                  T.C. Memo. 1996-368



                UNITED STATES TAX COURT



            E.W. RICHARDSON, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 27308-92.                    Filed August 12, 1996.



     During the years in issue, P was the sole
shareholder of I. I was a subch. S corporation that,
among other things, provided management consulting
services and operated an automobile dealership through
one of its divisions. I valued its new car and new
truck inventories on the last-in, first-out (LIFO)
method. During the years in issue, I owned and
maintained an airplane. The airplane was used in
connection with I’s operation of its divisions and in
providing management consulting services.
     1. Held: When I began defining its items of
inventory for its new car LIFO pool by model line,
rather than body size, it changed the treatment of a
material item. This change in item was material
because it affected the computation of beginning and
ending inventory. Since I changed the treatment of a
material item used in its overall method of inventory
accounting, it changed its method of accounting. Sec.
446(e), I.R.C.; sec. 1.446-1(e)(2)(ii)(a),(c), Income
Tax Regs.
                                   - 2 -

            2. Held, further, I’s method of accounting for
       its new car and new truck inventories did not clearly
       reflect income, as I inconsistently defined its items
       of inventory for both its new car and new truck pools.
       Sec. 446(b), I.R.C.; secs. 1.471-2(b), 1.472-8(a),
       Income Tax Regs.
            3. Held, further, R did not abuse her discretion
       in determining that I must define its items of
       inventory for its new car and new truck LIFO pools by
       model code. Sec. 446(b), I.R.C.
            4. Held, further, the expenses I incurred in
       owning and operating its airplane during the years at
       issue are allowable under sec. 162, I.R.C.



       Patricia Tucker, for petitioner.

       Thomas F. Eagan, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

       PARR, Judge:     Respondent determined deficiencies in,

additions to, and a penalty on petitioner’s Federal income tax

for taxable years 1988 and 1989 as follows:

                                 Additions to Tax and Penalty
                                 Sec.        Sec.       Sec.
Year        Deficiency        6653(a)(1)     6661      6662(a)

1988         $656,486         $11,971      $5,704       -0-
1989          323,343           -0-          -0-      $34,003

       All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.
                                - 3 -

     After concessions,1 the issues for decision are:   (1)

Whether Richardson Investments, Inc. (Investments), made an

unauthorized change in method of accounting.    We hold it did.

(2) Whether Investments’ method of inventory accounting clearly

reflected income.   We hold it did not.   (3) Whether respondent

abused her discretion in determining that Investments should

define its items of inventory for dollar-value LIFO purposes by

model code.   We hold she did not.   (4) Whether Investments’

claimed deductions arising from the ownership and operation of an

airplane are allowable.   We hold that such deductions are

allowable.

                          FINDINGS OF FACT

     Some of the facts have been stipulated.   The stipulated

facts and the accompanying exhibits are incorporated into our

findings by this reference.    Petitioner, E.W. Richardson, resided

in Albuquerque, New Mexico, on the date the petition was filed.

     During the taxable years 1988 and 1989, petitioner was the

sole shareholder of Investments, a subchapter S corporation.

Investments was incorporated under the laws of the State of New

Mexico on February 21, 1961.   Investments elected the status of

an S corporation on January 1, 1986.    Prior to 1986, Investments

owned three subsidiaries:   Rich Ford Sales, Rich Ford Leasing,


1
     Pursuant to a stipulation of agreed adjustments and a
concession on brief by respondent, the parties resolved all but
four of the issues raised by the pleadings. We leave it to the
parties to include these adjustments in their Rule 155
computations.
                                - 4 -

and Richardson Properties.   In 1986, the subsidiaries were

liquidated into Investments and thereafter operated as divisions

of Investments.   During the years at issue, Investments, through

its Rich Ford Sales division, operated a franchised Ford Motor

Co. (Ford) automobile and truck dealership in Albuquerque, New

Mexico, and also held franchises for the sale of Daihatsu

automobiles and Daihatsu and Isuzu trucks.

     Prior to the taxable year 1974, Investments valued its new

car and new truck inventory on the specific identification, lower

of cost or market, first-in, first-out (FIFO) method.    With its

Federal income tax return for the taxable year 1974, Investments

filed Form 970, Application to Use LIFO Inventory Method, the

Commissioner electing to use the last-in, first-out (LIFO) method

of valuing its inventory.    Specifically, Investments elected to

use the dollar-value, link-chain, earliest-acquisition method of

inventory valuation with a single LIFO inventory pool for both

its new cars and new trucks.2

     Investments’ 1974 Federal corporate income tax return was

audited by the Commissioner.    As a result of that audit, the

Commissioner issued a notice of deficiency.    The adjustments in

the notice of deficiency were redetermined by this Court in

Richardson Invs., Inc. v. Commissioner, 76 T.C. 736 (1981)

(Richardson I).

2
       Although Investments checked the “double-extension method”
block on its Form 970, respondent concedes that petitioner duly
elected the link-chain method of computing the last-in, first-out
(LIFO) value of its inventory.
                                - 5 -

     The primary issue in Richardson I was whether Investments

“properly adopted the use of a single LIFO inventory pool in

computing inventory values pursuant to the dollar-value, link-

chain LIFO method”.    Id. at 737.   Investments argued that it was

entitled to use a single pool for new cars and new trucks, and

the Commissioner argued that each model line3 should constitute a

separate dollar-value pool.    Id. at 745.   The Court rejected

Investments’ method of utilizing a single pool for new cars and

new trucks, and it rejected the Commissioner's single pool per

model line argument.   Id. at 747.   Rather, the Court held that

“new cars and new trucks should be placed in separate pools.”

Id. at 748.

     After the opinion in Richardson I was filed (May 11, 1981),

Investments recomputed its taxable year 1974 LIFO inventory

calculation, placing new cars and new trucks in separate pools.

The calculation was submitted to the Court under the Court’s Rule

155 procedure, and a decision was entered.    Investments and the

Commissioner reached an agreement on Investments’ inventory

calculations for taxable years 1975, 1976, and 1977, conforming

those calculations to the decision in Richardson I.    For taxable

years 1978, 1979, and 1980, Investments amended its tax returns

to conform its inventory calculations to the decision in

Richardson I.

3
     The parties have stipulated that vehicle “model lines” are
the different vehicle product lines offered by the manufacturers;
for example, Ford Motor Co. offers the Mustang model line, the
Escort model line, etc.
                                 - 6 -

     In its recomputations for the taxable years 1974 through

1980, Investments defined the units used to compute beginning of

the year value of ending inventory for its new car pool by

vehicle body size (body size).4    For example, in 1980,

Investments separated its new cars into six categories:    Full

size, luxury, midsize, compact, subcompact, and Escort. The full-

size category included eight model codes of full-size LTD

automobiles.   The luxury category included one model code of

Thunderbird automobiles.    The midsize category included four

model codes of midsize LTD automobiles and two model codes of

Granada automobiles.   The compact category included four model

codes of Fairmont automobiles.    The subcompact category included

four model codes of Mustang automobiles and three model codes of

Pinto automobiles.    The Escort model line was introduced for the

first time in 1980.

     Starting in 1981, Investments defined its new car pool

inventory units by model line.    Thus, each model line was a

different category, e.g., Mustang model line, Escort model line,

Tempo model line, etc.   After it began defining its new car pool

inventory units by model line, in place of body size, Investments

did not restate its LIFO indexes for 1974 through 1980 based on

the model line classification.    Furthermore, Investments did not

file Form 3115, Application for Change in Accounting Method, or


4
     All references to "inventory units" are to the definition of
the units used to compute beginning of the year value of ending
inventory. See discussion in sec. B.2., infra pp. 21-22.
                                - 7 -

otherwise request respondent’s consent to change its LIFO

inventory valuation method.

     In its new truck pool for years 1979 through 1985,

Investments treated all of its vans (E series) and extended body

vans (S series) as one inventory unit, but separated its full-

size pickups (F series), extended cab full-size pickups (X

series), and four-door full-size pickups (W series) into three

different inventory units by load-carrying ability (i.e., 1/2-

ton, 3/4-ton, and 1-ton).

     For 1986, 1987, and 1988, Investments treated all of its

full-size pickups (the F, X, and W series) as one inventory unit

and all of its vans (E series) and extended body vans (S series)

as another inventory unit.    For 1989, Investments treated each of

its E series vans, its S series vans, its F series pickups, its W

series pickups, and its X series pickups as separate inventory

units.

     For its Ranger trucks (R series) and Aerostar vans (A

series), Investments always treated each of those model lines as

one inventory unit, regardless of any submodels that were

introduced; but it always separated its Bronco trucks (U series)

by size; i.e., the full-size model (U15) and the Bronco II models

(U12 and U14).

     In addition to operating its automobile dealership through

its Rich Ford Sales division, Investments, among other things,

provided management consulting services to its operating
                                 - 8 -

divisions and certain “other entities”.     The “other entities”

were Pioneer Ford Sales, Inc. (Pioneer), Fiesta Lincoln-Mercury,

Inc. (Fiesta Lincoln), Heritage Auto Center, Inc. (Heritage),

Fiesta Dodge, Inc. (Fiesta Dodge), Sunland Ford, Inc. (Sunland),

Imports of Albuquerque, Inc. (Imports), Deep Seal International,

Inc. (Deep Seal), Horizon Life Insurance Co., Inc. (Horizon),

Ranch Partnership (Ranch), Valley Ford Sales, Inc. (Valley),

Warranty Protection Co., Inc. (Warranty), Theft-Shield

International, Inc. (Theft-Shield), and Arizona Aftermarket

Associates, Inc. (Aftermarket).

     Pioneer, Fiesta Lincoln, Heritage, Fiesta Dodge, Sunland,

and Imports each owned and operated dealerships for the sale of

new automobiles and trucks.   Deep Seal provided paint sealant to

be applied on new vehicles at the time of sale.     Horizon sold

credit life insurance on financed vehicles at the time of sale.

Theft-Shield provided theft protection for new vehicles.

Warranty provided extended service warranties for new vehicles at

the time of sale.   Valley and Aftermarket provided accessory

parts for new vehicles at the time of sale.     Ranch owned and

operated a large cattle ranch.

     Petitioner had an ownership interest in each of the other

entities, except Sunland.   Petitioner was a special trustee of a

business trust which owned Sunland.      Petitioner’s interest in the

other entities varied from 15 percent of Warranty to 100 percent
                                 - 9 -

of Imports.   Petitioner owned 50 percent or more of 7 of the 13

other entities.

     The management services provided by Investments included

consulting in the following areas:       Accounting, finance, legal,

sales, marketing, and personnel management.      These services were

provided both periodically and on an as-needed basis.

     The fees Investments charged for management services were

billed and paid monthly.   During the taxable years 1988 and 1989,

Investments billed management fees of $814,452 and $970,997,

respectively.

     During 1988 and 1989, Investments owned a Lear Jet Model 25D

airplane (airplane).   Investments used the airplane for travel

associated with the operating divisions and travel associated

with its management services activity.

     In regard to the operating divisions, the airplane was used

by Rich Ford Sales to transport its employees to conventions and

seminars.   The airplane was also used to fly key management

personnel to Detroit, Michigan, to respond to urgent business

Rich Ford Sales had with Ford.    Also, Rich Ford Sales used the

airplane to take employees to automobile shows.

     In connection with the management services activity,

Investments’ employees used the airplane to travel to the

following other entities during the taxable years at issue:

Pioneer, Fiesta Lincoln, Fiesta Dodge, Heritage, and Sunland.

Pioneer was located in Phoenix, Arizona.      Fiesta Lincoln and
                              - 10 -

Fiesta Dodge were located in San Antonio, Texas.   Heritage was

located in Kirkland, Washington, and Sunland in Apple Valley,

California.   The airplane allowed Investments’ employees to

provide management services in person to each of these out-of-

town dealerships.

     Investments generally used the airplane only if four or more

people needed to travel.   If fewer than four people were

traveling, the employees would usually fly commercially, as use

of the airplane in such circumstances was inefficient.   Use of a

private airplane saved time, as employees could fly to an out-of-

town dealership and return to Albuquerque, New Mexico, in the

same day, or they could visit two dealerships in the same day.

This was important, because the down time associated with having

a number of employees waiting for a commercial flight was costly.

Use of the private airplane also saved travel expenses, because

the reduced travel time often reduced the room and board costs

that would be associated with commercial travel.

     Overall, the airplane was flown a total of 112.98 and 68.30

hours for taxable years 1988 and 1989, respectively.   The

airplane was flown 63.77 and 52.30 hours for management services

for taxable years 1988 and 1989, respectively.   Accordingly, the

airplane was used 56 percent and 77 percent of the time in 1988

and 1989, respectively, for management services.

     The airplane was also used to fly employees to conventions,

seminars, and training in 1988.   It was used 12.86 hours for this
                               - 11 -

purpose, or 11 percent of its total 1988 use.      In addition, the

airplane was flown for crew training, maintenance, repair, and

testing purposes.   This use amounted to 33.45 hours in 1988 and

9.60 hours in 1989, representing 30 percent and 14 percent of the

total use, respectively.    Finally, petitioner used the airplane

wholly or partially for personal reasons on five occasions during

the years at issue.   Petitioner used the airplane for 2.9 hours

in 1988 and 6.4 hours in 1989, or 3 percent and 9 percent of the

total time, respectively.

     When the airplane was used to provide management services,

airplane service fees incurred for such travel were billed

separately from the management fees.      In these situations, the

airplane pilot would prepare the airplane service bill, and

Investments’ accounting department would process the bill and

separately charge the customer involved.      For the years at issue,

the airplane rental fees charged the other entities were $700 per

hour, plus out-of-pocket expenses of Investments’ employees for

meals, entertainment, and lodging.      The airplane pilot set the

$700 hourly airplane rental fee, based on the anticipated

expenses associated with 200 hours of billable flight time.      That

estimated hourly fee was low for 1988 and 1989, but the estimated

fee was subsequently adjusted upward.

     When petitioner used the airplane for personal use, he was

billed for and paid the direct costs of the flights; these direct

costs included, for example, fuel, hangar storage, tie-down,
                              - 12 -

etc., for each flight.   These charges varied from $450 per hour

to $760 per hour during 1988 and 1989.

     Investments’ total costs of owning, operating, and

maintaining its airplane, exclusive of pilot salary, during 1988

and 1989 were $218,452.14 and $142,427.85, respectively.

Investments collected a separate rental fee from Pioneer, Fiesta

Lincoln, Fiesta Dodge, Heritage, Ranch, and Sunland for the use

of its airplane during 1988 and 1989.    The airplane rental fees

collected by Investments during 1988 and 1989 were $48,048.50 and

$37,674, exclusive of meals, lodging, etc., respectively.

                              OPINION

     The issues in the instant case fall into two principal

groups which we will discuss under separate headings:   Accounting

for Inventories and Airplane Expenses.

Accounting for Inventories

     To set the stage for our review of respondent's

determinations, a discussion of the dollar-value LIFO method of

inventory accounting used by Investments to determine its ending

inventory is helpful.

     A. Dollar-Value LIFO

     Section 471 requires the use of inventories whenever

necessary in order to clearly reflect income.   Sec. 471(a); Fox

Chevrolet, Inc. v. Commissioner, 76 T.C. 708, 719 (1981).     The

regulations define “necessary” as being whenever the production,

purchase, or sale of merchandise is an income-producing factor.
                              - 13 -

Sec. 1.471-1, Income Tax Regs.   When inventories are required,

they must be maintained on a basis that conforms as nearly as

possible to the best accounting practice in the taxpayer's trade

or business and that most clearly reflects income. Sec. 471(a);

Fox Chevrolet, Inc. v. Commissioner, supra at 719-722.

     In a merchandising business, gross income from sales means

total sales less cost of goods sold (COGS).   Sec. 1.61-3(a),

Income Tax Regs.   COGS for the year is determined by subtracting

the value of ending inventory from the sum of the value of

beginning inventory and the cost of purchasing or producing goods

during the year.   Primo Pants Co. v. Commissioner, 78 T.C. 705,

723 (1982).   As a general rule, taxpayers will want to keep

ending inventory as low as possible so that COGS, which is an

offset to gross receipts, is made as large as possible, thereby

minimizing gross income.   Hamilton Indus., Inc. & Sub. v.

Commissioner, 97 T.C. 120, 129 (1991).

     Section 472 permits taxpayers to value their inventories

under the LIFO method.   In contrast to the FIFO method of

inventory valuation, which treats the first goods acquired as the

first goods sold, the LIFO method of inventory valuation treats

the last goods acquired as the first goods sold.   Sec. 472(b);

Fox Chevrolet, Inc. v. Commissioner, supra at 722.   Accordingly,

under the LIFO method, the earliest goods acquired are treated as

the goods remaining in ending inventory.   Fox Chevrolet, Inc. v.

Commissioner, supra at 722.   During a period of rising costs, the
                                - 14 -

use of the LIFO method generally results in lower taxes because

ending inventory will be lower, and therefore COGS will be

higher.    Amity Leather Prods. Co. v. Commissioner, 82 T.C. 726,

731 (1984).     “The theory behind LIFO is that income may be more

accurately determined by matching current costs against current

revenues, thereby eliminating from earnings any artificial

profits resulting from inflationary increases in inventory

costs.”     Id. at 732.

     In computing LIFO inventory values, two basic approaches are

used:     The specific-goods method and the dollar-value method.

Hamilton Indus., Inc. & Sub. v. Commissioner, supra at 130; see

secs. 1.472-2, 1.472-8, Income Tax Regs.     We have previously

compared the specific-goods LIFO method with the dollar-value

LIFO method:

          Under the specific-goods method, the physical quantity
     of homogeneous items of inventory at the end of the taxable
     year is compared with the quantity of like items in the
     beginning inventory to determine whether there has been an
     increase or decrease during the year. Because the
     specific-goods method requires the matching of physical
     units, practically speaking, it is only used as a method for
     valuing inventories in those industries with inventories
     which contain a limited number of items with quantities that
     are easily measured in units. In contrast to the
     specific-goods method, the dollar-value method measures
     increases or decreases in inventory quantities, not in terms
     of physical units, but in terms of total dollars. Thus, to
     determine whether there has been an increase or decrease in
     the inventory during the year, the ending inventory is
     valued in terms of total dollars that are equivalent in
     value to the dollars used to value the beginning inventory.
     Because it is not predicated upon the matching of specific
     items, use of the dollar-value method permits the
     application of the LIFO principle in those industries with
     complex inventories containing a vast number of items. * * *
                              - 15 -

      [Wendle Ford Sales, Inc. v. Commissioner, 72 T.C. 447, 452
      (1979); citations omitted.]

      Investments used the dollar-value LIFO method to calculate

its ending inventory.   Under the dollar-value method, inventory

is grouped into “pools”5 composed of “items”.   Hamilton Indus.,

Inc. & Sub. v. Commissioner, supra at 131; sec. 1.472-8(a),

Income Tax Regs.   To determine whether there has been a change in

inventory value from the prior year, the current year aggregate

cost of the items in ending inventory for each pool is valued at

“base-year cost”; base-year cost is the aggregate cost of all

items in the pool at what they cost (or would have cost) as of

the beginning of the taxable year for which the LIFO method was

first adopted.   Sec. 1.472-8(a), Income Tax Regs.   After

converting the current year ending inventory from current-year

cost to base-year cost, the value of the beginning and ending

inventory in terms of base-year cost is compared to determine

whether an increase or decrease in inventory value has occurred.

Id.   Thus, to ascertain whether a taxpayer’s ending inventory has

increased or decreased in real quantity terms, it is necessary to

compare the value of the beginning and ending inventories of a

particular taxable year expressed in terms of the same dollar



5
     In the case of a retailer, such as Investments, the
regulations provide that the inventory shall be grouped by “major
lines, types, or classes of goods.” Sec. 1.472-8(c), Income Tax
Regs. Investments, pursuant to Richardson Invs., Inc. v.
Commissioner, 76 T.C. 736 (1981), used two pools, one for new
cars and one for new trucks.
                              - 16 -

equivalent; i.e., base-year cost.    1 Schneider, Federal Income

Taxation of Inventories, sec. 14.01[1], at 14-4, 14-5 (1996).

     The regulations contain four alternative approaches to

determine base-year cost:   The double-extension method, the index

method, the link-chain method, and the retail method.    Sec.

1.472-8(e)(1), Income Tax Regs.    Investments used the “link-

chain” method of computing the base-year cost of the inventory in

its LIFO pools.6

     More specifically, Investments used the link-chain, dual-

index method for the determination of quantity changes and for

the valuation of increments in its LIFO pools.    Under the dual-

index method, a cumulative deflator index is used to value ending

inventory at base-year cost, and a layer-valuation index is used

to value increments in the pool.

     Each year Investments calculates an annual and a cumulative

deflator index for each pool in order to convert current year

ending inventory at “actual cost”7 to what it would be at base-



6
     Although the regulations do not contain a specific
description of the link-chain methodology, or an example of such
methodology, the parties have stipulated that Investments’ link-
chain methodology, as described below, was appropriate. For a
more detailed description of the link-chain methodology, see Rev.
Proc. 92-79, sec. 4, 1992-2 C.B. 457, 460 (describing alternative
LIFO method for automobile dealers); see also 1 Schneider,
Federal Income Taxation of Inventories, sec. 14.02[3][b], at 14-
96 (1996).
7
     In arriving at the actual cost of its ending inventory in
its new car and new truck pools each year, Investments uses the
actual invoice cost of each vehicle in inventory.
                                - 17 -

year cost.   To compute the annual deflator index, Investments

divides the ending inventory at actual cost by the beginning of

the year value of ending inventory.8     This results in a current

year annual deflator index.     The current year annual deflator

index is then multiplied by the annual deflator index from all

prior years to arrive at the cumulative deflator index.     The

ending inventory on the books at actual cost is then divided by

the cumulative deflator index to arrive at the ending inventory

expressed at base-year cost.9

     Once ending inventory at base-year cost is computed, it is

compared to beginning inventory at base-year cost.     See sec.

1.472-8(e)(2)(iv), Income Tax Regs.      If ending inventory valued

at base-year cost exceeds beginning inventory at base-year cost,


8
     Investments divided the total beginning of the year number
of vehicles for each unit of inventory, e.g., model line, by the
total beginning of the year cost for all the vehicles in that
unit, resulting in an average cost for the unit. This average
cost was then multiplied by the number of vehicles on hand and in
transit at yearend for that particular unit to determine the
beginning of the year value of ending inventory for the unit.
The total for each unit was then summed to reach beginning of the
year value of ending inventory.

9
     Comparing the link-chain method with the double-extension
method, one commentator has noted:

          The basic approach of the link-chain method is
     comparable to the double-extension method, except that the
     base year is rolled forward each year. Thus, instead of
     referring back to a fixed base period for purposes of
     pricing items, each years’s current costs are restated in
     terms of the prior year’s costs. These costs may then [be]
     indexed back to the base year through the use of a
     cumulative price index. [1 Schneider, supra at 14-96; fn.
     refs. omitted.]
                              - 18 -

there is an increment in inventory.    See id.   The LIFO value of

such increment is then computed, see id., and the increment is

added to beginning inventory for the pool to determine the

current year’s LIFO ending inventory for the pool, see id.; see

also Fox Chevrolet, Inc. v. Commissioner, 76 T.C. at 733 n.16.

     If ending inventory valued at base-year cost is less than

beginning inventory at base-year cost, there is a decrement in

inventory.   See sec. 1.472-8(e)(2)(iv), Income Tax Regs.   When

there is decrement, the current year’s LIFO ending inventory is

the beginning inventory reduced by the decrement.    See id.

     Once the total LIFO ending inventory is calculated, the

ending inventory figure is subtracted from the sum of the values

for beginning inventory and purchases during the year to produce

the COGS for the current year.   Fox Chevrolet, Inc. v.

Commissioner, supra at 722.

     B. Unauthorized Change in Method of Accounting

     Respondent determined that Investments made an unauthorized

change in method of accounting when it changed the definition of

its inventory units for its new car pool from model code10 to



10
     The parties have stipulated that vehicle "model code" is
synonymous with vehicle "body style". For the remainder of the
opinion, we will use model code to refer to both model code and
body style. Furthermore, the parties have stipulated that a
vehicle model code is a code given to each vehicle by the
manufacturer that differentiates the different body
configurations and interior styling packages of vehicles within
each model line (e.g., a two-door sports model, a four-door sedan
with standard interior, etc.).
                               - 19 -

body size in its inventory computations subsequent to Richardson

I.   In the alternative, respondent determined that Investments

made an unauthorized change in method of accounting when it

changed the definition of its inventory units for its new car

pool from body size to model line in taxable year 1981.

Petitioner asserts that Investments did not make an unauthorized

change in method of accounting in either instance.

     Section 446(e) provides that "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."11   The Internal Revenue Code does not define the

phrase “change in method of accounting”.    However, the

regulations under section 446(e) provide that 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.”      Sec.

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

to inventories, the regulations provide:

     A change in an overall plan or system of identifying or
     valuing items in inventory is a change in method of
     accounting. Also a change in the treatment of any material
     item used in the overall plan for identifying or valuing
     items in inventory is a change in method of accounting.
     [Sec. 1.446-1(e)(2)(ii)(c), Income Tax Regs.]




11
     Consent is requested by filing an application on Form 3115.
Sec. 1.446-1(e)(3)(i), Income Tax Regs.
                              - 20 -

The regulations define “material item” as “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.12

     The regulations also define certain situations in which a

change does not rise to the level of a change in method of

accounting.   Specifically, 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 * * *. 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. * * * A change in the method of accounting
     also does not include a change in treatment resulting from a
     change in underlying facts. * * *

     1. Unauthorized Change After Richardson I

     Respondent determined that Investments originally elected to

define its inventory units for its new car pool by model code but


12
     Sec. 472 and the regulations thereunder provide more
specific guidance on when a change in method occurs in the LIFO
method of accounting. Sec. 472(e) provides that a taxpayer may
not change from the LIFO method to another method of inventory
accounting without the consent of the Commissioner. With respect
to the dollar-value method of LIFO, the regulations provide that
a taxpayer may not change its pricing method, e.g., link-chain
method, without the consent of the Commissioner. Sec. 1.472-
8(e)(1), Income Tax Regs. In addition, the regulations provide
that any change in pooling used in computing LIFO inventories
requires the consent of the Commissioner. Sec. 1.472-8(g)(1),
Income Tax Regs. Here, respondent does not argue that
Investments changed its overall method of accounting for
inventory, i.e., the dollar-value LIFO method, nor does she argue
that Investments changed its overall pricing method or the number
of pools it utilized.
                              - 21 -

made an unauthorized change in method of accounting when it

changed the definition of such units to body size in its LIFO

inventory computations subsequent to Richardson I.     Petitioner

asserts that Investments elected to define its inventory units

for its new car pool by body size, and it consistently applied

the body size definition from the year of election through the

computations subsequent to Richardson I.     In the alternative,

petitioner asserts that respondent implicitly consented to a body

size definition of its inventory units.

     To determine the scope of a taxpayer’s LIFO election, we

examine the facts and circumstances of the case.     First Natl.

Bank v. Commissioner, 88 T.C. 1069, 1080 (1987).     In First Natl.

Bank, we addressed the issue of whether a taxpayer had elected to

include soil aggregate in its LIFO inventory.     After analyzing

the scope of the taxpayer’s business, the information provided on

its Form 970, its tax returns, and other business records, we

held that the taxpayer had elected to include the soil aggregate

in its LIFO inventory.   Id. at 1079-1080.    Petitioner has the

burden of proof on this issue.   Rule 142(a).

     There is some language in Richardson I which suggests that

Investments defined its inventory units by model code.

Richardson Invs., Inc. v. Commissioner, 76 T.C. at 739.     However,

as discussed more fully infra p. 36, this finding was not

material to the decision in that case.    Furthermore, Investments'

comptroller and Investments' C.P.A. both testified that
                              - 22 -

Investments never defined its inventory units for its new car

pool by model code.   The weight of the evidence in this case

suggests that Investments never defnied its inventory units for

its new car pool by model code, and we so find.

     2. Unauthorized Change in Taxable Year 1981

     Respondent determined that Investments made an unauthorized

change in the treatment of a material item when it changed the

definition of its inventory units for its new car pool from body

size to model line in taxable year 1981.    Petitioner asserts that

Investments’ change in definition of its inventory units was not

a change in the treatment of a material item used in its dollar-

value LIFO method of inventory accounting.13

     Petitioner initially argues that Investments did not change

the treatment of an item.   Essentially, petitioner argues that

the definition of the units used to compute beginning of the year

value of ending inventory did not serve to define its items of

inventory for dollar-value LIFO purposes.   Respondent disagrees.

     Under the dual-index, link-chain method, beginning of the

year value of ending inventory serves as the denominator in both

the annual deflator index computation and the layer-valuation


13
     Petitioner does not argue that Investments could change its
method of accounting without respondent's consent, as did the
taxpayers in Foley v. Commissioner,56 T.C. 765 (1971) and Silver
Queen Motel v. Commissioner, 55 T.C. 1101 (1971). In any event,
we would find these cases distinguishable, as Investments
regularly used a body size definition of item prior to 1981. Cf.
Foley v. Commissioner, supra at 769-770; Silver Queen Motel v.
Commissioner, supra at 1105; Convergent Technologies, Inc. v.
Commissioner, T.C. Memo. 1995-320.
                               - 23 -

index computation.    The annual deflator index and the layer-

valuation index are indexes of price change between the prior

year and the current year; therefore, the denominator of each

index, computationally, represents the aggregate of all items in

ending inventory at beginning of the year value.    When

Investments defined the units used to compute beginning of the

year value of ending inventory, it was in substance defining its

items of inventory.    Thus, when Investments changed the

definition of its inventory units from body size to model line,

it changed its definition of an item of inventory for purposes of

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

     Petitioner next argues that, even if the units used in the

computation are "items" for section 446 purposes, the change from

body size to model line was not a change in item for section

446(e) purposes, as such change was a permissible refinement or

delineation of Investments’ existing item definition.

     We have previously determined that new or separate items may

be created or arise in a taxpayer’s dollar-value LIFO pool.

Hamilton Indus., Inc. & Sub. v. Commissioner, 97 T.C. 120 (1991);

Amity Leather Prods. Co. v. Commissioner, 82 T.C. 726 (1984);

Wendle Ford Sales, Inc. v. Commissioner, 72 T.C. at 452.14    More



14
     These cases dealt with the double-extension method of
valuing the base-year cost of ending inventory. However, since
the double extension method and the link-chain method are both
concerned with valuing the taxpayer’s items in a pool, sec.
1.472-8(a), Income Tax Regs., the analysis in these cases is
relevant in the case at bar, even though Investments utilized the
link-chain method of pricing its items of inventory.
                              - 24 -

specifically, we have found that, if goods or products have

substantially dissimilar characteristics, whether in terms of

their physical nature, Wendle Ford Sales, Inc. v. Commissioner,

supra at 459, or whether in terms of cost, Amity Leather Prods.

Co. v. Commissioner, supra at 739-740, these goods or products

are properly treated as new or separate items.     Hamilton Indus.,

Inc. & Sub. v. Commissioner, supra at 136-137.15    Furthermore, a

reconstruction of base-year cost for a new or separate item will

not be treated as a change in method of accounting under section

446(e).   See Amity Leather Prods. Co. v. Commissioner, supra at

739-740; see also sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs.

     In analyzing whether a new or separate item was created or

arose in taxable year 1981, we note that petitioner does not

allege that the physical character or cost of Investments’ new

car inventory substantially changed between taxable years 1980

and 1981.   Furthermore, the record does not indicate that such a

change occurred.   Rather, it appears that Investments changed its

definition of its items of inventory without the predicate change

in facts required by the previously noted exception for the

creation of a new or separate item.    Accordingly, we hold that

Investments' change in definition of its items of inventory was

not due to the creation of a new or separate item.    Amity Leather


15
     To determine whether a new or separate item exists, we
examine the facts and circumstances of the case. Wendle Ford
Sales, Inc. v. Commissioner, 72 T.C. 447, 459 (1979).
                               - 25 -

Prods. Co. v. Commissioner, supra at 739-740; Wendle Ford Sales,

Inc. v. Commissioner, supra at 459.

     Petitioner next argues that, even if a change in the

treatment of an item is found to have occurred in taxable year

1981, the change does not rise to the level of a change in method

of accounting because such change was merely a change in

valuation.    In support of this argument, petitioner relies on the

regulatory exception for a change in underlying facts, section

1.446-1(e)(2)(ii)(b), Income Tax Regs, and the case of Baltimore

& O.R.R. v. United States, 221 Ct. Cl. 16, 603 F.2d 165 (1979).

In Baltimore & O.R.R., the court found that the taxpayer had not

changed its method of accounting by changing to a valuation

formula that more accurately estimated salvage value, finding

that such a change was merely a change in underlying fact.       Id.

at 168-169.

     The objective of inventory accounting is to value

inventories.    All-Steel Equip. Inc. v. Commissioner, 54 T.C.

1749, 1757 (1970), affd. in part and revd. in part 467 F.2d 1184

(7th Cir. 1972); see Fox Chevrolet, Inc. v. Commissioner, 76 T.C.

at 722.   Accordingly, any change in inventory accounting can be

characterized as a change in valuation.   Thus, under petitioner’s

argument, any change in inventory accounting could be

characterized as a change in underlying fact and, therefore, not

a change in method of accounting.   We reject petitioner’s
                              - 26 -

argument, as it is plainly at odds with section 446(e) and

section 1.446-1(e)(2)(ii)(c), Income Tax Regs.    Furthermore, the

case of Baltimore & O.R.R.. v. United States, supra, is

inapposite herein, because, unlike the case at bar, that case did

not involve an inventory accounting issue.    Pacific Enters. &

Subs. v. Commissioner, 101 T.C. 1, 21 (1993).

     Having found that Investments changed the treatment of an

item of inventory and that the change did not meet the exception

for a new or separate item, we now must examine whether the item

changed was “material”.   The regulations define “material item”

as “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 accord with the regulatory

definition of material item, we have previously found that the

essential characteristic of a material item is that it determines

the timing of income or deductions.    Hamilton Indus., Inc. & Sub.

v. Commissioner, supra at 126; Wayne Bolt & Nut Co. v.

Commissioner, 93 T.C. 500, 510 (1989); Primo Pants Co. v.

Commissioner, 78 T.C. at 722.16    Thus, we have held that a change

in the method of determining both beginning and ending inventory

16
     Although these cases deal with a change in method of
accounting for purposes of sec. 481, they are relevant to our
analysis herein because sec. 481 defers to sec. 446(e) for the
definition of change in method of accounting. Pacific Enters. &
Subs. v. Commissioner, 101 T.C. 1, 21 (1993); Primo Pants Co. v.
Commissioner, 78 T.C. 705, 721 (1982); sec. 1.481-1(a)(1), Income
Tax Regs.
                              - 27 -

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

constitutes a change in method of accounting.     Hamilton Indus.,

Inc. & Sub. v. Commissioner, supra at 126; Wayne Bolt & Nut Co.

v. Commissioner, supra at 511.

     Investments changed its definition of its items of inventory

for its new car pool from body size to model line in taxable year

1981.   This change caused Investments’ annual and cumulative

indexes to be lower than they would have been had Investments

continued using a body size definition of item.    For example, the

taxable year 1980 cumulative deflator index for the new car pool

under a body size definition of item would be 2.090204, while the

cumulative deflator index under a model line definition would be

1.970891.   Investments’ taxable year 1980 yearend new car

inventory at actual cost was $1,437,854.95.    Accordingly, under a

body size definition of item, Investments’ taxable year 1980

ending inventory for new cars at base-year cost would be

$687,889.88; in contrast, under a model line definition of item,

its ending inventory at base-year cost would be $729,545.65

(1,437,854.95/2.090204 and 1,437,854.95/1.970891, respectively).

     Since the annual and cumulative indexes would be lower under

the model line definition of item, Investments’ ending inventory

at base-year cost would be higher.     Although a higher base-year

cost of ending inventory will generally produce higher taxable

income, i.e., COGS will be lower, taxpayers may, nevertheless,

desire a higher base-year cost of ending inventory in a given
                               - 28 -

year to avoid liquidating a LIFO layer, causing a match of

historical costs against current revenues.    Thus, depending on a

taxpayer’s particular set of facts and circumstances, it may be

advantageous to have a lower annual deflator index.

     When Investments changed its definition of its items of

inventory, which resulted in lower annual and cumulative indexes

and, therefore, affected the computation of beginning and ending

inventory, the change was a change in the treatment of a material

item.   Hamilton Indus., Inc. & Sub. v. Commissioner, 97 T.C. at

126; Wayne Bolt & Nut Co. v. Commissioner, supra at 510; Primo

Pants Co. v. Commissioner, supra at 722.     After changing its

definition of items for its new car pool from body size to model

line in taxable year 1981, Investments did not file a Form 3115,

Application for Change in Accounting Method, or otherwise request

respondent’s consent to change its LIFO inventory valuation

method.17   Therefore, we hold that Investments changed its method

of accounting without respondent’s consent.18


17
     The purpose of the sec. 446(e) consent requirement is to
enable the Commissioner to prevent distortions of income that
often accompany changes in accounting methods by withholding her
consent until the taxpayer agrees to adjustments that will
prevent duplications or omissions of items of income and expense.
Advertisers Exch., Inc. v. Commissioner, 25 T.C. 1086, 1093
(1956), affd. 240 F.2d 958 (2d Cir. 1957); see sec. 481(a).
18
     Respondent also determined that Investments changed its
method of accounting when it changed the definition of its items
of inventory for its new truck pool. At trial and on brief,
petitioner argued that the change from body size to model line in
Investments' new car pool was not a change in method of
accounting. However, petitioner did not specifically address the
change in method of accounting issue with respect to Investments'
                                                   (continued...)
                               - 29 -

     C. Review of Determinations Made Under Section 446(b)

     1. Clear Reflection

     Even though a taxpayer is restricted from changing its

method of accounting without the Commissioner's consent, the

Commissioner can change the taxpayer's method when the existing

method does not clearly reflect income.   Sec. 446(b).   Respondent

determined that Investments’ method of accounting for its new car

and new truck inventories did not clearly reflect income.

Petitioner asserts that Investments’ method of accounting for its

new car and new truck inventories did clearly reflect income.

     Inventory accounting is governed by sections 446 and 471.

Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 531 (1979).

Sections 446 and 471 vest the Commissioner with wide discretion

in matters of inventory accounting and give her wide latitude to

adjust a taxpayer’s method of accounting for inventory so as to

clearly reflect income.    Id. at 532; Hamilton Indus., Inc. & Sub.

v. Commissioner, supra at 128.   Accordingly, the Commissioner's

determination with respect to clear reflection of income is

entitled to more than the usual presumption of correctness, and

the taxpayer bears a heavy burden of overcoming a determination

that a method of accounting does not clearly reflect income.

Hamilton Indus, Inc. & Sub. v. Commissioner, supra at 128; Rotolo

v. Commissioner, 88 T.C. 1500, 1513-1514 (1987).   However, if a



18
 (...continued)
new truck pool; accordingly, we find that petitioner conceded
this issue.
                              - 30 -

taxpayer establishes that a method of accounting clearly reflects

income, the Commissioner may not disturb the taxpayer's choice.

Ansley-Sheppard-Burgess Co. v. Commissioner, 104 T.C. 367, 371

(1995); RLC Indus. Co. v. Commissioner, 98 T.C. 457, 491 (1992),

affd. 58 F.3d 413 (9th Cir. 1995).     Whether a taxpayer’s method

of accounting clearly reflects income is a question of fact, and

the issue must be decided on a case-by-case basis.     Ansley-

Sheppard-Burgess Co. v. Commissioner, supra at 371; RLC Indus.

Co. v. Commissioner, supra at 492; Hamilton Indus., Inc. & Sub.

v. Commissioner, supra at 128.

     Section 446(a) requires a taxpayer to compute taxable income

under the method of accounting it regularly uses in keeping its

books.   Section 446(b), however, provides:

     If no method of accounting has been regularly used by the
     taxpayer, or if the method used 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.

The Commissioner's authority under section 446(b) reaches not

only overall methods of accounting but also a taxpayer's method

of accounting for specific items of income and expense.     Ford

Motor Co. v. Commissioner, 102 T.C. 87, 100 (1994), affd. 71 F.3d

209 (6th Cir. 1995); Prabel v. Commissioner, 91 T.C. 1101, 1112

(1988), affd. 882 F.2d 820 (3d Cir. 1989); sec. 1.446-1(a),

Income Tax Regs.

     In regard to inventory accounting, the regulations

establish two distinct tests to which an inventory must conform:
                              - 31 -

          (1) It must conform as nearly as may be to the best
     accounting practice in the trade or business, and

          (2) It must clearly reflect the income. [Sec. 1.471-
     2(a), Income Tax Regs.]

Furthermore, the regulations provide that, in order to clearly

reflect income:

     the inventory practice of a taxpayer should be consistent
     from year to year, and greater weight is to be given to
     consistency than to any particular method of inventorying or
     basis of valuation * * * [Sec. 1.471-2(b), Income Tax Regs.]

In addition, the regulations addressing dollar-value LIFO

provide:

     Any taxpayer may elect to determine the cost of his LIFO
     inventories under the so-called “dollar-value” LIFO method,
     provided such method is used consistently and clearly
     reflects the income of the taxpayer * * * [Sec. 1.472-8(a),
     Income Tax Regs.]

     The foregoing regulations unequivocally indicate that

consistent application of a method of accounting is necessary for

the method to clearly reflect income.   Sec. 446(b); secs. 1.471-

2(b), 1.472-8(a), Income Tax Regs. Accordingly, if a method of

inventory accounting is not consistently applied, this fact alone

may cause the method not to clearly reflect income.   Our case law

has also recognized the significance of the consistency

requirement when examining whether a method of accounting clearly

reflects income.   Fort Howard Paper Co. v. Commissioner, 49 T.C.

275, 284 (1967); Photo-Sonics, Inc. v. Commissioner, 42 T.C. 926,

935 (1964), affd. 357 F.2d 656 (9th Cir. 1966); Klein Chocolate

Co. v. Commissioner, 36 T.C. 142, 146 (1961), supplementing 32
                             - 32 -

T.C. 437 (1959); Advertisers Exch., Inc. v. Commissioner, 25 T.C.

1086, 1092 (1956), affd. 240 F.2d 958 (2d Cir. 1957).

     Investments defined its items of inventory for its new car

pool by body size for taxable years 1974 through 1980.    Despite

this general body size definition of item, Investments treated

the Escort model line as a separate item for taxable year 1980.

This treatment of the Escort model line was inconsistent with its

method of defining its items of inventory.   Subsequently, in

taxable year 1981, Investments began defining its items of

inventory for its new car pool by model line.   This definition of

its items of inventory for its new car pool was inconsistent with

its existing method of defining its items of inventory.   In its

new truck pool, Investments variously defined its items of

inventory by body type (i.e., all vans as one item), load

carrying ability, body size, and model line.    Each change in the

definition of its items of inventory for its new truck pool

represented an inconsistent application of its method of defining

its items of inventory.

     Investments’ inconsistent definition of its items of

inventory for both its new car and new truck LIFO pools strikes

at the heart of the requirement that a taxpayer’s inventory

accounting must clearly reflect income.   Investments’

inconsistent definition of its items of inventory violates the

clear reflection rules of the Code, sec. 446(b), the regulations,

secs. 1.471-2(b) and 1.472-8(a), Income Tax Regs., and our case
                                - 33 -

law, e.g., Fort Howard Paper Co. v. Commissioner, supra at 284.

Investments’ inventory practice was inconsistent from year to

year, and therefore its method of inventory accounting does not

clearly reflect income.19

     2. Abuse of Discretion

     Respondent determined that Investments should define its

items of inventory for both its new car and new truck pools by

model code.    Petitioner asserts that such a determination was an

abuse of discretion.

     Once the Commissioner determines that a taxpayer's method

does not clearly reflect income, she may select for the taxpayer

a method which, in her opinion, does clearly reflect income.

Sec. 446(b); Hamilton Indus., Inc. & Sub. v. Commissioner, 97

T.C. at 129.   The taxpayer has the burden of showing that the

method selected by the Commissioner is incorrect, and that burden

is extremely difficult to carry.     Photo-Sonics, Inc. v.

Commissioner, supra at 933.     Accordingly, the Commissioner’s

determination will not be set aside unless shown to be clearly

unlawful or plainly arbitrary.     Thor Power Tool Co. v.

Commissioner, 439 U.S. at 532; Hamilton Indus., Inc. & Sub. v.

Commissioner, supra at 129;     Richardson Invs., Inc. v.

Commissioner, 76 T.C. at 745.



19
     Respondent made alternative arguments as to why Investments'
method of defining its items of inventory did not clearly reflect
income. Having disposed of the clear reflection issue, we need
not address these alternative arguments.
                                - 34 -

     The Code and the regulations do not define the term “item”.

Amity Leather Prods. Co. v. Commissioner, 82 T.C. at 739-740;

Wendle Ford Sales, Inc. v. Commissioner, 72 T.C. at 455.

However, we have previously addressed the definition of the term

for purposes of the dollar-value LIFO method.    See Hamilton

Indus., Inc. & Sub. v. Commissioner, supra; Amity Leather Prods.

Co. v. Commissioner, supra; Wendle Ford Sales, Inc. v.

Commissioner, supra.20

     In our prior cases, we have found that the proper definition

of an item for dollar-value LIFO purposes depends on the specific

facts and circumstances of the case.     Wendle Ford Sales, Inc. v.

Commissioner, supra at 459, 461.     Furthermore, we have found that

we must examine the facts and circumstances of the case in light

of the objectives of the dollar-value LIFO method.    See Hamilton

Indus., Inc. & Sub. v. Commissioner, supra at 135-136; Amity

Leather Prods. Co. v. Commissioner, supra at 733-734; Wendle Ford

Sales, Inc. v. Commissioner, supra at 458-459.

     A major objective of the LIFO method is to eliminate from

earnings any artificial profits resulting from inflationary

increases in inventory costs.     Amity Leather Prods. Co. v.

Commissioner, supra at 732.     Consequently, the dollar-value

method is designed to ensure that any increase in the cost of

property passing through the inventory during the year is

reflected in the cost of goods sold.     Hamilton Indus., Inc. &


20
     See supra note 14.
                               - 35 -

Sub. v. Commissioner, supra at 132.     To properly reflect

increases attributable to inflation, we have noted that the goods

contained in a taxpayer’s item categories must have similar

characteristics, because a “system which groups like goods

together and separates dissimilar goods permits cost increases

attributable to inflation to be isolated and accurately

measured.”    Id. (fn. ref. omitted).   Therefore, we have found

that a “narrower definition of an item within a pool will

generally lead to a more accurate measure of inflation (i.e.,

price index) and thereby lead to a clearer reflection of income.”

Amity Leather Prods. Co. v. Commissioner, supra at 734.

       We have articulated another objective of dollar-value LIFO

and a related consideration in determining the proper definition

of an item.    We have noted that the dollar-value LIFO method does

not require the matching of specific goods in opening and closing

inventories, but focuses on the total dollars invested in

inventory.    Wendle Ford Sales, Inc. v. Commissioner, supra at

458.    Accordingly, minor modifications to an item should not

cause the item to be treated as new or separate.     Id. at 459.

“This freedom from having to take into account minor

technological changes in a product represents a major objective

of the dollar-value approach.”    Id. at 458.   Thus, we have

cautioned that the definition of an item of inventory must not be

so narrow as to impose unreasonable administrative burdens upon a

taxpayer, thus rendering impractical the taxpayer’s use of the
                                - 36 -

dollar-value LIFO method of inventory valuation.      Amity Leather

Prods. Co. v. Commissioner, supra at 734.

       Petitioner asserts that in Richardson I we rejected the

Commissioner's determination that Investments should define its

items by model line.    Accordingly, petitioner argues that

respondent’s determination in this case is an abuse of

discretion, as he argues that we have already rejected a model

line definition of item, which is less restrictive than a model

code definition of item.

       We disagree with petitioner’s reading of Richardson I.    In

Richardson Invs., Inc. v. Commissioner, 76 T.C. 736 (1981), the

primary issue was whether Investments “properly adopted the use

of a single LIFO inventory pool in computing inventory values

pursuant to the dollar-value, link-chain LIFO method”.      Id. at

737.    Respondent’s alternative argument in Richardson I was that

Investments “must compute a separate yearly index for each item

of a pool, which indexes will, in aggregate, represent the yearly

index for the pool.”     Id. at 749.   Rejecting this argument, the

Court found that “as long as petitioner selects a representative

portion of the inventory in a particular pool to compute an index

for the pool under the link-chain method, the computation will be

valid.”    Id.   Thus, we did not address the proper scope of an

item, i.e., whether items of inventory should be defined by model

line; rather, we merely indicated that the taxpayer could use a
                                - 37 -

combination of the link-chain method and the index method to

price its LIFO inventories.21

     Petitioner next argues that respondent’s proposed definition

of item is so narrow as to effectively require Investments to use

the specific goods LIFO method.    We disagree with petitioner’s

assertion.   Requiring Investments to use a model code definition

of item is not tantamount to placing Investments on the specific

goods method of LIFO, as the model code definition of an item

does not require Investments to match specific goods in opening

and closing inventory.   Simply put, even though the definition of

an item is narrower, Investments is still free to use the dollar-

value LIFO method.

     Finally, petitioner argues that the model code definition of

an item is too narrow, and that respondent abused her discretion

by requiring Investments to use that definition.      Petitioner does

not specify why the model code definition of an item is too

narrow, and we have previously found that a narrower definition

of an item more clearly reflects income.       Amity Leather Prods.

Co. v. Commissioner, supra at 734.       Furthermore, since petitioner

has stipulated that Investments has all of the data necessary to

implement a model code definition of an item, petitioner cannot



21
     We note that, in this case, the parties have stipulated that
Investments has never double extended a representative portion of
its new car and new truck inventory, but has always double
extended its entire inventory.
                              - 38 -

argue that the model code definition would be administratively

burdensome to implement.

     Based on the foregoing, petitioner has failed to demonstrate

that the method selected by respondent was clearly unlawful or

plainly arbitrary; therefore, we hold that respondent’s

determination must be upheld, and Investments must utilize a

model code definition of an item.22    Thor Power Tool Co. v.

Commissioner, 439 U.S. at 532; Hamilton Indus. v. Commissioner,

97 T.C. at 129.

Airplane Expenses

     Respondent disallowed the deductions arising from

Investments' operation of the airplane to the extent that such

deductions exceeded the airplane rental fees it received.

Respondent based her determination on alternative arguments;

specifically, respondent argued that the excess expenses were (1)

incurred primarily for the benefit of petitioner, (2) not

ordinary and necessary, or (3) unreasonable in amount.

Petitioner asserts that the excess expenditures are allowable.

     Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving that he is entitled to the


22
     Respondent’s determination effects a change in Investments’
method of accounting; accordingly, respondent may make a sec. 481
adjustment. Weiss v. Commissioner, 395 F.2d 500, 502 (10th Cir.
1968) (sec. 481 adjustment applies to subch. S shareholders),
affg. T.C. Memo. 1967-125; Hamilton Indus., Inc. & Sub. v.
Commissioner, 97 T.C. 120, 127-128 (1991). The parties may
include this adjustment in their Rule 155 computations.
                              - 39 -

deductions claimed.   Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992).

     Section 162(a) allows a taxpayer to deduct ordinary and

necessary expenses paid or incurred in carrying on a trade or

business.   If a corporation owns and maintains property primarily

for the benefit of a shareholder, the deductions arising from

such property will not be allowable, as such deductions are not

incurred in carrying on a trade or business.   International

Trading Co. v. Commissioner, 275 F.2d 578, 584, 585 (7th Cir.

1960), affg. T.C. Memo. 1958-104; Cirelli v. Commissioner, 82

T.C. 335, 350 (1984); International Artists, Ltd. v.

Commissioner, 55 T.C. 94, 104 (1970); Challenge Manufacturing Co.

v. Commissioner, 37 T.C. 650, 659-661 (1962); see A.E. Staley

Manufacturing Co. v. Commissioner, 105 T.C. 166, 191 (1995).     In

contrast,

     where the acquisition and maintenance of property such as an
     automobile or residence is primarily associated with profit-
     motivated purposes, and personal use can be said to be
     distinctly secondary and incidental, a deduction for
     maintenance expenses and depreciation will be permitted.
     [International Artists, Ltd. v. Commissioner, supra at 104.]

Furthermore, if substantial business and personal motives exist,

allocation of the expenditures becomes necessary.   Id. at 105;

see also International Trading Co. v. Commissioner, supra at 587;

Gibson Prods. Co. v. Commissioner, 8 T.C. 654, 660 (1947).

     In addition to the requirement that deductions be incurred

in the conduct of a trade or business, section 162(a) provides
                               - 40 -

that a deduction will be allowable only if it is “ordinary and

necessary”.    An “ordinary” expense is one that is normal or

common in the particular trade or business.    Palo Alto Town &

Country Village, Inc. v. Commissioner, 565 F.2d 1388, 1390 (9th

Cir. 1977), remanding    T.C. Memo. 1973-223; Noyce v.

Commissioner, 97 T.C. 670, 685 (1991).    “An expense is necessary

if it is appropriate and helpful in carrying on the trade or

business.”    Noyce v. Commissioner, supra at 685; see also Palo

Alto Town & Country Village, Inc. v. Commissioner, supra at 1390.

Finally, for an expense to be considered ordinary and necessary,

it must also be reasonable in amount in relation to its purpose.

Noyce v. Commissioner, supra at 687; Sherman v. Commissioner,

T.C. Memo. 1982-582; Harbor Medical Corp. v. Commissioner, T.C.

Memo. 1979-291, affd. without published opinion 676 F.2d 710 (9th

Cir. 1982).    We examine the facts and circumstances of the

particular case to determine whether an expense is ordinary and

necessary.    Palo Alto Town & Country Village, Inc. v.

Commissioner, supra at 1390; Noyce v. Commissioner, supra at 686-

688.

       Respondent first argues that the airplane expenditures were

incurred primarily for the personal benefit of petitioner.

Respondent does not premise this argument on petitioner’s

concededly personal use of the airplane, which accounted for 3

percent and 9 percent of the total use of the airplane for 1988

and 1989, as petitioner paid the actual cost associated with such
                               - 41 -

secondary and incidental use of the airplane.    Rather, respondent

focuses on petitioner’s relationship with the other entities and

the use of the airplane in providing management services to those

entities.

     During the taxable years at issue, the airplane was used to

transport Investments’ employees to six of the other entities so

that the employees could provide management services.    Since

petitioner had an ownership interest in five of these six

entities, respondent argues that the airplane was used primarily

to benefit petitioner as an owner of these entities, not to

benefit Investments.    Basically, respondent argues that the

airplane was used to improve the value of the other entities by

making Investments’ employees available for management

consultations.    It is true that the airplane facilitated the

availability of Investments’ employees to the other entities.

Accordingly, assuming the management services were beneficial to

the other entities, it is true that the expenses of the airplane

benefited petitioner, since he had an ownership interest in all

but one of the other entities serviced during the taxable years

at issue.   Nonetheless, we find this was an incidental benefit of

the acquisition and maintenance of the airplane.

     We find that Investments owned and maintained the airplane

primarily for the benefit of its business-related activities,

including its management services activity and its Rich Ford

Sales activity.    Investments charged substantial fees for its
                              - 42 -

management services during the years at issue; in addition, when

the airplane was used in the conduct of the management services

activity, Investments received reimbursements for some of the

actual costs associated with the maintenance of the airplane.

Overall, 56 percent and 77 percent of the airplane's total flight

time during taxable years 1988 and 1989, respectively, was

associated with providing management services.    In addition, 11

percent of the airplane’s total flight time for taxable year 1988

was for the benefit of Rich Ford Sales.   In contrast to this

substantial business-related use, petitioner’s actual use of the

airplane was minor, and he paid for such use.    Accordingly, we

reject respondent’s argument that the airplane was maintained

primarily for the benefit of petitioner, and we hold that the

airplane was owned and maintained primarily for the benefit of

Investments' business activities.

     Respondent next argues that the airplane expenditures were

not allowable because they were not ordinary and necessary.     Each

of the other entities was a substantial distance from

Albuquerque, New Mexico.   By maintaining an airplane, Investments

could provide the other entities with management, accounting, and

legal support within a short time period.   In addition, the

airplane enabled Investments’ employees to visit more than one of

the other entities in a single day, and it allowed the employees

to visit one of the other entities for part of the day and return

to Investments’ home office for the remainder of the day.    Based
                              - 43 -

on the location of the other entities, the service provided the

other entities, and Investments' conduct of a management

consulting service, we find that Investments’ maintenance of an

airplane was an ordinary expense.   See Palo Alto Town & Country

Village, Inc. v. Commissioner, supra at 1390; Harbor Medical

Corp. v. Commissioner, T.C. Memo. 1979-291.   Next, we must

examine whether the expense of maintaining the airplane was

necessary.

     The airplane was used by Investments in the conduct of both

Rich Ford Sales and in the provision of management services.    Use

of the airplane in either activity produced time and cost

savings.   The airplane produced time savings in that it allowed

Investments’ employees to travel when necessary, not when

commercial flights were available; furthermore, the airplane

allowed Investments’ employees to visit more than one location in

a single day, which often could not be accomplished on a

commercial schedule.   The airplane also saved other travel

expenses, as traveling in 1 day, instead of 2 or more days as

would be required via commercial airlines, saved room and board

expenditures.   The airplane also allowed Investments to quickly

respond to emergency situations arising in either the Rich Ford

Sales business or in the management services activity.   Based on

the foregoing facts and circumstances, we find that the ownership

and maintenance of the airplane were both appropriate and helpful
                                - 44 -

to Investments; accordingly, we find the expenditures arising

from the ownership and maintenance of the plane were necessary.

     Finally, respondent argues that the airplane expenditures

were unreasonable in amount compared to the objectives to be

accomplished.   Investments’ total costs of owning, operating, and

maintaining its airplane, exclusive of pilot salary, during 1988

and 1989 were $218,452.14 and $142,427.85, respectively.

However, as noted above, we have found that the airplane was both

an ordinary and necessary expense of the operation of

Investments’ Rich Ford Sales division and the operation of its

management services activity.    The latter activity alone

generated management fees of $814,452 and $970,997 for taxable

years 1988 and 1989, respectively.       In addition, Investments

received reimbursements for airplane expenditures of $48,048.50

and $37,674, exclusive of meals, lodging, etc., for 1988 and

1989, respectively.   Although the airplane expenditures were

large for the taxable years at issue, use of the airplane was an

ordinary and necessary part of Investments' businesses and

generated substantial income during the years at issue.

Accordingly, we find that the expenditures associated with owning

and maintaining the airplane for the years at issue were

reasonable.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
