                        T.C. Memo. 1998-98



                      UNITED STATES TAX COURT



          BUYERS HOME WARRANTY COMPANY, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24774-95.              Filed March 9, 1998.



     William L. Feinstein, for petitioner.

     Mark A. Weiner, for respondent.



                        MEMORANDUM OPINION

     RAUM, Judge:   The Commissioner determined a $356,179

deficiency in petitioner's 1990 Federal income taxes.    The

Commissioner determined that petitioner's method of accounting

did not accurately reflect petitioner's income.   The notice of

deficiency changed the method of accounting and implemented a
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corresponding adjustment under section 481.1   At issue is whether

the year of change, the first year the new accounting method is

applied, is the first open year, 1990, or the year in which the

IRS initiated the audit, 1993.    This case was submitted on the

basis of a stipulation of facts.

     Petitioner is a California corporation with its principal

office in Burbank, California.    Petitioner operates under a

license granted by the California State Department of Insurance.

It sold its first contract on January 12, 1988.

     Petitioner sells home warranty contracts to buyers and

sellers of previously owned residential property.    Under the

terms of the basic home warranty contract, petitioner agrees to

repair or replace appliances and covered systems (such as heating

systems) that become inoperative during the term of the contract.

Customers can buy additional coverage for other appliances and

systems not covered by the basic coverage for additional

consideration.

     The home warranty contracts commence with the close of

escrow and are in effect for 1 year, except for mobile home

contracts which are in effect for 6 months.    A homeowner can

renew the contract upon its expiration, but only if petitioner

agrees.   Approximately 10 percent of the contracts are renewed.


     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
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The contracts are noncancellable and nonrefundable, but can be

transferred to a subsequent buyer if within the contract period

and petitioner is notified.    The home warranty contracts do not

cover damage from certain events such as fire, flood, storm,

neglect or other acts of God.    They are intended to insure

against inoperation from normal wear and tear.

     Petitioner does not directly repair or replace any failed

appliance or covered system.    Rather, petitioner has contracted

with a network of independent contractors and technicians to make

the repairs.

     Petitioner reported as income 1/12 of the income received

for each month a contract was in effect during a taxable year.

It also incorporated a half-month convention for the month in

which the contract was sold.    For example, if a 1-year contract

was sold in July of year 1 for $240, $10 would be recognized as

income for July and $20 would be recognized for each month from

August through December of year 1.       Thus, from the $240 received

by petitioner in year 1, it would report $110 ($10 + $20 x 5).

The remaining $130 would be deferred until year 2.      In year 2,

petitioner would recognize $20 for each month from January

through June and $10 for July.    ($20 x 6 + $10 = $130)    A similar

method was used for the 6-month mobile home contracts.

     In addition to the above, petitioner deducted as an "other

deduction," an amount of 20 percent of the premiums it
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recognized.   (Except for 1988, when it deducted 20 percent of the

entire amount of contracts written in 1988.)    It described this

deduction as "provisions for reserves."    Thus, continuing the

example used above, when it recognized $110 in year 1, petitioner

would take a deduction of $22 in year 1 ($110 x .2) and called

this deduction a "provision for reserve."    In year 2, petitioner

would recognize as income the "provision for reserve" deduction

from the prior year.   Thus, in year 1, petitioner effectively

reported $88 ($110 - $22).    In year 2, petitioner reported $152

($130 + $22).

     Respondent commenced an examination of petitioner's 1990 and

1991 returns in March 1993.   (Later during the examination 1992

was included.)   Prior to the commencement of the examination,

petitioner made no application to respondent with respect to

changing its method of accounting for its income and deductions.

During respondent's examination of petitioner, the issue arose as

to whether the home warranty contracts constitute insurance

contracts for purposes of section 832.    To resolve that issue,

the parties participated in obtaining technical advice from

respondent's national office.   This process of obtaining

technical advice was initiated by respondent's revenue agent by

means of a memorandum (Form 4463, Request for Technical Advice

From Associate Chief Counsels (Technical) and (International))

dated June 17, 1993.   Petitioner participated in the technical
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advice process and advocated that the contracts it sold were

insurance contracts.   Respondent's revenue agent took the

position that the contracts were something other than insurance

contracts.    On December 10, 1993, respondent issued a Technical

Advice Memorandum concluding that the home warranty contracts are

insurance contracts for purposes of section 832.   At no time

during the examination did petitioner submit a Form 3115,

requesting a change in method of accounting, although in 1994

petitioner requested of respondent's Appeals Office that

petitioner be treated as if it had requested a change in method

of accounting.2

     The parties have since stipulated that the home warranty

contracts described above are insurance contracts; petitioner is

an "insurance company other than a life insurance company" as

described in section 831; and the revenue generated from the

insurance contracts is "gross income" as defined in section

832(b)(1) and (3).   Petitioner reported its income and deductions

from the sale of its insurance contracts using what it believed

to be a GAAP (Generally Accepted Accounting Principles) method of

accounting.   The method of accounting used by petitioner for

     2
       In its briefs, petitioner consistently maintains that the
year of change should be 1993. Petitioner argues that in 1993 it
requested of the Appeals Office that it be treated as if it had
requested a change in accounting method. However, the
stipulation of facts states that petitioner made the request of
the Appeals Office in 1994. Since petitioner uses 1993 in its
brief, we use that year henceforth in this opinion.
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taxable years 1988 through 1992 was not in accordance with

section 832(b)(4).

     The notice of deficiency made various adjustments to

petitioner's income and "provision for reserves" deductions so as

to put petitioner on the method of accounting prescribed by

section 832(b)(4).   The notice of deficiency made these changes

by determining a deficiency in the first open year, 1990.    The

notice of deficiency does not take into account any net operating

losses which may have been generated by the 1993 taxable year.

The only remaining issue for consideration is which year, 1990 or

1993, is the year of change.3

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

income using the method of accounting he uses to calculate his

income in keeping his books.    Section 446(b) provides that "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."    When the

taxpayer's accounting method is changed, section 481(a) requires

that adjustments be made to the taxpayer's income "to prevent

amounts from being duplicated or omitted".




     3
       The stipulation of facts states that petitioner does not
agree that respondent properly applied sec. 481(b). Petitioner
does not argue that point on brief. Therefore, we treat
petitioner as having conceded the issue.
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     The adjustments made to implement the new accounting method

are applied in the "year of change", defined by section 1.481-

1(a)(1), Income Tax Regs, as "the taxable year for which the

taxable income of the taxpayer is computed under a method of

accounting different from that used for the preceding taxable

year."   Neither section 481 nor the accompanying regulations

explain how the year of change is chosen.     When the taxpayer

requests a change in accounting method, the IRS uses Rev. Proc.

92-20, 1992-1 C.B. 685, to determine the year of change.       When

the taxpayer makes no request, the changes required by

examination are applied by default to the earliest open year for

which the limitations period has not expired.

     Here, the year of change is the earliest open year.

Petitioner has stipulated that before the examination began,

petitioner made no application to the IRS with respect to

changing its method of accounting.     At no time during the

examination did petitioner submit a Form 3115, formally

requesting to change its accounting method.     Since petitioner did

not initiate a change in its accounting method, Rev. Proc. 92-20,

supra, does not apply.   The IRS was free to apply the accounting

method changes to the earliest open year under examination.

Consequently, the year of change is 1990.

     Petitioner's sole contention is that the year of change

should be 1993 instead of 1990.   Petitioner makes two main
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arguments.    First, petitioner asserts that it was not "required"

to change its accounting method pursuant to section 1.481-

1(c)(5), Income Tax Regs.    Second, petitioner alleges that Rev.

Proc. 92-20, 1992-1 C.B. 685, violates equal protection.

     Section 1.481-1(c)(5), Income Tax Regs., provides that "A

change in the taxpayer's method of accounting required as a

result of an examination of the taxpayer's income tax return will

not be considered as initiated by the taxpayer."    (Emphasis

supplied.)    Both the regulations and Rev. Proc. 92-20, supra,

differentiate between accounting method changes initiated by the

taxpayer and those initiated by the Commissioner.    The year of

change is more favorable if the change is initiated by the

taxpayer.

     Petitioner asserts the following:    During the audit, the IRS

suggested petitioner be treated as a warranty company.    In

response, petitioner proposed, as a compromise, that it be

treated as an insurance company.    According to petitioner, that

compromise was accepted by respondent via the technical advice

memorandum.    Because it was a "compromise", petitioner argues

that "there was no requirement that petitioner change accounting

methods."    Petitioner's Opening Brief, p. 9.

     Despite the spin petitioner attempts to place on events,

nothing in the record indicates that petitioner initiated any of

the events relating to its change of accounting method.    The
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stipulation of facts states that petitioner advocated that it was

an insurance company.   There is nothing to support its contention

that it "proposed a compromise".   After the examination ended,

the Commissioner issued a notice of deficiency.    In its

Explanation of Adjustments, the notice of deficiency states:

"it is required that the taxpayer change the accounting methods

previously employed to methods permitted or required under the

provisions of the Code."   (Emphasis supplied.)   Petitioner was

required to submit to the audit, and it was required by the

notice of deficiency to change its accounting method.

Petitioner's situation falls squarely within the second sentence

of section 1.481-1(c)(5), Income Tax Regs.   Petitioner's

accounting method change was "required as a result of an

examination of the taxpayer's income tax return".

     Petitioner also contends that Rev. Proc. 92-20, supra,

violates equal protection.   The revenue procedure provides that

the year of change depends on whether and when a taxpayer

requests a change of accounting method.   Petitioner argues that

equal protection has been violated in its case because there were

no cases or other rulings that indicated that petitioner's

original method of accounting was erroneous.   Petitioner attempts

to bolster its argument by pointing out that the IRS agent who

proposed that the warranty method be used was overruled by the

national office.   According to petitioner, the fact that the
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national office did not concur with the field agent means

petitioner had no reason to presume its method was incorrect.

     Petitioner's argument is fundamentally flawed.   First, even

if one method advocated by the IRS was not adopted, it does not

follow that petitioner's existing method was correct.    Section

1.446-1(a)(2), Income Tax Regs., acknowledges that the same

method of accounting cannot be used by all taxpayers.    It is

required that the method chosen clearly reflect income.    In

petitioner's case, it agreed that it was an insurance company.

Thus, it is required by statute to use the method of accounting

prescribed by section 832.

     Second, petitioner injects a subjective element into the

Code that does not exist.    There is nothing in the statute or

regulations concerning what to do if the taxpayer thought,

incorrectly, that the method used clearly reflected income.      The

IRS is concerned with collecting the correct amount of revenue.

Nowhere in the applicable provisions of the Code does the

taxpayer get credit if it thought it correctly calculated income.

If the taxpayer acts in good faith, but is incorrect, it owes the

deficiency.   If it is willfully or negligently incorrect, it may

also owe penalties and additions to tax.    Petitioner here owes

only the deficiency.

     The purpose of Rev. Proc. 92-20, 1992-1 C.B. 685, is to

"encourage prompt voluntary compliance" and correct the
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deficiency of Rev. Proc. 84-74, 1984-2 C.B. 736.    That revenue

procedure had been used by a number of taxpayers to request a

change in a later year and on better terms than those contained

in the statute.   In other words, a taxpayer, even if aware that

its accounting method did not clearly reflect income, could apply

for a method change, and, in doing so, receive better terms than

if the IRS had mandated the change.    Rev. Proc. 92-20, 1992-1

C.B. at 688.

     Petitioner has stipulated that it should be following the

method of accounting described in section 832.    Petitioner

further stipulated that its method of accounting was not in

accordance with section 832(b)(4).     As a result, its method did

not clearly reflect income.   However, if petitioner is allowed to

use 1993 as the year of change, it will be allowed to knowingly

use an incorrect method for 3 years.    This is the situation Rev.

Proc. 92-20, supra, was implemented to prevent.

     Petitioner alludes to various sections of the revenue

procedure to bolster its claim that its year of change should be

1993.   These sections do not apply to petitioner for the simple

reason that petitioner was under examination.

     The Commissioner is given broad authority to determine

whether a taxpayer's accounting method clearly reflects income.

That determination "is not to be set aside unless it is shown to

be plainly arbitrary or an abuse of discretion."     Gustafson v.
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Commissioner, T.C. Memo. 1988-82.     Petitioner has failed to

demonstrate an abuse of discretion.

                                           Decision will be entered

                                      for respondent.
