 1983, 1984, and 1986 because that change is

a change of accounting method for which petitioner did not

obtain the consent of the Secretary, as required by section

446(e).   Respondent notes that beginning in 1983 and

continuing until 1993 when petitioner sold Cordero, a

period of approximately 11 years, petitioner consistently

accounted for all of its overburden removal costs at the

Gillette mine as mine development costs within the meaning

of section 616(a), and it capitalized and amortized a

portion of those costs, as required initially by section

291(b) and later by section 59(e).   Respondent acknowledges

that the subject overburden removal costs should have been

treated as production costs, but, respondent asserts, the

proposed change constitutes an impermissible retroactive

change in a method of accounting in contravention of

section 446(e).   According to respondent, the fact that

petitioner’s tax accounting method is erroneous does not

justify petitioner’s abandonment of this longstanding

method of accounting for such costs without the consent

of the Secretary required by section 446(e).

     Respondent acknowledges that the prior consent

requirement of section 446(e) applies only if the change

constitutes a change in method of accounting.   Respondent

argues that the change which petitioner proposes to make in
                           - 28 -

this case involves a change in the treatment of a material

item; that is, “any item which involves the proper time for

the inclusion of the item in income or the taking of a

deduction.”   Sec. 1.446-1(e)(2)(ii)(a), Income Tax Regs.

According to respondent, in determining whether an

accounting practice for an item involves timing, “the

relevant question is whether the practice permanently

changes the taxpayer’s lifetime income.”

     Respondent argues that the change in petitioner’s

treatment of Cordero’s overburden removal costs involves

timing.   The change is from development costs that are

deductible under section 616(a) but subject to partial

capitalization and amortization under section 291(b), to

production costs that can be offset against income without

limitation.   Respondent argues that this change affects the

tax years in which the deductions are reported over the

life of the mine and does not affect petitioner’s lifetime

income.   Therefore, respondent argues, the change involves

a material item under section 1.446-1(e)(2)(ii)(a), Income

Tax Regs., and is a change of accounting method because the

effect of the change would be to alter the timing of

deductions for overburden removal costs.

     Respondent argues that the change goes beyond a mere

correction of a posting error or an attempt to remedy
                           - 29 -

internal inconsistencies, as was involved in Standard Oil

Co. (Indiana) v. Commissioner, supra.    Respondent

distinguishes Standard Oil Co. (Indiana) on the ground

that in this case “petitioner treated all of Cordero’s

overburden removal costs as mine development expenses

deductible under I.R.C. § 616(a) for purposes of applying

the provisions of § 291(b)”, not just the amount

capitalized.   In effect, respondent argues that the

overburden removal costs in this case were not treated

inconsistently.   As an example, respondent notes that for

the first part of 1983, Cordero calculated overburden

removal costs of $13,743,557 and capitalized and amortized

15 percent of that amount, or $2,061,534, as required by

section 291(b).   Respondent notes:   “If petitioner had

treated any portion of Cordero’s overburden costs as

production costs, then the applicable percentage rate

specified in section 291 would not have been applied

against that portion, and a smaller amount of overburden

removal costs would have been capitalized and amortized

each year.”


Application of Section 446 to a Member of an Affiliated
Group of Corporations

     In the case of an affiliated group of corporations,

such as petitioner and the members of its affiliated group,
                           - 30 -

the separate taxable income of each member of the group is

computed, with certain modifications, in accordance with

the provisions of the Code covering the determination of

taxable income of separate corporations.   Sec. 1.1502-

12(d), Income Tax Regs.   Furthermore, the method of

accounting to be used by each member of the group is

determined in accordance with the provisions of section

446, as if each member filed a separate return.     Sec.

1.1502-17(a), Income Tax Regs.   Thus, each member of an

affiliated group of corporations determines its method of

accounting on a separate-company basis, and section 446

controls the determination of that member’s method of

accounting.   See General Motors Corp. & Subs. v.

Commissioner, 112 T.C. 270, 298-299 (1999).   Accordingly,

in order to resolve the issue in this case, whether

petitioner can change the manner in which the overburden

removal expenses of one of the members of its affiliated

group of corporations, Cordero, were reported on

petitioner’s returns for 1983, 1984, and 1986, we look to

Cordero’s method of accounting on a separate-company basis,

and we apply section 446 to Cordero as we would to a

separate corporation.
                            - 31 -

The Conformity Rule of Section 446(a)

     The provisions of section 446 spell out the relation-

ship between a taxpayer’s method of accounting for book

purposes and the manner of computing the taxpayer’s taxable

income for tax purposes.    The general rule for methods of

accounting, set out in subsection (a), requires a taxpayer

to compute taxable income “under the method of accounting

on the basis of which the taxpayer regularly computes his

income in keeping his books.”    Sec. 446(a).   The phrase

“income in keeping his books” used in section 446(a) and

(e) refers to net income computed for financial accounting

purposes, in accordance with the generally accepted

accounting principles in a particular trade or business

applied consistently from year to year.    See sec. 1.446-

1(a)(2), Income Tax Regs.    Thus, subsection (a) of section

446 requires the taxpayer’s method of computing taxable

income to conform to the taxpayer’s method of accounting

for book purposes.   We sometimes refer to this general rule

as the conformity requirement.

     Courts have consistently held that the conformity rule

of section 446(a) is not an absolute requirement and that

tax accounting requirements may diverge from financial

accounting standards.   See, e.g., FPL Group, Inc. &

Subs. v. Commissioner, 115 T.C. 554, 562-563 (2000); US
                            - 32 -

Freightways Corp. & Subs. v. Commissioner, 113 T.C. 329,

332 (1999), revd. on other grounds and remanded 270 F.3d

1137 (7th Cir. 2001); Public Serv. Co. v. Commissioner,

78 T.C. 445, 452-453 (1982); Geometric Stamping Co. v.

Commissioner, 26 T.C. 301, 305-306 (1956); Fidelity

Associates, Inc. v. Commissioner, T.C. Memo. 1992-142.

As observed by this and other courts, the objectives of

financial and tax accounting are “vastly different”.      E.g.,

Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 541

(1979); Public Serv. Co. v. Commissioner, supra; see also

United States v. Hughes Properties, Inc., 476 U.S. 593,

603 (1986).    The primary goal of financial accounting is

to provide useful information to management, shareholders,

creditors, and other interested persons, and it is biased

toward understating the net income and assets of an

enterprise.    See United States v. Hughes Properties, Inc.,

supra; Thor Power Tool Co. v. Commissioner, supra.      On

the other hand, the primary goal of tax accounting is the

equitable collection of revenue and the protection of the

public fisc.   See United States v. Hughes Properties,

Inc., supra; Thor Power Tool Co. v. Commissioner, supra.

As the Supreme Court has noted:      “Given this diversity,

even contrariety, of objectives, any presumptive

equivalency between tax and financial accounting would be
                            - 33 -

unacceptable.”    Thor Power Tool Co. v. Commissioner, supra

at 542-543.

       Furthermore, it is often difficult to find that a

taxpayer’s return is not in conformity with the taxpayer’s

books.    A taxpayer’s books often contain sufficient records

and data to permit a reconciliation of any differences

between a taxpayer’s return and its books.    See Patchen v.

Commissioner, 258 F.2d 544, 550 (5th Cir. 1958), revg. in

part on another ground and affg. in part 27 T.C. 592

(1956); Public Serv. Co. v. Commissioner, supra at 452;

St. Luke’s Hosp., Inc. v. Commissioner, 35 T.C. 236, 247

(1960).   According to the regulations promulgated under

section 446, such a reconciliation of differences between

the taxpayer’s books and his return form a part of the

taxpayer’s accounting records.   See sec. 1.446-1(a)(4),

Income Tax Regs.; see also Rev. Rul. 74-383, 1974-2 C.B.

146.

       Subsection (b) of section 446 sets forth statutory

exceptions to the conformity requirement.    Under that

subsection, if the taxpayer does not regularly use a method

of accounting, or if the method used does not clearly

reflect income, then “the computation of taxable income

shall be made under such method as, in the opinion of the

Secretary, does clearly reflect income.”     Sec. 446(b).
                           - 34 -

Thus, subsection (b) expressly limits the general rule

requiring conformity to cases where the taxpayer uses a

method of accounting for book purposes and where that

method of accounting clearly reflects income.   Id.

     The Code and the regulations vest the Commissioner

with wide discretion in exercising authority under section

446(b).   See, e.g., Thor Power Tool Co. v. Commissioner,

supra at 532; Brown v. Helvering, 291 U.S. 193, 203-204

(1934); Ford Motor Co. v. Commissioner, 102 T.C. 87, 91

(1994), affd. 71 F.3d 209 (6th Cir. 1995); So. Pac.

Transp. Co. v. Commissioner, 75 T.C. 497, 681 (1980),

supplemented by 82 T.C. 122 (1984).   As noted by the

Supreme Court, it is not within the province of the courts

“to weigh and determine the relative merits of systems of

accounting.”   Brown v. Helvering, supra at 204-205.    In

view of the wide latitude given to determinations of the

Commissioner under section 446, the Commissioner’s

interpretation of the clear-reflection standard of section

446(b) cannot be set aside unless it is “clearly unlawful”.

See, e.g., Thor Power Tool Co. v. Commissioner, supra at

532; Ford Motor Co. v. Commissioner, supra at 91; Capital

Fed. Sav. & Loan Association & Subs. v. Commissioner, 96

T.C. 204, 213 (1991); Prabel v. Commissioner, 91 T.C. 1101,

1111-1113 (1988), affd. 882 F.2d 820 (3d Cir. 1989).
                            - 35 -

Furthermore, in view of the Commissioner’s authority to

determine whether a method of accounting clearly reflects

income, the method of accounting used by a taxpayer for

book purposes is not binding on the Commissioner, even

if it is in accord with Generally Accepted Accounting

Principles.    See, e.g., Thor Power Tool Co. v. Commis-

sioner, supra at 540-543; Am. Auto. Association v. United

States, 367 U.S. 687, 692-693 (1961); Old Colony R. Co. v.

Commissioner, 284 U.S. 552, 562 (1932).    As stated by the

regulations:    “no method of accounting is acceptable

unless, in the opinion of the Commissioner, it clearly

reflects income.”    Sec. 1.446-1(a)(2), Income Tax Regs.

     At the same time, however, the Commissioner’s

discretion under section 446(b) is not unlimited.    As we

have noted in the past, the Commissioner cannot require a

taxpayer to change accounting methods if the taxpayer’s

method of accounting clearly reflects income.    See, e.g.,

Prabel v. Commissioner, supra at 1112; Hallmark Cards,

Inc. v. Commissioner, 90 T.C. 26, 31 (1988).    Similarly,

the Commissioner cannot require the taxpayer to change

from one incorrect to another incorrect method.    E.g.,

Prabel v. Commissioner, supra at 1112; Hosp. Corp. of Am.

v. Commissioner, T.C. Memo. 1996-105, affd. 348 F.3d 136

(6th Cir. 2003).
                           - 36 -

The Consent Requirement

     Section 446(e), the provision at issue in this case,

provides as follows:


          SEC. 446(e). Requirement Respecting Change
     of Accounting Method.--Except as otherwise
     expressly provided in this chapter, a taxpayer
     who changes the method of accounting on the basis
     of which he regularly computes his income in
     keeping his books shall, before computing his
     taxable income under the new method, secure the
     consent of the Secretary.


     The purpose of the consent requirement imposed by

section 446(e) is to require consistency in the method of

accounting used for tax purposes and, thus, to prevent

distortions of income, which usually accompany a change of

accounting methods and which could have an adverse effect

upon the revenue.   See Commissioner v. O. Liquidating

Corp., 292 F.2d 225, 231 (3d Cir. 1961), revg. T.C. Memo.

1960-29; Wright Contracting Co. v. Commissioner, 36 T.C.

620, 634 (1961), affd. 316 F.2d 249 (5th Cir. 1963); Casey

v. Commissioner, 38 T.C. 357, 386-387 (1962); Advertisers

Exchange, Inc. v. Commissioner, 25 T.C. 1086, 1092-1093

(1956), affd. per curiam 240 F.2d 958 (2d Cir. 1957).    In

part, the consent requirement is also intended to lessen

the Commissioner’s burden of administering the Internal

Revenue Code.   See Lord v. United States, 296 F.2d 333, 335

(9th Cir. 1962); Casey v. Commissioner, supra at 386.     In a
                           - 37 -

recent case, this Court identified the following as the

policy reasons served by section 446(e):


     (1) To protect against the loss of revenues;
     (2) to prevent administrative burdens and
     inconvenience in administering the tax laws;
     and (3) to promote consistent accounting
     practice thereby securing uniformity in
     collection of the revenue.


FPL Group, Inc. & Subs. v. Commissioner, 115 T.C. at 574

(quoting Barber v. Commissioner, 64 T.C. 314, 319 (1975)).


Section 446(e) in Operation

     By requiring the taxpayer to obtain the Commissioner’s

consent before changing his method of accounting, section

446(e) gives the Commissioner authority to approve or

disapprove such conforming changes prospectively.   We have

held that a logical inference to be drawn from section

446(e) is that the Commissioner also has authority to

consent to a change in a taxpayer’s method of computing

taxable income that has already been made; i.e., to give

consent retroactively.   See Barber v. Commissioner, 64 T.C.

314, 319 (1975).

     Generally, in order to secure the Commissioner’s

consent to a change of a taxpayer’s method of accounting

before 1998, the taxpayer was required to file an

application with the Commissioner on a form provided for
                           - 38 -

this purpose, Form 3115, during the taxable year in which

it was deemed to have made the change.    Sec. 1.446-

1(e)(3)(i), Income Tax Regs.   In effect, the filing of

such an application for consent to a change in accounting

method is a request for a ruling from the Commissioner.

See Capital Fed. Sav. & Loan Association & Subs. v.

Commissioner, 96 T.C. at 211; sec. 601.204(c), Statement

of Procedural Rules.   The issuance of such a ruling is a

matter within the discretion of the Commissioner.       Capital

Fed. Sav. & Loan Association & Subs. v. Commissioner, supra

at 212.

     The Commissioner will not grant permission to change

a taxpayer’s method of accounting unless the taxpayer and

the Commissioner agree to the prescribed terms, conditions,

and adjustments under which the change will be effected,

including the taxable year or years in which any adjustment

necessary to prevent amounts from being duplicated or

omitted is to be taken into account.     See sec. 1.446-

1(e)(3)(i), Income Tax Regs.   The general terms and

conditions under which the Commissioner will consent to a

change of accounting method are set forth from time to time

in revenue procedures.   The revenue procedures applicable

to the years in issue are Rev. Proc. 80-51, 1980-2 C.B.

818, superseded by Rev. Proc. 84-74, 1984-2 C.B. 736.
                          - 39 -

     If the Commissioner does not consent to the taxpayer’s

request to make a conforming change in the taxpayer’s

method of computing taxable income, then the taxpayer is

required to continue computing taxable income under the

taxpayer’s old method of accounting.   See, e.g., United

States v. Ekberg, 291 F.2d 913, 925 (8th Cir. 1961); Schram

v. United States, 118 F.2d 541, 543-544 (6th Cir. 1941);

Drazen v. Commissioner, 34 T.C. 1070, 1075-1076 (1960)

(and the cases cited thereat); Advertisers Exchange, Inc.

v. Commissioner, supra at 1092-1093.

     If the taxpayer changes the method of accounting used

in computing taxable income without first requesting the

Commissioner’s consent, then the Commissioner would appear

to have at least two choices.   First, the Commissioner

could assert section 446(e) and require the taxpayer to

abandon the new method of accounting and to report taxable

income using the old method of accounting.   See, e.g.,

O. Liquidating Corp. v. Commissioner, supra; Drazen v.

Commissioner, supra at 1076; Advertisers Exchange, Inc.

v. Commissioner, supra at 1093.    Second, the Commissioner

could accept the change of accounting method and require

the taxpayer to make any adjustments which might be

necessary to prevent amounts from being duplicated or

omitted, sometimes called transitional adjustments.     See
                           - 40 -

Ryan v. Commissioner, 42 T.C. 386, 391 (1964); Patchen

v. Commissioner, 27 T.C. at 597-598; cf. Brookshire v.

Commissioner, 31 T.C. 1157, 1162-1164 (1959), affd. 273

F.2d 638 (4th Cir. 1960); Carver v. Commissioner, 10 T.C.

171, 174 (1948), affd. per curiam 173 F.2d 29 (6th Cir.

1949); Yates v. United States, 205 F. Supp. 738, 740-741

(E.D. Ky. 1962).   Since the enactment of section 481, a

taxpayer has been required to make such adjustments if the

taxpayer’s taxable income is computed using a method of

accounting different from the method under which the

taxpayer’s income for the preceding taxable year was

computed.   See sec. 481(a).

     In deciding whether to consent to a change of

accounting method, the Commissioner is invested with wide

discretion.   See, e.g., Commissioner v. O. Liquidating

Corp., 292 F.2d at 231; Capital Fed. Sav. & Loan

Association & Subs. v. Commissioner, supra at 213; Drazen

v. Commissioner, supra at 1076.     In a case in which the

taxpayer has requested the Commissioner’s consent to change

methods of accounting, the Commissioner’s action in

refusing to give consent is reviewed under an abuse of

discretion standard.   See Brown v. Helvering, 291 U.S. at

204; Schram v. United States, supra at 544; Capital Fed.

Sav. & Loan Association & Sub. v. Commissioner, supra at
                            - 41 -

213; So. Pac. Transp. Co. v. Commissioner, 75 T.C. at 681.

“The applicable standard is whether the accounting clearly

reflects income”.    United States v. Ekberg, supra at 925

(opinion by Circuit Judge Blackmun).    The taxpayer must

show that the Commissioner acted arbitrarily upon any fair

view of the facts.   See Schram v. United States, supra at

543-544.

     On the other hand, in a case in which the taxpayer

did not first request the Commissioner’s consent, such as

where, as in the instant case, the taxpayer attempts in a

court proceeding to retroactively alter the manner in which

the taxpayer accounted for an item on his or her tax

return, then there is no action of the Commissioner to

review under the abuse of discretion standard.    The

question in such a case is whether the change constitutes

a change of accounting method that is subject to section

446(e) and not whether the Commissioner’s actions were

arbitrary and an abuse of discretion.    See So. Pac. Transp.

Co. v. Commissioner, supra at 682; Wright Contracting Co.

v. Commissioner, 36 T.C. at 635-636; cf. FPL Group, Inc. &

Subs. v. Commissioner, 115 T.C. at 572, 575; Poorbaugh v.

United States, 423 F.2d 157, 163 (3d Cir. 1970); Hackensack

Water Co. v. United States, 173 Ct. Cl. 606, 352 F.2d 807

(1965).    If the change constitutes a change of accounting
                           - 42 -

method that is subject to section 446(e), then the taxpayer

is foreclosed from making the change by section 446(e) and

the regulations promulgated thereunder without regard to

whether the new method would be proper.   See So. Pac.

Transp. Co. v. Commissioner, supra at 682; Wright

Contracting Co. v. Commissioner, supra at 635-636.    The

issue whether the change of accounting method is proper is

not pertinent until after the Commissioner has refused the

taxpayer’s request for consent to the change.   See Brown

v. Helvering, supra at 203; Wright Contracting Co. v.

Commissioner, supra at 636; Advertisers Exchange, Inc.,

v. Commissioner, 25 T.C. at 1093.


Meaning of the Phrase “Method of Accounting”

     The Code does not define the phrase “method of

accounting”.   We have held that the phrase includes “the

consistent treatment of any recurring, material item,

whether that treatment be correct or incorrect.”    See Bank

One Corp. v. Commissioner, 120 T.C. 174, 282 (2003); H.F.

Campbell Co. v. Commissioner, 53 T.C. 439, 447 (1969),

affd. 443 F.2d 965 (6th Cir. 1971).

     The regulations promulgated under section 446 state:

“The term ‘method of accounting’ includes not only the

over-all method of accounting of the taxpayer but also the

accounting treatment of any item.”    Sec. 1.446-1(a)(1),
                           - 43 -

Income Tax Regs.   The regulations also contain the

following discussion of changes of accounting method:


     A change in the method of accounting includes a
     change in the overall plan of accounting for
     gross income or deductions or a change in the
     treatment of any material item used in such
     overall plan. Although a method of accounting
     may exist under this definition without the
     necessity of a pattern of consistent treatment of
     an item, in most instances a method of accounting
     is not established for an item without such
     consistent treatment. A material item is any
     item which involves the proper time for the
     inclusion of the item in income or the taking of
     a deduction. [Sec. 1.446-1(e)(2)(ii)(a), Income
     Tax Regs.]


     In order to determine whether an item is one “which

involves the proper time for the inclusion of the item in

income or the taking of a deduction” and, hence, is a

material item under the above regulation, it is necessary

to determine whether a change in the treatment of that item

will change the taxpayer’s lifetime income or will merely

postpone or accelerate the reporting of income.    See, e.g.,

Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 510

(1989), where the Court stated:     “When an accounting

practice merely postpones the reporting of income, rather

than permanently avoiding the reporting of income over

the taxpayer’s lifetime, it involves the proper time

for reporting income.”   See Diebold, Inc. v. United States,

891 F.2d 1579, 1583 (Fed. Cir. 1989) (a change from
                          - 44 -

nondepreciable inventory to depreciable property is a

change in method of accounting); FPL Group, Inc. v.

Commissioner, 115 T.C. 554 (2000) (a change from

capitalizing and depreciating the costs of a group of

depreciable assets to expensing them involves a change

in the treatment of a material item and is, therefore, an

impermissible change in method of accounting); Pac. Enters.

v. Commissioner, 101 T.C. 1 (1993) (a change from “working

gas” (inventory) to “cushion gas” (capital asset) is a

change in method of accounting); Standard Oil Co. (Indiana)

v. Commissioner, 77 T.C. at 410 (a change in depreciation

method resulting from a change from section 1250 property

to section 1245 property is a change in method of

accounting).

     Finally, the regulations detail certain situations

that are not considered changes in method of accounting.

Section 1.446-1(e)(2)(ii)(b), Income Tax Regs., provides:


     A change in method of accounting does not include
     correction of mathematical or posting errors, or
     errors in the computation of tax liability (such
     as errors in computation of the foreign tax
     credit, net operating loss, percentage depletion
     or investment credit). Also, a change in method
     of accounting does not include adjustment of any
     item of income or deduction which does not
     involve the proper time for the inclusion of
     the item of income or the taking of a deduction.
     For example, corrections of items that are
     deducted as interest or salary, but which are in
     fact payments of dividends, and of items that are
                             - 45 -

     deducted as business expenses, but which are in
     fact personal expenses, are not changes in method
     of accounting. * * * A change in the method of
     accounting also does not include a change in
     treatment resulting from a change in underlying
     facts. On the other hand, for example, a
     correction to require depreciation in lieu of a
     deduction for the cost of a class of depreciable
     assets which had been consistently treated as an
     expense in the year of purchase involves the
     question of the proper timing of an item, and
     is to be treated as a change in method of
     accounting.


The Change That Petitioner Seeks To Make in This Case
Involves a Material Item

     In the present case, petitioner is not seeking to

change its overall plan of accounting for gross income or

deductions, such as by changing from the accrual method

to some other overall method of accounting.    Rather, the

change that petitioner seeks to make involves the treatment

of a single item, the overburden removal costs incurred by

Cordero at the Gillette mine, which forms a part of

petitioner’s overall plan.    We must determine whether this

is a material item; that is, an “item which involves the

proper time for the inclusion of the item in income or the

taking of a deduction.”   See sec. 1.446-1(e)(2)(ii)(a),

Income Tax Regs.   If it is a material item, then a change

in its treatment can involve a change in petitioner’s

method of accounting, and we must consider petitioner’s

other arguments.
                           - 46 -

     On this point, we agree with respondent.    As discussed

above, petitioner treated the overburden removal costs

incurred by Cordero at the Gillette mine as a development

expenditure on its returns for the years in issue.    This

meant, depending on the year involved, that 80 to 85

percent of the aggregate overburden removal costs incurred

during the taxable year was deducted against taxable income

under section 616(a).   See sec. 291(b)(1).   The remainder

was capitalized and was amortized over 5 years, beginning

with the year in which the costs were paid or incurred.

See sec. 291(b)(1) and (2).   Petitioner now proposes to

treat the overburden removal costs incurred during 1983,

1984, and 1986 as production costs that can fully offset

gross receipts as part of petitioner’s costs of goods sold.

     The difference between treating overburden removal

costs as a development expenditure and treating them as a

production cost is summarized in the following schedule:
                                     - 47 -
Year       Development Expenditure       Production Cost      Difference
              1                               2
 1             85.00% + 2.25%                  100%            (12.75%)
 2                      3.30                   --                3.30
 3                      3.15                   –-                3.15
 4                      3.15                   –-                3.15
 5                      3.15                   –-                3.15

           Total      100                         100            –-


       1
         80 percent for 1986.
       2
         Assuming, for simplicity’s sake, that all of the coal related
to the overburden removal expenditures was sold in the year the costs
were incurred.


As indicated above, if overburden removal costs are treated

as development expenditures, then 87.25 percent of the

total would be deductible in the year incurred, and 12.75

percent of the total would be spread, as deductions, over

years 2 through 5.          On the other hand, if overburden

removal costs are treated as production costs, then 100

percent of the total would be included in petitioner’s cost

of goods sold and would offset gross receipts from the mine

in the year the coal is sold.

       It is apparent from the above that the change in the

treatment of overburden removal costs that petitioner seeks

to make entails a change in the timing of the income

reported from the mine and not a change in the total income

realized over the life of the mine.                Accordingly, the

aggregate overburden removal costs petitioner incurred at

the Gillette mine are a material item because they involve
                           - 48 -

the proper time for the taking of a deduction.    See sec.

1.446-1(e)(2)(ii)(a), Income Tax Regs.


Petitioner’s Arguments Do Not Persuade Us That the Subject
Change Is Not a Change of Accounting Method

     Petitioner argues that the proposed change in the

treatment of its overburden removal costs is not a change

of accounting method but only a recharacterization of the

costs from development expenditures to production costs.

In support of that argument petitioner cites four cases:

Underhill v. Commissioner, 45 T.C. 489 (1966); Coulter

Elecs., Inc. v. Commissioner, T.C. Memo. 1990-186; Standard

Oil Co. (Indiana) v. Commissioner, 77 T.C. 349 (1981); and

Tex. Instruments Inc., & Consol. Subs. v. Commissioner,

T.C. Memo. 1992-306.

     We believe that the cases petitioner cites are

distinguishable.   In Underhill v. Commissioner, supra, the

Court held that a taxpayer’s switch to a cost recovery

method of determining income from certain promissory notes,

after having used a pro rata method with regard to the same

notes in previous years, was not a change in method of

accounting under section 446(e).    The Court held that

section 446 was inapplicable because the issue involved

“the extent to which payments received by * * * [the

taxpayer] are taxable or nontaxable–-i.e., the character
                            - 49 -

of the payment–-not the proper method or time of reporting

an item the character of which is not in question.”       Id. at

496.

       Similarly, in Coulter Elecs., Inc. v. Commissioner,

supra, the Court considered the character of payments

received by the taxpayer from a bank.    Initially, the

taxpayer had treated the transfer of certain equipment

leases to the bank as sales, but after audit, the taxpayer

sought to change the treatment from sales to pledges for

loans.    Relying on Underhill, the Court found that the

issue in the case was “not one of timing as contemplated

by section 446” but “Instead it [was] a question of

characterization, i.e., whether the transfer by * * * [the

taxpayer] of the leases to * * * [the bank] constituted

sales or pledges for loans.”    Coulter Elecs., Inc. v.

Commissioner, supra.    The Court quoted the Underhill case

regarding the taxability or nontaxability of a payment and

stated:    “Although there is a timing consequence to the

outcome of the characterization, it is automatically

determined by the characterization and no change of

accounting within the meaning of section 446 is involved.”

Id.

       The change in characterization in Coulter Elecs., Inc.

and in Underhill determined the taxability of the income
                           - 50 -

items at issue.   In each case, the character of the items

was changed from taxable to nontaxable, and the taxpayer’s

lifetime taxable income was affected.   In each case, the

Court held that the change was not a change in the

taxpayer’s method of accounting.

     The change in characterization in the instant case,

on the other hand, does not involve the same kind of

recharacterization that was involved in either Underhill or

Coulter Elecs., Inc.   In this case, the overburden removal

costs are deductible whether they are treated as mine

development expenses or production costs.   The change in

characterization affects only whether the overburden

removal costs are treated as an income offset or are

amortized over 5 years.   This is clearly a timing issue.

Petitioner’s lifetime taxable income is not affected.

     Petitioner refers to the following statement made by

the Court in Tex. Instruments, Inc., & Consol. Subs. v.

Commissioner, supra:


     We therefore conclude that, to the extent that
     petitioner was required to allocate those costs
     to its long-term contracts to comply with the
     regulations, respondent’s proposed adjustments
     would not constitute a change in petitioner’s
     method of accounting for those items within the
     meaning of section 1.446-1(e)(2)(ii), Income Tax
     Regs.
                           - 51 -

That statement was made in response to the taxpayer’s

argument to the effect that the Commissioner’s allocation

of certain general and administrative expenses, as called

for in the amendment to answer, was not a change of method

of accounting under Standard Oil Co. (Indiana) v.

Commissioner, supra, because the taxpayer was required by

the regulations to allocate those costs to long-term

contracts and did not have a “discretionary choice” to do

otherwise.

     Other than the above statement, we find nothing in

Tex. Instruments that is useful to petitioner in this case.

As we read the Court’s opinion in Tex. Instruments, the

statement quoted above is dictum.   Furthermore, the

statement was made about adjustments proposed by the

Commissioner, as to which section 446(e) does not apply.

See Complete Fin. Corp. v. Commissioner, 80 T.C. 1062, 1073

(1983) (“The restriction of section 446(e) does not apply

to changes initiated by the Commissioner.”), affd. 766 F.2d

436 (10th Cir. 1985).   Finally, the above statement is

nothing more that a reprise of the Court’s holding in

Standard Oil Co. (Indiana), a case which, as discussed

below, is unlike petitioner’s.

     Petitioner’s reliance on the last case cited, Standard

Oil Co. (Indiana), is also misplaced.   In that case, the
                           - 52 -

taxpayer had elected to deduct intangible drilling costs

(IDC), pursuant to section 1.612-4, Income Tax Regs., but

had capitalized and amortized, over the lives of the

assets, certain IDC.   We rejected the Commissioner’s

assertion that the taxpayer’s attempt to deduct that IDC in

the taxable years at issue was a change in its method of

accounting that required the Commissioner’s consent

because:


     If the election [to deduct IDC] is made, all
     IDC must be deducted. Petitioner’s tardy
     assertion that the “other” costs in issue should
     have been deducted does not * * * constitute a
     discretionary choice that such costs should be
     deducted. It is a discovery that petitioner
     failed to deduct costs which, under the
     accounting method it has chosen, had to be
     deducted. [Standard Oil Co. (Indiana) v.
     Commissioner, 77 T.C. at 382-383.]


We held that section 446(e) did not apply, but we added the

following caveat:


     We do not mean to suggest that section 446(e)
     would necessarily be inapplicable in the
     situation where a taxpayer has previously
     capitalized all IDC and then seeks to deduct
     such costs under section 263(c) without
     respondent’s consent. [Id. at 383-384.]


     We believe that the change petitioner proposed is

different from the “correction of internal inconsistencies”

necessitated by the “discovery” of the taxpayer’s failure
                             - 53 -

to deduct certain costs that was involved in Standard Oil

Co. (Indiana).    First, this case does not involve “internal

inconsistencies.”   Petitioner treated all of the overburden

removal expenses incurred at the Gillette mine as

development expenses for tax purposes.    The parties

stipulated:   “Cordero incorrectly classified its costs of

overburden removal at its Gillette mine as mine development

expenses.”    Petitioner now wants to reclassify all of those

costs as production costs.    Furthermore, we cannot find

that the change in treatment sought by petitioner was

necessitated by the discovery of an error, as opposed to

“a discretionary choice”.    All of the overburden removal

expenses incurred at the Gillette mine were treated as

production costs for book purposes, and the Schedule M-1,

Reconciliation of Income Per Books With Income Per Return,

filed with petitioner’s return for each of the years in

issue, reconciles that book treatment with the tax

treatment of the same overburden removal expenses as

development expenditures.

     In summary, the instant case does not involve the kind

of recharacterization that was involved in either Underhill

v. Commissioner, 45 T.C. 489 (1966), or Coulter Elecs.,

Inc. v. Commissioner, T.C. Memo. 1990-186, and that takes

into account the nontaxable character of payments that are
                           - 54 -

at issue.   Neither does this case involve the correction of

internal inconsistencies discovered by the taxpayer as

involved in Standard Oil Co. (Indiana) v. Commissioner, 77

T.C. 349 (1981).

     In light of the above, we agree with respondent that

petitioner’s overburden removal costs incurred at the

Gillette mine are a “material item” and that the change in

the treatment of that item proposed by petitioner is a

change of accounting method that is subject to the consent

requirement of section 446(e).   Petitioner concededly did

not obtain the Commissioner’s consent and, therefore,

petitioner is not entitled to make the change proposed.

     Finally, we disagree with petitioner’s second argument

that, even if the change is a change of accounting method,

section 446(e) does not apply because there is no potential

for distortion in this case.   Petitioner argues that there

is no potential for distortion because the first year at

issue, 1983, is the first year in which the tax treatment

of overburden removal costs differed from that of

production costs.   This and other courts have rejected

similar arguments in the past.   See Diebold, Inc. v. United

States, 891 F.2d at 1583; So. Pac. Transp. Co. v.

Commissioner, 75 T.C. at 682; cf. Pac. Natl. Co. v. Welch,

304 U.S. 191 (1938); Lord v. United States, 296 F.2d 333,
                           - 55 -

335 (9th Cir. 1962).   As we stated in So. Pac. Transp. Co.

v. Commissioner, supra, the Commissioner’s consent is

required when a taxpayer, in a Court proceeding, attempts

to alter retroactively the manner in which he accounted

for an item on his tax return.    We reject petitioner’s

argument because of the administrative burden that

would otherwise be placed on the Commissioner.     This

administrative burden is particularly evident in this case

where the treatment that petitioner seeks to change had

been followed consistently on its returns from 1983 through

1993 until it sold Cordero.

     On the basis of the above, concessions by the parties,

and our prior opinions issued in this case,


                                      An appropriate order

                                 will be issued.
